Commonwealth of Australia Explanatory Memoranda Commonwealth of Australia Explanatory Memoranda[Index] [Search] [Download] [Bill] [Help]
2004-2005-2006-2007
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
TAX LAWS AMENDMENT (TAXATION OF FINANCIAL
ARRANGEMENTS) BILL 2007
EXPLANATORY MEMORANDUM
(Circulated by authority of the
Treasurer, the Hon Peter Costello MP)
Table of contents
Glossary ....................................................................................... 1
General outline and financial impact ....................................................... 3
Chapter 1 Background and framework........................................... 7
Chapter 2 Definition of `financial arrangement'............................. 27
Chapter 3 Tax treatment of gains and losses from financial
arrangements............................................................... 87
Chapter 4 The compounding accruals and realisation
methods ..................................................................... 115
Chapter 5 Elective Subdivisions: common requirements .......... 181
Chapter 6 The elective fair value method................................... 199
Chapter 7 The elective foreign exchange retranslation
method....................................................................... 211
Chapter 8 The elective hedging financial arrangements
method....................................................................... 233
Chapter 9 The elective financial reports method ........................ 269
Chapter 10 Balancing adjustment on disposing of financial
arrangements............................................................. 285
Chapter 11 Interaction and consequential amendments .............. 299
Chapter 12 Commencement, transitional and
implementation issues ............................................... 331
Chapter 13 Case studies .............................................................. 343
Chapter 14 Regulation impact statement ..................................... 371
Index ................................................................................... 391
Glossary
The following abbreviations and acronyms are used throughout this
explanatory memorandum.
Abbreviation Definition
AASB 7 Australian Accounting Standard AASB 7
Financial Instruments: Disclosures
AASB 101 Australian Accounting Standard AASB 101
Presentation of Financial Statements
AASB 112 Australian Accounting Standard AASB 112
Income Taxes
AASB 117 Australian Accounting Standard AASB 117
Leases
AASB 118 Australian Accounting Standard AASB 118
Revenue
AASB 121 Australian Accounting Standard AASB 121
The Effects of Changes in Foreign Exchange
Rates
AASB 127 Australian Accounting Standard AASB 127
Consolidated and Separate Financial
Statements
AASB 132 Australian Accounting Standard AASB 132
Financial Instruments: Disclosure and
Presentation
AASB 137 Australian Accounting Standard AASB 137
Provisions, Contingent Liabilities and
Contingent Assets
AASB 139 Australian Accounting Standard AASB 139
Financial Instruments: Recognition and
Measurement
ADI authorised deposit-taking institution
ASIC Australian Securities and Investments
Commission
ASX Australian Securities Exchange
ATO Australian Taxation Office
CGT capital gains tax
Commissioner Commissioner of Taxation
CPI consumer price index
1
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
ITAA 1936 Income Tax Assessment Act 1936
ITAA 1997 Income Tax Assessment Act 1997
MEC group multiple entry consolidated group
NBTS (TOFA) Act 2003 New Business Tax System (Taxation of
Financial Arrangements) Act 2003
PAYG pay as you go
Ralph Report Review of Business Taxation: A Tax System
Redesigned
Ralph Review Review of Business Taxation
retranslation method elective foreign exchange retranslation
method
TAA 1953 Taxation Administration Act 1953
The Act the ITAA 1936 and ITAA 1997
TOFA taxation of financial arrangements
US United States of America
2
General outline and financial impact
Taxation of financial arrangements
This Bill amends the Income Tax Assessment Act 1997 by including a new
Division. Division 230 defines `financial arrangement' and sets out the
methods under which gains and losses from financial arrangements will
be brought to account for tax purposes. These methods -- accruals,
realisation, fair value, retranslation, hedging and financial records --
determine the tax-timing treatments of all financial arrangements covered
by Division 230. This Bill establishes criteria that determine how
different financial arrangements are assigned to, and treated under, the
different tax-timing methods. The Bill also effectively removes the
capital/revenue distinction for most financial arrangements by treating the
gains and losses on revenue account, except where specific rules apply.
Date of effect: These amendments will apply to income years
commencing on or after 1 July 2009, unless a taxpayer elects to apply the
amendments to income years commencing on or after 1 July 2008.
Proposal announced: This proposal was announced in the Treasurer's
Press Release No. 074 of 11 November 1999 and in the then Minister for
Revenue and Assistant Treasurer's Press Release No. 002 of
5 August 2004. Other announcements accompanied the release of
exposure drafts of this legislation -- the then Minister for Revenue and
Assistant Treasurer's Press Release No. 107 of 16 December 2005 and the
Minister for Revenue and Assistant Treasurer's Press Release No. 001 of
3 January 2007.
Financial impact: The revenue impact of this measure is unquantifiable.
Compliance cost impact: Division 230 will lower ongoing compliance
costs by providing greater coherency, clarity and certainty, using financial
accounting concepts from relevant financial accounting standards, basing
tax treatments on functional purposes, and removing uncertainties about
relevant tax-timing treatments.
3
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Summary of regulation impact statement
Regulation impact on business
Impact: The introduction of Division 230 is expected to cause medium
compliance cost increases for taxpayers and tax advisors during the
transitional period, but is expected to provide a medium overall reduction
in compliance costs on an ongoing basis.
Main points:
· During the transitional stage, compliance costs are expected
to be incurred by taxpayers in the form of formal training of
staff, comprehension of new obligations, enquiries and
requests for rulings, and reviews of tax planning strategies.
In terms of ongoing compliance costs, Division 230 should
allow compliance cost savings for taxpayers in terms of
record keeping, and enquiries and rulings.
- Taxpayers that base their commercial accounts on
accounting standards will be able to utilise the concepts
and methods in the accounting standards for tax
purposes. This will contribute to lower ongoing
compliance costs.
· The general areas where transitional compliance costs are
expected to be borne by tax advisors are formal training of
staff and comprehension of new obligations. A particular
cost on tax advisors will be to advise individual clients on the
various elections available under Division 230. Compliance
costs for tax advisors are expected to return to normal levels
following the transitional phase.
· The transitional administrative costs for the Australian
Taxation Office are expected to take the form of increased
demand for rulings and other advice products.
· Division 230 will not apply to individuals and most small and
medium businesses, except where those taxpayers hold a
qualifying security -- or where the taxpayer elects to have
this Division apply.
· Accruals taxation will apply on a wider basis than previously.
- Some taxpayers required by Division 230 to apply
accruals taxation where they were not required to do so
4
General outline and financial impact
previously may experience an ongoing compliance cost
increase.
- Taxpayers applying accruals taxation prior to the
introduction of Division 230 by virtue of Division 16E
of the Income Tax Assessment Act 1936 are expected to
enjoy a reduction in ongoing compliance costs as the
Division 230 accruals calculation is less onerous that the
Division 16E calculation.
· Systems developers employed by affected taxpayers are
expected to bear the costs of reviewing tax reporting systems
and processes during the transitional period. Compliance
costs for systems developers are expected to return to normal
during the ongoing stage of Division 230.
5
Chapter 1
Background and framework
Outline of chapter
1.1 Division 230 contains new rules for the taxation treatment of
financial arrangements.
1.2 This chapter:
· explains why reform of the taxation of financial
arrangements (TOFA) is necessary;
· explains the framework of Division 230; and
· provides an outline of how the Division applies.
Context of amendments
Why is the existing law inadequate?
1.3 Over recent decades the development of new financial
arrangements to provide finance and allocate risk has had broad ranging
impacts on the operation of capital markets. The income tax law has not
kept pace with this financial innovation.
1.4 Where the tax law has been amended to address new product
developments, the amendments have been largely in response to specific
pressures and have tended to be of a limited, ad hoc and piecemeal nature.
What has been lacking is an overarching framework which seeks to
systematically address the functional purposes of different financial
arrangements and the ways in which they are used. As a consequence,
current tax laws, which have continued to rely significantly on legal form,
represent an increasingly complex amalgam of both general and specific
provisions.
1.5 Under the current law, accruals rules, which spread gains and
losses from financial arrangements over time, have been narrowly
focused. Outside their purview, tax treatments do not adequately take into
7
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
account the time value of money or provide for an appropriate allocation
of economic income over time.
1.6 Current tax laws have resulted in tax-based timing and character
mismatches and lack the tax design architecture needed to facilitate
efficient hedging activity and market-making. In a number of areas, gaps
have appeared in the law, determinacy has been lacking, tax anomalies
and distortions have emerged, neutrality has not been achieved and
uncertainty has developed about the appropriate treatment of some basic
financial arrangements. As well, the law does not adequately address the
tax-timing treatment of emerging hybrid instruments or newer structured
products, including those with both fixed and contingent returns. As a
consequence, the existing tax system impacts adversely on pricing, risk
management and allocative efficiency.
1.7 The current income tax law has often placed greater emphasis on
the form rather than the substance of financial arrangements. This has
resulted in inconsistencies in the tax treatment of transactions with similar
economic substance which has impeded commercial decision-making,
created difficulties in addressing financial innovation and facilitated tax
deferral and tax arbitrage.
Division 230 and earlier reforms to the taxation of financial arrangements
1.8 Building on earlier consultative papers and extensive
consultations, recommended reforms to TOFA were set out in the
Review of Business Taxation: A Tax System Redesigned (July 1999).
Division 230 represents the combined third and fourth stages of TOFA
reforms emanating from the Government's in-principle support for those
earlier TOFA recommendations.
1.9 In 2001, in conjunction with the introduction of thin
capitalisation measures and in response to the failure of the legal
form-based tax system to cope with the creation of new financing
products, growing mischaracterisation of debt and equity interests and
general uncertainty over appropriate tax treatments, the Government
introduced Division 974 of the Income Tax Assessment Act 1997
(ITAA 1997).
1.10 Division 974 of the ITAA 1997 reformed the debt/equity tax
borderline and represented Stage 1 of the TOFA reforms. Under that
reform, the test for distinguishing debt interests from equity interests
focuses on a single organising principle -- debt is evident where an issuer
has an effective obligation to return to the investor an amount at least
equal to the amount invested.
8
Background and framework
1.11 In 2003, in response to uncertainty over the taxation of foreign
currency gains and losses, the Government introduced Division 775 and
Subdivisions 960-C and 960-D of the ITAA 1997. Those amendments
addressed anomalies and provided certainty as to how foreign currency
gains and losses are brought to account for tax purposes. At the same
time, reforms aimed at removing the taxing point at conversion or
exchange of certain financial instruments were introduced in
sections 26BB and 70B of the Income Tax Assessment Act 1936
(ITAA 1936). Together, these reforms represented Stage 2 of the
TOFA reforms.
1.12 Division 230 contains provisions which cover both the tax
treatment of hedges (Stage 3) and tax-timing treatments in respect of
arrangements other than hedges (Stage 4). The provisions address:
· the final stages of the TOFA reforms recommended by the
Review of Business Taxation (Ralph Review);
· the Government's announcement in the 2005-06 Budget to
extend the tax-timing hedge treatment for hedges of
commodities -- proposed by the Ralph Review -- to
hedging transactions generally; and
· the addition of tax status hedge rules which provide for
matching of the tax classification or status (capital, revenue,
assessable, exempt, non-assessable non-exempt) of the gain
or loss from the hedging financial arrangement with the tax
classification or status of the underlying.
Objectives of Division 230
1.13 The two overarching objectives underpinning Division 230 are
greater efficiency and the lowering of compliance costs.
1.14 Greater efficiency, in this context, means minimising the
extent to which the taxation of financial arrangements, by providing
inappropriate impediments or stimulation, distorts a taxpayer's trading,
financing, investment, pricing, risk taking and risk management decisions.
Such distortions impact adversely on the allocation of investment
activity both within the financial sector and between the financial and
non-financial sectors and also reduce the general efficiency, effectiveness
and competitiveness of capital markets. Removing such distortions
involves the development of an enhanced and more comprehensive and
coherent tax law framework.
9
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
1.15 Greater efficiency will result from:
· providing tax treatments that cover all financial arrangements
coherently and consistently;
· closer alignment of tax and commercial recognition of gains
and losses from financial arrangements;
· facilitating the appropriate allocation over time of the gains
and losses from financial arrangements for tax purposes;
· general recognition of gains and losses on revenue account;
· reducing tax-timing and tax-status mismatches;
· increasing reliance on economic substance over legal form;
and
· reducing opportunities for tax deferral and tax arbitrage.
1.16 The lowering of compliance costs necessarily involves greater
regard being given to the commercial context within which financial
arrangements are traded and exchanged. Lower compliance costs are
achieved through:
· reliance on the gains and losses required to be included in
commercial financial reports as the basis for taxation where
appropriate;
· otherwise incorporating the concepts and methods used in
financial accounting standards, where appropriate, as the
basis for tax treatments;
· reducing complexity and taxpayer uncertainty while
increasing clarity of the law; and
· increasing alignment of tax treatments with the functional
purposes that commercial parties have when entering
particular financial arrangements.
1.17 The Division 230 tax framework explicitly takes into account a
number of Australian accounting standards. These standards reflect the
adoption of the international financial reporting standards in Australia,
with effect from 1 January 2005. However, Division 230 does not
mandate that taxpayers use accounting standards as the basis for taxation.
Such an approach could impose unfair compliance costs on certain
10
Background and framework
taxpayers and could also lead to volatility in tax liabilities. Volatility in
taxation could arise, for instance, from mandatory application of fair value
treatment. Rather, the closer alignment with accounting standards and
taxation is achieved through two basic mechanisms. The first involves a
specific election to rely on gains and losses determined by relevant
accounting standards for tax purposes where certain specified
requirements are met. Outside the operation of that specific election,
Division 230 achieves, through the operation of a range of other
provisions, a substantial level of consistency with the concepts and
treatments used in accounting standards. This close alignment is most
evident in respect of the methods used for accruals purposes and the
concepts, methods and measurements available under the fair value
election, the retranslation election and the hedging election.
1.18 In developing this framework, particular regard was given to the
following Australian versions of the international accounting standards:
Australian Accounting Standard AASB 132 Financial Instruments:
Disclosure and Presentation (AASB 132) and Australian Accounting
Standard AASB 139 Financial Instruments: Recognition and
Measurement (AASB 139). The framework also takes into account other
accounting standards such as Australian Accounting Standard AASB 7
Financial Instruments: Disclosures (AASB 7), Australian Accounting
Standard AASB 101 Presentation of Financial Statements (AASB 101),
Australian Accounting Standard AASB 118 Revenue (AASB 118),
Australian Accounting Standard AASB 121 The Effects of Changes in
Foreign Exchange Rates (AASB 121) and Australian Accounting
Standard AASB 137 Provisions, Contingent Liabilities and Contingent
Assets (AASB 137).
Summary of new law
1.19 This legislation is built on a principle-based framework for the
taxation of gains and losses from financial arrangements. Gains from
financial arrangements are assessable and losses are deductible. A set of
principles and rules within the framework tells taxpayers how to work out
gains and losses each income year.
1.20 The legislation generally applies to all `financial arrangements'
as defined in Subdivision 230-A or included by the additional operation of
Subdivision 230-J. However, certain financial arrangements are
effectively subject to an exception under Subdivision 230-H.
1.21 Division 230 provides a range of elective methods for
determining gains and losses, including the elective fair value method, the
elective retranslation method, the elective hedging method and the
11
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
elective financial reports method. Where these elective methods are not,
or cannot be, adopted the tax treatment defaults to either the accruals or
realisation method.
1.22 This legislation does not apply to:
· financial arrangements of individuals;
· financial arrangements of authorised deposit-taking
institutions (ADIs), securitisation vehicles and financial
sector entities with an aggregated annual turnover of less
than $20 million per year; or
· financial arrangements of other entities with an aggregated
annual turnover of less than $100 million, except where the
arrangement is a qualifying security and its remaining life
after acquisition is more than 12 months or where the
taxpayer elects to have Division 230 apply to all of its
financial arrangements.
Comparison of key features of new law and current law
New law Current law
The new law contains a No comprehensive set of provisions
comprehensive set of principles and exists for the taxation of financial
rules for the tax-timing and character arrangements. Comprehensive
treatment of gains and losses from hedging rules and a general
financial arrangements. retranslation treatment do not exist.
There are six tax methods: There is no fair value tax treatment in
the current law except in the trading
· elective reliance on financial stock provisions which have limited
reports; application. Rules of an ad hoc and
· elective fair value; relatively limited nature apply to
certain specific financial
· elective retranslation; arrangements, namely to:
· elective hedging; · accrue gains and losses of
· accruals; and discounted and deferred
· realisation. interest securities;
There is a general balancing · assess gains and losses on the
adjustment for when an entity ceases disposal of `traditional
to have a financial arrangement. securities' such as bonds and
Generally gains are assessable and debentures;
losses are deductible. · allow a deduction for bad debts
Not all taxpayers will be subject to in certain circumstances;
Division 230.
12
Background and framework
New law Current law
· reflect gains from the
forgiveness of commercial
debts; and
· assess gains and losses from
foreign currency transactions.
Detailed explanation of new law
Approach to tax reforms for financial arrangements
1.23 Achieving the optimal set of tax reforms for financial
arrangements requires the balancing of the objectives of greater efficiency
and lower compliance costs with rules to ensure the integrity of the tax
system within a complex financial environment. This part of the chapter
discusses the manner in which the reforms to tax treatments have been
approached with these factors in mind.
1.24 The Division 230 framework more closely aligns the recognition
of gains and losses on financial arrangements with commercial norms.
1.25 Regard to that commercial context is given effect by:
· incorporating financial accounting concepts and methods and
hedging rules into the framework;
· providing an election to rely on financial reports;
· incorporating some flexibility in the tax-timing treatments for
financial arrangements; and
· placing many financial arrangements on revenue account.
Financial accounting concepts and methods
1.26 The default approach for Division 230 is accruals treatment of
gains and losses. Where gains or losses are not sufficiently certain a
realisation basis is used. In addition, Division 230 incorporates four
elective tax methods: an election to rely on financial reports, elective fair
value, elective retranslation and elective hedging. The fair value,
retranslation, hedging and the financial reports methodologies are not
recognised, to any significant extent, under the current income tax law.
Their adoption as part of these reforms reflects the different methods
found in financial accounting standards and practice. That is, the
13
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
so-called `mixed model' approach in financial accounting is an inherent
feature of the Division 230 framework.
1.27 The mixed model approach in turn reflects alternative functional
applications and the different ways in which financial arrangements are
used for commercial purposes (ie, trading, investing/financing and
hedging).
1.28 While financial accounting standards may provide important
information for investors, they may not be an appropriate basis for
taxation. The reason for this is that the standards aim to give investors
information upon which they can make financial decisions, including
making assessments about the stewardship of the entity in question during
a particular accounting period.
1.29 Financial accounting standards covering the measurement of
gains and losses from financial arrangements have adopted fair value
accounting as a default treatment to better reflect commercial realities and
to expose the potential risks in using derivatives. The mandatory use of
the fair value treatment in a tax context could result in taxpayers being
required to pay tax on large, unsystematic, unrealised gains which do not
eventuate, potentially causing cash flow difficulties.
1.30 However, allowing taxpayers to access fair value tax treatment
through an elective regime may facilitate price-making in relation to
market-making portfolios of financial arrangements typically held by
financial institutions. It could also provide overall compliance cost
savings for taxpayers who prepare financial reports in accordance with the
new financial accounting standards.
1.31 Division 230 provides an elective regime for the recognition of
gains and losses on a fair value basis for income tax purposes in respect of
those financial arrangements which are fair valued through the profit or
loss statement. Chapter 6 explains the operation of this election.
1.32 Similarly, Division 230 allows elective tax treatment for
retranslation and hedging (see Chapters 7 and 8 respectively).
1.33 This legislation also includes an election for taxpayers to rely on
their financial reports for taxation purposes in respect of their financial
arrangements, subject to specified conditions (see Chapter 9).
1.34 Appropriate safeguards are required to ensure that the use of the
elective regimes does not lead to adverse selection opportunities or other
inappropriate tax outcomes. The safeguards are explained in the relevant
chapters of this explanatory memorandum. Chapter 5 discusses the
general requirements common to all elective Subdivisions. Additional
14
Background and framework
specific requirements relevant to each election are outlined in the specific
chapters (ie, Chapters 6 to 9) covering the elective tax treatments.
Flexibility in tax-timing treatments
1.35 Substantial flexibility exists in the application of tax-timing
methods. For example:
· there is no prescriptive basis for valuation under the fair
value and retranslation tax elections, other than the proper
application of the financial accounting standard on which
these elections are based;
· if the compounding accruals basis is required for a financial
arrangement, any compounding interval that is not longer
than 12 months can be used. A reasonable approximation of
this basis may also be adopted. The effective interest method
used in accounting standards is generally permissible; and
· there is flexibility as to the allocation period under the
hedging method, provided certain safeguards are met.
1.36 To prevent this flexibility from being exploited for income tax
purposes, the legislative framework requires that a particular manner of
allocating gains and losses has to be applied consistently. [Schedule 1,
item 1, section 230-85]
1.37 Reliance on broad, clearly enunciated principles where
appropriate, rather than highly prescriptive rules, should provide greater
stability to the tax framework, allowing it to better cope with financial
innovation and the flexibility of financial arrangements themselves.
Placing many financial arrangements on revenue account
1.38 With some exceptions, gains and losses from financial
arrangements are generally to be taxed on revenue account (see Chapter 3
for more detail) [Schedule 1, item 1, section 230-15]. This removes the complex
capital/revenue distinction for many financial arrangements.
The legislative approach
1.39 Division 230 tells a taxpayer how to work out the amount of
gain or loss in an income year using the following steps:
· identify a financial arrangement (step 1);
15
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· determine whether an exclusion from the Division applies to
gains and losses from the financial arrangement (step 2);
· determine which tax method will apply to the financial
arrangement and, using relevant tax-timing treatments, work
out the gains and losses from the financial arrangement for
each income year (step 3); and
· determine whether the gains or losses from the financial
arrangement are assessable or deductible (step 4).
Identification of a financial arrangement
1.40 A financial arrangement is the core unit upon which a tax
liability is determined under Division 230.
1.41 Subdivision 230-A provides the test for determining whether an
arrangement is a financial arrangement [Schedule 1, item 1, section 230-50]. In
this context an arrangement consists of all the rights and obligations
(including contingent rights or obligations [Schedule 1, item 1, section 230-90]),
that are appropriately considered to be part of the same arrangement.
Section 230-60 sets out the factors to be considered when determining
what rights or obligations comprise an arrangement or two or more
separate arrangements [Schedule 1, item 1, section 230-60]. Importantly,
whether there is one or more arrangements takes into account normal
commercial understandings.
1.42 Under this test, relevant rights and obligations under an
arrangement comprise a financial arrangement to the extent they are `cash
settlable' legal or equitable rights or obligations to receive or provide
financial benefits, or combinations thereof, and the arrangement does not
consist of any other subsisting non-insignificant rights or obligations
[Schedule 1, item 1, subsections 230-5(1) and 230-50(1)]. The meaning of the term
`cash settlable', and its relationship to money or money equivalence, and
to intentions, purposes and commercial practices, is defined by this test,
and explained in Chapter 2 [Schedule 1, item 1, subsection 230-50(2)].
1.43 Some common examples of financial arrangements are:
· debt-type arrangements, including loans, bonds, promissory
notes and debentures; and
· risk-shifting derivatives, including swaps, forwards and
options.
16
Background and framework
1.44 An equity interest (such as an ordinary share) is also a financial
arrangement [Schedule 1, item 1, paragraph 230-5(2)(b) and section 230-55], but not
all tax-timing methods will apply to equity interests (for instance, an
equity interest will not be subject to the accruals or realisation tax-timing
methods) [Schedule 1, item 1, paragraph 230-45(2)(e)].
1.45 A simple delayed settlement is a financial arrangement, where
the payment occurs some time after the relevant thing is delivered. This is
because from the time of delivery the only subsisting rights and
obligations under such an arrangement are cash settlable. However,
where the period between delivery and the time for payment is
12 months or less, gains and losses from the financial arrangement are
excluded from Division 230 [Schedule 1, item 1, section 230-400]. More
complex financial arrangements include hybrid financial arrangements.
1.46 Arrangements which are not `financial arrangements' under the
definition include arrangements for the purchase of property (except
property that is itself a financial arrangement), goods or services, where
payment is made on entering into the arrangement but delivery of the
property, goods or services is deferred (usually referred to as
prepayments). This is because such arrangements have non-insignificant
non-cash settlable rights and obligations throughout the life of the
arrangement. This fact, together with the exclusion for deferred payments
of less than 12 months (discussed above), would mean that most
construction contracts, contracts for the provision of services and
arrangements known as farm-out arrangements would generally be
excluded from the operation of Division 230.
1.47 A number of things that do not satisfy the definition of `financial
arrangement' are specifically included in the scope of Division 230 by
virtue of Subdivision 230-H. These are:
· foreign currency;
· non-equity shares; and
· commodities held by traders.
[Schedule 1, item 1, Subdivision 230-H]
1.48 Chapter 2 explains what arrangements meet the definition of a
`financial arrangement' or are otherwise treated as financial arrangements.
1.49 In addition, the permanent establishments in Australia of an
offshore banking unit are treated as one person for the purpose of
Division 230. The other permanent establishments of the offshore
banking unit are treated as separate persons. This means that financial
17
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
arrangements between permanent establishments of an offshore banking
unit can be subject to Division 230 [Schedule 1, item 1, section 230-40]. This
reflects the treatment of permanent establishments of an offshore banking
unit under Part III of Division 9A of the ITAA 1936.
Determine whether an exclusion applies to the arrangement
1.50 A number of financial arrangements have gains and losses from
them excluded from the provisions of Division 230. The main categories
of excluded arrangements are:
· financial arrangements held by individuals that are not
qualifying securities, and qualifying securities held by
individuals which have a remaining life at the time of
acquisition of 12 months or less [Schedule 1, item 1,
paragraph 230-5(2)(a) and section 230-405];
· financial arrangements held by entities whose business is
essentially financial in nature with less than $20 million
aggregated annual turnover, or other entities (other than
individuals) with less than $100 million aggregated annual
turnover, which are not qualifying securities, and qualifying
securities held by such entities which have a remaining life at
the time of acquisition of 12 months or less [Schedule 1, item 1,
paragraph 230-5(2)(a) and section 230-405];
· short-term financial arrangements where a non-monetary
amount (property, goods or services) is involved [Schedule 1,
item 1, section 230-400]; and
· gains on the forgiveness of commercial debts [Schedule 1,
item 1, section 230-420].
1.51 Other particular arrangements have gains and losses excluded
from the Division to the extent to which they arise from specific rights
and obligations that are leasing or licensing arrangements over real and
intellectual property, certain interests in partnerships or trusts, certain
insurance policies, certain rights or obligations under a workers'
compensation scheme, certain guarantees or indemnities, personal
arrangements and personal injury, certain superannuation and pension
income arrangements, interests in a controlled foreign company, interests
in a foreign investment fund, retirement village residence and services
contracts, arrangements under which residential care or flexible care is
provided, proceeds from certain `earn-out' business sales, arrangements to
which Division 16L applies, arrangements to which section 121EK
applies, a right to receive, or obligation to provide, a farm management
18
Background and framework
deposit where the taxpayer is the owner of that deposit, and interests in
forestry-managed investment schemes which are deductible under
Division 394. The list of specific exclusions may be added to by
regulation. [Schedule 1, item 1, section 230-410 and subsections 230-425(3) and (4)]
1.52 If an arrangement is excluded, other provisions of the tax law
may apply to the arrangement.
1.53 Chapter 2 explains what financial arrangements have their gains
and losses excluded from Division 230.
Apply the appropriate tax method to work out the gain or loss for the
income year
1.54 One or more of the following tax methods applies to every
financial arrangement that is subject to Division 230:
· Default methods:
- compounding accruals [Schedule 1, item 1,
Subdivision 230-B];
- realisation [Schedule 1, item 1, Subdivision 230-B]; and/or
- balancing adjustment [Schedule 1, item 1, Subdivision 230-G];
and/or;
· Elective methods:
- elective fair value [Schedule 1, item 1, Subdivision 230-C];
- elective retranslation [Schedule 1, item 1, Subdivision 230-D];
- elective hedging [Schedule 1, item 1, Subdivision 230-E]; and
- elective financial reports method [Schedule 1, item 1,
Subdivision 230-F].
1.55 Use of any of the elective methods requires that the taxpayer
have financial reports prepared and audited in accordance with relevant
financial accounting and auditing standards.
19
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Diagram 1: Hierarchy of tax treatments (excluding balancing
adjustments)
Elective hedging
Elective methods
Elective financial reports
Elective fair value
Elective retranslation
Accruals
Default methods
Realisation
1.56 As well as the above tax methods, a balancing adjustment is
generally required to be calculated when a taxpayer ceases to have a
financial arrangement, or transfers part of a financial arrangement to
someone else [Schedule 1, item 1, Subdivision 230-G]. A separate balancing
adjustment may also arise where an election ceases to apply to a financial
arrangement [Schedule 1, item 1, sections 230-210, 230-250 and 230-380].
1.57 The tax methods determine the basis for calculating what
amounts are assessable or deductible in each income year. [Schedule 1,
item 1, section 230-45]
Elective fair value method
1.58 The elective fair value method allocates gains and losses from a
financial arrangement to each income year in accordance with changes in
the fair value. If adopted, the method applies to all financial arrangements
20
Background and framework
acquired in the income year in which the election is made, or in a later
income year, that are classified or designated as at fair value through
profit or loss for the purposes of relevant accounting standards, where
they are reported in financial reports prepared and audited in accordance
with relevant accounting and auditing standards. This method is elective,
but once a taxpayer elects to apply it to arrangements reported in its
financial reports, the election generally applies to those arrangements for
all future income years. An election will cease to apply to a financial
arrangement where relevant criteria are no longer satisfied [Schedule 1,
item 1, Subdivision 230-C]. A balancing adjustment must be made if the fair
value election ceases [Schedule 1, item 1, section 230-210].
1.59 Chapter 6 explains the fair value method in more detail.
Elective foreign exchange retranslation method
1.60 The elective retranslation method allocates gains and losses
from changes in the value of foreign currency to the income year in which
the change occurs. The elective foreign exchange retranslation method
may apply to:
· all relevant arrangements that are subject to retranslation
treatment under a relevant accounting standard and which are
reported in a relevant financial report prepared and audited in
accordance with the accounting and auditing standards
[Schedule 1, item 1, Subdivision 230-D] and which are acquired in
the year in which the election is made or later years; or
· designated qualifying foreign exchange accounts [Schedule 1,
item 1, Subdivision 230-D].
1.61 The effect of applying this Subdivision is that, for tax-timing
purposes, the taxpayer will generally recognise gains and losses from the
foreign currency component independently of gains and losses from the
rest of the arrangement. Accordingly, this method may apply in addition
to other tax-timing methods.
1.62 The foreign exchange retranslation method only applies where
the taxpayer elects to apply it.
1.63 An entity can make a foreign currency retranslation election in
respect of a qualifying foreign exchange account after it starts to have the
account. In such cases, a balancing adjustment is required to bring to
account any unrealised foreign currency gains or losses on the account.
Like the fair value election, the foreign exchange retranslation election
will cease to apply where relevant criteria are no longer satisfied and a
balancing adjustment will be necessary when the foreign currency
21
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
retranslation election ceases to have effect [Schedule 1, item 1, section 230-250].
It should be noted that the balancing adjustment in relation to the
cessation of the foreign currency retranslation election captures only the
foreign currency component of the relevant financial arrangement.
1.64 Chapter 7 explains the elective foreign exchange retranslation
method in detail. For taxpayers subject to Division 230, foreign currency
denominated arrangements excluded from the operation of Division 230
can be retranslated under the retranslation provisions in Division 775.
Elective hedging method
1.65 The elective hedging method allocates gains and losses from a
hedging financial arrangement on a basis that corresponds with the gains
and losses from the relevant hedged item. The hedging rules provide for
both tax-timing and tax classification (ie, capital, revenue, assessable,
exempt, non-assessable non-exempt) matching. The scope of the hedging
treatment is determined by the coverage of `hedging financial
arrangements' defined for accounting standards purposes but, as well,
may include certain other financial arrangements. To use the elective
hedging method the taxpayer must have financial reports prepared and
audited in accordance with relevant financial accounting and auditing
standards [Schedule 1, item 1, Subdivision 230-E], and must meet certain other
requirements, including record keeping and hedge effectiveness criteria.
1.66 The balancing adjustment required under Subdivision 230-G is
not required in relation to a financial arrangement that is covered by the
hedging financial arrangement election. [Schedule 1, item 1,
subsection 230-390(1)]
1.67 Chapter 8 explains the elective hedging method in detail.
Election to rely on financial reports
1.68 The election to rely on financial reports determines gains and
losses from financial arrangements by reference to relevant accounting
standards. This election effectively aligns the tax treatment of relevant
arrangements to the accounting treatment.
1.69 To make this election the taxpayer needs to have financial
reports which are prepared and audited in accordance with relevant
accounting and auditing standards. Other requirements include that the
relevant auditor's report must be unqualified, and meeting certain
standards in relation to accounting systems and controls.
1.70 Further, the election can only apply to a financial arrangement if
it is reasonably expected that the difference between the amount of the
22
Background and framework
overall gain or loss and its allocation over time derived from using the
accounting reports and that which would be determined under the other
provisions of Division 230 would reasonably be expected not to be
substantial. [Schedule 1, item 1, Subdivision 230-F]
1.71 A balancing adjustment is required when the election to rely on
financial reports ceases to apply. [Schedule 1, item 1, section 230-380]
1.72 Chapter 9 explains the financial reports election in detail.
Compounding accruals and realisation methods
1.73 All financial arrangements within the scope of Division 230
(after taking into account any exceptions or additions) will have gains and
losses worked out using the accruals or realisation methods unless:
· an elective method applies to the arrangement. However, in
the case of the elective foreign currency retranslation method
(where that method applies to determine the foreign currency
gain or loss from the arrangement) the accruals or realisation
treatment may still apply to determine the non-foreign
currency gain or loss component of the financial
arrangement; or
· the arrangement is an equity interest or is a right to receive or
an obligation to provide an equity interest and that right or
obligation is not `cash settlable'.
Compounding accruals method
1.74 The compounding accruals method allocates gains and losses
from a financial arrangement to income years according to an implicit rate
of return. This rate of return is commercially known as the `internal rate
of return' or the `effective interest rate'. The compounding accruals
method applies when an overall, or a particular, gain or loss from a
financial arrangement is sufficiently certain. An amount or value is
`sufficiently certain' if it is `fixed or determinable with reasonable
accuracy'. [Schedule 1, item 1, sections 230-105, 230-110, 230-120 and 230-135]
1.75 Where material changes are made to terms or conditions or
circumstances that affect arrangements, taxpayers are required to make
fresh assessments of gains and losses subject to accruals treatment. In
certain circumstances they may need to re-estimate relevant gains and
losses. [Schedule 1, item 1, sections 230-155 and 230-160]
23
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
1.76 A running balancing adjustment is made to correct for any
underestimation or overestimation resulting from application of the
accruals method. [Schedule 1, item 1, section 230-145]
1.77 Chapter 4 explains the compounding accruals method in more
detail.
Realisation method
1.78 The realisation method allocates gains and losses to income
years when they occur, which will generally be when the relevant
financial benefit representing the gain or loss is due to be provided or
received, as the case may be. This method applies to the extent that the
compounding accruals method or the elective methods do not apply.
[Schedule 1, item 1, subsections 230-45(2) and 230-105(5) and section 230-150]
1.79 Chapter 4 explains the realisation method in more detail.
Available choices among the tax treatments
1.80 Gains and losses a taxpayer makes when they cease to hold a
financial arrangement (including if they transfer part of a financial
arrangement) other than a hedging financial arrangement are recognised
using the balancing adjustment provisions, and not under any of the other
methods (see Chapter 10). [Schedule 1, item 1, subsection 230-45(1),
Subdivision 230-G]
1.81 However, while a taxpayer holds a financial arrangement, gains
and losses they make from that arrangement can be calculated under the
accruals or realisation methods or any of the elective methods (subject to
the relevant criteria being satisfied). [Schedule 1, item 1, subsection 230-45(1)]
1.82 Amongst the elective methods, the elective hedging method, to
the extent that it is applicable, takes priority over the other elective
methods. Subject to this, if an election to rely on financial reports is
made, gains and losses from all relevant financial arrangements are
determined using this method. [Schedule 1, item 1, subsection 230-45(5)]
1.83 Where the fair value treatment applies to the whole of a financial
arrangement, the taxpayer does not have to consider other tax-timing
methods (except to the extent to which the elective hedging method or the
election to rely on financial reports applies to the financial arrangement).
[Schedule 1, item 1, subsection 230-45(3)]
24
Background and framework
1.84 However, if the fair value treatment applies to only a part of a
financial arrangement then the other part is deemed to be a separate
financial arrangement and must be subject to another tax-timing
treatment. [Schedule 1, item 1, section 230-200]
1.85 The foreign exchange retranslation method may apply to
determine the foreign currency component of gains or losses from a
financial arrangement only if none of the other elective methods apply to
that arrangement [Schedule 1, item 1, subsection 230-45(4)]. If the retranslation
method and other elective methods do not apply, the foreign currency gain
or loss may be taxed on a realisation basis.
1.86 If the financial arrangement is subject to one of the elective
methods (other than the retranslation method), the accruals and realisation
methods will not apply. Where the foreign exchange retranslation method
applies to the financial arrangement, the accruals or realisation methods
will also apply to determine any gains or losses from the financial
arrangement, to the extent they are not attributable to currency exchange
movements. [Schedule 1, item 1, subsection 230-45(2)]
1.87 Neither the accruals, realisation, nor retranslation methods will
apply to a financial arrangement that is an equity interest, or to other
`equity' financial arrangements within the meaning of
subsection 230-55(2). The hedging method will only apply to a financial
arrangement that is an equity interest if it is a foreign currency hedge and
is issued by the taxpayer. [Schedule 1, item 1, paragraph 230-45(2)(e) and
sections 230-230 and 230-285]
1.88 Finally, the realisation method will apply to a gain or loss from a
financial arrangement only where the accruals method does not apply.
[Schedule 1, item 1, subsection 230-105(5)]
If the year is the final holding year, work out any gain or loss from
ceasing to have the financial arrangement
1.89 In the last year that a taxpayer holds a financial arrangement, the
taxpayer needs to work out the gain or loss it makes from ceasing to hold
the financial arrangement. This is to ensure that the total gain assessable,
or the total loss deductible, on the arrangement reflects the actual gain or
loss [Schedule 1, item 1, section 230-385 and subsection 230-45(1)]. Chapter 10
addresses the treatment of gains and losses from ceasing to hold a
financial arrangement.
25
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Integrity rules
Consistency
1.90 Gains and losses must be worked out consistently for each
financial arrangement through time. This means that the methods used
should be used consistently both from year to year for a particular
financial arrangement (subject to a particular method ceasing to apply, for
example where the requirements for its application are no longer met),
and where the taxpayer is entitled to choose to apply a method in a
particular manner they must use the same manner for all financial
arrangements that are of a similar nature. [Schedule 1, item 1, section 230-85]
Application and transitional provisions
1.91 The rules will apply to financial arrangements acquired on or
after the first day of the first income year on or after 1 July 2009. A
taxpayer may also elect to apply the rules to financial arrangements
acquired on or after the first day of the first income year on or after
1 July 2008.
1.92 A taxpayer may elect to apply the rules contained in
Division 230 to existing arrangements (ie, to those financial arrangements
which the taxpayer acquired before the start of the first applicable income
year but still held at that time). Such an election may give rise to an
amount in the nature of a transitional `balancing adjustment' if the amount
taken into account under the ITAA 1936 and the ITAA 1997 prior to the
application of Division 230 differs from the amount that would have been
taken into account under Division 230 if it had applied from the
commencement of the arrangement. The transitional balancing
adjustment is to be spread over the first applicable income year and the
next three income years [Schedule 1, Part 3, items 97 to 99]. The election to
apply Division 230 to existing arrangements does not extend to the
alignment of tax classification treatment for gains and losses from
hedging financial arrangements under Subdivision 230-E where the
taxpayer first started to hold the arrangement prior to the commencement
of Division 230 [Schedule 1, Part 3, subitem 99(7)]. Chapter 12 explains the
application and transitional provisions in more detail.
26
Chapter 2
Definition of `financial arrangement'
Outline of chapter
2.1 Division 230 uses the term `financial arrangement' as the item to
which taxation applies. Gains and losses in relation to a financial
arrangement are taken into account in determining taxable income.
2.2 This chapter sets out:
· the meaning and scope of the term `financial arrangement';
· which financial arrangements are specifically excepted from
the operation of Division 230; and
· the additional operation of Division 230 to certain things.
Context of amendments
What is a financial arrangement?
2.3 As explained in Chapter 1, financial innovation has spawned an
endless variety of arrangements under which finance is provided or risk is
shifted. The characteristics of such arrangements can mean that
arrangements with similar form can vary significantly in terms of the risks
and benefits involved, or that there is very little difference in substance
notwithstanding that the form and the name given to the two are quite
different.
2.4 Traditionally the income tax law has tended to place emphasis
on the legal form of the arrangement to determine its tax treatment. This
is not sustainable in the face of modern financial innovation. More
recently, specific areas of income tax law have been designed so that tax
treatments better reflect the economic and commercial characteristics of
arrangements: see, for example, the debt/equity rules in Division 974 of
the Income Tax Assessment Act 1997 (ITAA 1997).
27
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.5 Reflecting this trend -- and the need to minimise the
distortionary tax treatment that can arise under the current tax law in
respect of economically similar financial arrangements -- development of
a set of principles to establish the definitional scope of financing and risk
shifting arrangements for the purposes of Division 230 has taken into
account the common economic substance underpinning all such
arrangements. As well, account has been taken of the need to align tax
(to the greatest extent possible) with the commercial recognition of gains
and losses from financial arrangements. Centred on these foundations the
general and broadly applicable definition of a `financial arrangement'
adopted in Division 230 is intended to enhance tax neutrality, consistency
and the functional effectiveness of the tax system.
2.6 A possible approach to the definition of `financial arrangement'
would be to rely on the relevant definitions in financial accounting
standards. For example, the scope of Australian Accounting Standard
AASB 132 Financial Instruments: Disclosure and Presentation
(AASB 132) is governed by the definition of the term `financial
instrument' which, in turn, is based on definitions of the terms `financial
asset' and `financial liability'. For measurement purposes, Australian
Accounting Standard AASB 139 Financial Instruments: Recognition and
Measurement (AASB 139) adopts the same meaning of `financial
instrument' as used in AASB 132.
2.7 The Division 230 definition of `financial arrangement' draws on
and closely corresponds with the definitions in these accounting standards.
A complete alignment was not considered appropriate after consideration
was given to a range of factors including those set out in the paragraphs
below.
2.8 The AASB 132 definition of `financial instrument' was
developed in a different context to that relevant to the tax law. First, that
standard is but one of a number of interrelated standards that form a
broader financial accounting framework. These accounting standards
have different purposes to the income tax system.
2.9 Second, the approach of AASB 132 and AASB 139 to the
question of scope appears to be based on rights and obligations under
individual contracts. However, the provision of finance and risk-shifting
can occur through arrangements that comprise one or more contracts
(eg, stapled securities) and by way of rights and obligations that are not
necessarily founded on contract.
2.10 Third, not all entities subject to Division 230 would be required
to prepare financial accounts which classify arrangements based on the
definitions in AASB 139. If the scope of the Division was based on the
scope of particular financial accounting standards, these entities would
28
Definition of `financial arrangement'
need to understand, or obtain advice on, the scope of relevant financial
accounting standards, including changes to these standards and their
interpretation, merely for income tax purposes. Such entities may view
such compliance as burdensome and unfair.
2.11 Against this background, the definition of `financial
arrangement' for the purposes of Division 230 is cast in terms of what
fundamental and common elements, in principle, characterise both the
provision of finance and the shifting or allocation of risk. In this regard,
key common elements of all financial arrangements are the right to
receive, or obligation to provide, a financial benefit (irrespective of
whether the value or existence of the right or obligation is contingent on
some event or other thing) which is:
· monetary in nature;
· non-monetary in nature and may be settled by money or a
money equivalent; or
· in substance and effect monetary in nature.
2.12 Collectively, these rights and obligations are described in
Division 230 as `cash settlable'.
2.13 Limiting the definition of financial arrangement solely to
formal (legal) rights to receive, or obligations to provide, financial
benefits of a monetary nature would not facilitate tax neutrality and
consistency, or enable the taxation of certain transactions to be aligned
with commercial outcomes. In particular, this could occur where the right
to receive, or the obligation to provide, a financial benefit is of a
non-monetary nature but having regard to factors such as the pricing,
terms and conditions of the arrangement, business practices, the intention
of the parties, or the nature of the activities relating to the arrangement,
those rights and obligations will be likely settled in monetary terms. This
is why the cash settlable rights and obligations relevant for Division 230
purposes include those which are in substance or effect monetary in
nature.
2.14 Because the definition of `financial arrangement' in
Division 230 is based on characteristics common to all financial
arrangements it will cope better with future financial innovation than
would a definition based on legal form or on lists of arrangements. In that
sense the definition is considered to be appropriately comprehensive and
durable.
29
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Additions and exceptions
2.15 Equity interests, including rights to receive, and obligations to
provide, equity interests, are specifically brought into the scope of
Division 230 as a separate category of financial arrangement. However,
gains and losses made from these `equity' financial arrangements will be
subject to Division 230 only in limited circumstances.
2.16 In addition to the general definition for financial arrangements
and `equity' financial arrangements, specific inclusion provisions exist to
ensure that arrangements which can operate in a similar way to these
defined financial arrangements are bought within the scope of
Division 230 -- specifically, foreign currency, non-equity shares and
commodities held by traders in certain circumstances.
2.17 Division 230 also provides for various exceptions which exclude
gains and losses made from particular financial arrangements from being
subject to Division 230. For example, there are circumstances in which an
arrangement that conceptually comes within the scope of the definition of
financial arrangement is covered by another specific area of the income
tax law, and there are policy reasons for it to continue to be so covered. In
such cases, gains and losses from the arrangement are specifically
excluded from being dealt with under Division 230.
2.18 In addition, there are compliance and administrative reasons for
excluding other types of arrangements from treatment under Division 230.
Those arrangements are also the subject of either a general or specific
exclusion.
2.19 The scope of Division 230 should therefore be considered by
looking at what, by definition, is a financial arrangement together with the
exclusions and the additional operation of the Division.
Unit of taxation
2.20 The definition of `financial arrangement' is important because it
determines the unit of taxation in respect of which gains and losses are
recognised under Division 230. That is, the applicable tax-timing
methods apply in relation to a defined financial arrangement (and to those
arising from the additional operation of this Division) to determine the
gains and losses that will be subject to Division 230 (excluding financial
arrangements from which the gains and losses are covered by an
exception).
30
Definition of `financial arrangement'
2.21 A financial arrangement is an arrangement which at the relevant
time satisfies the definition of financial arrangement under Division 230
(see paragraph 2.24).
2.22 Typically, an arrangement will be constituted by a contract.
Generally, this would be the case for ordinary financial instruments,
common hybrid instruments and derivatives. However, the concept of
arrangement as used in Division 230 recognises that a contractual basis
may be insufficient to reflect the substance of an arrangement in all
circumstances. It is recognised that modern arrangements can be put
together in very complex ways and that their substance may be different
from their form.
2.23 To deal with the various forms in which relevant arrangements
may take, what rights and obligations constitute the relevant arrangement
for Division 230 purposes (ie, the arrangement to be tested to determine
whether it is or is not a financial arrangement), is based on various factors.
These factors go to the substance of these rights and obligations and the
facts and circumstances surrounding them.
Summary of new law
2.24 A financial arrangement is defined as a cash settlable right to
receive, or obligation to provide, a financial benefit, or a combination of
such rights and obligations (irrespective of whether the value or existence
of the right or obligation is contingent on some event or other thing)
which exist under an arrangement. An exception will apply where, under
the same arrangement, there are other rights and obligations that are not
insignificant (ie, the cash settlable rights and/or obligations otherwise
comprising the financial arrangement must be the only rights and/or
obligations of any significance subsisting under the arrangement before a
financial arrangement will arise).
2.25 A right to receive a financial benefit or an obligation to provide
a financial benefit will be cash settlable where the financial benefit is
broadly:
· money or a money equivalent; or
31
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· non-monetary, but the right or obligation to that financial
benefit is in substance and effect expected to be dealt with in
a manner that results in receiving or paying money or a
money equivalent, when regard is given to factors such as:
- the taxpayer's intended way of settling the right or
obligation;
- the practice by which the taxpayer settles similar rights
and/or obligations;
- the taxpayer's dealings with respect to the rights or
obligations or similar rights and/or obligations; or
- the liquidity of the financial benefit, or the ability to
cash settle the right or obligation, where the financial
benefit is to be provided or received other than as part of
the taxpayer's expected purchase, sale or usage
requirements.
2.26 Division 230 does not generally apply to gains and losses from
arrangements that do not satisfy this definition of a financial arrangement.
However, equity interests (and certain rights and obligations to equity
interests that are not otherwise financial arrangements) are a separate
category of a financial arrangement that will have gains and losses dealt
with under Division 230 in limited circumstances. In addition, specific
inclusion provisions exist to ensure that arrangements which can operate
in a similar way to these types of financial arrangements are bought within
the scope of Division 230.
2.27 Division 230 also provides for various exceptions which take
gains and losses from certain financial arrangements outside the scope of
the Division.
32
Definition of `financial arrangement'
Comparison of key features of new law and current law
New law Current law
The definition of `financial There is no comprehensive definition
arrangement' is based on rights to of financial arrangement, which
receive, or obligations to pay, creates gaps, distortions and
financial benefits that are cash anomalies in tax treatments.
settlable.
Specific additions include certain
arrangements that have a similar
effect or operation to these financial
arrangements.
Some financial arrangements have Certain types and classes of financial
their gains and losses disregarded for arrangements are not specifically
the purposes of Division 230 for addressed.
compliance, administrative or other
policy reasons.
Arrangements comprising a number Arrangements are generally treated
of different rights and obligations are based on legal form.
generally determined on a
stand-alone contractual basis where
the form of the contract is consistent
with its substance.
The ability to cope with financial It is inadequate to deal with financial
innovation is increased. innovation.
Detailed explanation of new law
2.28 Whether or not a particular arrangement is a financial
arrangement will depend on whether or not it satisfies:
· the principal financial arrangement definition dealing with
cash settlable rights and obligations to financial benefits
(a cash settlable financial arrangement), or
· the secondary financial arrangement definition dealing with
equity interests and rights and obligations to equity interests
(an equity financial arrangement).
An entity can have rights to receive financial benefits and/or obligations
to provide financial benefits. Accordingly, an entity can be either a holder
of a financial arrangement that is an asset or an issuer of a financial
arrangement that is a liability.
[Schedule 1, item 1, sections 230-50 and 230-55]
33
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
The arrangement that is being tested
2.29 Before it can be decided whether either of the tests for a
financial arrangement are satisfied, the particular arrangement being
tested must be determined.
2.30 An arrangement, as defined in the ITAA 1997, is a broad
concept. It includes any arrangement, agreement, understanding, promise
or undertaking, whether express or implied. Moreover, it does not need to
be enforceable, or intended to be enforceable, by legal proceedings.
2.31 Division 230 modifies this broad notion of an arrangement,
providing guidance as to which specific rights and obligations will make
up the relevant arrangement to be tested for the purposes of the Division.
[Schedule 1, item 1, subsection 230-60(4)]
2.32 Arrangements can be constructed in very flexible ways.
However, for straightforward situations, an arrangement will often be
contract based. So too for Division 230 purposes, a contract will often
define the boundaries of a relevant arrangement. This is where the form
of the contract is consistent with its substance.
2.33 The various rights and obligations subsisting under a contract
will typically constitute the relevant arrangement for the purposes of
Division 230. That is, the contract is typically viewed on a `stand-alone'
basis. In this context, the contract is neither aggregated with another
contract (or contracts), nor disaggregated into component parts, when
determining the relevant arrangement to be considered under
Division 230.
2.34 On this basis, all cash flows under an instrument will typically
form part of the one arrangement and will not be disaggregated to
represent separate arrangements. For example, in the usual case, a right to
receive dividends will form part of a share instrument, and an obligation
to pay interest will form part of a loan agreement.
2.35 However, in certain cases, the form of the contract may be
inconsistent with the economic or commercial substance of an
arrangement. This could arise where, for instance, one or more rights and
obligations under separate formal contracts (whether or not they come into
existence at the same time) are intended to give rise to a single
arrangement (such as the case with a stapled security). Division 230 is
directed at reflecting the commercial and economic substance of
arrangements; `commercial' in this sense refers to non-tax factors driving
the way in which the particular arrangement is structured.
34
Definition of `financial arrangement'
2.36 Which rights and/or obligations comprise the relevant
arrangement for Division 230 purposes is a question of fact and degree.
To determine whether a number of rights and/or obligations arise under
one or more arrangements, regard is to be given to the:
· nature of those rights and/or obligations, when considered
separately and in combination (including having regard to the
substance and character of the rights and/or obligations);
· terms and conditions of the rights and/or obligations,
including those relating to any payment or other
consideration for them, both when considered separately and
when considered in combination (including having regard to
the legal terms of the rights and/or obligations in their
economic context, including those relating to the amount and
timing of the consideration to be paid or received, and the
pricing of those rights and/or obligations relative to what
would otherwise be expected of such rights and/or
obligations, when considered separately and together);
· circumstances surrounding the creation of those rights and/or
obligations and their proposed exercise or performance,
(including what can reasonably be seen as the purposes of
one or more of the parties involved), when the rights and/or
obligations are considered separately and when considered in
combination (also taking into account the context in which
the rights and/or obligations were created and are anticipated
to cease, when consideration is given to one or more of the
relevant parties' intentions);
· whether the rights and/or obligations can be dealt with
separately or whether they must be dealt with together
(eg, the separate interests that comprise a stapled security
cannot be separately dealt with);
· normal commercial understandings and practices in relation
to the rights and/or obligations when considered separately
and when considered in combination, including whether
commercially they are regarded as separate things or as a
group or a series that forms a whole (a comparison with
similar or typical commercial arrangements may help
determine the commercial understanding of the relevant
rights and/or obligations under consideration); and
· objects of Division 230 (and so having regard to minimising
the extent to which the tax treatment of relevant
35
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
arrangements distorts commercial decision making, more
closely aligning the tax and commercial treatment of relevant
arrangements, and minimising compliance costs).
[Schedule 1, item 1, subsection 230-60(4)]
Example 2.1: Loan and hedge
Oz Co borrows in pounds sterling from Bank Co. To hedge its
exposure to pounds sterling, Oz Co also enters a cross currency swap.
Without this exposure being hedged, Bank Co would not lend to Oz Co
in pounds sterling.
The fact that the swap and the borrowing may not have been entered
into without the other, is not sufficient for them to comprise one
arrangement. A consideration of the following factors:
· the nature of the loan and the swap, and the rights and
obligations which comprise them, differ;
· the loan and the swap are not contractually bound together
(ie, amongst other things the termination of one will not
automatically lead to the termination of the other, such that their
creation and performance times may differ);
· the payment terms and conditions, including the counterparties
and relevant dates may differ;
· the commercial effect of the loan or the swap can be, and is
typically, understood without reference to the other;
· commercially the loan and the swap are regarded as separate
arrangements, and each can be defeased or assigned to a third
party separately; and
· treating the loan and swap as separate arrangements would not
defeat the objects of the Division,
reveals that for the purpose of Division 230 the loan and the swap
should be treated as separate arrangements, each of which may be
assessed to determine whether or not it is a financial arrangement
subject to the Division (subsection 230-60(4)).
Later in this chapter, in Example 2.17, consideration is given to
whether Oz Co's hedge and loan are, when considered separately,
financial arrangements.
36
Definition of `financial arrangement'
Example 2.2: Convertible note
Hamish Co holds a convertible note that pays coupon payments at a
floating rate over the life of the note. At maturity of the note,
Hamish Co has the option to convert the note and receive ordinary
shares of the issuing company. If Hamish Co chooses not to take this
option, it will receive a return of its original investment in the note on
maturity instead of the note converting into ordinary shares.
