1996

The Parliament of the Commonwealth of Australia

HOUSE OF REPRESENTATIVES

Taxation Laws amendment bill (No. 3) 1996

Explanatory Memorandum

(Circulated by authority of the
Treasurer, the Hon Peter Costello, MP)

79298 Cat. No. 96 5314 7 ISBN 0644 482907

General outline and financial impact	1
Chapter
1	Tax rebate for low income aged persons	9
2	Rebatable annuities	15
3	Medical expenses rebate	21
4	Sale of mining rights	23
5	Equity investments in small-medium enterprises	27
6	Co-operative companies	31
7	Tax exempt entities that become taxable	35
8	Infrastructure borrowings - amendment of the Development 
	Allowance Authority Act 1992	63
9	Research and development activities	71

Index	95

AMENDMENT OF THE INCOME TAX ASSESSMENT ACT 1936
Tax rebate for low income aged persons
Inserts two new sections to provide an income tax rebate for persons who are: 
	of age pension age; and
	not in receipt of the age pension; and
	considered to be residents for age pension purposes; and
	in receipt of taxable income below the pensioner rebate cut-out threshold.
Date of effect: Applies for the income year 1996-97 and subsequent income years. Half only of the normal pensioner rebate will be available for the 1996-97 income year.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: The estimated reduction in revenue will be $10 million in 1996-97, $48 million in 1997-98, $65 million in 1998-99 and the following year.
Compliance cost impact: Some compliance costs will arise with taxpayers understanding of the taxation and social security entitlement rules for the rebate and the provision of extra information in tax returns. The rules will be explained in Tax Pack.
The rebate will be available on assessment. However, from the 1996-97 year of income, taxpayers can choose to vary their provisional tax, or apply to the Commissioner to reduce their tax instalment deductions, to take account of entitlements to the rebate. This would involve some costs to taxpayers and employers would incur some costs in keeping records and varying payroll systems.
Rebatable annuities
Amends the definition of 'qualifying annuity' in subsection 27A(1) of the Income Tax Assessment Act 1936 to ensure that, subject to exceptions for certain annuities purchased on or before 9 December 1987, only annuities purchased wholly with funds accumulated within the superannuation system are treated as eligible termination payment (ETP) amounts on commutation or termination. The purpose of the amendment is to prevent the conversion of ordinary annuities to rebatable annuities and pensions.
Date of effect: Applies to annuities commuted or terminated on or after 15 June 1996.
Proposal announced: By the Assistant Treasurer in Press Release No. AT15 on 14 June 1996.
Financial impact: No additional revenue is expected. However, failure to correct the anomaly poses a potentially significant threat to the revenue.
Compliance cost impact: The amendments are not expected to impose any additional compliance costs on taxpayers because taxpayers will continue to be able to commute these annuities and there will be no additional paperwork requirements.
Medical expenses rebate
Amends the income tax law  to raise the threshold above which the medical expenses rebate applies.
Date of effect: Applies for the income year 1996-97 and subsequent income years.
Proposal announced: 1996-97 Budget, 20 August 1996.
Financial impact: This measure is expected to raise $26 million in 
1997-98, $23 million in 1998-99 and $24 million in 1999-00.
Compliance cost impact: There will be no additional compliance costs in regard to this measure as taxpayers will not be required to keep additional records. To qualify for the rebate taxpayers will have to keep records of medical expenses as they do under the existing law.
Sale of mining rights
Amends the income tax law to remove the exemption from tax on income derived from the sale, transfer or assignment of rights to mine for gold or for any prescribed metal or mineral.
Date of effect:  Where the sale, transfer or assignment is under a contract entered into after 31 December 1996.
Proposal announced:  1996-97 Budget, 20 August 1996.
Financial impact:  The estimated revenue saving is $2 million in 1997‑98, $20 million in 1998-99 and $40 million per year thereafter.
Compliance cost impact:  Bona fide prospectors will now be required to declare income previously exempt with a resultant increase in their cost of compliance.
Equity investments in small-medium enterprises
Amends the income tax law to change the taxation treatment of eligible investments from being on revenue account to being subject to capital gains tax.
Date of effect:  Applies to eligible equity investments made after 30 June 1996.
Proposal announced:  1996-97 Budget, 20 August 1996.
Financial impact:  The revenue impact is not quantifiable.
Compliance cost impact:  There will be no real impact on compliance costs because institutions will still need to maintain records so that they can calculate any capital gain or loss on disposal.
Co-operative companies
Repeals paragraph 120(1)(c) of the Income Tax Assessment Act 1936 to remove the tax deduction for loan repayments in respect of certain loans made to co-operatives by governments. Loans already in existence at 7.30pm Eastern Standard Time on 20 August 1996 will continue to be eligible for the deduction.
Date of effect:  The amendment applies, subject to certain transitional arrangements, to loans entered into after 7.30pm Eastern Standard Time on 20 August 1996, and to existing loans where their terms are altered after this time.
Proposal announced:  1996-97 Budget, 20 August 1996.
Financial impact:  The measure is expected to save the revenue $2 million in 1997-98, $4 million in 1998-99 and $6 million in 1999-00.
Compliance cost impact:  The repeal of the paragraph will have no impact on compliance costs.
Tax exempt entities that become taxable
Amends the income tax law to deal with transition issues that arise when a tax exempt entity becomes taxable (for instance when a Government Business Enterprise is sold to private interests). The amendments are designed to allocate income, deductions, gains and losses to the period either before or after loss of exemption. To achieve this the amendments will:
	deny deductions for superannuation payments, bad debts, eligible termination payments, and employee leave entitlements to the extent that they relate to the period when the entity was exempt; 
	allocate income and deductions relating to the pre or post transition period in which they were derived or incurred for the purposes of the income tax law and ensure losses of the exempt period are not recognised for the purposes of the income tax law;
	value assets and liabilities of the entity at market value as at the date of transition, so as to allocate gains and losses in relation to those assets and liabilities to the pre or post transition period to which they relate;
	ensure changes in the value of trading stock are calculated from the time the entity becomes taxable;
	ensure that certain expenditure which provides an enduring benefit (eg. mining allowable capital expenditure and depreciation) is notionally written down during the exempt period. It will also ensure that an entity is able to claim remaining deductions for expenditure written off over more than one year where the expenditure was originally incurred by a predecessor government entity (eg. a department of State).;
	ensure no deduction is available for mining exploration and prospecting expenditure incurred before transition.
Date of effect:  The amendments will apply to entities which become taxable on or after 3 July 1995.
Proposal announced:  Not previously announced. On 3 July 1995 the previous Government announced a 'rule of books' approach to entities in transition from tax exempt to taxable status. Legislation to implement the announcement was introduced in Taxation Laws Amendment Bill (No. 5) 1995. That Bill lapsed with the proroguing of the Parliament.
Financial impact:  It is difficult to determine the financial impact of generic legislation, however the amendments are expected to be revenue neutral.
Compliance cost impact:  In designing the legislation the Government has been mindful to minimise compliance costs. For example, liability for pre-transition leave, bad debts and superannuation are established on the basis of the amounts determined as at transition. Any future deductions for these items are denied until the amount of this threshold is exceeded.
This avoids the need for employers to keep records of pre and post leave entitlement for each employee, and removes the need for individual apportionment calculations for each employee. No additional cost should be incurred in determining this liability over the cost that would be expected to be incurred upon the disposal of a business.
The proposed amendments are designed to clarify the taxation consequences of an exempt entity becoming taxable. This should reduce compliance costs which would otherwise have been incurred in the absence of the proposed generic legislation.
Taxpayers affected by the amendments will incur costs in gaining an understanding of the proposed new law and in ensuring the correct allocation of income, deductions, gains and losses to the relevant period.
Infrastructure borrowings - amendment of the Development Allowance Authority Act 1992
Prevents certain types of schemes undermining the integrity of the infrastructure borrowings program by breaking the symmetry in the special tax treatments of the payer and receiver of interest. Such schemes enable indirect infrastructure borrowings to be made functionally independent of the financing of an infrastructure project thereby increasing the value of tax benefits to those involved and the cost to revenue without a commensurate increase in the funding for private sector projects. To this end, the amending legislation will require: 
·	new indirect infrastructure borrowings or refinancing infrastructure borrowings that succeed them to be made only by Australian resident taxpayers; and
·	any transfer of rights by a direct infrastructure borrowing lender or repayment of a direct infrastructure borrowing to be accompanied by repayment or parallel transfer of any associated indirect infrastructure borrowing or refinancing infrastructure borrowing that has succeeded the indirect infrastructure borrowing.
Date of effect: 30 October 1995.
Proposal announced: 1996-97 Budget, 20 August 1996.  The proposal was previously announced by the former Government on 30 October 1995.
Financial impact:  The proposed amendments have the potential to prevent a future loss to the revenue. The amount of potential revenue loss is not quantifiable.
Compliance cost impact:  The measures will have no effect on compliance costs.
AMENDMENT OF THE INCOME TAX ASSESSMENT ACT 1936 and the Industry research and development act 1986
Research and development activities
Amends the research and development provisions of the income tax law to:
	reduce from 150 per cent to 125 per cent the deduction for expenditure on plant, contracted R&D and other R&D expenditures;
	prevent companies in partnership from claiming expenditure on R&D activities;
	limit to four years the period in which tax assessments can be amended to reflect expenditures on R&D activities;
	modify the R&D deductibility rules relating to interest, core technology, pilot plant and feedstock;
	clarify the definition of 'research and development activities'.
Amends the research and development provisions of the Industry, Research and Development Act 1986 to:
	remove the Industry Research and Development Board's (the Board) power to register syndicates under section 39P for the tax concession;
	allow the Minister to provide formal advice to the Board and its committees;
	ensure that the general administrative arrangements for research and development programs contained in the Industry, Research and Development Act 1986 will also apply to programs administered through delegated legislation authorised by sections 19 and 20. 
Date of effect:  The reduced deduction rate of 125 per cent will apply from 7.30 p.m., by standard time in the Australian Capital Territory on 20 August 1996.  All other measures in the Income Tax Assessment Act 1936 and the removal of syndication under section 39P of the Industry, Research and Development Act 1986 apply from 5pm, by standard time in the Australian Capital Territory on 23 July 1996.  Other measures in the Industry, Research and Development Act 1986 apply from Royal Assent. 
Proposal announced:  Measures other than the reduction in the concessional deduction rate were announced on 23 July 1996.  The reduction to 125% was announced on 20 August 1996.
Financial impact:	96/97	        97/98	  98/99	          99/00
				$59m	        $718m	   $630m        $840m
Compliance cost impact:  The reduction of the rate of concessional deduction from 150% to 125% may involve some marginal additional record keeping costs for companies incurring expenditure available for the concession before and after the date of effect of the new rate.  The additional record keeping costs should be minor and limited to the transitional year of income (1996/97).
The limitation of the period in which tax assessments may be amended will have no compliance cost implications.
The modified deduction rules for interest expenditure will not cause additional record keeping.
The modification of the deduction rules for core technology, pilot plant and feedstock will require eligible companies to do more computation and record keeping, albeit within a limited compass of expenditure types.  In the case of feedstock, there will be some additional valuation and accounting obligations.
Clarification of the definition of 'R&D activities' should not increase the costs of compliance by eligible companies. The amendment should help to reduce compliance costs by clarifying the meaning of 'R&D activities'.
Removal of the right of companies in partnership to claim expenditure on R&D activities has no implications for compliance costs.
There will be some initial costs incurred by companies in understanding the new legislative rules relating to research and development.

Overview
1.1	The amendments contained in Part 1 of Schedule 1 of the Bill will insert two new sections in the Income Tax Assessment Act 1936 (the Act) to provide a tax rebate for certain persons of age pension age who are not in receipt of the age pension.
Summary of the amendments
Purpose of the amendments
1.2	The proposed amendments will provide for a tax rebate for a taxpayer: 
	of age pension age; 
	not in receipt of the age pension; 
	considered to be a resident for age pension purposes; and 
	in receipt of taxable income below the relevant pensioner rebate cut-out thresholds.
Date of effect
1.3	The proposed rebate will apply for the 1996-97 income year and subsequent income years. For the 1996-97 income year the rebate will be available at half the levels of the pensioner rebate. For subsequent income years it will be available at the same levels as the pensioner rebate.
Background to the legislation
1.4	Section 160AAA of the Act provides for a tax rebate in respect of age pensions to offset the tax on an age pension where the pension is paid at the full rate for the full year. The rebate also allows the recipient of this pension to receive a certain amount of non-pension income without paying tax on it. This latter amount is equal to the amount of non-pension income a pensioner can receive without the pension being reduced and is referred to as the income test-free area.
1.5	The rebate is set for each income year at three levels: single, married and married but separated owing to illness or infirmity. The levels are ascertained in accordance with the Income Tax Regulations (the regulations).  
1.6	Where the taxable income of a pensioner exceeds the rebate threshold which is generally equal to the sum of 
	the pension; and 
	the income-test free area 
the rebate reduces in accordance with the regulations. The rate of reduction is 12.5 cents for every dollar of taxable income in excess of the rebate threshold.
1.7	For example, for the 1995-96 income year, the rebate threshold for a single pensioner is $11,185 and the rebate is $1,157. Where a pensioner receives taxable income in excess of the rebate threshold the rebate will reduce until it cuts out totally at a taxable income of $20,441. The point at which the rebate cuts out is referred to as the cut-out threshold.
1.8	Subject to phasing out of the pensioner rebate for taxable income in excess of the rebate threshold, an age pensioner is entitled to a pensioner rebate if he or she receives the age pension for as little as one day in an income year.
1.9	Where one member of a pensioner couple does not receive sufficient taxable income to require the use of all his/her rebate the unused portion can be transferred to the other member of the couple. Provision for the transfer is contained in the regulations.
1.10	A person may not receive an age pension although his/her taxable income is below the cut-out threshold relevant to the pensioner rebate because, for example, the person does not pass the assets test applicable to the age pension. Such a person does not at present qualify for the pensioner rebate, even though his/her taxable income may be the same as that of an age pensioner.
Explanation of the amendments
1.11	The amendments will insert a new section 160AAAA in the Act to provide for an income tax rebate for certain taxpayers of age pension age who do not receive the age pension. The amendments also insert a new section 160AAAB. New section 160AAAB mirrors new section 160AAAA except that it deals with a situation where the age pension age person is a presently entitled beneficiary of a trust estate and is under a legal disability. In such a case the trustee is assessed in respect of the person's trust income under section 98 of the Act. Such a trustee will be entitled to the new rebate when assessed under section 98 if the beneficiary would be entitled under the new section 160AAAA if the trust income were taken to be their only income. This is consistent with the provisions relating to other personal income tax rebates.
1.12	Subsections 160AAAA(1) and 160AAAB(1) will provide that the taxpayer will be entitled to a rebate of income tax if two conditions are satisfied. The amount of the rebate will be ascertained in accordance with the regulations. [Item 1]
1.13	The first condition will consist of three elements [subsections 160AAAA(2) and 160AAAB(2)]. The taxpayer or beneficiary must:
	attain age pension age (65 years for men, initially 60.5 years for women);
	meet the residential requirements for age pensioners;
	not be in gaol. [Item 1]
1.14	The elements of the first condition for the new rebate must apply for at least one day in the income year. This is consistent with the requirement that the pensioner rebate is available to a taxpayer who receives the age pension for at least one day in the income year. [Item 1]
1.15	New subsections 160AAAA(3) and 160AAAB(3) will provide that the second condition consists of two elements. The first element will require that the taxpayer's taxable income or the beneficiary's trust income assessed under section 98 of the Act (new subsection 160AAAB(4)) for the year of income be less than an amount ascertained in accordance with the regulations. This amount will be the cut-out threshold for the pensioner rebate and will vary with marital status and whether spouses are separated owing to ill-health. [Item 1] 
1.16	The second element will require that the taxpayer or beneficiary is not entitled to a pensioner or beneficiary rebate. [Item 1]
1.17	New subsections 160AAAA(4) and 160AAAB(5) will provide that, for the purposes of qualifying for the rebate, the members of a couple are income tested jointly, ie. half their combined income each needs to be less than the amount ascertained in accordance with the regulations [item 1]. This is consistent with the joint income-testing for entitlement to an age pension and, effectively, for the pensioner rebate. Where new section 160AAAA applies, the relevant incomes to be tested are the taxable income of the taxpayer and the taxable income of the taxpayer's spouse (including any share of the net income of a trust estate to which the spouse is presently entitled and that is assessed under section 98 of the Act, even if this is the only income of the spouse). Where new section 160AAAB applies, the relevant incomes to be tested are the share of net income of the presently entitled beneficiary and the taxable income of the beneficiary's spouse (including any trust income assessed under section 98, even if this is the only income of the spouse).
1.18	New subsections 160AAAA(5) and 160AAAB(6) will provide for regulations made for the purposes of new sections 160AAAA and 160AAAB to be made retrospectively. This is necessary as the data used to calculate pensioner rebates and rebate thresholds will not be available for an income year until well into that income year, due to the indexing of age pensions. [Item 1]
1.19	Item 2 inserts a reference to the new rebate in the definition of 'qualifying rebates' in subsection 221YAB(1) of the Act. A reference to the new rebate under new section 160AAAB is not inserted because section 221YAB does not apply to trustees.
1.20	Section 221YAB provides a test by which taxpayers in receipt of salary or wage income are subjected to provisional tax.  When such a taxpayer has an amount to pay on assessment of $3,000 or more that is directly referable to a shortfall in tax instalment deductions from the taxpayer's salary or wage income, the taxpayer becomes subject to provisional tax.
1.21	In calculating whether the amount to pay on assessment arises because of a shortfall of tax instalment deductions, certain rebates considered likely to recur to a taxpayer's benefit are taken into account.
1.22	Because it is possible that a taxpayer who receives the new rebate could receive salary or wage income, it is appropriate to take account of the new rebate in the test.
1.23	Subitem 5(1) provides that the rebate becomes available in taxpayers' 1996-97 assessments and is first used in calculating the shortfall test at the same time.
1.24	Items 3 and 4 insert references to the new rebate in the provisions of the Act concerned with the furnishing of taxpayer provisional tax estimates.
1.25	Section 221YDA allows a taxpayer who has been notified of provisional tax or an instalment of provisional tax to furnish his or her own estimate of certain amounts to the Commissioner and for the provisional tax to be recalculated accordingly.
1.26	Paragraph 221YDA(1)(da) provides that a taxpayer, in the expectation of being entitled to certain rebates in the taxpayer's next assessment, may make an estimate of them.  Subparagraph 221YDA(2)(a)(ii) provides for the recalculation of the provisional tax based on the estimate.
1.27	It is possible that a taxpayer who receives the new rebate could be subject to provisional tax, and have had the new rebate taken into account in the calculation of provisional tax notified. Therefore it is appropriate to allow a taxpayer to make an estimate of the amount of rebate to which the taxpayer will be entitled, for the purpose of varying the provisional tax notified.
1.28	The amendments made by items 3 and 4 operate in respect of the 1996-97 and later years of income [subitem 5(2)].
1.29	Taxpayers who have income subject to pay-as-you-earn tax instalment deductions will be able to vary those deductions under section 221D of the Act on the same basis as provisional taxpayers.

Overview
2.1	The amendments contained in Part 2 of Schedule 1 of the Bill amend the definition of 'qualifying annuity' in subsection 27A(1) of the Income Tax Assessment Act 1936 (the Act) to:
	ensure that, subject to certain exceptions for some annuities purchased on or before 9 December 1987, only annuities purchased wholly with rolled-over amounts are treated as eligible termination payments (ETPs) on commutation or termination;
	prevent the conversion of ordinary (non-ETP) annuities to rebatable annuities and pensions.
Summary of the amendments
Purpose of the amendments
2.2	The purpose of the amendments is to ensure that:
	subject to exceptions for certain annuities purchased on or before 9 December 1987, only annuities purchased entirely with amounts accumulated within the superannuation system receive concessional taxation treatment as ETPs on commutation or termination;  
	ordinary (non-ETP) annuities can not be converted to rebatable ETP annuities and superannuation pensions;
	the existing treatment of certain annuities which were purchased on or before 9 December 1987 with a mix of ETP and non-ETP amounts is maintained, so that they continue to be treated as ETPs on commutation or termination.
Date of effect
2.3	The amendments apply to annuities commuted or terminated on or after 15 June 1996.
Background to the legislation
2.4	Amendments to the Act were made in 1994 (contained in the Taxation Laws Amendment (Superannuation) Act 1992) to allow annuities already within the superannuation system to be treated as ETPs and further rolled-over on commutation or termination.  
2.5	Prior to the 1994 amendments, amounts received on the commutation or termination of a qualifying annuity were included in the definition of an ETP. However the amount to be treated as an ETP was reduced by the unused undeducted purchase price (UUPP) of the annuity. As the UUPP of an ordinary (non-ETP) annuity equalled the entire amount received on commutation or termination, the effect of this was that no amount received on the commutation or termination of such an annuity was an ETP.  
2.6	A qualifying annuity is defined in subsection 27A(1) of the Act to mean:
	an annuity purchased after 12 January 1987 that is an eligible annuity or the subject of an eligible policy;
	an annuity purchased on or before 12 January 1987 that is an eligible annuity as defined before that date;
	an immediate annuity purchased on or before 9 December 1987.
2.7	The 1994 amendments provided for the UUPP of a qualifying annuity to be treated as an ETP by removing the exclusion of UUPP from the definition of an ETP in paragraph 27A(1)(g) of the Act, and including UUPP in the definition of undeducted contributions in subsection 27A(1) of the Act. Undeducted contributions are a component of an ETP and can be rolled-over.  
2.8	The amendments had the unintended consequence of allowing ordinary (non-ETP) annuities which are the subject of eligible policies to be treated as ETPs on commutation or termination. As ETPs these annuities were eligible to be rolled-over into the superannuation system and used to purchase rebatable annuities and pensions.  
2.9	The ability to convert ordinary (non-ETP) annuities to rebatable annuities and pensions was not the intention of the amending legislation and is inconsistent with past and present Government policy in this area. 
2.10	Rebates for ETP annuities and superannuation pensions purchased wholly with rolled-over amounts are available under section 159SU and section 159SM of the Act. The rebate was brought in to compensate for the impact of tax on contributions to superannuation funds. The rebate is clearly intended to apply only to pensions and annuities purchased with superannuation amounts. Amounts received on the commutation or termination of an ordinary (non-ETP) annuity are not superannuation amounts and should therefore not be treated as an ETP or be eligible for the rebate.  
2.11	An exception to this approach is the treatment of immediate annuities purchased on or before 9 December 1987, with a mixture of ETP and non-ETP amounts. Prior to legislative amendment contained in the Taxation Laws Amendment Act (1988), which had effect from 1987, immediate annuities purchased only partly with an ETP amount could be treated as an ETP on commutation or termination. 
2.12	For reasons of equity these annuities have continued to be treated as ETPs on commutation or termination. This treatment is to be maintained by the amendment. 
Explanation of the amendments
2.13	The Bill amends the definition of 'qualifying annuity' contained in subsection 27A(1) of the Act. The amount received on commutation or termination of an annuity is an ETP if the annuity is a qualifying annuity as defined in subsection 27A(1). The amount received as an ETP can be rolled-over to purchase an ETP annuity or superannuation pension that may be eligible for a rebate. The definition of 'qualifying annuity' is therefore amended to ensure that only annuities which have been purchased wholly, or in some cases partly, with rolled-over amounts will satisfy the definition of 'qualifying annuity'.
2.14	The amendments apply to annuities commuted or terminated on or after 15 June 1996 [item 9]. That is, the amendments will apply to any amount received in relation to a commutation or termination of an annuity received on or after 15 June 1996. Amounts received on the termination of an annuity are known as the 'residual capital value' of an annuity and are covered by these amendments. 
2.15	References in the amendments to rolled-over amounts also include a rolled-over amount. The amendments apply to annuities purchased with a single rolled-over amount and to annuities purchased with two or more rolled-over amounts.
2.16	Paragraph (a) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly with rolled-over amounts [item 7]. This has the effect of ensuring that annuities purchased after     12 January 1987 and commuted or terminated on or after 15 June 1996, will only satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased wholly with rolled-over amounts. 
2.17	The definition of 'eligible annuity' was amended with effect from 12 January 1987 to ensure that for an annuity to be an 'eligible annuity' it must satisfy certain conditions. One of these conditions is that the annuity must be one whose purchase price consists wholly of a rolled-over amount or rolled-over amounts. The effect of the current amendment then, is to ensure that an annuity which is the subject of an eligible policy within the meaning of Division 8 or 8A is similarly required to have been purchased wholly with rolled-over amounts.
2.18	Paragraph (b) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly or partly with rolled-over amounts [item 7]. This has the effect of ensuring that annuities purchased before 12 January 1987 and commuted or terminated on or after 15 June 1996, will satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased either wholly or partly with rolled-over amounts.
2.19	The definition of 'eligible annuity' prior to the 12 January 1987 amendment, other than in the case of a deferred annuity (see definition of roll-over annuity in subsection 27A(1)), did not contain the condition that the purchase price consist wholly of a rolled-over amount or rolled-over amounts. Thus, prior to 12 January 1987 an annuity would have satisfied the definition of an 'eligible annuity' if it was purchased wholly or partly with a rolled-over amounts.
2.20	This amendment to paragraph (b) of the definition maintains the previous treatment of annuities purchased on or before 12 January 1987, which will continue to be treated as qualifying annuities and hence as ETPs when they were purchased either wholly or partly with rolled-over amounts.
2.21	Paragraph (c) of the definition of 'qualifying annuity' is amended to require that the annuity be purchased wholly or partly with rolled-over amounts [item 8]. This has the effect of ensuring that immediate annuities purchased on or before 9 December 1987 and commuted or terminated on or after 15 June 1996, will satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased either wholly or partly with rolled-over amounts. 
2.22	This amendment to paragraph (c) of the definition maintains the previous treatment of immediate annuities purchased on or before              9 December 1987, which will continue to be treated as qualifying annuities and hence as ETPs when purchased only partly with rolled-over amounts.
2.23	The amendment to paragraph (c) of the definition augments the amendment to paragraph (a) in that the paragraph (c) amendment will apply to immediate annuities purchased before 9 December 1987 and which do not satisfy the definition of 'eligible annuity'. The amendment to paragraph (a) of the definition applies to immediate annuities which do satisfy the 'eligible annuity' definition.
2.24	Immediate annuities purchased after 9 December 1987 and commuted or terminated on or after 15 June 1996 will only satisfy the definition of qualifying annuity and hence the definition of ETP if they were purchased wholly with rolled-over amounts.

Overview
3.1	The amendments in Part 3 of Schedule 1 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to raise the threshold above which the medical expenses rebate will apply.
Summary of the amendments
Purpose of the amendments
3.2	The proposed amendments will:
	for the 1996-97 income year, raise the threshold above which the medical expenses rebate will apply from the existing level of $1,000 to $1,430; and
	 for subsequent income years, raise the threshold to $1,500.
Date of effect
3.3	The raising of the threshold to $1,430 will apply to assessments in respect of the 1996-97 year of income.
3.4	The raising of the threshold to $1,500 will apply to assessments in respect of the 1997-98 and subsequent years of income.
Background to the legislation
3.5	The medical expenses rebate was introduced effective for the 1985-86 income year to replace a concessional expenditure rebate for medical expenses. Originally the rebate was calculated at the rate of 30 cents for each dollar of medical expenses in excess of $1,000. Between its introduction and the 1991-92 income year, this rate was progressively decreased to 20 cents.
3.6	Section 159P of the Act provides for a rebate to a taxpayer whose medical expenses, net of Medicare and private health fund reimbursement, exceed $1,000 during the year of income. To qualify for the rebate the expenses must be paid by a resident taxpayer in respect of himself or a resident dependant. The rate of rebate is 20 cents for each dollar of net medical expenses above the threshold of $1,000.
Explanation of the amendments
3.7	In the 1996-97 Budget, the Government announced an increase in the medical expenses threshold from $1,000 to $1,500, with effect from the date of announcement.
3.8	For the income year 1996-97, on a pro rata basis, the threshold will therefore be $1,430. Item 10 amends paragraph 159P(3A)(b) of the Act to effect the change. This amendment applies to assessments in respect of income of the 1996-97 year of income [item 12(1)].
3.9	For 1997-98 and subsequent income years the threshold will be $1,500. Item 11 amends paragraph 159P(3A)(b) to substitute the $1500 threshold for the pro rata rate applicable for the 1996-97 income year. This amendment applies to assessments in respect of income of the 1997-98 and all subsequent income years [item 12(2)].

Overview
4.1	Part 4 of Schedule 1 of the Bill will remove the exemption from tax under paragraph 23(pa) of the Income Tax Assessment Act 1936 (the Act).  The exemption will not be available in respect of income derived from the sale, transfer or assignment, under contracts entered into after 31 December 1996, of rights to mine for gold or for any prescribed metal or mineral. 
Summary of the amendments
Purpose of the amendments
4.2	The purpose of the amendment is to remove the exemption from tax on the income derived by bona fide prospectors when they sell, transfer or assign their rights to mine for gold or for any prescribed metal or mineral.
Date of effect
4.3	The amendment will apply to income derived under contracts entered into after 31 December 1996.
Background to the legislation
4.4	Paragraph 23(pa) exempts income derived from the sale, transfer or assignment of rights to mine for gold or for any prescribed metal or prescribed mineral.  The exemption only applies to sales by 'bona fide' prospectors, as defined in the law.
4.5	The prescribed metals and prescribed minerals are listed in Regulation 4 of the Income Tax Regulations.  They are:
Asbestos				       Ores of
Bauxite						Antimony
Chromite					Arsenic
Emery						Beryllium
Fluorspar					Bismuth
Graphite						Cobalt
Ilmenite						Columbium
Kyanite						Copper
Magnesite					Lithium
Manganese oxides			Mercury
Mica						Molybdenum
Monazite					Nickel
Pyrite						Osmiridium
Quartz Crystal (piezo-electric quality)	Platinum
Radio-active Ores				Selenium
Rutile						Strontium
Sillimanite				Tantalum
Vermiculite				Tellurium
Zircon						Tin
						Tungsten
						Vanadium
4.6	This exemption was enacted as an incentive for 'bona fide' prospectors to search for prescribed metals and minerals, which they do not necessarily have the means to mine themselves, with the knowledge that the income from transferring the rights to mine would not be reduced by taxation.
4.7	The list reflects past concerns that known resources of certain metals and minerals were inadequate for Australia's present and prospective domestic consumption.  These concerns are no longer justified in the light of Australia's current reserves and the global trading environment.
Explanation of the amendments
4.8	The exemption from income tax provided by paragraph 23(pa) is withdrawn for income derived under contracts entered into after 31 December 1996. [Item 13]
4.9	Paragraph 23(pa) is not repealed. References to the paragraph in other parts of the Act will have a continuing operation, such as provisions calculating the amount of undeducted exploration and prospecting expenditure or unrecouped capital expenditure.

Overview
5.1	The amendments contained in Part 5 of Schedule 1 of the Bill will introduce new Division 11B into the Income Tax Assessment Act 1936 (the Act) to change the tax treatment of certain equity investments in small and medium enterprises (SMEs) where the investment is held by a lending institution.  Any profit or loss from the eligible equity investments will now be taxed under Part IIIA, the capital gains tax provisions, rather than on revenue account.
Summary of the amendments
Purpose of the amendments
5.2	The purpose of the amendments is to facilitate investment in SMEs by lending institutions.
Date of effect
5.3	Applies to eligible equity investments made after 30 June 1996.
Background to the legislation
5.4	Some SMEs have reported difficulties in obtaining finance.
5.5	At present, equity investments by banks and other financial intermediaries who provide equity finance as part of their business are usually taxed on revenue account.  At the time an equity investment is made by such taxpayers there is no deduction for the expenditure.  When the investment is realised its initial cost is taken into account in determining any profit or loss.
5.6	The new measure, the subjecting of eligible equity investments to capital gains tax, will facilitate equity investment in SMEs as investors will be now able to index the cost of their investments.
Explanation of the amendments
5.7	The proposed amendments will extend the capital gains tax treatment to gains and losses on realisation of eligible equity investments in SMEs that have been undertaken by banks and by other financial institutions conducting a business of lending money and for whom these eligible equity investments do not constitute trading stock.
Small-medium enterprise (SME)
5.8	An SME, for the purposes of this measure, is a company which has assets the total value of which is no more than $50 million.  This valuation is obtained from the last audited accounts prepared for the purposes of the relevant Corporations law.  [New subsections 128TK(1) and (2)]
5.9	If no audited accounts were prepared in the previous 12 months from the date of the share issue, or if the last set of audited accounts were prepared 18 months or more before the share issue, the company the subject of the equity investment is not an SME unless the investor obtains an audited statement.  This statement must show that before the shares were issued the value of the SME's assets did not exceed $50 million.  [New subsection 128TK(3)]
5.10	For the purposes of these provisions, an audited statement is a statement prepared by a person who is a company auditor under the relevant corporations law or who is eligible to consent to such an appointment.  [New subsection 128TK(4)]
Eligible equity investment
5.11	An eligible equity investment for the purposes of this new Division in the Act is a share holding that represents at least 10% of the paid-up capital of the company (including the newly issued ordinary shares).
5.12	Where the 10% share holding is acquired, the taxpayer has only to pay the amount necessary to effect the purchase.  The proposed provisions assume that all the amounts that are payable for the issue of the shares have been paid for the purposes of determining whether the 10% threshold has been met.  [New section 128TJ]

Other equity investments
5.13	Where a lending institution acquires shares before 1 July 1996, those shares can never be counted towards the 10% threshold.  However, where the lending institution has acquired a parcel of shares in an SME on or after 1 July 1996, which is less than the threshold and at a later date it acquires additional shares so that the total parcel equals or is more than the threshold, there will be a deemed disposal and reacquisition.  The shares will be disposed of and reacquired at their market value.  Any profit or loss that occurs on the deemed disposal will be brought to account under section 25 or section 51 of the Act in the year of income in which the shares are actually disposed of.  The shares acquired by the deemed reacquisition will then be subject to capital gains tax and their cost base will be their market value on the date of the reacquisition.  [New section 128TI]
Business of lending money
5.14	Whether a business is engaged in lending money is a matter determined by an evaluation of facts surrounding the conduct of the business.  It is a concept already used in paragraph 63(1)(b) of the Act.
Consequences of new provisions
5.15	As a consequence of the proposed amendments, and subject to the various conditions in those amendments, profits or losses made by lending institutions from the sale of shares held in SMEs will be dealt with under the capital gains tax provisions of the Act instead of being dealt with under sections 25 or 51 of the Act.