Hamish Co does not have the sole or dominant purpose of entering into
the convertible note to receive the shares.
Economically, Hamish Co's convertible note represents one
arrangement that comprises both a fixed income security (similar to a
bond) and an equity derivative embedded in the security (the option to
convert).
However, in light of the fact that:
· normal commercial practice is for the holder of a convertible
note to deal with the note as one arrangement;
· packaged as a note the various components of the convertible
note have the nature of them being only one arrangement;
· the terms and conditions indicate the arrangement, whilst having
the same effect as its separate components, must be dealt with
together and contain no provision for separate assignment of the
various embedded rights and obligations;
· the rights and obligations under the notes were created under the
one arrangement and at the same time, and are proposed to
extinguish together on maturity;
· it would be reasonable to assume that Hamish Co intends to deal
with its rights and obligations under the note together and not
separately. Arguably, commercial understandings would
suggest that where taxpayers intend on dealing with a fixed
income security and an equity derivative separately, they would
be more inclined to enter into an arrangement that comprises an
equity linked debt security with equity warrants, which is
economically similar to a convertible note with the exception
that normal commercial understanding is that the equity
warrants are detachable and may be dealt with separately; and
· the objectives of more closely aligning tax and commercial
treatment of relevant arrangements,
Hamish Co's rights and obligations under the convertible note will be
taken to comprise one arrangement (subsection 230-60(4)).
37
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Whether or not Hamish Co's convertible note arrangement is a
financial arrangement is considered later in this chapter, in
Example 2.17.
Example 2.3: CPI index-linked bond
At the end of the 2008 income year High Hope Co, a company with an
aggregated turnover of $3 billion, purchases a five-year index-linked
bond with a face value of A$100 from the issuer, XYZ Co, for its face
value (A$100). The index-linked bond pays coupons calculated by
reference to movements in the United States of America (US)
consumer price index (CPI). Specifically, the index-linked bond pays
annual coupons of 7 per cent of the face value of the bond, adjusted
upwards or downwards according to the percentage movement on the
US CPI. If the percentage movement in the CPI in the relevant period
falls below the initial set percentage, no coupon will be paid in that
period. The bond contains no separate or detachable option. The bond
will pay A$100 on redemption (at the end of the 2013 income year).
Based on history the US CPI is expected to increase by 2 per cent per
annum over the relevant five-year period.
Having regard to the features of High Hope Co's CPI indexed-linked
bond and the circumstances surrounding this arrangement, it will be
treated as a single arrangement for the purposes of Division 230,
having regard to the fact that (see subsection 230-60(4)):
· the rights and obligations under the CPI index-linked bond are
dealt with together as one arrangement;
· the terms and conditions reflect those of a common commercial
arrangement that is commercially treated as a single
arrangement;
· normal commercial practice is to view CPI index-linked bonds
as one arrangement, and High Hope Co's bond is consistent with
other such bonds commonly available; and
· treating High Hopes Co's bond as such would be consistent with
the objects of the Division.
Whether or not High Hope Co's CPI index-linked bond, as a single
arrangement, is a financial arrangement, is set out later in this chapter,
in Example 2.17.
For similar reasons to those listed in relation to High Hope Co's CPI
indexed-linked bond, typical equity linked bonds, where the coupon
return is based on the movement in an equity interest or basket of
equity interests, would also constitute the one arrangement.
38
Definition of `financial arrangement'
However, other arrangements where a return based on a share or index
movement is artificially or unusually attached to what would otherwise
be a stand-alone arrangement may not, having regard to the factors set
out in subsection 230-60(4), be treated as being the one arrangement
for the purposes of Division 230.
Example 2.4: Two arrangements under the one contract
LA Co enters into a contract to purchase an office building from
Vendor Co. LA Co also arranges to acquire a significant amount
of office furniture from Vendor Co. Both the building and the
office furniture are delivered at the same time, but Vendor Co
agrees to defer payment of the building for two years. The office
furniture is paid for at the time of delivery. While this transaction
may have been structured under the one contract, the purchase of
the office building and the purchase of the furniture, taking into
account the following factors, are treated as separate arrangements
(see subsection 230-60(4)):
· The payment terms and timeline for performance of each, are
significantly different.
· They can be commercially understood separately, and could be
negotiated separately.
· Having regard to the objects of the Division, and the fact that
accounting would treat the deferred arrangement differently to
that which was paid for on delivery, each purchase should be
treated as a separate arrangement.
Therefore, the contract entered into by LA Co represents two separate
arrangements. Each of these arrangements will have to be separately
tested to determine whether it is a financial arrangement as defined
within the Division. For a discussion on whether or not LA Co's
arrangements are financial arrangements, see Example 2.17.
Example 2.5: Sale and repurchase agreement
A typical cash-based sale and repurchase agreement involves the sale
of a cash-based security (such as a bond or bank bill) and a
simultaneous agreement to buy it, or substantially the same security,
back at an agreed future date for an agreed price (which may be the
sale price plus a lender's return). The combined sale and repurchase
arrangement is often referred to as a `repo'.
In terms of subsection 230-60(4):
· The nature of the rights and/or obligations under the repo are
such that the sale of the security would not be entered into
without entering into the repurchase agreement.
39
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· The terms and conditions of the repo suggest that, in substance,
it is one arrangement.
· The parties to a repo would ordinarily view the sale and
repurchase rights and/or obligations together, and intend that
they be considered together.
· It would be unlikely for the sale rights and/or obligations to be
dealt with separately to the repurchase rights and/or obligations.
· Normal commercial understandings and practices are that the
sale and repurchase rights and/or obligations would be viewed
as being integrally related to each other. For example,
AASB 139 would consider them in combination and not
de-recognise the security because the seller retains substantially
all the risks and rewards of ownership (see paragraph AG51(b)
of AASB 139).
· Treatment of the repo as an arrangement under
subsection 230-60(4) is consistent with the substance of the
situation and, accordingly, with the objects of Division 230.
In the circumstances, typical repos would constitute one arrangement
for the purposes of Division 230.
Right or obligation to more than one financial benefit
2.37 A right to receive two or more financial benefits, or an
obligation to provide two or more financial benefits, is taken for the
purpose of Division 230 to be two or more separate rights, or two or more
separate obligations, respectively. [Schedule 1, item 1, subsections 230-60(1)
and (2)]
Example 2.6: Interest bearing bank account
Retailer Pty Ltd opens a current account with Bank Ltd on 1 July 2010.
Under the terms of the account, Retailer Pty Ltd may make deposits
and withdrawals at any time, provided it does not overdraw the
account. Interest is calculated daily (on the minimum daily balance)
and payable on 31 July each year. If the account is closed, interest
calculated up until the date it is closed becomes payable at that time.
The interest rate is set in advance and can change at any time at
Bank Ltd's discretion.
A bank account is a single debt existing between the customer and the
banker in their respective capacities as creditor and debtor (Foley v Hill
[1843-1860] All ER 16). The right to receive the balance of the bank
account is therefore taken to be the one right. However, that right is in
relation to each dollar that comprises the balance of the account. Each
dollar is a relevant financial benefit. Hence, for the purposes of the
Division, Retailer Pty Ltd is taken to have a separate right to receive
40
Definition of `financial arrangement'
each dollar that comprises the balance of the account
(subsection 230-60(1)).
Having regard to the features of Retailer Pty Ltd's bank account and
the circumstances surrounding this arrangement, it will be treated as a
single arrangement for the purposes of Division 230, having regard to
the fact that (see subsection 230-60(4)):
· the rights and obligations under the bank account are dealt with
together as one arrangement;
· the terms and conditions reflect those of a common commercial
arrangement that is commercially treated as a single
arrangement;
· normal commercial practice is to view the bank account as one
arrangement, and Retailer Pty Ltd's bank account is consistent
with other such accounts that are commonly available; and
· treating Retailer Pty Ltd's bank account as such would be
consistent with the objects of the Division.
As explained in Example 2.17, Retailer Pty Ltd's bank account with
Bank Ltd is a cash settlable financial arrangement.
Is the relevant arrangement subject to Division 230?
2.38 The relevant arrangement for Division 230 purposes, determined
using the principles set out above, must meet the definition of a `financial
arrangement' before it will be subject to Division 230. As mentioned
above, whether or not the relevant arrangement is a financial arrangement
will depend on whether or not it satisfies:
· the principal `financial arrangement' definition dealing with
cash settlable rights and obligations to financial benefits
(a cash settlable financial arrangement); or
· the secondary `financial arrangement' definition dealing with
equity interests and rights and obligations to equity interests
(an equity financial arrangement).
[Schedule 1, item 1, sections 230-50 and 230-55]
41
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Cash settlable financial arrangement
Background
2.39 In a commercial context, arrangements commonly identified as
`financial instruments', `financial transactions', `financial assets' and
`financial liabilities' include:
· debt instruments such as bonds, loans, bills of exchange and
promissory notes, whether Australian dollar or foreign
currency denominated; and
· derivatives such as options, forwards and swaps.
2.40 A factor that is common to all of the above -- and to equivalent
arrangements -- is that a party to the arrangement has either a right to
receive, or an obligation to provide, cash or something equivalent to cash
or some combination thereof.
2.41 The rights and obligations embodied in such arrangements
represent a promise by one party to the arrangement to provide something
of economic value that is money or a money equivalent and a
corresponding right of another party to receive something of economic
value that is money or a money equivalent. Financially and economically,
the value embodied in these commercial arrangements is based on the
time value of money and risk.
2.42 In other situations, even though the rights and obligations
associated with an arrangement are in respect of a non-monetary item, it is
possible that the way in which the arrangement is settled or dealt with will
have the same effect as the provision or receipt of a financial benefit that
is in respect of money or a money equivalent.
2.43 For example, taxpayers holding rights or obligations to financial
benefits that are non-monetary, may, through business practices, settle
these rights or obligations with money, a money equivalent or by transfer
or entry into another financial arrangement (monetary financial benefits).
In other cases, taxpayers may by intention settle non-monetary rights and
obligations in a way that result in the receipt or payment of monetary
financial benefits. Even without this practice or intention, a non-monetary
right or obligation that is able to be settled in monetary financial benefits
may have the same effect as a monetary right or obligation if the taxpayer
did not have the sole or dominant purpose of receiving or providing that
non-monetary thing as part of its expected purchase, sale or usage
requirements in the ordinary course of business.
42
Definition of `financial arrangement'
2.44 In other circumstances taxpayers may enter into arrangements
giving rise to highly liquid non-monetary rights and obligations which are
readily convertible to money or a money equivalent, and which are not
entered into for the purpose of their ordinary business dealings or usage.
2.45 There will also be circumstances where a taxpayer might carry
on, for profit, a business as dealer or trader in the rights and obligations in
respect of financial benefits of a non-monetary nature. An example of
such a dealer would be one who deals in rights to commodities with the
objective of profiting from differences in the buy and sell margins from
holding offsetting positions, or through short-term strategies seeking to
exploit fluctuations in the price of the rights to the commodity.
2.46 The arrangements described above, in substance and effect have
identical consequences to those of monetary arrangements -- that is, they,
through the conduct of the parties, give rise to rights and obligations to
provide financial benefits that are monetary in nature. The concept of a
cash settlable financial arrangement, as set out in section 230-50, seeks to
bring within the scope of the Division those arrangements that in
commercial and economic terms reflect these attributes.
What is a cash settlable financial arrangement?
2.47 An entity has a cash settlable financial arrangement where,
under an arrangement (as determined under section 230-60 as discussed
above):
· the entity has one or more cash settlable legal or equitable
rights to receive, and/or obligations to provide, a financial
benefit; and
· in comparison to these rights and/or obligations, the entity
does not also have one or more non-insignificant rights
and/or obligations that:
- are not cash settlable; and/or
- are not rights to receive, or obligations to provide, a
financial benefit.
[Schedule 1, item 1, subsection 230-50(1)]
2.48 If the entity meets these conditions at any time, looking only at
the entity's subsisting rights and obligations under an arrangement, then at
that time, by definition, the entity will have a financial arrangement that
consists (only) of any of its cash settlable legal or equitable rights to
receive, and obligations to provide, a financial benefit under that
43
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
arrangement (however, see paragraph 2.49). In including only cash
settlable rights and obligations, the financial arrangement as defined may
be narrower than the arrangement being tested, which is determined under
the principles in section 230-60. [Schedule 1, item 1, subsection 230-50(1)]
Additional rights and obligations or financial benefits may be taken into
account
2.49 As mentioned in paragraph 2.48, the financial arrangement as
defined will only comprise the cash settlable rights to receive, and
obligations to provide, financial benefits under the arrangement.
However, for the purpose of working out any gain or loss from that
financial arrangement, financial benefits the taxpayer receives or provides
(or has a right or obligation to do so) which play an integral role in
determining whether a gain or loss is made from the financial
arrangement, are also taken to be relevant rights and obligations under that
financial arrangement. These rules ensure that an appropriate cost or
amount of proceeds is allocated to the cash settlable financial
arrangement; the rules are described in more detail in Chapter 3.
[Schedule 1, item 1, section 230-65]
Relevant rights and obligations
2.50 It is critical to the definition of a `cash settlable' financial
arrangement that there be one or more cash settlable rights to receive, or
obligations to provide, a financial benefit. The term financial benefit as
defined in the ITAA 1997 means anything of economic value. Economic
value encapsulates money, money equivalent and non-monetary items.
2.51 A right to receive, or an obligation to provide, a financial benefit
for the purposes of Division 230 will exist irrespective of whether the
value or existence of the right or obligation to the financial benefit is
contingent on some event or other thing. For example, a party that issues
an option assumes an obligation to provide a financial benefit,
notwithstanding that the value or existence of the obligation is contingent
on the exercise of the option. [Schedule 1, item 1, section 230-90]
2.52 In addition to being in respect of a financial benefit, it is
fundamental to the definition of a `cash settlable' financial arrangement
that the relevant rights and obligations be cash settlable. The general
limitation of the scope of cash settlable financial arrangements to cash
settlable rights to receive, or obligations to provide, financial benefits
supports the relatively close correspondence between tax and commercial
outcomes to financial arrangements.
2.53 Because a right or obligation may be settled or dealt with in a
way that makes it cash settlable, whether or not a particular right or
44
Definition of `financial arrangement'
obligation is a cash settlable right or obligation must be determined from
the relevant taxpayer's perspective. That is, the question of whether or
not an arrangement is a cash settlable financial arrangement is a relative
question, needing to be determined separately from the viewpoint of each
relevant taxpayer. This means that a particular taxpayer may have a cash
settlable financial arrangement, but the relevant counterparty's
corresponding rights and obligations under that arrangement may or may
not amount to a cash settlable financial arrangement from their
perspective.
Definition of cash settlable
2.54 Cash settlable rights and obligations naturally include those
rights and obligations to the receipt or payment of money or a money
equivalent. However, limiting cash settlable rights and obligations to only
monetary rights and obligations would not appropriately reflect the
circumstances where `cash-like' rights and obligations are dealt with in
the same way as monetary rights and obligations, as discussed in the
background above. Accordingly, cash settlable rights and obligations
include all of the following.
Money or a money equivalent
2.55 For the purpose of the definition of `cash settlable', a right to
receive money, or an obligation to provide money, is taken to be a `cash
settlable' right or obligation. In addition, the definition of `cash settlable'
rights and obligations includes a right to receive, or an obligation to
provide, a money equivalent. [Schedule 1, item 1, paragraph 230-50(2)(a)]
2.56 A money equivalent for the purposes of Division 230 is
defined as:
· a right to receive money, or something that is a money
equivalent; and
· a cash settlable financial arrangement.
[Schedule 1, item 21, subsection 995-1(1) of the ITAA 1997]
2.57 Because of this definition of `money equivalent', a cash settlable
right or obligation includes a right to receive, or obligation to provide, a
financial arrangement which itself meets the test for a cash settlable
financial arrangement, in addition to a right to receive, or obligation to
provide, a right to such a financial arrangement, or a right to receive
money.
45
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.58 Money in its simplest form is cash or a unit of currency. An
item that is a money equivalent will typically have a degree of proximity
to cash. Some examples would include bonds, loans and other forms of
financial accommodation.
Example 2.7: Option to settle by money equivalent: satisfaction of a
debt by the issue of a bond
Oil Co has an outstanding loan owing to Grease Co of $100,000 which
is due on 20 June 2010. Under the terms of the loan Oil Co is entitled
to issue a five-year zero-coupon bond with a face value of $150,000 in
satisfaction of that loan obligation.
Oil Co's option to settle its obligation under the loan by the provision
of the bond is a contingent obligation to provide a bond (contingent in
the sense that it is subject to Oil Co choosing to settle the loan through
the provision of the bond instead of satisfying its loan obligation by the
provision of money).
The five-year bond is both a right to receive money (being the right to
receive its $150,000 face, or redemption, value) and is itself a cash
settlable financial arrangement (in that it consists only of cash settlable
rights to receive, and/or obligations to provide, financial benefits). As
such, Oil Co's contingent obligation to provide the bond satisfies both
limbs of the definition of `money equivalent'.
Oil Co therefore has an arrangement consisting of its contingent, cash
settlable, obligation to provide Grease Co with $100,000 (being its
loan obligation) and its contingent, cash settlable, obligation to provide
Grease Co with a money equivalent (being its contingent option to
provide the bond in satisfaction of this loan obligation). (Note that the
settlement of either one of these obligations, being alternative
obligations, would effectively be a settlement of that obligation and an
extinguishment of the alternative obligation.)
Example 2.17 explains that these obligations satisfy the definition of a
`cash settlable financial arrangement'.
Example 2.8: Value of a monetary item determined by a
non-monetary amount
Kramer Co enters into an agreement with Diamond Co under which
Kramer Co receives $10,000, in consideration for assuming an
obligation to pay Diamond Co a cash amount in five years time,
determined by a formula that is based on a commodity value.
The fact that Kramer Co's obligation to pay a monetary amount is
calculated by reference to a change in a non-monetary variable does
not prevent it from being a cash settlable obligation to provide a
financial benefit (specifically, it is an obligation to pay money).
46
Definition of `financial arrangement'
Whether or not Kramer Co's arrangement is a cash settlable financial
arrangement is discussed in Example 2.17.
Non-monetary financial benefits
2.59 In certain situations, even though the rights and obligations
associated with an arrangement are in respect of a non-monetary item, it is
possible that the way in which the arrangement is settled or dealt with will
have the same effect as the provision or receipt of a financial benefit that
is money or a money equivalent. For example, in some cases, taxpayers
holding rights or obligations to financial benefits that are non-monetary,
may intend to settle, or have a practice of settling, these rights or
obligations with money, a money equivalent or by cessation of, or entry
into, another cash settlable financial arrangement. These types of rights
and obligations, amongst others having a similar effect, are captured
within the definition of `cash settlable' as follows.
Intention to settle with money or money equivalent, or by starting or
ceasing to have another financial arrangement (monetary items)
2.60 Where a taxpayer has an obligation to provide a non-monetary
financial benefit that they intend to settle by the provision of money, a
money equivalent, or by the starting or ceasing to have another cash
settlable financial arrangement (the provision of `monetary items'), that
obligation will be taken to be cash settlable. This confirms the economic
substance of such an arrangement. [Schedule 1, item 1, paragraph 230-50(2)(c)]
2.61 Likewise, a right to receive a non-monetary financial benefit that
the taxpayer intends to satisfy by the receipt of money, a money
equivalent, or by starting or ceasing to have another cash settlable
financial arrangement (the receipt of `monetary items') will be treated as
being a cash settlable right to receive a financial benefit. [Schedule 1, item 1,
paragraph 230-50(2)(b)]
2.62 In a general sense, the provision of a monetary item as explained
above also encapsulates set-off of monetary rights and obligations or the
waiving of a present right to receive money or a money equivalent.
Similarly, the receipt of a monetary item will include the extinguishment
of a present obligation to provide a monetary item and a relevant set-off.
[Schedule 1, item 1, paragraphs 230-50(2)(b) and (c) and section 230-70]
2.63 What is meant by satisfy or settle also takes its commercial
meaning, so there must in substance be a satisfaction or settlement of the
relevant right or obligation as such. For example, a penalty for
non-performance may in substance settle an obligation to deliver or a right
to receive a non-monetary thing, if the amount of the penalty is based on
changes in the price of that non-monetary thing. However, a fixed penalty
47
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
for such non-performance will often not amount to settlement of the
relevant right or obligation (see Example 2.10).
Practice of settling with monetary items
2.64 Where a taxpayer has an obligation to provide a non-monetary
financial benefit, but they have a practice of settling similar obligations
by the provision of a monetary item (in the sense explained in
paragraphs 2.60, 2.62 and 2.63), the obligation will be taken to be
a cash settlable financial benefit. Likewise, a right to receive a
non-monetary financial benefit will be taken to be cash settlable where
the taxpayer has a practice of settling similar rights by the receipt of a
monetary item (in the sense explained in paragraphs 2.61 to 2.63).
[Schedule 1, item 1, paragraph 230-50(2)(d)]
Example 2.9: Practice to settle futures contract by cash payment
(set-off)
Ore Co usually enters into nickel futures contracts with the
Metals Exchange, whereby Ore Co will agree to sell a set quantity of
nickel for an agreed price. The contracts require delivery of the
underlying commodity. However, the practice as between Ore Co and
the Metals Exchange is to settle these contracts by cash payment equal
to the difference between the agreed price for that quantity of nickel
and the prevailing market price for that nickel at the exchange date.
Ore Co currently has a futures contract with the Metals Exchange
under which it has an obligation to provide two tonnes of nickel at
$40,000 per tonne for delivery in six months time. Were the market
value of the nickel to be $45,000 per tonne at the settlement date,
Ore Co's prior practice with similar contracts would suggest that it will
pay the Metals Exchange $10,000 rather than providing the nickel (in
full satisfaction of both its obligation to provide nickel worth $90,000
and its right to receive $80,000 from the Metals Exchange). Likewise,
were the market price of nickel to fall to $35,000 per tonne, Ore Co's
previous practice with its nickel futures contracts would suggest that it
will receive $10,000 from the Metals Exchange (in full satisfaction of
both its obligation to provide the nickel worth $70,000 and its right to
receive $80,000 from the Metals Exchange).
Ore Co in fact intends to satisfy this particular contract through the
delivery of the nickel. Nonetheless, because Ore Co has a practice of
settling similar obligations by the provision of money or a money
equivalent (including where relevant by the extinguishment of its right
to otherwise receive a greater sum from the Metals Exchange, where
the prevailing market price is less than the agreed price), its obligation
to provide the nickel is taken to be cash settlable.
Example 2.17 explains that Ore Co's arrangement is a cash settlable
financial arrangement.
48
Definition of `financial arrangement'
Example 2.10: Take-or-pay penalty clause
Kanga Co, a deep sea mining company, enters into a take-or-pay
arrangement to supply natural gas on a monthly basis to Roo Co, a fuel
processing company, over a period of 4 years. Under the arrangement,
Roo Co is required to pay a penalty for any delivery it refuses to accept
below a set threshold. As Roo Co's demand for natural gas varies
widely from month to month in line with demand for its fuel products,
it is not uncommon for the penalty to be invoked.
The penalty is based on a fixed fee determined at the commencement
of the arrangement (indexed by the CPI annually), multiplied by the
difference between the volume of natural gas delivered and the
specified threshold.
Under this arrangement, Roo Co has a right to receive natural gas on a
monthly basis and an obligation to provide payment on delivery of the
natural gas, as well as a contingent obligation to provide an amount of
money as a penalty for non-receipt, if non-receipt occurs because it
refuses to accept at least the threshold amount.
The payment of the penalty, in the event that Roo Co requires delivery
of a volume of natural gas below the specified monthly threshold, is
a fixed fee arrangement that is not dependent on the actual market
price of the underlying item at the time it is to be supplied. In these
circumstances, the payment of the penalty does not amount to a
dealing of a non-monetary nature in Roo Co's right to receive the
non-monetary thing, being a volume of natural gas that it had agreed
to take.
Notwithstanding Roo Co's history of having such a penalty clause
exercised against it, payments under such penalty clauses are not in
satisfaction or settlement of a right to receive a non-monetary thing.
Accordingly, no part of its right to receive the non-monetary thing
(the natural gas) under this arrangement is a cash settlable right.
Whether or not Roo Co's take-or-pay arrangement is a cash settlable
financial arrangement is discussed in Example 2.17.
Dealing for profit from a dealer's margin and/or short-term price
fluctuations
2.65 There will be circumstances where a taxpayer might carry on a
business as a dealer or trader in rights to receive, or obligations to provide,
non-monetary financial benefits for profit. An example of such a dealer
would be one who deals in rights to receive commodities with the
objective of profiting from differences in the buy and sell margins from
holding offsetting positions, or through short-term strategies seeking to
exploit fluctuations in price of the commodity (and thus in the value of the
rights and/or obligations).
49
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.66 Where a taxpayer `deals' with a right to receive, or an obligation
to provide, a non-monetary financial benefit, or with similar rights or
obligations, for the purpose of:
· generating a profit from short-term changes in price; and/or
· the purpose of generating a profit from a dealer's margin,
the right or obligation will be taken to be cash settlable. [Schedule 1, item 1,
paragraph 230-50(2)(e)]
2.67 Note that the relevant dealing, for the purpose of this aspect of
the definition of `cash settlable', must be with the relevant rights and
obligations themselves, and not in respect of the particular non-monetary
financial benefits that the taxpayer has the right to receive, or obligation to
provide. This means, for example, that a dealing by a taxpayer with a
physical item of trading stock it has a right to receive, or a taxpayer's
dealings in items of trading stock similar to that which it has a right to
receive, would not be relevant dealings for the purpose of this aspect of
the definition of cash settlable.
2.68 A taxpayer may `deal' with rights or obligations in a relevant
sense where, for example:
· the taxpayer deals with the non-monetary right or obligation,
or similar rights and obligations, on a short-term basis with
the purpose of taking advantage of price fluctuations;
· the taxpayer frequently deals with similar non-monetary
rights or obligations for short-term price fluctuation gains or
dealer's margins; or
· the taxpayer acquires the rights or obligations, or similar
rights or obligations, and offsets the resulting risk by entering
into offsetting arrangements that provide the taxpayer with a
profit margin.
[Schedule 1, item 1, note to subsection 230-50(2)]
Highly liquid rights and/or obligations readily convertible into money or
money equivalent
2.69 Where the relevant financial benefit the taxpayer has a right to
receive, or an obligation to provide, under the arrangement is:
· readily convertible into an amount of money or a money
equivalent; and
50
Definition of `financial arrangement'
· there is a market for the financial benefit that has a high
degree of liquidity, (a `liquid financial benefit'), and
· either:
- the taxpayer had a purpose of liquidating or converting
the financial benefit into money or a money equivalent
(purpose of converting); or
- the amount of money or money equivalent the financial
benefit is convertible into is a set amount or is not
subject to a substantial risk of changes in value
(set value),
the right to receive, or obligation to provide, the liquid financial benefit
will be economically equivalent to a right to receive or obligation to
provide cash (or a money equivalent). Such a right or obligation will
therefore be taken to be a cash settlable right or obligation. [Schedule 1,
item 1, paragraph 230-50(2)(f) and subsection 230-50(3)]
2.70 A financial benefit will be readily convertible into money or a
money equivalent and be subject to a highly liquid market if, for example,
the financial benefit is a security or commodity traded in an active market
or if it is an amount of foreign currency that is readily convertible into the
functional currency of the taxpayer. A right to receive, or an obligation to
provide, a financial benefit that is a publicly traded security for which the
market is not very active will still be readily convertible to cash and
subject to a highly liquid market if the number of shares or other units of
the security the right or obligation is for, is small relative to the daily
transaction volume for that security. A right to receive, or an obligation to
provide, that same security would not be so readily convertible if the
number of shares or units the right or obligation is for is large relative to
the daily transaction volume for that security. [Schedule 1, item 1,
subparagraph 230-50(3)(c)(ii)]
Purpose of converting
2.71 Where the taxpayer does not intend to deal with such a liquid
financial benefit as part of its ordinary business requirements, but rather
intends to liquidate or convert the financial benefit into money or a money
equivalent, it is appropriate that it be treated in a similar manner as a right
to receive money or a money equivalent. However, where the taxpayer
intends to provide or receive such a financial benefit as part of its ordinary
business requirements (in the sense that the taxpayer plans to deal with the
financial benefit as a non-monetary item and not as a substitute for
money), it will not be treated as being like money despite it being readily
convertible to cash. [Schedule 1, item 1, subparagraph 230-50(3)(c)(ii)]
51
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Set value
2.72 The exception to this ordinary course of business exclusion will
occur where the value of the highly liquid thing is predetermined. That is,
the value the taxpayer has a right to receive or an obligation to provide, as
represented by the thing that is readily convertible into money or a money
equivalent, is either known or not subject to a substantial risk of change in
value. In this situation, the highly liquid non-monetary thing is a proxy
for that value of money or a money equivalent. [Schedule 1, item 1,
subparagraph 230-50(3)(c)(i)]
Example 2.11: Right to receive shares
Henry Group Ltd enters into a forward contract under which it will
acquire 10,000 Kaye Co shares in 18 months for $200,000. Henry
Group Ltd has an obligation to make a large cash payment in
18 months time under a separate arrangement, and has entered into this
forward contract with the view that the value of Kaye Co shares will
increase at a higher rate than other prevailing investment options.
Henry Group Ltd is not acquiring these shares as part of its ordinary
course of business, and irrespective of their value in 18 months time
intends to dispose of the Kaye Co shares as soon as they are delivered,
due to its cash requirements at that time.
Henry Group Ltd does not have an intention, practice or ability to
settle this contract anyway other than through delivery of the shares.
Henry Group Ltd does not deal with its rights under this forward
contract. Nor does Henry Group Ltd deal with any of its similar rights
to receive shares (under other arrangements) in order to generate a
profit from short-term price movements or from a dealer's margin.
Kaye Co shares are listed on a national stock exchange and subject to
high trading volumes. That is, they are subject to a highly liquid
market, and are readily convertible into money or a money equivalent.
Henry Group Ltd's right to receive 10,000 Kaye Co shares, from the
time Henry Group Ltd starts to have this right under its arrangement, is
a cash settlable right. It is a right to receive a financial benefit that is
readily convertible into money, and that is subject to a highly liquid
market, that Henry Group Ltd intends to convert into money by
disposing of it. In determining whether this is a cash settlable financial
arrangement, because Henry Group Ltd intends to convert the Kaye Co
shares and this is not part of the ordinary course of its business, it is not
relevant that the precise value of the financial benefit owed by
Kaye Co to Henry Group Ltd, in the form of 10,000 shares, is
unknown (paragraph 230-50(2)(f) and subparagraph 230-50(3)(c)(ii)).
Example 2.17 explains that Henry Group Ltd's arrangement under the
forward contract is a cash settlable financial arrangement.
52
Definition of `financial arrangement'
Note that on these facts if Henry Group Ltd did not intend to dispose of
the Kaye Co shares but instead intended to hold them for a reasonable
time, its right to receive these shares under the arrangement would not
be a cash settlable right. This is because their value between the time
Henry Group Ltd acquired the right and when it will be satisfied is not
set, and will be subject to a substantial risk of changes in value.
However, had Henry Group Ltd instead contracted to acquire $200,000
worth of Kaye Co shares, determined at the time of delivery, the right
would still be cash settlable (paragraph 230-50(2)(f) and
subparagraph 230-50(3)(c)(i)).
The ability to settle a non-monetary right and/or obligation with a
monetary item, where the non-monetary item is not part of the expected
purchase sale or usage requirements
2.73 Where a taxpayer has a right to receive, or an obligation to
provide, a non-monetary financial benefit that it is able to settle by the
receipt or provision of a monetary item (in the sense explained in
paragraphs 2.60 to 2.63), the right or obligation will be taken to be cash
settlable if the taxpayer does not have the sole or dominant purpose of
entering into the arrangement to receive or provide the relevant
non-monetary financial benefit as part of its expected purchase, sale or
usage requirements. [Schedule 1, item 1, paragraph 230-50(2)(g)]
2.74 For example, where a non-monetary financial benefit may be
provided in satisfaction of a right under an arrangement, but the taxpayer
is able to instead receive a monetary payment in satisfaction of that right,
and the taxpayer is indifferent as to what it receives, the right will be a
cash settlable right. [Schedule 1, item 1, paragraph 230-50(2)(g)]
Example 2.12: An obligation is not cash settlable merely due to an
ability to cash settle
On 1 June 2009, Cereal Co enters into a forward contract with
Corn Co-operative to deliver on 20 June 2010, 200 bushels of corn for
$10,000. Under the terms of the forward contract, Cereal Co has the
choice of delivering 200 bushels of corn or settling the forward
contract by the payment of an amount of cash (referable to the value of
corn).
Under this forward contract, Cereal Co therefore has a contingent
obligation to provide a non-monetary financial benefit (200 bushels of
corn) and an alternative contingent obligation to pay an amount of
money.
Cereal Co does not intend to settle its forward contract in cash, nor
does it have the practice of settling similar arrangements other than by
delivering the corn. Cereal Co is not a dealer in rights or obligations
such as those under this forward contract.
53
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
The contract was entered into as part of Cereal Co's expected sale
requirements, and thus despite being able to be settled by a monetary
payment, Cereal Co's obligation to provide 200 bushels of corn is not
cash settlable. This obligation is not insignificant in comparison with
Corn Co's other rights and obligations under the forward contract.
For the reasons given in Example 2.17, Cereal Co's arrangement is
therefore not a cash settlable financial arrangement.
Example 2.13: Damages or compensation payments
Commercial Textiles Co enters into a contract to purchase a new
warehouse. This is not in the ordinary course of its business of
manufacturing. Under the arrangement Commercial Textiles Co has a
right to receive the warehouse, and a corresponding obligation to pay
the contract price for it.
The terms of the agreement also provide that should the vendor default
on the agreement, it will pay Commercial Textiles Co a cash payment
in full satisfaction of its rights and obligations under the agreement.
Because of the specific terms, this has the effect that Commercial
Textiles Co's right to receive the warehouse under the agreement is
able to, in the appropriate circumstances, be settled by a payment of
money.
Because Commercial Textile Co entered into the agreement with the
purpose of acquiring the warehouse as part of its expected purchase
and usage requirements (albeit not part of its ordinary requirements),
its right to receive the warehouse will not be deemed to be cash
settlable. This is despite the ability for this right, in certain
circumstances, to be satisfied by the vendor paying a money amount.
Accordingly, the only cash settlable rights and/or obligations under this
arrangement is Commercial Textile Co's obligation to pay the contract
price, and its contingent right to receive a cash payment from the
vendor in the event of default. Its right to receive the warehouse under
the arrangement is not cash settlable within the meaning of
subsection 230-50(2).
As explained in Example 2.17, this has the effect that Commercial
Textile Co's arrangement is not a cash settlable financial arrangement.
2.75 A right or obligation having a value limited by a set amount of
money, or referable to a set amount of money, will not necessarily be a
cash settlable right or obligation.
Example 2.14: Consumer loyalty points and gift certificates
Yvonne is an individual who, due to the particular financial
arrangements relevant to her business, has elected to have her gains
and losses from financial arrangements be subject to Division 230
54
Definition of `financial arrangement'
under subsection 230-405(5) (see discussion in paragraphs 2.117
and 2.118).
In addition to her main business transactions, Yvonne is awarded
points as part of a consumer loyalty programme (`the programme') of
which she is a member. Under the terms of the programme, and
subject to certain eligibility requirements and thresholds, she is entitled
to redeem these points for various products and services, or gift
certificates with a prescribed cash face value, exchangeable by her for
goods and services. As her points have an economic value, Yvonne
therefore has a right to receive financial benefits under the programme.
This right is not money or a money equivalent. Yvonne does not have
the practice, intention or ability to settle her right to receive financial
benefits under the programme by receiving money, a money
equivalent, or by starting or ceasing to have another financial
arrangement. Yvonne cannot deal in her right to receive financial
benefits under the programme (or under any gift certificate she
acquires). The financial benefits she has a right to receive, including to
the gift certificates with a set cash face value, are not readily
convertible into money or a money equivalent, nor are subject to a
liquid market.
Yvonne's rights under the programme, and under any gift certificates
acquired, are not cash settlable and, as explained in Example 2.17,
therefore do not constitute a cash settlable financial arrangement.
Exception to the test for a cash settlable financial arrangement
2.76 An arrangement (as determined under section 230-60) may
consist of both cash settlable and non-cash settlable rights and obligations.
The arrangement will only be a cash settlable financial arrangement at a
time when:
· compared to the cash settlable rights to receive financial
benefits under the arrangement and the cash settlable
obligations to provide financial benefits under the
arrangement:
- any non-cash settlable rights and obligations under the
arrangement are insignificant, and
- any rights to receive or obligations to provide something
that is not a financial benefit are insignificant; or
· any non-cash settlable rights and obligations under the
arrangement, or rights and obligations to things other than
financial benefits, that are not insignificant when compared
55
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
to the cash settlable rights and obligations to financial
benefits, have ceased. In this case, the only subsisting rights
and obligations under the arrangement that are not
insignificant must be cash settlable rights to receive and/or
obligations to provide, financial benefits.
[Schedule 1, item 1, paragraphs 230-50(1)(d)(e) and (f)]
2.77 This further demonstrates that whether or not an arrangement is
a financial arrangement may change over time. At the point in time when
the only rights and obligations remaining under an arrangement are cash
settlable rights and/or obligations to receive or provide financial benefits,
the arrangement will be a cash settlable financial arrangement, which is
comprised of those cash settlable rights and obligations. Note further that
for the purpose of working out any gain or loss from the cash settlable
financial arrangement, other financial benefits which play an integral role
in determining whether a gain or loss is made from the financial
arrangement, are also taken to be relevant rights and obligations under that
financial arrangement: see paragraph 2.49. [Schedule 1, item 1,
subsection 230-50(1) and section 230-65]
2.78 An arrangement such as this will not be precluded from being a
cash settlable financial arrangement merely because the arrangement also
consists of other rights and obligations that are insignificant when
compared to those cash settlable rights and obligations comprising the
financial arrangement. However, during any period any other, non-cash
settable, rights or obligations under the arrangement subsist and are not
insignificant when compared to the cash settable rights and/or obligations
to financial benefits under the arrangement, the arrangement will not be a
cash settlable financial arrangement. [Schedule 1, item 1,
paragraphs 230-50(1)(d) to (f)]
2.79 The intent of this exception is to ensure that arrangements that
predominantly relate to transactions that involve one side of the
arrangement being of a monetary nature and the other side being
non-monetary are excluded from the definition of a `financial
arrangement'.
Example 2.15: No financial arrangement where there is an
outstanding non-monetary benefit
Bill Co enters into an agreement on 1 July 2006 to sell land to Jim Co
for $100,000. At the time of the agreement, Bill Co has a right to
receive a financial benefit of a monetary nature (ie, $100,000) and an
obligation to provide a non-monetary benefit (title to the land). As
Bill Co's obligation to provide the land is not insignificant when
compared to its right to receive payment from Jim Co, the entire
arrangement will not constitute a financial arrangement.
56
Definition of `financial arrangement'
The arrangement may later become a financial arrangement if, after
delivery of the land, payment to Bill Co remains outstanding. If
payment remains outstanding after the land is delivered, the only
subsisting rights and/or obligations under the arrangement will be
Bill Co's (cash settlable) right to receive payment from Jim Co. Note
further, though, that if payment is due within 12 months of delivery of
the land, Division 230 will not apply to Bill Co's gains and losses from
this financial arrangement (see paragraphs 2.102 to 2.107).
2.80 What is or is not an insignificant right or obligation to provide a
financial benefit of a non-monetary nature is to be determined by the facts
and circumstances of each case, the purpose of the arrangement, the
intention of the parties to the arrangement and the objects of Division 230.
2.81 The effect of this exception to the definition of a `cash settlable
financial arrangement' is that many arrangements for the supply of
property or goods or services will not, be cash settlable financial
arrangements. Most prepayments for property or goods or services (other
than the situations where the property or goods or services are themselves
cash settlable) are excluded. However, as illustrated in Example 2.15, this
exclusion will not extend to periods after the obligation to provide, or
right to receive, property or services has been satisfied, and the cash
settlable amount to be paid or received as consideration remains
outstanding. As such, the definition of a cash settlable financial
arrangement will extend to deferred settlement arrangements where
property or services that the taxpayer had a non-cash settlable right or
obligation to receive or provide has been delivered, and only the payment
remains outstanding. However, gains and losses from these deferred
settlement arrangements where the relevant property or services are not
money or a money equivalent, will not be subject to Division 230 unless
payment is deferred in excess of 12 months after receipt or delivery of that
property or services. (This matter is discussed in further detail in
paragraphs 2.102 to 2.107.)
Testing time for the existence of a financial arrangement
2.82 Generally, it will be necessary to classify a set of rights or
obligations as a financial arrangement or a non-financial arrangement at
the time that arrangement comes into existence or commences to be held.
2.83 Some rights and/or obligations under an arrangement can start or
cease to be held at times different to other rights and/or obligations under
the arrangement. This can occur even where there is no new agreement
between a party to the arrangement and another party (either the
counterparty or a third party). Over the term of an arrangement, as
illustrated above, there may be a point in time where a financial benefit of
a monetary nature and financial benefit of a non-monetary nature co-exist,
57
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
but at a later point in time only the monetary or non-monetary financial
benefits exist.
2.84 As discussed above, such outcomes can result in an arrangement
not being a cash settlable financial arrangement at a particular time but
becoming a cash settlable financial arrangement at another time. As a
result, when an arrangement moves from having some non-cash settlable
rights and/or obligations that are not insignificant (whether or not there
are also cash settlable rights and/or obligations) to effectively having only
cash settlable rights and/or obligations, or vice versa, there is a need to
re-assess whether the arrangement (even where there is no new agreement
between parties to the arrangement) is a financial arrangement.
Example 2.16: Financial arrangement -- deferred payment
Steam Co enters into an arrangement with Big Co to acquire a train for
$1 million. Steam Co's obligation to pay for the train is a cash
settlable obligation to provide a financial benefit, and its right to
receive the train from Big Co is not cash settlable.
Scenario 1: The train is delivered and payment is made at the same
time.
Under this scenario, there is no financial arrangement as under the
arrangement there is, until the time of settlement, a non-insignificant
non-cash settlable right, and after settlement there are no subsisting
rights or obligations under the arrangement.
Scenario 2: The terms of the agreement are such that the train will be
delivered to Steam Co immediately, but payment will be deferred for
18 months.
Under this Scenario, there is a financial arrangement immediately after
delivery of the train (which is at the date of contract) as, at this time,
the only subsisting rights and obligations under the arrangement are
cash settlable.
Scenario 3: The terms of the agreement are such that the train will be
delivered to Steam Co after 12 months, and payment will be deferred
for 18 months (ie, six months after delivery of the train).
Under this Scenario, there is also a financial arrangement immediately
after delivery of the train, which in this case is 12 months after the date
of the contract. Until this time, the arrangement includes a
non-insignificant non-cash settlable right (being the right to receive
delivery of the train). After the time at which the train is delivered, the
only subsisting rights and/or obligations under the arrangement are
cash settlable (the obligation to pay for the train), and thus from this
time the arrangement is a financial arrangement. However, because
58
Definition of `financial arrangement'
the time between delivery of the train and the date that payment is due
is less than 12 months, any gains and losses from this financial
arrangement will not be subject to Division 230 (see paragraphs 2.102
to 2.107).
Scenario 4: Under the terms of the arrangement, the train must be
delivered in 12 months time and payment is to be made at that time.
However Steam Co and Big Co agree to defer payment for three years
after delivery.
Similarly to above, until delivery of the train there is no financial
arrangement, as the arrangement includes a subsisting right that is not
cash settlable, and is not insignificant in relation to the other rights and
obligations under the arrangement (the right to receive the train). After
delivery, by agreement, the only rights and/or obligations that remain
are those of a monetary nature. At this time, a financial arrangement
will come into existence. Because the time between delivery of the
train and the date that payment is due is more than 12 months, any
gains and losses from this financial arrangement will be subject to
Division 230.
Example 2.17: Cash settlable financial arrangements under earlier
examples
Continuation of Example 2.1 -- Loan and hedge (cash settlable
financial arrangement)
Oz Co's loan and cross-currency swap would both be cash settlable
financial arrangements, as from inception both arrangements consist
only of cash settable rights and obligations to receive or provide
financial benefits.
Continuation of Example 2.2 -- Convertible note (cash settlable
financial arrangement)
Hamish Co's convertible note is a cash settlable financial arrangement.
This is because under this arrangement Hamish has the right to receive
cash coupon payments, and the ability to redeem the note upon
maturity by receiving a payment of money, and Hamish Co did not
have the sole or dominant purpose when entering into the arrangement
of receiving the shares on conversion instead (subsection 230-50(1)
and paragraph 230-50(2)(g)).
If Hamish Co's convertible note is an equity interest, it will also satisfy
the definition of an `equity financial arrangement', and therefore be
subject only to a limited operation of Division 230 (see
paragraphs 2.88 and 2.92 to 2.95).
59
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Continuation of Example 2.3 -- CPI index-linked bond (cash settlable
financial arrangement)
The rights and obligations under High Hope Co's index-linked bond
(being the right to receive the coupon payments, as adjusted for the
index movement) and the right to receive the face value of the bond on
maturity) are all cash settlable and so the arrangement is a cash
settlable financial arrangement (section 230-50).
Continuation of Example 2.4 -- Two arrangements under the one
contract (only one cash settlable financial arrangement)
In this example, LA Co has an arrangement to purchase an office
building which is paid for two years after delivery, and an arrangement
to purchase office furniture paid for at the time of delivery.
The office furniture arrangement is not a financial arrangement at any
time as, at all times under the arrangement, LA Co's subsisting rights
and obligations include a significant non-cash settlable right to receive
furniture (section 230-50).
The office building arrangement will become a financial arrangement
after delivery of the office building, as from this time the only rights
and/or obligations subsisting under the arrangement is LA Co's cash
settlable obligation to pay Vendor Co for the building (section 230-50).
Continuation of Example 2.6 -- Interest bearing bank account
(cash settlable financial arrangement)
Retailer Pty Ltd's rights and obligations under its current account held
with Bank Ltd consist entirely of its rights to receive financial benefits
totalling the amount standing to the credit of its account, as explained
in Example 2.6.
Each right to receive a dollar of the balance of the account (the
financial benefit) is a `cash settable' right to a financial benefit because
the benefit is money (paragraph 230-50(2)(a)).
Retailer Pty Ltd's rights under its bank account therefore comprise a
cash settlable financial arrangement (section 230-50).
Continuation of Example 2.7 -- Option to settle by money equivalent:
satisfaction of a debt by the issue of a bond (cash settlable financial
arrangement)
Oil Co's loan to Grease Co is a cash settlable financial arrangement
consisting of its contingent obligation to provide Grease Co with
$100,000 and its contingent cash settlable obligation to provide
Grease Co with the bond (section 230-50).
60
Definition of `financial arrangement'
Continuation of Example 2.8 -- Value of a monetary item determined
by a non-monetary amount (cash settlable financial arrangement)
Kramer Co's agreement with Diamond Co is a cash settlable financial
arrangement, as from its inception all of Kramer Co's rights and
obligations under this agreement are cash settlable and in respect of
financial benefits (section 230-50).
Continuation of Example 2.9 -- Practice to settle futures contract by
cash payment (cash settlable financial arrangement)
Ore Co's futures contract with the Metals Exchange is a cash settlable
financial arrangement consisting of its right to receive a set payment
from the Metals Exchange, and its cash settlable obligation to provide
nickel to the Metal's Exchange. Ore Co has no rights or obligations
under this arrangement that are not cash settlable (section 230-50).
Continuation of Example 2.10 -- Take or pay arrangement (not a cash
settlable financial arrangement)
Roo Co's agreement with Kanga Co is to receive natural gas in
exchange for making a payment for the gas. As explained in
Example 2.10, no part of Roo Co's right to receive natural gas is cash
settlable. Because this right is not insignificant when compared to
Roo Co's other rights and obligations under the arrangement, its
take-or-pay arrangement with Kanga Co is not a cash settlable
financial arrangement (paragraphs 230-50(1)(d)(e) and (f)).
Continuation of Example 2.11 -- Right to receive shares
(cash settlable financial arrangement)
Henry Group Ltd's rights and obligations under its forward contract
comprise a right to receive 10,000 shares in Kaye Co, and an
obligation to pay $200,000. For the reasons given in Example 2.11,
Henry Group Ltd's right to receive 10,000 Kaye Co shares is a cash
settlable right.
Henry Group Ltd's arrangement under the forward contract will
therefore be a cash settlable financial arrangement, within the meaning
of section 230-50, comprised by its cash settlable right to receive
10,000 Kaye Co shares and its cash settlable obligation to pay
$200,000. Henry Group Ltd has no rights or obligations under this
arrangement that are not cash settlable (section 230-50).
If Henry Group Co's right to receive Kaye Co shares was not cash
settlable, its forward contract would not be a cash settlable financial
arrangement as its right to receive Kaye Co shares is not insignificant
when compared to Henry Group Ltd's other rights and obligations
under the arrangement (paragraphs 230-50(1)(d)(e) and (f)).
61
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Continuation of Example 2.12 -- Obligation is not cash settlable
merely due to an ability to cash settle (not a cash settlable financial
arrangement)
Cereal Co's forward contract with Corn Co-operative is not a cash
settlable financial arrangement despite having a cash settlable right to
receive $10,000 and an option to settle its obligation to provide corn
with a cash payment (a cash settlable obligation). Cereal Co's forward
contract is not a cash settlable financial arrangement because
Cereal Co may also settle its obligation under the contract by providing
corn. This alternative obligation, despite being able to be settled in
cash, is not a cash settlable obligation due to Cereal Co's purpose at
the time of entering into the arrangement as explained in
Example 2.12. Therefore, for the duration of the arrangement, Cereal
Co has a non-insignificant non-cash settlable obligation to provide 200
bushels of Corn, in addition to its other rights and obligations under the
arrangement which are cash settlable.
Accordingly, as Cereal Co has a non-insignificant non-cash settlable
obligation for the duration of its arrangement, its arrangement with
Corn Co-operative is not a cash settlable financial arrangement
(section 230-50).
Continuation of Example 2.13 -- Damages or compensation payments
(not a cash settlable financial arrangement)
Commercial Textile Co's right to receive the warehouse is not, for the
reasons given in Example 2.13, a cash settlable right. Because this
non-cash settlable right to receive the warehouse is not insignificant in
comparison to Commercial Textile Co's other rights and obligations
under the arrangement, its warehouse purchase arrangement is not a
cash settlable financial arrangement within the meaning of
section 230-50.
Continuation of Example 2.14 -- Consumer loyalty points and gift
certificates (not a cash settlable financial arrangement)
Because Yvonne has no cash settable rights or obligations under her
arrangement as described, that arrangement is not a cash settlable
financial arrangement.
Equity interest is a financial arrangement
Equity interest financial arrangements
2.85 An `equity interest', as defined in the ITAA 1997, is also a
financial arrangement. [Schedule 1, item 1, subsection 230-55(1)]
62
Definition of `financial arrangement'
2.86 An equity interest has the meaning given by Subdivision 974-C
of the ITAA 1997 in the case of a company (contained within
Division 974 of the ITAA 1997 dealing with debt and equity interests),
and by section 820-930 of the ITAA 1997 in the case of a partnership or
trust (contained within Subdivision 820-J of the ITAA 1997, dealing with
equity interests in a trust or partnership under the thin capitalisation rules).
[Schedule 1, item 7, subsection 820-930(1)]
2.87 Once determined under these other provisions of the
ITAA 1997, an equity interest in its entirety will constitute a relevant
financial arrangement. [Schedule 1, item 1, subsection 230-55(1)]
2.88 An equity interest will comprise a financial arrangement under
subsection 230-55(1), even if it comprises an arrangement that fails to
satisfy the definition of a financial arrangement under section 230-50.
Such an arrangement, being an equity interest or part of an equity interest,
will be subject to the limited scope of Division 230 that applies to equity
financial arrangements (see paragraphs 2.92 to 2.95).
Financial arrangements consisting of a right or obligation to an equity
interest
2.89 A right or obligation to receive or provide an equity interest, or a
combination of such rights and/or obligations will also be an equity
financial arrangement, if such a right, obligation or combination does not
already meet the definition of a cash settlable financial arrangement in
section 230-50. [Schedule 1, item 1, subsection 230-55(2)]
2.90 Likewise, a right or obligation to receive or provide such a
financial arrangement (or a combination of these rights and/or obligations,
whether or not together with other rights and/or obligations to other equity
interests) will also be a financial arrangement if it is not already a cash
settlable financial arrangement (or part of a cash settlable financial
arrangement) under section 230-50. [Schedule 1, item 1, paragraph 230-55(2)(b)]
2.91 For these types of equity financial arrangements, the financial
arrangement is constituted by the relevant right, obligation or combination
explained above. However, for the purpose of working out any gain or
loss from equity financial arrangements, other financial benefits which
play an integral role in determining whether a gain or loss is made from
the financial arrangement, are also taken to be relevant rights and
obligations under that financial arrangement (see paragraph 2.49).
[Schedule 1, item 1, subsection 230-55(2) and section 230-65]
63
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Limited scope of Division 230 to equity financial arrangements
2.92 Equity financial arrangements as explained above will be
`financial arrangements' as defined in Division 230. However, they will
not be subject to all of the provisions of Division 230 that apply to cash
settlable financial arrangements. As a general rule, other areas of the
income tax law -- such as the capital gains, imputation and general
income provisions -- largely provide an adequate basis for recognising
the gains and losses, including dividends, from equity interests.
2.93 Specifically, an equity financial arrangement will not be subject
to:
· Subdivision 230-B, which contains the accruals and
realisation methods for calculating gains and losses from
financial arrangements [Schedule 1, item 1, paragraph 230-45(2)(e)];
· a foreign exchange retranslation election in
Subdivision 230-D [Schedule 1, item 1, subsection 230-230(1)]; or
· a hedging financial arrangement election in
Subdivision 230-E, except to the extent it is a foreign
currency hedge issued by the taxpayer (as explained in
Chapter 8) [Schedule 1, item 1, subsection 230-285(1)].
2.94 In addition, an equity financial arrangement will only be subject
to a fair value election under Subdivision 230-D (where the taxpayer has
made such an election) and/or the election to rely on financial reports in
Subdivision 230-F (where the taxpayer has made such an election) if:
· the taxpayer is required by the accounting standards (or
comparable foreign standards) to classify or designate the
equity financial arrangement as at fair value through profit or
loss; and
· where the financial arrangement is an equity interest, the
taxpayer is not the issuer of that interest.
[Schedule 1, item 1, paragraph 230-185(1)(c), subsection 230-190(1),
paragraph 230-360(1)(d) and subsection 230-365(1)]
2.95 Finally, an equity financial arrangement will only be subject to
the balancing adjustment in Subdivision 230-G if it is otherwise subject to
either the fair value election or the election to rely on financial reports, as
explained above. [Schedule 1, item 1, subsection 230-390(1)]
64
Definition of `financial arrangement'
2.96 The fair value election and the election to rely on financial
reports are explained in more detail in Chapters 6 and 9.
Additional operation of Division 230
2.97 The application of Subdivision 230-J extends the operation of
Division 230 to arrangements that would not otherwise satisfy the
definition of a financial arrangement. The extended operation of
Division 230 applies to:
· foreign currency [Schedule 1, item 1, subsection 230-445(1)];
· non-equity shares in companies [Schedule 1, item 1,
subsection 230-445(2)]; and
· certain commodities held by traders for the purposes of
dealing, and fair valued through profit or loss for accounting
purposes [Schedule 1, item 1, subsection 230-445(3)],
as though these assets were a right that constituted a financial
arrangement.
2.98 The extended operation of the Division to these assets is directed
at ensuring that arrangements that give rise to cash settlable rights and
obligations to financial benefits are not inappropriately excluded from the
scope of Division 230.