Overview
6.1	Part 6 of Schedule 1 of the Bill amends the Income Tax Assessment Act 1936 (the Act) to ensure that co-operative companies will no longer receive a deduction under paragraph 120(1)(c) for the repayment of new government loans.
Summary of the amendments
Purpose of the amendments
6.2	The purpose of the amendment is to remove the deduction that eligible co-operative companies have been entitled to in respect of certain government loans used to purchase assets. This will remove the preference the provision gives to co-operatives over other companies, as well as the preference it gives to borrowers (the effective double deduction is only available to the extent that assets are paid for from borrowings).
Date of effect
6.3	Subject to the transitional arrangements explained below in paragraphs 6.8 - 6.13, the amendment applies to loan repayments made pursuant to a contractual obligation entered into after 7.30pm Eastern Standard Time on 20 August 1996. Loans in existence before that time will retain entitlement to the deduction. However, if their terms are altered after that time they will be taken to be new loans. [Subitem 18(1) and subparagraph (b)(i) of subitem 18(4)]
6.4	Whether or not a loan exists at the relevant time is a question of fact. No loan exists unless the borrower and the lender have a legally binding and enforceable contract under which both parties are committed to the transaction.
6.5	A loan agreement in force at 7.30pm on 20 August will be treated as if it was entered into after that time if it is rolled over or extended after that time. A rollover will not be taken to have occurred solely because periodic interest rate adjustments are made in accordance with the original loan agreement. [Subparagraphs (b)(ii) and (iii) of subitem 18(4)]
6.6	The effect of subitem 18(5) is that, irrespective of the actual terms of the loan agreement, the loan amount will be taken to be equal to any principal outstanding at 7.30pm on 20 August 1996 and any further amounts which, at that time, the borrower was contractually obliged to borrow. As a result, any amounts borrowed after that time which are not part of that deemed loan amount will be treated as an alteration of the terms of the loan and therefore will result in there being a loan entered into after the relevant time by subparagraph (b)(i) of subitem 18(4). Therefore, the only amounts still eligible for deduction under the former paragraph 120(1)(c) are repayments of principal outstanding at 7.30pm on 20 August 1996 and repayments of other principal borrowed after that time but which, at that time, the borrower was contractually obliged to borrow. [Subitem 18(5)]
6.7	A loan facility under which drawdowns can be made is merely an agreement to make loans in the future.  It is not a contractual obligation to borrow money. It follows that a loan facility is not an existing loan - a new loan comes into existence as each drawdown is made. 
Transitional arrangements
6.8	Subitems 18(2) and 18(3) provide for the application of transitional provisions to certain co-operatives.
6.9	The transitional provision contained in subitem 18(2) ensures that certain loans to eligible co-operatives that were entered into after 7.30pm on 20 August 1996 but on or before 31 December 1996 will remain eligible for the paragraph 120(1)(c) tax deduction provided the company has, in the three years leading up to 20 August 1996, had a loan to which paragraph 120(1)(c) applies. This transitional provision applies if the loan was entered into for the sole purpose of acquiring a specified asset pursuant to:
	an authorisation given by the directors of the co-operative before 7.30pm on 20 August 1996 (and recorded in the minutes of the co-operative) to acquire the asset, provided the authorisation to acquire the asset is in accordance with an approved business plan and the asset is contracted for by 31 December 1996; or
	a contract which was entered into before 7.30pm on 20 August 1996.
The specified asset must be plant or articles for the purposes of section 54 of the Act (other than a passenger motor vehicle), or an eligible building for the purposes of section 124ZF of the Act. It must be installed ready for use by 30 June 1998. [Subitem 18(2)]
6.10	In determining whether a loan is entered into on or before 31 December 1996 the tests in subitem 18(4) (explained above in paragraphs 6.3 - 6.5) apply.  Therefore if a loan entered into before that time is rolled over, or its terms are altered (for instance, by borrowing additional money which the co-operative was not under a contractual obligation to borrow before that time - see subitem 18(5), explained above in paragraph 6.6) or the loan period is extended after that time, then the loan will be treated as having been entered into after that time and will therefore be ineligible for the deduction.
6.11	Subitem 18(3) contains a further transitional provision which applies where a co-operative has entered into a contract before 7.30pm on 20 August 1996 to acquire an asset and has an agreement for the provision of finance in place before that time.  In such a case, any drawdowns of funds under that agreement after that time for the sole purpose of acquiring the asset will be eligible for the tax deduction. [Subitem 18(3)]
6.12	For the purposes of this measure, an agreement for the provision of finance exists if an offer of a loan has been accepted such that a contract has been entered into, or a loan facility agreement has been executed.
6.13	If a loan is entered into after 7.30pm on 20 August 1996 and satisfies the requirements of subitem 18(3), the loan will nevertheless become ineligible for the paragraph 120(1)(c) tax deduction if the acquisition of the asset ceases to be the sole purpose of the loan.  For example, an increase in the loan amount for a purpose other than the purchase of the specified asset will result in a change to the purpose of the loan. [Subitem 18(3)]
Background to the legislation
6.14	Paragraph 120(1)(c) effectively allowed eligible co-operatives double deductions for the cost of assets. They received a tax deduction for repayment of money lent to the co-operative by the government, in addition to normal deductions for interest on money lent. They also received normal tax deductions for depreciation in relation to the cost of the assets. Therefore, the net effect of paragraph 120(1)(c) was that an eligible co-operative could claim an effective 200 per cent tax deduction for capital expenditure - full write-off of the cost of an asset and deductions for capital repayments.
Explanation of the amendments
6.15	Item 17 of Schedule 1 is the operative provision.  It repeals subsection 120(1) of the Act and substitutes a new subsection without existing paragraph 120(1)(c).  [Item 17 - substitutes subsection 120(1)]
6.16	Item 18 provides that, subject to certain transitional provisions, new subsection 120(1) applies to loans entered into after 7.30pm Eastern Standard Time on 20 August 1996, and to existing loans whose terms are changed after that time.  This application provision is explained above under the heading 'Date of effect'.  [Item 18]

Overview
7.1	The amendments contained in Schedule 2 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to insert a new Division 57 to provide for transitional tax issues which arise when an entity the income of which is exempt becomes, for any reason, subject to tax on any part of its income under the provisions of the Act.
Summary of the amendments
Purpose of the amendments
7.2	The amendments will alter the operation of the Act to ensure that all, and only, the income, deductions, gains and losses that relate to the period after an entity's transition to taxable status are taken into account in determining the tax position of the entity [new section 57-1]. The provisions will apply to Government exempt entities which are privatised either by legislation or by sale to private interests and non-Government exempt entities which cease to be exempt. 
Date of effect
7.3	The amendments will apply to entities which become taxable on or after 3 July 1995. [Item 2]
Background to the legislation
7.4	There are several possible models for dealing with the tax consequences of a change from exempt to taxable status.
New taxpayer
7.5	Under this model, an entity becoming taxable is treated as if it comes into existence at the moment it becomes taxable. Such a new taxpayer has assets and liabilities and a variety of rights and obligations. Unless costs of its assets and consideration for its liabilities are imputed to it, it will have extreme tax consequences of any realisation of assets or satisfaction of liabilities; the most obvious way of dealing with this is to impute to the new taxpayer costs and consideration based on value at the moment the entity becomes taxable. Depreciation would have to be based on an imputed cost of depreciable assets, as otherwise all depreciation for existing assets would be denied; again, the market value at the moment the entity becomes taxable is an obvious possible starting point. Income and outgoings, if treated on the basis that the entity is a new taxpayer, could fall capriciously: that is, income could be fortuitously derived before or after the moment the entity becomes taxable and comes into existence as a taxpayer, and outgoings could arise similarly. A 'new taxpayer' model suggests that only what is derived or incurred by the new taxpayer is and is wholly relevant to the new taxpayer's tax position.
Continuing taxpayer without modification
7.6	This model involves the application of the existing law without modification. It results in the transition to taxable status having both positive and adverse income tax consequences. For instance, an assessable profit realised after transition will form part of assessable income, even if its value did not increase after transition. Many transitions to the Commonwealth tax net have so far occurred by this 'seamless transition' approach, or have relied on it with only minor modifications.
Continuing taxpayer, apportionment to taxable period
7.7	This model is colloquially referred to as the 'rule the books' approach. It involves ensuring that, to the extent that is practical, only income and deductions, gains and losses and tax effects that relate to the taxable period are included in that period, while those relating to the exempt period are excluded. In many cases, the simplest way to do this in relation to later gains and losses is by reference to the market value of assets and liabilities, when the entity becomes taxable, and so on these issues this will produce the same solutions as the most likely imputed costs and consideration under the 'new taxpayer' model.
7.8	Legislation modifying the Act has been introduced on a 'case by case' approach for Government Business Enterprises (GBEs) that have become taxable. In each case the tax implications of the entity becoming taxable have been considered and the operation of the Act modified for specific tax issues.
7.9	The taxation issues are the same for both private and Government owned entities changing from exempt to taxable status. A privately owned entity that is exempt, for example under paragraph 23(g) of the Act for the promotion of sport, might lose its exempt status, for example when it starts to be carried on for other purposes. A Commonwealth GBE will become taxable when the Commonwealth Government legislates to make the GBE taxable even without any change of ownership. A GBE will cease to be exempt when it is wholly or partially transferred to private beneficial ownership. At present State and Territory GBEs are exempted from income tax as State/Territory bodies under section 24AM of the Act. A GBE ceases to be an STB usually if it ceases to be wholly owned by a State or Territory.
Preferred approach
7.10	To date the approach when government entities are privatised has been either the 'seamless transition' or the continuing taxpayer, apportionment to taxable period models. The previous Government decided however, that the latter model represented the fairest method of bringing new taxpayers into the Commonwealth tax net. The model ensures that an entity's gains, losses, income and deductions that relate to the period of exemption are not included in calculating assessable income. It also ensures that only outgoings which relate to the derivation of assessable income are allowed as deductions when calculating its tax position.
7.11	The previous Government announced on 3 July 1995 that legislative changes would be introduced to give effect to this general rule, and to specific applications of the rule in relation to some particular issues, with effect from the date of announcement. This Bill includes the broad provisions of the general rule and the specific applications announced by the previous Government, other than the specific application to franking credits, which will be put before the Parliament at a later time.
Explanation of the amendments
Entities to which the Division applies
7.12	New Subdivision 57-A sets out the circumstances in which the Division applies. New section 57-5 provides a test to work out if the Division applies to an entity.
7.13	Under new paragraphs 57-5(a) and (b) if at any time;
	all of the income of an entity is fully exempt from income tax; and 
	immediately afterwards, any of its income becomes assessable to any extent; then
new Division 57 applies.
7.14	The need for all income of an entity to have been exempt for the Division to apply means that entities that receive only partial exemption from income tax on their income are not subject to the provisions if that partial exemption is removed. For example the provisions would not apply to a taxpayer, that is otherwise subject to tax on its income but has an exemption from income tax for one component of its income if that exemption is removed.
7.15	Conversely, the Division applies if any part of a fully exempt entity's income becomes assessable to any extent. So the provisions would apply even if an entity remained exempt from income tax on part of its income, and even if the part of its income that became assessable was only partly so, for instance because only a proportion of that income was to be brought to account as assessable.
7.16	An entity to which new section 57-5 applies because at least part of its income has become at least partly assessable, is termed the 'transition taxpayer'. The time at which at least part of its income becomes assessable to at least some extent is the 'transition time' [new paragraphs 57-5(c) and 57-5(d)]. Although the term 'transition taxpayer' is used the term applies to identify the entity in relation to matters arising before, at, and after the transition time.
7.17	Under new paragraph 57-5(e) the year of income of the newly taxable entity in which the transition time occurs, that is, in which at least a part of its income becomes at least partly assessable is called the 'transition year' for the entity.
7.18	The provisions apply to a taxpayer for which a transition time occurs. It is possible for a taxpayer to be wholly exempt from income tax to the end of one year of income and commence to be assessable at the beginning of the following year of income. In that case, the transition time occurs at the beginning of the year in which the taxpayer commences to be assessable, and that year is the 'transition year'. The operative provisions of this Division are designed so that such a transition time does not hinder their operation. There is always a transition year, because the time when at least part of an entity's income becomes at least partly assessable always occurs in a year of income.
Predecessors of the transition taxpayer
7.19	Certain Government owned transition taxpayers may be undertaking activities which were previously undertaken by another Government owned entity or emanation of the State.
7.20	The predecessor may have incurred expenditure on long lived assets which, if the entity had been taxable, would have been deductible over several years.
7.21	In such circumstances it is appropriate that the transition taxpayer obtain the benefit of such deductions as would remain to the predecessor if it had become taxable itself at the time when the transition taxpayer became taxable.
7.22	New section 57-10 will therefore ensure that deductions to those transition taxpayers for capital expenditure which is deductible over more than one year will be based on the amount paid originally by the predecessor. 
7.23	The following is an example of how this will work in practice:
	A GBE carries on the complete range of timber operations as defined in Division 10A of the Act. That is; planting, tending, felling, removing and milling.
	In year 1 the GBE incurs capital expenditure which would (if it were taxable) be deductible under sections 124F (access roads) and 124JA (timber mill building) over a 25 year period.
	In year 5 the timber milling activities only are transferred to a corporate entity (the transition taxpayer) set up by the Government specifically for that purpose.
	In year 10 the transition taxpayer is sold to private interests, thus becoming taxable.
The transition taxpayer would therefore be entitled, through the interaction of new sections 57-10 and new Subdivision 57-J to the remaining 15 years of deduction under section 124JA for the expenditure incurred by the GBE.
7.24	The transition taxpayer would not, however, be entitled to any deduction for the expenditure on access roads which relates to the remaining timber operations that were not transferred to it and remain in Government hands.
Income of the exempt period
7.25	New section 57-15 ensures that the 'rule the books' approach applies correctly to income derived by an entity that relates to the period before the transition time. The section ensures that to the extent that income is derived by an entity after the transition time for services rendered or goods provided or the doing of any other thing before that time, the income is treated for the purposes of the Act as having been derived before that time. Interest can be considered to be received in respect of the doing of a thing, being the allowing of a sum of money to a borrower. The interest income would be considered to be derived over the period that the money was lent.
7.26	One of the situations which the provision applies to is the supply of goods in advance of billing. For example an energy utility, which provides gas to customers prior to the transition time but bills customers in the post transition period, will not be assessable in the post transition period to the extent to which unbilled gas had been supplied to customers prior to the transition time.
Income of the taxable period
7.27	New section 57-15 also ensures that the correct apportionment is made of income derived by an entity that relates to the period after it becomes taxable. The section ensures that to the extent that income is derived by an entity before the transition time for services rendered or goods provided or the doing of any other thing at or after that time, the income is treated for the purposes of the Act as having been derived at or after that time. The income is treated as having been derived at the time or over the period in which the services were rendered or goods provided or the thing was done.
7.28	The situations to which the provision will apply include those in which an entity is paid in advance for goods or services before the transition time but does not earn the income until the goods or services are provided after the transition time.
7.29	An alternative approach would have been to make no legislative provision, but to have relied upon the decision in Arthur Murray (NSW) Pty Ltd v FC. of T (1965) 114 CLR 314. That decision provides authority for the view that in some circumstances the price of services paid for in advance is derived only as the services are provided.
7.30	The legislative approach was however adopted to place beyond any doubt the treatment that applies to all prepayments for things to be done at or after the transition time, even if the prepayment could be said to be derived earlier and not to be derived after the transition time.
Deductions of the taxable period
7.31	New section 57-20 ensures that the rule the books approach applies correctly to deductions allowable to the transition taxpayer. The section applies to a loss or outgoing incurred by an entity before the transition time to the extent that it is for services rendered, goods provided, or the doing of any other thing once the entity was at least partly taxable. The effect of the provision is to treat the appropriate part of the loss or outgoing as having been incurred for the purposes of the Act at the time when the entity was taxable; the time the services were rendered or the goods provided or the thing was done. That part of the loss or outgoing will therefore be taken to be deductible. The time at which this occurs may fall within the transition year or may extend beyond it over one or more years of income.
7.32	A payment which qualifies for a deduction under subsection 51(1) may be made by an entity before the transition time for services performed for it in part during the month before the transition time and equally during the month after the transition time. The effect of the provision would be to allow one half of such expenditure as a deduction in the post transition period.
Deductions of the exempt period
7.33	It has been suggested in the past that losses or outgoings incurred while a taxpayer's income is exempt might be deductible, so far as they were expected to contribute to assessable income. On this view, an exempt body which planned a change of status might get tax deductions denied to a similar body which became taxable unexpectedly - perhaps because of a change to the law. That view is not correct; and in any event new section 57-20 ensures that deductions depend on the extent to which losses or outgoings relate to the provision of services, goods or other things once the activity has become subject to taxation, not on the extent of the entity's notice of the change. Combined with the provisions of new subdivision 57-E, relating to assets and liabilities, this attributes deductions to their proper periods. 
7.34	New section 57-20 also ensures the correct apportionment of deductions incurred by an entity after it becomes taxable. The section applies to a loss or outgoing within the meaning of the general deduction provision, section 51. Such a loss or outgoing may be wholly or partly incurred by an entity at or after the taxable transition but for services rendered or goods provided or the doing of some other thing before the transition time. The loss or outgoing is treated to that extent as having been incurred at the time the services were rendered or the goods provided. So the loss or outgoing will not be deductible to that extent.
Deemed disposal and re acquisition of assets
7.35	The amendments will generally treat the assets of newly taxable entities as having been disposed of immediately before the entity becomes taxable and re-acquired when it becomes taxable, for the purposes of determining future gains or losses arising from disposal of those assets [new subsections 57-25(1) and (2)]. This effectively allocates that part of any gains and losses which relate to the period of exemption to that period and ensures that only increases or decreases in value from the transition time are relevant in determining a gain or loss on a particular asset.
7.36	New subsection 57-25(3) will deem the assets of the newly taxable entity to have been reacquired at 'adjusted market value' at transition time. This provision overcomes the problem of 'double exclusion' or 'double inclusion' of income as a result of the operation of new sections 57-15 and 57-25 in relation to certain assets, if an unadjusted market value was used. This is better illustrated by example.
Example 1:  Assume an exempt taxpayer acquires an interest bearing security at year 1 (T1) for $100; interest of $10 is received in arrears at T2, T3, T4 and T5; the security is redeemed at T5; transition time is T/T; and at T/T $6 of the $10 interest receivable at T3 has accrued. Also, the prevailing interest rates at T/T are the same as those that existed at T1, and the market value of the instrument is $106.

7.37	At T/T both new section 57-15 and new section 57-25 apply. The total cash flow resulting from the application of new section 57-15 alone is $24; $4 at T3, $10 at T4 and at T5 with no gain or loss at redemption. However, with the application of both new sections 57-15 and 57-25, using an unadjusted market value, the result is $18; $4 at T3, $10 at T4 and at T5 and a $6 loss at redemption ($106 - $100). Under this approach the $6 interest which accrued prior to the transition time would have been excluded twice from the assessable income - once through the operation of new section 57-15 (at T3) and then again as a deduction for $6 loss on redemption through the operation of new section 57-25. The market value thus needs an adjustment to ensure that double counting does not occur.
Example 2: Assume similar facts to example 1 except that interest is received in advance.

7.38	Similar difficulties arise where interest is received in advance. In the example, $4 of the interest received in advance at T2 in respect of the taxable period (ie. for the period from T/T to T3) would be included twice in the assessable income - once through the operation of new section 57-15 and then again as a $4 gain at redemption through the operation of new section 57-25, if an unadjusted market value was used. The gain results because the market value of the asset at transition time is taken as $96 (ie. the $4 interest received in advance at T2 is reflected in the market value) and it is redeemed at $100. 
7.39	The double inclusion and exclusion referred to above could happen where interest is received or accrues on an asset on a daily basis. Interest could be received either in advance or in arrears. New section 57-15 will apply at transition time to effectively allocate any interest income relating to the exempt period to that period and will ensure that only interest income relating to the period after transition time is allocated to that period. At the same time new section 57-25 also applies and deems a disposal and re-acquisition of the asset.
7.40	The difficulty as explained above is overcome by new subsection 57-25(3) deeming the re-acquisition of assets at their 'adjusted market value'. The adjusted market value is taken to be the asset's market value at transition time reduced by any amount received or receivable in respect of the asset after the transition time that would have otherwise been included in the assessable income, but for either (i) the operation of new subsection 57-15(2) or (ii) the taxpayer being exempt from tax. The market value will be increased by any amount received or receivable in respect of the asset before the transition time that is included in the assessable income because of the operation of new subsection 57-15(1) or because the transition taxpayer's income ceased to be exempt from income tax. An amount could also be held assessable and thus included in the assessable income of the transition taxpayer by virtue of other provisions, eg subsection 25(1) or Division 16E. Any amount so included will need an adjustment because it will affect the market value the same way it does for amounts included under new subsection 57-15(1).
7.41	The 'adjusted market value' concept in new subsection 57-25(3) will generally only have an effect on financial assets like interest bearing loans and interest rate swaps which also have a cash flow.
7.42	For instance, an asset which was purchased by the entity for, say, $100 but has a market value of $120 at the time when the entity becomes taxable, will be taken, for the purposes of determining future gains or losses arising from disposal of that asset, to have been acquired by the entity for $120. If the asset is later sold for $125, the maximum amount that could be assessable in respect of the sale is $5.
7.43	There are some exceptions to the general rule established in new subsection 57-25(2). The general revaluation of assets provided for in that subsection will not apply for the purposes of section 54 to 62AAV, Divisions 10 to 10D or Subdivision B of Division 3 of Part III of the Act [new subsection 57-25(4)]. This provision makes it clear that depreciation and other capital allowance deductions will be based on the original cost of the particular items of plant or property. 
7.44	This general rule is considered to be more appropriate than seeking to bring to account on disposal of an asset a proportion of an overall gain or loss, based on the original actual cost of the asset, and apportioned between the part of the time for which the asset was held before the transition time and the balance of the period for which it was held.
7.45	One effect of this general rule is that assets acquired by the entity before the date of effect of the capital gains provisions will nevertheless be treated as acquired later, and so possibly subject to those provisions when sold. This might be thought to be inconsistent with the 'rule the books' approach. However, assets are deemed to have been disposed of and reacquired in any event for the purposes of the capital gains tax provisions once a majority of underlying interests change (see section 160ZZS). As entities most commonly become taxable in the context of progressive privatisation, a failure to apply this general rule could be likely to hinder the orderly privatisation of formerly exempt government entities.
7.46	The exceptions mentioned above are only for the purposes of the operation of those sections. The assets are still subject to the deemed disposal and re-acquisition rule in quantifying any gain or loss made on the subsequent disposal or change in value of that asset.
7.47	Similarly new subsections 57-25(5) and (6) are inserted to ensure that the deemed acquisition rule in new subsection 57-25(2) will not affect the operation of sections 26BB, 26C, 70B or Divisions 3B and 16E of Part III. The dates of effect of those provisions ensure, for example, that certain securities do not come within their operation. Where an asset was acquired before the date of effect of those provisions and therefore should not be affected by those provisions, the deemed acquisition in new subsection 57-25(2) will not make those assets subject to those provisions. For example an asset acquired by an entity on or before 10 May 1989 will not, because of the operation of new subsection 57-25, now be subject to section 26BB. Again the assets themselves will still be subject to the deemed disposal and re-acquisition rule for the purposes of quantifying any future gain or loss.
7.48	The fact that the transition taxpayer is taken to have purchased its assets at the transition time does not mean that deductions which have been incurred before the first taxing time and which are for goods provided, services rendered or the doing of another thing in that period are reincurred and become deductible. Similarly, the deemed acquisition rule does not mean that a deduction which is incurred at or after the transition but which is in respect of goods provided, services rendered or the doing of some other thing in the exempt period loses its relationship to the exempt period. This is made clear by new subsection 57-25(1), which provides that the section applies to the disposal of an asset after the transition time.
7.49	A loan asset of a newly taxable entity may have a market value, due to the amount of doubtful debt provision, considerably less than its face value. New subsection 57-25(7) puts beyond doubt that if the market value of the debt is lower than the face value of the debt less the specific provision, then a deduction in the event of writing off the debt as bad is limited to this lower amount.
7.50	The words 'disposed of' are meant to be given the widest possible meaning to cover all forms of disposal. As such an act of disposal would therefore include certain actions which may not effect an alienation of the asset or right to payment like an extinguishment of a debt [new subsection 57-25(8)].
Deemed cessation and re-assumption of liabilities
7.51	For the purposes of working out deductions that are allowable or gains that are assessable after the transition time, the amendments will treat liabilities of an entity as having been satisfied immediately before the entity becomes taxable and then assumed again immediately after it becomes taxable [new subsection 57-30(1)]. The entity will be taken to have received consideration in return for taking on these liabilities equal to the market value of the corresponding asset or right held by the person to whom the liability is owed. This is because it is not strictly possible to talk about a liability as having a market value of its own. In broad terms, liabilities will be valued at the amount the entity would have had to pay to meet those liabilities immediately before it became taxable.
7.52	The deemed re-assumption of liabilities could have an effect, for instance, where the entity subsequently satisfies a liability that it had before it became taxable. Assume the entity originally received $900 from the issue of a discounted security and is required to pay $1000 to the holder on maturity. If half of the discount period had elapsed at the time of the entity becoming taxable then, in broad terms, half of the discount expense would have accrued during that period. In that case, the entity could expect to obtain a deduction after it becomes taxable of $50, in respect of the remaining discount expense. However, if the market value of the security at the time it becomes taxable was, say, $940, the effect of new subsection 57-30(1) would be to allow a deduction of $60, being the difference between the consideration deemed to have been received at the time of becoming taxable and the amount required to be paid on maturity (ie. $1000 - $940).
7.53	The market value of the right or other asset corresponding to the liability that has been re-assumed has to be adjusted in a similar way to that done for assets in new subsection 57-30(3). This is done to overcome the problem of 'double exclusion' or 'double inclusion' of an amount of deduction for interest paid as a result of the operation of new sections 57-20 and 57-30. The following example illustrates the problem.
Example 3:	Assume an exempt taxpayer borrows $100 at T1, interest payments of $10 are due at T2, T3, T4 and T5, the transition time is T/T, at T/T $6 of the interest payment payable at time T3 is due. The prevailing interest rates at T/T are the same as existed at T1, and the market value of the loan at T/T is $106. The loan matures at T5.

7.54	New sections 57-20 and 57-30 both apply at T/T. The total amount of deduction allowable as a result of the application of new section 57-20 alone is $24; $4 at T3, $10 at T4 and at T5 with no gain or loss at final settlement/discharge. However, with the application of both new sections 57-20 and 57-30 using an unadjusted market value, the result is $18; $4 at T3, $10 at T4 and at T5 with a $6 gain on settlement ($106 - $100). Under this approach the $6 interest payment which relates to the exempt period has been excluded twice from deductibility - once through the operation of new section 57-20 and then again through the operation of new section 57-30 total deduction allowable has been reduced by $6 because the liability is taken to be $106 ( ie. at T/T the $6 interest payment relating to the exempt period is reflected in the market value of the corresponding asset). To overcome this problem the market value of the corresponding asset needs adjustment.
Example 4: assume similar facts to example 3 except that interest is paid in advance.