2.99 These specific inclusion provisions operate to treat:
· foreign currency as a right that constituted a financial
arrangement [Schedule 1, item 1, subsection 230-445(1)];
· a non-equity share in a company as if the share were a right
that constituted a financial arrangement. A non-equity share
is defined in subsection 6(1) of the ITAA 1936 as a legal
form share that is not an equity interest in the company. A
share will not be an equity interest if it is characterised as, or
forms part of a larger interest that is characterised as, a debt
interest under Subdivision 974-B of the ITAA 1997
[Schedule 1, item 1, subsection 230-445(2)]; and
65
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· a commodity as if the commodity were a right that
compromised a financial arrangement where all of the
following are satisfied [Schedule 1, item 1, subsection 230-445(3)]:
- it is held by a taxpayer who trades or deals in that
commodity, and who holds the relevant commodity for
the purposes of dealing in the commodity;
- that taxpayer also trades or deals in financial
arrangements whose value changes in response to the
price or value of that commodity;
- the taxpayer has made a fair value election
(see Chapter 6) or an election to rely on financial reports
(see Chapter 9); and
- the commodity is an asset that the taxpayer is required to
designate or classify as at fair value through profit or
loss in its financial reports, in accordance with the
Australian Accounting Standards (or comparable foreign
accounting standards if the Australian standards do not
apply).
Specific disaggregation provisions
2.100 Once a financial arrangement has been determined, there are
specific disaggregation provisions in Division 230 that apply in particular
circumstances, which may operate to split the financial arrangement into
two financial arrangements. An example of this is where an entity elects
fair value tax treatment and has hybrid financial arrangements in respect
of which the host and derivative components have dissimilar economic
characteristics and risks (see Chapter 6 for further details). [Schedule 1,
item 1, section 230-200]
Exceptions for certain financial arrangements
2.101 Division 230 will not apply to the gains and losses of a number
of other financial arrangements. While these financial arrangements meet
the essential characteristics of the definition of a financial arrangement,
there are administrative, compliance or other policy reasons for effectively
excluding them from Division 230.
Short-term arrangements where non-monetary amounts are involved
2.102 Division 230 will not apply to gains and losses arising from
certain short-term financial arrangements. A key feature of financing is
where one party to an arrangement performs its part in advance of another
66
Definition of `financial arrangement'
party. However, where the delay in performance is relatively short it
could be said that the financing component is usually subservient to the
purpose of providing goods or services. For compliance and
administrative reasons, Division 230 will not apply to the gains and losses
that arise from financial arrangements which satisfy all of the items listed
below.
Financial arrangement consideration for property or services
2.103 The financial benefits the taxpayer is to provide (or receive)
under the financial arrangement are consideration for property (including
goods) or services:
· that the taxpayer has acquired from (or provided to) another
person; and
· that is not money or a money equivalent (see
paragraph 2.56).
[Schedule 1, item 1, paragraph 230-400(b)]
No more than 12 months delay in payment
2.104 The period from the time the taxpayer acquired (or provided) the
property or services (or a substantial proportion of them), until the time
the taxpayer is to provide (or receive) the consideration (or a substantial
proportion of it), is not more than 12 months. [Schedule 1, item 1,
paragraph 230-400(c)]
The arrangement is a cash settlable financial arrangement
2.105 The arrangement is a cash settlable financial arrangement, as
described above in this Chapter. [Schedule 1, item 1, paragraph 230-400(a) and
section 230-50]
The arrangement is not a derivative financial arrangement
2.106 The financial arrangement is not a derivative financial
arrangement for any income year [Schedule 1, item 1, paragraph 230-400(d)].
Derivative financial arrangements are arrangements that:
· change in value in response to a change in a specified
variable or variables; and
· require little or no net investment, in that the net investment
is smaller than that required for other types of financial
arrangements, besides other derivative financial
arrangements, that would be expected to have similar results
to changes in market factors (see Chapter 8).
[Schedule 1, item 1, subsection 230-305(1)]
67
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
The fair value election does not apply
2.107 The fair value election does not apply to the financial
arrangement [Schedule 1, item 1, paragraph 230-400(e)]. For a discussion of the
fair value election, see Chapter 6.
Example 2.18: Short-term trade credits
Manufacturer Co sells widgets (which are not money or a money
equivalent) to Retailer Co on 90-day terms. That is, Retailer Co has
90 days after delivery of the widgets to pay for them. Manufacturer Co
does not recognise gains and losses from these contracts on the basis of
fair value through profit or loss under AASB 139.
For the 90-day period, it could be said that Manufacturer Co is
financing Retailer Co's purchase of the widgets. During this period
Manufacturer Co's only subsisting rights and obligations under these
contracts is its right to receive payment for the widgets. From the time
of delivery, Manufacturer Co therefore has a cash settlable financial
arrangement (under section 230-50).
However, the period between delivery of the widgets and the time for
payment is not more than 12 months. As the contracts are not subject
to a fair value election under section 230-180, the gains or losses
arising from these financial arrangements will be disregarded for
Division 230 purposes (pursuant to section 230-400).
Example 2.19: Continuation of Example 2.11 -- forward contract
over shares
In Example 2.11, Henry Group Ltd entered into a forward contract
under which it will acquire 10,000 Kaye Co shares in 18 months
for consideration of $200,000. As explained in Example 2.17,
Henry Group Ltd's arrangement under the forward contract is a cash
settlable financial arrangement.
On settlement of this contract, Henry Group Ltd receives property
(Kaye Co shares) and is obliged to make payment immediately
(ie, there is no delay, so that the period between acquisition of the
property, and the time Kaye Co is to provide the $200,000
consideration, is not more than 12 months).
Notwithstanding that Henry Group Ltd's right to receive the shares is a
cash settlable right (as explained in Example 2.11), the shares are not
money or a money equivalent as defined (see paragraph 2.56).
Accordingly, assuming Henry Group Ltd has not made a fair value
election that could apply to this arrangement, it will be subject to the
exception for short-term arrangements where non-monetary amounts
68
Definition of `financial arrangement'
are involved, unless it is a derivative financial arrangement
(section 230-400).
Henry Group Ltd's financial arrangement is its rights and obligations
under the forward contract, which is a forward purchase of shares. The
value of this arrangement changes over time in response to changes in
the value of Kaye Co shares. Henry Group Ltd would have either paid
a premium of an amount less than the value of 10,000 Kaye Co shares
at that time, or received a premium of less than this amount, or paid or
received nothing at the time of entering into the forward contract. This
will be considerably less than the amount Henry Group Ltd would
have otherwise had to pay at the time of entry into the forward contract
were it to have purchased those shares at that time. Further, the shares
would be expected to have similar responses to changes in market
factors as the forward contract.
Henry Group Ltd's financial arrangement constituted by its cash
settlable rights and obligations under the forward contract is therefore a
derivative financial arrangement, and not subject to this exception for
short-term arrangements where non-monetary amounts are involved
(paragraph 230-400(d) and subsection 230-305(1)).
2.108 Where an arrangement otherwise satisfies the requirements for
the exception for short-term arrangements where non-monetary amounts
are involved, but the deferral of payment from the time the property or
services is received or provided is more than 12 months, Division 230 will
apply to the financial arrangement constituted by the `deferred settlement'
or trade credit arrangement. (See Chapters 3 and 11 for an explanation of
how Division 230 interacts with the other provisions of the ITAA 1997 or
the ITAA 1936 that may apply to the relevant property or services in these
cases). [Schedule 1, item 1, section 230-440]
Individuals and those businesses that satisfy the turnover tests where
there is no significant deferral
2.109 For compliance cost reasons, gains and losses from financial
arrangements of individuals and those businesses that satisfy the relevant
turnover test will not be subject to Division 230, except to the extent that:
· the arrangement is a qualifying security with a remaining
term of more than 12 months at the time the taxpayer started
to have it [Schedule 1, item 1, paragraph 230-405(1)(b)]; or
· the taxpayer has made an election to have Division 230 apply
to all their financial arrangements, and the taxpayer started to
have the arrangement in or after the year of making that
election [Schedule 1, item 1, subsection 230-405(4)].
69
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.110 To have gains and losses from financial arrangements subject to
this exception, the taxpayer must be :
· an individual;
· an authorised deposit-taking institution, securitisation vehicle
or entity which is required to register under the Financial
Sector (Collection of Data) Act 2001, (or would be required
to so register if the entity were a corporation) with an
aggregated turnover of less than $20 million; or
· another entity with an aggregated turnover of less than
$100 million.
[Schedule 1, item 1, paragraph 230-405(1)(a) and subsections 230-405(2) and
230-405(3)]
2.111 `Aggregated turnover' is defined in section 328-115 of the
ITAA 1997, and for the purpose of this Division 230 test it carries the
same meaning. In summary, an entity's aggregated turnover for an
income year is the sum of the relevant annual turnovers (adjusted in
particular circumstances) of the entity, its connected entities and affiliates.
Amongst other things, this definition ensures that where an entity does not
carry on its business for an entire income year, its aggregated turnover is
worked out using a reasonable estimate of what it would be if that entity
carried on business for the whole of the relevant income year.
2.112 For the purpose of this exception, the timing of the relevant
turnover test is specified, and may vary for different entities. An entity
determines whether or not it meets this turnover test for a particular
income year (the relevant income year) for the purpose of this exception
based on:
· its turnover in the immediately preceding income year,
(worked out at the end of that income year) [Schedule 1, item 1,
subparagraphs 230-405(2)(b)(ii) and (3)(b)(ii)]; or
· where the entity only came into existence during the
particular income year, its turnover as worked out at the end
of that relevant income year [Schedule 1, item 1,
subparagraphs 230-405(2)(b)(i) and (3)(b)(i)].
2.113 The gains and losses from the financial arrangements of these
taxpayers (individuals, and entities falling below the relevant turnover
threshold) will not be subject to Division 230, except in the situations set
out below. [Schedule 1, item 1, subsections 230-405(1) and (4)]
70
Definition of `financial arrangement'
Qualifying securities of more than 12 months
2.114 Gains and losses from a financial arrangement of an individual
or entity falling below the relevant turnover threshold may still be subject
to Division 230 where that arrangement is a `qualifying security' within
the meaning of Division 16E of Part III of the ITAA 1936. [Schedule 1,
item 1, paragraph 230-405(1)(b), definition of `qualifying security' in
subsection 159GP(1) of the ITAA 1936]
2.115 Broadly, a `qualifying security' is a security which, at the time
of issue, is reasonably likely to result in the sum of the payments
(excluding periodic interest as defined in subsection 159GP(6) of the
ITAA 1936) exceeding the statutorily established formula in
subsection 159GP(1) of the ITAA 1936.
2.116 Where an individual or entity falling below the relevant turnover
threshold starts to have a qualifying security, and it is otherwise a
financial arrangement that would be subject to Division 230, its gains and
losses will not be excluded from the Division under section 230-405,
where that security has more than 12 months remaining of its term at the
time when the taxpayer starts to have the qualifying security. That is,
these qualifying securities will have gains and losses on them subject to
Division 230. [Schedule 1, item 1, paragraph 230-405(1)(b)]
Irrevocable election to have Division 230 apply to all financial assets and
liabilities
2.117 Those taxpayers referred to in paragraph 2.110 may make an
election to have Division 230 apply to all their gains and losses from their
financial arrangements. The election once made is irrevocable and applies
to all financial arrangements a taxpayer acquires, or otherwise starts to
have (such as a financial arrangement the taxpayer creates) in the income
year in which the election is made and for subsequent income years.
[Schedule 1, item 1, subsections 230-405(4) and (5)]
2.118 An individual or entity falling below the relevant turnover
threshold who makes this election will have the gains and losses from all
of the financial arrangements it starts to have in or after the income year in
which the election is made, not just its relevant qualifying securities,
subject to Division 230, unless those arrangements are otherwise subject
to another exception (such as those discussed below).
Exceptions for various rights and/or obligations
2.119 Division 230 does not apply to a taxpayer's gains and losses
from a financial arrangement for an income year to the extent that the
rights and/or obligations under that arrangement are subject to any of the
following exceptions.
71
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Leasing or property arrangement
2.120 Most leasing arrangements will not be cash settlable financial
arrangements, as under the arrangement the taxpayer will have not
insignificant non-cash settlable rights or obligations (the lessee's right to
use the relevant thing being leased, and the lessor's obligation to allow,
and be deprived of, such use). However, to the extent that particular
leasing arrangements do satisfy the definition of a financial arrangement,
the leasing or property exception will apply to a right or obligation arising
under:
· a luxury car lease under Division 42A of Schedule 2E to the
ITAA 1936 [Schedule 1, item 1, paragraph 230-410(2)(a)];
· sale and loan arrangements to which Division 240 of the
ITAA 1997 applies [Schedule 1, item 1, paragraph 230-410(2)(b)];
or
· an arrangement that:
- is a licence to use; or
- in substance or effect, depends on the use of a specific
asset, and gives a right to control the use of that specific
asset, where that asset is,
goods or a personal chattel (other than money or a money
equivalent -- see paragraph 2.56), real property, or
intellectual property [Schedule 1, item 1, paragraphs 230-410(2)(c)
and (d)].
2.121 A luxury car lease within the meaning of Division 42A of
Schedule 2E to the ITAA 1936 excludes hire purchase agreements and
short-term hiring arrangements. The leases that are subject to this
Division are treated as a notional sale (generally for the cost of the
vehicle) and a loan transaction. The Division contains specific rules to
determine the finance charge under this notional loan, and how the
notional loan is to be treated for tax purposes. Division 230 will not
disturb the tax treatment of arrangements subject to Division 42A of
Schedule 2E to the ITAA 1936.
2.122 Division 240 of the ITAA 1997 operates to recharacterise some
arrangements (such as hire purchase agreements) as a sale of property,
combined with a loan, by the notional seller to the notional buyer, to
finance the purchase price. Amongst other things, this Division
determines the notional interest on this notional loan, and how it is treated
72
Definition of `financial arrangement'
for tax purposes. Division 230 will not disturb the tax treatment of
arrangements subject to Division 240 of the ITAA 1997.
2.123 The third category under this exclusion broadly covers licences
and leases over goods (other than money or a money equivalent), real
property, and intellectual property.
2.124 Goods, personal chattels, real and intellectual property take their
ordinary meaning, and so in a broad sense cover personal property (other
than money or a money equivalent), land, and interests in land and rights
in respect of creative and intellectual effort including copyright, registered
designs, patents and trademarks.
Interest in a partnership or trust
2.125 A right that is, or that is carried by, an interest in a partnership or
trust (or a corresponding obligation) will be subject to an exception if
there is only one class of interest in the partnership or trust, or the interest
is an equity interest in the partnership or trust [Schedule 1, item 1,
subsections 230-410(3) and (4)]. As mentioned in paragraph 2.86, the
reference to an equity interest in the context of a partnership or trust takes
its meaning from section 820-930 of the ITAA 1997.
2.126 The exception also applies to a right that is, or that is carried by,
an interest in a trust (or a corresponding obligation) where there is more
than one class of interest in the trust, if that trust is managed by a funds
manager or custodian, or a responsible entity of a registered scheme.
[Schedule 1, item 1, paragraph 230-410(3)(c)]
2.127 What is meant by the reference to a funds manager and a
custodian takes on its ordinary commercial meaning. A responsible entity
of a registered scheme draws its meaning from the Corporations Law. It
is the company named in the Australian Securities and Investments
Commission's record of the scheme's registration as the responsible entity
or temporary responsible entity of a managed investment scheme
registered under section 601EB of the Corporations Act 2001. In a
general sense, a managed investment scheme as defined under the
Corporations Act 2001 covers (subject to certain exceptions) a scheme
where the contribution made by members to acquire interests in the
scheme are pooled and used to produce benefits for members, where the
members do not have day-to-day control of the operation of the scheme
(see section 9 of the Corporations Act 2001).
2.128 The exception for multi-class trusts that are managed by a funds
manager or custodian promotes competitive neutrality, avoiding the
unnecessary creation of multiple single class trusts that are managed by
73
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
the same funds manager, custodian or responsible entity. [Schedule 1, item 1,
paragraph 230-410(3)(c)]
2.129 Where a right carried by such an interest in a partnership or trust
as explained above (or a corresponding obligation) is a right (or
obligation) under a financial arrangement that is subject to either a fair
value election or an election to rely on financial reports, this exception for
certain interests in a partnership or trust will not apply to that right (or
obligation). [Schedule 1, item 1, subsection 230-410(4)]
Certain insurance policies
2.130 A right or obligation under a life insurance policy or a general
insurance policy is subject to an exception from Division 230. [Schedule 1,
item 1, subsections 230-410(5) and (6)]
2.131 The exception for certain insurance policies applies to both the
issuer and the holder of an insurance policy. Accordingly, the exception
can apply to a life insurance company, a general insurance company,
certain life insurance policyholders and certain general insurance
policyholders.
2.132 Subject to certain exclusions applying to holders of policies, the
exceptions ensure that Division 230 does not apply to rights and
obligations under life insurance policies and general insurance policies.
These rights and obligations may also be taken into account under the
insurance taxation rules in Division 320 of the ITAA 1997, Division 321
of Schedule 2J to the ITAA 1936 and Division 15 of Part III of the
ITAA 1936. To this extent, the exceptions have the effect of preventing
the application of both Division 230 and the specific insurance provisions
to an excepted policy right or obligation.
2.133 The exception does not extend to investments (other than
investments by way of a policy covered by the exceptions) that support
the policy liabilities of the insurance company from the operation of
Division 230 of the ITAA 1997.
Exception for life insurance policies
2.134 A right or obligation under a life insurance policy is subject to
an exception. This exception ensures that Division 230 does not apply to
rights and obligations under those life insurance policies that are subject
to taxation under Division 320 of the ITAA 1997. [Schedule 1, item 1,
subsection 230-410(5)]
2.135 The exception does not apply to a life insurance policy if the
policy is an annuity that is a qualifying security and the entity is not a life
74
Definition of `financial arrangement'
insurance company (as defined by the ITAA 1997) that is the insurer.
Therefore, the holder of such a security would not be eligible for the
exception.
2.136 However, from the holder's perspective, the exception will
apply in respect of an annuity if it is an `ineligible annuity' within the
meaning of Division 16E of Part III of the ITAA 1936 (as these annuities
are not qualifying securities).
2.137 A life insurance policy is defined in subsection 995-1(1) of the
ITAA 1997 to have the meaning given to the expression `life policy' in
the Life Insurance Act 1995, but includes:
· a contract made in the course of carrying on business that is
life insurance business because of a declaration in force
under section 12A or 12B of the Life Insurance Act 1995;
and
· a sinking fund policy within the meaning of the Life
Insurance Act 1995.
Example 2.20: A life insurance policy that is subject to exception
Bianca is an individual who has elected under subsection 230-405(5) to
have all of her gains and losses from financial arrangements that are
not otherwise excepted, subject to Division 230. She holds an
endowment life insurance policy issued to her by a life insurance
company in her own right. As a result of the application of
subsection 230-410(5), Division 230 will not apply to any gain or loss
that Bianca makes under the policy.
Exception for general insurance policies
2.138 A right or obligation under a general insurance policy is subject
to an exception, except where the policy is a derivative financial
arrangement and the taxpayer is not a general insurance company as
defined by the ITAA 1997. [Schedule 1, item 1, subsection 230-410(6)]
2.139 This exception ensures that Division 230 does not apply to rights
and obligations under those general insurance policies that are subject to
taxation under Division 321 of Schedule 2J to the ITAA 1936.
2.140 A general insurance policy is defined in subsection 995-1(1) of
the ITAA 1997 to mean a policy of insurance that is not a life insurance
policy or an annuity instrument. The term `policy of insurance' is not
defined and therefore takes its ordinary meaning. It may include a policy
of reinsurance. Examples of general insurance policies include fire, theft,
75
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
injury, accidental damage, negligence, storm and professional indemnity
insurance.
2.141 The activities of a general insurance company can be split into
underwriting and investment activities. As previously stated, investment
activities involving financial arrangements will generally be subject to
Division 230. The underwriting activities of a general insurance company
(to the extent that they would otherwise be subject to Division 230) will
usually be the subject of this exception and would therefore be excluded
from the operation of Division 230.
Certain workers' compensation arrangements
2.142 A right or obligation in relation to an outstanding claims liability
for certain workers' compensation liabilities is subject to an exception.
This exception ensures that Division 230 does not apply to rights
or obligations arising under these workers' compensation liabilities that
are subject to the taxation treatment set out under Division 323 of
Schedule 2J to the ITAA 1936. [Schedule 1, item 1, subsection 230-410(7)]
2.143 Division 323 of Schedule 2J to the ITAA 1936 specifies the
taxation treatment of outstanding claims liabilities for workers'
compensation liabilities of companies that are not required by law to
insure, and do not insure, against liability for such claims (`self insurers').
Certain guarantees and indemnities
2.144 A right or obligation under a guarantee or indemnity will be
subject to an exception unless:
· the financial arrangement is the subject of a fair value
election, or an election to rely on financial reports (see
Chapters 6 and 9) [Schedule 1, item 1, paragraph 230-410(8)(a)];
· the financial arrangement is a derivative financial
arrangement (see paragraph 2.106 and Chapter 8) for any
income year [Schedule 1, item 1, paragraph 230-410(8)(b)]; or
· the actual guarantee or indemnity is itself given in relation to
another financial arrangement [Schedule 1, item 1,
paragraph 230-410(8)(c)].
2.145 What is meant by a `guarantee' or an `indemnity' takes on its
ordinary meaning to include a promise to answer for the debt or default of
another, or to make good a loss suffered through a third party.
76
Definition of `financial arrangement'
Example 2.21: Cash settlable guarantee
On 1 September 2008 Gez Co enters into an arrangement to acquire a
fleet of cars for use in its business. Both delivery of the vehicles and
payment occurs on 1 October 2008. Under the arrangement, from the
date of delivery, Gez Co continues to have a subsisting right to be
indemnified against the cost of repairing a specified range of potential
faults that may arise in the vehicles, for a period of three years.
Gez Co is an entity with a relevant aggregated turnover in excess of
$100 million, that has not made any elections under Division 230.
As the contingent right to receive a payment under this indemnity
clause in the arrangement is a cash-settlable right under
paragraph 230-50(2)(a), and it is the only subsisting right or obligation
Gez Co has under its fleet purchase arrangement, from the time of
delivery of the fleet cars, Gez Co has a cash settlable financial
arrangement.
However, the only right under Gez Co's arrangement is a right under
an indemnity, that is not a derivative financial arrangement and that is
not subject to a relevant election under Division 230. Further, it is not
an indemnity in relation to a financial arrangement (as the obligation of
Gez Co to pay the cost of repairing the potential faults it is being
indemnified for, does not itself arise under a financial arrangement).
As such, any gains or losses Gez Co makes from its financial
arrangement constituted by its rights under the indemnity will not be
subject to Division 230.
2.146 An example of where this exception would not apply is where a
guarantee is provided in respect of a loan agreement. As the loan
agreement is itself a financial arrangement, the guarantee would be
subject to Division 230. [Schedule 1, item 1, paragraph 230-410(8)(c)]
Personal arrangements and personal injury
2.147 Certain personal arrangements and arrangements in respect of
personal injuries will not have their gains and losses subject to
Division 230. Specifically, rights and obligations under a financial
arrangement are the subject of an exception in the following
circumstances.
Personal services
2.148 A right to receive consideration, or an obligation to provide
consideration, for the provision of personal services is the subject of an
exception [Schedule 1, item 1, paragraph 230-410(9)(a)]. Personal services are
broadly the provision of personal effort, labour or skill of an individual.
77
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Deceased estates
2.149 A right, or an obligation, that arises from the administration of a
deceased estate is the subject of an exception [Schedule 1, item 1,
paragraph 230-410(9)(b)]. Rights and obligations arising from the
administration of a deceased estate include those arising under a will as
well as those arising through common law or legislatively, such as in the
case of an intestate estate.
Gifts under deed
2.150 A right to receive, or an obligation to provide, a gift under a
deed, is the subject of an exception. [Schedule 1, item 1,
paragraph 230-410(9)(c)]
Maintenance amounts
2.151 A right to receive, or an obligation to provide, a financial benefit
by way of maintenance:
· to an individual who is a spouse or former spouse of the
person liable to provide the financial benefit;
· to, or for the benefit of, an individual who is a child (or who
was a child), of the person liable to provide the financial
benefit; or
· to, or for the benefit of, an individual who is a child (or who
was a child) of a spouse or former spouse of the person liable
to provide the financial benefit,
is the subject of an exception [Schedule 1, item 1, paragraph 230-410(9)(d)]
2.152 In this context, maintenance refers to a financial benefit paid to,
or for the relevant individual, to assist in that individual's support. A right
to receive or an obligation to provide a financial benefit by way of
maintenance may include periodic payments, lump sum payments, and/or
a transfer of property.
Personal injury
2.153 A right to receive, or an obligation to provide, a financial benefit
in relation to personal injury to an individual is the subject of an exception
[Schedule 1, item 1, paragraph 230-410(9)(e)]. Personal injury includes any
injury or disease sustained to an individual's person.
78
Definition of `financial arrangement'
2.154 Where a taxpayer has a right to receive, or an obligation to
provide, a financial benefit in relation to personal injury of an individual,
the exception will apply even if:
· the personal injury is in the form of a wrong to the individual
or an illness of the individual; and/or
· the person to whom the financial benefit is provided is not
the individual who was injured.
[Schedule 1, item 1, subsection 230-410(10)]
Injury to reputation
2.155 A right to receive, or an obligation to provide, a financial benefit
in relation to an injury to an individual's reputation is the subject of an
exception [Schedule 1, item 1, paragraph 230-410(9)(f)]. Such rights or
obligations may arise, for example, from defamation actions.
Superannuation and pension income
2.156 A right to receive, or an obligation to provide, financial benefits
will be subject to an exception if that right or obligation arises from a
person's membership of a superannuation or pension scheme. This may
include the right of a dependant of a member to receive financial benefits
(or the corresponding obligation to provide financial benefits to that
dependant). It may also include the right or obligation arising from an
interest in a complying or non-complying superannuation fund, a pooled
superannuation trust or an approved deposit fund. [Schedule 1, item 1,
subsection 230-410(11)]
2.157 This exception ensures that Division 230 does not apply to rights
and obligations that arise under certain superannuation or pension
schemes and that where relevant the primacy of other provisions (such as
those contained in Division 295 of the ITAA 1997) in respect of those
rights and obligations are preserved.
An interest in a foreign investment fund, foreign life policy or a controlled
foreign company
2.158 Division 230 does not apply to gains and losses from a financial
arrangement for any income year to the extent that the rights and/or
obligations under the arrangement arise under an interest in a foreign
investment fund or an interest in a foreign life assurance policy (both as
defined in Part XI of the ITAA 1936). [Schedule 1, item 1,
subsection 230-410(12)]
79
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.159 An interest in a foreign investment fund includes an interest in a
foreign company or foreign trust. An interest in a foreign company
includes an interest in a company that is a controlled foreign company.
Therefore, the exception covers not only an interest in a foreign company
to which Part XI of the ITAA 1936 applies, but also includes an interest in
a foreign company to which the controlled foreign company rules in
Part X of the ITAA 1936 applies.
2.160 These relevant interests in foreign investment funds and
controlled foreign companies are in a broad sense akin to equity interests.
As set out in paragraphs 2.92 to 2.95, Division 230 only has a limited
operation in respect of financial arrangements that are equity interests.
This exception for relevant interests in foreign investment funds and
controlled foreign companies ensures that they are not given an
inappropriate treatment under Division 230.
Proceeds from certain business sales
2.161 A right to receive, or an obligation to provide, financial benefits
arising from the direct or indirect sale of business, including those rights
or obligations arising from the sale of shares in a company (or interests in
a trust) that operates the business, may be the subject of an exception.
These rights and obligations will only be the subject of this exception
where the amounts or the values of the financial benefits to be received or
provided are contingent on the economic performance of the business
after the sale. [Schedule 1, item 1, subsection 230-410(13)]
2.162 This exception applies to exclude arrangements commonly
known as `earn-outs'.
2.163 For the purposes of Division 230, a right to receive one or more
financial benefits is treated as being two separate rights (see Chapter 3)
[Schedule 1, item 1, subsection 230-60(1)]. This means that if an earn-out
arrangement includes a right to receive a fixed amount, plus a right to
receive an amount that is contingent on the economic performance of a
business that has been sold, the latter right will itself be subject to this
exception. Division 230 can continue to apply to the arrangement to the
extent that any rights or obligations (including the right to receive a fixed
amount) are not subject to this (or any other) exception.
Infrastructure borrowings
2.164 Division 16L of the ITAA 1936 broadly provides tax
concessions for infrastructure borrowings in respect of which a certificate
has been issued by the Development Allowance Authority. Whilst no new
certificates have been issued in the last 10 years, existing arrangements in
80
Definition of `financial arrangement'
respect of previously issued certificates can be traded or novated, so can
start to become new arrangements in the hands of different taxpayers.
2.165 Generally speaking, one of the outcomes of Division 16L of the
ITAA 1936 is that interest derived from infrastructure borrowings is tax
exempt, whilst any interest incurred by an investor on funds borrowed for
the purpose of investing in infrastructure borrowings may be deductible as
if the interest derived from infrastructure borrowings were not exempt.
2.166 Often arrangements under which an investor may borrow to
invest in infrastructure borrowings are packaged together with the
infrastructure bond itself, such that under Division 230 it may be
considered to be the one arrangement. Such an arrangement may (due to
certainty of cash flows) have an overall gain for the purposes of
Subdivision 230-B (the accrual rules). However, this gain (which should
essentially be exempt) may have been calculated by taking into account
outgoings that would otherwise be deductible.
2.167 As Division 16L of the ITAA 1936 has ceased to have effect for
any new infrastructure arrangements, its treatment of infrastructure
borrowings only continues to have residual application. It nevertheless
continues to have application to relevant arrangements which are excluded
from Division 230.
2.168 Note also that Division 16E of the ITAA 1936 is only excluded
from applying during the first 15 years of an infrastructure borrowing.
After this time it may start to have application. Division 16E will
continue to apply to those arrangements that are subject to Division 16L,
as appropriate. [Schedule 1, item 1, subsection 230-410(14)]
Farm management deposits
2.169 A right to receive, or obligation to provide, financial benefits
arising under a farm management deposit (within the meaning of
Schedule 2G to the ITAA 1936) is the subject of an exception, provided
the right or obligation is held by the owner of the farm management
deposit. This exception therefore does not apply to a financial institution
with whom the farm management deposit is held. [Schedule 1, item 1,
subsection 230-410(15)]
2.170 Broadly speaking, a farm management deposit is an account
held with a financial institution which enables the relevant primary
producer owner to deduct amounts deposited into such an account in the
year of deposit, while requiring that amounts when repaid be included in
assessable income. In this way, farm management deposits are tax-linked,
financial risk management tools, designed to allow primary producers to
81
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
set aside income from profitable years for subsequent `draw-down' in
low-income years.
2.171 It is not intended that Division 230 disturb the tax treatment of
farm management deposits, which is the reason for this exception.
Rights and obligations to which section 121EK applies
2.172 In certain circumstances, the owner of an offshore banking unit
will be deemed to have received a payment in the nature of interest. The
deemed interest is assessable income in the hands of the owner of the
offshore banking unit. An exception has been included in Division 230 so
that a right or obligation that gives rise to a deemed interest payment is
not a financial arrangement to which Division 230 applies. [Schedule 1,
item 1, subsection 230-410(16)]
Forestry managed investment schemes
2.173 Division 394 of the ITAA 1997 broadly provides that initial
investors in forestry managed investment schemes (forestry schemes) will
receive a tax deduction equal to 100 per cent of their contributions and
subsequent investors will receive a tax deduction for their ongoing
contributions to forestry schemes, provided that at least 70 per cent of the
scheme manager's expenditure under the scheme is expenditure
attributable to establishing, tending and felling trees for harvesting (direct
forestry expenditure).
2.174 Subsection 394-15(3) of the ITAA 1997 defines a forestry
interest in a forestry managed investment scheme to be a right to benefits
produced by the scheme (whether the right is actual, prospective or
contingent and whether it is enforceable or not). A right to receive, or
obligation to provide, financial benefits arising under a forestry interest in
a forestry managed investment scheme would ordinarily be a financial
arrangement as it constitutes a cash settlable right to receive, or obligation
to provide, such benefits. An exception from Division 230 has been
inserted for situations where the investor can claim deductions under
section 394-10. [Schedule 1, item 1, subsection 230-410(17)]
Regulation-making power for exceptions
2.175 Subsection 230-410(18) contains a regulation-making power to
enable regulations to be made that specify a right or obligation as being
the subject of an exception. [Schedule 1, item 1, subsection 230-410(18)]
82
Definition of `financial arrangement'
Ceasing to hold financial arrangements in certain circumstances
2.176 Section 230-415 broadly operates to prevent losses from being
allowed as revenue losses under Division 230 as a result of the disposal
(including partial disposal) or redemption (including partial redemption)
of a financial arrangement, where it can be objectively concluded that a
reason for the disposal or redemption was an apprehension or belief that
the issuer, or other parties to the arrangement, would likely be unable or
unwilling to discharge their obligations to make payments under the
financial arrangement.
2.177 Section 230-415 applies if:
· a taxpayer ceases to have a financial arrangement (or part of
a financial arrangement);
· the taxpayer makes a loss, in the context of Division 230 (see
Chapter 3) from ceasing to have the financial arrangement
(or relevant part);
· the financial arrangement is either not a marketable security
within the meaning of section 70B of the ITAA 1936 or,
where it is such a marketable security:
- the taxpayer did not acquire the financial arrangement in
the ordinary course of trading on a securities market and
at the time of acquisition the taxpayer did not have the
ability to acquire an identical financial arrangement in
the ordinary course of trading on a securities market;
and
- the taxpayer did not dispose of the financial arrangement
in the course of trading on a securities market; and
· it would be concluded that the taxpayer ceased to have the
financial arrangement wholly or partly because there was an
apprehension or belief that the other party or other parties to
the financial arrangement were, or would be likely to be,
unable or unwilling to discharge all their liabilities to pay
amounts under the financial arrangement.
[Schedule 1, item 1, subsection 230-415(1)]
83
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
2.178 Subsection 70B(7) of the ITAA 1936 defines a marketable
security as a traditional security (within the meaning of
subsection 26BB(2) of the ITAA 1936) that is either a stock, bond,
debenture, certificate of entitlement, bill of exchange, promissory note or
other security.
2.179 In determining whether the taxpayer has ceased to have a
financial arrangement because there was an apprehension or belief that the
other party would be unable or unwilling to disclose its liabilities, regard
is to be had to:
· the financial position of the other party or parties to the
arrangement;
· the perceptions of the financial position of the other party or
parties; and
· other relevant matters.
[Schedule 1, item 1, subsection 230-415(3)]
2.180 Where section 230-415 applies to a financial arrangement, a
deduction is not allowable under Division 230 in respect of the amount of
the loss that is a loss of capital or of a capital nature. However, this loss
may still be treated as a capital loss under the CGT provisions. [Schedule 1,
item 1, subsection 230-415(2)]
Forgiveness of commercial debts
2.181 To ensure that relevant gains made from the release, waiver or
extinguishment of a debt under a financial arrangement continue to be
subject to the commercial debt forgiveness provisions as set out in
Subdivision 245-B of Schedule 2C to the ITAA 1936, Division 230
provides that where a taxpayer makes a gain from a financial arrangement
from the forgiveness of a debt in accordance with the commercial debt
forgiveness provisions, that gain is decreased by:
· the debt's net forgiven amount. This is in accordance with
paragraph 245-85(2)(a) of Schedule 2C to the ITAA 1936
where section 245-90 -- dealing with agreements to forgo
capital losses or revenue deductions -- does not apply; or
· the debt's provisional net forgiven amount. This is in
accordance with paragraph 245-85(2)(b) -- where
section 245-90 applies.
[Schedule 1, item 1, section 230-420]
84
Definition of `financial arrangement'
Exceptions by way of clarification only
2.182 For the avoidance of doubt, Division 230 does not apply to a
taxpayer's gains and losses from a financial arrangement for any income
year to the extent that the taxpayer's rights and/or obligations are a right
or obligation arising under a retirement village residence contract, a
retirement village services contract or an arrangement under which
residential care or flexible care is provided. [Schedule 1, item 1,
subsection 230-425(3)]
2.183 The reason why this exception is only for the avoidance of doubt
is that it is expected that these arrangements will include non-insignificant
non-cash settlable rights and obligations for their duration, and therefore
be prevented from being cash settlable financial arrangements under
subsection 230-50(1).
Retirement village residence contracts
2.184 A right or obligation arising under a `retirement village
residence contract' is the subject of an exception. [Schedule 1, item 1,
paragraph 230-425(3)(a)]
2.185 A retirement village residence contract is a contract that gives
rise to a right to occupy `residential premises' in a `retirement village'
[Schedule 1, item 1, paragraph 230-425(4)(a)]. These terms take their meaning
from section 195-1 of the A New Tax System (Goods and Services)
Act 1999. That definition provides that a residential premises in a
retirement village exists if:
· the premises are occupied by one or more persons as a main
residence;
· accommodation in the premises is intended to be for persons
who are at least 55 years old, or who are a certain age that is
more than 55 years; and
· the premises include communal facilities for use by the
residents of the premises;
but excludes:
· premises used, or intended to be used, for the provision of
residential care (within the meaning of the Aged Care
Act 1997) by an approved provider (within the meaning of
that Act); and
85
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· `commercial residential premises` as defined in section 195-1
of the A New Tax System (Goods and Services) Act 1999.
Retirement village services contracts
2.186 A right or obligation arising under a `retirement village services
contract' is the subject of an exception [Schedule 1, item 1,
subsection 230-425(1), paragraph 230-425(3)(b)]. A retirement village services
contract is a contract under which a retirement village resident is provided
with general or personal services in the retirement village [Schedule 1,
item 1, paragraph 230-425(4)(b)].
Provision of residential or flexible care
2.187 A right or obligation arising under an arrangement under which
residential care or flexible care is provided is the subject of an exception.
[Schedule 1, item 1, subsection 230-425(1) and paragraph 230-425(3)(c)]. This
exception is intended to exclude gains and losses from rights or
obligations arising under an accommodation bond style arrangement
arising from residential or flexible care.
2.188 `Residential care' is defined to have the same meaning as in
section 41-3 of the Aged Care Act 1997, while `flexible care' is defined
under section 49-3 of the Aged Care Act 1997. Residential care covers
personal and/or nursing care provided to individuals in residential care
facilities, but does not cover such care when it is provided via a hospital,
personal residence, psychiatric facility or a non-aged care facility.
Flexible care refers to alternative care provided in the same setting as
residential care.
86
Chapter 3
Tax treatment of gains and losses from
financial arrangements
Outline of chapter
3.1 This chapter explains:
· the rationale, under Division 230, for recognising gains and
losses rather than, for example, receipts and outgoings;
· the revenue character of gains and losses;
· the elements that contribute to a gain or loss; and
· which gains and losses are disregarded.
Context of amendments
Gains and losses from financial arrangements
3.2 Under current income tax law, the taxation of financial
arrangements is based on an amalgam of provisions, including the
ordinary income provision (section 6-5 of the Income Tax Assessment
Act 1997 (ITAA 1997)), the general deduction provision (section 8-1 of
the ITAA 1997) and various specific provisions.
3.3 The application of the ordinary income and general deduction
provisions to financial arrangements may not always produce appropriate
results. Because of the complexity in the structure of many financial
arrangements, greater clarity, consistency and coherency can be obtained
by only recognising gains and losses from relevant financial arrangements
for income tax purposes.
87
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.4 The concept of gain or loss connotes the appropriate offsetting
of the cost (broadly, financial benefits provided under the financial
arrangement) against proceeds (broadly, financial benefits received under
the financial arrangement). However, in recognising that a gain or loss is
a net concept, it is important to note that:
· the gain or loss may be recognised despite not all offsetting
amounts being fully known (eg, a gain or loss will be
recognised under the accruals method if it is known with
sufficient certainty to be of at least a certain amount);
· whilst an overall gain or loss will often be able to be
determined for a financial arrangement as a whole, more than
one gain or loss may be made from a financial arrangement;
· a mere receipt of a financial benefit or payment of a financial
benefit may itself represent a gain or loss if no offsetting
financial benefits are reasonably attributable to that particular
receipt or payment;
· a payment need not be received in order to make a gain
(eg, the receipt of a financial benefit includes the reduction or
saving of an amount of a liability);
· gains and losses can be made from holding a financial
arrangement, as well as on the cessation or disposal of that
financial arrangement; and
· the gain or loss is to be calculated in nominal, rather than
present value, terms (ie, the financial benefits to be received
or provided under the arrangement should, in determining a
gain or loss from that arrangement, be taken into account at
the value they have, or will have, at the time they are
received or provided, rather than being discounted to their
present values when a taxpayer first starts to have the
arrangement).
Example 3.1: Gain or loss from an option
A typical option requires the payment of a premium at the time the
arrangement is entered into.
However, the mere payment of the premium does not represent a loss
for the purchaser of the option (the option holder). While the premium
is an outgoing of the option holder, it is an outgoing which is
reasonably attributable to any financial benefits that may be received
88
Tax treatment of gains and losses from financial arrangements
under the option agreement. Likewise, the mere receipt of the option
premium does not yet produce a gain for the issuer of the option.
That is, the gain or loss on a typical option is calculated by offsetting
the cost or proceeds represented by the premium against the net
amounts, if any, received or paid from disposal or exercise of that
option.
For example, as part of its speculative activities, U-mine Co acquires
an option to purchase US$100,000 in 18 months time for a set amount
of Australian dollars, by paying a A$2,000 option premium. U-mine
Co will not make a gain or loss from its option arrangement until its
rights under the option agreement cease (eg, through being disposed of,
exercised or expiring). Note, however, that some of the tax-timing
methods in Division 230 may apply to calculate a gain or a loss from
the arrangement before this time.
Character of gains and losses from financial arrangements
3.5 If the tax framework in Division 230 did not clarify that gains
and losses from financial arrangements are to be on revenue account
unless subject to a specific rule, existing tests and factors would need to
be considered in determining the character of gains and losses from a
particular financial arrangement. The revenue/capital distinction in the
income tax law is often a very difficult distinction to make, relying on
factors such as purpose, the degree of periodicity, and the circumstances
in which the relevant amount is found in the hands of the particular
taxpayer. Determining the character of the gains and losses against
factors such as these can be very demanding and complex and the
outcome may be uncertain.
3.6 In this regard, certainty as to the character of some gains and
losses from financial arrangements has been provided by a number of
existing specific provisions. Specifically, revenue treatment has been
provided by:
· sections 26BB and 70B of the Income Tax Assessment
Act 1936 (ITAA 1936), in relation to the disposal of
traditional securities;
· Division 3B of the ITAA 1936, in relation to foreign
currency gains and losses; and
· Division 775 of the ITAA 1997, in relation to foreign
currency denominated arrangements (with limited
exceptions).
89
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.7 Complexity will be further reduced by removing the
capital/revenue distinction in respect of financial arrangements by taxing
all gains and losses on revenue account under Division 230. An exception
to the requirement that a gain or loss from a financial arrangement will
always be on revenue account is contained within the hedging financial
arrangements election, and is applicable to certain hedging financial
arrangements. Under this exception, the tax characterisation of a hedging
financial arrangement may be based on the characterisation already given
to the hedged item under the taxation law, and to that extent will not of
itself increase complexity to any significant extent.
3.8 In addition, any gains and losses to which Division 230
expressly does not apply (such as through an exception as set out in
Subdivision 230-H as explained in Chapter 2) will fall for consideration
under the existing tax law. This means their tax treatment, including their
character, is to be determined by any residual operation of the ITAA 1936
and the ITAA 1997.
Nexus test for losses
3.9 To be deductible, the current income tax law requires a
sufficient nexus between losses and the gaining or producing of assessable
income. This concept is preserved under Division 230.
Summary of new law
3.10 Unless otherwise specified, gains and losses from financial
arrangements are on revenue account. Unless specifically provided for:
· gains from financial arrangements are included in assessable
income; and
· losses from financial arrangements made in gaining or
producing assessable income, or necessarily made in carrying
on a business for the purpose of gaining or producing such
income, are deductible.
3.11 Losses from financial arrangements made in gaining or
producing exempt or non-assessable non-exempt income are generally
disregarded. Gains made in similar circumstances will be respectively
exempt income or non-assessable non-exempt income.
3.12 Gains and losses made from borrowings used for private or
domestic purposes or by individuals from derivative financial
90
Tax treatment of gains and losses from financial arrangements
arrangements held or used for private or domestic purposes are
disregarded.
3.13 Gains and losses from financial arrangements are recognised
only once for tax purposes.
Comparison of key features of new law and current law
New law Current law
Unless subject to specified There is lack of clarity as to whether
exemption, or as provided for under the basis for taxation is gains and
the hedging financial arrangement losses made under an arrangement,
method, all gains and losses from or receipts and outgoings, or some
financial arrangements are on combination thereof.
revenue account. There is a complex mixture of
Unless subject to specified revenue and capital account
exemption, all gains from financial treatment for gains and losses from
arrangements are assessable. many financial arrangements, often
Unless subject to specified involving uncertainty as to
exemption, all losses from financial appropriate treatment.
arrangements made in deriving Gains and losses on disposal of
assessable income are deductible. liabilities are not systematically
addressed.
Detailed explanation of new law
Determining the gain or loss from a financial arrangement
3.14 The various tax-timing methods available under
Division 230, discussed in detail in later chapters of this explanatory
memorandum, are used to determine the timing and quantum of gains and
losses made from a financial arrangement. [Schedule 1, item 1, section 230-45]
3.15 Unless otherwise specified, the gain or loss recognised over the
life of the financial arrangement is the total gain or loss. In some cases,
recognition of the total gain or loss may come about through a
combination of provisions in Division 230 (eg, the compounding accruals
method in Subdivision 230-B and the balancing adjustment required when
the taxpayer ceases to have a financial arrangement in
Subdivision 230-G). [Schedule 1, item 1, section 230-45]
3.16 The concept of gain or loss connotes the appropriate offsetting
of the cost (financial benefits provided or to be provided, or rights to
91
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
financial benefits forgone under the financial arrangement) against
proceeds (financial benefits received or to be received, or obligations to
pay financial benefits saved under the financial arrangement). [Schedule 1,
item 1, sections 230-75 and 230-80]
3.17 In recognising that a gain or loss is a net concept, it is important
to note that the gain or loss is generally determined by making a
reasonable allocation of:
· the costs of the financial arrangement (financial benefits
provided or to be provided, either under the financial
arrangement or which are integral to the calculation of a gain
or loss from the arrangement); and
· the proceeds from the financial arrangement (financial
benefits received or to be received, either under the financial
arrangement or which are integral to the calculation of a gain
or loss from the arrangement).
[Schedule 1, item 1, sections 230-65, 230-75 and 230-80]
Costs and proceeds of a financial arrangement
3.18 The costs of, and proceeds from, the financial arrangement
naturally include financial benefits provided and/or received in
satisfaction of the obligations and/or rights that comprise the relevant
financial arrangement. These will be financial benefits received and/or
provided under the relevant financial arrangement.
3.19 Notably, the costs of, and proceeds from, the financial
arrangement also include financial benefits in addition to those financial
benefits provided or received under the financial arrangement.
Specifically, the costs of, and proceeds from, the financial arrangement
will also include other financial benefits received or provided (or those
which the taxpayer is entitled to receive or obliged to provide) that play an
integral role in determining whether the taxpayer will make a gain or loss
(or a gain or loss of a particular amount) from the financial arrangement.
3.20 For this purpose, a financial benefit received or provided (or a
financial benefit which the taxpayer is entitled to receive or obliged to
provide) will be integral to determining whether the taxpayer will make a
relevant gain or loss from the financial arrangement if it is an essential
part of determining that gain or loss. This will be where the financial
benefit is integral to determining whether the taxpayer will make a gain or
a loss from the financial arrangement at all, or where it is integral to
quantifying such a gain or loss (such that it is integral to determining
92
Tax treatment of gains and losses from financial arrangements
whether the taxpayer will make a gain or a loss from the financial
arrangement of a particular amount).
3.21 Such integral financial benefits may include the costs incurred to
acquire the financial arrangement (including, for example, any application
or processing charges, in addition to the specific consideration for the
relevant rights and obligations under the arrangement) and amounts
received on transfer or cessation of all or part of the financial
arrangement. [Schedule 1, item 1, section 230-65]
Example 3.2: Continuation of Example 2.15, scenario 2
In this scenario, Steam Co has a financial arrangement consisting
entirely of its obligation to pay $1 million to Big Co, which it started to
have as consideration for, and at the time of, receiving delivery of the
train from Big Co.
The proceeds Steam Co receives (the train that was delivered) for
starting to have this obligation, is integral to the calculation of the gain
or loss that is made from its financial arrangement constituted by
Steam Co's outstanding obligation. Accordingly, the train (valued at
the time it is received by Steam Co), is a financial benefit that
Steam Co is taken to have had the right to receive under its financial
arrangement, broadly for the purpose of determining any gains and
losses Steam Co makes from that arrangement (subsection 230-65(2))
Note, however, that this amount taken to have been received under
section 230-65 will, on these facts, be modified by section 230-440.
Section 230-440 will override section 230-65 and Steam Co will be
taken to have received an amount equal to the market value of its
obligation to pay $1 million (determined under section 230-440 at the
date the train is received) as consideration for starting to have its
financial arrangement.
3.22 More generally, what is considered to be integral or essential to
determining whether the taxpayer makes a relevant gain or loss from the
financial arrangement can be determined by commercially accepted
principles and the relevant facts and circumstances of each arrangement.
However, the costs of, or proceeds from, the financial arrangement, where
they are integral to the calculation of a gain or loss from the arrangement,
need not necessarily be provided or received from parties to the particular
financial arrangement. [Schedule 1, item 1, section 230-65]
Summary
3.23 The above paragraphs have outlined the basic case of how the
cost and proceeds from a financial arrangement are determined. It can be
93
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
seen that the gain or loss from a cash settlable financial arrangement can
therefore be determined by comparing:
· the financial benefits provided, or to be provided, as
consideration for (or that are integral to) obtaining a cash
settlable right to receive a financial benefit, with the financial
benefits received, or to be received, as consideration for (or
that are integral to) the satisfaction or other cessation of that
right; and
· the financial benefits received, or to be received, as
consideration for (or that are integral to) assuming a cash
settlable obligation to provide a financial benefit, with the
financial benefits provided, or to be provided, in
consideration for (or that are integral to) the satisfaction or
other cessation of that obligation.
Cost or proceeds where a financial arrangement starts or ceases to be
held as consideration for providing or acquiring something else
3.24 As mentioned in paragraph 3.21, section 230-65 will include in
the calculation of a gain or a loss from a financial arrangement, the
financial benefits provided to acquire the financial arrangement, and those
received on cessation of the financial arrangement. However, where the
thing provided or received in return for starting, or ceasing, to have the
financial arrangement is something other than money, section 230-440
will apply and, where applicable, will override the normal cost rules in
section 230-65. [Schedule 1, item 1, section 230-440]
3.25 The primary function of section 230-440 is to provide
appropriate interaction between the provisions of Division 230 and the
other provisions of the ITAA 1936 and the ITAA 1997 where a financial
arrangement (or part of a financial arrangement) whose gains and losses
are subject to Division 230 is received or provided as consideration in
some other tax-relevant transaction. In a broad sense, the provision
ensures that the consideration received or provided for that other thing, is
taken to be the market value of the financial arrangement (or relevant part
of the financial arrangement) used as consideration. [Schedule 1, item 1,
subsections 230-440(1) and (2)]
3.26 Section 230-440 will not apply where gains and losses from
the relevant financial arrangement used as consideration under the
transaction are not subject to Division 230. This means that, for example,
where a taxpayer provides an asset to another party in exchange for a right
to receive a payment of money from that party in the future (a cash
settlable financial arrangement), in circumstances where gains and losses
from that right are not subject to Division 230 (eg, under section 230-405
94
Tax treatment of gains and losses from financial arrangements
because of the taxpayer's traits, or under section 230-400 because of the
period for which the right will be outstanding), section 230-440 will have
no application in resetting the amount taken to have been received for that
asset for tax purposes. Section 230-440 only applies in respect of dealings
with financial arrangements that are themselves dealt with under
Division 230. [Schedule 1, item 1, paragraphs 230-440(1)(a) and (4)(a)]
3.27 The impact of the operation of section 230-440 upon the tax
treatment of a tax relevant thing, that a relevant financial arrangement has
been used as consideration for, is discussed in detail in Chapter 11.
3.28 To ensure consistency across the transaction, and appropriate
interaction within Division 230, where it applies, section 230-440 will
also have an impact on the cost or proceeds of the financial arrangement
that is either acquired or given up as consideration under the relevant
transaction. For Division 230 purposes, section 230-440 will ensure that
the taxpayer is taken to have started, or ceased, to have the relevant
financial arrangement (or part of a financial arrangement) used as
consideration for the other tax-relevant thing for its market value at the
time the taxpayer started or ceased (as the case may be) to have it.
[Schedule 1, item 1, subsections 230-440(2) and (5)]
Market value of a financial arrangement
3.29 As set out above, where a taxpayer starts or ceases to have all or
part of a financial arrangement whose gains and losses are subject to
Division 230 as consideration for some other thing, the market value of
the arrangement (or relevant part) will be taken to have been received or
provided as consideration for that other thing. In addition, the taxpayer
will be taken to have started or ceased to have that financial arrangement
(or relevant part) also for its market value. Accordingly, the market value
of a financial arrangement that is dealt with under Division 230 will be
critical to the tax treatment of transactions under which such a financial
arrangement is used as consideration.
3.30 In applying section 230-440, the market value of the financial
arrangement (or the part of the financial arrangement) that is used as
consideration for the other thing is determined by the sum of the present
values of the rights to receive and obligations to provide financial benefits
under that arrangement (or relevant part). The present value of these
rights and obligations is to be determined at the time that the market value
is to be determined (ie, at the time when the financial arrangement, or
relevant part, starts or ceases to be held by the taxpayer). [Schedule 1, item 1,
paragraph 230-440(8)(a)]
95
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.31 The discount rate to be used in working out the present value of
a right to receive, or an obligation to provide, a financial benefit to be
provided or received under section 230-440 is:
· the average, expressed as a decimal fraction, of the assessed
secondary market yields in respect of 10-year non-rebate
Treasury bonds published by the Reserve Bank during the
financial year immediately preceding the financial year in
which the financial arrangement (or relevant part) starts or
ceases to be held, increased by 200 basis points (2 per cent);
or
· if no assessed secondary market yield in respect of bonds of
that kind was published by the Reserve Bank during the year,
the decimal fraction determined by the Treasurer for the
purposes of the definition of `long-term bond rate' in
section 2 of the Petroleum Resource Rent Tax Assessment
Act 1987 in relation to the financial year immediately
preceding the financial year in which the financial
arrangement (or relevant part) starts or ceases to be held,
increased by 200 basis points (2 per cent).
[Schedule 1, item 1, paragraph 230-440(8)(a) and subsections 230-440(9) and (10)]
3.32 The long-term bond rate determined by the Treasurer for the
purposes of the Petroleum Resource Rent Tax Assessment Act 1987 in
2006 was 5.40 per cent. This rate is published annually on the Australian
Taxation Office (ATO) website.
3.33 Regulations may prescribe an alternative method for
determining the market value of a financial arrangement for the purposes
of section 230-440. [Schedule 1, item 1, paragraph 230-440(8)(b)]
Example 3.3: Sale of a CGT asset for a bond
Saint Co purchased a factory in 2000 for $1.1 million.
In April 2011 it sells the factory to Pivot Co in exchange for receiving
a 5-year zero coupon bond, with a face value of $3 million, and a
present value at that time of $2.3 million (determined by discounting
the right to receive $3 million in five years time using the average
10-year non-rebate Treasury bond secondary market yield rate for the
year ended 30 June 2010 plus 200 basis points). That is, the market
value of the bond at the date of sale is taken to be $2.3 million. At the
date of sale, Saint Co's factory has an estimated value of $2.5 million.
The bond is a cash settlable financial arrangement.
96
Tax treatment of gains and losses from financial arrangements
Because of the operation of section 230-440, for the purposes of the
ITAA 1936 and the ITAA 1997, the proceeds Saint Co receives for
sale of the factory will be taken to be the market value of the bond as
determined under that section, that is, $2.3 million
(subsections 230-440(1), (8), (9) and (10)).
In addition, section 230-440 goes on to provide that Saint Co will be
taken to have acquired the bond for this market value (rather than for
the market value of the factory sold). This overrides what would
otherwise be the cost attributed to the bond under section 230-65.
Instead, Saint Co will be taken to have provided $2.3 million to acquire
the bond, which will be taken to be an amount paid under the bond for
the purpose of determining any gain or loss Saint Co makes from the
bond (subsections 230-65(1) and 230-440(2)).
In this way, any difference between Saint Co's cost of the factory
($1.1 million) and the market value of the bond that was received
($2.3 million) will be taken into account under Parts 3-1 and 3-3 of the
ITAA 1997 (a $1.2 million capital gain), whereas any difference
between the market value of the bond when it was received
($2.3 million) and any proceeds Saint Co receives from the bond on
redemption ($3 million) (a $700,000 gain) will be taken into account
under Division 230.
3.34 The value that section 230-440 deems to have been provided
or received as consideration for starting or ceasing to have the relevant
financial arrangement will override what section 230-65 or other
provisions would otherwise provide as the relevant cost or proceeds for
that financial arrangement.
3.35 In the absence of the rule in section 230-440, section 230-65
would otherwise provide that the cost or proceeds for a financial
arrangement that started or ceased to be held as consideration for
receiving or providing, or otherwise starting or ceasing to have, something
that is not money, is (or includes) the market value of the relevant
non-monetary thing when it is provided or acquired (being a financial
benefit that is integral to calculating a gain or loss from that financial
arrangement) (see paragraphs 3.18 to 3.22). As demonstrated in
Example 3.3, section 230-440 will replace this amount with the market
value of the relevant financial arrangement (as determined for the
purposes of section 230-440) at the time when it (relevantly) starts to, or
ceases to, be held by the taxpayer. [Schedule 1, item 1, subsections 230-440(2)
and (5)]
97
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Example 3.4: Continuation of Example 2.14
In Example 2.14, Bill Co had an agreement to sell land to Jim Co for
$100,000.
Additional facts
At the time Bill Co delivers the land (the settlement date), it agrees to
allow Jim Co 18 months from the settlement date to pay.
In the hands of Bill Co, the land was a CGT asset, held on capital
account.
At the settlement date, the right to receive $100,000 in 18 months time
from Jim Co, has a market value (determined using the method set out
in subsections 230-440(9) and (10)) of $87,000.
As postulated in Example 2.14, on these facts Bill Co will start to have
a financial arrangement on the settlement date consisting of its cash
settlable right to receive $100,000 from Jim Co (section 230-50).
For the purpose of calculating a capital gain or loss on disposal of the
land, Bill Co is taken to have received capital proceeds from disposal
of the land equal to the market value of its right to receive $100,000
from Jim Co, determined under section 230-440 at the time when the
financial arrangement started to be held by Bill Co (ie, the market
value of this right determined under section 230-440 at the settlement
date, or $87,000). This is because Bill Co started to have the financial
arrangement at that time as consideration for something that it
provided (the land) (subsection 230-440(1)).
The value of the land provided as consideration for Bill Co starting to
have its right to receive $100,000 from Jim Co, will be taken, by
section 230-65, to be an amount provided by Bill Co under the
financial arrangement comprised of this right to receive $100,000,
given that it is integral to determining the gain or loss from this
financial arrangement. However, irrespective of the value of the land,
subsection 230-440(2) will instead provide that Bill Co is taken to have
provided the market value of the financial arrangement, determined
under subsections 230-440(9) and (10), at the time it started to be held
($87,000) as consideration for starting to have that arrangement
(subsections 230-65(1) and 230-440(2)).
Accordingly, Bill Co will calculate its capital gain or loss from
disposal of the land on the basis of receiving $87,000 capital proceeds,
and will make a $13,000 gain on its financial arrangement comprised
of its right to receive $100,000 from Jim Co.
98
Tax treatment of gains and losses from financial arrangements
Where one financial arrangement (or part thereof) is dealt with as
consideration for another financial arrangement (or part thereof)
3.36 Particular issues arise where the relevant thing that starts, or
ceases, to be held as consideration for starting or ceasing to have all or
part of a financial arrangement is also a financial arrangement (or part of a
financial arrangement). In such a situation, subsection 230-440(1) or (4),
in addition to subsection 230-440(2) or (5), may both apply so as to
determine the amount that is taken to be received, or provided, for starting
or ceasing to have the relevant financial arrangement (or part thereof).
This is because where all or part of a financial arrangement is used as
consideration for a dealing with all or part of a separate financial
arrangement, it will be both a financial arrangement referred to in
section 230-440, and a relevant thing referred to in that section.
[Schedule 1, item 1, subsections 230-440(3) and (6)]
3.37 For these transactions, subsection 230-440(1) or (4) would apply
to deem a different amount to have been received, or provided, for starting
or ceasing to have a financial arrangement (being the relevant thing
referred to in the provision), than would otherwise be deemed under
subsection 230-440(2) or (5) to have been so received or provided for
starting or ceasing to have the financial arrangement (as the relevant
financial arrangement referred to in the provision). In this case, the
tie-breaker rule in subsection 230-440(3) or (6) provides that
subsection 230-440(2) or (4) (as relevant), relating to the financial
arrangement used as consideration, is to take precedence. [Schedule 1,
item 1, subsections 230-440(3) and (6)]
3.38 The effect of this tie-breaker rule is that where one financial
arrangement is dealt with in consideration for another, each financial
arrangement will be taken to have been dealt with for its respective
market value, rather than each financial arrangement being deemed to
have been dealt with for the value of the corresponding arrangement,
pursuant to either subsection 230-440(1) or (4). [Schedule 1, item 1,
subsections 230-440(3) and (6)]
3.39 For an illustration of when this tie-breaker rule may arise and
how it applies, see Case study 4 in Chapter 13.
Allocation of costs to proceeds
3.40 As mentioned above, the determination of a gain or a loss from a
financial arrangement involves an allocation of the cost of that
arrangement to any proceeds taken to be from that arrangement (or, more
specifically, an allocation of the financial benefits taken to be received
and provided under that financial arrangement). Where there is more than
one gain or loss made from the financial arrangement over its lifetime
99
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
(eg, where an overall gain or loss cannot be determined from the financial
arrangement at its inception, but there are several particular gains and
losses made from the arrangement over its lifetime (see Chapter 4), it is
particularly important that the financial benefits provided, or to be
provided, under the financial arrangement are appropriately allocated to
the relevant financial benefits received, or to be received, under that
financial arrangement.
3.41 The attribution of the costs of the financial arrangement to the
proceeds from the financial arrangement is reasonable only if it reflects
appropriate and commercially accepted valuation techniques. The cost
and proceeds allocation, in reflecting such techniques, must properly take
into account:
· the nature of the rights and obligations under the financial
arrangement;
· the risks associated with each of the rights, obligations and
financial benefits under the arrangement; and
· the time value of money.
[Schedule 1, item 1, subsections 230-75(4) and 230-80(4)]
3.42 Requiring that the attribution of cost and proceeds reflect
valuation principles that take into account the time value of money, does
not mean that the value of the financial benefits used to determine the
overall gain or loss from the arrangement can be discounted. Rather, a
relevant cost amount is to be appropriately spread, taking into account the
time value of money, when being allocated in its entirety to relevant
proceed amounts. It does not go so far as to say that the cost and proceeds
(and the corresponding calculation of gain or loss) can be discounted to
present value. The calculation of the gain or loss from the financial
arrangement is specifically to be conducted in nominal (and not present
value) terms. [Schedule 1, item 1, subsections 230-75(1) and (4) and
230-80(1) and (4)]
3.43 Importantly, this requires that the value of the relevant financial
benefit must be determined as at the time when it is (or is to be) received
or provided.
100
Tax treatment of gains and losses from financial arrangements
Example 3.5: Valuing financial benefits integral to gain or loss
Under an arrangement, Cat Co receives $100 from Dog Co, in return
for assuming an obligation to pay Dog Co $150 in three years time.
Cat Co has a financial arrangement consisting of its cash settlable
obligation to pay $150. At the time of assuming this obligation,
Cat Co's obligation to pay Dog Co has a present value of $100.
From the outset of the arrangement, Cat Co's obligation is not valued
in present value terms but is taken for the purposes of Division 230 to
be an obligation to pay $150.
In addition, as the proceeds for assuming this obligation are integral to
calculating Cat Co's gain or loss from the financial arrangement,
Cat Co is taken to have received the $100 financial benefit it received
in relation to this arrangement, under the arrangement (section 230-65).
At the time of entering the arrangement, then, Cat Co is sufficiently
certain that it will make a $50 loss (calculated in nominal terms) from
the arrangement.
However, one year into the arrangement, Cat Co novates its obligation
to Bird Co, in return for providing a bond to Bird Co. The value of
both the outstanding obligation and the bond at the time of novation is
$130. The bond is due to mature several years after the time of
novation, for its face value of $200.
Again, being integral to calculating the gain or loss Cat Co makes on
its financial arrangement, Cat Co is taken to have provided the bond
under its financial arrangement with Dog Co. It does not matter that
Cat Co provided the bond to an entity (Bird Co) that is a third party to
its arrangement with Dog Co (subsection 230-65(1)).
On these facts, the financial benefit Cat Co in fact provides (the bond)
is taken to be $130. This is the value of the financial benefits that
Cat Co, at the time it provides them, has given to Bird Co and therefore
the amount taken to have been provided by Cat Co under the
arrangement pursuant to section 230-65. Subsection 230-80(1) makes
it clear that it is the gain or loss, and not the individual financial
benefits that are in fact provided or in fact received, that must be
calculated in nominal terms. It would be an anomaly if Cat Co were
taken to have provided $200 to extinguish its obligation to Dog Co.
On these facts, Cat Co will therefore make a $30 loss from its financial
arrangement rather than its expected $50 loss.
The requirement that the gain or loss must be calculated in nominal
terms is designed to ensure that the outcome is not that Cat Co makes
no loss from the arrangement. Without such a requirement, it may be
argued that, as the present value of Cat Co's obligation to pay $150
under the financial arrangement was, when it was incurred, only $100,
101
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
no gain or loss is made as Cat Co also received $100 under the
arrangement. Such an approach is not permissible under
sections 230-75 and 230-80.
Note that section 230-440, which operates to set the value of the
proceeds that Cat Co receives upon ceasing to have its obligation (as
explained above, in substitution for the amounts otherwise
determined), would not alter the outcome in this example if the market
value (determined under that provision) of the bond Cat Co provides to
Bird Co at the time it is provided, and of its outstanding obligation to
Dog Co at the time of novation, is also $130.
3.44 Example 3.5 illustrates that if a financial benefit received or
provided under an arrangement is, for example, an asset that itself consists
of a series of future cash flows, the financial benefit being the asset is to
be taken into account in determining a gain or loss from the financial
arrangement at its market value when received or provided. The cash
flows it represents are not amounts provided under the relevant financial
arrangement, or that are integral to calculating the gain or loss from the
relevant financial arrangement. The requirement that a gain or loss from
the financial arrangement be calculated in nominal terms does not go so
far as to suggest that where the financial benefit provided under the
arrangement is such an asset, its value must be represented by the dollar
sum of its expected cash flows.
3.45 A specific legislative articulation of this principle is prescribed
for instances of rights to receive, or obligations to provide, financial
benefits being waived. Section 230-70 provides that where a right to a
financial benefit is received in the form of an obligation being waived, or
an obligation to provide a financial benefit is provided in the form of
waiving a right to receive a financial benefit from someone else, the
amount of those financial benefits is taken to be the market value of the
debt waived, as determined at the time of the waiver. [Schedule 1, item 1,
section 230-70]
Allocation of cost and proceeds may also occur within a particular
tax-timing method
3.46 Under some of the tax-timing methods, the allocation of costs
and proceeds is required for determining particular gains and losses from
a financial arrangement over the period for which it is held (whilst other
tax-timing methods have their own methodology for determining gains
and losses from the financial arrangement over this period). It is therefore
critical to refer to the relevant tax-timing method to determine the timing
and quantum of relevant gains and losses from a financial arrangement.
102
Tax treatment of gains and losses from financial arrangements
A special rule for interest for particular gains and losses, and realised
gains and losses
3.47 As mentioned above, many of the tax-timing methods have their
own methodology for determining what is the gain or loss that is made
from a financial arrangement, and under these methods, together with the
balancing adjustment in Subdivision 230-G where relevant, the entire gain
or loss from the financial arrangement will be brought to account under
Division 230. However, the methodologies in Subdivision 230-B
(accruals and realisation methods) will largely rely on the core provisions
in Subdivision 230-A to determine what is the relevant gain or loss in the
appropriate circumstance. As indicated in paragraph 3.40, the allocation
of financial benefits received, to those provided in order to determine the
quantum of the relevant gain or loss, will be particularly important where
there is more than one gain or loss from the financial arrangement. In an
accruals and realisation sense, this will be relevant for determining
particular gains and losses, and in determining gains and losses made
under the realisation method.
3.48 When a financial benefit is received or provided as an interest
receipt or payment (or where it is in the nature of interest or can
reasonably be regarded as a substitute for interest), it is intended that this
financial benefit (or cash flow) itself be a gain or a loss. These cash flows
under the current law are typically treated on a gross basis. For
Division 230 to disturb this treatment in those provisions looking to
recognise particular gains and losses or realised gains and losses would in
some instances be unnecessarily burdensome, and in others produce
unintended consequences. It is therefore intended that in a broad sense
the current treatment of these cash flows not be disturbed in these
circumstances.
3.49 However, despite this intention, economically and
commercially, interest receipts and payments are reasonably attributed a
cost, and so too would they be under the ordinary operation of
subsections 230-75(1), (2) and (4) and subsections 230-80(1), (2) and (4).
For example, an arrangement costing $100 for an interest stream together
with a $100 return on maturity would economically have a portion of the
$100 cost attributed to the right to receive $100 in the future (broadly
speaking, a cost reasonably approximating the present value of that right),
and the balance of the $100 cost will be attributed to the right to receive
the interest cash flows. Because section 230-75 takes into account the
time value of money when attributing cost to proceeds (as discussed in
paragraph 3.42), this economic position would be a reasonable allocation
of cost to proceeds for the purpose of subsections 230-75(1), (2) and (4).
[Schedule 1, item 1, subsections 230-75(1), (2) and (4)]
103
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.50 However, to avoid this allocation of cost (or proceeds) to cash
flows representing interest receipts (or payments), special rules are
contained in subsections 230-75(3) and 230-80(3). These rules ensure
that no costs (or proceeds) are allocated to the receipt (or payment) of
interest (or an amount in the nature of, or in substitution for, interest)
when determining the relevant gain or loss on such a receipt (or payment).
Under these rules, which apply only in calculating a particular gain or loss
under the accruals methodology, or a gain or loss that occurs under the
realisation method, the receipt of an amount of, in the nature of, or in
substitution for, interest, will represent a gain in its entirety. Likewise, the
payment of an amount that is interest, interest in nature, or in substitution
for interest, will be a loss made under a financial arrangement in its
entirety for the purpose of these methods. [Schedule 1, item 1,
subsections 230-75(3) and 230-80(3)]
3.51 As these rules only apply for the purpose of determining a
particular gain or loss under the accruals methodology or for determining
a gain or loss that occurs under the realisation method, they will not apply,
for example, to prohibit a cost being attributed to an interest income
stream disposed of, or proceeds being allocated to interest obligations that
are assigned, novated or that otherwise cease. When a financial
arrangement ceases or is partially transferred any financial benefits
reasonably attributable to a right or obligation to an amount in the nature
of interest under that arrangement continues to be appropriately allocated.
This ensures that an appropriate gain or loss can be calculated upon the
cessation or relevant partial disposal of a financial arrangement.
[Schedule 1, item 1, paragraphs 230-75(3)(a) and (b) and 230-80(3)(a) and (b),
subsection 230-170(2), and section 230-395]
3.52 In addition, the acquisition of an interest stream of itself will not
invoke these rules so as to deny that income stream from having any cost.
This is because in the hands of the acquirer, the `interest' income is a
series of cash flows that it has simply acquired. Not being connected with
any loan, provision of credit or borrowing of sorts of the relevant
taxpayer, these payments in isolation are not interest, interest in nature, or
in substitution for interest. [Schedule 1, item 1, paragraph 230-75(3)(c)]
General rule for the taxation of gains and losses made from financial
arrangements
3.53 Under Division 230, gains from financial arrangements are
assessable income unless otherwise specified. [Schedule 1, item 1,
subsection 230-15(1)]
3.54 Gains from financial arrangements included in assessable
income pursuant to subsection 230-15(1) will still retain their character as
either statutory or ordinary income (see note 2 to subsection 6-10(2) of the
104
Tax treatment of gains and losses from financial arrangements
ITAA 1997). As Division 230 specifically does not disturb the general
rules relating to foreign residents contained within Division 6 of the
ITAA 1997, the structure of that Division (and, in particular,
subsections 6-5(3) and 6-10(5) of the ITAA 1997) ensures that
non-residents are only taxed on their gains from financial arrangements
that have a foreign source. [Schedule 1, item 1, subsection 230-15(7)]
3.55 Under Division 230, losses from financial arrangements are
deductible to the extent that they are made in gaining or producing
assessable income or are necessarily made in carrying on a business for
the purpose of gaining or producing assessable income, unless otherwise
specified. [Schedule 1, item 1, subsection 230-15(2)]
3.56 This rule reflects the current general deduction rule in
section 8-1 of the ITAA 1997 with the exception that it generally does not
deny deductions for a loss of a capital nature. This is consistent with an
object of Division 230, which is to ignore distinctions between capital and
revenue. [Schedule 1, item 1, subparagraph 230-10(b)(ii)]
Dividends paid on debt interests
3.57 As noted above, the rule in subsection 230-15(2) reflects the
current general deduction rule in section 8-1 of the ITAA 1997 -- in
particular the `nexus' aspects of section 8-1. Hence, the case law in
respect of the nexus aspects would also apply in determining whether
losses made from a financial arrangement will satisfy the test for
deductibility in subsection 230-15(2). Given the nexus requirements,
deductions may not be allowable where a loss is made from interests
(including debt/equity hybrids) that satisfy the debt test under
Division 974 of the ITAA 1997 (eg, an interest that would be an equity
interest but for the fact that it satisfies the debt test, such as a mandatorily
redeemable preference share) where the loss represents the application of
income derived (ie, a post-derivation outlay). Such outlays may be
dividends paid in respect of the relevant interest (see Commissioner of
Taxation v Boulder Perseverance (1937) 58 CLR 223).
3.58 Further, although the rule in subsection 230-15(2) generally will
not deny deductions for losses of a capital nature (which may otherwise
have denied deductibility for dividends paid on debt interests because they
could be said to be of a capital nature), there is case law that suggests that
such dividend payments are not made for the purpose of gaining or
producing assessable income (see Macquarie Finance Limited v
Commissioner of Taxation [2005] FCAFC 205). Rather, these dividend
payments may be said to be outgoings relevant to the raising of permanent
additional capital. This means that such payments, which are themselves
the losses made on financial arrangements that are debt interests, could be
prevented from deductibility under subsection 230-15(2) because it could
105
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
be said that they were not made in gaining or producing assessable
income or necessarily made in carrying on a business for the purpose of
gaining or producing assessable income.
3.59 In respect of section 8-1, in order to address these issues,
section 25-85 of the ITAA 1997 specifically provides for deductibility in
respect of dividends (subject to certain restrictions). Section 25-85 will
not apply to financial benefits paid or received in respect of financial
arrangements that are debt interests due to the operation of the
anti-overlap rule in subsection 230-25 (which is explained further below).
However, the effect of section 25-85 is reflected in subsections 230-15(4)
to (6). That is, if the financial arrangement is a debt interest
(as determined under Division 974 of the ITAA 1997), the loss made at
the time a dividend is paid on that debt interest is not denied deductibility
merely because the financial benefit (ie, the dividend) is contingent on the
economic performance of the taxpayer or a connected entity of the
taxpayer; or that the dividend is considered to secure a permanent or
enduring benefit for the taxpayer. [Schedule 1, item 1, subsection 230-15(4)]
3.60 As a revenue safeguard it is necessary to prevent excessive
deductible payments on debt/equity hybrids that satisfy the debt test. The
same risk to the revenue identified in respect of section 25-85 of the
ITAA 1997 exists under Division 230 -- that is, that a company could
distribute its profits as deductible payments in lieu of frankable dividends
by making the distribution in respect of a hybrid that has been artificially
characterised as debt. The artificiality of the characterisation would be
indicated by a return on the interest considerably in excess of the interest
payable on an equivalent interest without any equity component
(ie, straight debt). The deduction allowable in these circumstances is
capped by reference to the rate of return on an equivalent straight debt
interest, increased by a margin to recognise the premium paid for the
increased risk of non-payment because of the contingency. That rate of
return is referred to as the `benchmark rate of return', and the margin is
150 basis points [Schedule 1, item 1, subsection 230-15(5)]. The margin may be
increased or decreased by reference to regulations made under
subsection 25-85(6) of the ITAA 1997 [Schedule 1, item 1,
subsection 230-15(6)].
Gains and losses relating to exempt and non-assessable non-exempt
income
Losses
3.61 A loss from a financial arrangement will be disregarded under
Division 230 if it is made in gaining or producing exempt income or
non-assessable non-exempt income. [Schedule 1, item 1, subsection 230-30(1)]
106
Tax treatment of gains and losses from financial arrangements
3.62 An exception to this general rule is losses from financial
arrangements made by Australian entities in deriving foreign source
income that is non-assessable non-exempt under section 23AI, 23AJ or
23AK of the ITAA 1936, where the loss is a cost in relation to a debt
interest covered by paragraph (a) of the definition of `debt deduction' in
subsection 820-40(1) of the ITAA 1997 (the `thin capitalisation'
provisions) [Schedule 1, item 1, subsections 230-15(3) and 230-30(2)]. This
treatment maintains the current treatment of such costs under
section 25-90 of the ITAA 1997.
Gains
3.63 A gain from a financial arrangement will be treated as being
exempt income, or non-assessable non-exempt income, in situations
where, if had it have been a loss, it would have been made in gaining or
producing exempt income or non-assessable non-exempt income
respectively. [Schedule 1, item 1, section 230-35]
Gains and losses of a private or domestic nature
3.64 Under Division 230, gains and losses from certain financial
arrangements having a private or domestic purpose will be disregarded.
3.65 The specific arrangements subject to this exclusion are:
· a borrowing or provision of credit under an arrangement
where the taxpayer is the borrower, or is provided with the
credit, to the extent that the borrowing or provision of credit
is used for private or domestic purposes; and
· derivative financial arrangements of individuals, to the extent
they are held or used for private or domestic purposes.
[Schedule 1, item 1, subsection 230-30(3)]
Private or domestic borrowings
3.66 A gain or loss made from an arrangement under which finance is
raised by the taxpayer (ie, where the taxpayer has borrowed funds or has
been provided with credit) will be disregarded to the extent the finance is
used for a private or domestic purpose. [Schedule 1, item 1,
paragraph 230-30(3)(a)]
3.67 The intended operation of this exception is to exclude from
Division 230, gains and losses made in respect of borrowings and other
forms of raising finance used to fund private or domestic arrangements. It
107
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
does not include an arrangement under which the taxpayer is the provider,
rather than the recipient, of the finance.
3.68 A borrowing is broadly defined in subsection 995-1(1) of the
ITAA 1997 to cover any form of borrowing, whether secured or
unsecured. The provision of credit is a similarly broad concept, entailing
a financial contribution to the taxpayer in respect of which the taxpayer
pays a return.
3.69 In determining whether borrowed funds, or credit provided, have
been used for a private or domestic purpose, it is important to consider all
the relevant circumstances and features of the particular arrangement, in
addition to the taxpayer's intention.
Example 3.6: A loss made from an arrangement used to raise finance
for a private purpose
Hoa's Haulage, a truck importing business, is conducted by Hoa as a
sole trader.
As an individual, Division 230 does not apply to Hoa's gains and
losses from financial arrangements on a mandatory basis
(section 230-405). However, Hoa makes an election to have all
financial arrangements subjected to Division 230
(subsection 230-405(4)).
After making this election, Hoa then borrows $50,000. $30,000 of the
borrowed funds are to acquire a second-hand prime-mover truck as
part of the trading stock of Hoa's Haulage, and the remaining $20,000
funds Hoa's personal overseas travels.
The interest payments Hoa makes on repayment of the loan are losses
made from a financial arrangement (see Chapter 2). However,
40 per cent of the losses made relate to a borrowing that was used for a
private purpose. Accordingly, despite being losses made from a
financial arrangement to which Division 230 applies, 40 per cent of
Hoa's interest payments will be denied deductibility under
paragraph 230-30(3)(a).
(Note that it is not necessary for Hoa to make a subsection 230-405(4)
election in order to obtain a deduction for the cost of that part of the
borrowed funds used to acquire the prime-mover truck under other
provisions of the Act.)
Derivatives held for private or domestic purposes
3.70 Under Division 230, a gain or loss made by an individual from a
derivative financial arrangement, to the extent that it is held or used for
108
Tax treatment of gains and losses from financial arrangements
private or domestic purposes, will also be disregarded. [Schedule 1, item 1,
paragraph 230-30(3)(b)]
3.71 Whilst individuals will not be compulsorily subject to
Division 230 except in relation to their qualifying securities, they may
elect to have all of their financial arrangements subject to the Division
(see Chapter 2). [Schedule 1, item 1, subsection 230-405(4)]
3.72 Derivative financial arrangements are arrangements that:
· change in value in response to a change in a specified
variable or variables; and
· require little or no net investment, in that the net investment
is smaller than that required for other types of financial
arrangements, except other derivative financial arrangements,
that would be expected to have similar results to changes in
market factors (see Chapter 8).
[Schedule 1, item 1, subsection 230-305(1)]
3.73 Where a derivative financial arrangement (such as an interest
rate option) is used or held by an individual for private or domestic
purposes (eg, to hedge the risk associated with a private underlying
transaction), any gain or loss made on it will be disregarded under
Division 230.
Gains and losses to which Division 230 does not apply
3.74 In addition to gains and losses that are disregarded in relation to
certain exempt income, non-assessable non-exempt income or private or
domestic transactions, Division 230 either will not apply to gains and
losses from specified financial arrangements or specific provisions will
reduce gains and losses from particular financial arrangements.
[Schedule 1, item 1, note to subsections 230-15(1) and (2)]
3.75 These specified exceptions to the general scope of the Division
have the effect of limiting the application of the general taxing provisions
in section 230-15. They are discussed in detail in Chapter 2.
Gains and losses from financial arrangements generally on revenue
account
3.76 As the above paragraphs have illustrated, by being generally
assessable or deductible, gains and losses from financial arrangements are
typically taxed on revenue account under Division 230.
109
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.77 Under existing legislation, not only are there questions of fact
and law in determining the appropriate character of gains and losses, but
also potentially difficult apportionment issues because gains and losses
can be attributable to both periodic and non-periodic cash flows.
3.78 Putting all gains and losses on revenue account, other than
where an exception or exclusion applies, simplifies the determination of
the tax treatment. It is also consistent with the operation of some existing
tax provisions relating to financial arrangements (eg, see the provisions
listed in paragraph 3.6).
3.79 However, a different character may be attributed to the gains and
losses of a financial arrangement that is a hedging financial arrangement,
if the hedging financial arrangement method is applied to take account of
those gains and losses from a financial arrangement. Under this method,
the gain or loss from the hedging financial arrangement will in most
instances be aligned with the tax treatment of the underlying hedged item.
[Schedule 1, item 1, section 230-270]
3.80 If the hedging financial arrangement method specifically
provides that a gain or loss on a hedging financial arrangement is to be
dealt with in a particular way (whether or not by providing that it be on
capital account), this takes priority over the treatment provided for in the
general rule for the taxation of gains and losses from financial
arrangements. [Schedule 1, item 1, subsections 230-260(1) and 230-270(3) and
section 230-45]
3.81 For a more comprehensive discussion of the hedging financial
arrangement method (including what are hedging financial arrangements
and hedged items), refer to Chapter 8.
3.82 Financial arrangements which have their gains and losses
specifically excluded from the operation of Division 230 may also be
taxed on capital account.
Anti-overlap rule
3.83 Sections 230-20 and 230-25 contain rules to ensure that:
· a gain or loss from a financial arrangement that is, or will be,
taken into account under Division 230; and
· any associated financial benefits making up the calculation of
that gain or loss,
are not taken into account more than once under Division 230, and are not
included in assessable income or allowable as a deduction under a
110
Tax treatment of gains and losses from financial arrangements
provision of the ITAA 1936 or the ITAA 1997 outside of Division 230.
[Schedule 1, item 1, sections 230-20 and 230-25]
3.84 These anti-overlap rules ensure that:
· gains and losses from financial arrangements are recognised
only once for tax purposes;
· to the extent that a gain or loss from a financial arrangement
is, or will be, assessable or deductible under Division 230, or
dealt with under the hedging rules, this takes priority over
other provisions of the ITAA 1936 or the ITAA 1997; and
· to the extent to which Division 230 does not deal with a gain
or loss from a financial arrangement the other provisions of
the ITAA 1936 or the ITAA 1997 will have residual
operation unless otherwise specified (ie, Division 230 does
not represent an exclusive code for the taxation of gains and
losses from financial arrangements).
[Schedule 1, item 1, sections 230-20 and 230-25; item 62, section 118-27]
3.85 The operation of the anti-overlap rules in sections 230-20 and
230-25 require that if a gain or loss from a financial arrangement is, or is
to be, included in assessable income or allowable as a deduction under
Division 230, or dealt with in accordance with subsection 230-270(4)
(which, as explained in Chapter 8, sets out particular tax classifications for
gains and losses from certain hedging financial arrangements), then no
part of that gain or loss can be:
· included in assessable income;
· allowable as a deduction; or
· dealt with in accordance with subsection 230-270(4),
again under Division 230, or under any other provision of the ITAA 1936
or the ITAA 1997, in any income year. [Schedule 1, item 1,
subsections 230-20(1), (3) and (4)]
3.86 In addition, no part of the amount or value of any financial
benefits taken into account in determining an assessable gain or
deductible loss under Division 230, or a gain or loss dealt with in
accordance with subsection 230-270(4), can be either included in
assessable income or allowable as a deduction under any other provision
of the ITAA 1936 or the ITAA 1997 in any income year. [Schedule 1,
item 1, subsection 230-25(2)]
111
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Relevance for other parts of the Act
3.87 The intention of the anti-overlap rule is to ensure that gains and
losses from financial arrangements (including any component parts of
such gains and losses) are only recognised once for tax purposes. It is not
intended to restrict the other workings of the ITAA 1936 or the
ITAA 1997. In this regard, the anti-overlap rule does not prevent such
gains and losses (or any financial benefits taken into account in
determining them) from being used to work out other tax-relevant
amounts, as long as no part of any gain or loss from a financial
arrangement is dealt with more than once. [Schedule 1, item 1,
subsection 230-20(2)]
Financial arrangements used as consideration in other dealings
3.88 In keeping with this intention, the anti-overlap rule does not go
so far as to provide that where a taxpayer is taken to have received or
provided a financial benefit as the cost or proceeds for a particular
financial arrangement, that a financial benefit of an equal value cannot be
assessable or deductible elsewhere. For instance, in Example 3.4, Bill Co
is taken to have received capital proceeds on disposal of its land equal to
the market value of the financial arrangement it starts to have. Bill Co is
also taken to have started to have that financial arrangement by providing
an amount of that same value. In this example, even though the values are
the same, they are in respect of different financial benefits (one being the
financial benefit received for the land and the other being the financial
benefit provided for starting to have the financial arrangement).
Subsections 230-25(3) and (4) clarify this point for the avoidance of
doubt. [Schedule 1, item 1, subsections 230-25(3) and (4)]
Bad debts
3.89 Where a financial arrangement arises in respect of the provision
of goods, services or other property on deferred payment terms (and
section 230-400, dealing with certain short-term arrangements, does not
apply), a special rule is required to allow a deduction under section 25-35
if the relevant debt that arises on provision of those goods, services or
other property goes bad. This is because, despite the amount taken to
have been received for the provision of such property or services being a
different financial benefit from that taken to have been provided for
starting to have the financial arrangement (as described in
paragraph 3.88), in these circumstances, the debt that arises at the time the
goods, services or other property is provided is in fact satisfied by the
acquisition of the financial arrangement.
3.90 The value that is included in assessable income in respect of the
provision of the goods, services or other property is determined under
112
Tax treatment of gains and losses from financial arrangements
section 230-440 (see explanation above and in Chapter 11). For the
special rule to apply, the financial benefit (as determined under
section 230-440) must have been brought to account as assessable income
under a provision outside of Division 230 [Schedule 1, item 1,
paragraph 230-25(5)(a)]. Where this amount is written-off as a bad debt by
the taxpayer, a deduction for the value of the financial benefit the taxpayer
is taken to have provided to acquire the financial arrangement is to be
claimed under section 25-35 of the ITAA 1997 (subject to the relevant
restrictions in that section) [Schedule 1, item 1, subsection 230-25(5)].
3.91 If a gain has been included in the taxpayer's assessable income
under Division 230, and an amount that includes or represents that gain
has been written off as a bad debt, specific provisions in
Subdivision 230-B will apply to recognise a loss under Division 230 to
the extent of the gain previously brought to account (see Chapter 4).
3.92 Further, if the taxpayer ceases to have the relevant financial
arrangement (eg, by disposing of the debt to a third party), after it has
written-off the relevant debt as bad and claimed the deduction available
under section 25-35, the balancing adjustment under Subdivision 230-G is
adjusted to take this previously claimed deduction into account.
Therefore, in calculating an amount of a gain or loss on the relevant
ceased financial arrangement, the amount of any deduction that has been
claimed under section 25-35 of the ITAA 1997 is to be taken into account
under step 1(b) of the method statement in section 230-395
(see Chapter 10) [Schedule 1, item 1, subsection 230-395(7)]. This rule is
consistent with the underlying policy in sections 230-20 and 230-25, that
amounts are not to be included in assessable income or allowable as a
deduction more than once under the ITAA 1936 or the ITAA 1997.
Exempt income
3.93 Subsection 6-20(2) of the ITAA 1997 provides that amounts
of ordinary income that are excluded from being assessable income, are
exempt income. This means that absent a special rule, an amount
(rightly) excluded from being double counted under section 230-20 or
section 230-25, may arguably go to reducing a taxpayer's tax losses in
addition to being dealt with under Division 230 (eg, if a financial benefit
is itself an amount of ordinary income, but is taken into account in
determining the amount of a loss from a financial arrangement).
Subsections 230-20(5) and 230-25(6) ensure that just because an amount
of a gain or a financial benefit is excluded from being assessable income
under other provisions of the Act, this of itself will not make those
amounts exempt income. [Schedule 1, item 1, subsections 230-20(5) and
230-25(6)]
113
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
3.94 Notably, an amount that is included in assessable income
pursuant to section 230-15 may itself specifically be made exempt income
or non-assessable non-exempt income under another provision of the Act.
In these circumstances, Division 6 of the ITAA 1997 (and in particular
sections 6-20 and 6-23 of the ITAA 1997) ensures that the amount is
not assessable, but rather will be exempt income or non-assessable
non-exempt income as provided for.
Threshold calculations
3.95 By only requiring that gains and losses from financial
arrangements (or any financial benefits taken into account in determining
them) not be taken into account more than once in working out a
taxpayer's taxable income, the anti-overlap rules do not prevent these
amounts from being included in other calculations. For example, these
amounts can be included in calculations for various tax-thresholds, such
as the thin capitalisation tests in Division 820 of the ITAA 1997 and
similar threshold tests such as the calculations for tainted income under
the controlled foreign corporation rules in Division 7 of Part X of the
ITAA 1936.
114
Chapter 4
The compounding accruals and
realisation methods
Outline of chapter
4.1 This chapter:
· explains the rationale for compounding accruals and
realisation tax treatment;
· explains what compounding accruals and realisation are;
· sets out the basis for determining when taxpayers apply the
compounding accruals or the realisation method to a financial
arrangement;
· explains the manner in which the compounding accruals and
realisation methods are applied;
· explains situations in which a re-assessment of the
compounding accruals or realisation method should apply to
a gain or loss arising from a financial arrangement; and
· explains the application of the re-estimation and running
balancing adjustment provisions.
Context of amendments
4.2 Under the current law, the scope of accruals tax treatment has
broadened through legislative and judicial developments over recent
decades. However, the current accruals system is incomplete and has not
adapted sufficiently to be able to deal effectively with the rapid pace of
financial innovation over this period. The application of the compounding
accruals method under Division 230 will further broaden the scope of
accruals tax treatment. This further broadening mainly reflects the need
to modernise the tax treatment of financial arrangements in order for it to
appropriately apply to newer, innovative financial arrangements and also
115
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
for it to operate in a generally consistent manner for both traditional
arrangements and hybrid financial arrangements.
4.3 The realisation tax treatment has provided a basic treatment that
applies when no other tax-timing treatment is appropriate. This role for
realisation treatment is to remain essentially unchanged.
4.4 In general, the setting of the borderline between the realisation
regime and the accruals regime in Division 230 takes into account the
need to prevent manipulation and tax deferral, and the need to avoid the
early and premature taxation of significant, unsystematic gains and losses
that may not be realised.
What is accruals?
4.5 Compounding accruals in the context of the taxation of financial
arrangements refers to the allocation or spreading of gains or losses over
time, where the gain or loss is calculated by reference to known or
estimated future amounts (represented by the financial benefits under the
arrangement) and on the assumption that the entity will continue to have
the arrangement for its remaining term.
4.6 Compounding accruals, in this sense, is in contrast to the
concept of fair value, which calculates the gain or loss in each period by
effectively assuming that the entity ceases to have the financial
arrangement, which it holds, at the end of each income period and starts to
have it at the beginning of the next period. This distinction between
compounding accruals and fair value is important because it means that
the volatility which can arise when gains and losses are accounted for on a
fair value basis can be smoothed by spreading (using the compounding
accruals method) the estimated gains or losses over a number of income
periods.
4.7 This smoothing means that -- relative to the outcomes from the
fair value tax method -- taxpayers will generally not be required to pay
tax on unsystematic gains that may not be realised. The likelihood of this
happening is further reduced by the principle which governs the
circumstances in which the accruals method should apply. In principle, it
should apply to spread estimated gains and losses that are sufficiently
certain. The gains and losses that are so spread are then the subject of
taxation.
4.8 The period over which the sufficiently certain gains or losses are
intended to be spread is the period to which the gains or losses relate. The
intended basis of allocation of the relevant gain or loss under this accruals
(spreading) principle reflects the financial concept of interest on interest,
116
The compounding accruals and realisation methods
or compound interest. For the purpose of Division 230, this form of
accrual is referred to as `compounding accruals'.
4.9 The `compounding accruals' allocation methodology is
conceptually identical to the `effective interest method' adopted by
Accounting Standard AASB 139 Financial Instruments: Recognition and
Measurement (AASB 139) -- that is, the financial accounting accruals
methodology used to allocate gains and losses from loans, receivables,
and held-to-maturity investments.
Why is compounding accruals important?
4.10 A compounding accruals principle is important for income tax
purposes for two reasons. First, it moves tax outcomes closer to
commercial (accounting) outcomes with attendant opportunities to reduce
compliance costs. Second, and related to the first, it reduces tax deferral
and tax arbitrage opportunities.
4.11 If the tax system relied only on a realisation tax method to tax
all financial arrangements, opportunities would be created for taxpayers to
delay the taxation of gains, and to bring forward losses and related tax
deductions. This would undermine the revenue base and, over time, result
in a distorted and inefficient allocation of investments and resources.
4.12 Compounding accruals methods generally recognise sufficiently
certain (known or estimated) future gains and losses over the life of a
financial arrangement. Such gains and losses, which are sufficiently
certain to occur, can be subject to taxation on a compounding accruals
(spreading) basis, rather than at realisation and will be brought to account
under the compounding accruals method without significant unexpected,
and potentially adverse, tax-based cash flow impacts on the taxpayer.
When does accruals treatment apply under the current income tax law?
4.13 Under the current income tax law, the main specific accruals
rule is found in Division 16E of Part III of the Income Tax Assessment
Act 1936 (ITAA 1936). As discussed below, Division 16E is limited in
scope and is quite prescriptive in its operation.
4.14 Apart from Division 16E, the question of whether accruals or
realisation applies to a particular financial arrangement largely depends on
the operation of the ordinary income and general deduction provisions in
sections 6-5 and 8-1 of the Income Tax Assessment Act 1997 (ITAA 1997)
respectively. For income, the issue turns on when the income is `derived'
and, for deductions, the issue turns on when a loss or outgoing is
`incurred'.
117
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.15 Whilst there is some authority for losses or outgoings to be
incurred on an accruals basis in certain situations, there is very little
clarity on whether, for example, interest or discount income is subject to
accruals or realisation tax treatment. However, under Taxation Ruling
TR 93/27, the Commissioner of Taxation has ruled that the interest
income and expense of a financial institution may be brought to account
on an accruals basis.
Division 16E of the ITAA 1936
4.16 Division 16E was introduced into the tax law in 1984 to remove
the then-existing distortions and tax deferral opportunities arising out of
long term (more than 12 months) discounted and deferred interest
securities. Before the introduction of Division 16E, a taxpayer (eg, a
financial institution) could issue long term debt instruments, which
deferred payment of interest until maturity, but could claim a deduction
for interest on an accruals basis. However, a non-financial institution that
held those instruments did not have to pay tax on the interest until the
cash was received at maturity. The purpose of Division 16E was to
remove such tax deferral opportunities by bringing the interest to tax on
an accruals basis.
4.17 In general, Division 16E applies to qualifying securities where
the non-periodic (ie, deferred) receipts are reasonably likely to exceed the
payment needed to acquire the security. In broad terms, Division 16E
spreads discount and deferred interest income to the holder, and
corresponding expense to the issuer, of the security on a semi-annual
compounding basis.
4.18 Division 16E has a relatively narrow scope. Where
Division 16E does not apply, the tax-timing treatment of discount income
and discount expense remains uncertain. There are gaps in the application
of Division 16E -- for instance in the case of premiums and market
discounts that arise after issuance when the security is not a qualifying
security.
4.19 There is general uncertainty over whether, and if so how,
accruals tax treatment applies to various financial arrangements, including
swaps, other derivatives, and hybrid arrangements.
4.20 The incomplete coverage of Division 16E leaves complexity,
anomalies and opportunities for tax deferral, avoidance and manipulation.
118
The compounding accruals and realisation methods
What is realisation?
4.21 Realisation tax treatment has been a common and traditional
basis for recognising gains and losses from financial arrangements under
the current law.
4.22 The realisation method applies in Division 230 to bring to
account gains or losses in the income year in which the gain or loss
occurs. Generally, a gain or loss occurs when the last of the financial
benefits that are taken into account in calculating the relevant gain or loss
is provided or is to be provided -- that is when the gain or loss comes
home to the taxpayer. Hence, if a gain or loss under a financial
arrangement is subject to the realisation method, and a number of
financial benefits are to be provided under the arrangement, there may be
a number of separate gains or losses brought to account under that method
at different points in time.
4.23 The application of the realisation method is distinguished from
circumstances where the taxpayer must apply the balancing adjustment
provisions in Subdivision 230-G. The balancing adjustment applies
where the taxpayer ceases to have all of their rights or obligations under
an arrangement or where the taxpayer transfers some or all of their rights
and obligations under the arrangement -- that is when the financial
arrangement is disposed of or partly disposed of. The realisation method
generally applies where particular rights or obligations come to an end
through performance of those rights or obligations. Chapter 10 discusses
the consequences of disposing of financial arrangements.
4.24 It is possible for both the compounding accruals method and the
realisation method to apply to gains or losses arising from a single
financial arrangement. This may occur because some of the financial
benefits under the financial arrangement are sufficiently certain and others
are not. The sufficiently certain financial benefits may give rise to either
an overall, or a particular, gain or loss that will be subject to the
compounding accruals method and the remaining financial benefits that
are not sufficiently certain in regards to occurrence or as to amount will,
at the appropriate time, give rise to a gain or loss that is brought to
account under the realisation method.
Summary of new law
4.25 Division 230 provides for a number of methods that can be
applied to determine when gains or losses that a taxpayer makes from a
financial arrangement should be brought to account for tax purposes.
Where none of the elections available under Division 230 have been
119
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
made, the compounding accruals method or the realisation method will
apply.
4.26 The assessment of whether compounding accruals tax treatment
is appropriate or not for any particular financial arrangement is to be
based on an objective evaluation of the relevant considerations. In
particular, regard must be had to the terms and conditions of the financial
arrangement, accepted pricing and valuation techniques and the economic,
or commercial, substance or effect of the financial arrangement.
The compounding accruals method
4.27 Under Subdivision 230-B, a taxpayer must apply the
compounding accruals tax-timing method to a gain, or loss, from a
financial arrangement when there is sufficient certainty that such a gain,
or loss, will occur. The gain or loss may either be a gain or loss in respect
of the entire financial arrangement (a `sufficiently certain overall gain or
loss') or a gain or loss made in respect of particular financial benefits (a
`particular sufficiently certain gain or loss').
4.28 The sufficiently certain overall gain or loss is determined by
reference to the difference between the sum of all known and expected
outlays (payments) and all known and expected inflows (receipts). These
inflows and outflows are represented by the financial benefits to be
received and provided under the relevant financial arrangement. A
sufficiently certain overall gain will only arise if expected inflows under
an arrangement will exceed all known and expected outlays such that
there will be a gain of at least a specific amount. The converse is true for
a sufficiently certain overall loss.
4.29 A particular sufficiently certain gain or loss can also arise under
a financial arrangement in respect of a particular financial benefit or
particular financial benefits. Such a gain or loss may arise where:
· it is sufficiently certain at the time when the taxpayer starts to
have the arrangement, but before the taxpayer is to receive or
provide the financial benefit or benefits; or
· it becomes sufficiently certain after the time the taxpayer
starts to have the arrangement, but before the taxpayer is to
receive or provide the financial benefit.
4.30 If there is a material change to circumstances, or to terms and
conditions, adjustments may be required to be made to the amount of the
gain or loss that is accrued during the term of the financial arrangement.
Such material changes may also affect whether the compounding accruals
120
The compounding accruals and realisation methods
method will continue to apply to a gain or loss, or if the realisation
method becomes more appropriate.
4.31 Individuals and entities (other than an individual) which fall
below the turnover threshold in section 230-405, will only be subject to
Division 230 in respect of a financial arrangement that has a term of more
than 12 months and is a `qualifying security', within the meaning of that
term in Division 16E of the ITAA 1936. However, such taxpayers can
make an election for Division 230 to apply to all of their financial
arrangements (see Chapter 2).
4.32 The spreading of the sufficiently certain gain or loss for tax
purposes is done using a compounding accruals method, or a method
whose results approximate those obtained using the prescribed method.
4.33 If the compounding accruals method does not apply to a
financial arrangement, or to some of the financial benefits under the
financial arrangement because the gain or loss in respect of those benefits
is not sufficiently certain, then the realisation method applies to bring to
account those gains or losses arising from that financial arrangement or
part thereof.
The realisation method
4.34 A gain or loss from a financial arrangement is brought to
account under the realisation method in Subdivision 230-B when no other
tax-timing method is appropriate and:
· when a financial benefit is received or provided under the
financial arrangement; or
· if a financial benefit is not received or provided at the time it
is due, when the time comes for that financial benefit to be
received or provided under the financial arrangement.
4.35 The gain or loss recognised under the realisation method is the
difference between the amount received or provided, or the amount which
is to be received or provided, and the cost of the financial arrangement
which is attributable to that financial benefit. The general approach under
Division 230 to determining whether realisation tax-timing treatment for a
gain or loss is appropriate, and the basis of applying the realisation
tax-timing treatment, is largely unchanged from the existing law. That is,
the realisation tax-timing treatment applies where other tax-timing
treatments are inappropriate. Gains and losses that are subject to the
realisation method, are recognised in the income year in which the time
comes for the last of the financial benefits which are taken into account in
121
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
calculating the gain or loss received or provided -- or the income year in
which the financial benefit is actually received or provided (ie, the time at
which the gain or loss occurs for Division 230 purposes).
122
123
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Accruals Diagram 1:
Application (Part 1)
This diagram provides an overview of how to determine whether of the compounding accruals or realisation
methods should apply to a gain or loss made under a financial arrangement.
Step 1: You Bundle of cash
have a financial settlable rights and
arrangement obligations to
financial benefits.
Yes
All financial benefits At a particular time, some of the None of the
Step 2: What is are sufficiently financial benefits are sufficiently financial benefits
the classification certain. No certain and some of the financial No are sufficiently
of the cash flows benefits are not sufficiently certain. certain.
at this point
in time?
Yes Yes Yes Yes
There is a sufficiently A sufficiently certain There may be particular There is no
Step 3: Is the
certain overall gain or overall gain or loss can sufficiently certain sufficiently
gain or loss
loss. be calculated. gains or losses in certain gain or
sufficiently
addition to the loss.
certain or not?
It is the difference It is the difference sufficiently certain
What is the
between the financial between the total overall gain or loss.
gain or loss?
benefits that are received sufficiently certain OR
and the financial benefit financial benefits and
that are provided (cost) There may only be
the cost of the particular sufficiently
under the financial arrangement.
arrangement. certain gains or losses
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Accruals Diagram 1:
Application (Part 2)
The sufficiently certain The sufficiently certain The gains and losses The gains or losses
overall gain or loss is overall gain or loss is arising from the arising from the
Step 4: What is allocated over the life of allocated over the life of financial benefits that financial benefits which
the period over the arrangement. the arrangement. become sufficiently are not sufficiently
which the gain or certain (ie, particular certain before they
loss is allocated? The gains and losses sufficiently certain gains become due and payable
from the other financial and losses) are allocated or due and receivable are
benefits that are not over the period to which recognised on a
sufficiently certain may they relate. realisation basis.
be recognised on a
realisation basis.
Divide the period into Divide the period into Divide the period to There is no accrual
equal intervals not equal intervals not which the gain or loss treatment for gains and
Step 5: What is greater than 12 months. greater than 12 months. relates into intervals not losses recognised on a
the basis of greater than 12 months. realisation basis.
allocation? Allocate gain or loss to Allocate gain or loss to
those intervals using a those intervals using a Allocate gains or losses Gains or losses are taken
compounding accruals compounding accruals to those intervals using a into account under the
method or another method or another compounding accruals realisation method in the
method that method that method or another income year in which
approximates the result approximates the result method that the gain or loss
from that method. from that method. approximates the result occurred.
from that method.
Parts of gains or losses Parts of gains or losses
so allocated are brought so allocated are brought Gains for losses so
to account in the income to account in the income allocated are brought to
year in which the year in which the account in the income
interval falls. interval falls. year in which the
interval falls.
124
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Comparison of key features of new law and current law
New law Current law
If one of the elective tax-timing To use an accruals method under
methods does not apply to a financial Division 16E a `qualifying security'
arrangement, the compounding requires an `eligible return'.
accruals tax treatment will apply if An `eligible return' on a security is,
the financial arrangement has a at the time of the security's issue,
sufficiently certain gain or loss. The either known (in the case of a fixed
sufficiently certain gain or loss may return security) or, the payments to
include both periodic (such as be made -- other than periodic
interest-like amounts) and interest -- to the holder are
non-periodic amounts (such as reasonably likely (in the case of a
discounts or premiums). variable return security) to exceed
A method that approximates the the issue price of the security.
results of the compounding accruals Other requirements of a qualifying
method can be used. security are that it must have a term
which is longer than one year and, in
the case of a fixed return security, an
eligible return of more than
1.5 per cent per year.
The realisation tax-timing treatment The realisation treatment applies
applies where other basic tax-timing where an accruals treatment does not
treatments (compounding accruals, apply.
elective fair value, elective
retranslation and elective use of
financial reports) will not apply. It
will apply in those circumstances to
the extent to which the hedging
election does not apply.
Detailed explanation of new law
4.36 The main object of the accruals and realisation methods is to
properly recognise gains or losses from financial arrangements by
allocating such gains or losses to appropriate periods of time [Schedule 1,
item 1, paragraph 230-100(a)]. The compounding accruals method provided
for in Subdivision 230-B is also intended to reflect commercial
accounting concepts, so as to reduce compliance costs for taxpayers
[Schedule 1, item 1, paragraph 230-100(b)].
4.37 The compounding accruals method is also intended to minimise
tax deferral, which could occur under a realisation method [Schedule 1,
item 1, paragraph 230-100(c)]. This is reflected in the main object of
125
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Subdivision 230-B, as proper allocation of gains and losses to the periods
to which they relate also reduces tax deferral.
4.38 The question of whether accruals or realisation treatment is
applicable to a financial arrangement is determined by the nature of the
terms, conditions, pricing and valuation techniques used; the nature of the
financial benefits under the arrangement; and whether there is sufficient
certainty in respect of the gain or loss.
Application of the accruals and realisation methods to individuals and
certain entities
4.39 Generally, Division 230 does not apply to individuals, or to
entities (where that entity satisfies the relevant turnover test in
section 230-405), unless an election to have the Division apply has been
made [Schedule 1, item 1, subsection 230-405(5)]. However, if an individual or
an entity which has not made an election under subsection 230-405(5) has
a financial arrangement that is a `qualifying security' within the meaning
of Division 16E of the ITAA 1936, and that security has a remaining term
after acquisition of more than 12 months, the accruals or realisation
method under Division 230 may apply to that financial arrangement
[Schedule 1, item 1, subsection 230-405(1)]. The application of Division 230 to
individuals and to entities that satisfy the turnover test is further discussed
in Chapter 2.
4.40 Where such an entity has a qualifying security that is a financial
arrangement, the accruals method will apply to bring to account the gain
or loss from the qualifying security only where the gain or loss satisfies
the conditions for being a sufficiently certain overall gain or loss
[Schedule 1, item 1, subsection 230-110(1)]. The compounding accruals method
will not apply to a particular sufficiently certain gain or loss from a
financial arrangement held by such an entity [Schedule 1, item 1,
subsection 230-115(4)].
4.41 The exclusion of individuals and those relevant entities from the
particular sufficiently certain gain or loss provisions is intended to provide
a compliance cost saving in respect of such instruments. The requirement
to have to attribute particular financial benefits that are provided, or that
are expected to be provided (outlays), to those that are received, or that
are expected to be received (inflows), is avoided by the application of the
sufficiently certain overall gain or loss concept. A sufficiently certain
overall gain can only arise where the sufficiently certain financial benefits
that are to be received exceed the sufficiently certain financial benefits
that are to be provided (or vice versa for a loss) [Schedule 1, item 1,
subsection 230-110(1)]. Hence, under the overall gain or loss concept, all of
the `cost' of the financial benefits that are to be provided under the
126
The compounding accruals and realisation methods
financial arrangement will be automatically attributed to those sufficiently
certain financial benefits that are to be received at the start of the
arrangement. This will be the case even if, economically, some part of the
`cost' of the financial arrangement could be attributed to other financial
benefits under the financial arrangement which are not sufficiently certain
at the start of the arrangement. For further discussion on attribution of
financial benefits under Division 230, see Chapter 3.
4.42 In cases where there is a sufficiently certain overall gain or loss
under a qualifying security held by taxpayers which would not otherwise
be subject to Division 230, and there are one or more financial benefits
that become sufficiently certain after the start of the qualifying security,
the realisation method will apply to gains or losses arising from those
financial benefits. [Schedule 1, item 1, subsection 230-105(5)]
4.43 However, if the individual, or the entity that satisfies the
turnover test, makes an election under subsection 230-405(4) to have
Division 230 apply to its financial arrangements, then the compounding
accruals method may apply to particular gains or losses made under the
relevant qualifying security. [Schedule 1, item 1, paragraph 230-105(4)(c)]
When to use the compounding accruals method?