7.55	Where interest payment is made in advance the $4 interest paid in advance at T2 in respect of the taxable period (ie between T/T and T3) is allowed as a deduction twice - once through the operation of new section 57-20(1) and then again through the operation of new section 57-30 a deduction of $4 is allowable for the loss on final settlement because the liability is taken to be at $96. This loss is also only a paper loss. An adjustment to the market value of the corresponding asset is required to overcome this problem.
7.56	The difficulty as explained above is overcome by new subsection 57-30(2) which deems the liabilities to have been re-assumed at the transition time in return for consideration equal to the 'adjusted market value' of the right or the corresponding asset.
7.57	The 'adjusted market value' of the right or other corresponding asset is taken to be the market value of the right or corresponding asset reduced by any amount paid or that became payable in respect of the liability that is not an allowable deduction either because of new subsection 57-20(2) or because of any other provision of the Act; and increased by any amount paid or that became payable in respect of the liability that is allowed or allowable as a deduction either because of new subsection 57-20(1) or because of any other provision of the Act.
7.58	The definitions of asset and liability have been deliberately cast widely to ensure that appropriate assets and liabilities are included in the revaluation [new section 57-35]. Trading stock has been excluded from the definition of asset because it is dealt with in new section 57-115.
7.59	Assets and liabilities which would not be appropriately treated under new Subdivision 57-E would be those dealt with under the specific provisions of new sections 57-15 and 57-20. For example, the transition taxpayer may have derived, but not received, income before the transition time. At transition time it will have an asset viz. the right to receive income. When the income is actually received the asset is arguably disposed of. In this case a specific provision [new section 57-15] will have correctly allocated the income so there is no further function for new section 57-25 to perform.
Superannuation contributions
7.60	Section 82AAC of the Act allows a deduction, in general terms, for superannuation contributions made by an employer to a complying superannuation fund for the benefit of an employee.
7.61	New section 57-40 modifies how section 82AAC applies to contributions under a defined benefit scheme made by a transition taxpayer in relation to an employee.
7.62	New section 57-45 allows a deduction to a transition taxpayer in the transition year for any surplus existing at the transition time in respect of a defined benefit scheme.
7.63	New section 57-50 modifies how section 82AAC applies to contributions made by a transition taxpayer to  superannuation funds generally. Contributions will include those made to accumulation funds and to defined benefit schemes.
7.64	In each case, superannuation contributions that would otherwise be allowable are available only to the extent that they exceed unfunded liabilities at the transition time and outstanding contributions at that time. New section 57-55 will ensure that deductions are not reduced under both new sections 57-40 and 57-50.
Defined benefit contributions
7.65	New section 57-40 applies to a superannuation contribution made by a transition taxpayer:
	under a defined benefit scheme (within the meaning of section 6A of the Superannuation Guarantee (Administration) Act 1992); and
	in relation to a person who was ever, whether before or after the transition time, an employee of the entity [new subsection 57-40(1)].
The section will deny a deduction for contributions to defined benefit schemes to the extent of any overall shortfall at the transition time in defined benefit schemes.
7.66	New subsection 57-40(2) provides that such contributions are not tax deductible if total contributions in a year of income don't exceed a threshold amount, termed the 'defined benefit threshold amount'. This term is defined in new subsection 57-40(4) to mean, if the relevant year is the transition year, the transition taxpayer's 'unfunded liability amount'. The latter amount refers to the deficit which occurs when the transition taxpayer has outstanding unfunded liabilities to provide benefits for its employees, based on actuarial principles.
7.67	In a year of income after the transition year, new paragraph 57-40(4)(b) provides that the 'defined benefit threshold amount' is the amount worked out for the transition year as reduced by contributions denied as a deduction to the transition taxpayer in previous years under new subsections 57-40(2) or (3). The amount will be progressively reduced in this way until it is extinguished.
7.68	If total contributions in a year of income exceed the 'defined benefit threshold amount', the excess is deductible. New subsection 57-40(3) is required because it is possible to make more than one contribution in a year and each separate contribution is potentially deductible. The subsection provides that if the sum of all superannuation contributions in a year exceed the deduction limit in new subsection 57-40(2), then an allocation of a part of the deduction limit to be disallowed is made to each superannuation contribution made in the year. This has the effect of allocating to each individual deduction a proportion to be disallowed based upon the ratio of the threshold limit to the total deductions otherwise allowable.
7.69	In the transition year the 'unfunded liability amount' is defined by new subsection 57-40(5) as the actuarial value of the liabilities for superannuation benefits which the transition taxpayer must provide for employees or dependants of employees of the transition taxpayer, that:
	had accrued at the transition time;
	were, based on actuarial principles, unfunded at that time; and
	related only to defined benefit schemes.
Fund surpluses
7.70	A defined benefit scheme may have a surplus in the reserves of the scheme. The surplus would be available to meet the benefit obligations of the scheme and would therefore reduce the actuarial value of the unfunded obligations of the scheme in determining the 'unfunded liability amount' of the scheme.
7.71	New section 57-45 provides therefore that a transition taxpayer will be entitled to a tax deduction in the transition year for the amount of any remaining surplus in excess of the unfunded liabilities. The deduction is only allowable where an amount has been set aside for the sole purpose of meeting unfunded liabilities.
Contributions generally
7.72	Whereas a defined benefit scheme provides an agreed level of benefits for members of the scheme at retirement, accumulation funds provide benefits to a member based on the amount contributed to the fund. 
7.73	New section 57-50 ensures that superannuation contributions made after transition are not tax deductible to the extent that they are in respect of liabilities that accrued during the period the entity was exempt from tax. The contributions for which deductions are limited may relate to employees employed at any time, before the entity became taxable, or on or after that time.
7.74	New subsection 57-50(2) provides that deductions to which the section applies are not allowable if they don't exceed the 'general superannuation threshold amount'. This term is defined in new subsection 57-50(4) to mean, if the relevant year is the transition year, the transition taxpayer's 'undischarged superannuation liability amount'. The latter amount refers to the deficit in the transition taxpayer's obligations to make contributions in respect of service by its employees.
7.75	In a year of income after the transition year, the 'general superannuation threshold amount' is the amount worked out for the transition year as reduced by an amount of contributions denied as a deduction to the entity in previous years under new subsections 57-50(2) or (3). The amount will be progressively reduced in this way until it is extinguished.
7.76	If total contributions in a year of income exceed the 'general superannuation threshold amount', the excess is deductible. New subsection 57-50(3) is required because it is possible to make more than one contribution in a year and each separate contribution is potentially deductible. The subsection provides that if the sum of all superannuation contributions in a year exceed the deduction threshold amount in new subsection 57-50(2), then an allocation of a part of the deduction threshold amount to be disallowed is made to each superannuation contribution made in the year. This has the effect of allocating to each individual deduction a proportion to be disallowed based upon the ratio of the threshold limit to the total deductions otherwise allowable.
7.77	The transition taxpayer's 'undischarged superannuation liability amount' is determined by way of a five step method in new subsection 57-50(5). A net figure is reached for each employee after subtracting actual contributions in Step 2 from required contributions in Step 1. These individual figures are added together in order to arrive at the transition taxpayer's total amount.
7.78	Step 3 of new subsection 57-50(5) ensures that contributions are matched only against individual obligations in respect of a particular employee. Where a transition taxpayer makes excess contributions in respect of any employee, those contributions will not reduce the total shortfall for all employees. That is, contributions which are still outstanding in respect of employee X (because of an award etc. or superannuation guarantee requirement) cannot be offset by excess contributions applied to employee Y. If a contribution in relation to a particular employee is greater than the obligation in relation to that employee, then the figure obtained after step 2 would be negative. In such a case, step 3 converts the negative amount to zero, so that when the total 'undischarged superannuation liability amount' is determined, the overall figure is not reduced.
7.79	The amounts in paragraphs (a), (b) and (c) in new subsection 57-50(5) refer to those contributions that the transition taxpayer is required to make in respect of an employee because of an award etc, or because of the superannuation guarantee obligation. The amounts in paragraphs (d) and (e) of new subsection 57-50(5) are those which are contributed by the transition taxpayer either because of an award etc or superannuation guarantee legislation requirement, or voluntarily.
7.80	The component parts (a), (b) and (c) of new subsection 57-50(5) also address the various possible scenarios which may apply to employees employed by the transition taxpayer at any time before the transition time. This measure is necessary because the shortfall amount before the transition time may vary for different employees, as demonstrated by the following examples:
	Employee A is subject to an award from the time he or she commences employment until the Superannuation Guarantee (Administration) Act 1992 (SGAA) came into effect. The shortfall for that period is therefore measured by required award etc. contribution amounts less any actual contributions. From the time of the SGAA coming into effect and for a further period, the superannuation guarantee minimum is higher, and the shortfall for this period is measured by the required superannuation guarantee contribution amount less actual contributions. At some later stage the award changes so that the award amount is higher up until the transition time. The shortfall amount in relation to this period is the required award amount less actual contributions. The total shortfall for employee A is calculated by adding these three net figures together.
	Employee B is subject to a different award. For this employee the award minimum is higher for the entire period up until the transition time, and therefore the shortfall is measured by the required award etc. contribution amounts less actual contributions.
	Employee C commences employment after the SGAA comes into effect, and although an award applies, the superannuation guarantee minimum amount is always higher up until the transition time. Therefore the shortfall for this employee is measured by the required superannuation guarantee contribution amounts less actual contributions.
7.81	The 'superannuation guarantee period' is that period beginning at the start of the earliest contribution period (as defined by the SGAA) and ending at the transition time [new subsection 57-50(6)]. This provision also ensures that new section 57-50 is applicable to superannuation obligations which have accrued as at the transition time, as the component parts of new subsection 57-50(5) refer to either the period before the commencement of the superannuation guarantee period, or the superannuation guarantee period itself. Therefore, as the latter is defined as that period of time ending at the transition time, only those obligations which arose before the transition taxpayer became taxable are to be included.
7.82	The term 'required award etc. contribution amount' as used in new subsection 57-50(5) is defined in new subsection 57-50(7) as the amount required to be contributed to an employee superannuation fund under an award, arrangement, law, or applicable superannuation scheme or otherwise.
7.83	The term 'required superannuation guarantee contribution amount' is defined in new subsection 57-50(8) as the amount that would need to be contributed by an employer in respect of a contribution period, as defined by the SGAA, so that no superannuation guarantee shortfall would arise for that period.
7.84	New section 57-55 ensures that there is not a double reduction in deductibility because of new sections 57-40 and 57-50 For example, where the transition taxpayer contributes $50 to a fund, and both the 'defined benefit threshold amount' [new subsection 57-40(4)] and the 'general superannuation threshold amount' [new subsection 57-50(4)] are $25, the amount to be denied as a deduction will be $25 and not $50 [new paragraph 57-55(b)].
7.85	New section 57-55 also deals with the case where one section would result in a greater denial, for example, where the threshold amounts are $35 and $25 respectively. New paragraph 57-55(a) provides that the greater denial applies.
7.86	However, new section 57-55 is to be disregarded for the purposes of calculating the 'defined benefit threshold amount' [new subsection 57-40(4)] and the 'general superannuation threshold amount' [new subsection 57-50(4)] in a year of income after the transition year. This ensures that where a contribution by an employer is subject to the deduction limit under both new sections 57-40 and 57-50, both the thresholds are reduced by the amount of the contribution [new paragraphs 57-40(4)(b) and 57-50(4)(b)].
Pre-transition time accrued leave entitlements
7.87	New section 57-60 ensures that long service leave and annual leave payments (including leave loadings) otherwise allowable, whether for employees before or after the transition time [new subsection 57-60(1)], are not deductible under subsection 51(1) to the extent of obligations and potential obligations existing immediately before the entity became taxable. 
7.88	The amount of (or remaining amount of) pre-existing obligations is known as the '(pre-transition time service) leave amount' [new subsection 57-60(5)]. Deductions for annual or long service leave will be denied until, in total, they exceed this amount [new subsections 57-60(2) (3) and (4)].
7.89	There are two types of leave amounts which make up this total. The first is an amount payable for long service leave and annual leave that (at the transition time) employees are eligible to take. An example is an amount for long service leave of employees who have worked ten or more years but have not taken the leave where the award provides that employees are entitled to the leave after ten years' service. This sort of amount is valued as at transition time, at the current rate of pay of employees to whom it relates.
7.90	The other type of leave is that which is not a vested entitlement of a particular employee at the time the entity becomes taxable. For example, at the time of transition an entity may have an employee who only has two years of employment for long service leave purposes and therefore the entity has no legal obligation in respect of long service leave for that employee. However if that employee later becomes entitled to long service leave (for example after completing another eight years' service), that leave would relate in part to the exempt period.
7.91	The Bill will therefore provide a means of determining the amount of long service leave and annual leave accrued at the date the exempt entity becomes taxable where that leave has not become an entitlement for the period of service due to, for example, an insufficient period of service by an employee.
7.92	The entity may choose from two options in calculating this annual or long service leave obligation. The entity may simply assume that all employees have become entitled at transition time and calculate the obligation on that basis [new paragraph 57-60(5)(c)]. This is a simple calculation and is provided as an option for those entities who do not wish to make more complex calculations. 
7.93	Because not all employees will necessarily remain in employment and qualify for long service leave and in some cases annual leave, the entity may elect to use an actuarial calculation [new paragraph 57-60(5)(b) and new subsection 57-60(6)]. This method allows an entity to calculate the present value of an amount needed to satisfy annual leave and long service leave liabilities which would reasonably be expected to arise. This calculation would take into account, for example, the probability that not all employees would eventually become entitled to the leave because of resignation, death etc. It would also take into account salary increases and inflation, over the period before which the leave would be taken, and the return on any amounts set aside at transition.
7.94	It would be expected that in most transitions in which an entity is acquired by a new owner, the new owner would carry out a calculation of leave liability. This requirement should therefore not add to the compliance costs of such purchasers.
Pre-transition time provision for bad debts
7.95	After an entity becomes taxable it will be entitled to tax deductions in respect of bad debts it writes off. The Bill will deny deductions otherwise available for bad debts written off by an entity to the extent to which debts were known to be doubtful before the entity became taxable. [New section 57-65]
7.96	At the transition time an entity will need to identify the amount which, under generally accepted accounting principles, would represent an appropriate doubtful debt provision for each of the debts of the entity. This is called the 'pre-transition doubtful debt limit' [new subsection 57-65(5)]. This amount may be fully reflected in the final accounts of the entity at transition time. However the limit is expressed in terms of an objective test and so the proper amount will be required by the section in situations of under, over or nil provisioning.
7.97	Where the 'doubtful debt provision limit' has included in it a specific provision against a debt, and the debt is recovered in excess of the net amount (that is, debt less the provision), then the 'doubtful debt provision limit' will be reduced by the excess amount.  The new subsection 57-65(6) will enable the 'doubtful debt provision limit' to be adjusted to reflect the actual situation in relation to debts.
7.98	Deductions for bad debts written off after the transition time will be disallowed until this limit is exhausted. This will be so even if the debt came into existence after the transition time. If the sum of all deductions otherwise allowable for bad debts written off in a year of income exceeds the 'doubtful debt provision limit' (defined as the 'pre-transition doubtful debt limit', reduced by the amount of any bad debt deductions denied under this provision in earlier years, in new subsection 57-65(4)]) the limit will be apportioned over all of the deductions for that year [new subsection 57-65(3)].
7.99	The rule will not apply to general provisioning for doubtful debts which covers non-specific, unidentified risks. Where such general provisioning bears no relationship to any particular debt, it would not be appropriate to take it into account in denying deductions in respect of any debts written off after the entity becomes taxable. It would not represent doubtful debt provisioning under generally accepted accounting principles.
7.100	There are generally two ways in which debts are covered by specific provisions for doubtful debts. The first way is when specific provision is made against an individual debt. The second way is when debts of a particular class are covered by a specific provision for doubtful debts against that class of debts. An example of the second type is where a financial institution makes a specific provision against all credit card debts. Both types of bad debt provisioning make up the 'pre-transition doubtful debt provision limit'.
7.101	New section 57-65 applies to deductions for writing off a bad debt based on the original face value of the debt. The deemed disposal and re acquisition of the debt by virtue of new subsection 57-25(2) does not allow a deduction to which new subsection 57-65 applies to exceed the market value of the debt at the transition time.
Eligible termination payments
7.102	The Bill will deny deductions for eligible termination payments made by an entity to a person who was employed at any time before the transition time [new section 57-70]. The deduction denied will be so much of the deduction as relates to the period of service before the transition date [new subsection 57-70(2)]. 
7.103	Approved early retirement scheme payments and bona fide redundancy payments (as defined in section 27A(1) of the Act) are excluded from the operation of this section [new subsection 57-70(3)]. This is because essentially these payments are an expense of the trading entity in restructuring for the future and are properly referrable to the taxable period.
7.104	The fact that deductions will be fully allowable for approved early retirement scheme payments and bona fide redundancy payments does not mean that the Government is encouraging the use of such payments as a device by entities. Only legitimate arrangements are likely to meet the definitions of approved early retirement scheme payments and bona fide redundancy payments. Wrongful dismissal laws also discourage entities considering large scale dismissals as a device for avoiding the limit on deductions for eligible termination payments.
Domestic losses
7.105	Generally, a company is entitled to carry forward losses incurred in one income year for deduction against its assessable income in subsequent years, subject to certain limitations. Section 79E of the Act provides that domestic losses incurred in the 1989/90 and later income years may be carried forward indefinitely until absorbed. Section 80 provides that domestic losses incurred in pre-1989/90 income years could be carried forward for a maximum of seven years.
7.106	A loss is incurred in any income year if the company's allowable deductions, other than any unrecouped losses brought forward from an earlier year, exceed the sum of its assessable income and the net exempt income of the year. This loss may be carried forward and deducted in arriving at the taxpayer's taxable income of succeeding income years.
7.107	New section 57-75 ensures that losses incurred while the transition taxpayer was exempt are not recognised because these losses occurred at a time when income was exempt and carry forward losses were non-deductible.
7.108	Therefore, where a transition taxpayer applies section 79E, 79F, 80, 80AAA or 80AA of the ITAA for the purposes of calculating any tax loss that may be carried forward, new section 57-75 effectivley ensures that:
	exempt income derived before the transition time, in the transition year, cannot be used to reduce any loss of the transition year [new paragraph 57-75(a)]; and
	non-loss deductions (as defined in section 79E) can include only those non-capital expenses which were incurred at or after the transition time [new paragraph 57-75(b)].
Opening written down value of depreciable assets
7.109	The Bill will ensure that depreciable assets are brought into the tax system at a value which reflects the fact that they have been used since they were first acquired or constructed. [New section 57-80]
7.110	For instance, where an item was acquired originally by a government department and was later transferred to a corporatised government entity which is then sold (and so becomes taxable) new section 57-80 in conjunction with new section 57-10 ensure that the item is notionally depreciated from the original date of acquisition of the item by the government department. Notional depreciation means, in effect, that it is assumed that both the government department and the corporatised entity were tax paying entities and therefore subject to the depreciation provisions. 
7.111	This effect follows because the new section applies to every unit of plant or articles that an entity owns at the transition time. It applies wherever the entity (or an associate) acquired or constructed the unit at some time before transition, so that the unit has been owned by the entity or its associate continuously from that time to the beginning of the depreciation period. [New subsection 57-80(1)]
7.112	Such a unit of property is treated as having been depreciable to the entity or any relevant associate from the time it was so acquired or constructed. This produces the opening written down value at the transition time. [New subsection 57-80(2)]
7.113	An entity can choose either the prime cost or diminishing value method of depreciation. However, the Bill will ensure that the method used to obtain the opening written down value at transition time is the method used for the remainder of the life of the asset [new subsection 57-80(3)]. This ensures that the entity receives the same treatment that other taxpayers receive when making an election under section 56 of the Act.
7.114	In new subsection 57-80(1) the Bill refers to property being plant or articles. This is not the same as saying 'property subject to depreciation'. There is no argument therefore that property is not subject to this provision because an entity was exempt and not subject to depreciation.
Capital allowances and certain other deductions
7.115	New Subdivision 57-J deals with capital allowances and certain other deductions which would otherwise be allowable to the transition taxpayer had they always been taxable. Such expenditure is recognised as having a benefit which may endure into the taxable period and, to the extent to which it does endure, should become deductible. Where a transition taxpayer has incurred this type of expenditure before the transition time, deductions will be apportioned in the transition year according to whether the expenditure was incurred in a year before the transition year, or in the transition year before the transition time.
7.116	Many capital allowance and other provisions allow expenditure to be written off over a number of years. Alternatively, expenditure may be written off entirely in the year of income in which the expenditure was incurred. In both cases, new sections 57-85, 57-90 and 57-95 apportion expenditure incurred while the transition taxpayer was exempt, in two scenarios:
	expenditure is incurred in a year before the transition year and the transition taxpayer becomes taxable in a later year, within the time limit for writing off expenditure;
	expenditure is incurred in the transition year before the transition time, where the transition year is the first year of amortisation, or the deduction is allowable in full in that year.
7.117	New section 57-85 sets out the expenditure provisions of the Act to which the new rules will apply. Each of these provisions are described as a 'modified deduction rule' for the purposes of apportionment of expenditure before the transition time. 
7.118	New section 57-90 assumes a notional write down. The assumption is that for the purposes of calculation of deductions, all of the modified deduction rules had applied at all times. For example, it ensures that where a transition taxpayer has incurred capital expenditure which is deductible over more than one year, and the transition year is a year of income later than that in which the expenditure was incurred, the remaining deductions will be allowed as if the transition taxpayer had always been taxable. That is, after the transition year, the taxable entity will be able to write off expenditure using the original expenditure as a basis.
7.119	New section 57-95 ensures that expenditure is apportioned in the transition year in order to address both of the scenarios described above. Expenditure incurred before the transition time is apportioned according to the formula set out in new subsection 57-95(1). This formula applies whether or not expenditure is incurred during the transition year, and is based on the number of whole days in the transition year after the transition time, divided by the 'post expenditure part'.
7.120	Where expenditure was incurred before the transition year, the 'post expenditure part' is defined as the number of days in the transition year [new paragraph 57-95(1)(a)]. This addresses the scenario where expenditure is written off over several years, and was incurred in a prior year. For example, a transition taxpayer may have otherwise been entitled to a deduction under section 70A in the 1990/91 income year for the connection of mains electricity. This deduction would ordinarily be written off over 10 years. In the 1995/96 income year, the transition taxpayer becomes taxable. Therefore, for the purposes of apportioning expenditure in the transition year, the 'post expenditure part' is based on the number of whole days in the transition year, and the deduction amount is based on the amount that the transition taxpayer would have been entitled to had it been taxable in the 1990/91 income year. The taxpayer will then continue to claim the remaining deductions between the years 1996/97 and 1999/2000.
7.121	Where the expenditure was incurred in the transition year but before the transition time, the 'post expenditure part' is defined as the number of days in the period from the beginning of the day on which the expenditure is incurred until the end of the transition year. This method of apportionment takes into account the length of time between the incurring of the expenditure and the transition time. Since a deduction is allowable in full if the expenditure is incurred after the transition time, the formula allows a deduction which approaches the full amount of deduction for the year, the closer the incurring is to the transition time. The formula applies both where the expenditure is fully deductible in the year in which it is incurred, and where it is allowed over several years.
7.122	New subsection 57-95(2) provides that the section does not apply to an amount to which new paragraph 57-110(1)(b) applies. This paragraph deals with apportionment of a balancing deduction which the transition taxpayer would otherwise have claimed under the relevant balancing adjustment provisions of the Act. New subsection 57-95(2) ensures that the balancing deduction referred to in new paragraph 57-110(1)(b) is not included in the capital allowance and other deduction provisions, and is therefore not apportioned in the manner set out in new section 57-95.
Elections
7.123	Certain deductions in the 'modified deduction rule' list in new section 57-85 include provisions allowing elections, declarations or the giving of a notice by the taxpayer. A taxpayer would, were it not exempt, be entitled to make such an election or declaration or give such a notice in relation to a year of income in certain circumstances. Although notional deductions can be calculated on the basis that the taxpayer was not exempt at the relevant time, it is not possible to determine whether a particular taxpayer would have made an election or declaration or provided a notice in a given circumstance. New section 57-100 provides therefore that these elections, declarations or notices are to be disregarded for the purpose of working out the transition taxpayer's allowable deductions under a modified deduction rule [new paragraph 57-100(a)].
7.124	Further, new paragraph 57-100(b) provides that any such election, notification or notice under a modified deduction rule in relation to the transition year has no effect in so far as it relates to expenditure incurred before the transition time. This ensures that a transition taxpayer cannot make an election or declaration, or give a notice, in relation to the transition year, unless the expenditure to which it relates is incurred after the transition time. Expenditure incurred before transition time cannot therefore be transferred to another taxpayer. An exception to this is provided for a declaration under subsection 124AZDA(1). This declaration is a prerequisite for obtaining a deduction for expenditure on Australian films so is necessary if a deduction is to be obtained.
Special rules for mining and quarrying
7.125	New subsection 57-105(1) assumes that no exploration or prospecting expenditure is incurred prior to the transition time. This assumption ensures that there will be no deduction after the transition time for expenditure incurred before the transition time.
7.126	Without this provision it is arguable that a transition taxpayer could claim a deduction for all expenditure of this type which it incurred before the transition time. As such expenditure clearly relates to the exempt period it is appropriate that a deduction is not available.
7.127	The rules under new subdivision 57- J effectively create a notional write off for capital expenditure. Certain mining capital expenditure may be able to be carried forward if there is insufficient income against which to deduct it. New subsection 57-105(2) effectively ensures that no unused deductions under the mining provisions can be carried forward into the tax net. It does this by assuming that the expenditure will be fully written off in each year before the transition year. 
Balancing adjustments
7.128	Certain provisions of the Act allow for a balancing adjustment where property in respect of which a deduction is allowable is disposed of lost or destroyed. Ordinarily, where a taxpayer disposes of, loses or destroys the property to which capital expenditure relates, they are entitled to a deduction where the consideration received in respect of the disposal etc, or the value of the property at the date of disposal, plus deductions allowable, is less than the total capital expenditure in respect of that property. The amount of the difference is allowable as a deduction. Where the consideration received on disposal, or the value at that time, plus deductions allowable, is greater than the total capital expenditure in respect of that property, the taxpayer is required to declare the excess in their assessable income.
7.129	In the case of an exempt taxpayer the deductions allowable over a period of years are notional until the transition time. After that time the taxpayer will be able to claim the remaining actual deductions, as provided by new section 57-90. In order to reflect the fact that capital expenditure was incurred on property that was used for exempt purposes for some of the period of use by the taxpayer, the balancing adjustment will therefore be apportioned in the manner set out in new section 57-110. This apportionment will apply to amounts included or deducted in the transition year or in a later year of income.
7.130	New subsection 57-110(1) provides a formula which determines how much of the balancing adjustment will be included in the assessable income of the transition taxpayer, or is allowable as a deduction, as the case may be. The relevant amount is determined by multiplying the balancing adjustment otherwise allowable by the following formula:
Actual deductions divided by actual deductions plus notional deductions
'Actual deductions' is defined as the sum of all actual deductions actually allowed or allowable to the transition taxpayer for the expenditure under the deduction rule to which the balancing adjustment provision relates.
'Notional deductions' is defined as the sum of all deductions for the expenditure that would have been allowable to the transition taxpayer under the deduction rule to which the balancing adjustment provision relates, if the transition taxpayer had never been wholly exempt from income tax.
7.131	The 'balancing adjustment provisions' are described in new subsection 57-110(2). These are provisions of the Act which entitle the taxpayer to a balancing deduction or impose a balancing charge on disposal, loss or destruction of property to which capital expenditure relates.
7.132	The 'deduction rules' are set out in new subsection 57-110(3). These are the provisions of the Act to which the relevant balancing adjustment relates, and are categorised as follows:
	Subdivision A of Division 3, which contains a balancing adjustment provision in section 59 in respect of depreciated property;
	Division 10C, which contains a balancing adjustment provision in section 124ZE in respect of expenditure on short-term traveller accommodation;
	Division 10D, which contains a balancing adjustment provision in section 124ZK in respect of expenditure on building and structural improvements;
	in any other case, the balancing adjustment provisions contained in the 'modified deduction rule' list set out in new section 57-85. It should be noted that not all of the provisions in that list contain a corresponding balancing adjustment provision.
Trading stock
7.133	The existing trading stock provisions provide a mechanism which allows a deduction in the year of income for the cost of producing stock which was sold in the year of income. This is achieved by allowing the excess of opening stock over closing stock as a deduction in the year of income. 
7.134	The trading stock provisions require the value at the beginning of a year of income to be the value at the end of the immediately preceding year (section 29). The amendments effectively provide that this is the value immediately before the transition time. [New subsection 57-115(2)]
7.135	Section 28 of the Act requires a taxpayer to ascertain the difference in value of trading stock at the beginning and end of the year in order to determine whether they have assessable income or an allowable deduction. New subsection 57-115(1) requires that, for the purposes of that calculation in the transition year, the only trading stock that is to be taken into account as being on hand at the beginning of the transition year is such trading stock as was on hand at the transition time. This effectively excludes all pre transition purchases and disposals from the calculation.
7.136	The above provisions effectively ensure that the transition taxpayer is only assessed for trading stock purposes, in the transition year, on changes in value from transition time to the end of the year.
7.137	To ensure that transition taxpayers are able to calculate their net taxable income for the first tax year on a realistic basis, a mechanism similar to the existing trading stock provisions in section 28 is provided.  Transition taxpayers will be allowed to bring stock on hand at the transition time into account for the purpose of determining taxable income in a similar way as other taxpayers, either at cost, market or replacement value.
7.138	The section will also allow transition taxpayers to change the basis of valuation for closing stock in a similar way as the existing trading stock provisions, ie. cost, market or replacement value. However, this could allow a paper loss to be claimed as a deduction before the stock is actually disposed of.
7.139	An anti-avoidance measure [new subsection 57-115(3)] will defeat those taxpayers who would seek to manipulate stock values, where the stock is not disposed of, to obtain a once only paper deduction by selecting a high opening value, eg. market, and then opting for a lower value, eg. cost, for closing stock. This measure will only have an effect for the transition year.