4.44 If an entity does not opt for one of the elective tax-timing
methods in Division 230 to apply to its relevant financial arrangements, or
the entity does make such a choice but no elective method applies to a
particular financial arrangement, the default tax-timing method will be
either the compounding accruals or realisation method, or a combination
of these methods, which will be applied to bring to account gains or losses
made from the particular financial arrangement [Schedule 1, item 1,
subsection 230-45(2)]. The compounding accruals method applies where
there is a sufficiently certain gain or loss from the financial arrangement.
A gain or loss arising from a financial arrangement will be sufficiently
certain if the financial benefits used to calculate that gain or loss are
themselves sufficiently certain (see paragraphs 4.78 to 4.98).
4.45 If the financial arrangement is denominated in a foreign
currency, and a retranslation election has been made by the taxpayer, the
accruals or realisation tax treatments may still apply to the gain or loss to
the extent that it is not subject to the retranslation election. [Schedule 1,
item 1, paragraph 230-45(2)(b)]
4.46 If the hedging financial arrangement method applies to the
financial arrangement, and that arrangement is a foreign currency hedge
that is a `debt interest' (as defined in Division 974 of the ITAA 1997),
only the gain or loss that is attributable to movements in currency
127
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
exchange rates, in respect of the outstanding balance in relation to the debt
interest, is brought to account under the hedging financial arrangement
election [Schedule 1, item 1, subsection 230-260(6)]. The gain or loss that may
arise from the foreign currency hedge, other that specified under the
hedging rules and absent any other elections under Division 230, would
then be subject to the accruals or realisation methods as appropriate
[Schedule 1, item 1, paragraph 230-45(2)(c)].
Sufficiently certain gain and loss -- an overview
4.47 For the purposes of the accruals provisions, gains and losses
which arise from financial arrangements may be an overall gain or loss or
a particular gain or loss. That gain or loss is calculated with reference to
sufficiently certain financial benefits which are to be received and
provided under the financial arrangement.
4.48 Financial arrangements may incorporate financial benefits that
are paid or received on a periodic and/or non-periodic basis. Most
commonly, but not always, financial benefits are represented by cash
inflows (for rights to receive) and cash outflows (for obligations to pay).
For example, an annual interest payment on a bond would be a financial
benefit that would be paid on a periodic basis. A non-periodic financial
benefit would be represented by the end payment (return) of an initial
outlay when a bond reaches full term, or by a partial return of the initial
outlay. Hybrid financial arrangements may also comprise both periodic
and non-periodic financial benefits -- a convertible note, or an
equity-linked bond, usually incorporates both periodic and non-periodic
payments. If financial benefits are periodic, generally, subject to the facts
and circumstances of each case, such benefits could be reasonably
expected to be paid or received.
4.49 Both periodic and non-periodic financial benefits may be fixed
in terms of amount and the time at which they will be paid or received
(ie, they are completely certain) or they may be sufficiently certain, or
they may not be sufficiently certain. Consequently, within the one
financial arrangement there may be a mixture of different financial
benefits some of which are sufficiently certain and some of which are not.
4.50 An overall gain or loss is that gain or loss generated by the
entire financial arrangement. An overall gain, which is determined at
inception, can only arise where all of the sufficiently certain financial
benefits that are to be received will exceed the total of all of the
sufficiently certain financial benefits that are to be provided (or vice versa
for a loss). Hence, generally, an overall gain or loss will be calculated
with reference to all of the financial benefits under the arrangement
because those financial benefits are sufficiently certain at the start of the
arrangement. There may be circumstances where an overall gain (or loss)
128
The compounding accruals and realisation methods
arises from a financial arrangement, despite some of the financial benefits
under the arrangement being not sufficiently certain. An example of this
is where the total magnitude of an overall gain or loss may be unknown at
inception, because of the existence of a contingent payment within the
arrangement, but it may be known that an overall gain or loss of at least a
specific amount will be made. This amount would be subject to the
accruals method [Schedule 1, item 1, subsection 230-110(1)]. The compounding
accruals method will apply to spread the sufficiently certain overall gain
or loss over the life of the arrangement [Schedule 1, item 1,
subsection 230-130(1)].
4.51 The concept of an overall gain or loss of at least a particular
amount is required in the accruals provisions for two reasons:
· first, it is intended policy that where an overall gain or loss of
at least a specific amount would be made from a financial
arrangement, and that financial arrangement has an
embedded option, none of the cost of the arrangement should
be attributed to that embedded option; and
· second, the overall gain or loss concept is intended to deliver
compliance cost savings by not requiring taxpayers to apply
complex calculations to attribute the cost of the financial
arrangement to expected financial benefits where it is clear
that a gain or loss of at least a specific amount will be made
from the financial arrangement.
4.52 A particular gain or loss is that gain or loss generated from a
particular event under the arrangement (eg, the payment of a periodic
return). As such, there could be several particular gains or losses arising
under the one financial arrangement. For some financial arrangements
(eg, hybrids) which may involve a mixture of both `sufficiently certain'
and `not sufficiently certain' financial benefits, it may not be possible to
determine at inception the expected overall gain or loss. It may, however,
be possible to estimate a sufficiently certain particular gain or loss that
will be made from such arrangements in advance of the time at which the
relevant financial benefits will be received or provided. Those particular
gains or losses would then be subject to compounding accruals treatment.
Those periodic payments that may not become known in advance of
payment or receipt with sufficient certainty will give rise to gains or
losses that will be subject to realisation tax treatment.
4.53 The particular gain or loss concept encapsulates one of the key
objects of the accruals methodology -- that is, gains or losses are to be
recognised as they become sufficiently certain and are to be attributed to
the period to which that particular gain or loss relates [Schedule 1, item 1,
129
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
paragraph 230-100(a)].
By recognising gains and losses in this manner,
inappropriate deferral of gains and bringing forward of losses is avoided.
Sufficiently certain overall gain and loss
4.54 A taxpayer must allocate a gain or loss from a financial
arrangement using the compounding accruals method when there is
sufficient certainty, at the time the taxpayer starts to have the
arrangement, that the taxpayer will make an overall gain or loss under the
arrangement [Schedule 1, item 1, subsection 230-105(2)]. An overall gain will
only arise where the sufficiently certain financial benefits that the
taxpayer is to receive exceed the cost of the financial arrangement, that is,
the sufficiently certain financial benefits that a taxpayer is to provide (or
vice versa for an overall loss) [Schedule 1, item 1, note to
paragraph 230-110(2)(b)].
4.55 In this sense, the overall gain or loss necessarily requires that the
entire `cost' (ie, the financial benefits that have been or are to be
provided) of the financial arrangement be attributed to those sufficiently
certain financial benefits that are to be received. This will be the case
despite the fact that economically some of that cost may be attributable to
other financial benefits that are not sufficiently certain at the start of the
arrangement. [Schedule 1, item 1, note to paragraph 230-110(1)]
4.56 In calculating the sufficiently certain overall gain or loss it must
be assumed that the taxpayer will have the financial arrangement for the
rest of its life [Schedule 1, item 1, paragraph 230-110(2)(a)]. Generally, the life
of a financial arrangement is dictated by the period between the time the
arrangement is created or acquired and its maturity date. This could also
be referred to as the `estimated life' of the arrangement. If, for example, a
financial arrangement has no defined maturity date (eg, because it may
last in perpetuity) then the life of the arrangement is taken to span the
period into perpetuity. This assumption is important because, as was
noted above, an overall gain or loss is generally generated from the entire
arrangement.
4.57 If there is a financial benefit that may reduce or eliminate an
otherwise sufficiently certain overall gain or overall loss, it may be the
case that it cannot be concluded with sufficient certainty that there will be
an overall gain or overall loss of at least a particular amount [Schedule 1,
item 1, paragraph 230-110(2)(b)]. The overall gain or loss must be of at least a
specific amount because it would be inappropriate to have a taxpayer
accrue an amount of a gain or loss where there is insufficient certainty that
it will be realised. If there is a sufficient risk that a financial benefit, that
is itself not sufficiently certain at the start of the arrangement, may in fact
reduce an amount of a gain or decrease an amount of a loss (such that part
of the estimated gain or loss would never have been made), then it would
130
The compounding accruals and realisation methods
be inappropriate to require an accrual of the otherwise sufficiently certain
overall unrealised gain or unrealised loss. (At the same time, there may
be a particular sufficiently certain gain or loss, as discussed in
paragraphs 4.64 to 4.67.)
4.58 However, there may still be a sufficiently certain overall gain or
loss which should be subject to the accruals method, despite the fact that
there may be some financial benefits that are not sufficiently certain. Of
particular relevance is the situation where the effect of those financial
benefits which are not sufficiently certain will be to increase the amount
of the sufficiently certain overall gain or loss. This is because, in such
situations, there is sufficient certainty that the estimated overall gain or
overall loss will be made, and the uncertainty generated by the financial
benefit that is not sufficiently certain relates to whether the estimated gain
or estimated loss will in fact be more than the specific amount of the
overall gain or loss of at least a certain amount. In these circumstances,
the accruals method is applied to the estimated overall gain or overall loss
that is known with sufficient certainty at the start of the arrangement. In
other situations, the financial benefits that are not sufficiently certain may
be such that the likelihood of them reducing or eliminating an otherwise
sufficiently certain overall gain or loss is artificial or `immaterially
remote'.
4.59 Once the contingency is resolved, in respect of those financial
benefits which are not sufficiently certain at the start of the arrangement
(as they become sufficiently certain), one of two outcomes may arise.
First, the effect of those benefits becoming sufficiently certain may affect
the amount of the previously estimated overall gain or loss so that a fresh
determination of the overall gain or loss is required. If this is the case,
then the implications of such an event are covered by the re-estimation
provisions (see paragraphs 4.133 to 4.151).
4.60 Alternatively, the financial benefits that become sufficiently
certain may themselves give rise to a gain or loss, separate to the
estimated overall gain or overall loss. If the financial benefits give rise to
a separate gain or loss, that gain or loss may be either:
· accrued as a particular sufficiently certain gain or loss (where
the financial benefit becomes sufficiently certain before it is
received or provided) [Schedule 1, item 1, subsection 230-105(3)];
or
· brought to account under the realisation method (where the
uncertainty surrounding the financial benefit is resolved at
the time it is received or paid, or the time comes for it to be
received or paid) [Schedule 1, item 1, subsection 230-105(5)].
131
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.61 Broadly, arrangements which have the following characteristics
may give rise to a sufficiently certain overall gain (for the holder) or
overall loss (for the issuer):
· periodic returns under the arrangement are determined and
set in advance of the period to which they relate and are paid
in arrears;
· the initial outlay will be returned at maturity; and
· if there are cash flows (financial benefits) that are not known
at the start of the arrangement, those cash flows will not have
the effect of reducing the estimated overall gain or loss.
4.62 Often periodic returns are calculated with reference to a variable
(such as an interest rate) or the rate of change of a variable (such as the
consumer price index (CPI)). This `feature' which can affect the quantum
of financial benefits arising under a financial arrangement will not of itself
affect whether there is an overall gain or overall loss from the
arrangement. This is because in calculating the relevant gain or loss on a
financial arrangement, the taxpayer is required to assume that the variable
or the rate of change of the variable affecting the quantum of the financial
benefit will remain constant for the period of the arrangement [Schedule 1,
item 1, subsections 230-120(4) and (5)]. In this sense, the fact that the variable
or the rate of change of the variable may vary, and hence may practically
affect the amount of the gain or loss, is overcome by the required
assumption. Any discrepancy between the assumed variable rate and the
actual variable rate, provided the difference is insignificant, will be
brought to account under the running balancing adjustment mechanism
(see paragraphs 4.129 to 4.132).
4.63 Example 4.3 provides further guidance on when an overall gain
or loss may arise.
Particular sufficiently certain gain or loss
4.64 The compounding accruals method will also apply to a
particular gain or loss that arises from a financial benefit that the taxpayer
is to receive or provide under the arrangement, if it is sufficiently certain
at a particular time before that financial benefit is to be received or
provided that the taxpayer will make that gain or loss [Schedule 1, item 1,
subsection 230-105(3)]. In policy terms the accruals method will apply to
bring to account particular sufficiently certain gains or losses so that there
is no inappropriate deferral in relation to the recognition of that particular
gain or loss [Schedule 1, item 1, paragraphs 230-100(a) and (c)].
132
The compounding accruals and realisation methods
4.65 A particular sufficiently certain gain or loss arises where it is
sufficiently certain at a particular time that a gain or loss of a particular
amount, or at least a particular amount, will be made when:
· the taxpayer receives a particular financial benefit or one of
the taxpayer's rights ceases under the arrangement [Schedule 1,
item 1, paragraph 230-115(1)(c)]; or
· the taxpayer provides a particular financial benefit or one of
the taxpayer's obligations ceases under the arrangement
[Schedule 1, item 1, paragraph 230-115(1)(d)].
That is, the occurrence of one of the events listed above may give rise to a
gain or loss. To calculate that gain or loss, which is a net concept for
these purposes, there must be an offsetting of costs with proceeds. As was
discussed in Chapter 3, economically under an arrangement, some part of
the financial benefits the taxpayer has provided under the arrangement can
be said to be reasonably attributable to the financial benefits that the
taxpayer is to receive. This principle is encapsulated in sections 230-75
and 230-80 (about apportionment of financial benefits on receipt or
payment of particular financial benefits), which will apply to calculate the
amount of a particular sufficiently certain gain or loss [Schedule 1, item 1,
note to subsection 230-115(2)]. Such apportionment must take into account the
nature of the rights and obligations, risks associated with each of the
rights, obligations and financial benefits and the time value of money (for
further discussion see Chapter 3).
4.66 In order for the accruals method to apply, the amount of the
particular sufficiently certain gain or loss will be a particular amount or at
least a particular amount [Schedule 1, item 1, paragraphs 230-115(1)(a) and (b)].
Therefore, in working out whether, at a particular time, there is a
particular sufficiently certain gain or loss, the taxpayer must have regard
to the risk that a particular financial benefit which is not sufficiently
certain at that time will reduce or eliminate the amount of the gain or loss
[Schedule 1, item 1, paragraph 230-115(2)(a)]. For the same reasons as outlined
in paragraph 4.57, this requirement ensures that taxpayers are not required
to recognise gains or losses that may never be made, to the extent to
which they are not sufficiently certain.
4.67 Further, under this attribution process, a financial benefit is not
to be taken into account more than once in determining the gain or loss
that will arise from a single financial arrangement [Schedule 1, item 1,
paragraphs 230-115(2)(b) and (c)]. This means that, to the extent to which a
financial benefit that the taxpayer has or will provide under the
arrangement has been allocated to a financial benefit that is to be received,
that financial benefit that has or will be provided (or that part of the
133
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
financial benefit that has or will be provided) is not to be taken into
account (apportioned) to another financial benefit that is to be received.
To recognise a particular financial benefit (or part thereof) more than once
in respect of a single financial arrangement would result in the taxpayer
recognising the same gain or loss more than once. Such an outcome is
inappropriate, since economically the taxpayer has only made the gain or
loss once.
Can there be more than one sufficiently certain gain or loss for a single
financial arrangement?
4.68 It is possible for there to be more than one sufficiently certain
gain or loss that is to be brought to account in respect of a single financial
arrangement. Likewise, it is possible for there to be a number of separate
particular sufficiently certain gains or losses under the same financial
arrangement. Both a sufficiently certain overall gain or loss and particular
sufficiently certain gains or losses can arise from a single financial
arrangement.
4.69 This situation can arise because, despite the fact that some of the
financial benefits under a financial arrangement are not sufficiently
certain at the start of the arrangement, the financial benefits that are
sufficiently certain at that time are such that they give rise to a sufficiently
certain overall gain or loss (see discussion in paragraphs 4.54 to 4.63).
When the other financial benefits under the financial arrangement not
taken into account in determining the sufficiently certain overall gain or
loss become sufficiently certain before they are due to be paid or received,
a separate particular sufficiently certain gain or loss may arise. This
particular sufficiently certain gain or loss is separate and distinct from the
overall gain or loss calculated at the start of the arrangement and will be
accrued separately from that overall gain or loss. The `anti-overlap'
provision in paragraphs 230-115(2)(b) and (c) -- which requires that a
particular financial benefit should not be taken into account more than
once under a financial arrangement -- operates to ensure that there is no
double counting of gains or losses.
Example 4.1: A bond with contingent returns and guaranteed
redemption value
Investor Co acquires from Issuer Co a 10-year bond for $100,000. The
terms of the bond provide that Investor Co is entitled to annual interest
payments of 8 per cent per annum, subject to Issuer Co agreeing to
make the payment. At maturity, Investor Co is entitled to receive
120 per cent of the investment amount. Both entities exceed the
turnover threshold in section 230-405.
134
The compounding accruals and realisation methods
Tax implications for Investor Co
When Investor Co starts to hold the financial arrangement, it must
determine if it has a sufficiently certain gain or loss that would be
subject to the accruals method. The relevant financial benefits are:
· the payment of $120,000 at the end of 10 years (calculated with
reference to the guaranteed payment of 120 per cent of the
investment amount); and
· each individual interest payment over the term of the bond
(which is subject to Issuer Co agreeing to make the payment).
As discussed below, a sufficiently certain gain or loss is determined
only by reference to financial benefits that are sufficiently certain
(subsection 230-120(1)). A financial benefit is sufficiently certain if it
is reasonably expected that the financial benefit will be received or
provided (assuming the bond is held for its life -- ie, until maturity)
and that the amount or value of the financial benefit is fixed or
determinable with reasonable accuracy (subsection 230-120(2)).
Applying these criteria, it can be said that only the financial benefit
represented by the payment of $120,000 due to be paid at the end of
the 10 years can be said to be sufficiently certain at the start of the
arrangement.
Hence, Investor Co has a sufficiently certain overall gain at the start of
the arrangement because the financial benefit that it is sufficiently
certain to receive exceeds the cost of the financial arrangement.
The cost of the financial arrangement is represented by the $100,000
Investor Co paid to acquire the bond. That financial benefit is
integral to calculating the overall gain or loss and hence is taken
to be a financial benefit provided under the financial arrangement
(subsection 230-65(2)). The amount of the difference between the
sufficiently certain financial benefit provided and the financial benefit
received is the sufficiently certain overall gain of $20,000
(ie, $120,000 less $100,000). The rights to the interest payments over
the next 10 years, which are themselves subject to a contingency, such
that it would not be reasonable to expect that those benefits will be
received, will not have the effect of reducing this overall gain of
$20,000. In fact, the contingent interest payments, if received, will
have the effect of increasing the amount of the gain made on the
financial arrangement as a whole. Hence, the compounding accruals
method will apply to bring the overall sufficiently certain gain of
$20,000, which is calculated at the start of the arrangement, to account
over the life of the bond (subsection 230-130(1)).
If, some time after Investor Co acquires the bond, Issuer Co determines
that it will make an interest payment two years before the payment is
due, then once that determination is made, that financial benefit which
represents the interest payment becomes sufficiently certain. From
135
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Investor Co's perspective, the amount of the gain is equal to the value
of the entire interest payment (the relevant financial benefit)
(subsection 230-75(3)). That gain is a particular sufficiently certain
gain to which the compounding accruals method would apply to bring
to account the amount of the gain over the next two years.
Tax implications for Issuer Co
From Issuer Co's perspective it has a sufficiently certain overall loss at
the start of the arrangement of $20,000 (represented by the shortfall
between the proceeds received from the issue of the bond and the
payment required on redemption of the bond). The relevant financial
benefits will be sufficiently certain at the start of the arrangement for
the same reasons as outlined above. Provided the requirements of
section 230-15 are satisfied, that overall loss is to be accrued over the
life of the bond.
Further, on making the determination to pay interest, a particular
sufficiently certain loss arises at the time of the determination.
Provided the particular loss satisfies the requirements of
section 230-15, Issuer Co will apply the compounding accruals method
to that loss to determine the amount of the deduction for each income
year over the next two years.
If Issuer Co were to make a further separate determination to pay
interest, that determination may give rise to a third, and separate
particular sufficiently certain gain (for Investor Co), or loss (for
Issuer Co), that is taken to be made under the bond. Depending on the
circumstances surrounding this further determination, that gain or loss
may be subject to either the accruals or realisation methods.
Application of the accruals method to particular situations -- swaps
4.70 A common example of a financial arrangement where
sufficiently certain particular gains or losses may arise over the period of
the arrangement is a swap. In general terms, a swap is an agreement
between two parties under which they exchange cash flows over time.
The value of the cash flows is often calculated based on a notional
principal. Often swaps will have no upfront payments.
4.71 At a general level, as is the case with all financial arrangements,
before it can be assessed which tax-timing method might apply to bring to
account the relevant gain or loss under the swap, it is necessary to decide
whether a taxpayer's rights and obligations under a swap constitutes a
single, aggregate arrangement or two separate arrangements [Schedule 1,
item 1, subsection 230-60(4)]. One analysis is that there are separate
arrangements which are represented by, first, the rights (together with the
corresponding obligations of the counterparty) and, second, the
obligations (together with the corresponding rights of the counterparty).
136
The compounding accruals and realisation methods
Each of these two possible financial arrangements are often referred to as
the separate `legs' of the swap.
4.72 Whether a number of rights or obligations constitute one or
more arrangements is a question of fact and degree (see Chapter 2 for
further discussion). Having regard to the factors outlined in
subsection 230-60(4), a swap financial arrangement (comprising all of the
taxpayer's rights and obligations) is to be considered as one arrangement.
This flows from the general nature, terms and conditions of the financial
arrangement and the purpose of most swap arrangements. The terms and
conditions of many swap arrangements often require net settlement and,
commercially, swaps generally derive their intended result when viewed
as a whole arrangement -- that is, considering both `legs' in combination
[Schedule 1, item 1, section 230-60]. Further analysis of the nature of a swap
arrangement is contained in the case study on swaps in Chapter 13.
4.73 In standard interest rate swaps, the relevant fixed and floating
rates are determined at the reset dates which occur at the beginning of
each of the calculation periods. Commonly, the terms of `standard' swap
agreements require payment of the net difference between the fixed and
floating payments at the end of the relevant period. Assuming that none
of the elective tax-timing methods under Division 230 have been chosen,
the question arises as to whether the gains or losses on the swap should be
subject to the compounding accruals or realisation method.
4.74 Like variable (floating) rate debt instruments, the taxpayer is
required to assume -- in relation to the floating interest rate leg of a
standard interest rate swap -- that the variable interest rate will remain
constant for the entire period of the arrangement [Schedule 1, item 1,
subsection 230-120(4)]. Based on this assumption, the cash flow for both legs
of the swap can be estimated and the net flow (outcome) calculated. The
net result of those cash flows represents a sufficiently certain overall gain
or loss from such swap arrangements. The sufficiently certain gain or loss
is an overall gain or loss because, by virtue of the assumption that the
interest rate stays fixed, all of the financial benefits under the arrangement
are sufficiently certain at the start of the arrangement.
4.75 This net result, the overall gain or loss, is then subject to the
compounding accruals method. Any difference between the value of a
financial benefit which is determined by reference to the rate fixed by the
operation of subsection 230-120(4), and the value of that financial benefit
at the time it is received or provided, will be brought to account under the
running balancing adjustment provisions (section 230-145). If there was
to be a material change in the variable interest rate, the taxpayer may need
to re-estimate the amount of the gain or loss from the swap arrangement
which is to be accrued in the remaining period of the arrangement.
137
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.76 There may be cases where some of the more complicated swap
arrangements may give rise to particular sufficiently certain gains and
losses or gains or losses to which the realisation method would apply.
Consistent with the general operation of the provisions, the principles in
Subdivision 230-B are relevant to determining which of the compounding
accruals or realisation methods should apply, and whether an overall or a
particular sufficiently certain gain or loss arises on a financial
arrangement. [Schedule 1, item 1, section 230-105]
4.77 For illustrative purposes, the outcome in relation to total return
swaps is considered in the example below.
Example 4.2: Total return swaps -- sufficiently certain gains or
losses?
Party A enters into a three-year swap arrangement with Party B. Under
the terms of the swap arrangement, Party A makes periodic payments
and Party B is either required to make, or entitled to receive, a single
payment at the end of the swap arrangement. The amount or value of
Party B's payment or receipt is calculated by reference to the
movement of a share price over the three-year life of the swap. Such
swaps are sometimes referred to as a total return swap. Any estimated
gain or loss would have to take into account a financial benefit, the
value of which is dependent on the movement in the share price.
Under the terms of the swap arrangement, this amount will not be
known until the time the payment is due. Share prices are relatively
volatile and are not known ahead of time with sufficient certainty.
No sufficiently certain gain or loss can be calculated on this swap at
the start of, or during, the arrangement. Accordingly, both parties will
recognise gains or losses made under the arrangement on a realisation
basis for the whole term of the swap arrangement. Importantly, the
fact that Party A makes periodic payments -- of either a certain or
uncertain amount -- does not lead to the conclusion that a gain or loss
is realised when the payments are due and payable. Whether a gain or
loss is made on such dates depends on the extent to which the payment
or receipt by Party B at the end of the swap arrangement can be said to
be attributable to those periodic payments (subsection 230-80(2)). In
turn, this depends on the application of the attribution principles in
subsection 230-80(4) (see the discussion in Chapter 3). Generally,
because gains or losses are a net concept, a determination of the
amount of a gain or loss requires the attribution of the cost of a
financial arrangement to the proceeds that arise from that arrangement.
From Party A's point of view, having regard to the risks associated
with receiving a payment from Party B -- indeed it is commercially
possible that Party A will have to make a further payment under the
swap at the end of the three-year period -- and the fact that any
Party B payment can only be made at maturity, and it is not one in
respect of which an assumption has to be made under
138
The compounding accruals and realisation methods
subsection 230-120(4) (about holding certain variables constant), no
attribution of cost is possible (note that this is not to say that there is an
attribution of no cost). Accordingly, it cannot be said that there is a
gain or loss when the Party A periodic payments are made. This
reflects the position that these payments can be broadly characterised
as instalments of the price payable for the right to any obligation of
Party B to make a payment, rather than constituting periodic gains or
losses in themselves.
Therefore, in the circumstances of this particular swap arrangement,
any gain or loss is realised at the maturity of the total return swap
arrangement.
When is a financial benefit sufficiently certain?
4.78 The compounding accruals method only applies to bring to
account a sufficiently certain overall gain or loss or a particular
sufficiently certain gain or loss. In deciding whether such a gain or loss is
sufficiently certain at a particular time, the taxpayer can only have regard
to those financial benefits that the taxpayer is sufficiently certain to
receive or provide [Schedule 1, item 1, subsection 230-120(1)]. In this sense, the
borderline between the compounding accruals and realisation methods is
encapsulated in the `sufficiently certain' concept.
4.79 A financial benefit that is to be received or provided will be
treated as being sufficiently certain only if both of the following
requirements are met:
· it is reasonably expected that the taxpayer will receive or
provide the financial benefit. This analysis is to be done on
the assumption that the taxpayer will have the financial
arrangement for the remaining term of its life, or until
maturity. For discussion on what the relevant life of a
financial arrangement is, refer to paragraph 4.56 [Schedule 1,
item 1, paragraph 230-120(2)(a)]; and
· the amount or value of the financial benefit is, at that time,
fixed or determinable with reasonable accuracy [Schedule 1,
item 1, paragraph 230-120(2)(b)].
4.80 Both parts of the test are intended to ensure that the taxpayer
will only accrue an estimated gain or loss made under a financial
arrangement where there is more than a mere expectation that the
estimated gain or loss will actually be made -- the expectation must be
quite firm.
4.81 Requiring the taxpayer to apply the accruals method would be
inappropriate where a gain or loss can be estimated but there exists a real
139
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
possibility that the taxpayer may never make the relevant estimated gain
or loss because of the circumstances that may affect whether or not certain
financial benefits will actually be received or provided. In this sense, the
manner in which contingencies may affect such receipts or payments will
need to be considered.
4.82 It would be equally inappropriate to require a taxpayer to accrue
an estimated gain or loss where the payment of a particular financial
benefit to be paid or received under the arrangement at a particular time
was certain, but where the amount or the value of the financial benefit
could not be estimated with reasonable accuracy. Note that it is not
sufficient that the amount or value of the financial benefit be fixed or
determinable. It must be fixed and determinable with reasonable
accuracy.
4.83 It is intended that where all of the financial benefits under the
financial arrangement are denominated in a particular foreign currency,
the financial benefits are not to be translated into the taxpayer's functional
currency (generally, the Australian dollar) for the purposes of applying the
tests in subsection 230-120(2) [Schedule 1, item 1, subsection 230-120(8)]. This
requirement is to ensure that, in those particular circumstances,
uncertainties in relation to exchange rate movements are to be ignored in
determining whether the relevant financial benefits are sufficiently
certain. The special rule is required because the definition of `special
accrual amount' applies to amounts that are to be included in the
taxpayer's assessable income or allowable as a deduction. The test as to
whether financial benefits are sufficiently certain is applied prior to
determining whether an amount should be included in the taxpayer's
assessable income. Once a sufficiently certain gain or loss has been
calculated, that amount is taken to be a special accrual amount for the
purposes of applying the translation rules in Subdivision 960-C of the
ITAA 1997 [Schedule 1, item 29, subsection 995-1(1), definition of `special accrual
amount'].
When is it reasonable to expect that a taxpayer will receive or provide a
financial benefit?
4.84 The first limb of the sufficiently certain test is intended to
encapsulate, in a principled way, the level of certainty of cash flows
which are expected under the relevant financial arrangement. An analysis
of this type involves an examination of the contingencies which particular
financial benefits are subject to and the extent to which this may affect
payment or receipt of these financial benefits under the arrangement. The
analysis is focused on the probability of whether such benefits will be
received or provided (if at all). This analysis will be different from the
analysis of contingencies within the context of the debt/equity borderline.
The design of the accruals/realisation borderline under Division 230 is
140
The compounding accruals and realisation methods
distinct from that of the debt/equity borderline in Division 974 of the
ITAA 1997. Illustrative of this, the accruals/realisation borderline
addresses both derivatives and financing arrangements.
4.85 The term `reasonably expected' is not defined in the legislation,
although its meaning has been contemplated in a number of tax law cases.
In FC of T v. Peabody (1994) 181 CLR 359 the court stated at 385 that:
`A reasonable expectation requires more than a possibility. It involves
a prediction as to events which would have taken place if the relevant
scheme had not been entered into or carried out and the prediction
must be sufficiently reliable for it to be regarded as reasonable.'
4.86 However, how much more likely than a `possibility' is the
expectation that a financial benefit will be provided or received is not
clear from Peabody. In the context of accruals tax treatment, one key
objective is to not accrue significant unsystematic gains and losses on an
unrealised basis. Another objective is to prevent tax deferral. In the light
of the context of these joint objectives, there must be quite a firm
expectation that the financial benefit will be provided or received.
4.87 The basis on which this expectation is to be considered is not to
be limited to the form of a particular financial arrangement. Rather,
whether a particular financial benefit will be received or provided, based
on the contingency which attaches to it or which it is subject to, is to be
considered by reference to the circumstances surrounding the relevant
financial arrangement. In particular, the taxpayer is to have regard to:
· the terms and conditions of the financial arrangement;
· accepted pricing and valuation techniques;
· the economic and commercial substance and effect of the
financial arrangement; and
· contingencies that attach to other financial benefits that are to
be provided or received under the arrangement and any
interaction these contingencies may have with the financial
benefits under consideration.
[Schedule 1, item 1, paragraph 230-120(3)(a)]
4.88 Further, the expectation test is to be applied on an objective
basis (FC of T v Arklay (1989); 85 ALR 368; Eastern Nitrogen Ltd v
FC of T (1999) FCA 1536).
141
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.89 The terms and conditions of the financial arrangement provide
information on whether the right or obligation in relation to the financial
benefit is subject to a contingency. The effect of the contingency, in
relation to whether or not the financial benefit will actually be paid or
received, can also be determined from an examination of the terms and
conditions of the arrangement. For example, the terms and conditions of a
financial arrangement may require a particular outcome upon which the
satisfaction of a contingency depends. It could be said that the terms and
conditions of the financial arrangement constitute the `legal form' of the
arrangement.
4.90 However, if the determination of whether it is reasonable to
expect that a financial benefit is to be received or provided under the
arrangement were limited to an analysis of the legal form of the
arrangement, this could lead to different tax-timing treatments being
applied to financial arrangements that are equivalent in economic
substance. This would encourage tax arbitrage and tax motivated
practices. To address this issue, the taxpayer must look at the substance
and effect of the terms and conditions and also have regard to factors
external to the terms and conditions of the arrangement. Under
paragraph 230-120(3)(a) this concept is to be applied on an objective
basis. For example, in this context, if the terms and conditions of the
arrangement include a contingency that is, in substance, artificial or
contrived, then on an objective basis those contingencies would be
effectively disregarded in determining whether it is reasonable to expect
that the financial benefit will be received or provided.
4.91 Generally, subsection 230-120(2) requires that each financial
benefit be individually tested to determine whether it is sufficiently
certain. The situation may arise where a particular financial benefit, when
tested in isolation to the other financial benefits under the arrangement,
would not be considered to be sufficiently certain. However, when that
financial benefit (the `test financial benefit') is considered together with
other financial benefits (the `group financial benefits') under the financial
arrangement, contingencies attaching to the test financial benefit may be
nullified by the effect of the group financial benefits. Applying
paragraph 230-120(3)(b), the combined effect of the financial benefits
may be that a sufficiently certain gain or loss of at least a particular
amount can be calculated in respect of the financial arrangement because
the contingencies attaching to all the financial benefits under the financial
arrangement may, in effect, create sufficiently certain rights to receive or
obligations to provide. Consistent with the policy that the substance and
effect of the terms and conditions of a financial arrangement are to be
taken into account, the test financial benefit is to be treated in such
circumstances as if there were no contingency attaching to it (see
Example 4.4 for further discussion). [Schedule 1, item 1,
subparagraph 230-120(3)(a)(iv) and paragraph 230-120(3)(b)]
142
The compounding accruals and realisation methods
4.92 The economic or commercial substance and effect of the
financial arrangement should also be taken into account [Schedule 1, item 1,
subparagraph 230-120(3)(a)(iii)]. This analysis would include consideration of
the circumstances surrounding the financial arrangement which may
involve the in-substance existence of a contingency (which is not present
in the form of the terms and conditions of the arrangement) which may
affect whether a financial benefit will be received or provided. In this
context, regard could be had to a number of factors including:
· prevailing market conditions at the time the financial
arrangement was entered into or at subsequent material
events;
· the intended effect of the financial arrangement as
determined by reference to the intention of the parties
(determined objectively); and
· the normal commercial understandings and practices in
relation to similar instruments in the market.
4.93 Regard should also be had to generally accepted pricing and
valuation techniques, and whether such techniques were used to establish
the values (whether these be proceeds or cost) of the relevant financial
benefits [Schedule 1, item 1, subparagraph 230-120(3)(a)(ii)]. This is a necessary
consideration when determining whether a financial benefit can be
reasonably expected to be received or provided because, where
appropriate and accepted pricing or valuation techniques have been used,
the pricing, or valuation, of a financial benefit may be indicative of the
nature of a contingency that affects the right to receive or the obligation to
provide the relevant financial benefit.
4.94 For instance, where there is a right to receive, or the obligation
to provide, a financial benefit, the existence or satisfaction of which is
affected by a contingency (considered in the context of the other rights
and obligations comprising the financial arrangement), and the cost of
such a financial benefit is lower than may be expected for a comparable
and certain financial benefit, this could indicate that a genuine
contingency existed (the outcome of which was uncertain). Hence, it may
not be able to be said that on an objective basis there is a reasonable
expectation that the financial benefit will be received or provided, such
that it could be considered sufficiently certain.
What is meant by `fixed or determinable with reasonable accuracy'?
4.95 A financial benefit will only be treated as being sufficiently
certain where there is a reasonable expectation that the financial benefit
will be received or provided and the value of the financial benefit is fixed
143
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
or determinable with reasonable accuracy [Schedule 1, item 1,
paragraph 230-120(2)(b)].
The extent to which the value of the financial
benefit can be estimated, or can be said to be fixed or determinable with
reasonable accuracy, depends on a number of factors. Factors to which
the taxpayer should have particular regard are:
· the terms and conditions of the financial arrangement;
· whether accepted pricing and valuation techniques were used
or are relevant in determining the value of the financial
benefits;
· the economic or commercial substance and effect of the
financial arrangement; and
· the contingencies that attach to the other financial benefits
that are to be provided or received under the arrangement.
[Schedule 1, item 1, subsection 230-120(3)]
4.96 The considerations taken into account in determining whether
there is a reasonable expectation that a financial benefit will be received
or provided under a financial arrangement as outlined in paragraphs 4.84
to 4.94, may also be relevant in determining if the financial benefit is
fixed or determinable with reasonable accuracy.
4.97 In an accounting context, a `fixed or determinable' payment in
respect of held-to-maturity instruments, and loans and receivables, means
that a contractual arrangement defines the amounts and date of payments
to the holder, such as interest and principal payments. Such payments
would also be considered to be `fixed or determinable with reasonable
accuracy' for the purposes of Division 230.
4.98 Contingencies will not only affect whether it is sufficiently
certain that a financial benefit will be received or provided -- the amount
or value of a financial benefit may also be the subject of a contingency or
uncertainty. A contingency only in respect of value, in itself, will not
always preclude the value of a financial benefit from being fixed or
determinable with reasonable accuracy (particularly due to the application
of the assumptions in subsections 230-120(4) and (5)). Additionally, if
the value of a financial benefit is not specifically stated in the terms and
conditions of the financial arrangement, but the taxpayer can nonetheless
estimate with `reasonable accuracy' the likely value of that financial
benefit, (eg, by reference to other financial benefits) then the requirements
of paragraph 230-120(2)(b) are satisfied.
144
The compounding accruals and realisation methods
Holding certain variables constant
4.99 In applying the `sufficiently certain' test in
subsection 230-120(2), certain assumptions are required to be made. The
assumption is relevant to the second part of the test only -- that is,
whether a financial benefit can be said to be fixed or determinable with
reasonable accuracy. Where calculation of a financial benefit relies on a
certain type of variable (such as a floating interest rate) or a rate of change
of a type of variable (such as a CPI), the taxpayer is required to assume
that the variable will remain constant at the value it had at the particular
time at which the test was applied. [Schedule 1, item 1, subsections 230-120(4)
and (5)]
4.100 The inception of the financial arrangement is not necessarily the
only time at which the value of a particular variable should be tested to
determine whether it is fixed or determinable with reasonable accuracy
under paragraph 230-120(2)(b). For instance, the relevant financial
benefit may be subject to a contingency so that it is not reasonable to
expect the financial benefit will be received or provided at the start of the
arrangement -- such a contingency may subsequently be resolved, so that
at a later time, and by virtue of the assumptions in subsection 230-120(4)
or (5), the financial benefit becomes sufficiently certain. The value the
variable has at the time the financial benefit becomes sufficiently certain
is the value that should be held constant for the purposes of calculating the
amount of the overall or particular sufficiently certain gain or loss.
[Schedule 1, item 1, subsection 230-120(6)]
4.101 Further, if there is a material change in the variable which
requires a re-estimation of the gain or loss previously estimated, the
assumptions in relation to the variables to which subsections 230-120(4)
and (5) applied must be re-examined. The value which is to be held
constant for the purposes of a fresh determination of the gain or loss under
the re-estimation provisions is the value of the variable at the time that the
re-estimation is triggered.
4.102 Only those variables referred to in subsections 230-120(4)
and (5) are required to be held constant. From a policy perspective, it is
considered that it is appropriate to require such variables to be held
constant because:
· the variables specifically referred to are considered to be
relatively `stable', in that their values are less likely to
fluctuate over a large range, in the short to medium term;
· the variables are considered to be those which generally
increase over time, such that the value estimated at the
145
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
relevant test time would generally be the minimum value for
that variable over the life of the instrument; and
· the variables can be reliably measured.
Further examples of sufficiently certain gains or losses
4.103 By way of further guidance, the following examples provide
illustrations of the sufficiently certain overall gain or loss, and the
particular sufficiently certain gain or loss, concepts and consider -- for
some of the more common type examples -- whether the accruals or
realisation methods are appropriate.
Example 4.3: Sufficiently certain overall gain or loss -- CPI-linked
bond
On 1 July 2010, Hristina Co, a company with a turnover of $3 billion,
purchases a five-year security with a face value of $100,000 from
Jen Co. Hristina Co is entitled to receive an annual coupon of
7 per cent plus any percentage increase in the Australian CPI. As well,
Jen Co is obliged to pay Hristina Co the face value of the bond
($100,000) at the end of the five years. The CPI increased by
2.0 per cent in 2010. The historical volatility of the CPI is very low.
Based on history, and anticipated stable monetary policy settings, the
CPI is expected to increase by between 2 and 3 per cent per annum
over the next five years.
It was illustrated in Example 2.3 that a CPI-linked bond (that was
similar to the one purchased by Hristina Co), is taken to be one
arrangement -- which satisfies the definition of `cash settlable'
financial arrangement. This is because the rights and obligations under
an index-linked bond -- being the right to receive the coupon
payments, as adjusted for the index movement and the right to receive
the face value of the bond on maturity -- are all cash settlable
(subsection 230-50(2)).
The accruals method will apply to gains or losses from the bond if
there is a sufficiently certain overall gain or loss or a particular
sufficiently certain gain or loss, made from the financial arrangement
(section 230-105). The sufficiently certain gain or loss is calculated by
reference only to financial benefits that are sufficiently certain
(subsection 230-120(1)) (see paragraph 4.106 for further discussion).
A financial benefit is sufficiently certain if:
· it is reasonably expected that Hristina Co will receive the
financial benefit (assuming Hristina Co will continue to have the
CPI-linked bond until redemption -- that is, for the life of the
arrangement) (paragraph 230-120(2)(a)); and
146
The compounding accruals and realisation methods
· the amount, or value, of the financial benefit is fixed or
determinable with reasonable accuracy
(paragraph 230-120(2)(b)).
Certain assumptions are required to be made in determining
whether a particular financial benefit is sufficiently certain. In
particular, if the financial benefit depends on the change in a variable
that is based on the CPI then the rate of change of that variable is taken
to continue to be the rate of change for the life of the financial
arrangement (subsection 230-120(5)). Hence, for the purposes of
determining if the coupon payments are financial benefits which are
sufficiently certain, this assumption is applied to ensure that the
coupons will satisfy the fixed or determinable with reasonable
accuracy test in paragraph 230-120(2)(b).
Taking into account the terms and conditions of the arrangement, and
the economic or commercial substance and effect of the arrangement,
each of the financial benefits to be received under the arrangement are
sufficiently certain (subsection 230-120(2)). This is because the
financial benefit which is the coupon payment that is paid each year is
taken to be 9 per cent -- 7 per cent guaranteed, plus the 2 per cent
increase in the CPI, which is assumed to continue to have the same rate
of increase that it had at the time at which it is determined whether the
financial benefits are sufficiently certain, as per subsection 230-120(5)
-- and Hristina Co is guaranteed to receive the face value of the bond
at maturity. Hence, Hristina Co will make a sufficiently certain overall
gain from the arrangement of at least a particular amount, under
subsection 230-110(1).
Example 4.4: Particular sufficiently certain gain or loss --
exchangeable note
On 1 January 2009 Company A issues 2,000 exchangeable notes at
par, each with a face value of $1,000, representing a total investment of
$2 million to Company B. The terms and conditions of the
exchangeable note provide for interest to be paid annually, at a fixed
rate of 6 per cent per annum. At the end of year three, at the holder's
option, either the issuer will be required to redeem the notes for their
face value plus 5 per cent (ie, $2.1 million), or the notes could be
exchanged for a specified number of shares in a third party company,
Company C. Company C's shares are listed on the Australian
Securities Exchange (ASX).
Company A has an annual aggregated turnover of $200 million and
Company B has an annual aggregated turnover of $300 million.
Neither Company A, nor Company B, has the sole or dominant
purpose of entering into the exchangeable notes to deliver or receive
the shares. Company B has not made any of the elections available
under Division 230.
147
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
For the purposes of the illustration, the commentary below will focus
on the tax consequences for Company B.
Is the exchangeable note a cash settlable financial arrangement?
The characteristics of the exchangeable note are very similar to those
of the convertible note in Example 2.2. In that example, it was
established that the convertible note was a single arrangement. The
same reasoning would apply in this case -- such that the exchangeable
notes are also each a single arrangement. In particular:
· the terms and conditions indicate that the arrangement, whilst
having the same effect as its separate components, must be dealt
with together, and contain no provision for the separate
assignment of the various embedded rights and obligations
(subsection 230-60(4));
· the rights and obligations under the notes were created under the
one arrangement, at the same time, and will extinguish together
on maturity (subsection 230-60(4)); and
· it would be reasonable to assume that Company B intends to
deal with its rights and obligations under the note together, and
not separately. (For the holder of such an exchangeable note,
objectively it may be concluded that the general and principal
purpose of entering into the exchangeable note is to benefit from
both the annual interest payments and from holding a right to
shares, the value of which may appreciate in the future, after the
right is exercised and the shares are acquired)
(subsection 230-60(4)).
Under this arrangement Company B has the right to receive cash
coupon payments and, upon maturity, a right to the redemption
amount -- which is to be satisfied by receiving a payment of money.
Both of these rights are cash settlable (paragraph 230-50(2)(a)).
Company B also has a right to receive shares under the arrangement
-- that right is still a relevant right even though it is subject to a
contingency. The right is the exercise of the option by Company B
(paragraph 230-90(a)). The right to receive shares is a cash settlable
right, because there is a market for the shares which has a high degree
of liquidity and the shares constitute the right to receive the financial
benefit. Company B also did not have as its sole or dominant purpose
for entering into the arrangement its purchase or usage requirements in
the ordinary course of its business (subsection 230-50(1) and
paragraph 230-50(2)(g)).
Hence, each of the exchangeable notes is a cash settlable financial
arrangement for the purposes of Division 230.
148
The compounding accruals and realisation methods
Is there a sufficiently certain gain or loss?
Given Company B has not made any of the elections under
Division 230, the gains or losses from the exchangeable notes may be
subject to either the accruals or realisation methods. The accruals
method will apply to gains or losses from the exchangeable note if
there is a sufficiently certain overall gain or loss or a particular
sufficiently certain gain or loss made from the arrangement
(section 230-105). The sufficiently certain gain or loss is calculated by
reference only to financial benefits that are sufficiently certain
(subsection 230-120(1)).
A financial benefit is sufficiently certain if:
· it is reasonable to expect that Company B will receive or
provide the financial benefit (assuming Company B will
continue to have the exchangeable notes until redemption --
ie, for the estimated life of the arrangement)
(paragraph 230-120(2)(a)); and
· the amount or value of the financial benefit is fixed or
determinable with reasonable accuracy
(paragraph 230-120(2)(b)).
Taking into account the terms and conditions of the arrangement, and
the economic or commercial substance and effect of the arrangement,
the interest payments can be said to be sufficiently certain
(subsection 230-120(2)). This is because at the start of the
arrangement, it is reasonable to expect that Company B will receive an
amount of interest that is determinable with reasonable accuracy --
this is because the amount of interest is able to be calculated as
6 per cent of the original amount invested.
The financial benefits which are represented by the shares in
Company C, and the redemption amount, are not sufficiently certain
when taken on an individual basis. However, Company B is required
to have regard to contingencies which attach to other financial benefits
under the arrangement (subparagraph 230-120(3)(a)(iv)). This means
that, in determining whether the financial benefit represented by the
redemption amount is sufficiently certain, Company B is required to
take into account the effect of the right to the shares in Company C.
When the effect of the contingencies attaching to each of the financial
benefits is taken into account, it could be objectively concluded that at
the end of the arrangement Company B would make a gain of at least
$100,000 -- this is the gain made where the redemption amount, as
opposed to the shares, is taken.
This is because at the start of the arrangement, although the amount of
the actual gain made by Company B cannot be calculated -- because
this would depend, amongst other things, on the value of Company C's
shares at the time of redemption -- Company B would not choose the
149
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
shares if the market value of the shares gave rise to a gain that was less
than $100,000.
For the purposes of determining whether the right to the redemption
amount is sufficiently certain, it is appropriate to treat that financial
benefit as if it were not contingent (paragraph 230-120(3)(b)).
Therefore, it could be said, on the basis of this required assumption,
that it is reasonable to expect that the redemption amount will be
received at the end of the arrangement.
It is also reasonable to attribute the cost of the exchangeable notes to
the final redemption amount. Hence, there will be a sufficiently certain
overall gain made from the exchangeable notes of at least $100,000.
Further, the rule in subsection 230-75(3) applies to the interest
payments. Under this rule, which applies in calculating a particular
gain or loss under the accruals method, the receipt of an amount of, in
the nature of, or in substitution for, interest, will represent a gain in its
entirety (see Chapter 3 for further discussion of this rule). Were there
no sufficiently certain gain, the interest payments would still be
accrued because of the operation of subsection 230-75(3). However, in
this situation as there is clearly an overall sufficiently certain gain the
interest payments will form part of the overall sufficiently certain gain,
which is required to be accrued.
Both the sufficiently certain overall gain of $100,000 and the
sufficiently certain interest payments are to be brought to account over
the three-year term of the notes on a compounding accruals basis.
4.104 Ordinary options and forwards over shares have relatively
uncertain outcomes and a gain or loss in respect of them is not fixed or
determinable with reasonable accuracy. The financial benefits under the
financial arrangement may be the subject of a material contingency.
Therefore, any gain or loss under the arrangement cannot be determined
with sufficient certainty. Rather, any gains or losses should be subject to
the realisation method.
4.105 Generally, for comparison and reference, consider the case of an
ordinary share traded on a stock exchange. (Note that ordinary shares are
`equity interests' and generally are not subject to Division 230 except
where the fair value or financial reports election applies [Schedule 1, item 1,
paragraph 230-45(2)(e)]). Typically, an ordinary share is subject to relatively
high price volatility, and the value of their expected future financial
benefits is relatively uncertain; the gains or losses from holding the share
are similarly uncertain. Hence, a financial arrangement where the
relevant financial benefits are directly linked to movements in an
individual share price, or with returns (financial benefits) that are as
uncertain as the returns on an ordinary share that is traded on the ASX,
150
The compounding accruals and realisation methods
would ordinarily not be subject to the compounding accruals
methodology.
4.106 Furthermore, in the case of a financial arrangement where the
relevant values of the financial benefits are directly linked to movements
in a broad-based share price index (such as the ASX All Ordinaries
Index), or are as uncertain as are the returns based on that index, such
gains or losses would not ordinarily be subject to compounding accruals
treatment, but would instead be brought to account on a realisation basis.
Calculation of a gain or loss
4.107 As discussed in Chapter 3, to work out if there is a gain or loss
arising from a financial arrangement, a taxpayer is generally required to
compare:
· the financial benefits which the taxpayer has provided, or
which are to be provided, or rights to financial benefits
surrendered under the financial arrangement (the `cost'); with
· the financial benefits which are received, or which are to be
received, or the obligations to transfer financial benefits
under the financial arrangement (the `proceeds').
4.108 The comparison recognises that a gain or loss, for the purposes
of Division 230, is a net concept. As is discussed in Chapter 3, there is a
requirement that the taxpayer make a reasonable (in other words, an
objectively supportable) allocation of costs to proceeds. In particular,
subsection 230-120(1) requires that for the purposes of Division 230, to
determine whether a gain or loss is sufficiently certain at a particular time,
only those financial benefits that are sufficiently certain to be received or
provided under the arrangement can be taken into account, unless gains or
losses which are not sufficiently certain may lead to an over-accrual of a
sufficiently certain gain or loss (see earlier discussion). In this sense, the
test in subsection 230-120(1) is focused on those financial benefits that
are yet to be received or provided. It does not necessarily preclude, in the
calculation of the relevant gain or loss, the taxpayer from taking into
account financial benefits already received or provided under the
arrangement. Such financial benefits are, by the very fact that they have
been provided or received, taken to be certain for the purposes of
determining whether a gain or loss is sufficiently certain at a particular
time -- although such financial benefits, or part thereof, should not be
attributed or included in the calculation of a sufficiently certain gain or
loss more than once. [Schedule 1, item 1, subsection 230-120(9)]
151
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.109 As was noted in paragraph 4.50, the calculation of a sufficiently
certain overall gain or loss requires that the entire value of the costs of the
arrangement be attributed to those financial benefits that are sufficiently
certain at the start of the arrangement. The concept of a particular gain or
loss necessarily requires that the financial benefits which represent the
cost of the financial arrangement be reasonably attributed to the
sufficiently certain financial benefit that will give rise to a gain or loss
[Schedule 1, item 1, sections 230-75 and 230-80]. Whether the attribution of those
financial benefits provided is reasonable is determined by taking into
account the factors listed in subsection 230-75(4). Chapter 3 further
discusses the attribution process.
4.110 Financial benefits that have been taken into account in
calculating a sufficiently certain overall gain or loss are required to be
disregarded when calculating a particular sufficiently certain gain or loss
[Schedule 1, item 1, paragraph 230-115(2)(b)]. Practically this will mean that
where there is a sufficiently certain overall gain or loss calculated for a
financial arrangement with reference to some, but not all, of the financial
benefits which are to be received (because some of those financial
benefits are not sufficiently certain at the start of the arrangement), then
once those financial benefits become sufficiently certain, the amount of
the gain or loss on that financial benefit will reflect the entire value of the
financial benefit. This is because all of the cost of the financial
arrangement would have been attributed to the calculation of the
sufficiently certain overall gain or loss.
The compounding accruals method
4.111 The compounding accruals method spreads gains or losses that
are sufficiently certain to occur [Schedule 1, item 1, section 230-105]. In order
to `spread' the sufficiently certain gain or loss, the taxpayer needs to
establish:
· a period over which the gain or loss should be spread;
· the method used to allocate the gain or loss to particular
intervals within the period established; and
· how to work out an allocation of part of a gain or loss that is
allocated to an interval that straddles two income years.
[Schedule 1, item 1, section 230-125]
152
The compounding accruals and realisation methods
Period over which the gain or loss is to be spread
Relevant period for a sufficiently certain overall gain or loss
4.112 If it is established that there is a sufficiently certain overall gain
or loss from a financial arrangement, that gain or loss is to be spread
(recognised) over a period that starts when the taxpayer starts to have the
financial arrangement and ends when the taxpayer ceases to have the
financial arrangement. [Schedule 1, item 1, subsection 230-130(1)]
4.113 In some instances, the period over which the financial
arrangement is held will not be known at the start of the arrangement --
for example, in the case of financial arrangements that last in perpetuity.
For the purposes of determining the start and the end of the arrangement,
the taxpayer must assume that they will continue to have the financial
arrangement for the rest of the life of the financial arrangement [Schedule 1,
item 1, subsection 230-130(1)]. Hence, the life of such a financial arrangement
starts at the time the taxpayer acquires or creates the arrangement and
ends in perpetuity.
4.114 The period stated in paragraph 4.112 is the appropriate period
over which the overall gain or loss should be spread because, consistent
with the general policy underpinning the accruals method in
Subdivision 230-B, this is the period to which that overall gain or loss
relates. This policy is encapsulated in the principles stated in the
particular sufficiently certain gain or loss case in subsection 230-130(2).
However, where all financial benefits become sufficiently certain
following the start of a financial arrangement, such that the overall gain or
loss, or gain or loss of at least a particular amount, arising on the financial
arrangement becomes known with sufficient certainty, that gain or loss
should be treated as a particular sufficiently certain gain or loss and
spread from the time at which it becomes certain to the time at which the
arrangement matures, or for the rest of its life, as per
paragraph 230-110(2)(a).
The relevant period for a sufficiently certain particular gain or loss that
arises from a financial benefit
4.115 Where there is a sufficiently certain particular gain or loss that
arises from a particular financial benefit, the relevant period over which
that gain or loss is to be spread is the period to which the gain or loss
relates. In determining the period to which that gain or loss relates, regard
must be had to the pricing, terms and conditions of the financial
arrangement [Schedule 1, item 1, subsection 230-130(2)]. The pricing, terms and
conditions, amongst other considerations, will give an indication of what
the financial benefit was provided for or received for, and hence a
reference point to which period that financial benefit relates. Under the
153
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
particular sufficiently certain gain or loss method, the gain or loss is taken
to arise from that particular financial benefit, and so, generally, the period
to which the financial benefit relates would also be the period to which the
particular gain or loss relates, except in cases of deferral of payment
where the time value of money may not be fully reflected.
4.116 Despite the general requirement to allocate the gain or loss to
the period to which it relates, a specific boundary is placed on when that
period can start and when that period can end. The period over which the
sufficiently certain gain or loss is to be spread must not start earlier than
the time at which the taxpayer starts to have the financial arrangement nor
earlier than the beginning of the income year in which the gain or loss
becomes sufficiently certain [Schedule 1, item 1, subsection 230-130(3)].
Additionally, the end of the period over which the gain or loss is to be
spread must not end later than:
· the time the taxpayer will cease to have the financial
arrangement [Schedule 1, item 1, paragraph 230-130(4)(a)];
· the end of the income year in which the particular financial
benefit that gives rise to the gain or loss is to be received or
provided [Schedule 1, item 1, subparagraph 230-130(4)(b)(i)]; or
· the end of the income year during which the right or
obligation (the cessation of which gives rise to the gain or
loss) is to cease [Schedule 1, item 1, subparagraph 230-130(4)(b)(ii)].
Example 4.5: Calculation of relevant period for debt interest
Spices Ltd invests $1,000 into a three-year debt interest on
30 June 2010. The terms provide that if the profits in Tech Co are at a
certain level on 30 June 2012, then on 30 June 2013, $2,000 is payable
on redemption.
Assume that the profits of Tech Co achieve the levels required on
30 June 2012.
In the present case, there is a sufficiently certain gain for Spices Ltd
under the financial arrangement determinable at 30 June 2012. On
30 June 2012, it is reasonably expected that Spices Ltd will receive a
fixed and determinable amount of $2,000. This financial benefit is
therefore sufficiently certain. It is reasonable to attribute the entire
cost of the debt interest to the financial benefit that becomes
sufficiently certain on 30 June 2012. Hence, at that time it is
sufficiently certain that Spices Ltd will make a particular gain of
$1,000.
154
The compounding accruals and realisation methods
Consistent with the period specified in subsection 230-130(4), the
period will end on 30 June 2013 -- the time at which Spices Ltd will
redeem the investment and hence the time at which Spices Ltd will
receive the financial benefit.
Having regard to the pricing, terms and conditions of the financial
arrangement, the period over which the particular sufficiently certain
gain of $1,000 is to be allocated will commence on 1 July 2011 (the
start of the income year in which the gain becomes sufficiently certain
(paragraph 230-130(3)(b)) and end on 30 June 2013
(paragraph 230-130(4)(b)).
How the gain or loss is spread
4.117 Once the entire period over which the relevant gain or loss
should be spread is determined, the method used to spread that gain or
loss over that period must be established. A taxpayer must apply a
compounding accruals method to spread the gain or loss [Schedule 1, item 1,
paragraph 230-135(2)(a)]. Alternatively, a taxpayer may use a different
method, the results of which approximates those obtained under the
specified compounding accruals method [Schedule 1, item 1,
paragraph 230-135(2)(b)].
4.118 Whichever method is chosen, the method is to be applied to
spread the gain or loss on the assumption that the taxpayer will continue
to have the financial arrangement for the rest of the arrangement's life.
[Schedule 1, item 1, subsection 230-135(4)]
4.119 Generally, to apply the compounding accruals method, a
taxpayer estimates the rate of return (the discount rate) that equates the net
present value of all relevant cash flows (financial benefits) to zero. A
taxpayer applies that rate to the initial investment, to provide an estimated
year-by-year gain which forms the basis for taxation. Although the
discount rate is determined by reference to net present values,
Division 230 applies to gains or losses so that the total nominal gains or
losses are brought to account [Schedule 1, item 1, subsections 230-75(1) and
230-80(1)]. However, in making such an allocation of the gain or loss to
the relevant intervals, regard must be had to the financial benefits that are
to be provided or received in each of those intervals [Schedule 1, item 1,
subsection 230-135(5)]. For example, if under a financial arrangement there
are a number of financial benefits that are to be provided towards the start
of the arrangement, and those financial benefits give rise to an overall
gain, the allocation of parts of that gain to the relevant intervals should
take into account the fact that these payments will be made in the intervals
towards the start of the arrangement.
4.120 For the purposes of applying the compounding accruals method,
the length of a particular compounding interval is not prescribed, but it
155
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
cannot exceed 12 months [Schedule 1, item 1, paragraph 230-135(3)(a)]. Each of
the intervals must be of the same length, except for the first and last
interval which may be shorter than the other intervals used [Schedule 1,
item 1, paragraph 230-135(3)(b)]. The first and last interval may be shorter
than the other intervals during the accrual period because the financial
arrangement may have been created or acquired part way through the
financial year of the taxpayer, and not at a designated interval. Equally,
the relevant financial arrangement may cease partway through an interval
period. For example, a designated interval may be a three-month period,
consistent with a financial quarter. That is, an interval might have
otherwise started on 1 July and ended on 30 September. However, the
financial arrangement may have been acquired on 10 August. The
taxpayer could still use intervals that are consistent with a financial
quarter, but the first interval will be from 10 August to 30 September -- a
lesser period that the other intervals in the accrual period.
Example 4.6: Application of the compounding accruals method -- a
bond without a periodic payment
John Doe invests $100 in a zero coupon bond that will pay $120 at
maturity in four years time. The bond satisfies the definition of
`qualifying security' for the purposes of Division 16E in the
ITAA 1936. The bond, by its terms, satisfies the definition of
`financial arrangement' for Division 230 purposes.
Figure 4.1: Zero coupon bond -- representation of the holder's
financial benefits $
Time
$
This is represented diagrammatically in Figure 4.1 by the return of the
investment extending beyond the cost (shown as the small horizontal
dash).
This bond would be subject to the compounding accruals method
because there is a sufficiently certain overall gain that arises at the time
the bond starts to be held by John Doe. The overall gain is sufficiently
certain because it is reasonable to expect that, assuming John Doe
holds the bond for its life (ie, until maturity) the financial benefits will
be received under the arrangement and those benefits have a fixed
156
The compounding accruals and realisation methods
value (section 230-120). For the purposes of accruing the gain,
John Doe has chosen a 12-month compounding period.
To work out the part of the overall gain or loss that is to be recognised
in each income year:
· Estimate all cash flows as in column (c) of Table 4.1.
· Calculate the discount rate at which the net present value of
those cash flows is zero. This discount rate is also known as the
internal rate of return, or the effective interest rate. In this
example it is 4.66 per cent per year.
· Apply the discount rate to the cost of the financial arrangement
on a compounding basis to create column (b).
This is the gain or loss from the compounding accruals method each
year. Effectively the gain of $20 is spread on a compounding accruals
basis over the four-year period as shown in column (b).
Table 4.1: Accrual of sufficiently certain overall gain
Year Amortised Accrued Cash Amortised cost (year
cost (year interest flows end)
start) due
(a) (b) (c) (a) + (b) (c)
0 $0.00 $0.00 $100.00 $100.00
1 $100.00 $4.66 $0.00 $104.66
2 $104.66 $4.88 $0.00 $109.54
3 $109.54 $5.11 $0.00 $114.65
4 $114.65 $5.35 $120.00 $0.00
Methods other than a compounding accruals method
4.121 A method other than the prescribed compounding accruals
method may be used to spread a sufficiently certain gain or loss where the
outcome under that method approximates the outcome under the
compounding accruals method. The focus of the provision is in relation to
the method used and not only the result from the application of that
method. This means that taxpayer will not have to do two separate
calculations -- one under the prescribed method, and one under the
alternative method -- as long as the alternative method can be shown to
have approximated what would have been the outcome under the
compounding accruals method.
157
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
4.122 In determining whether a method gives rise to results which
approximate those obtained under the compounding accruals method,
regard must be had to the length of the period over which the gain or loss
is to be spread. For example, the straight-line spreading method could be
used for short-term financial arrangements, such as 90-day bills or
arrangements which pay interest at least annually, and which have been
acquired for face value. [Schedule 1, item 1, paragraph 230-135(2)(b)]
4.123 Generally, the gain and loss worked out under the compounding
accruals method will be the same as the amounts calculated under the
`effective interest rate' method required by AASB 139. The opportunity
to use the `effective interest rate' method for the purposes of applying the
compounding accruals method accords with the objective of minimising
compliance costs for taxpayers wherever possible. [Schedule 1, item 1,
paragraph 230-100(b)]
4.124 The `effective interest rate' method is a method of calculating
the amortised cost of a financial instrument and of allocating the interest
income or interest expense over the relevant time period (usually the term
of the financial instrument). In most cases, the financial instrument that is
captured under AASB 139 will be the same as the financial arrangement
that is subject to Division 230.
4.125 The `effective interest rate' is the rate that exactly discounts
estimated future cash payments or receipts through the expected life of the
financial arrangement, to the net carrying amount of the financial
instrument. When calculating the effective interest rate, an entity shall
estimate cash flows considering all contractual terms of the financial
instrument but shall not consider future credit losses. The calculation
includes all fees and points paid or received between parties to the
contract that are an integral part of the effective interest rate, transaction
costs, and other premiums and discounts (Paragraph 9 of the AASB 139).
4.126 The requirements of the compounding accruals method replicate
those elements of the effective interest rate method. For example, it is
specifically stated that financial benefits received and provided under a
financial arrangement to another party are specifically included in the
financial arrangement if it is integral to determining whether the taxpayer
has a gain or loss from the arrangement. [Schedule 1, item 1, section 230-65]
Allocating gain or loss to income years
4.127 That part of a gain or loss that has been allocated, pursuant to
the compounding accruals or other acceptable method, to a particular
interval must be brought to account under section 230-15 as:
· assessable income; or
158
The compounding accruals and realisation methods
· an allowable deduction, provided the loss requirements in
section 230-15 are satisfied,
in the income year in which the interval falls. [Schedule 1, item 1,
subsection 230-140(1)]
4.128 If the relevant interval straddles an income year, such that it
starts in one income year and ends in the subsequent income year, the part
of the gain or loss that relates to that interval must be allocated between
the income years on a reasonable basis. The relevant amount that is
brought to account under section 230-15 is so much of that part of the
gain or loss that has been allocated to each income year. [Schedule 1, item 1,
subsection 230-140(2)]
Running balancing adjustment
4.129 As noted above, the amount of a gain or loss that is subject to
the compounding accruals provisions is calculated using sufficiently
certain financial benefits, the values of which were fixed or determinable
with reasonable accuracy at a particular point in time. That is, the values
of the relevant financial benefits were estimated. Over time, the financial
benefits that are to be received or provided under the financial
arrangement will be received or paid. At the time a financial benefit is
received or provided (or the time comes for the financial benefit to be
received or provided), a balancing adjustment may be required.
4.130 The difference between the estimated value of a financial benefit
and the amount that a taxpayer receives or provides will be brought to
account by the application of the running balancing adjustment as either a
gain or loss for the purposes of Division 230. This means that the
taxpayer will recognise an amount of assessable income or, where the
relevant loss requirements are satisfied, an allowable deduction which is
equal to the relevant excess or shortfall. The excess or shortfall is brought
to account for tax purposes in the income year in which the time for the
financial benefit to be received or provided occurs, or at the time the
financial benefit is actually received or provided if this is earlier.
[Schedule 1, item 1, section 230-145]
4.131 More specifically, by virtue of the running balancing
adjustment, an amount of a loss may be recognised where the
compounding accruals method applied to the financial arrangement at a
particular time and the taxpayer:
· was sufficiently certain that they would receive a financial
benefit of at least a particular amount and, at the time when
the financial benefit is received or is to be received, the
amount received is a nil amount or an amount that was less
159
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
than the estimated amount of the financial benefit [Schedule 1,
item 1, subsection 230-145(1)];
or
· was sufficiently certain that they would provide a financial
benefit of at least a particular amount and, at the time when
the financial benefit is provided or is to be provided, the
amount provided is more than the estimated value of the
financial benefit [Schedule 1, item 1, subsection 230-145(4)].
4.132 Equally, the running balancing adjustment will apply in cases
where an amount of a gain is recognised where the compounding accruals
method applied to the financial arrangement and, at a particular time, the
taxpayer:
· was sufficiently certain that they would receive a financial
benefit of at least a particular amount and, at the time when
the financial benefit is received or is to be received, the
amount received is more than the estimated amount of the
financial benefit [Schedule 1, item 1, subsection 230-145(2)]; or
· was sufficiently certain that they would provide a financial
benefit of at least a particular amount and, at the time when
the financial benefit is provided or is to be provided, the
amount provided is nil or less than the estimated value of the
financial benefit [Schedule 1, item 1, subsection 230-145(3)].
Re-estimation of gain or loss
4.133 Whether a financial arrangement will be subject to the
compounding accruals method is to be determined initially at the time
when the taxpayer starts to have the financial arrangement or when
specific financial benefits become sufficiently certain so as to give rise to
a particular sufficiently certain gain or loss. Generally, for many financial
arrangements, the taxpayer will apply the compounding accruals method
to the relevant gain or loss for the term of the financial arrangement.
However, some circumstances may arise where, during the term of the
financial arrangement, the calculation of the gain or loss to be accrued
must be re-estimated. For example, previously contingent amounts that
are no longer contingent may affect the amount of the gain or loss that is
sufficiently certain to occur under the financial arrangement.
160
The compounding accruals and realisation methods
When is re-estimation necessary?
4.134 A taxpayer is required to re-estimate a gain or loss from a
financial arrangement if:
· the compounding accruals method applies to that gain or
loss; and
· there is a material change to the circumstances that affect the
estimate, in respect of an amount or value of a financial
benefit or the timing of the provision of a financial benefit.
The taxpayer is required to make that re-estimation as soon as practicable
after they become aware of the relevant material changes to the
circumstances. [Schedule 1, item 1, subsection 230-160(1)]
4.135 Relevant circumstances which would require a re-estimation
include, but are not limited to:
· a material change in market conditions which is relevant to
the amount or value of financial benefits that are to be
received or provided under the financial arrangement
[Schedule 1, item 1, paragraph 230-160(2)(a)];
· the cash flow or flows which were previously estimated
become known [Schedule 1, item 1, paragraph 230-160(2)(b)];
· the right to, or part of a right to, a financial benefit under the
financial arrangement is written off as a bad debt [Schedule 1,
item 1, paragraph 230-160(2)(c)]; and
· a re-assessment of the gains or losses to which the
compounding accruals method should apply (pursuant to
section 230-155) being undertaken and it being determined
that the compounding accruals method was still the
appropriate method to apply to those gains or losses
[Schedule 1, item 1, paragraph 230-160(2)(d)].
4.136 A taxpayer is not required to re-estimate the amount of the gain
or loss if the change in the value or amount of the financial benefit or the
timing of the financial benefit is not significant. The requirement is that a
change to those circumstances affecting a financial benefit is a material
change. Whether there has been a material change is a question of fact
which depends on the relevant circumstances of each situation. An
example is where there is a change to circumstances such that a cash flow
which was previously estimated becomes known, but where the difference
between the estimated value of the cash flow and the actual value of the
161
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
cash flow is small or negligible in nominal terms. In such an instance, the
change would not be material. Hence, a re-estimation is not required in
such a situation and the taxpayer will continue to accrue the originally
calculated sufficiently certain gain or loss. In such cases the small
differences between the estimated values and the actual values of the
relevant financial benefits will be brought to account by way of the
running balancing adjustment in section 230-145.
4.137 Under section 230-160, a re-estimation is only done where a
change in the circumstances will materially affect the amount or value or
timing of a financial benefit that was used to calculate a gain or loss made
from the financial arrangement. However, if, consistent with a taxpayer's
accounting systems, a re-estimation is still required where there is a
change in circumstances which gives rise to an insignificant difference
between the value of estimated cash flows and the value when those cash
flows become known, a taxpayer may still apply the re-estimation
provisions to the relevant financial arrangement. That re-estimation can
be done where the method used in the taxpayer's accounting systems
approximates the results under the compounding accruals method.
Generally, if the changes are insignificant, then it may be considered that
the results are a reasonable approximation of the method under
Subdivision 230-B. Such a practice must be adopted consistently -- that
is, if a re-estimation is to be done for insignificant differences between
estimated and actual values for financial benefits in relation to a particular
financial arrangement, that re-estimation must be done for all similar
financial arrangements. [Schedule 1, item 1, section 230-85]
4.138 A re-estimation of a gain or loss is not done where there has
been a change in the credit rating or creditworthiness of a party or parties
to the financial arrangement or/and where the relevant right to receive a
particular financial benefit or benefits is impaired (within the meaning of
the accounting standards). In this context, AASB 139 specifies the
criteria for impairment of relevant financial assets which would be
relevant considerations for financial arrangements under Division 230,
and whether rights to receive certain financial benefits under such
financial arrangements would be impaired. [Schedule 1, item 1,
subsection 230-160(3)]
4.139 The case of impairment is to be distinguished from cases where
rights to financial benefits have been written-off as a bad debt. The
taxpayer will re-estimate the relevant gain from the financial arrangement
only where such rights have been written-off as a bad debt. Taxation
Ruling 92/18 provides guidance as to when a debt is a bad debt. A debt
will not be a bad debt if it is simply doubtful that the debt will be
recovered [Schedule 1, item 1, paragraph 230-160(2)(c)]. Further, the amount of
the loss that is available where a bad debt is written-off is limited to the
extent provided for in the legislation.
162
The compounding accruals and realisation methods
Re-estimation where there is a partial disposal
4.140 A re-estimation is also required where the accruals method
applies to gains or losses made from the financial arrangement, and the
balancing adjustment under Subdivision 230-G is made in relation to the
same financial arrangement. The re-estimation is made where the
balancing adjustment in Subdivision 230-G applied because a
proportionate share of the rights or obligations or particular rights or
obligations under the arrangement were transferred to another person
[Schedule 1, item 1, subsection 230-170(1)]. In such a situation, only the method
prescribed under section 230-170 should be used to re-estimate the
relevant gain or loss that will be made from the financial arrangement
[Schedule 1, item 1, paragraph 230-160(1)(c)].
4.141 The balancing adjustment under Subdivision 230-G should bring
to account, at the time of disposal of the relevant rights and obligations, a
gain or loss referable to those rights and obligations. The re-estimation
provisions are triggered because the transfer of one or more rights and/or
obligations would be expected to materially affect the amount or value
and timing of financial benefits that were taken into account in calculating
the amount of the originally determined sufficiently certain gain or loss.
It would be inappropriate then to allow that same amount of gain or loss
to be recognised under the re-estimation. This would have been the
outcome if the provisions in section 230-160 were to apply without
adjustment.
4.142 Further, where the part of the financial arrangement disposed of
was a right to an interest stream, Subdivision 230-G will have
appropriately allocated a cost to that interest income stream disposed of,
and calculated a gain or loss with reference to that cost and the proceeds
received for the disposal. The requirement to disregard the special rules
in relation to interest or things in the nature of interest in
subsections 230-75(3) and 230-80(3) is intended to ensure that the
remaining gain or loss to be accrued can appropriately take account of that
part of the cost of the financial arrangement that has been attributed to the
portion disposed of. [Schedule 1, item 1, subsection 230-170(2)]
Nature of a re-estimation
4.143 A re-estimation for the purposes of Division 230 involves two
parts -- first, a fresh determination of the amount of the gain or loss and a
reallocation of the remaining part of that revised amount over the
remaining part of the accrual period. [Schedule 1, item 1, subsection 230-160(4)]
4.144 The calculation of the re-estimated gain or loss will require a
comparison of the values of the relevant sufficiently certain financial
benefits that are to be received and provided by the taxpayer using
163
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
the re-estimated values where relevant (see paragraphs 4.107 to 4.110 for
a discussion on the calculation of gains and losses). A `balancing
adjustment' is recognised at the time the re-estimation is done if the
method in paragraph 230-165(5)(a) is used. This balancing adjustment
will ensure that, at the time of re-estimation, there is a correction made
such that only the value of the actual gain or loss which is made by the
taxpayer is brought to account under Division 230 during the life of the
arrangement, so that a large adjustment will not be required at the end of
arrangement.
4.145 In situations where there is a partial disposal of a financial
arrangement by way of a transfer of one or more rights and/or obligations
in relation to financial benefits, a fresh determination of the amount of the
gain or loss is also required. In making a fresh determination, the
taxpayer is required to disregard those financial benefits to the extent to
which they are reasonably attributable to the proportionate share or right
or obligation that were transferred [Schedule 1, item 1,
subparagraph 230-170(2)(a)(i)]. The taxpayer is also required to disregard
amounts of the gain or loss that have already been allocated to intervals
ending before the re-estimation is made, to the extent to which that part of
the gain or loss is reasonably attributable to the part of the financial
arrangement that was transferred [Schedule 1, item 1,
subparagraph 230-170(2)(a)(ii)]. Disregarding such financial benefits and
proportionate amounts of the relevant gain or loss will ensure that there is
no double recognition of amounts in the recalculated gain or loss.
Basis for re-estimation -- method used for fresh allocation
4.146 As noted in paragraph 4.143, the nature of a re-estimation
involves two parts. The first part is a fresh determination of the gain or
loss that is estimated to be made under the financial arrangement. The
second part of the re-estimation process requires that a taxpayer make a
fresh allocation of the part of the recalculated gain or loss to the remaining
part of the accrual period. One of two methods can be used to make a
fresh allocation:
· the first method is to maintain the rate of return which was
used prior to the re-estimation and adjust the amount to
which that rate of return is applied; or
· the second method is to maintain the amount to which the
rate of return was applied prior to the re-estimation and
adjust the rate of return that is applied to that amount.
[Schedule 1, item 1, subsection 230-160(5)]
164
The compounding accruals and realisation methods
4.147 The amount to which the rate of return is applied depends on the
method used. The first method involves adjusting the amount to which
the rate of return is applied to equal the present value of the estimated
future (revised) cash flows, discounted at the rate of return that is being
maintained. This adjusted amount becomes the amortised cost to which
the maintained rate of return will be applied to calculate the amount of the
remaining gain or loss that is to be accrued. [Schedule 1, item 1,
paragraph 230-160(5)(a)]
4.148 The second method requires an adjustment of the rate of return
and maintaining the amount to which that rate of return will be applied.
That amount is the amortised cost of the arrangement at the time of the
re-estimation. The adjusted rate of return is calculated by reference to the
amortised cost and the present value of the (revised) estimated future cash
flows at the time of re-estimation [Schedule 1, item 1, paragraph 230-160(5)(b)].
The application of these methods is demonstrated in Example 4.7.
4.149 The object of the two methods is to bring the re-estimated gain
or loss to account on an appropriate basis such that the gain or loss is
properly accounted for over the whole period over which the gain or loss
is spread. Compliance cost issues would arise if the taxpayer is required
to amend prior year's returns each time a re-estimation of an amount is
required. Hence, the object of the fresh allocation is to ensure that the
remaining part of the re-estimated gain or loss is allocated to the
remaining intervals under the financial arrangement. That is, the fresh
allocation of the remaining gain or loss applies from the income year in
which the taxpayer makes the re-estimation until the end of the relevant
accrual period. A wash-up of over-accrued or under-accrued amounts is
achieved by way of a specific balancing adjustment where the first
method above is used [Schedule 1, item 1, section 230-165]. The balancing
adjustment that is made on a re-estimation is to be distinguished from the
running balancing adjustment, which applies during the life of the
arrangement as financial benefits which were estimated become known
(see discussion at paragraphs 4.129 to 4.132). Any amounts previously
recognised under the running balancing adjustment rule in
section 230-145 are taken to have been allocated to intervals ending
before the re-estimation was done.
4.150 Once a particular basis for a fresh allocation has been adopted in
respect of a financial arrangement, the taxpayer must apply the same basis
to all other re-estimations of gains or losses in respect of all of their
financial arrangements [Schedule 1, item 1, subsection 230-160(6)]. This
requirement is intended to address tax planning opportunities that may
have arisen if the taxpayer were able to choose which method to apply on
an arrangement-by-arrangement basis. This rule is also reflected in the
consistency principle in section 230-85, which requires a particular
165
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
method to be applied consistently to a financial arrangement for all
income years [Schedule 1, item 1, section 230-85].
4.151 The same consistency rule is not relevant where there has been a
partial disposal of a financial arrangement by way of a transfer of one or
more rights and/or obligations under the arrangement to another person.
In such situations, the taxpayer is required to re-allocate the remaining
part of the recalculated gain or loss (that has not already been allocated to
intervals occurring before the time of re-estimation) over the remaining
part of the accrual period by maintaining the relevant rate of return and
adjusting the amount to which that rate is applied. The adjusted amount is
equal to the present value of the estimated future cash flows discounted at
the maintained rate of return. [Schedule 1, item 1, subsection 230-170(3)]
Balancing adjustment if the rate of return maintained
4.152 Where a taxpayer has chosen to make a fresh allocation of the
re-estimated gain or loss by maintaining the original rate of return and
adjusting the amount to which the rate of return is applied, other than in
the case of a partial disposal, an amount is brought to account in the
income year in which the re-estimation is made [Schedule 1, item 1,
subsection 230-165(1)]. The adjustment is intended to capture the amount of
the difference between the amount of the re-estimated gain or loss which
should have been brought to account up until the time of re-estimation and
the amount of the previously estimated gain or loss which had been
brought to account. A similar adjustment is made under the accounting
standard AASB 139, where a financial instrument is subject to the
effective interest rate method (eg, see paragraph AG 8 of AASB 139).
4.153 On applying the balancing adjustment provisions, a gain will
arise in the income year in which the re-estimation is made if:
· the re-estimated amount is a gain and the amount to which
the maintained rate of return is applied increases in value as a
result of the re-estimation. The amount of the gain is equal
to that increase [Schedule 1, item 1, paragraph 230-165(1)(a)]; or
· the re-estimated amount is a loss and the amount to which the
maintained rate of return is applied decreases in value as a
result of the re-estimation. The amount of the gain is equal
to that decrease [Schedule 1, item 1, paragraph 230-165(1)(d)].
4.154 On applying the balancing adjustment provisions, a loss will
arise in the income year in which the re-estimation is made if:
· the re-estimated amount is a gain and the amount to which
the maintained rate of return is applied decreases in value as
166
The compounding accruals and realisation methods
a result of the re-estimation. The amount of the loss is equal
to that decrease [Schedule 1, item 1, paragraph 230 165(1)(b)]; or
· the re-estimated amount is a loss and the amount to which the
maintained rate of return is applied increases in value as a
result of the re-estimation. The amount of the loss is equal to
that increase [Schedule 1, item 1, paragraph 230-165(1)(c)].
4.155 The gain or loss that is made on applying the balancing
adjustment provision in subsection 230-165(1) is brought to account as
assessable income or an allowable deduction (provided the loss
requirements of section 230-15 are satisfied) in the income year in which
the re-estimation is made.
4.156 Where there has been a partial disposal of some of the rights
and/or obligations under the arrangement, no balancing adjustment, other
than that under Subdivision 230-G, is available for the reasons provided in
paragraph 4.141. [Schedule 1, item 1, subsection 230-170(3)]
Example 4.7: Application of the re-estimation provisions: income
security with non-periodic cash flows
FLD Finance Co buys a four-year security for $1,000 at the beginning
of the income year (year 1). FLD Finance Co has an annual turnover
of $40 million and has not made any elections under Division 230.
Under the security, FLD Finance Co is entitled to fixed cash flows at
the end of years 1, 2, 3 and 4 as outlined in Table 4.2. FLD Finance
Co is also entitled to additional contingent amounts payable at the end
of each of these years; the contingency does not relate to credit risk.
Assume that the contingent amounts are sufficiently certain (because
despite the contingency, it is reasonable to expect that the financial
benefits will be received) and that, as a result, the following amounts
will be added to the fixed payments at the ends of years 1, 2, 3 and 4:
$20, $30, $60 and $100. A summary of expected cash flows from the
arrangement are outlined in Table 4.2.
Table 4.2: Summary of cash flows
Year Fixed cash Estimated cash Total cash flow
flows flows for the year
0 $1,000.00 $0.00 $1,000.00
1 $20.00 $20.00 $40.00
2 $20.00 $30.00 $50.00
3 $20.00 $60.00 $80.00
4 $1,000 $100.00 $1,100
167
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
This will mean that FLD Finance Co will have an overall gain of $270
from the arrangement that must be accrued over the life of the
arrangement.
Based on the estimated values of the financial benefits, the internal rate
of return of the security is 6.58 per cent per annum1.
Assume that in income years 1 and 2, FLD Finance Co receives the
amounts that it estimated it would receive. However, at the beginning
of income year 3, FLD Finance Co determines that the contingent
amounts in that year and income year 4 will be fixed at $40 and $70
respectively because the contingency that relates to that part of those
payments has been resolved. Hence, for those years, the entire amount
of the fixed cash flows will instead be $60 and $70 respectively.
This is a situation in which there would be a requirement to re-estimate
the amount of gain that FLD Finance Co will make under the
arrangement because the previously estimated cash flows have become
known (paragraph 230-160(2)(b)).
If there was no re-estimation during the term of the security, the tax
calculations would have been as shown in Table 4.3.
Table 4.3: The amounts that would have been accrued if there was no
re-estimation
Year Amortised Gain Cash flows Amortised cost
cost (year (year end)
start)
(a) (b) (c) (a) + (b) (c)
0 $0.00 $0.00 $1,000.00 $1,000.00
1 $1,000.00 $65.83 $40.00 $1,025.83
2 $1,025.83 $67.53 $50.00 $1,043.36
3 $1,043.37 $68.69 $80.00 $1,032.06
4 $1,032.06 $67.94 $1,100.00 $0.00
Application of the re-estimation provisions
Making a re-estimation in such circumstances involves:
· a fresh determination of the amount of the gain
(subsection 230-160(4)); and
1
This is the interest rate (r) that satisfies the following equation:
0 = $1000 + 40/(1 + r)^1 + $50/(1 + r)^2 + $80/1 + r)^3 + $1,100/(1 + r)^4.
168
The compounding accruals and realisation methods
· a reapplication of the accruals method to the redetermined gain
to make a fresh allocation of that redetermined gain. The
reallocation of the redetermined gain applies only to that part of
the gain that has not already been allocated to intervals ending
before the re-estimation is made (subsection 230-160(4)).
FLD Finance Co chooses to apply the first method -- maintaining the
original rate of return and adjusting the amount to which that rate is to
be applied (paragraph 230-160(5)(a)).
Making a fresh determination of the amount of the gain
The fresh determination of the gain would be calculated with reference
to the revised values of the financial benefits under the financial
arrangement. That amount would be:
$1,000 principal paid at the start of the arrangement;
plus
$220 representing the value of cash flows over the period of the
arrangement;
plus
$1,000 return of the principal at the end of the arrangement.
The redetermined gain would therefore be $220.
FLD Finance Co must reapply the accruals method to the gain or loss
to make a fresh allocation of that part of the redetermined gain that has
not already been allocated to intervals ending before the re-estimation
is made. An amount of $133.36 has already been brought to account in
intervals ending before the re-estimation is made. Hence the remaining
amount of the redetermined gain is $86.64 (ie, $220 less $133.36).
FLD Finance Co makes that fresh allocation by maintaining the rate of
return being used and adjusting the amount to which the rate of return
is applied. The adjusted amount comprises the present value of the
estimated future cash flows, discounted at the maintained rate of return
(ie, 6.58 per cent per annum). This results in an adjusted tax cost of
$998.19.
Assuming that there are no further re-estimations, and that
FLD Finance Co receives the revised cash flows, the tax
calculations for income years 3 and 4 would -- based on applying
the originally determined rate of return to the adjusted (amortised cost)
amount -- be as follows.
169
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Table 4.4: Amounts to be accrued using the method in
paragraph 230-160(5)(a)
Year Amortised cost Gain Cash Amortised cost
(year start) flows (year end)
(a) (b) (c) (a) + (b) (c)
3 $998.19 $65.71 $60.00 $1,003.90
4 $1,003.91 $66.09 $1,070.00 $0.00
Under this method, FLD Finance Co is also required to make a
balancing adjustment at the time of the re-estimation
(subsection 230-165(1)). The amount of the balancing adjustment is
equal to the difference between the amount which FLD Finance Co
applied to the maintained rate of return, and the adjusted amount to
which the maintained rate of return is to be applied. The amount to
which FLD Finance Co would have, instead, applied the original rate
of return is $1,043.36. The balancing adjustment that is to be applied
in these circumstances will bring to account the difference between
that amount and the adjusted tax cost of $998.19. That difference,
$45.18, is a loss that would be recognised in income year 3 -- the
income year in which the re-estimation is made
(paragraph 230-165(1)(b)).
Calculation required where method under
paragraph 230-165(5)(b) is applied
If, instead, FLD Finance Co had chosen to apply the second method of
adjusting the rate of return and maintaining the amount to which that
rate is to be applied, the following calculation would be done. Firstly,
the relevant gain or loss must be re-estimated. This calculation would
be no different from the method under paragraph 230-160(5)(a).
Hence, the re-estimated gain will be $220.
FLD Finance Co must reapply the accruals method to the gain or loss
to make a fresh allocation of that part of the redetermined gain that has
not already been allocated to intervals ending before the re-estimation
is made. Hence the remaining amount of the redetermined gain is
$86.64.
FLD Finance Co makes that fresh allocation by adjusting the rate of
return and maintaining the amount to which the recalculated rate of
return is applied. FLD Finance Co does this by calculating a new
internal rate of return, based on the amortised cost of $1043.37, and the
expected future cash flows of $60 in year 3 and $1,070 in year 4.
170
The compounding accruals and realisation methods
The adjusted rate of return for these future cash flows will be
4.18 per cent2.
Assuming that there are no further re-estimations and that
FLD Finance Co receives the revised cash flows, the tax calculations
for income years 3 and 4 would, under the method in
paragraph 230-160(5)(b), be:
Table 4.5: Amounts to be accrued using method in
paragraph 230-160(5)(b)
Year Amortised cost Gain Cash Amortised cost
(year start) flows (year end)
(a) (b) (c) (a) + (b) (c)
3 $1,043.37 $43.65 $60.00 $1,027.02
4 $1,027.02 $42.98 $1,070 $0.00
The amount that is brought to account under this method over the
remaining two years is equal to the amount of the remaining part of the
redetermined gain -- that is, a gain of $86.63.
Limit on balancing adjustment amount where the re-estimation is
triggered by a bad debt write-off
4.157 The accruals method applies to gains or losses which are
calculated on a net basis. If a debt or part of the debt (which is a financial
arrangement) goes bad, difficulties arise as to how to identify the effect
that the financial benefits, which have become bad should have, in respect
of the amount of the estimated gain which should now be accrued. This is
because the effect of some of the financial benefits going bad is that the
overall or particular gain which was previously sufficiently certain would
have been a lesser amount, had it been known at that time that the relevant
financial benefits were going to go bad -- hence, the value which should
have been allocated to each of the intervals, in the entire accrual period,
would have been a different amount.
4.158 The policy intent of this provision is to provide a deduction, by
way of a balancing adjustment, which is limited to an amount that is
referable to that part of the gain or loss which was previously bought to
account in respect of the financial arrangement and which is reasonably
attributable to the right, or part of the right, to the financial benefit that
has been written off as bad. It is not intended that the balancing
2
This is the interest rate (r) that satisfies the following equation.
0 = $1043.37 + $60/(1 + r)^1 + $1070/(1 + r)^2.
171
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
adjustment under section 230-165 apply to effectively allow a deduction
for doubtful debts, or of an amount of capital (eg, the principal investment
provided under the debt). This policy intent is also reflected in the
specific exclusion from the re-estimation provisions, where the
re-estimation is triggered by an impairment of the financial arrangement
(within the meaning of that term in the Australian accounting standards).
[Schedule 1, item 1, paragraph 230-160(3)(b)]
4.159 A `bad debt' for the purposes of Division 230 is intended to be
the same concept as that encompassed in section 25-35 of the ITAA 1997.
Where the re-estimation is triggered by a bad debt write-off, the amount
of the balancing adjustment deduction, which would have otherwise been
calculated under subsection 230-160(5), is instead limited to the amount
of the gain that has already been assessed under Division 230, to the
extent that the gain was reasonably attributable to the financial benefit
which was written off as bad [Schedule 1, item 1, subsection 230-165(3)]. The
limit to the deduction allowed under subsection 230-165(1) applies where:
· the taxpayer has written off, as a bad debt, a right to receive a
financial benefit or part of a financial benefit. Generally,
provided a bona fide commercial decision is taken by a
taxpayer as to the likelihood of the non-recovery of a debt, it
will be accepted that the debt is bad for these purposes
(see Taxation Ruling TR 92/18 for guidelines); and
· the right is not one of the following:
- a right in respect of money which the taxpayer lent in
the ordinary course of their business of lending money
(note that the term `business' is defined in
subsection 995-1(1) of the ITAA 1997); or
- a right which is one that the taxpayer bought in the
ordinary course of their business of lending money.
[Schedule 1, item 1, subsection 230-165(2)]
4.160 In situations where the taxpayer has lent money in the course of
their business of lending money, the full amount of the adjustment under
subsection 230-165(1) is available. Further, if the taxpayer has bought a
right to receive a financial benefit in the ordinary course of their business
of lending money (ie, the taxpayer bought a debt) the policy intention is to
provide a deduction, limited to the cost of acquiring the right [Schedule 1,
item 1, subsection 230-165(5)]. This reflects the policy in section 25-35 of the
ITAA 1997, which is intended to be replicated for the purposes of
Subdivision 230-B. Further, an exception to the anti-overlap rule in
section 230-25 is specifically included -- to allow a deduction for a bad
172
The compounding accruals and realisation methods
debt write-off where the amount of a financial benefit was included in a
taxpayer's assessable income under a provision outside of Division 230
(see Chapter 3 for further discussion).
4.161 There are special rules contained in subsection 25-35(5) of the
ITAA 1997 which affect a taxpayer's entitlement to a bad debt deduction
under section 25-35 or which may result in deductions under that section
being reversed. It is intended that the same adjustments apply to bad debt
deductions which are allowable under Division 230, as opposed to
section 25-35. The fact that the deduction for the bad debt is recognised
under section 230-15, rather than section 25-35, should not result in such
adjustments being ignored for the purposes of the ITAA 1997. This is
achieved by requiring that the deduction allowable under Division 230, in
respect of the balancing adjustment, be treated as a deduction of a bad
debt for the purposes of the ITAA 1936 and the ITAA 1997. [Schedule 1,
item 1, subsection 230-165(6)]
When to use the realisation method
4.162 The realisation tax-timing treatment applies to financial
arrangements which are not the subject of the elective fair value method
or where:
· the taxpayer has elected to rely on their financial accounts
under Subdivision 230-F; or
· the financial arrangement is an equity interest for the
purposes of Division 974 of the ITAA 1997.
4.163 The realisation method may have residual application in relation
to a financial arrangement, to the extent to which the following methods
do not apply to that financial arrangement:
· the compounding accruals method;
· the elective retranslation method -- in respect of foreign
currency gains and losses; and
· the elective hedging regime.
[Schedule 1, item 1, subsection 230-45(2)]
4.164 Generally, the realisation method will apply to those financial
benefits where it is not sufficiently certain that they will occur because,
for example, they are the subject of a contingency, or where the value or
amount of the financial benefit is not fixed or determinable with
173
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
reasonable accuracy. A discussion as to whether a financial benefit will
be sufficiently certain is contained in paragraphs 4.78 to 4.102.
4.165 For example, the realisation method may apply to vanilla option
and forward contracts that are entered into at market rates. Under such
arrangements it would be improbable to conclude that the financial
benefits are sufficiently certain so as to give rise to a sufficiently certain
gain or loss from the derivative. This assumes that there are no payments
fixed in advance for more than the normal settlement period for such
contracts (approximately three days).
4.166 The realisation method can be distinguished from the balancing
adjustment provisions in Subdivision 230-G. Under Subdivision 230-G a
gain or loss is recognised only where the taxpayer either transfers some or
all of the rights and obligations under the arrangement to another person,
or all of the rights or obligations under the arrangement otherwise cease
[Schedule 1, item 1, subsection 230-385(1)]. In contrast, the realisation method
applies where a financial benefit under a financial arrangement which is
not sufficiently certain is paid, or received, or the time comes for it to be
paid or received. Although the payment or receipt of a financial benefit
will result in the right or obligation to that financial benefit ceasing, other
rights and/or obligations to financial benefits under the arrangement may
still be held by the taxpayer.
Realisation treatment and hybrid financial arrangements
4.167 Generally, for the purposes of Division 230, hybrid financial
arrangements will be assessed on a stand-alone (whole of hybrid) basis.
However, hybrid financial arrangements that are bifurcated by taxpayers
applying the relevant accounting standards, where part of that hybrid is
subject to a fair value tax-timing election, will also be bifurcated for tax
purposes [Schedule 1, item 1, section 230-200]. Further discussion in relation to
this bifurcation rule is contained in Chapter 6.
4.168 Therefore, gains or losses that are made under a hybrid financial
arrangement which do not become sufficiently certain before they are due
to be paid or received would be subject to the realisation method if none
of the other elective methods apply.
4.169 It should be noted that a hybrid financing arrangement which is
an `equity interest' under Division 974 is excluded from the realisation
method applied under Division 230. [Schedule 1, item 1,
paragraph 230-45(2)(e)]
174
The compounding accruals and realisation methods
How is a gain or loss calculated under the realisation method
4.170 As was explained in Chapter 3, a gain or loss for the purposes of
Division 230 is a net concept. For the purposes of the realisation method,
the gain or loss is calculated as the difference between the value of
financial benefits received or that are to be received (the proceeds), and
the financial benefits provided or which are to be provided which are
attributable to those proceeds (the cost of the financial benefit). Details,
as to the application of the attribution rules in calculating a gain or loss,
are contained in Chapter 3. Further, if those financial benefits are
denominated in a foreign currency, each element of the calculation
(ie, each financial benefit that is integral to calculating the relevant gain or
loss) is to be translated into the taxpayer's applicable functional currency
-- and then the gain or loss for realisation purposes is to be calculated.
The provisions in Subdivision 960-C of the ITAA 1997 will apply to
determine the exchange rate at which to translate the relevant financial
benefits.
When to recognise a gain or loss under the realisation method
4.171 Where the realisation method applies to a gain or loss, that gain
or loss is brought to account for tax purposes in the income year in which
the gain or loss occurs [Schedule 1, item 1, section 230-150]. For the purposes
of applying the realisation method, a gain or loss `occurs' at the time the
last of the financial benefits which are to be taken into account in
calculating a gain or loss from the arrangement:
· are provided [Schedule 1, item 1, paragraph 230-150(2)(a)]; or
· are due to be provided, if the financial benefit was not
provided at that time and it is reasonable to expect that the
financial benefit will be provided [Schedule 1, item 1,
paragraph 230-150(2)(b)]. Similar considerations in respect of
the test in section 230-120, in respect of whether a financial
benefit is sufficiently certain are relevant here. In particular,
whether it would be reasonable to expect that the financial
benefit will actually be provided is determined on an
objective basis.
4.172 The time at which the last of the financial benefits is to be
provided is based on an objective analysis of the timing of the rights and
obligations under the financial arrangement, rather than an analysis from
the point of view of a particular party to the arrangement. This means that
the time at which the last financial benefit is to be provided -- regardless
of which party to the arrangement is under an obligation to provide that
benefit -- is taken to be the time at which that gain or loss occurs. This
175
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
will ensure that the timing of the recognition of the gains by one party to
the arrangement will correspond accordingly with the loss that will be
made by the counterparty to the arrangement.
4.173 Further, the rules in relation to the apportionment of financial
benefits in sections 230-75 and 230-80 are relevant to determining
whether a gain or loss occurs for realisation purposes. In this sense, there
could be several gains or losses that are made from a single financial
arrangement -- which could arise from a number of different payments or
receipts made under the arrangement. Such gains or losses might each
separately represent a gain or loss which is subject to the realisation
method.
Deductions for bad debts
4.174 The time at which a financial benefit is due to be provided may
arise before that benefit is actually provided. The realisation rule requires
recognition for tax purposes of the gain or loss at the earlier time --
where there is a reasonable expectation that the financial benefits will be
provided [Schedule 1, item 1, subsection 230-150(2)]. Circumstances may arise
where a financial benefit that was taken into account in calculating a gain
or loss under the realisation method is not subsequently provided. This
may be due to a change of circumstances which happens after the gain or
loss is taken to have occurred for Division 230 purposes -- such that the
relevant right to receive the financial benefit is written off as a bad debt.
In such cases, where certain requirements are met, the taxpayer is taken to
have made a loss for Division 230 purposes.
4.175 The realisation method principle is contained in
subsection 230-150(1) -- that is, a taxpayer is required to recognise a gain
or loss under the realisation method, when that gain or loss occurs. Where
the circumstances required for a deduction for a bad debt write-off are
satisfied, the loss which arises is taken to occur when the taxpayer writes
off the right to receive a financial benefit as a bad debt [Schedule 1, item 1,
subsection 230-150(4)]. This is a separate and distinct rule as to the time a
loss occurs for realisation purposes, when compared to the primary test
contained in subsection 230-150(2).
4.176 In order for such a loss to be recognised, the loss must be made
from the writing off a right to receive a financial benefit as a bad debt:
· where that benefit was taken into account in working out the
amount of a gain that was worked out under the realisation
method and has been included in the taxpayer's assessable
income under Division 230 [Schedule 1, item 1,
paragraph 230-150(3)(a)]. The amount of the loss is equal to so
much of the gain which was attributable to the right to the
176
The compounding accruals and realisation methods
financial benefit which was written off as bad [Schedule 1,
item 1, paragraph 230-150(5)(a)]; or
· where the right is in respect of money lent in the ordinary
course of the taxpayer's business of lending money
[Schedule 1, item 1, paragraph 230-150(3)(b)]. The amount of the
loss is equal to the amount of the financial benefit in respect
of which the relevant right was written off as bad [Schedule 1,
item 1, paragraph 230-150(5)(b)]; or
· where the right is one that the taxpayer bought in the
ordinary course of their business of lending money
[Schedule 1, item 1, paragraph 230-150(3)(c)]. The amount of the
loss is equal to the cost, to the taxpayer, of the right to the
financial benefit [Schedule 1, item 1, paragraph 230-150(5)(c)].
4.177 As was stated in paragraph 4.161, it is intended that the same
adjustments, which are contained in subsection 25-35(5) of the
ITAA 1997 apply to bad debt deductions as are allowable under
Division 230 (rather than under section 25-35). This is achieved by
requiring that the deduction allowable under Division 230, in respect of
the balancing adjustment, be treated as a deduction of a bad debt for the
purposes of the ITAA 1936 and the ITAA 1997 [Schedule 1, item 1,
subsection 230-150(6)]. Further, an exception to the anti-overlap rule in
section 230-25 is specifically included -- to allow a deduction for a bad
debt write-off where the amount of a financial benefit was included in the
taxpayer's assessable income, under a provision outside of Division 230
(see Chapter 3 for further discussion).
Re-assessment of whether to apply an accruals or realisation method
4.178 A gain or loss under a financial arrangement which is not
subject to any of the elective methods under Division 230, must be
assessed when the taxpayer starts to have the arrangement -- to determine
whether the gains or losses should be brought to account using the
accruals or realisation method. After that point, the taxpayer is only
required to reassess whether the accruals or realisation method is
appropriately applied to a gain or loss where there is a material change in
the terms and conditions of the arrangement, or the circumstances
affecting the arrangement. [Schedule 1, item 1, subsection 230-155(1)]
What constitutes a material change that triggers a reassessment?
4.179 Whether a change is a material change depends on the facts and
circumstances of the relevant arrangement. A change to the
circumstances external to the terms and conditions of the arrangement, but
177
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
which nonetheless affect the gains or losses that arise under the
arrangement, may trigger a reassessment. Also, not every change to the
terms and conditions, or the circumstances affecting the financial
arrangement, will be of a material nature. The legislation specifically
states a number of changes which are considered to be material changes
and which trigger a reassessment. This is not an exclusive list, and other
changes may constitute a relevant, material change sufficient to trigger a
re-assessment under section 230-155.
4.180 However, a mere change in the fair value of the financial
benefits under the financial arrangement will not, of itself, be considered
to be a material change sufficient to require a reassessment. [Schedule 1,
item 1, subsection 230-155(3)]
Change to the terms or conditions that alters the essential nature of an
interest
4.181 A material change to the terms and conditions of the financial
arrangement in a way which alters the essential nature of the arrangement
will trigger a reassessment. One example is where a debt interest
becomes an equity interest for the purposes of Division 974 of the
ITAA 1997 [Schedule 1, item 1, paragraph 230-155(2)(a)]. The test for
reassessment under section 230-135 is slightly different from the material
change test under the debt and equity provisions in Division 974 -- in
particular the provisions in section 974-110. Under section 974-110, the
issuer of an interest is required to re-test the instrument every time there is
a change to an existing scheme, to ensure it is not a material change that
changes its classification under Division 974 from debt to equity or vice
versa. In contrast, a material change under section 230-155 is one which
has, in fact, affected the classification of an instrument and triggers a
reassessment.
Change to the terms and conditions that materially affects the
contingencies in respect of significant rights or obligations
4.182 A material change requiring reassessment would be a change to
the terms and conditions of the arrangement in a way which materially
affects the contingencies on which significant obligations, or rights, under
the arrangement are dependent [Schedule 1, item 1, paragraph 230-155(2)(b)].
The relevant obligations or rights which are affected must be significant,
in the context of the financial arrangement.
4.183 The compounding accruals method only applies to gains or
losses that are sufficiently certain. A contingency may affect whether a
financial benefit, in respect of which certain rights or obligations relate, is
sufficiently certain. If a contingency in relation to such a right or
obligation is removed, or is resolved, then an amount of a gain or loss
178
The compounding accruals and realisation methods
which was not previously sufficiently certain, and as a result subject to the
realisation method, may become sufficiently certain, such that it would be
more appropriate to apply the compounding accruals method.
4.184 Likewise, if a financial benefit was taken into account in
working out a sufficiently certain gain or loss, but the right or obligation
to which it relates is made subject to a contingency, then that gain or loss
may no longer be sufficiently certain and should be subject to the
realisation provisions.
4.185 A change in relation to a contingency may trigger a
reassessment but the conclusion may be that the compounding accruals
method should still apply to the relevant gain or loss. However, the effect
of the change in the contingency may be that the amount of the gain or
loss will need to be re-estimated. [Schedule 1, item 1, paragraph 230-160(2)(d)]
A change in circumstances that materially affects the contingencies in
respect of significant rights or obligations
4.186 A change that materially affects a pre-existing contingency does
not necessarily have to be affected by a change to the terms and
conditions of an arrangement. A pre-existing contingency affecting
significant rights or obligations under the arrangement may be removed
by circumstances surrounding the financial arrangement [Schedule 1, item 1,
paragraph 230-155(2)(c)]. An example of this may be that a number of
contingencies may apply to a significant obligation, or right, and the
obligation or right becomes no longer subject to the contingencies -- or
becomes effectively non-contingent -- when only one of the
contingencies is satisfied.
A change to the terms on which credit is provided to a third party
4.187 A reassessment is required where there is a change to the terms
on which credit is to be provided to, or a change to the credit rating of, a
person that is not a party to the arrangement, where significant obligations
or rights under the arrangement depend on that other person's credit
profile. [Schedule 1, item 1, paragraph 230-155(2)(d)]
4.188 In one sense, if the significant right or obligation is dependent
on the other person's ability to obtain credit, or maintain a rating, a
change to either of those circumstances will introduce contingencies
which will affect whether the relevant financial benefits to which the
significant rights and obligations relate will be sufficiently certain.
179
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
A change to the terms or conditions or circumstances that are sufficient to
treat a loan as impaired
4.189 A reassessment is required if the financial arrangement is, or
includes, a loan and the taxpayer prepares financial reports in accordance
with the Australian accounting standards, or comparable standards and
there is a change to the terms and conditions or the circumstances
affecting the loan -- such that it would be treated as impaired for the
purposes of those standards. [Schedule 1, item 1, paragraph 230-155(2)(e)]
4.190 This particular trigger for a reassessment will not apply to
individuals or entities which satisfy the turnover test in section 230-405.
It may apply to entities satisfying that turnover test which have made an
election to have Division 230 apply to them, and who prepare financial
reports in accordance with the Australian accounting standards.
4.191 A loan may also be the subject of the fair value election -- if
made by a taxpayer and where the taxpayer has elected to fair value the
loan through profit or loss in its financial reports. An impairment of the
loan may affect the fair value of that loan, at the particular time. Such
changes in the fair value are recognised for tax purposes under the fair
value election. [Schedule 1, item 1, section 230-195]
4.192 `Impairment' for accounting purposes relates to financial assets
where the carrying amount of the asset exceeds its estimated recoverable
amount (see paragraphs 58 to 70 of the AASB 139). Objective evidence
of impairment is required under AASB 139 before a financial asset is
considered to be impaired.
4.193 For tax purposes, under the current law, Taxation Ruling
TR 94/32 (Income Tax: non-accrual loans) specifies what would
constitute a non-accrual loan for tax purposes. In particular, the taxation
ruling refers to indicators which would provide support for a bona fide
assessment based on sound commercial considerations, that interest which
was previously accrued is not likely to be received (in particular refer to
paragraph 47 of the TR 94/32). Such indicators may be relevant in
determining if impairment of a loan has occurred, for the purposes of the
accounting standards.
4.194 The effect of impairment for the purposes of the reassessment
provisions would be that the future gains (represented by interest
payments on the loan) would no longer be accrued but instead would be
brought to account under the realisation method.
180
Chapter 5
Elective Subdivisions: common
requirements
Outline of chapter
5.1 This chapter explains:
· the requirements that are common to the elective tax-timing
elections and which need to be met for any of the elective
Subdivisions to apply: these are referred to as `common
requirements';
· how the elective Subdivisions apply to relevant financial
arrangements;
· the circumstances under which an election under an elective
Subdivision will cease to apply and the consequences of
cessation in respect of gains or losses made from the
financial arrangements that were subject to an elective
methodology; and
· the consequences of making a new election where an election
has ceased.
5.2 The elections which are the subject of this chapter are those
provided by Subdivisions 230-C (fair value election), 230-D (general
foreign exchange retranslation election only), 230-E (hedging financial
arrangement election) and 230-F (election to rely on financial reports). In
this chapter, these Subdivisions are referred to as the `elective
Subdivisions'.
Context of amendments
5.3 The framework of Division 230 incorporates a number of
elective Subdivisions which provide for different tax treatments (fair
value, retranslation, hedging, and the financial reports method).
Taxpayers are able to select among these elective regimes in order to
181
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
obtain the tax treatment that best suits their commercial circumstances and
the functions of the financial arrangements they hold or issue.
Summary of new law
5.4 In order to rely on any of the elective Subdivisions taxpayers
must have prepared financial reports in accordance with relevant
accounting standards and these reports must be audited in accordance with
relevant auditing standards. Taxpayers must continue to satisfy these
requirements for these elections to continue to apply.
5.5 Once an election has been made, the elective Subdivisions allow
for the gains and losses on relevant financial arrangements to be
determined, in appropriate circumstances, in accordance with relevant
accounting standards. That is, in these circumstances taxpayers can
effectively rely on amounts in their financial reports for determining gains
and losses for tax purposes for relevant financial arrangements.
5.6 Where the elective requirements cease to be satisfied, relevant
financial arrangements will be deemed to have been disposed of and
reacquired and the election will cease to apply. Taxpayers may make new
elections where the requirements are once more satisfied.