Overview
8.1	The amendments in Schedule 3 of the Bill will amend the Development Allowance Authority Act 1992 (the DAA Act).
Summary of the amendments
Purpose of the amendments
8.2	The objective of these amendments to Chapter 3 of the DAA Act is to prevent certain types of schemes undermining the integrity of the infrastructure borrowings program by breaking the symmetry in the special tax treatments of the payer and receiver of interest. Such schemes enable indirect infrastructure borrowings to be made functionally independent of the financing of an infrastructure project thereby increasing the value of tax benefits to those involved and the cost to revenue without a commensurate increase in the funding for private sector projects. To this end, the amendments will require:
·	new indirect infrastructure borrowings or refinancing infrastructure borrowings that succeed them to be made only by Australian resident taxpayers; and
·	any transfer of rights by a direct infrastructure borrowing lender or repayment of a direct infrastructure borrowing to be accompanied by repayment or parallel transfer of any associated indirect infrastructure borrowing or refinancing infrastructure borrowing that has succeeded the indirect infrastructure borrowing.

Date of effect
8.3	These amendments will apply from 30 October 1995.
Background to the legislation
General
8.4	Taxpayers who borrow funds to finance construction projects may not be able to utilise tax deductions for their interest costs in the early years of a project because the project produces no profits in those years and the taxpayer has no other source of income to absorb the deductions.
8.5	To encourage private investment in the construction of certain public infrastructure projects, legislation was enacted to allow companies borrowing to finance the construction of infrastructure projects effectively to transfer the interest deduction incurred on those borrowings to the providers of the finance.
8.6	This is achieved by the borrower foregoing deductions for the interest expense and the lender being exempt from tax in respect of the corresponding interest income (hereinafter to be read as entitling the lender to elect instead for a rebate of tax at the corporate rate, currently 36 per cent).
8.7	The double tax benefit of exempt interest/deductible interest expense is only available once in relation to each infrastructure borrowing.  For example, if a bank raises funds from the public via an infrastructure bond issue and on lends the funds directly to an infrastructure developer, the individual infrastructure bond investors are entitled to the double benefit.  In such a case the bank is treated as a mere conduit between the investors and the infrastructure developer, so that while its interest receipts from the developer are tax exempt its interest payments are not deductible:  it is simply a vehicle for getting investors’ funds to the developer.
8.8	This policy is embodied in Chapter 3 of the DAA Act and Division 16L of the Income Tax Assessment Act 1936 (ITAA).  The Development Allowance Authority and the Australian Taxation Office separately administer those acts and therefore jointly administer the infrastructure borrowings tax concession.
8.9	The DAA Act lays down the administrative requirements which must be satisfied before an infrastructure borrowings certificate may be granted.  Concessional tax treatment becomes available when a certificate is issued.  The requirements list the criteria for a borrower.
8.10	There are three kinds of infrastructure borrowing.  These comprise:
·	direct infrastructure borrowing (DIB)( section 93F of the DAA	Act); 
·	indirect infrastructure borrowing (IIB)(section 93G); and
·	refinancing infrastructure borrowing (RIB)(section 93H).
8.11	Each of the borrowings is required to meet the borrower requirements set out in section 93I of the DAA Act.  The basic requirements are listed in subsection 93I(2).
8.12	A DIB certificate holder needs also to comply with a spending requirement (section 93J of the DAA Act) and an intention to use requirement (section 93K of the DAA Act).
8.13	There are seven eligible types of infrastructure:  a land transport facility, air transport facility, seaport facility, electricity generating, transmission or distribution facility, gas pipeline facility, water supply facility, sewage or wastewater facility.  (Section 93L of the DAA Act)
8.14	The special tax treatment for infrastructure borrowings is available for a maximum period of 15 years.  (Section 159GZZZZD of the ITAA)
8.15	Once an infrastructure borrowing has been certified by the Development Allowance Authority, the tax effects of the borrowings on borrowers and investors are:
·	interest derived under infrastructure borrowings is not 	assessable to investors;
·	interest paid on infrastructure borrowings is not an allowable 	deduction to borrowers;
·	any profit of a trading, revenue or capital nature derived on 	disposal or redemption of any debt instrument that constitutes an 	infrastructure borrowing is tax exempt;
·	any loss of a trading, revenue or capital nature incurred on the 	disposal or redemption of any debt instrument that constitutes an 	infrastructure borrowing is not tax deductible.
Schemes to establish a free standing indirect borrowing
8.16	In late 1995, the Development Allowance Authority, the Australian Taxation Office, and Treasury became aware of attempts to market schemes which clearly contravened the intention of the infrastructure borrowings concession by seeking to obtain a multiplication of the infrastructure tax benefits.
8.17	On 30 October 1995, the previous Government issued a press release stating it would move against those sorts of schemes, ie those schemes which ‘...have the effect that indirect infrastructure borrowings can be made functionally independent of the financing of an infrastructure project. A 'free-standing' indirect borrowing would lack any justification for the special tax treatment which applies to it.  The schemes also have the effect that the symmetry in the special tax treatments of the payer and receiver of interest, which is needed in order to limit the cost to revenue of infrastructure borrowings, is broken.’
8.18	The Government has endorsed this decision in the 
1996-97 Budget with the objective of preventing those sorts of schemes from undermining the integrity of the program.  Statement 4 in Budget Paper No.1 reported: ‘If allowed to proceed, such schemes would substantially increase the value of tax benefits to those involved, and the cost to revenue, without a commensurate increase in the funding for private sector infrastructure projects.’
8.19	The arrangements outlined in the press release of 30 October 1995 are based on the quite straightforward idea that a bank or other financier, which holds an IIB and is the conduit through which infrastructure borrowings are passed on to the infrastructure developer, can assign its interest as the eligible direct infrastructure lender to another entity.  In simple terms, the original direct lender sells out its direct lending interest to another entity whilst retaining the IIB.
8.20	When that is done, the new entity obtains status as a direct infrastructure lender.  It is eligible for the double benefit of tax exemption on interest received from the developer and tax deductibility for interest paid on borrowings raised to fund the assignment.   The result, in summary, is that there are two unrelated groups of lenders in the exempt interest/deductible interest category for the one set of interest payments that are non-deductible to the project developer.
Schemes involving overseas entities
8.21	In some cases the intermediary which holds an IIB certificate is not an Australian resident and does not have a permanent establishment in Australia.  In these cases:
·	exempt interest paid to the intermediary or payments for the 	assignment of the direct borrowing rights are free of withholding 	tax in Australia; and
·	exempt interest paid by the intermediary to the Australian lenders is fully deductible in the country where the intermediary is taxed.
Explanation of the amendments
Indirect infrastructure borrowings restricted to resident taxpayers
8.22	By inserting in subsection 93D(1) definitions of ‘non-exempt resident company’ [item 2], ‘non-exempt resident corporate limited partnership’ [item 3], ‘relevant exempting provision’ [item 4] and ‘resident’ [item 5] effect is given to the Government's decison that only Australian resident taxpayers can be indirect infrastructure borrowing certificate holders.  Because of the interrelationship between the DAA Act and the ITAA, the definition of "resident" is adopted from the ITAA.  A minor alteration is made to the definition of ‘Crown lease’ [item 1].
8.23	New subsections 93I(4A), 93I(4B) and 93I(4C) require that an eligible borrower of either an IIB or a refinancing infrastructure borrowing that succeeds an IIB must be either a non-exempt resident company at the time of the borrowing or a non-exempt resident corporate limited partnership in relation to the year of income in which the borrowing is made.  Neither type of borrower can be acting in the capacity of trustee.
8.24	While holding an indirect infrastructure borrowing certificate (or a refinancing borrowing that has succeeded an indirect borrowing), the holder must remain an Australian resident taxpayer at all times. [Item 6]
8.25	If the certificate holder's taxpaying residency status changes while the indirect infrastructure borrowings (IIBs) is on foot, the Development Allowance Authority is taken to have cancelled the certificate with effect from the time of cessation of residency. [Item 7 - new section 93ZAA]
8.26	The DAA Act currently provides for grounds for cancellation of an infrastructure borrowing certificate.  Proposed new subsection 93ZAA(3) deems cessation of residency to be an additional ground for cancellation of the certificate.
Transfer of rights or repayment of a DIB
8.27	These amendments give effect to the Government’s decision that any transfer of rights or repayment under a DIB must be accompanied by a repayment or parallel transfer of any associated IIB or RIB that has succeeded the IIB.  This is intended to prevent the situation arising where IIBs are functionally independent of the financing of an infrastructure project eg. because previously related direct borrowing rights have been assigned by the direct lender to another person or have been paid out.
Transfer of rights under a DIB
8.28	Whenever a direct infrastructure lender transfers any of its rights under the direct lending instrument to another party, it will be required to either repay a related IIB or transfer the IIB certificate and all its obligations to the transferee of the rights under the direct borrowing.  Failure to do this within 30 days will cause the IIB certificate to be taken to have been cancelled by the DAA from the date of the transfer. [Item 7 - new section 93ZAB]  The transfer of any or all of the rights, interests and obligations under the IIB is deemed, in these circumstances to be an additional ground for cancellation of certificates by the DAA.
8.29	A direct infrastructure lender must repay all amounts owing on related IIBs if it transfers to another entity all its rights under the direct lending contract.  If it does not do so, cancellation of the IIB certificate may be avoided by transferring to the same transferee all remaining rights and obligations under the related IIB contract, with a consequent transfer of the IIB certificate to that transferee under section 93V of the DAA Act. [Subparagraph 93ZAB(1)(c)(i)]
8.30	If a direct infrastructure lender transfers to another entity only some of its rights under the direct lending contract, eg. by assigning its rights to receive repayments of principal or interest, it would be required to repay all amounts owing on related IIBs. [Subparagraph 93ZAB(1)(c)(ii)]
Repayment of a DIB
8.31	If the whole of a DIB is repaid, the direct lender is to be required to repay the whole of a related IIB unless the repayment of the DIB was financed by a RIB.  In this case, the IIB certificate holder can either repay the IIB or pass the certificate transfer test.  This test requires that an application be made to the DAA for the IIB certificate to be transferred to the refinancing infrastructure borrower and the DAA has transferred or is required to transfer the certificate.  Failure to do this within 30 days will cause the IIB certificate to be taken to have been cancelled by the DAA from the date of the payment.  The repayment of the DIB is an additional ground for certificate cancellation by the DAA.  [Item 7 - new section 93ZAC]
8.32	In a case where only a part of a DIB is repaid, the direct lender will be given the opportunity to reduce, in a similar proportion, the amount owing on a related IIB. Failure to do this within 30 days will cause the IIB certificate to be taken to have been cancelled by the DAA from the date of the payment.  An indirect infrastructure borrower may repay a greater proportion of the IIB within the 30 days.  [Item 7 - new section 93ZAD]
Consequential amendments
8.33	Subsection 93ZB(3) is amended so that if an IIB certificate is taken to have been cancelled a related RIB certificate is also taken to have been cancelled at the same time and for the same grounds as the IIB. [Items 8 and 9]
Application of amendments
8.34	These amendments apply where a certificate in respect of an IIB or a RIB that succeeded an IIB was issued on or after 30 October 1995. [Item 10]