Comparison of key features of new law and current law
New law Current law
In order for taxpayers to access the There is no basis under the current
treatments provided for in the law for electing to use accounting
elective Subdivisions, they must standards concepts, methods and
meet requirements common to all the valuations (as appropriate) to
elective Subdivisions. These calculate gains and losses for tax
requirements are that financial purposes and, as a result, no
reports be prepared in accordance comparable common elective
with relevant accounting standards requirements.
and appropriately audited.
182
Elective Subdivisions: common requirements
Detailed explanation of new law
The elective Subdivisions
5.7 There are four elective Subdivisions under which taxpayers may
elect to apply a tax-timing method to relevant financial arrangements,
subject to their meeting relevant requirements. These elective
Subdivisions allow a taxpayer to bring gains and losses from their
financial arrangements to account on a:
· fair value basis (Subdivision 230-C);
· retranslation basis (Subdivision 230-D) -- (this chapter discusses
the general foreign exchange retranslation election only);
· basis that is consistent with the tax treatment of the hedged item
(Subdivision 230-E); or
· basis which relies on the relevant accounting standards more
broadly (Subdivision 230-F).
5.8 The operation of the elective Subdivisions will assist in reducing
taxpayers' compliance costs as the elective treatments will, in effect,
allow taxpayers to rely on their financial reports, to determine the amount
of the gain or loss from relevant financial arrangements that is, for income
tax purposes, attributable to a particular income year.
5.9 The common requirements and the outcomes under the elective
Subdivisions are discussed within this chapter to avoid duplication in each
relevant chapter. Further details that are specific to each election are then
discussed in Chapters 6 to 9.
Common requirements for making an election
Accounting and auditing requirements
5.10 In order for a taxpayer to make an election under one of the
elective Subdivisions, they must have financial reports that are:
· prepared in accordance with relevant accounting standards;
and
· audited in accordance with relevant auditing standards.
[Schedule 1, item 1, subsections 230-180(2), 230-220(2), 230-275(2) and 230-350(2)]
183
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
5.11 As under the elective Subdivisions the financial reports of a
taxpayer may, in effect, be relied upon to determine the amount of the
gains or losses made from a financial arrangement that are to be brought
to account for income tax purposes, the integrity of those reports is
important. The accounting and auditing requirements, which the taxpayer
must meet to be able to make an election under any of the elective
Subdivisions, provide a level of integrity and certainty around processes
and methodologies used to calculate the amount of the gains or losses
from financial arrangements, that are to be brought to account for tax
purposes using the elective treatments. That integrity will work to ensure
that opportunities for tax avoidance or tax deferral are minimised.
Financial reports
5.12 The Corporations Act 2001 and Australian accounting standards
(eg, Australian Accounting Standard AASB 101 Presentation of Financial
Statements) set out what is meant by the term `financial report'.
A financial report includes:
· a balance sheet;
· an income statement (profit or loss statement);
· a statement of changes in equity showing either:
- all changes in equity; or
- changes in equity other than those arising from
transactions with equity holders acting in their capacity
as equity holders;
· a cash flow statement; and
· notes, comprising a summary of significant accounting
policies and other explanatory notes.
Prepared in accordance with accounting standards
5.13 The requirement in the elective Subdivisions for the preparation
of financial reports in accordance with accounting standards is a
fundamental requirement which ensures that the timing and measurement
of the gains and losses made from relevant financial arrangements are
reliable and suitable for tax purposes.
5.14 In the case of financial reports not prepared in accordance with
the accounting standards, there may not be sufficient integrity associated
184
Elective Subdivisions: common requirements
with the preparation of such reports to allow them to be relied upon for
tax purposes.
5.15 In the context of the elective Subdivisions within Division 230,
three of the most relevant accounting standards are:
· Australian Accounting Standard AASB 139 Financial
Instruments: Recognition and Measurement (AASB 139) --
which covers recognition and measurement of financial
assets and liabilities;
· Australian Accounting Standard AASB 121 The Effects of
Changes in Foreign Exchange Rates (AASB 121) -- which
covers certain gains and losses attributable to changes in
foreign exchange rates; and
· Australian Accounting Standard AASB 127 Consolidated
and Separate Financial Statements (AASB 127) -- which
covers the preparation and presentation of consolidated
financial statements for a group of entities under the control
of a parent.
5.16 While these are the most relevant accounting standards for the
methodologies contained within the elective Subdivisions, other
Australian accounting standards may also be relevant (see additional
Australian accounting standards mentioned in Chapter 1).
5.17 Where an entity prepares a financial report using comparable
accounting standards of a foreign jurisdiction, those financial reports will
satisfy this accounting standards requirement. (What constitutes a
comparable standard is explained in paragraphs 5.26 to 5.28.)
5.18 Whether or not a taxpayer's financial reports have been prepared
in accordance with relevant accounting standards is a question of fact.
However, where an entity purports to have prepared a financial report in
accordance with relevant accounting standards and there is an unqualified
auditor's report in respect of the financial report, the auditor's report will
ordinarily be indicative of, but not necessarily conclusive of, the fact that
the financial report has been prepared in accordance with the relevant
accounting standards.
Class Orders
5.19 Some entities within an accounting consolidated group may not
be required to prepare financial reports, for example, because of an
Australian Securities and Investment Commission Class Order. However,
if a particular financial asset or liability is held by such an entity and that
185
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
financial asset or liability is reflected in a set of audited financial reports
of another entity within the accounting consolidated group -- typically
the consolidated financial reports -- then the elective Subdivisions may
still be able to apply to that financial asset or liability -- provided it is a
financial arrangement which is subject to Division 230. [Schedule 1, item 1,
paragraphs 230-185(1)(b), 230-225(1)(b), 230-290(1)(c) and 230-360(1)(c)]
Audited in accordance with auditing standards
5.20 It is a requirement of the elective Subdivisions that the financial
reports of the taxpayer be audited in accordance with the Australian
auditing standards or comparable foreign standards. This audit
requirement provides additional integrity in respect of the amounts which
are in effect relied upon for income tax purposes.
5.21 Under section 336 of the Corporations Act 2001, an auditing
standard is defined as a standard that is made by the Auditing Standards
Board for the purposes of the Corporations Act 2001. An auditor will be
required to follow those auditing standards in the audit of a financial
report.
5.22 Where the audit is conducted in accordance with Australian
Auditing Standards, Auditing Standard ASA 700 -- The Auditor's Report
on a General Purpose Financial Report states, in paragraph 39, that:
`The auditor's report shall state that the audit was conducted in
accordance with Australian Auditing Standards.'
Auditing Standard ASA 700 is operative for financial reporting periods
commencing on or after 1 July 2006.
5.23 However, as is the case for the preparation of financial reports,
where the preparation or audit of the relevant financial report is carried
out in a foreign jurisdiction, then comparable auditing standards will be
seen to provide integrity in the same manner as the Australian auditing
standards. For further discussion on what would be required for an
accounting or auditing standard to be considered comparable, see
paragraphs 5.26 to 5.28.
5.24 Not all entities are required by Australian law to have their
financial reports audited in accordance with the auditing standards (or by
comparable foreign law and auditing standards made under a foreign law).
To the extent that this is true, an entity is not precluded from making an
election under any of the elective Subdivisions provided the financial
reports of that entity are in fact audited in accordance with the relevant
auditing standards.
186
Elective Subdivisions: common requirements
5.25 The auditing requirement in the elective Subdivisions has been
structured such that either of the following election eligibility conditions
must be satisfied prior to making an election:
· the financial reports are audited in accordance with the relevant
Australian auditing standards; or
· the financial reports are audited in accordance with relevant
comparable foreign auditing standards.
[Schedule 1, item 1, paragraphs 230-180(2)(b), 230-220(2)(b), 230-275(2)(b) and
230-350(2)(b)]
Comparable accounting and auditing standards
5.26 In having regard to what is a comparable accounting or auditing
standard, consideration is to be given to whether the foreign accounting or
auditing standard, when compared to the Australian accounting or
auditing standard, results in a particular financial asset or liability being:
· recognised, classified and treated in the same way in the
financial reports of the entity;
· measured in the same way in the financial reports of the
entity. That is, the methods by which the changes in value,
or gains and losses are calculated, is the same or is
substantially the same; and
· subject to the same level of scrutiny as required under the
Australian auditing standards.
5.27 Comparable accounting standards include United States of
America Financial Accounting Standards and those standards that are
compliant with International Financial Reporting Standards in the broad
sense of the term (ie, compliance with the entire body of International
Accounting Standards Board pronouncements). [Schedule 1, item 1,
subparagraphs 230-180(2)(a)(ii) and (b)(ii), 230-220(2)(a)(ii) and (b)(ii),
230-275(2)(a)(ii) and (b)(ii) and 230-350(2)(a)(ii) and (b)(ii)]
5.28 Regulations may be made to specify whether a particular foreign
accounting or auditing standard is to be treated as comparable with the
Australian accounting and auditing standards for the purposes of
Division 230. [Schedule 1, item 1, section 230-435]
5.29 As previously mentioned, in addition to the generic
requirements mentioned in this chapter, there are additional requirements
that are specific to particular elective Subdivisions which also need to be
187
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
met for the elective Subdivisions to apply. For discussion on these
specific requirements for elections, see each of the relevant chapters --
Chapter 6 (fair value election), Chapter 7 (the foreign exchange
retranslation election), Chapter 8 (hedging financial arrangements
election) and Chapter 9 (financial reports election).
Making an election under the elective Subdivisions
Who may make an election
5.30 Generally, entities that are subject to Division 230 may make an
election under one or more of the elective Subdivisions (see Chapter 1 for
discussion of the hierarchy of elective treatments).
5.31 However, individuals and entities which have an aggregated
turnover of less than the relevant threshold levels specified in
subsections 230-405(2) and (3), are generally excluded from the operation
of Division 230 (except in relation to certain qualifying securities they
hold). For such taxpayers an election under one of the elective
Subdivisions will only have effect if the taxpayer has also made the
election under subsection 230-405(5) to have Division 230 apply to all of
their financial arrangements (apart from those excluded in
Subdivision 230-H).
Example 5.1: Individual excluded
Nik is an individual who is in the business of trading securities. His
annual turnover is $15 million -- which is less than the threshold
specified in subsection 230-405(3). As Nik has not made an election
under subsection 230-405(5) to apply Division 230 to all of his
financial arrangements any election(s) Nik may make under any of the
elective Subdivisions will have no effect (see subsections 230-190(2),
230-230(2), 230-285(3) and 230-365(2)).
Elections where a group is a tax consolidated group or a MEC group
5.32 In the case of a tax consolidated group or a multiple entry
consolidated group (MEC group), elections are made by the head
company of the group. Generally, an election under Division 230 will
apply to all the relevant transactions of all members of the consolidated
group or MEC group.
5.33 However, there is an exception to this where a tax consolidated
group or MEC group includes a member that carries on a `life insurance
business' (as defined in subsection 995-1(1) of the ITAA 1997). The
member running the life insurance business will be a life insurance
company that is registered under the Life Insurance Act 1995.
188
Elective Subdivisions: common requirements
5.34 A financial arrangement relates to life insurance business carried
on by a life insurance company that is a member of a consolidated group
or MEC group if the financial arrangement is held directly or indirectly by
the life insurance company. Therefore, a financial arrangement that is
held by a wholly-owned subsidiary of the life insurance company relates
to the life insurance business carried on by the life insurance company
member and therefore is covered by the exception.
5.35 Tax consolidated groups and MEC groups may wish to elect to
apply one of the elective Subdivisions. However, for tax consolidated or
MEC groups which contain, for example, both a financial institution
member and a life insurance company member, bringing to account gains
or losses which arise on an unsystematic, unrealised basis may provide a
competitive disadvantage to the life insurance company of the tax
consolidated group or MEC group. For this reason the head company of a
tax consolidated group or MEC group which contains a member that
carries on a life insurance business may elect to:
· have an election under one of the elective Subdivisions apply
to all of their relevant financial arrangements; or
· specify that an election under one of the elective
Subdivisions is to only apply to all of their relevant financial
arrangements excluding those related to the life insurance
business carried on by a member of the group.
[Schedule 1, item 1, subsections 230-190(3), 230-230(3), 230-285(4) and 230-365(3)]
Remaking an election -- life insurance company as a joining entity
5.36 The amendments to subsection 715-660(1) of the ITAA 1997
(discussed in Chapter 11) ensure that the elections under Division 230 are
subject to the operation of Subdivision 715-J of the ITAA 1997. Broadly,
Subdivision 715-J operates to override the entry history rule in relation to
certain choices by an entity that joins a consolidated group or MEC group
(including the absence of a choice) and to extend the time for the head
company of the group to make a new choice.
5.37 Therefore, the head company of an existing consolidated or
MEC group is able to remake its Division 230 election in respect of
the group if:
· a life insurance company joins the group;
· the life insurance company has made an election under
Division 230 prior to its entry into the group; and
189
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· the life insurance company's election is inconsistent with the
existing Division 230 election of the head company.
5.38 In these circumstances, the head company has until the later of
the following times to make a new election under Division 230:
· the last time the head company may make an election under
Division 230 (ie, by the end of the relevant income year); and
· the end of 90 days after the Commissioner of Taxation
(Commissioner) is given notice under Division 703 of the
ITAA 1997 that the life insurance company has become a
member of the group or such later time as the Commissioner
allows.
5.39 Consequently, if a life insurance company joins an existing
consolidated group or MEC group, the head company will be able to make
an election under Division 230 in relation to its life insurance business
that is different to the election that applies to its other business.
5.40 However, if a life insurance company that joins an existing
consolidated group or MEC group has made an election under
Division 230 prior to joining the group that is consistent with the existing
election of the head company, then the head company is precluded from
making a new election under Division 230. This includes a situation
where the group already carries on life insurance business and has made
an election under Division 230 in respect of that business which is
consistent with the Division 230 election of the joining life insurance
company. [Schedule 1, item 1, subsections 230-190(3), 230-230(3),
subsections 230-285(4) and 230-365(3)]
Tax and accounting consolidated groups
5.41 It is important to note that what constitutes a consolidated (or
MEC) group for tax purposes may differ from an accounting consolidated
group. An election made by the head company under the elective
Subdivisions will only apply to gains and losses from financial
arrangements that are held, by virtue of the single entity rule in
subsection 701-1(1) of the ITAA 1997, by the head company of the tax
consolidated (or MEC) group. That is, gains and losses made from
financial arrangements that are held by entities that are part of the
accounting consolidated group but are not members of the tax
consolidated (or MEC) group, cannot be subject to an election made by
the head company of the tax consolidated (or MEC) group under the
elective Subdivisions.
190
Elective Subdivisions: common requirements
The manner in which elections are to be made
5.42 The form by which the taxpayer makes an election available
under the elective Subdivisions is not prescribed in Division 230.
However, the election will need to be made in a manner that clearly
reflects that the election has been made and also the time when the
election is made. That election will need to form part of the tax records of
the entity.
Elections are irrevocable
5.43 An election made under one of the elective Subdivisions is
irrevocable. [Schedule 1, item 1, subsections 230-180(3), 230-220(5), 230-275(3) and
230-350(4)]
Financial arrangements that are subject to the election, and the effect of
the election
Financial arrangements to which the elective Subdivisions apply
5.44 Elections made under the elective Subdivisions apply to relevant
Division 230 financial arrangements to the extent that:
· the relevant financial arrangement starts to be held in the
income year in which the election is made, or the relevant
financial arrangement starts to be held in income years
following the income year in which the election is made; and
· the gain or loss on the relevant financial arrangement is
recognised or recorded in the taxpayer's financial reports.
[Schedule 1, item 1, subsections 230-185(1) and 230-225(1), section 230-280 and
subsection 230-360(1)]
5.45 An election under the elective Subdivisions does not apply to
financial arrangements that are held by a taxpayer prior to the income year
in which the election is made. An exception applies where the taxpayer
makes a transitional year election for existing financial arrangements
(discussed in Chapter 12).
191
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Financial arrangements to which the elective Subdivisions do not apply
5.46 If the taxpayer makes an election under Subdivisions 230-C or
230-F, the election does not apply in respect of:
· a financial arrangement that is an equity interest that:
- is not classified or designated as at fair value through
profit or loss; or
- is issued by the taxpayer; and
· franked distributions. The assessability of these distributions
will remain outside Division 230. For example, dividends
will remain assessable in accordance with section 44 of the
Income Tax Assessment Act 1936.
Refer to Chapters 6 and 9 for more information on these exceptions.
[Schedule 1, item 1, subsections 230-190(1), 230-195(2), 230-365(1) and 230-370(2)]
5.47 Where the head company of a consolidated or MEC group
chooses not to make elections in respect of its life insurance business
Subdivision 230-C, 230-D, 230-E or 230-F will not apply to financial
arrangements of that member of the consolidated group to the extent that
the financial arrangement relates to the life insurance business. [Schedule 1,
item 1, subsections 230-190(3), 230-230(3), 230-285(4) and 230-365(3)]
5.48 Regulations may also exclude other financial arrangements
associated with a business of a specified kind from an election under
Subdivisions 230-C and 230-F. [Schedule 1, item 1, subsections 230-190(4),
230-230(4), 230-285(5) and 230-365(4)]
5.49 Note that although individuals, and entities with a turnover less
than the threshold levels specified in section 230-405(2), can make an
election under the elective Subdivisions, such an election will have no
effect unless that taxpayer has also made an election under
subsection 230-405(4) -- refer to paragraph 5.31. [Schedule 1, item 1,
subsections 230-185(3), 230-225(3), 230-280(3) and 230-360(4)]
Effect of relying on elective Subdivisions
5.50 Where an election made under the elective Subdivisions applies
to a financial arrangement, the gain or loss that is made from that financial
arrangement is equal to the amount that is required by the relevant
accounting standards to be recognised for that financial arrangement in
the entity's profit and loss statement of its financial reports.
192
Elective Subdivisions: common requirements
5.51 Generally, the effect of making an election under the elective
Subdivisions is that the taxpayer relies on their financial reports to
determine the amount of any gain or loss that is taken to have been
made from a relevant financial arrangement. [Schedule 1, item 1,
subsections 230-195(1), 230-240(1), 230-260(2) and 230-370(1)]
5.52 With respect to specific elective Subdivisions:
· financial arrangements or assets or liabilities that fall
within the definition of `financial arrangement', including
those arrangements that fall within the additional operation
of the Division as set out in Subdivision 230-J, which are
fair valued for the purpose of the profit or loss account,
can be fair valued for tax purposes [Schedule 1, item 1,
subsection 230-195(1)];
· amounts that are recognised in taxpayers' profit or loss
statements of their financial reports that are attributable to the
change in currency exchange rates are recognised as gains
and losses for tax purposes [Schedule 1, item 1,
subsection 230-240(1)]; and
· amounts that are recognised in the profit or loss statement of
the financial reports, in effect, determine whether, and the
amount of, a gain or loss from a relevant financial
arrangement is regarded as arising. Financial reports also
determine when the gain or loss is regarded as arising
[Schedule 1, item 1, subsection 230-370(1)].
Intra-group transaction for the purposes of AASB 127
5.53 Where an election is made by a head company of a consolidated
group or of a MEC group and a financial arrangement is not recognised in
an audited financial report only because the arrangement is an intra-group
transaction under AASB 127, then the requirement that the financial
arrangement be recognised in the financial reports is deemed to have been
satisfied in relation to that financial arrangement.
5.54 This provision is intended to allow taxpayers to rely on entity
accounts for the purposes of satisfying this requirement. The reason for
departing from the default position in this circumstance is that tax and
accounting consolidated groups do not always align. To the extent that
the arrangement is recognised for tax purposes, the taxpayer is able to rely
on the relevant entity accounts for the purpose of determining the amount
of relevant gains and losses.
193
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
That is, this provision only extends to transactions that occur between two
tax entities but within the one accounting consolidated group. [Schedule 1,
item 1, paragraphs 230-185(2)(b), 230-225(2)(b), subsections 230-360(3) to (6),
paragraphs 230-370(1)(b) and subparagraph 230-240(1)(b)(ii)]
Financial arrangement leaving a consolidated group
5.55 Where a leaving entity takes a financial arrangement that was
subject to the fair value election, the foreign exchange retranslation
election or the financial reports election when held by the head company,
the gain or loss that the head company is taken to have made from the
financial arrangement is calculated on the basis that the circumstances that
existed at the leaving time remain unchanged until the end of the income
year. The gain or loss is allocated to the income year of the head company
in which the gain or loss occurred. [Schedule 1, item 1, subsections 230-195(3)
and (4), 230-240(3) and (4), 230-370(3) and (4)]
5.56 Consistent with the principles contained in the Australian
accounting standards, the circumstances are taken to remain static for the
purposes of establishing the gain or loss on the financial arrangement at
the leaving time.
5.57 For financial arrangements subject to the fair value election, the
gain or loss recognised by the head company for that income year will be
the difference between its fair value at the start of the income year, and its
fair value at the leaving time. That difference is taken to be the amount
which the Australian accounting standards require the head company to
recognise in profit or loss for the income year from the asset that was
subject to the fair value election. [Schedule 1, item 1, 230-195(3) and (4)]
5.58 For financial arrangements subject to the foreign exchange
retranslation election, the gain or loss the head company makes from the
financial arrangement is calculated with reference to the gain or loss that
the relevant standard would require the group to recognise in profit or loss
in that income year up until the leaving time. [Schedule 1, item 1,
subsections 230-240(3) and (4)]
5.59 For financial arrangements subject to the financial reports
election, the gain or loss the head company makes from the financial
arrangement is calculated with reference to the relevant values of the
financial arrangement at the leaving time rather than the value at the end
of the head company's income year. [Schedule 1, item 1, subsections 230-370(3)
and (4)]
5.60 For further discussion on these amendments, see Chapter 11.
194
Elective Subdivisions: common requirements
The order in which the elections under the elective Subdivisions apply
5.61 It is important to note that, where more than one election has
been made under the elective Subdivisions, only one elective method may
apply to an eligible financial arrangement. For further discussion of the
hierarchy of tax treatments refer to Chapter 1. [Schedule 1, item 1,
section 230-45]
Where requirements for an election are no longer satisfied
5.62 Although an election under the elective Subdivisions is
irrevocable, the election may cease to apply, depending on the
circumstances applying to either:
· all of a taxpayer's financial arrangements; or
· one or more particular financial arrangements of the
taxpayer.
When an election ceases to apply to all existing financial arrangements
5.63 The elections, other than (in certain circumstances) an election
under Subdivision 230-E, will cease to apply to all of the relevant
financial arrangements in the following circumstances:
· the accounting requirement is no longer satisfied;
· the auditing requirement is no longer satisfied; or
· a requirement particular to an elective Subdivision is no
longer satisfied.
[Schedule 1, item 1, subsections 230-205(1), 230-245(1), 230-325(1) and 230-375(1)]
Where an election ceases to apply to particular financial arrangements
5.64 The elections will cease to apply to one or more particular
financial arrangements in the following circumstances:
· it is no longer recognised in financial reports;
· it is recognised in financial reports which are not audited; or
· the taxpayer ceases to meet a particular requirement of an
elective Subdivision.
[Schedule 1, item 1, subsections 230-205(3), 230-245(3) and 230-375(3)]
195
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
When does the election cease to apply?
5.65 Where the election(s) made under the elective Subdivisions
cease to apply to all, or particular financial arrangements, the election
ceases to apply from the start of the income year in which the
circumstances described above occur. [Schedule 1, item 1,
subsections 230-205(1) and (3), 230-245(1) and (3), 230-325(1) and 230-375(1) and (3)]
5.66 If an election under any of the elective Subdivisions ceases to a
financial arrangement, that election cannot subsequently apply to it again.
Further, even if a subsequent election under the relevant elective
Subdivision is made, that election cannot apply to any financial
arrangement to which the prior election applied. [Schedule 1, item 1,
subsections 230-205(2) and (4), 230-245(2) and (4), 230-325(2) and 230-375(1) and (4)]
A balancing adjustment if an election ceases to apply
5.67 Where an election made under an elective Subdivision ceases to
have effect, a balancing adjustment must be made in respect of all the
financial arrangements to which the election ceases to apply. [Schedule 1,
item 1, subsections 230-210(1), 230-250(1) and 230-380(1)]
5.68 Where an election made under an elective Subdivision ceases to
apply to a particular financial arrangement, a balancing adjustment must
be made in respect of that arrangement. [Schedule 1, item 1,
subsections 230-210(3), 230-250(3) and 230-380(3)]
5.69 The balancing adjustment rules deem the taxpayer to have
disposed of the relevant financial arrangement(s) at the time the election
ceases to apply (ie, at the start of the relevant income year). The disposal
is deemed to be for the financial arrangement's fair value at that time, and
any balancing adjustment gain or loss is brought to account accordingly.
The balancing adjustment gain or loss is calculated as if it were a
balancing adjustment made under Subdivision 230-G. Further, the
taxpayer is taken to have immediately reacquired the financial
arrangement for its fair value. [Schedule 1, item 1, subsections 230-210(2), (4)
and (5), 230-250(2), (4) and (5) and 230-380(2), (5) and (6)]
5.70 Note that, for those financial arrangements subject to
Subdivision 230-D (the general foreign exchange retranslation election)
the balancing adjustment will only apply in respect of those gains or
losses attributable to foreign currency exchange rate fluctuations. Further,
this balancing adjustment does not apply to Subdivision 230-E (hedging
financial arrangements method). Subdivision 230-E has specific
provisions dealing with the consequences if an election ceases to have
effect (see Chapter 8).
196
Elective Subdivisions: common requirements
5.71 Chapter 10 provides a comprehensive outline of the operation of
the balancing adjustment rules contained in Subdivision 230-G.
The making of a new election
5.72 Where an election made by a taxpayer ceases to have effect
because one or more of the requirements for making the election is no
longer being met, they may subsequently make a new election where the
requirements for making the election are once more satisfied [Schedule 1,
item 1, subsections 230-205(2), 230-245(2), 230-325(2) and 230-375(2)]. For each of
the elective methods, other than Subdivision 230-E, only financial
arrangements that are entered into after the new election is made can be
subject to that election. This means that those financial arrangements that
were held at the time the election ceases to have effect cannot then be
subject to a subsequent election that is made [Schedule 1, item 1,
subsections 230-205(4), 230-245(4) and 230-375(4)].
197
Chapter 6
The elective fair value method
Outline of chapter
6.1 This chapter outlines how the elective fair value method
operates. The chapter explains:
· when the taxpayer can apply the elective fair value tax-timing
method;
· the effect of the elective fair value tax-timing method; and
· what valuations are used for the purposes of the elective fair
value tax-timing method.
Context of amendments
6.2 The current income tax law does not specifically provide for
gains and losses to be recognised on a fair value basis. The current
trading stock provisions provide the closest proxy by allowing taxpayers
to revalue trading stock on-hand by reference to changes in market value.
However, these provisions have limited application to many financial
arrangements.
6.3 The absence of an elective fair value method for the recognition
of gains and losses from a trading portfolio of financial arrangements
could mean that, while the portfolio is largely hedged in value terms, the
tax-timing method applying to the individual financial arrangements may
produce significant gains or losses that do not reflect the manner in which
those portfolio gains or losses are earned. This tax result is inconsistent
with the way that the gains and losses from the portfolio are recognised
for financial accounting purposes and managed for risk management
purposes. Where the portfolio is integral to the price-making function in a
financial market, the potentially significant difference between the tax and
financial accounting results would be distortionary.
6.4 The elective fair value method is a tax-timing methodology that
measures gain or loss for tax purposes as the change in the value of a
financial arrangement between two points in time. Under fair value tax
199
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
accounting the gain or loss from a financial arrangement for a particular
period is the increase or decrease in its fair value between the beginning
and end of the period, adjusted for amounts paid or received during the
period.
6.5 While the elective fair value method has a number of potential
advantages, mandatory application to all financial arrangements and all
taxpayers could potentially result in excessive volatility in reported
profits/losses and tax liabilities, creating adverse cash flow and liquidity
issues for some taxpayers. Imposing the elective fair value method could
also create substantial compliance costs for taxpayers where they are not
required to use the fair value method for accounting purposes. For these
reasons the fair value tax treatment is elective.
6.6 The elective fair value method requires integrity measures to
ensure that the elective treatment is not tax motivated. It is against this
background that the accounting and auditing requirements are necessary.
That is, the accounting and auditing requirements, which the taxpayer
must meet to make the fair value election and apply it to the financial
arrangements which they have, provide a level of integrity around
facilitating the elective fair value method in the appropriate circumstances
and minimising tax motivated accounting or selection practices. These
requirements, with other common requirements and conditions, are
discussed in more detail in Chapter 5.
Summary of new law
6.7 Relevant taxpayers may irrevocably elect to use the elective fair
value method to determine gains and losses on financial arrangements
including equity interests (other than equity interests of which they are the
issuers) for the income year. The fair value gain or loss for an income
year will be the same as that recorded on a fair value basis in the entity's
audited profit or loss account under relevant Australian accounting
standards or their comparable foreign equivalents.
6.8 When the requirements for making the election cease to be
satisfied, the fair value election ceases to have effect and a balancing
adjustment is required to be made.
200
The elective fair value method
Comparison of key features of new law and current law
New law Current law
Taxpayers who prepare financial Only limited fair value tax treatment
reports in accordance with the is available for financial
relevant financial accounting arrangements.
standards and have audited financial
accounts can elect to have financial
arrangements (other than equity
interests of which they are the
issuers) taxed annually under the fair
value method, if those financial
arrangements are accorded fair value
treatment in their profit or loss
statement.
If a taxpayer adopts the elective fair
value method it applies to all assets
and liabilities that are financial
arrangements which are fair valued
through their audited profit or loss
account for accounting purposes.
The election is irrevocable and once
elected it applies on a mandatory
basis to all financial arrangements
that are accorded fair value treatment
in the audited profit or loss account.
The fair value election applies for the
income year in which the election is
made and for all future income years,
unless one or more of the
requirements associated with that
election cease to be satisfied.
Detailed explanation of new law
6.9 To apply the elective fair value method to a financial
arrangement, the taxpayer must:
· elect the method [Schedule 1, item 1 , subsection 230-180(1)];
· meet the common requirements for a valid election -- that is,
prepare financial reports in accordance with the relevant
accounting standards and have those financial reports audited
in accordance with the relevant auditing standards (for more
detail on the common requirements for the elective
201
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Subdivisions refer to Chapter 5) [Schedule 1, item 1,
subsection 230-180(2)];
· classify the financial arrangement in the financial report,
pursuant to the operation of the relevant accounting
standards, as an asset or liability at fair value through profit
or loss -- noting the exception for financial arrangements
that are not recognised in a set of financial reports because of
the application of accounting standard Australian Accounting
Standard AASB 127 Consolidated and Separate Financial
Statements (AASB 127) (or comparable) [Schedule 1, item 1,
subparagraph 230-185(1)(c)];
· treat the asset or liability that is classified at fair value
through profit or loss (or that part of the asset or liability) as
comprising the whole of the relevant financial arrangement
(with any balance of the `financial arrangement' as defined in
this Division being treated as a separate financial
arrangement) [Schedule 1, item 1, section 230-200]; and
· apply the fair value tax-timing election to the financial
arrangement if:
- it starts to be held in the income year in which the
election is made or any subsequent income year
[Schedule 1, item 1, paragraph 230-185(1)(d)]; and
- it is not subject to certain exceptions [Schedule 1, item 1,
section 230-190].
Which entities can elect the fair value tax-timing method?
6.10 Any entity that prepares audited financial reports is able to make
a fair value election [Schedule 1, item 1, section 230-180]. However, only
certain taxpayers may want to elect to use the fair value tax-timing
method. For instance, traders holding instruments or commodities for
relatively short times, and buying and selling commodities or financial
instruments primarily for market-making purposes, might elect fair value
tax treatment. `Traders' generally have fully or largely hedged exposures.
6.11 Traders are often financial institutions that have separate trading
books. These institutions usually have large portfolios of financial
arrangements which are fair valued through profit or loss for financial
accounting purposes. If such institutions are able to elect fair value tax
treatment for such financial arrangements both their accounting and tax
treatments would be on the same fair value basis, and they would benefit
202
The elective fair value method
from substantial economies in record keeping and data management.
Overall compliance costs are expected to be reduced as a result.
6.12 Some other entities, outside the financial sector, may also have
relatively sophisticated risk management systems which would allow
them to cope with any price risk and tax volatility that may arise from
using the fair value tax-timing method. Such entities may also want to
elect fair value tax treatment. Furthermore, entities that record gains and
losses on a fair value basis in their audited profit or loss accounts may
also want to elect fair value tax treatment to reduce overall compliance
costs.
Making the election
6.13 Any taxpayer may make a fair value election, but an election
will only be valid for those taxpayers who meet the requirements of
Subdivision 230-C.
6.14 In the case of a tax consolidated group or a multiple entry
consolidated group (MEC group), elections are made by the head
company of the group. Generally, an election under Division 230 will
apply to all the relevant transactions of all members of the consolidated
group or MEC group. However, there is an exception to this where a tax
consolidated group or MEC group includes a member that carries on a
`life insurance business'. Where a member of the group carries on a life
insurance business the head company can specify whether or not the
election will apply to the life insurance business carried on by that
member of the group. [Schedule 1, item 1, subsection 230-190(3)]
6.15 A regulation-making power allows for regulations to be made
specifying other types of businesses for which a fair value election made
by the head company of a consolidated group or MEC group will not
apply. [Schedule 1, item 1, subsection 230-190(4)]
6.16 The making of a valid election and its application to a member
of a consolidated group that carries on life insurance business is discussed
in more detail in Chapter 5.
The elective fair value tax-timing requirements
6.17 For the elective fair value method to apply to the financial
arrangements of a taxpayer for the bringing to account of gains and losses,
a taxpayer must elect for the elective fair value method to apply. An
election will only be valid if the accounting and audit requirements listed
in subsection 230-180(2) are met. There are elective requirements
common to the elective Subdivisions (Subdivisions 230-C, 230-D, 230-E
203
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
and 230-F). These accounting and audit elective requirements are
discussed in detail in Chapter 5. There are also a number of requirements
which a particular financial arrangement must meet in order for the
election to validly apply, which are discussed below.
Financial arrangements fair valued through the profit or loss
6.18 Once a fair value election has been made the election applies to
all financial arrangements which are first held in the income year in which
the election is made or in later income years and which are fair valued
through profit or loss [Schedule 1, item 1, paragraphs 230-185(1)(c) and (d)]. In
addition, a transitional election may be made to apply the elective fair
value method to financial arrangements being fair valued through profit or
loss that existed at the time of commencement of the Division [Schedule 1,
Part 3, subitems 99(5) and (8)]. The transitional election requirements are
discussed in Chapter 12.
6.19 Where a financial arrangement is an intra-group transaction for
the purposes of accounting standard AASB 127 (or comparable), the
financial arrangement is deemed to be an arrangement that is recognised
in a set of audited financial reports and classified as at fair value through
profit or loss [Schedule 1, item 1, subsections 230-185(2) and 230-195(2)]. For
further discussion of this, see Chapter 5.
6.20 Arrangements that fall within the extended operation of
Division 230, as set out in section 230-445 (eg, foreign currency,
non-equity shares and commodities held by traders), which are fair valued
for the purpose of the profit or loss statement can also be fair valued for
tax purposes. [Schedule 1, item 1, section 230-445]
6.21 Financial arrangements which are fair valued, and which are not
classified as fair value through profit or loss because the change in fair
value is initially taken to equity, cannot be fair valued for the purposes of
Division 230. [Schedule 1, item 1, paragraph 230-185(1)(c)]
Financial assets and liabilities that comprise the whole or part of the
financial arrangement
6.22 The application of the elective fair value tax method is limited to
those financial arrangements which, in whole or in part, comprise assets
or liabilities classified in the relevant accounts as at fair value through
profit or loss [Schedule 1, item 1, paragraph 230-185(1)(c)]. Where only part of a
financial arrangement is subject to fair value (eg, the financial
arrangement may comprise a financial asset or liability that is fair valued
through the profit or loss and another financial asset or liability which is
not), that part of the arrangement is treated as a separate financial
204
The elective fair value method
arrangement that is subject to this Subdivision. The remaining part of the
financial arrangement will be treated as a separate financial arrangement
and will be subject to the other provisions of the Division [Schedule 1,
item 1, section 230-200].
6.23 Where a hybrid financial arrangement (comprising a host
instrument and an embedded derivative) is bifurcated (separated) under
the relevant accounting standards (Australian Accounting Standard
AASB 132 Financial Instruments: Disclosure and Presentation
(AASB 132) and Australian Accounting Standard AASB 139 Financial
Instruments: Recognition and Measurement (AASB 139)) the derivative
may be fair valued for accounting purposes. However, such a hybrid
arrangement may be a single arrangement for the purpose of Division 230
[Schedule 1, item 1, section 230-60]. If the taxpayer has made a fair value
tax-timing election in relation to such a hybrid arrangement that is a
financial arrangement, it is the intention that such derivatives, which are
part of the hybrid arrangement, would be fair valued for tax purposes
[Schedule 1, item 1, section 230-200].
Consequences of making a fair value election
6.24 A fair value tax-timing election requires the taxpayer to apply
the elective fair value method to all financial arrangements that are
required by the relevant accounting standards to be fair valued through
profit or loss, and that are not subject to an exception. The fair value
election, once made, applies from the beginning of the income year in
which the election is made. The election will apply to all financial
arrangements which start to be held in the income year in which the
election is made (including arrangements subject to a transitional election
-- see Chapter 12) or a later income year so long as the election remains
valid and continues to apply. [Schedule 1, item 1, paragraph 230-185(1)(d)]
6.25 An election will continue to be valid as long as the requirements
which a taxpayer must meet in order to make the election, including the
accounting and auditing requirements, continue to be met [Schedule 1,
item 1, subsection 230-205(1)]. Chapter 5 discusses these common
requirements and the making of an election. In the income year in which
one or more of these requirements ceases to be met, the election will cease
to be valid and the elective fair value method may not be applied to
financial arrangements then held by the taxpayer (see paragraphs 6.34 to
6.36). For those financial arrangements which were previously being fair
valued, a balancing adjustment is required to be made (see
paragraphs 6.37 to 6.39 and Chapter 10) when the election ceases to be
valid.
205
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
The application of fair value to financial arrangements that are equity
interests
6.26 The elective fair value method may apply to all financial
arrangements, including financial arrangements which are equity interests
under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997),
subject to the satisfaction of the fair value tax-timing requirements and the
exclusion set out below.
6.27 A taxpayer that has issued its own equity interests is not
permitted to fair value those entity interests [Schedule 1, item 1,
subsection 230-190(1)]. This rule is directed at ensuring that an entity does
not obtain a tax deduction for losses on its own equity including
deductions for dividends paid.
Gains and losses taken into account where a fair value election is made
6.28 Where a fair value election applies to a financial arrangement
the gains or losses for an income year will be determined by relevant
accounting standards. Where the Australian accounting standards, or
comparable foreign accounting standards, require that a fair value
measurement through profit or loss be used to determine accounting
profits or losses on financial arrangements for an income year, these gains
and losses shall be used to determine the taxpayer's gain or loss for an
income year from those financial arrangements, should the taxpayer make
the fair value election that validly applies to those financial arrangements.
[Schedule 1, item 1, subsection 230-195(1)]
6.29 Franked distributions (received either directly by the taxpayer or
indirectly through a partnership or trust) and rights to receive franked
distributions (either directly or indirectly) are not to be included as a gain
or loss that is brought to account in accordance with Subdivision 230-C.
The effect of excluding franked distributions from the scope of the fair
value election is to ensure that these distributions will remain assessable
in accordance with section 44 of the Income Tax Assessment Act 1936
(ITAA 1936). Assessing the distribution under section 44 of the
ITAA 1936 rather than under Division 230 will ensure that the imputation
system works appropriately in respect of distributions such that franking
credits allocated to such distributions are available to the recipient in the
income year in which the distribution is taxed to the recipient.
6.30 Absent a specific rule, a dividend (distribution) may be declared
in favour of a shareholder and the accounting standards (eg, Australian
Accounting Standard AASB 118 Revenue) would have required the
taxpayer to recognise revenue (ie, a gain) in respect of the declared
distribution. At this time, however, the dividend could not be franked.
206
The elective fair value method
Later when the dividend is actually paid, that payment would not be
assessed to the taxpayer because of the operation of the anti-overlap rule
(section 230-20) and, accordingly, franking benefits would not be allowed
to the shareholder. In such cases, the right to receive the franked
distribution (that would arise at the time the dividend is declared) is also
excluded from the scope of the fair value election [Schedule 1, item 1,
subsection 230-195(2)]. To the extent that the distribution is an unfranked
distribution, the differences between the time the distribution is declared
and paid will not cause any imputation issues to arise. Therefore, if the
distribution is unfranked, it is still within the scope of the fair value
election and will be recognised in accordance with the accounting
standards.
6.31 The exclusion in subsection 230-195(2) will apply equally to
distributions received directly by the taxpayer from a corporate tax entity
or received indirectly by the taxpayer as a beneficiary of a trust or through
a partnership. In these cases, a beneficiary of a trust (and equally a
taxpayer that will receive franked distributions through a partnership) will
only recognise a dividend either when it is received through the trust or
when the dividend is declared but not paid and the beneficiary knows how
much it will actually receive. If this cannot be determined by the
beneficiary, then the exclusion in subsection 230-195(2) will not apply.
Example 6.1: Dividend payment
On 1 July 2008 Company A acquires ordinary shares in Company B
for $50 million and makes the fair value election in respect of all its
financial arrangements. At 30 June 2009 the shares in Company B
have a market value of $65 million. On 1 May 2009 Company B pays
dividends of $6 million. Company A's taxable income for the
2008-2009 year includes the fair value gain of $15 million
($65 million $50 million) and a dividend of $6 million (ignoring
grossing-up for franking credits). However, Division 230 will only
assess the fair value gain of $15 million. The dividend paid by
Company B will be assessed under section 44 of the ITAA 1936.
At 30 June 2010 the shares in Company B have a market value of
$90 million. No dividends have been paid for this income year.
Company A's taxable income for the 2009-10 income year includes the
fair value gain of $25 million ($90 million $65 million).
Valuation issues
6.32 The term fair value is not defined in Division 230. The term
should take its ordinary commercial meaning. In this regard, AASB 139
defines fair value as `...the amount for which an asset could be exchanged
207
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
or a liability settled, between knowledgeable, willing parties in arm's
length transactions'.
6.33 The valuation methods used, and the guidance, definitions and
requirements for the elective fair value method ought to generally be the
same as those used for the fair value valuation in relevant accounting
standards. Therefore, if taxpayers use fair value estimates in their profit
or loss accounts that accord with commercially acceptable valuation
techniques, they can generally use the same estimates for the purpose of
the elective fair value method.
Where requirements for election are no longer satisfied
6.34 Although an election under the elective Subdivisions is
irrevocable, the election may cease to apply, depending on the
circumstances of either:
· all of a taxpayer's financial arrangements; or
· one or more particular financial arrangements of the
taxpayer.
6.35 If an election under any of the elective Subdivisions ceases to
apply to all financial arrangements, or to a particular financial
arrangement, that election cannot subsequently apply to it again.
[Schedule 1, item 1, section 230-205]
6.36 Refer to Chapter 5 for further information as to when an election
will cease to apply.
Balancing adjustment if election ceases to apply
6.37 Where an election made under an elective Subdivision ceases to
have effect, or ceases to apply to a particular financial arrangement, from
the start of a particular income year, a balancing adjustment is made at
that time in respect of any financial arrangement that is no longer subject
to the election. [Schedule 1, item 1, subsections 230-210(1) and (3)]
6.38 The balancing adjustment is to be made in accordance with the
balancing adjustment requirements as set out in Subdivision 230-G
(see Chapter 10). The balancing adjustment when applied to a financial
arrangement has the effect of a disposal of that financial arrangement --
for its market value at the start of the income year in which the election
ceases to apply -- followed by an immediate reacquisition for that market
value. [Schedule 1, item 1, section 230-210]
208
The elective fair value method
6.39 Chapter 5, in respect of the elective Subdivisions, and
Chapter 10 more generally, provide further detail as to the operation of the
balancing adjustment rules contained in Subdivision 230-G.
Example 6.2
On 22 April 2009 Spice Co makes a fair value election under
section 230-180. Assume Spice Co has a balance date for tax purposes
of 30 June.
After the financial year ending 30 June 2010, Spice Co ceases to have
its financial reports audited.
From the financial year beginning 1 July 2012, Spice Co again satisfies
all the requirements for making a fair value election (including the
requirement that its accounts are audited). Spice Co makes a new fair
value election under section 230-180.
The consequences of Spice Co ceasing to maintain audited financial
reports from 1 July 2010 results in Spice Co not being able to apply the
elective fair value method to the financial arrangements it holds at
1 July 2010, as its election ceases to apply from this time. A balancing
adjustment will be required to be made on 1 July 2010 for those
financial arrangements which were being fair valued through profit or
loss subject to the fair value election.
On 1 July 2012, Spice Co again makes a valid fair value tax-timing
election. From this time, the elective fair value method will apply to
any new assets and liabilities that comprise a financial arrangement
(or part thereof) that start to be held on or after this time by Spice Co,
which are fair valued through profit or loss in accordance with the
relevant accounting standards.
6.40 Once a financial arrangement is taken to be reacquired and no
longer subject to the elective fair value method, a taxpayer will need to
assess which other relevant tax-timing method under Division 230, is to
be applied to the financial arrangement. For example, where the taxpayer
ceases to have financial reports prepared in accordance with Australian
accounting standards, the default tax-timing methods under Division 230
(accruals or realisation) will typically apply.
Making a new election
6.41 Where a taxpayer has made an election which ceases to have
effect, they may later make a new election where the conditions for
making an election are once more satisfied (refer Chapter 5). [Schedule 1,
item 1, subsection 230-205(2)]
209
Chapter 7
The elective foreign exchange
retranslation method
Outline of chapter
7.1 This chapter outlines how the elective foreign exchange
retranslation method (retranslation method) will operate. The chapter
explains:
· when the retranslation method may be applied;
· the effect of the retranslation method;
· special rules applying when taxpayers elect the retranslation
method only in respect of their qualifying foreign exchange
accounts; and
· the interaction of the retranslation method with the other
elective methods under Division 230.
Context of amendments
7.2 The retranslation method measures the gain or loss that arises
from translating a given number of units of one currency into another
currency, which is due to different prevailing exchange rates at different
points in time. The retranslation tax-timing method will only be relevant
to those taxpayers with arrangements denominated in, or determined by
reference to, a foreign currency or, in the case of taxpayers who have
made an election under Subdivision 960-D of the Income Tax Assessment
Act 1997 (ITAA 1997), a non-functional currency.
7.3 The scope of the retranslation method is determined by the two
foreign exchange retranslation elections available to taxpayers:
· the general foreign exchange retranslation election, the scope
of which is determined by the amounts required by
Australian Accounting Standard AASB 121 The Effects of
Changes in Foreign Exchange Rates (AASB 121) to be
recognised in the profit or loss statement in a taxpayer's set
211
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
of financial statements, in respect of all financial
arrangements and other arrangements (general retranslation
election) -- where those amounts have not previously been
recognised in the taxpayer's set of financial statements; and
· the qualifying foreign exchange accounts retranslation
election (the scope of which is determined by the scope of
the current retranslation election in Subdivision 775-E of the
ITAA 1997 and which is extended by this amendment). The
scope of the `qualifying forex accounts retranslation election'
and the retranslation election contained in Subdivision 775-E
of the ITAA 1997 is determined by the definition of
`qualifying forex retranslation account' which is being
amended to cover transactional accounts more broadly.
7.4 Under AASB 121, certain annual gains and losses attributable to
changes in foreign exchange rates are recognised in profit or loss in an
entity's financial reports (foreign exchange gains and losses). The
retranslation method is intended to apply only to these annual foreign
exchange gains and losses.
7.5 Foreign exchange gains and losses, which are referred to in
AASB 121 as exchange differences, are the differences resulting from
translating a given number of units of one currency into another currency
at different exchange rates. There is an initial translation when the
relevant item is first recognised for financial accounting purposes. At
subsequent reporting dates, there is another translation, sometimes
referred to as `retranslation'. These foreign exchange gains and losses are
recognised in the profit or loss statement for accounting purposes, despite
typically being unrealised (in the sense that an amount representing the
gain or loss is not yet due for payment at receipt).
7.6 Foreign exchange gains and losses can also arise under
AASB 121 on the settlement or maturity of the relevant item (eg, where
this occurs during an income year).
7.7 Movements in foreign exchange rates and the use of the
financial accounting retranslation method in respect of a financial
arrangement (or other arrangement) will generally result in the recognition
of unrealised foreign exchange gains and losses. If the entity continues to
hold the financial arrangement (or other arrangement), taxation of any
unrealised foreign exchange gains or losses as a result of applying the
retranslation method may, like the fair value tax-timing method, cause
volatility to an entity's taxable income. Taxpayers will need to determine
whether this method is suitable for determining foreign exchange gains
and losses for tax purposes.
212
The elective foreign exchange retranslation method
7.8 Retranslation is different to fair value in that it only recognises
gains and losses attributable to movements in foreign currency exchange
rates. Fair value, on the other hand, recognises gains and losses
attributable to changes in other variables such as interest rates and
creditworthiness in addition to any gains or losses attributable to
movements in foreign currency exchange rates. Consistent with the
approach relating to the fair value tax rules, Division 230 does not
mandate retranslation tax treatment.
7.9 However, for some taxpayers, recognising foreign exchange
gains and losses from arrangements for tax purposes in a manner
consistent with what is required under AASB 121 may be beneficial from
a compliance perspective. Their foreign exchange exposures are likely to
be such that the retranslation method in AASB 121 does not impose
significant volatility in earnings, and therefore alignment between the
financial accounting and tax outcomes would also not impose any
significant volatility in taxable income.
7.10 Other taxpayers may see benefits in recognising for tax purposes
foreign exchange gains and losses as determined under AASB 121 only in
respect of those financial arrangements such as transactional accounts,
where there is a high volume of foreign exchange gains and losses being
realised -- that is, in respect of `qualifying forex accounts'.
7.11 To a limited extent this latter option (of retranslating certain,
high-volume financial arrangements) is available to taxpayers under the
existing law. Under Subdivision 775-E of the ITAA 1997, a retranslation
election that operates to imitate the retranslation method in AASB 121 is
available for certain transactional foreign currency denominated accounts
maintained with a bank or similar financial institution.
7.12 On 5 August 2004 the then Minister for Revenue and Assistant
Treasurer announced, in Press Release No. 002, that the ITAA 1997
would be amended to allow this limited retranslation election to be
extended to all transactional foreign currency denominated accounts.
7.13 In this context, where a taxpayer does not want the retranslation
method to apply to all of its relevant arrangements, it may still elect for
any of its transactional foreign currency denominated financial
arrangements to have foreign exchange gains and losses determined using
a retranslation method which is in accordance with the Australian
accounting standards or comparable foreign accounting standards.
213
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Summary of new law
7.14 Taxpayers that prepare audited financial reports in accordance
with the Australian accounting standards or comparable foreign
accounting standards may elect to use the retranslation method to
determine annual gains and losses from financial arrangements to the
extent they are attributable to foreign exchange changes. The general
retranslation election, if made, will also apply to determine foreign
exchange gains and losses made from arrangements that do not have their
gains and losses subject to Division 230 (such as financial arrangements
subject to an exception in Subdivision 230-H, as discussed in Chapter 2).
7.15 Once made, a general retranslation election applies to all
arrangements which are first held in the income year in which the election
is made or in a subsequent income year, in respect of which the relevant
accounting standards recognise an amount attributable to foreign currency
exchange changes in profit or loss. This includes, in the case of a
retranslation election made by the head company of a consolidated group,
or a multiple entry consolidated group (MEC group), intra-group
transactions that are financial arrangements which would be recognised by
the Australian Accounting Standard AASB 127 Consolidated and
Separate Financial Statements (AASB 127), or a comparable foreign
accounting standard.
7.16 The general retranslation election does not have to apply to the
financial arrangements in relation to the life insurance business of the
head company of a consolidated group or a MEC group, as the head
company may choose that the election does not apply to these financial
arrangements. Regulations may also be made to allow the head company
of a consolidated or MEC group to choose to elect to exclude the financial
arrangements in relation to other businesses of the group.
7.17 Taxpayers not making the general retranslation election may still
elect to use the retranslation method to determine annual foreign exchange
gains and losses from, broadly, any transactional accounts they select.
This limited election is the `qualifying forex accounts election'.
7.18 The foreign exchange retranslation gain or loss, recognised on a
Division 230 financial arrangement (or other arrangement) for an income
year, will be the same as that which is required to be recognised under
AASB 121 or its foreign equivalent.
7.19 Both the general retranslation election and the qualifying forex
accounts election are irrevocable.
7.20 Where the requirements for making either election cease to be
satisfied, the election ceases to have effect and a balancing adjustment is
required to be made.
214
The elective foreign exchange retranslation method
Comparison of key features of new law and current law
New law Current law
Taxpayers that adopt relevant There is no general retranslation tax
accounting standards and have treatment available for financial
audited financial accounts are able to arrangements under the existing
elect to have annual foreign tax law.
exchange gains and losses from all The election in the current law which
relevant arrangements taxed under permits certain accounts to imitate
the retranslation method. the retranslation method, is only
Alternatively, taxpayers with available for transactional accounts
financial arrangements that are held with, broadly, banks.
transactional accounts may elect to
have annual foreign exchange gains
and losses, from one or more of these
financial arrangements, taxed under
the retranslation method.
Detailed explanation of new law
When can the foreign exchange method be used?
7.21 The retranslation method will only apply in respect of an
arrangement if a foreign exchange retranslation election validly applies to
that arrangement.
7.22 A foreign exchange retranslation election may apply in two
circumstances:
· at the taxpayer's election, to all relevant arrangements, where
the specified accounting and auditing requirements are
satisfied (general retranslation election) [Schedule 1, item 1,
subsections 230-220(1) and (2); item 6, section 775-295]; or
· to financial arrangements that are qualifying foreign
exchange accounts, in respect of which an election has been
made (qualifying forex accounts election) [Schedule 1, item 1,
subsections 230-220(3) and (4)].
General retranslation election
Election requirements
7.23 Certain criteria must be satisfied before a general retranslation
election can apply. These criteria are essentially financial reporting and
215
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
auditing requirements, which provide integrity to the elective foreign
exchange retranslation treatment. [Schedule 1, item 1, subsection 230-220(2)]
7.24 In respect of both these accounting and auditing requirements,
what is meant by financial reports, accounting standards, and auditing
standards (including comparable accounting and auditing standards) is
explained in Chapter 5.
Scope of taxpayers who can make the general retranslation election
7.25 Any taxpayer may make a general retranslation election but an
election will only be valid for Division 230 purposes in respect of those
taxpayers which meet the requirements of the election. The scope of
taxpayers that may be able to make a valid election is discussed in
Chapter 5.
Scope of general foreign exchange retranslation election
7.26 If the general foreign exchange retranslation election is made
under subsection 230-220(1), the retranslation method will apply to
determine all foreign exchange gains and losses from those arrangements
to which the election applies.
7.27 A general foreign exchange retranslation election will apply to
all arrangements:
· that the taxpayer starts to have in the income year in which
the election is made, or in a later income year [Schedule 1,
item 1, paragraph 230-225(1)(d); item 6, paragraph 775-295(1)(a)];
· that are recognised in a financial report in respect of which
the accounting and auditing requirements are satisfied
[Schedule 1, item 1, paragraph 230-225(1)(b); item 1,
paragraph 230-295(1)(b)];
· in respect of which an amount attributable to changes in
currency exchange rates (if any) is required to be recognised
in profit or loss in the financial reports, pursuant to
AASB 121 (or another standard prescribed in the regulations)
or, where this standard does not apply, a comparable foreign
accounting standard (the foreign exchange gain or loss
requirement) [Schedule 1, item 1, paragraph 230-225(1)(c); item 1,
paragraph 230-295(1)(c)];
· where the amount attributable to changes in currency
exchange rates (for the arrangement) is recognised in the
profit or loss statement in the taxpayer's financial reports and
216
The elective foreign exchange retranslation method
which has not previously been recognised in the equity
reserves in the taxpayer's financial reports [Schedule 1, item 6,
subsection 775-305(4)]; and
· including, where the election is made by the head company
of a consolidated or MEC group, intra group transactions,
that are financial arrangements which have not been
recognised in the financial reports because they have been
disregarded for financial accounting purposes under
Australian accounting standard AASB 127, or a comparable
foreign accounting standard [Schedule 1, item 1,
subsection 230-225(2)].