Overview
9.1	The amendments contained in Schedule 4 of the Bill amend the research and development tax concession provisions contained in the Income Tax Assessment Act 1936 (ITAA) and the Industry, Research and Development Act 1986 (IR&DA) to give effect to various changes announced on 23 July 1996 and 20 August 1996.
9.2	The amendments to the ITAA are set out in Part 1 of Schedule 4 of the Bill and discussed in Section 1 of this Chapter.
9.3	The amendments to the IR&DA are set out in Part 2 of Schedule 4 of the Bill and discussed in Section 2 of this Chapter.
Section 1 - Amendments to the ITAA
Summary of the amendments
Purpose of the amendments
9.4	The amendments will:
	reduce the deduction for expenditure on plant, contracted R&D and other R&D expenditures currently deductible under section 73B of the ITAA at 150 per cent to 125 per cent [items 1 to 10];
	make companies in partnership ineligible to claim expenditure on R&D activities under section 73B [items 11 to 14];  
	limit to four years the period in which tax assessments may be amended to reduce tax liability by reason of deductions allowable for expenditure on R&D activities claimed under section 73B [items 15 to 17];
	modify the deduction rules under section 73B for interest [items 18 to 22], feedstock [items 23 to 32], core technology [items 33 to 42], and pilot plant [items 43 to 56];  
	clarify the definition of 'research and development activities' [items 57 to 61].
Date of effect
9.5	The general reduction in the premium rate of deduction will apply to expenditure incurred from 7.30 p.m., by standard time in the Australian Capital Territory on 20 August 1996 except expenditure that was required to be incurred by a contact entered into before that time other than a contract of service. [Item 10]  
9.6	The change to limit the period for amending assessments applies to the amendment of assessments after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless a request for amendment was made before that time and the taxpayer had given the Commissioner sufficient information to decide the application. [Item 17] 
9.7	 The reduction in the rate of deduction for interest expenditure applies to interest expenditure incurred after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless the expenditure was incurred under a fixed term contract entered into before that time. [Item 22]
9.8	The changed deduction rules for feedstock expenditure, core technology expenditure and pilot plant expenditure apply to expenditure incurred under contracts entered into after 5pm, by standard time in the Australian Capital Territory on 23 July 1996.  [Items 32, 36, 56]
9.9	The changes to the definition of 'research and development activities' apply from 5pm, by standard time in the Australian Capital Territory on 23 July 1996. [Item 61] 
Background to the legislation
(a)  Reduce the rate of deduction from 150 per cent to 125 per cent
9.10	Expenditure on plant (subsection 73B(15)), contracted expenditure (subsection 73B(13)) and other R&D expenditure (subsection 73B(14)) may give rise to a deduction equal to 1.5 times the amount of the expenditure incurred.
9.11	Where the 'aggregate research and development amount' (defined in subsection 73B(1)) during a year of income is greater than $20,000, the allowable deduction for 'research and development expenditure' (defined in subsection 73B(1)), other than contracted expenditure, incurred in a year of income is 1.5 times the amount of expenditure. 
9.12	Where the 'aggregate research and development amount' during a year of income is greater than $20,000, the allowable deduction for plant expenditure (defined in subsection 73B(1)), is spread over 3 years at the annual rate of one third of the amount of the expenditure multiplied by 1.5. Where the 'aggregate research and development amount' during a year of income is less than or equal to $20,000 the allowable deduction in each of the 3 years is one third of the actual amount of expenditure.
9.13	The deduction allowable under subsection 73B(13) for contracted expenditure (as defined in subsection 73B(1)) is 1.5 times the amount of the expenditure. 
(b)  Partnerships ineligible for the R&D tax concession  
9.14	Subsection 39P of the IR&DA allows companies to register with the Industry, Research and Development Board (the Board) for the R&D tax concession. Once registered each company in the partnership may be entitled to deductions under section 73B of the ITAA for expenditure incurred on R&D activities. Paragraph 73B(10) of the ITAA disallows deductions to a company which is not registered with the Board.
(c)  Limit the period for amending assessments to four years
9.15	Subsection 170(10) of the ITAA permits income tax assessments to be amended at any time to allow a deduction for R&D expenditure incurred since the commencement of the R&D tax concession or to include in assessable income amounts receivable in respect of the recoupment etc. of R&D expenditure or the results of R&D activities.   
(d)  Modify the deduction rules for interest
9.16	Interest expenditure on debt used to finance R&D activities may fall within the meaning of 'research and development expenditure' and is therefore deductible under subsection 73B(14) at the rate of 150 per cent if the 'aggregate R&D amount' of the company for the year of income is greater than $20,000.
(e)  Modify the deduction rules for feedstock  
9.17	The cost of raw materials fed into processes that qualify as 'R&D activities' as defined in subsection 73B(1), may qualify for deduction at the concessional rate of 150 per cent under subsection 73B(14). However, the value of resultant product that may be commercially valuable or useable in further processes does not affect the quantum of the deduction.  
(f)  Modify the deduction rules for core technology
9.18	Core technology expenditure is wholly deductible under subsection 73B(12) in the year of income in which the expenditure is incurred. Core technology (defined in subsection 73B(1AB)) is existing technology in respect of which further research and development activities may be undertaken to produce new knowledge, products, processes, etc.  
(g)  Modify the deduction rules for pilot plant
9.19	Pilot plant expenditure (as defined in subsection 73B(1)) is deductible under subsection 73B(15). The relevant deduction is spread over 3 years of income. Where the 'aggregate R&D amount' (as defined in section 73B(1)) in a year of income exceeds $20,000, the amount of deduction for pilot plant expenditure is one third of the expenditure multiplied by 1.5.
(h)  Clarify the definition of 'research and development activities'
9.20	'R&D activities' are defined in section 73B(1). Subsection 73B(2) excludes certain activities from the definition. A deduction is only available under section 73B for expenditure incurred in respect of eligible 'research and development activities'.
9.21	The Board's decision that particular activities are not 'R&D activities' is an appealable administrative decision to the administrative Appeals Tribunal.  
9.22	Interpretation of the R&D activities that would be eligible for the R&D tax concession was widened with the decision of the Administrative Appeals Tribunal (AAT) in the recent AAT case of Charles IFE Pty Ltd & Industry Research and Development Board 95 ATC 2149. The Tribunal overturned the Board's decision and held that the particular activities (adaptation of equipment) conducted by the applicant were R&D activities within the definition of section 73B. This decision underscored the need to clarify subsections 73B(1) and (2).
Explanation of the amendments 
(a)  Reduce the rate of deduction from 150 per cent to 125 per cent
9.23	The deduction allowable at the concessional rate of 150 per cent in respect of research and development expenditure, contracted expenditure, plant expenditure and pilot plant expenditure is being reduced to 125 per cent. The reduced rate of deduction applies in respect of relevant expenditure incurred from 7.30 p.m., by standard time in the Australian Capital Territory on 20 August 1996 except expenditure that was required to be incurred by a contact entered into before that time, other than a contract of service entered into before that time.
9.24	The reduction is being effected by items 1 to 9 of Division 1 of Part 1 of Schedule 4 of the Bill, and is reflected in amended subsection 73B(13) (contracted expenditure), amended subsection 73B(14) (R&D expenditure), amended paragraph 73B(15)(a) (qualifying plant expenditure deduction), amended subparagraph 73B(23)(e)(i) (loss of plant), amended subsection 73C(8) (contracted expenditure clawback), amended subsection 73C(9) (non contracted expenditure clawback), new subsection 73B(4E) (post 23 July 1996 pilot plant deductions) and new subsection 73B(15AB) (limit on post 23 July 1996 pilot plant deductions).
(b)  Partnerships ineligible for the R&D tax concession
9.25	Existing rules contained in subsections 73B(3A) and 73B(9A) which permit expenditure incurred by a partnership or a partner in specified circumstances to qualify for deduction under section 73B are being changed so that only companies jointly registered under section 39P of the IR&DA and companies which are partners in a Co-operative Research Centre will continue to qualify under those rules. The changes are being effected by item 11 of Division 2 of Part 1 of Schedule 4 which restricts eligibility to a partnership comprising companies jointly registered under section 39P of the IR&DA or a Co-operative Research Centre. Item 14 ensures the changes apply with effect from 5pm, by standard time in the Australian Capital Territory on 23 July 1996.
9.26	Companies will not be eligible to jointly register with the Industry Research and Development Board (the Board) under section 39P of the IR&DA from 5pm, by standard time in the Australian Capital Territory on 23 July 1996 and therefore will not be able to claim a deduction under section 73B (refer to paragraphs 9.76 and 9.91).
9.27	The IR&DA is being amended to provide transitional rules that will allow syndicates that have received advance approval from the Board before 24 July 1996, for their proposed R&D activities and finance scheme, to seek registration under section 39P from the Board. All syndicates registered under section 39P will continue to be eligible for the tax concession. (Refer to paragraphs 9.92 to 9.110)  
(c)  Limit the period for amending assessments to four years
9.28	The period in which tax assessments may be amended to reduce tax liability for the purpose of giving effect to section 73B and related provisions dealing with research and development expenditure is being limited to four years from the date of an assessment [item 15]. This is consistent with the general limit on amendments contained in the income tax law [amended subsection 170(10)].
9.29	The Commissioner of Taxation's capacity to increase an assessment at anytime for that purpose will not change, because of design features within the research and development tax concession which may require increased assessments beyond the usual four year limit, under various circumstances. [Item 16]
9.30	A transitional rule will allow the Commissioner to amend an assessment, irrespective of when the tax under the assessment notice was due and payable, in relation to 'research and development activities', where an application was lodged by a company on or before 5pm, by standard time in the Australian Capital Territory on 23 July 1996 and all information necessary for the Commissioner to determine the amendment to the assessment was supplied. [Item 17]
(d)  Modify the deduction rules for interest
9.31	Items 18 to 21 in Division 4 of Part 1 of Schedule 4 of the Bill have the effect that 100 per cent of interest on debt to finance research and development activities will be deductible as research and development expenditure.  [New subsection 73B(14A)]
9.32	For that purpose, 'interest expenditure' will be defined to be interest, or an amount in the nature of interest, that is incurred by a company during the year of income for financing 'research and development activities'.  [New definition in subsection 73B(1)] 
9.33	The 100 per cent deduction rule will apply to interest incurred after 5pm, by standard time in the Australian Capital Territory on 23 July 1996 unless under a fixed-term contract entered into before that time.  
9.34	In conjunction with this change, the definition of 'aggregate research and development amount' is being amended to make clear that interest expenditure falls within the ambit of research and development activities.  [Amended definition in subsection 73B(1)]
(e)  Modify the deduction rules for feedstock  
9.35	Items 23 to 31 of Division 5 of Part 1 of Schedule 4 of the Bill will apply so that the concessional rate of deduction for the cost of feedstock that qualifies as research and development expenditure will be limited to the net costs of the feedstock. This is to be achieved by subtracting the value of any products derived from processing or transforming feedstock as part of the research and development activities from the value of the feedstock that was used in that process or transformation.
Eligible feedstock expenditure
9.36	For this purpose, several new definitions are being included.  The first is 'eligible feedstock expenditure', being inserted in subsection 73B(1) and defined in new subsection 73B(1A). Eligible feedstock expenditure is the amount (if any) by which the company's 'feedstock input' (refer to item 25 ) exceeds the company's 'feedstock output' (refer to item 26) in respect of related research and development activities. By item 28, 'eligible feedstock expenditure' is included within 'research and development expenditure' for the purposes of the concessional rate of deduction (150 per cent up to 7.30 p.m. on 20 August 1996 and 125 per cent thereafter) where the 'aggregate research and development amount' during the year of income exceeds $20,000.
Feedstock input
9.37	This new definition is being inserted in subsection 73B(1) by item 25. It is the expenditure incurred on feedstock that was processed or transformed in a year of income.
Feedstock output
9.38	This new definition is being inserted in subsection 73B(1) by item 26. It is the value of products derived from processing or transforming feedstock in a year of income. More particularly, it is the selling value of any such products sold during the year of income under arm's length transactions and the amount that could have been obtained if the remaining products were sold at the end of the year under arm's length transactions. If there is no ready market, that latter amount could be measured by reference to the arm's length price the taxpayer would be prepared to pay another person to obtain those products.
Residual feedstock expenditure
9.39	This new definition is being inserted into subsection 73B(1) by item 29. It is the feedstock input or the feedstock output, whichever is the lesser. New subsection 73B(14B), being inserted by item 31, will authorise a deduction equal to the residual feedstock expenditure of a year of income against a company's assessable income of that year.
9.40	In applying the concessional rate of deduction for eligible feedstock expenditure [items 23 and 30] and the 100 per cent rate of deduction for residual feedstock expenditure [item 29], it is necessary to have regard to the meaning of 'feedstock expenditure' being inserted in subsection 73B(1) by item 24. It is expenditure incurred by a company in acquiring or producing materials or goods to be the subject of processing or transformation in research and development activities, including expenditure incurred on direct energy inputs to the processing or transformation.
Example 1
				Year 1		Year 2		Year 3		Year 4
				($,000)		($,000)		($,000)		($,000)
A	Feedstock Input	  700		  400		  900		  200
B	Feedstock Output	  400		  800		  300		    50
C	Eligible Feedstock	  300		    0		  600		  150
	Expenditure
	(Amount A exceeds B)
D	Residual Feedstock	  400		  400		  300		    50
	Expenditure
	(Lesser of A or B)
In this example, the company spent $2,200,000 of which $1,050,000 was deductible at the premium rate (eligible feedstock expenditure) and $1,150,000 was deductible at the 100 per cent rate (residual feedstock expenditure).
Example 2
				Year 1		Year 2		Year 3		Year 4
				($,000)		($,000)		($,000)		($,000)
A	Feedstock Input	  400		  800		  700		  400
B	Feedstock Output	  600		  500		  300		  600
C	Eligible Feedstock	    0		  300		  400		    0
	Expenditure
	(Amount A exceeds B)
D	Residual Feedstock	  400		  500		  300		  400
	Expenditure
	(Lesser of A or B)
In this example, the company spent $2,300,000 of which $700,000 was deductible at the premium rate (eligible feedstock expenditure) and $1,600,000 was deductible at the 100 per cent rate (residual feedstock expenditure). 	
(f)  Modify the deduction rules for core technology
9.41	Items 33 to 41 of Division 6 of Part 1 of Schedule 4 of the Bill will apply to alter the basis of deduction under section 73B of core technology expenditure. The new deduction rule is contained in new subsection 73B(12A).
9.42	New subsection 73B(12A) limits the deduction for core technology expenditure incurred in a year of income to a maximum of one-third of the amount of research and development expenditure (as defined in subsection 73B(1)) incurred during the year on particular research and development activities that are related to the core technology. Existing subsection 73B(1AB) defines the conditions under which core technology is related to particular research and development activities.
9.43	Any undeducted amount of the core technology expenditure may be carried forward and deducted in a future year in which research and development activities related to the core technology occur. The amount carried forward for deduction is called 'undeducted past expenditure' (see new subsection 73B(12B)). It is simply that part of the relevant core technology expenditure as has not been allowed previously as a deduction. In any year, the deduction will be limited to one-third of the related research and development expenditure.
9.44	If core technology is disposed of, the existing law treats as assessable income of the vendor any amount received or receivable in relation to the disposal. To take account of the fact that, at the time of disposal, a proportion of the vendor's core technology expenditure may not have been deducted - because of the limitations expressed in new subsection 73B(12A) - the assessable amount on disposal of core technology will be reduced to the extent that the core technology expenditure of the vendor has not been allowed as a deduction under new subsection 73B(12A). This is being achieved by item 41 which amends existing subsection 73B(27C) so that an amount included (under subsection 73B(27A)) in assessable income from the disposal of core technology only includes any excess of the amount receivable on disposal over the 'core technology adjustment amount' (see item 35).  
9.45	Core technology adjustment amount means the total amount of a company's expenditure on the core technology, less amounts deductible in respect of that core technology under new subsection 73B(12A).
9.46	In a year in which core technology is disposed of, the amount carried forward for deduction will be reduced by an amount called the 'current year core technology adjustment amount' (see new subsection 73B(12B)). It is the lesser of the core technology adjustment amount (ie. the undeducted core technology expenditure) and any amount that would have been included in the vendor's assessable income except for being extinguished by the core technology adjustment amount (see definition of 'current year core technology adjustment amount' in new subsection 73B(12B)).
Example
		A company incurs core technology expenditure of $100,000.
	Under subsection 73B(12A), it has been allowed deductions of 	$30,000.
	It disposes of the core technology for $40,000.
On disposal, the amount of $40,000 is assessable under 73B(27A), but new paragraph 73B(27C)(c) requires the assessable amount to be reduced by the 'core technology adjustment amount', in this case $100,000 less $30,000 = $70,000. Therefore, no amount is included in assessable income.
The company's 'current year core technology adjustment amount' is the lesser of $70,000 (the core technology adjustment amount) and $40,000 (the amount that would have been assessable under subsection 73B(27A) but for new paragraph 73B(27C)(c)). That means the undeducted past expenditure which may be carried forward for deduction is reduced by $40,000. 
(g)  Modify the deduction rules for pilot plant
9.47	Items 43 to 55 of Division 7 of Part 1 of Schedule 4 of the Bill alter the basis of deduction under section 73B for the cost of pilot plant that is acquired or constructed under a contract entered into after 5pm, by standard time in the Australian Capital Territory on 23 July 1996. (See the definition of 'post - 23 July pilot plant' being inserted by item 47 in subsection 73B(1) and explained in new subsection 73B(4C) [item 50]).
9.48	New subsection 73B (15AA) [item 51] allows a deduction in respect of a unit of post - 23 July 1996 pilot plant in a year of income for the 'deductible amount' of the qualifying expenditure in respect of the unit. Qualifying expenditure is expenditure incurred in the acquisition or construction by a company of a unit of pilot plant for use by the company exclusively for the purpose of carrying on by or on behalf of the company of research and development activities. (See new subsection 73B(4C) being inserted by item 50).
9.49	The 'deductible amount' is the qualifying expenditure (as defined in new subsection 73B(4C)) multiplied by the 'annual deduction percentage' multiplied by 1.5 (see new subsection 73B(4E) being inserted by item 50). The 1.5 multiplier is reduced to 1.25 in respect of qualifying expenditure incurred after 7.30pm, by standard time in the Australian Capital Territory, on 20 August 1996. (See the amendment to new subsection 73B(4E) by item 2).
9.50	The 'annual deduction percentage' is worked out in the same way as the annual depreciation percentage would be worked out under section 55 if the pilot plant were depreciable plant or articles to which section 54 applied. For that purpose, use in carrying on research and development activities is treated as use for assessable income-producing purposes, and the term 'useful life' is substituted for the term 'effective life' that is used in calculating depreciation allowances. (See new subsection 73B(4J) being inserted by item 50).
9.51	In summary, qualifying pilot plant expenditure is deductible on a straight line basis by multiplying the expenditure by the annual deduction percentage based on the useful life of the pilot plant. The new deduction rule means that the deduction allowable for pilot plant under section 73B is the same as would be allowable under section 54 at the prime cost rate calculated under paragraph 56(1)(b), i.e. 2/3rds of the annual depreciation percentage fixed under section 55 according to the effective life of the pilot plant. One departure from the depreciation basis of deduction is that the deduction under section 73B will not be subject to pro-rating (as under subsection 56(1A)) where the pilot plant is not used in research and development activities for the whole of the income year.
(h)  Clarify the definition of 'research and development activities'
9.52	The definition of 'research and development activities' will be made more explicit by importing concepts from the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986. This will make the definition of 'research and development activities' more effective in two ways:
	firstly, the interpretation of the definition of 'research and development activities' is clearer at first glance, and will aid the policy of self assessment in taxation matters; and
	secondly, it puts Parliament's intent for the meaning of 'research and development activities' into a statutory framework which is easier to interpret and administer.
9.53	This amendment specifically recognises the needs of small companies, who do not have the benefit of specialist advisers to provide guidance on the interpretation of the definition of 'research and development activities' when determining their taxable income. This is achieved while maintaining the original intent of Parliament.
9.54	The meanings of 'innovation', 'high levels of technical risk' and activities which are not taken to be systematic experimental or investigative for the purposes of the definition of 'research and development activities' are taken directly from the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986.
9.55	The explanatory notes to the concept of 'innovation' in the Explanatory Memorandum to the Income Tax Assessment Amendment (Research & Development) Act 1986 also apply in respect of the new provisions, namely that innovation may be assessed according to several criteria, including that:
	the activities are seeking previously undiscovered phenomena, structures or relationships;
	the activities are attempting to apply knowledge or techniques in a new way; or
	the activities are likely to result in patentable or other protectable intellectual property.
9.56	Innovation is to involve an appreciable element of novelty. This means that a fairly large constituent part of the activity must involve novelty.
[Amended definition in subsection 73B(1), new subsections 73B(2B) and 73B(2C)]
Section 2 - Amendments to the IR&DA
Summary of the amendments
Purpose of the amendments
9.57	The amendments will:
	remove the Industry Research and Development Board's (the Board) power to register syndicates under section 39P for the tax concession;
	allow the Minister to provide formal advice to the Board and its committees;
	ensure that the general administrative arrangements for research and development programs contained in the Industry, Research and Development Act 1986 will also apply to programs administered through delegated legislation authorised under sections 19 and 20. 
Date of effect
9.58	The removal of syndication under section 39P of the Industry, Research and Development Act 1986 (IR&DA), and related provisions, apply from 5pm, by standard time in the Australian Capital Territory on 23 July 1996. Other measures apply from Royal Assent.
Explanation of the amendments 
Clarification of grant provisions
9.59	Item 62 amends the definitions of 'agreement under this Act' in subsection 4(1), so that it conforms with modern practice for the drafting of legislation.
9.60	Item 63 amends the IR&DA’s definition of 'agreement under this Act' so that the definition includes agreements made in the course of programs that are administered through delegated legislation.
9.61	In the past the administrative arrangements for industry research and development assistance programs were contained in the body of the IR&DA. The administrative arrangements for existing programs are contained in delegated legislation in the form of ministerial directions given to the Board under subsection 19(1) and section 20. Administrative arrangements for future programs will also be set out in delegated legislation made under subsection 19(1) and section 20.  
9.62	The item 63 amendment is to ensure that sections 36 to 39 of the IR&DA will apply to agreements made in the course of programs governed by delegated legislation. Section 36 prevents the Board from making an agreement unless it is satisfied that the results of the project will be exploited on normal commercial terms for the benefit of the Australian economy. Section 37 allows the Board to reduce the amount of a subsidy to take into account other Commonwealth assistance given to the researcher for the same project. Section 38 protects the Commonwealth’s right to seek the repayment of a subsidy in the event of breach by the researcher. Section 39 restricts the payment of a subsidy to a person who has incurred the cost of the research and development project.
9.63	Item 64 amends the definitions of 'application' in subsection 4(1), so that it conforms with modern practice for the drafting of legislation. The definition of 'subsidy' is similarly amended by item 66.
9.64	Item 65 amends the IR&DA’s definition of 'application' so that applications made in the course of programs that are administered through delegated legislation are included in the definition. The definition of 'subsidy' is similarly amended by item 67.
9.65	The purpose of item 65 is similar to that of item 63. This amendment ensures that section 35 will apply to applications made in the course of programs governed by delegated legislation. Section 35 requires that an application be in a form approved by the Board, deems that an application has not been made until the Board has received it and empowers the Board to refuse to consider an application unless the applicant provides further information. 
9.66	Part III of the IR&DA specifically provides for four industry research and development assistance programs but the Board will not enter new agreements under these provisions. This item introduces a sunset clause for the national procurement development program in order to prevent any confusion between this program and existing or future programs that are administered through delegated legislation.
Clarification of Minister’s powers of direction
9.67	As discussed at paragraph 9.66, the Board no longer enters into agreements under the programs specified in the IR&DA, ie: the discretionary grant program, the generic technology agreements program, the national interest agreements program and the national procurement development agreements program. Subsection 20(1) contains a list of examples of the Board’s functions and powers in parentheses. The discontinued programs are included in the list. The amendment removes this list of examples as it is out of date and no longer aids in the interpretation of the section.
Introduction of new power for Minister to provide advice
9.68	Item 69 introduces new section 20A to the IR&DA. This new provision creates a power in the Minister to give advice to the Board or a committee of the Board.
9.69	The purpose of the amendment is to allow the Minister a formal channel of communication with the Board and its committees, one where the Board or committee is not bound by the terms of the communication.  This new channel of communication is to be distinguished from the power in subsection 20(1). Subsection 20(1) empowers the Minister to instruct the Board as to how it must perform its functions. The new power in new subsection 20A(1) will allow the Minister to recommend that the Board or a committee take into account certain factors in the performance of its functions, but it is not obliged to do so.
9.70	Examples of the advice that the Minister may offer the Board and its committees include:
	a recommendation that the Board take into account certain reference material when considering the research and development activities of companies in a particular industry; eg a report that discusses what is or is not innovative in the software industry; and
	a recommendation as to how the Board or a committee might prioritise its workload.
9.71	The new section allows the Minister to provide advice to a committee of the Board for two reasons. Firstly, the subject of the advice may relate to the activities of a particular committee of the Board and in this case it would be more expedient for the Minister to provide the advice directly to the committee. Secondly, not all members of committees are also members of the Board and these members might not be informed if that advice could only be forwarded to the Board.
9.72	The provision of ministerial advice to the Board or a committee under this section is to be documented and included on the public record to ensure transparency and accountability in administration. The combination of new subsection 20A(2), new subsection 20A(4) and amended subsection 46(2) achieve this purpose. New subsection 20A(2) requires that ministerial advice be in writing, expressly state that it is given under this section and be delivered to the Chairperson of the Board or committee. New subsection 20A(4) requires the Board or committee to acknowledge receipt of advice at its next meeting. Amended subsection 46(2) requires that the Board publicly acknowledge the receipt of ministerial advice in its Annual Report - see paragraph 9.75. Neither new subsection 20A(4) nor amended subsection 46(2) require the Board or committee to make any comment on how it will treat the advice received.
9.73	New subsection 20A(3) prohibits the Minister from offering advice on how the Board should perform its functions in respect of a particular person, natural or corporate. This subsection protects the principle of procedural fairness by preventing the Minister from offering advice that relates to a particular applicant.
9.74	Item 78 amends subsection 46(2) of the IR&DA so that it conforms with modern practice for the drafting of legislation.
9.75	Item 79 amends section 46(2) to require the Board to publish details of any advice given to the Board or a committee of the Board under section 20A in its Annual Report. The report need not contain a copy of the advice but should report the subject matter of the advice, any recommendations made by the Minister and the date of the meeting at which the Board or committee first considered the advice. The report need not include any other details of the Board’s or committee’s consideration of the advice. 
Cessation of Board’s powers to register companies jointly
9.76	Item 71 modifies section 39P to take into account new section 39PA.
9.77	Item 72 inserts new section 39PA. Subsection 39PA(1) ends the Board’s power to register companies jointly for the tax concession for research and development. Companies registered jointly under section 39P are commonly referred to as a syndicate. Subsections 39PA(2) and 39PA(3) introduce transitional provisions that permit the Board to consider two classes of unregistered syndicate proposals - for the first class see paragraphs 9.79-9.85 and 9.88-9.90; for the second class see paragraphs 9.86- 9.87.
9.78	The purpose of new section 39PA is to end the registration of syndicates, not merely restrict or alter it. Syndicate registration was introduced into the legislation to allow companies to work together on research and development projects that they were unable to attempt alone. The program has, however, become a focus for elaborate financial mechanisms that generate guaranteed returns to investors rather than for the purpose of undertaking R&D with a realistic prospect of successful commercialisation. New subsection 39PA(1) is introduced to prevent additional Commonwealth funds from being expended through an incentive program which has not met its objective at an acceptable cost to revenue.
9.79	Subsection 39P(2) is a transitional provision that allows the Board to register some syndicates. Syndicate proposals will only be eligible for consideration if they received a favourable advance approval opinion from the Board in respect of both their research and development activities and their finance scheme on or before 23 July 1996.  
9.80	An advance opinion is a written statement of the Board that is given in response to a request from a person interested in applying for registration under section 39P. Advance opinions were given to facilitate that person’s consideration of whether or not to apply for joint registration. The giving of an advance opinion is not essential for the Board’s performance of its functions under Part IIIA of the IR&DA; it is not a decision made under the IR&DA or the finance scheme guidelines and is therefore not reviewable. However, this activity is relevant to the transitional arrangements that accompany these amendments. Accordingly, new paragraph 39PA(4) provides a statutory definition of a favourable advance approval opinion as advance approvals are not otherwise mentioned in the IR&DA.
9.81	New subsection 39PA(2) recognises and accommodates a practice that has grown among syndicate promoters and participants.  Promoters have tended to seek the Board’s advance opinion of the key elements of a syndicate, then use these advance opinions to seek out investors and further develop the syndicate proposal. Applications for registration under section 39P have usually been lodged at a very late stage in the development of a syndicate proposal. In recognition of this, new subsection 39PA(2) allows syndicate proposals that have received both components of a favourable advance approval opinion but have not lodged an application under section 39P(1) to lodge an application and have their proposal considered for registration. Syndicate proposals in this situation must lodge an application within 12 months of the commencement of the section. 
9.82	It has been the Board’s practice to place a nine month time limit on the validity of its advance approval for a syndicate’s R&D activities. This time limit has allowed for the fact that advancements in science and technology occur rapidly. Activities that were considered eligible research and development at the time of an advance opinion might not be considered innovative nine months later and hence be ineligible. This time limit was imposed to warn potential investors that the syndicate’s R&D activities may not be approved at registration stage, despite the existence of the advance opinion. This nine month time limit has no effect on a proposed syndicate’s eligibility to apply for registration under new subsection 39PA(2). A favourable advance opinion of R&D activities that was given more than nine months before the commencement of the section is a favourable advance approval opinion of R&D activities for the purposes of the section. 
9.83	New subsection 39PA(2) does not oblige the Board to register a syndicate proposal merely because the proposal has received a favourable advance opinion of its R&D activities and finance scheme. When making its decision on joint registration, the Board must consider all the criteria in subsection 39P(3). As has always been the case, it is open to the Board to depart from its advance opinion when making a registration decision under subsection 39P(3).  
9.84	New subsection 39PA(2) only permits the Board to register a syndicate in relation to the same project for which the favourable advance approval opinion was granted: the advance opinion was given 'in relation to a proposed project' and the Board may register 'in relation to the project'. Unregistered syndicate proposals cannot remodel their proposals and seek registration of a different project under the guise of the project for which a favourable advance approval opinion was given. The following lists some examples of changes which would constitute a remodelled proposal:
	additional core technology; or
	significant, additional expenditure on core technology; or
	a different or modified technical objective; or
	a different researcher; or
	significant changes to the legal rights and obligations between syndicate participants; or
	significant changes to the syndicate’s finance scheme,
	This list is not exhaustive.
9.85	The terms of new subsection 39PA(2) allow a syndicate to change the year or years of income in which the participants will incur expenditure in relation to the project. The subsection empowers the Board to register the syndicate 'in respect of the year of income or years of income specified in the application'. It is possible that the years of income specified in the application will differ from the years of income the syndicate specified when the favourable advance approval opinion was given.
9.86	New subsection 39PA(3) allows the Board to register a syndicate where, before the commencement of this section, the Board had refused to register the syndicate under subsection 39P(3) but that decision to refuse registration has since been overturned on review.
9.87	New subsection 39PA(3) ensures that nothing in these amendments affects the rights of review of a person in respect of a joint registration decision made prior to the commencement of this section.
9.88	New subsection 39PA(4) defines favourable advance approval opinion. To have a favourable advance approval opinion a syndicate proposal must have the Board’s advance approval of both its R&D activities and its finance scheme.
9.89	The provision expressly distinguishes an advance approval opinion in respect of a proposed finance scheme and decision made by the Board under the IR&DA or the finance scheme guidelines. It does this to avoid any potential confusion about the operation of subsection 39S(1A). Subsection 39S(1A) allows for the review of decisions made under the finance scheme guidelines. An advance opinion on the eligibility of a finance scheme is not a decision, and it is not made under the finance scheme guidelines: 
	as discussed at paragraph 9.80, an advance opinion is not a decision but rather a service provided by the Board in order to facilitate a person’s consideration of whether or not to apply for registration under section 39P(1); and
	when the Board considers the eligibility of a syndicate’s finance scheme it refers to the finance scheme guidelines but it does not make a decision under those guidelines.
9.90	Section 39EA(4) enables the Board to make finance scheme guidelines that confer functions and powers on the Board. Only decisions made in the exercise of functions and powers conferred by the finance scheme guidelines are decisions ‘made under the finance scheme guidelines’. To date, the Board has not created finance scheme guidelines that confer functions and powers on the Board. As the finance scheme guidelines do not confer a function or power to provide advance opinions subsection 39S(1A) does not apply to advance approval opinions. 
9.91	Item 73 introduces a transitional provision which ensures that where the Board registers a syndicates proposal after 23 July 1996, being a proposal which does not meet the criteria contained in new subsections 39PA(2) and 39PA(3), that registration has no effect. 

Extension of registration to complete project
9.92	To date, the IR&DA has not made provision for the variation or extension of an existing syndicate registration. Any material variation was considered a new syndicate requiring new registration. In the past, syndicates wishing to vary the terms or extend the term of their registration under section 39P would make a new application under subsection 39P(1). With the introduction of new subsection 39PA(1), syndicates will not be able to make new applications for registration therefore the right of a syndicate to vary its registration ceases.
9.93	However, item 74 inserts new section 39PB which creates a mechanism for the Board to approve an extension of a syndicate’s period of registration under section 39P. This mechanism is for extensions of time only; it cannot be used to approve a variation to a syndicate’s registration. - see paragraph 9.98.
9.94	Where changes to a project have been approved in writing by the Board after the date of registration and before 23 July 1996, the project as at 23 July 1996 is the project for which the companies have registration under section 39P.
9.95	This transitional provision has two purposes. The first is to allow syndicates whose R&D project has run overtime to complete the R&D activities for which they were registered and claim the tax concession for those activities. The second purpose is to encourage syndicates to commercialise the outcomes of their R&D projects by allowing them to lengthen the period in which they can claim deductions for interest expenditure.
9.96	Registered syndicates must lodge their applications for extension under new subsection 39PB(1) before their original period of registration expires. This will ensure that new section 39PB is not used to revive syndicates that are finished. Syndicates must lodge their applications for extension before 30 June 2000; this allows sufficient time for a syndicate to determine if the R&D project will run over time or if an extension is needed for successful commercialisation of the project outcomes.
9.97	New subsection 39PB(3) empowers the Board to extend the registration of a syndicate up to and including the 2004/2005 year of income; this period is sufficient for syndicates to complete and commercialise their R&D projects.
9.98	New subsection 39PB(4) provides criteria for the type of extensions that the Board can approve. These criteria are specified in order to prevent the Board from approving extensions which involve variations to the syndicate and/or which increase the cost of the syndicate to Commonwealth revenue. In particular, the Board may not extend the syndicate’s registration under section 39P of the IR&DA to cover additional expenditure on core technology or additional R&D activities for which the syndicate was not registered.
9.99	The prohibition on additional core technology expenditure will also prevent the revaluation of core technology that has already been the subject of a syndicate’s registration. This will prevent the transfer of funds that were earmarked for R&D activities to core technology expenditure in order to increase the tax benefit received by an investor.
9.100	New paragraph 39PB(4)(c) requires the Board to satisfy itself that a syndicate will exploit the results of the R&D project on normal commercial terms and for the benefit of the Australian economy prior to granting an extension of time. The syndicate’s project will be close to completion when an extension is sought under new section 39PB, thus assisting the syndicate to demonstrate the planned exploitation for the outcomes of the project.
9.101	New paragraph 39PB(4)(d) prevents syndicates from using the extension of time mechanism to increase the total amount of expenditure they will incur in respect of the research and development activities for which they are registered, as specified in accordance with paragraph 39P(2)(c) in the application for registration.
9.102	This means that the extension of time will apply only up to the point that a syndicate reaches the expenditure ceiling specified under paragraph 39P(2)(c). Syndicates cannot obtain the tax benefits that flow from section 39P registration for any expenditure above that ceiling even if the expenditure is in respect of R&D activities for which the syndicate had been registered.
9.103	Section 39PB allows the syndicate to incur that expenditure over a greater period of time. It does not allow the syndicate to increase its total expenditure, as this would involve an additional cost to Commonwealth revenue and be contrary to the action of subsection 39PA(1) to end syndicate registration.
9.104	For reasons of procedural fairness, the Board must give reasons for its decision to an applicant where it decides not to grant an extension of time. A refusal to grant an extension is reviewable by the Board under subsection 39S(1) of the IR&DA and also by the Administrative Appeals Tribunal.
9.105	New paragraph 39PB(6) provides an enforcement mechanism. Syndicates are granted extensions of the period of their registration only if they meet the criteria listed in new subsection 39PB(4). If, after the extension is granted, the Board becomes aware that a syndicate no longer meets those criteria the Board must issue a certificate to the Commissioner of Taxation under new subsection 39PB(6).
9.106	Where the Board becomes of the opinion that a syndicate has incurred expenditure which was not identified in the application for registration under paragraph 39P(2)(c), the Board’s certificate must indicate the date from which the ineligible expenditure was incurred.
9.107	Once the Commissioner receives a certificate issued by the Board under new subsection 39PB(6), new subsection 73B(33BA) of the Income Tax Assessment Act 1936 obliges the Commissioner to disallow any deductions for expenditure that were beyond the scope of the syndicate’s registration under section 39P.  Where the Board’s certificate indicates a date in which the limit of expenditure specified in the syndicate’s application under paragraph 39P(2)(c) was exceeded, the Commissioner will disallow deductions from that date.
9.108	New subsection 73B(33BB) of the Income Tax Assessment Act 1936 ensures that new subsection 73B(33BA) does not affect or restrict a syndicate participant from claiming expenditure in respect of R&D activities for which it is registered under section 39J of the IR&DA. This certificate mechanism only enforces the use of the extension provisions in new section 39PB, it does not affect other rights.
9.109	Before it issues a certificate under new subsection 39PB(6), the Board must notify any companies affected that it is considering issuing such a certificate and provide reasons for this consideration. The Board must allow any affected company a reasonable opportunity to make a submission, and must give appropriate consideration to any submissions it receives.
9.110	Under section 39T(1), the decision to issue a certificate under new subsection 39PB(6) is reviewable by the Administrative Appeals Tribunal.
Modification to account for loans assistance
9.111	Item 77 modifies section 42 of the Act to reflect that the Commonwealth now provides assistance through the Act by way of loans, as well as by way of grants. The imposition of a three month limit on advances of subsidies may not be appropriate in the case of a loan, and the Board may now provide an advance in respect of a longer period where the Board considers this to be appropriate.
9.112	In some instances the Board may enter into an agreement, whereby the recipient of the financial assistance is required to repay that assistance from income generated as a result of the project supported by that assistance. Where this is the case, and the Board does not require the recipient to repay the assistance if there is no income generated as a result of the project supported by that assistance, then that assistance does not constitute a loan, and the three month limit on advances applies. In determining whether assistance is a loan, repayment of assistance as a result of a recipient breaching the terms of the agreement under which the assistance was provided should not be taken into account. 

Section	Description	Paragraph reference
1.	Short Title	*
2.	Commencement	*
3.	Schedules	*
Schedule 1 - Amendment of the Income Tax Assessment Act 1936
Part 1 - Tax rebate for low income aged persons
Item No.
1.			1.12-18
2.			1.19
3.			1.24, 1.28
4.			1.24, 1.28
5.			1.23, 1.28
Part 2 - Rebatable annuities
6.			2.16
7.			2.18
8.			2.21
9.			2.14
Part 3 - Medical expenses rebate
10.			3.8
11.			3.8
12.			3.8
Part 4 - Sale of mining rights
13.			4.8
Part 5 - Equity investments in small-medium enterprises
14.			*
Division 11B - Equity investments in small-medium enterprises
New section
128TG	Summary of this Division	*
128TH	When Division applies	*
128TI	Consequences of Division applying	5.13
128TJ	Acquiring a threshold interest in an SME	5.12
128TK	SME or small-medium enterprise	5.8-10
15.			*
16.			*
Part 6 - Co-operative companies
17.			6.17
18.			6.3, 6.5-6, 6.8-11, 6.13, 6.18
Schedule 2 - Amendment of the Income Tax Assessment Act 1936: tax exempt entities that become taxable
Item No.
1.			7.1
Schedule 2D - Tax exempt entities that become taxable
Division 57 - Tax exempt entities that become taxable
Subdivisons
57-A Key concepts	7.12-18
57-B Predecessors of the transition taxpayer	7.19-24
57-C Time when income derived	7.25-30
57-D Time when losses and outgoings incurred	7.31-34
57-E Assets and liabilities	7.35-59
57-F Superannuation deductions	7.60-86
57-G Denial of certain deductions	7.87-104
57-H Domestic losses	7.105-108
57-I Depreciation deductions	7.109-114
57-J Capital allowances and certain other deductions	7.115-127
57-K Balancing adjustments	7.128-132
57-L Trading stock	7.133-139
Item No.
2.			7.3
Schedule 3 - Amendment of the Development Allowance Authority Act 1992
Item No.
1.			8.22
2.			8.22
3.			8.22
4.			8.22
5.			8.22
6.			8.24
7.			8.25
New section
93ZAA			8.25
93ZAB			8.28-30
93ZAC			8.31
93ZAD			8.32
8.			8.33
9.			8.33
10.			8.34
Schedule 4 - Research and development activities
Part 1 - Amendment of the Income Tax Assessment Act 1936
Division 1 - Amendment to reduce the rate of deduction from 150% to 125%
Item No.
1.			9.4, 9.24
2.			9.4, 9.24
3.			9.4, 9.24
4.			9.4, 9.24
5.			9.4, 9.24
6.			9.4, 9.24
7.			9.4, 9.24
8.			9.4, 9.24
9.			9.4, 9.24
10.			9.4-5
Division 2 - Amendments relating to deductions for expenditure incurred by partnerships
11.			9.4, 9.25
12.			9.4
13.			9.4
14.			9.4, 9.25
Division 3 - Amendments to limit the period for amending assessments to give effect to provisions relating to deductions for expenditure on research and development activities
15.			9.4, 9.28
16.			9.4, 9.29
17.			9.4, 9.6, 9.30
Division 4 - Amendments relating to deductions for interest payments
18.			9.4, 9.31
19.			9.4, 9.31
20.			9.4, 9.31
21.			9.4, 9.31
22.			9.4, 9.7
Division 5 - Amendments relating to feedstock expenditure
23.			9.4, 9.35, 9.40
24.			9.4, 9.35, 9.40
25.			9.4, 9.35-7, 9.40
26.			9.4, 9.35-36, 9.38, 9.40
27.			9.4, 9.35, 9.40
28.			9.4, 9.35-36, 9.40
29.			9.4, 9.35, 9.39-40
30.			9.4, 9.35, 9.40
31.			9.4, 9.35, 9.39
32.			9.4, 9.8
Division 6 - Amendments relating to core technology expenditure
33.			9.4, 9.41
34.			9.4, 9.41
35.			9.4, 9.41, 9.44
36.			9.4, 9.8, 9.41
37.			9.4, 9.41
38.			9.4, 9.41
39.			9.4, 9.41
40.			9.4, 9.41
41.			9.4, 9.41, 9.44
42.			9.4
Division 7 - Amendments relating to pilot plant
43.			9.4, 9.47
44.			9.4, 9.47
45.			9.4, 9.47
46.			9.4, 9.47
47.			9.4, 9.47
48.			9.4, 9.47
49.			9.4, 9.47
50.			9.4, 9.47-50
51.			9.4, 9.47-48
52.			9.4, 9.47
53.			9.4, 9.47
54.			9.4, 9.47
55.			9.4, 9.47
56.			9.4, 9.8
Division 8 - Amendments to clarify the meaning of research and development activities
57.			9.4
58.			9.4
59.			9.4
60.			9.4
61.			9.4, 9.9
Part 2 - Amendment of the Industry Research and Development Act 1986
62.			9.59
63.			9.60, 9.62, 9.65
64.			9.63
65.			9.64-65
66.			*
67.			9.64
68.			*
69.			9.68
70.			*
71.			9.76
72.			9.77
73.			9.91
74.			9.93
75.			*
76.			*
77.			9.111
78.			9.74
79.			9.75

*	No specific reference to item