7.28 Under AASB 121 (or comparable foreign accounting
standards -- see Chapter 5), certain gains and losses attributable to
changes in foreign exchange rates (foreign exchange gains and losses) are
recognised in the profit or loss statement in an entity's financial reports.
For the general retranslation election to apply to a financial arrangement
(or an arrangement), AASB 121 (or a comparable foreign accounting
standard) must require the recognition, in profit or loss, of foreign
exchange gains and losses (if any) from the arrangement in the year in
which the gain or loss arises. The requirement that a gain or loss must be
recognised in profit or loss will not be satisfied where the gain or loss is
recognised in profit or loss after having earlier been recognised in an
equity reserve.
7.29 In respect of this requirement, the regulations may prescribe that
the annual foreign exchange gain or loss may be required to be recognised
under accounting standards other than AASB 121. For example, if
AASB 121 is replaced subsequent to the enactment of Division 230, and
the replacement standard provides for retranslation, such a replacement
standard would be expected to be prescribed by the regulations as being a
relevant accounting standard. If so, foreign exchange gains and losses
from relevant arrangements will be required to be recognised under such a
replacement standard. Likewise, to the extent to which comparable
foreign standards require foreign exchange gains and losses from financial
arrangements to be recognised in profit or loss, and where those amounts
have not been recognised in an equity reserve previously, this requirement
will also be satisfied.
7.30 Where a general retranslation election applies to an arrangement,
the foreign exchange gains and losses from that arrangement will be
determined using a retranslation method, as discussed below. These gains
and losses may be brought to account under either Division 230 or 775 of
the ITAA 1997, depending on the type of arrangement the general foreign
exchange retranslation election is applying to. Whilst Division 775 will
technically apply to all arrangements that are subject to a general foreign
217
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
exchange retranslation election, subsection 230-20(2) has the effect of
disregarding gains and losses from such arrangements under Division 775
to the extent they are, or will be, included in assessable income or
allowable as a deduction under Division 230. This is the case
notwithstanding the assessing provisions in Division 775 which would
otherwise have application. This is clarified by a note, following
subsections 775-15(4) and 775-30(4), inserted by this Schedule, which
clarifies that Division 230 is to apply where Division 775 would also
apply, but for subsection 230-20(2). [Schedule 1, items 2 and 3]
Division 230 retranslation arrangements
7.31 Where a general retranslation election applies to a financial
arrangement as described in Chapter 2, its gains and losses attributable to
currency exchange rate changes will be subject to Division 230 unless:
· the financial arrangement is subject to an exception that
provides that its gains and losses are not subject to
Division 230 (discussed in Chapter 2); or
· the financial arrangement is specifically excluded from
having the general retranslation method apply to it under
Division 230, by subsection 230-230(3) or (4) -- see
Chapter 5.
7.32 Those financial arrangements specifically excluded from
retranslation treatment under Division 230 are:
· equity financial arrangements (including equity interests and
certain rights or obligations in respect of equity interests, as
explained in Chapters 2 and 5) [Schedule 1, item 1,
subsection 230-230(1)]; and
· qualifying securities held by individuals and by other entities
with a turnover less than the relevant threshold, who have not
elected to have their financial arrangements subject to
Division 230 (as explained in Chapter 5) [Schedule 1, item 1,
subsection 230-230(2)].
7.33 Where a general retranslation election applies to a relevant
financial arrangement, the amount taken to be a gain or loss for the
purposes of Division 230 is determined by AASB 121 or a comparable
foreign accounting standard. The gain or loss taken to be made from the
financial arrangement is the amount which AASB 121 or a comparable
foreign accounting standard requires to be recognised in profit or loss for
that financial arrangement. [Schedule 1, item 1, subsection 230-240(1)]
218
The elective foreign exchange retranslation method
Foreign exchange retranslation under Division 775 of the ITAA 1997
7.34 An arrangement to which the general retranslation election
applies will have its foreign exchange gains and losses subject to
Division 775 if it is:
· a financial arrangement whose gains and losses are not
subject to Division 230 (as set out in Subdivision 230-H and
explained in Chapter 2);
· a financial arrangement in respect of which the general
retranslation election does not apply for the purposes of
Division 230 [Schedule 1, item 1, section 230-230]; or
· an arrangement, which constitutes a right and/or an
obligation to receive or provide foreign currency, which is
not a financial arrangement.
[Schedule 1, item 6, Subdivision 775-F]
7.35 Where Division 775 of the ITAA 1997 applies to an
arrangement to which the general retranslation election applies, the
amount taken to be a foreign exchange realisation gain or loss for the
purposes of that Division is also determined by AASB 121 or a
comparable foreign accounting standard. The gain or loss taken to be
made is the amount attributable to a foreign exchange gain or loss in
respect of that arrangement, which is required by AASB 121 or a
comparable foreign accounting standard to be recognised in profit or loss
for that arrangement. This foreign exchange realisation gain or loss will
be recognised under new foreign exchange realisation event 9, contained
in Subdivision 775-F of the ITAA 1997. [Schedule 1, item 6, section 775-305]
The general retranslation election ceases to apply
7.36 Arrangements to which the general retranslation election applies
pursuant to either section 230-225 or 775-295 of the ITAA 1997, will
cease to be subject to that method from the start of any income year
during which the taxpayer stops meeting the accounting or auditing
requirements. This may occur if, for example, the taxpayer no longer
prepares its reports in accordance with the relevant accounting standards,
or it no longer satisfies the requirement that the reports are audited
(see Chapter 5). [Schedule 1, item 1, subsection 230-245(1)]
7.37 The cessation of the general retranslation election in this
circumstance does not prevent a fresh election being made, should those
requirements once again be satisfied. However, a remade general
219
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
retranslation election will apply only to those relevant arrangements the
taxpayer starts to have in the year the election is remade, or in subsequent
income years. [Schedule 1, item 1, subsection 230-245(2)]
7.38 In addition, the general retranslation election will cease to apply
to a particular arrangement from the start of any income year the
arrangement is:
· no longer recognised in a financial report that meets the
relevant accounting requirements discussed in Chapter 5; or
· no longer required to have amounts attributable to currency
exchange changes (if any) recognised in profit or loss
statements pursuant to AASB 121, a prescribed accounting
standard or a comparable foreign accounting standard,
discussed in paragraphs 7.28 and 7.29.
[Schedule 1, item 1, subsection 230-245(3); item 6, subsection 775-310(1)]
7.39 The general retranslation method cannot subsequently reapply to
such an arrangement, even where the relevant reporting, auditing and
particular accounting standard requirements are later satisfied once again.
[Schedule 1, item 1, subsection 230-245(4); item 6, subsection 775-310(2)]
Example 7.1: A financial arrangement ceases to be recognised in a
relevant financial report
Yvee Imports Ltd (Yvee) is a large Australian company that imports
forensic tools and equipment from various foreign sources for law
enforcement organisations. Yvee prepares accounts in accordance
with Australian accounting standards, and has its accounts audited in
accordance with the Australian auditing standards.
Yvee has various foreign currency denominated financial
arrangements in respect of which it is required to recognise amounts
in profit or loss in its financial reports, in accordance with
AASB 121.
Over time, several arrangements that had previously had amounts in
respect of currency exchange changes recognised under AASB 121
had diminished in value such that they, and the value they
represented, were no longer recognised in the financial reports, under
the accounting practice regarding materiality.
From the start of the income year in which the financial
arrangements were no longer recognised in the financial reports, the
elective retranslation method ceased to apply to these particular
arrangements of Yvee. Yvee continues to apply the retranslation
method to the remainder of its arrangements that satisfy the relevant
criteria.
220
The elective foreign exchange retranslation method
Balancing adjustment under Division 230 where the general
retranslation election ceases to apply
7.40 When the general retranslation method ceases to apply (as
discussed in paragraphs 7.35 to 7.38) to a Division 230 financial
arrangement (ie, a financial arrangement whose gains and losses are
subject to Division 230), a balancing adjustment is required to be made in
respect of that financial arrangement. [Schedule 1, item 1,
subsections 230-250(1) and (3)]
7.41 The balancing adjustment is to be made in accordance with the
balancing adjustment requirements as set out in Subdivision 230-G
(see Chapter 10). The balancing adjustment is:
· calculated on the assumption that the financial arrangement is
disposed of when the general retranslation method ceases to
apply (at the start of the income year in which the relevant
requirements are failed) for its market value at that time; and
· is limited to the extent to which the balancing adjustment so
calculated is reasonably attributable to a currency exchange
rate effect.
[Schedule 1, item 1, subsections 230-250(2) and (4)]
7.42 The provisions further provide that the relevant financial
arrangement is taken to be reacquired for its fair value at the time the
election ceased to apply. [Schedule 1, item 1, subsection 230-250(5)]
7.43 A currency exchange rate effect is defined in the ITAA 1997 to
mean any currency exchange rate fluctuations or the difference between
an agreed currency exchange rate for a future time and the applicable
currency exchange rate at that time. This ensures that only foreign
exchange gains and losses are taken into account at the time of the
deemed disposal when the general retranslation election ceases to apply to
a relevant financial arrangement.
7.44 As the retranslation method will no longer apply to such a
financial arrangement, the other tax-timing methods need to be considered
in respect of that arrangement.
221
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Consequences under Division 775 of the ITAA 1997 where the general
retranslation method ceases to apply
7.45 When the general retranslation method ceases to apply (as
discussed in paragraphs 7.36 to 7.39) to an arrangement that is being
retranslated under Division 775, the taxpayer will be taken to have:
· disposed of the relevant arrangement -- immediately prior to
the time the general retranslation election is taken to cease to
have effect or ceases to apply to that arrangement -- for its
market value at that time; and
· reacquired the arrangement -- immediately after the time the
general retranslation election is taken to cease to have effect
or cease to apply to it for that same value.
[Schedule 1, item 6, section 775-315]
7.46 Any difference between the retranslated value of the
arrangement at the time it was last retranslated and the time immediately
prior to the election ceasing, will be recognised as a gain or a loss under
foreign exchange realisation event 9. [Schedule 1, item 6, sections 775-305
and 775-315]
7.47 For the purposes of Division 775 of the ITAA 1997, any future
foreign exchange realisation gains or losses from the reacquired
arrangement will be determined under the general provisions of
Division 775.
Qualifying foreign exchange accounts retranslation election
Election requirements
7.48 Instead of making a general retranslation election that would
apply to all relevant arrangements, a taxpayer may elect to apply the
retranslation method to one or more of its qualifying foreign exchange
accounts that are financial arrangements. This election can only be made
where a general retranslation election (that applies to all relevant
arrangements) does not apply to the particular foreign exchange account.
Each financial arrangement in respect of which such an election is made
must be a qualifying foreign exchange account. [Schedule 1, item 1,
paragraph 230-220(3)(a)]
7.49 Note also that existing retranslation elections that apply to
qualifying foreign exchange accounts under Subdivision 775-E of the
ITAA 1997 will cease to apply to any account to which a general
retranslation election applies. [Schedule 1, item 5, subsection 775-270(1A)]
222
The elective foreign exchange retranslation method
Qualifying foreign exchange account
7.50 A qualifying forex account is an account that is denominated in
a foreign currency, and which either has the primary purpose of
facilitating transactions, or is a credit card account. [Schedule 1, item 22,
definition of `qualifying forex account' in subsection 995-1(1) of the ITAA 1997]
7.51 The current restriction which limited `qualifying forex accounts'
to accounts held with an `ADI' (authorised deposit-taking institution) as
defined in the ITAA 1997 has been removed [Schedule 1, item 22, definition of
`qualifying forex account' in subsection 995-1(1) of the ITAA 1997]. In a general
sense, the limitation in the existing law has meant that only accounts held
with banks and financial institutions were able to be retranslated under
Subdivision 775-E of the ITAA 1997.
7.52 The effect of this change is to broaden the category of accounts
which may be subject to foreign exchange retranslation treatment under
Subdivision 775-E of the ITAA 1997 and under the new provisions
contained in Subdivision 230-D.
The scope of the `qualifying forex account' retranslation election
7.53 A foreign exchange retranslation election may be made under
subsection 230-220(3) (the `qualifying forex account' retranslation
election) in respect of any financial arrangement that is a `qualifying forex
account'. This election can be made in respect of one or more qualifying
foreign exchange accounts at any time, subject to a general retranslation
election not applying to the account.
7.54 A qualifying foreign exchange account retranslation election
made in respect of a financial arrangement that is a `qualifying forex
account' will apply to determine all foreign exchange gains and losses
from that account. A qualifying forex account election made under
Subdivision 230-D can apply to those qualifying foreign exchange
account financial arrangements which were entered into prior to making
such an election. [Schedule 1, item 1, subsection 230-220(4)]
7.55 If a taxpayer makes a qualifying foreign exchange account
retranslation election before they start to have the financial arrangement
that is a qualifying foreign exchange account, then the retranslation
method applies from the time the taxpayer starts to hold that account
[Schedule 1, item 1, paragraph 230-220(4)(a)]. However, if the taxpayer already
held the qualifying foreign exchange account (the relevant financial
arrangement) prior to making the qualifying foreign exchange account
retranslation election, the retranslation method will apply from the start of
the year in which the taxpayer made that election [Schedule 1, item 1,
paragraph 230-220(4)(b)].
223
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
A balancing adjustment for a qualifying foreign exchange account entered
into before a qualifying foreign exchange account retranslation election is
made
7.56 At the time at which Division 230 first applies to a taxpayer,
they are able to elect to have Division 230 apply to all existing financial
arrangements. For more information on this refer to Chapter 12.
[Schedule 1, Part 3, subitem 99(2)]
7.57 Where a qualifying foreign exchange account retranslation
election is to apply to an existing qualifying foreign exchange account
(ie, one already held by the taxpayer at the time of making the election),
the election takes effect from the commencement of the income year in
which it is made. [Schedule 1, item 1, paragraph 230-220(4)(b)]
7.58 In this case, the taxpayer will be required to make a balancing
adjustment, determined as though the taxpayer ceased to hold the
qualifying foreign exchange account at the time the election first takes
effect in relation to that account (ie, at the start of the income year in
which the foreign exchange retranslation election is made), to the extent it
is attributable to a currency exchange rate effect (as described in
paragraph 7.41) [Schedule 1, item 1, section 230-235]. For information on how
to calculate the balancing adjustment, see Chapter 10.
7.59 For taxpayers already retranslating their qualifying foreign
exchange accounts under Subdivision 775-E of the ITAA 1997 and who
make a foreign exchange retranslation election in respect of those
qualifying foreign exchange accounts in the first year in which
Division 230 could apply to them, the balancing adjustment will only
have a practical impact where there is a gain or loss in respect of the
arrangement that is not attributable to currency exchange rate changes.
This is because the Subdivision 775-E of the ITAA 1997 retranslation
calculation would have already brought to tax gains and losses attributable
to currency exchange rate changes, up until the end of the immediately
preceding income year.
When a `qualifying forex account' retranslation election may cease to
apply
7.60 Financial arrangements to which the elective retranslation
method applies pursuant to a `qualifying forex account election' will
cease to be subject to that method from the start of any income year
during which:
· the financial arrangement stops being a `qualifying forex
account'; or
224
The elective foreign exchange retranslation method
· the taxpayer makes a foreign exchange retranslation
accounting election under subsection 230-220(1).
[Schedule 1, item 1, subsection 230-245(5)]
7.61 Where a qualifying foreign exchange account retranslation
election ceases to apply to a qualifying forex account, it cannot
subsequently reapply to that account, even if the relevant requirements
begin to be satisfied once more in relation to that account. (Refer to
Chapter 5 for further discussion of this point.) [Schedule 1, item 1,
subsection 230-245(6)]
A balancing adjustment under Division 230 where the qualifying foreign
exchange account retranslation election ceases to apply
7.62 When the `qualifying forex accounts retranslation election'
ceases to apply, a balancing adjustment is required to be made in respect
of that financial arrangement, in the same manner and with the same
consequences as for financial arrangements in respect of which the
general retranslation election ceases to apply under Division 230
(see paragraphs 7.39 to 7.43). [Schedule 1, item 1, subsections 230-250(3) to (5)]
Foreign exchange retranslation elections are irrevocable
7.63 A validly made general retranslation election or qualifying
foreign exchange account retranslation election cannot be revoked.
[Schedule 1, item 1, subsection 230-220(5)]
7.64 Notwithstanding the fact that a validly made general
retranslation election is irrevocable, it may, nonetheless cease (discussed
in paragraphs 7.36 to 7.44). Where an election ceases to have effect, a
taxpayer may later make a new election where the conditions for making a
general retranslation election are once more satisfied. Such a remade
election will only apply to arrangements the taxpayer starts to have in, or
after, the year in which the remade election takes effect, that were not
previously subject to such an election (see Chapter 5). [Schedule 1, item 1,
subsections 230-245(2) and (4)]
Interaction with other tax-timing methods in Division 230
7.65 Where a foreign currency denominated financial arrangement is
subject to a fair value election (see Chapter 6) any foreign currency gain
or loss on the arrangement will be brought to account under that method
[Schedule 1, item 1, paragraph 230-45(4)(a)], and the retranslation method will
not apply (despite any election that has been made). The reason for this is
that the fair value method recognises, as gains and losses, changes in fair
225
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
value between two points in time. Any change attributable to currency
movements will be picked up under that method.
7.66 To the extent to which a hedging financial arrangement election
applies to a financial arrangement (see Chapter 8), the retranslation
election will have no application [Schedule 1, item 1, paragraph 230-45(4)(b)].
Gains and losses from that financial arrangement will be determined
under the hedging method.
7.67 Finally, if an election to rely on financial reports applies to a
financial arrangement, the retranslation election does not apply [Schedule 1,
item 1, paragraph 230-45(4)(c)]. The financial reports method broadly
recognises gains and losses from financial arrangements based on the
method used in an entity's financial reports to recognise amounts from
financial arrangements. As such, to the extent to which AASB 121
applies to a financial arrangement, gains and losses required to be
recognised under that standard in respect of financial arrangements will be
recognised under the financial reports method. As a result, the
retranslation election will have no application.
7.68 In a hierarchical sense, these are the most fundamental
exclusions from the retranslation method, other than the exceptions
specified within the method itself, and already detailed above.
7.69 Note that in the absence of any elective tax-timing method
(including the retranslation method) applying to a foreign currency
denominated financial arrangement, the gain or loss attributable to
changes in the exchange rate will also be brought to account under the
accruals or realisation methods. This result will be achieved through the
combined operation of the accruals and realisation rules in Division 230,
and the translation rules in Subdivisions 960-C and 960-D of the
ITAA 1997.
7.70 The calculations under the accruals method in respect of a
foreign currency denominated financial arrangement are to be determined
in the relevant foreign currency. This effectively means that the accrual
calculation will only apply to gains and losses (from a financial
arrangement) which are not attributable to currency exchange rate
fluctuations. This is because the rule that ordinarily requires elements in a
calculation to be first translated to Australian currency (or the relevant
functional currency) before the calculation is conducted (in
subsections 960-50(4) and 960-80(4) of the ITAA 1997), does not apply
to amounts worked out under the accruals method in Division 230.
[Schedule 1, item 29, definition of `special accrual amount' in subsection 995-1(1) of
the ITAA 1997]
226
The elective foreign exchange retranslation method
7.71 Consistent with AASB 121 and its relationship with Australian
Accounting Standard AASB 139 Financial Instruments: Recognition and
Measurement, the retranslation method is intended to work in tandem with
the accruals and realisation methods. For this purpose, the retranslation
tax treatment operates with respect to the foreign currency component
while the remaining methods operate with respect to any domestic
currency components of the overall gain or loss from the financial
arrangement. See Examples 7.2 and 7.3.
Example 7.2: No foreign exchange retranslation election
A Co acquires a US dollar (US$) denominated promissory note with a
face value of US$100,000 for a cost of US$98,550. Assume the note is
acquired on the first day of A Co's income year and that the
promissory note matures in three years time.
A Co has not made a foreign exchange retranslation election, hedging
financial arrangement election, fair value election or election to rely on
financial reports under Division 230 in relation to the promissory note.
A Co has also not made a functional currency election under
Subdivision 960-D of the ITAA 1997.
The provisions in Subdivision 960-C of the ITAA 1997 which require
foreign currency amounts to be translated into Australian dollars will
apply for the US$ denominated amounts.
The relevant US$/A$ exchange rate prevailing:
· at the time the promissory note is acquired, is 0.75;
· at the end of year 1, is 0.73;
· at the end of year 2, is 0.76; and
· at the end of year 3, is 0.78.
The promissory note is a financial arrangement, as the only rights and
obligations A Co has under the promissory note is its right to receive
US$100,000, thus satisfying the test for a cash-settlable financial
arrangement (section 230-40).
A Co pays the US$98,550 when the promissory note is acquired.
The discount to the face value of the promissory note will be brought
to account under the accrual rules in Subdivision 230-B. The accrual
calculation undertaken to determine the amount of the relevant gain or
loss on the financial arrangement to be accrued each year, is to be
undertaken in the relevant foreign currency (definition of `special
accrual amount' in subsection 995-1(1) of the ITAA 1997).
227
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
The gain to be accrued is the US$1,450 discount, as this is a
sufficiently certain overall gain or loss from the financial
arrangement (the promissory note) that is known at the start time
(subsections 230-105(2) and 230-110(1)). The period over which this
gain is to be spread, on a compounding accruals basis, is the three-year
period from when A Co acquired the promissory note, to when it
matures (subsection 230-130(1) and section 230-135).
Over this three-year arrangement the internal rate of return calculates
to 0.488 per cent. This means the gain taken to be made from the
financial arrangement in each year under the accrual rules
(subsection 230-140(1)) is as follows:
· year 1 -- US$481;
· year 2 -- US$483; and
· year 3 -- US$486.
These gains are included in the assessable income of A Co
(subsection 230-15(1)). A Co must translate these assessable amounts
into Australian currency, using the translation rules in Subdivision
960-C of the ITAA 1997. Assuming A Co does not choose to use any
alternate translation rules allowed in Schedule 2 to the Income Tax
Assessment Regulations 1997, (such as a relevant average exchange
rate), these amounts translate to:
· A$659 in year 1 (US$481/0.73);
· A$636 in year 2 (US$483/0.76); and
· A$623 in year 3 (US$486/0.78).
However, as the arrangement has come to an end in year 3 (as on
receipt of the US$100,000, all of A Co's rights and obligations under
the financial arrangement have ceased), a balancing adjustment is
made (paragraph 230-385(1)(b)).
The balancing adjustment broadly involves comparing the financial
benefits and consideration received and paid under the financial
arrangement, with the gains and losses from the financial arrangement
assessable or allowable as deductions (subsection 230-395(1)).
Even though the US$98,550 A Co paid, not being an obligation
persisting when the promissory note is acquired, is not part of the
financial arrangement, it plays an integral role in determining whether
A Co has a gain or loss from the arrangement and therefore is
considered to be a financial benefit A Co provided under the financial
arrangement (subsection 230-65(1)).
228
The elective foreign exchange retranslation method
As such, under the balancing adjustment, A Co compares (in
Australian dollar terms, pursuant to subsection 960-50(4) of the
ITAA 1997), the US$100,000 received (step 1), with the US$98,550
paid plus any assessable gains made from the financial arrangement,
(ie, the accrual amounts) (step 2) (subsection 230-395(1)).
Balancing adjustment US$ Exchange A$
(section 230-300) rate
US$/A$
step 1 Financial benefit 100,000 0.78 128,205
received under
arrangement (face
value of note).
step 2 Financial benefit taken 98,550 0.75 131,400
to be provided under
arrangement (cost of
note)
plus
assessable gains from
arrangement (accrual
gains)
year 1 659
year 2 636
year 3 623
133,318
step 3 Excess of step 2 over (5,113)
step 1 is a loss made
from the financial
arrangement.
This loss of A$5,113, calculated under the balancing adjustment, is
taken to be a loss made from the financial arrangement, and deductible
in year 3 (subsections 230-395(1) and 230-15(2)).
Accordingly, the tax treatment of A Co's gains and losses from its
promissory note in total is:
· year 1 -- A$659 assessable gain;
· year 2 -- A$636 assessable gain;
· year 3 -- A$623 assessable gain; plus
-- A$5,113 allowable deduction
· NET -- A$3,195 deductible loss.
229
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
A Co's net position is a deductible loss of A$3,195. This is equal to
the difference, in Australian dollar terms, of the amount paid for the
promissory note (A$131,400), and the amount received on its maturity
(A$128,205).
Example 7.3: Foreign exchange retranslation election
Assume the facts are the same as for Example 7.2, but that A Co has
made a valid retranslation election.
The calculation of the gain or loss to be accrued will be the same.
In addition, any foreign exchange gains and losses will be calculated
each year under the retranslation method. Under AASB 121, the
carrying amount of A Co's promissory note will be translated into
Australian dollar currency at the date it was acquired, and at
subsequent recording dates, with any exchange differences required to
be recognised in profit or loss. Under the retranslation method, these
amounts will be taken to be gains or losses made from the financial
arrangement (subsection 230-240(1)).
It is assumed that A Co has been discounting its promissory note for
financial accounting purposes using the effective interest rate method,
on the same basis as the accrual calculations discussed in Example 7.2.
In the relevant years, the amount required by AASB 121 to be
recognised in profit or loss is therefore:
Year Carrying value (US$) Foreign exchange retranslation
gain / (loss) (A$)
(difference between carrying value
at closing and opening rates)
1 98,550 3,600
(US$98,550 × (1/0.73 1/0.75))
2 99,031 (5,355)
(98,550 plus 481 (US$99,031 × (1/0.76 1/0.73))
accrual gain from
year 1 -- see
Example 7.2)
3 99,514 (3,357)
(99,031 plus 483 (US$99,514 × (1/0.78 1/0.76))
accrual gain from
year 2 -- see
Example 7.2)
Therefore, under the retranslation method, a gain of A$3,600 will be
assessable in year 1, and losses of A$5,355 and A$3,357 will be
deductible in years 2 and 3 respectively (subsections 230-240(1) and
230-15(1) and (2)).
230
The elective foreign exchange retranslation method
In addition, as with Example 7.2, a balancing adjustment is required in
year 3, as at the end of year 3 the financial arrangement is realised.
Under the balancing adjustment, compare (in Australian dollar terms,
pursuant to subsection 960-50(4) of the ITAA 1997), the US$100,000
received plus any deductible losses made from the financial
arrangement (ie, any foreign exchange retranslation losses) (step 1),
with the US$98,550 paid plus any assessable gains made from the
financial arrangement, (ie, any accrual gains plus any foreign exchange
retranslation gains) (step 2) (subsection 230-395(1).
Exchange
Step Balancing adjustment US$ rate A$
US$/A$
step 1 Financial benefit received under 100,000 0.78 128,205
arrangement (face value of note)
plus
Deductible losses from arrangement:
year 2 retranslation loss 5,355
year 3 retranslation loss 3,357
Total of step 1 136,917
step 2 Financial benefit taken to be provided 98,550 0.75 131,400
under arrangement (cost of note)
plus
Assessable gains from arrangement
year 1 retranslation gain 3600
year 1 accrual gain (per Example 7.2) 659
year 2 accrual gain (per Example 7.2) 636
year 3 accrual gain (per Example 7.2) 623
Total of step 2 136,918
step 3 Excess of step 2 over step 1 is a loss (1)
made from the arrangement
As would be expected, as the retranslation method was used to
determine gains and losses on the promissory note attributable to
changes in foreign exchange rates, and the accruals method was used
to calculate the underlying gain made on the promissory note, there is
little left to capture under the balancing adjustment. The A$1 loss that
is taken to have been made under the balancing adjustment is
attributable to the rounding required under the other methods. This
A$1 is deductible to A Co in year 3 (subsections 230-395(1) and
15(2)).
Accordingly, the combined effect for A Co of an application of both
the accrual and retranslation methodologies, and the balancing
231
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
adjustment is that the total gain or loss calculated in the relevant years
from the promissory note is:
· year 1 -- A$4,259 gain
(A$3600 retranslation gain, plus A$659 accrual gain, per
Example 7.2);
· year 2 -- A$4,719 loss
(A$5,355 retranslation loss, plus A$636 accrual gain per
Example 7.2);
· year 3 -- A$2,734 loss
(A$3,357 retranslation loss, plus A$623 accrual gain per
Example 7.2, plus A$1 balancing adjustment loss);
· NET -- A$3,194 deductible loss.
As in Example 7.2, A Co's net position is a deductible loss of
A$3,194.
232
Chapter 8
The elective hedging financial
arrangements method
Outline of chapter
8.1 This chapter outlines the elective tax-hedge rules. The chapter:
· outlines the eligibility requirements that entities need to
satisfy if they wish to make use of the elective tax-hedge
rules; and
· explains the rationale, structure and operation of the
tax-hedge rules.
Context of amendments
8.2 Hedging activity is ordinarily conducted by businesses on a
pre-tax basis and is designed to manage, reduce or eliminate risk and
uncertainty associated with the taxpayer's financial exposures created
when anticipating the purchase, sale or production of commodities and
other items, or when having financial assets or liabilities. Derivative
instruments (such as swaps, options or forward contracts) are often the
means used to hedge such exposures.
8.3 A hedging transaction undertaken in respect of the financial risk
arising from an underlying item is effective to the extent that it offsets the
movements in an underlying transaction. Generally, a hedging transaction
will offset an adverse financial impact, in respect of a hedged item, arising
out of a movement in a price or other financial variable.
8.4 Subdivision 230-E (hedging financial arrangements method)
seeks to appropriately facilitate, subject to safeguarding requirements,
pre-tax hedging decisions. The approach used to achieve this is to more
closely align the tax treatment of the hedging financial arrangement with
that of the items they hedge, thereby improving the degree of post-tax
matching. Under current tax law, comprehensive tax-hedge rules do not
exist, and there has been considerable uncertainty about when gains and
losses from specific hedging instruments are recognised. For instance,
233
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
uncertainty occurs in situations where rolling hedges are used as hedging
instruments. In such situations, taxpayers have not known whether the
point of termination of one hedging instrument, is or is not, to be regarded
as a taxing point for the gain or loss on that particular hedging instrument.
8.5 The tax system is differentiated as to tax treatments. For
instance, some financial arrangements are taxed on a realisation basis and
some are taxed on an accruals basis. If a financial arrangement that is
subject to the former basis is used to hedge a risk in relation to an
arrangement that is subject to the latter, a tax mismatch may arise. A tax
mismatch could also occur where a gain or loss in respect of the financial
arrangement is brought to account as assessable income or an allowable
deduction (ie, taxed on `revenue account') but the gain or loss on the
underlying item (referred to as a `hedged item') is brought to account as a
capital gain or a capital loss (ie, taxed on capital account).
8.6 The outcome of a tax mismatch is that the effectiveness of
pre-tax hedging activity is reduced on an after-tax basis. Such
mismatches may produce anomalous tax outcomes, distort
decision-making, disrupt the ability of taxpayers to reduce or manage risk
and, in general, impede efficiency of risk allocation and management.
8.7 Tax-hedge rules recognise the purpose of the hedging activity.
In appropriate circumstances, tax-hedge rules remove distorting tax
mismatch effects on pre-tax hedging activity by changing the way that the
hedging financial arrangement would have been taxed, to a way that is
consistent with the tax treatment of the hedged item. That is, reducing the
post-tax mismatch is achieved by altering the tax-timing and tax-status of
the hedging financial arrangement and more closely matching it with that
of the hedged item.
8.8 At the same time, where the tax treatment of a hedging financial
arrangement depends on the purpose of the taxpayer, there is the potential
for an inappropriate level of selectivity of tax treatment. It appears that
the rigorous hedge criteria set out in Australian Accounting Standard
AASB 139 Financial Instruments: Recognition and Measurement
(AASB 139) also reflect a concern about selectivity. Similarly,
purpose-based tax-hedge rules have the potential to create administrative
difficulties. Without adequate safeguards, the ability to administer
tax-hedge rules would be severely constrained.
8.9 Tax-hedge rules that draw heavily on financial accounting
concepts will provide greater clarity and neutrality for the taxation of
gains or losses arising from arrangements that are part of hedging
relationships and will contribute to lower overall compliance costs.
Existing uncertainties over relevant tax treatments will be reduced, risk
234
The elective hedging financial arrangements method
management will be enhanced, and there will be less scope for deferral
possibilities arising from adverse selection.
8.10 Greater matching between the taxation of the hedging financial
arrangement and the underlying or hedged item may, however, not always
lead to greater consistency between the taxation and financial accounting
treatment of the hedging financial arrangement. The reason is that
taxation treatment of the hedged item may be different to the financial
accounting treatment of the item. In this circumstance, the matching
process may give rise to a different tax allocation of hedge gains and
losses over time, to the financial accounting allocation.
8.11 Further, financial accounting does not have some of the
distinctions found in the income tax law. For example, distinctions such
as:
· the different treatment of capital and revenue gains and
losses;
· income which is assessable in some cases and not in others;
and
· expenses which are deductible in some cases and not in
others.
8.12 The tax-hedge provisions nevertheless are designed to reduce
the degree of tax mismatches which might otherwise occur in a tax, albeit
not in a financial accounting, context. Reducing tax mismatches that go
beyond what financial accounting does (ie, principally matching the time
at which the hedging instrument and hedged item are recognised),
increases the amount of rules, the level of complexity and the need for
integrity requirements. The proposed tax-hedge rules represent a
balancing of these factors.
Summary of new law
8.13 The proposed tax-hedge rules are designed to facilitate efficient
management of financial risk by reducing post-tax mismatches where
hedging takes place. At the same time, the rules seek to minimise tax
deferral and tax motivated practices.
8.14 These objectives are given effect by allowing entities, subject to
proposed Division 230, to elect tax-hedge treatment in respect of all their
financial arrangements whose purpose is to hedge against risk. The
235
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
election can be made if certain requirements are met. In broad terms these
requirements are that:
· each financial arrangement must either be a `derivative
financial arrangement' or a `foreign currency hedge' (as
defined);
· the entity must satisfy documentation requirements that build
on those contained in AASB 139;
· the entity prepares a financial report in accordance with
appropriate accounting standards and the report is
appropriately audited;
· the hedging of the relevant risk must meet specified tests of
effectiveness; and
· subject to the satisfaction of certain additional requirements,
the taxpayer can adopt hedge tax treatment in respect of a
limited number of specific hedging financial arrangements
that do not meet the financial accounting standard hedge
requirements.
8.15 Once a valid hedging financial arrangement election is made, an
entity is generally able to allocate gains and losses from a hedging
financial arrangement on an objective, fair and reasonable basis. The
allocation must correspond with the basis on which gains, losses or other
amounts in relation to the hedged item or items are allocated for tax
purposes (referred to as `tax-timing matching'). The entity will, in many
cases, also be able to align the tax classification of the hedging financial
arrangement with that of the hedged item (referred to as `tax-status
matching').
8.16 The tax-hedge rules also provide that, under certain
circumstances, the hedging financial arrangement ceases to be held and is
reacquired for its then fair value. Proposed Division 230, other than the
tax-hedge rules, is then applied to bring to account gains or losses made
from the reacquired financial arrangement.
Comparison of key features of new law and current law
New law Current law
Elective tax-hedge rules will There are no comprehensive
potentially be available to all entities tax-hedge rules in the existing law.
236
The elective hedging financial arrangements method
New law Current law
that adopt and comply with the
requirements of relevant accounting
standards and have audited financial
accounts.
The election applies to all hedging
financial arrangements of the entity
that meet specified tests.
Detailed explanation of new law
Overview of the tax-hedge method
8.17 Tax-hedge treatment is limited to `hedging financial
arrangements' to which the hedging financial arrangement election apply
[Schedule 1, item 1, section 230-260]. A `hedging financial arrangement' is
defined as a financial arrangement that is a `derivative financial
arrangement' or a `foreign currency hedge' and meets certain purposive
and other tests [Schedule 1, item 1, subsection 230-290(1)].
8.18 Generally, to be a hedging financial arrangement, the
arrangement must be a hedging instrument for financial accounting
purposes [Schedule 1, item 1, subsection 230-290(1)]. However, a hedging
financial arrangement can exist, in limited circumstances, even if
particular aspects of the financial accounting tests are not satisfied
[Schedule 1, item 1, subsection 230-290(2)], provided that the taxpayer meets
certain record keeping requirements [Schedule 1, item 1, subsection 230-310(5)]
or, in limited circumstances, where the Commissioner of Taxation
(Commissioner) exercises a discretion to treat a financial arrangement as a
hedging financial arrangement [Schedule 1, item 1, section 230-300] or to treat
certain requirements as having been met [Schedule 1, item 1, section 230-335].
8.19 The hedged item does not have to be a financial arrangement.
Neither does it have to be a current transaction. It can be an existing asset
or liability, a firm commitment, a highly probable future transaction or a
net investment in a foreign operation. It can also be a part of one of these
things. [Schedule 1, item 1, subsection 230-290(9)]
8.20 In addition, an anticipated dividend from a connected entity
that is non-assessable non-exempt income under section 23AJ of the
Income Tax Assessment Act 1936 (ITAA 1936), can be a hedged item
[Schedule 1, item 1, subsection 230-290(10)] and the regulations may prescribe
something to be a hedged item [Schedule 1, item 1, paragraph 230-290(9)(f)].
237
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
8.21 Tax-hedge treatment is obtained by making a `hedging financial
arrangement election' which will apply to all the entity's hedging
financial arrangements [Schedule 1, item 1, sections 230-275 and 230-280]. As a
major objective for tax-hedge rules is to reduce tax mismatches, there may
be numerous hedging financial arrangements for which entities seek
tax-hedge treatment. The `one-in, all-in' election means that an entity
does not have to make a separate election for each of the arrangements. It
also means that there is less opportunity for picking and choosing the
situations in which the tax-hedge rules will be applied (so as to access the
changed tax treatment that hedge tax rules allow); without the requirement
to apply the tax-hedge rules on a one-in, all-in basis, administration of the
rules would potentially be more difficult.
Accounting and auditing requirement
8.22 There are two basic requirements that have to be satisfied before
being able to make a valid hedging financial arrangement election
[Schedule 1, item 1, paragraph 230-275(2)]:
· the entity must prepare a financial report for the relevant
income year in accordance with Australian or comparable
accounting standards; and
· the report is either required by Australian or comparable
foreign law to be audited in accordance with relevant
auditing standards; or
· where there is no requirement to apply the auditing standards,
the report is in fact audited in accordance with those
standards.
These requirements are common to all elective regimes in Division 230.
Chapter 5 explains in more detail the generic requirements and operation
of the hedging financial arrangement election and other elections that may
be made under Division 230.
Arrangements to which the election applies
8.23 Once a valid hedging financial arrangement election has been
made, it applies to all hedging financial arrangements which are first held
in the income year in which the election is made or in later income years.
8.24 The general rule is that the election will not apply to financial
arrangements that are equity interests [Schedule 1, item 1,
subsection 230-285(1)]. However, there is an exception to this rule, namely
where the taxpayer is the issuer of a hedging financial arrangement that is
238
The elective hedging financial arrangements method
an equity interest and a foreign currency hedge [Schedule 1, item 1,
subsection 230-285(2)].
8.25 Further, if no election is made under subsection 230-405(5)
(about electing to have Division 230 apply to all the taxpayer's financial
arrangements), the hedging financial arrangement election will not apply
to a financial arrangement if the taxpayer is an individual or an entity
that satisfies the relevant turnover test in subsection 230-405(2) or (3) and
the arrangement is a qualifying security that has a remaining term, after
acquisition, of more than 12 months [Schedule 1, item 1, subsection 230-285(3)].
Note that if the arrangement is not such a security but the taxpayer is
such an entity, the gains and losses will still not be eligible for
tax-hedge treatment unless the taxpayer makes the election in
subsection 230-405(5).
8.26 Where a hedging financial arrangement election is made by a
head company of a consolidated group or multiple entry consolidated
group (MEC group), the election can specify that it does not apply to
financial arrangements in relation to the life insurance business carried on
by a member of the consolidated or MEC group [Schedule 1, item 1,
subsection 230-285(4)]. Nor will the election apply to financial arrangements
associated with a business of a kind which may be specified by regulation
[Schedule 1, item 1, subsection 230-285(5)]. See Chapter 5 for further discussion
on this.
Documentation, recording and effectiveness requirements
8.27 In addition to the generic requirements referred to above,
where a hedging financial arrangement election has been made, it applies
to hedging financial arrangements if specified tax requirements relating to
the following are met:
· documentation of the hedging relationship [Schedule 1, item 1,
section 230-310];
· determining the basis of the tax allocation of the gains and
losses from the hedging financial arrangement [Schedule 1,
item 1, section 230-315]; and
· effectiveness of the hedge [Schedule 1, item 1, section 230-320].
Basis of allocation
8.28 If the hedging financial arrangement election applies, the gain or
loss from the hedging financial arrangement is (subject to any
disqualifying condition) recognised for income tax purposes on the
following basis:
239
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· the gain or loss is allocated over income years according to
the basis determined and set out in the record [Schedule 1,
item 1, subsections 230-260(2) and 230-315(1)]; and
· where the tax classification of the hedged item is listed in the
table in subsection 230-270(4), the gain or loss is treated in
accordance with that table [Schedule 1, item 1,
subsection 230-270(4)].
8.29 This tax allocation and tax classification is subject to certain
exceptions. In particular, the treatment specified above will apply where
there is no event within the allocation period that has the effect of treating
the hedging financial arrangement as ceasing to be held and being
reacquired for its then fair value. [Schedule 1, item 1, subsection 230-260(4) and
section 230-265]
Transitional election
8.30 Transitional election rules are explained in Chapter 12.
Essentially, tax-time matching is only available for hedging arrangements
that the taxpayer has at the time of commencement of Division 230 where
a transitional election is made and where specific record keeping
requirements are met. Tax-status hedging is not available to hedging
arrangements that the taxpayer has at the time of commencement of
Division 230. What this means is that section 230-270 does not apply to
hedging financial arrangements that exist at the time the taxpayer first
commences to apply the Division. [Schedule 1, subitems 99(6) and 99(7)]
8.31 The rest of this chapter explains the tax-hedge method in more
detail.
What is a derivative financial arrangement?
8.32 A derivative financial arrangement is a financial arrangement
that has the following characteristics:
· its value changes in response to changes in a specified
variable or variables; and
· it requires no net investment, or it requires a subsequent net
investment that is smaller than would be required for other
types of financial arrangements that would be expected to
have a similar response to changes in market factors.
[Schedule 1, item 1, subsection 230-305(1)]
240
The elective hedging financial arrangements method
8.33 A specified variable includes an interest rate, credit rating, a
financial instrument or commodity price, a foreign exchange rate and an
index.
8.34 The Division 230 definition is very similar to the definition of
`derivative' in AASB 139. However, the tax definition explicitly caters
for the situation where there is a subsequent net investment in relation to
the financial arrangement. Thus, if there is a substantial net investment
after the financial arrangement has been entered into, it will not be a
derivative financial arrangement for the purposes of Division 230. This is
different to the application of the definition of `derivative' in AASB 139
where a financial instrument will still be a derivative where there is a
subsequent (substantial) investment made after the start of the
arrangement. This is because the accounting definition of derivative
focuses on whether there is an initial net investment that is of a particular
magnitude, rather than any subsequent investments.
8.35 Further, the financial arrangement will be a derivative financial
arrangement where, if there is a requirement for a net investment, the
amount of the net investment is smaller than that required for other types
of financial arrangements. This means that the particular comparison is to
be done in relation to the financial arrangement being tested under the
definition in subsection 230-305(1) and contracts of a type other than
derivative financial arrangements. For example, an option to buy a
financial arrangement (say a share) would be a derivative financial
arrangement because the premium that is paid is much less than the
amount that is required to acquire that share.
8.36 Typical derivative financial arrangements that are used as
hedging financial arrangements are swaps, options and forward contracts.
What is a foreign currency hedge?
8.37 To be a `hedging financial arrangement', the arrangement has to
be either a `derivative financial arrangement' or a `foreign currency
hedge'. A foreign currency hedge in this regard is a financial
arrangement:
· whose value changes in response to changes in a specified
variable or variables;
· in respect of which there is a requirement for a net
investment (whether this be an initial or subsequent net
investment) that is not smaller than would be required for
other types of financial arrangement that would be expected
241
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
to have a similar response to changes in market factors
(ie, paragraph 230-305(1)(b) is not satisfied); and
· that hedges a risk in relation to movements in currency
exchange rates.
[Schedule 1, item 1, subsection 230-305(2)]
8.38 To be a hedging financial arrangement, a foreign currency
hedge, amongst other requirements, must have been created, acquired or
applied for the purpose of hedging a risk or risks in relation to a hedged
item. [Schedule 1, item 1, paragraph 230-290(1)(a)]
8.39 However, the financial arrangement is not disqualified from
being a hedging financial arrangement if it is also used for an investment
or borrowing purpose (ie, for the purpose of financing). Thus, unlike
derivative financial arrangements, a foreign currency hedge can be a
financing arrangement and, reflecting AASB 139, represents an exception
to the general position that only derivatives can obtain hedge tax
treatment.
When will a derivative financial arrangement or foreign currency hedge
be treated as a hedging financial arrangement?
8.40 A hedging financial arrangement to which a hedging financial
arrangement election applies can attract hedge tax-timing and hedge tax
classification. As indicated above, there are two ways in which a
derivative financial arrangement or foreign currency hedge can be a
hedging financial arrangement. The first is by the financial accounting
route, that is, essentially by being a hedging instrument for financial
accounting purposes [Schedule 1, item 1, subsection 230-290(1)], (ie, explained
in paragraph 8.38). The second is where the financial arrangement is not
a hedging instrument for financial accounting purposes but meets certain
other requirements [Schedule 1, item 1, subsection 230-290(2)], (this is explained
in paragraphs 8.60 to 8.66).
242
The elective hedging financial arrangements method
8.41 A derivative financial arrangement or foreign currency hedge is
to be treated as a hedging financial arrangement if, in the income year in
which the rights and/or obligations that comprise the relevant financial
arrangement are created, acquired or applied:
· the financial arrangement is created, acquired or applied for
the purpose of hedging a risk or risks in relation to an
existing asset or liability or, in terms of the accounting
standards, a firm commitment, a highly probable future
transaction or a net investment in a foreign operation
[Schedule 1, item 1, paragraph 230-290(1)(a)];
· at the time it is created, acquired or applied the financial
arrangement satisfies the requirements of a hedging
instrument for the purposes of Australian accounting
standards or applicable comparable foreign financial
accounting standards [Schedule 1, item 1, paragraph 230-290(1)(b)];
and
· it is recorded as a hedging instrument in the financial report
of the entity unless it is a foreign currency hedge, in which
case it is recorded in the financial report of a financial
accounting consolidated entity in which the entity is included
[Schedule 1, item 1, paragraph 230-290(1)(c)].
8.42 The requirement that a financial arrangement must have been
created, acquired or applied for the purpose of hedging a risk, or risks, in
relation to a hedged item, or items, in order to be a hedging financial
arrangement underpins the hedging relationship and the link between the
financial arrangement and the hedged item or items. In turn, this link is at
the centre of determining effectiveness and the basis of the allocation of
the hedge gain or loss, as well as of the integrity of hedge accounting for
tax purposes (and perhaps financial accounting purposes as well). At the
same time, this purpose test may be met notwithstanding that there is a
more important purpose for the entity in entering into the arrangement, for
example, to manage risk at the entity level.
8.43 Where, in terms of paragraph 230-290(1)(b) or (c) (or both), the
accounting requirements relating to a hedging financial arrangement are
not satisfied through an honest mistake or inadvertence, the
Commissioner may nevertheless exercise a discretion to treat the
arrangement as a hedging financial arrangement [Schedule 1, item 1,
section 230-300]. In deciding whether to exercise the discretion, the
Commissioner shall have regard to the entity's documented risk
management practices and policies, its record keeping practices, its
accounting systems and controls, its internal governance processes, the
circumstances surrounding the mistake or inadvertence, the extent to
243
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
which the accounting standards and the recording requirements are met,
and the objects of Subdivision 230-E.
8.44 Because the scope of this discretion is limited to circumstances
where there an honest mistake or inadvertence, if a financial arrangement
is not a hedging instrument for financial accounting purposes it can only
obtain tax-hedge treatment if it falls within the list set out in
subsection 230-290(2) (including the possibility of inclusion by
regulation).
What constitutes the hedging financial arrangement?
8.45 Generally, it is the whole of a derivative financial arrangement,
or a foreign currency hedge, considered in its entirety, that must satisfy
the requirements for an arrangement to be a hedging financial
arrangement [Schedule 1, item 1, section 230-295]. However, reflecting various
hedging relationships that can be designated for the purposes of
AASB 139, Subdivision 230-E permits a number of variations to this
general rule. In broad terms, to the extent that these parts of the financial
arrangement (represented by the relevant financial benefits) satisfy the
requirements in subsections 230-290(1) and (2), the variations are:
· the intrinsic value of an option can be designated as the
hedging financial arrangement (`partial hedges') [Schedule 1,
item 1, subsection 230-295(2)];
· the spot price of a forward contract can be designated as the
hedging financial arrangement [Schedule 1, item 1,
subsection 230-295(3)]; or
· a specified proportion of a financial arrangement can be
designated as the hedging financial arrangement
(`proportionate hedges') [Schedule 1, item 1,
subsection 230-295(4)].
8.46 Where one of the above variations leads to a part or a proportion
of a financial arrangement being treated as a hedging financial
arrangement, it is taken to be a separate financial arrangement for the
purposes of Division 230 and the remaining part or proportion is also
taken to be a separate financial arrangement [Schedule 1, item 1,
subsections 230-290(5) and (6)]. It is therefore possible, for example, for the
remaining proportion to itself be a hedging financial arrangement that
hedges a hedged item that is separate and distinct to the hedged item being
hedged by the other proportion.
244
The elective hedging financial arrangements method
Example 8.1: Proportion of a hedging financial arrangement
Serendipity Co has a highly probable forecast transaction under which
it is to borrow $90 million in five months. Serendipity Co also has a
forward rate agreement that would be highly effective in offsetting its
exposure to an increase in interest rates in the next five months.
However, the notional principal on the forward rate agreement is
$120 million.
Serendipity Co may treat $90 million or 75 per cent of the forward rate
agreement as a hedging financial arrangement in relation to the
anticipated borrowing, provided that that proportion meets the
requirements of subsection 230-290(1) or (2) (subsection 230-295(4)).
In the event that that proportion of the forward rate agreement is
a hedging financial arrangement, the remaining proportion
(ie, $30 million or 25 per cent) of the agreement is taken to be a
separate financial arrangement for the purposes of Division 230
(subsection 230-295(5)).
Further, the remaining proportion could qualify as a hedging financial
arrangement in relation to another hedged item, provided it satisfied
the necessary tax-hedge criteria.
8.47 It is possible for a financial arrangement to hedge more than one
type of risk. However, for Subdivision 230-E purposes, it can only
qualify as a hedging financial arrangement if the applicable financial
accounting standards allow the arrangement to be designated as a hedge of
those risks. [Schedule 1, item 1, subsection 230-290(7)]
8.48 It is also possible for two or more financial arrangements to
hedge the same risk or risks. However, for Subdivision 230-E purposes,
they may only qualify as hedging financial arrangements if the applicable
financial accounting standards allow them to be viewed in combination
and jointly designated as hedging that risk or those risks. [Schedule 1,
item 1, subsection 230-290(8)]
The hedged item
8.49 The hedged item may be an existing asset or liability, a firm
commitment, a highly probable future transaction or a net investment
in a foreign operation whose risk is being hedged by the particular
hedging financial arrangement. It can also be a part of one of these
things. A hedged item can also be prescribed by regulations. [Schedule 1,
item 1, subsection 230-290(9)]
8.50 The terms `firm commitment', `highly probable forecast
transaction' and `net investment in a foreign operation' all take their
meaning from the equivalent terms in the Australian accounting standards.
245
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
A firm commitment or highly probable future transaction might, for
example, be prospective crops (eg, in future crop years) or prospective
resources or output (eg, expected gold production in a future year).
8.51 An anticipated dividend from a connected entity that is
non-assessable non-exempt income under section 23AJ of the ITAA 1936,
can also be a hedged item. [Schedule 1, item 1, subsection 230-290(10)]
Record keeping requirements
8.52 The following are record keeping requirements that the taxpayer
must meet in order for a hedging financial arrangement to be eligible for
tax-hedge treatment.
· There is a formal designation and documentation of the
hedging relationship. The documentation must include
designation of the hedging financial arrangement in respect
of which the hedging financial arrangement election applies,
and identification of the hedged item or items. It must also
set out the nature of the risk or risks being hedged and how
the entity will assess the hedging financial arrangement's
effectiveness in offsetting the exposure to changes in the
hedged item's fair value, cash flows or foreign currency
exposure attributable to the hedged risk or risks. Further, the
record must state the risk management objective and strategy
to be followed in acquiring, creating or applying the hedging
financial arrangement [Schedule 1, item 1, subsection 230-310(1)].
· In addition, the record must contain any details that the
accounting standards require, by way of documentation, for
an arrangement to be recorded in the financial report as a
hedging instrument [Schedule 1, item 1, paragraph 230-310(1)(b)].
This is irrespective of whether the hedging financial
arrangement is in fact recorded in the financial report as a
hedging instrument [Schedule 1, item 1, subsection 230-310(1)]. An
example is where a hedging arrangement occurs between
financial reporting periods but the hedging instrument is
nevertheless recorded or captured in the accounting records
for the relevant period.
· The documentation must set out the terms of the
determination made about the allocation of the
hedging financial arrangement gain or loss over income years
[Schedule 1, item 1, paragraph 230-310(1)(c)]. This determination
forms the basis of the tax-timing and tax classification of the
246
The elective hedging financial arrangements method
hedging financial arrangement gains and losses, as discussed
in further detail below.
· The documentation must set out the risk in respect of the
hedged item with sufficient precision and detail that it is
clear:
- that the risk was hedged by the particular hedging
financial arrangement [Schedule 1, item 1,
paragraph 230-310(4)(a)];
- the extent to which the risk was hedged [Schedule 1, item 1,
paragraph 230-310(4)(b)];
and
- that the rights and/or obligations that comprise the
hedging financial arrangement were in fact created,
acquired or applied for the purpose of hedging the risk
[Schedule 1, item 1, paragraph 230-310(4)(c)].
8.53 This record must be made or be in place at, or soon after, the
time that the entity creates, acquires or applies the hedging financial
arrangement [Schedule 1, item 1, subsection 230-310(3)] unless regulations
provide otherwise [Schedule 1, item 1, paragraph 230-310(3)(b)]. For the
integrity of the tax-hedge rules, it is important that the relevant record in
relation to a hedging relationship either be in place at the inception of the
relationship or be made in a reasonably contemporaneous manner.
Subsection 230-310(3) permits the record to be made soon after the
relationship starts. The reason for this short period is to take into account
administrative and systems processes of the particular entity and not to
allow designation of the hedging financial arrangement to be determined
by reference to whether it creates a favourable outcome in hindsight.
8.54 The record may consist of one or more documents [Schedule 1,
item 1, subsection 230-310(2)].
This allows the record to be based on an
amalgamation of a hedging policy document that covers a number of the
details of a type of class of hedging financial arrangements that have
similar characteristics (eg, swap contracts relating to interest rate risk in
relation to housing loans) and an associated document that contains details
of the specific arrangement (eg, date, notional principal, currency, term,
counterparty, transaction number, and hedged item details). It is likely
that such an amalgamation would be consistent with record keeping
practices with respect to routine or high volume hedges. The policy
document and associated specific document must together meet the record
keeping requirements in section 230-310.
247
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Hedge effectiveness requirement
8.55 To maintain tax-hedge treatment while the derivative financial
arrangement or foreign currency hedge (in relation to a non-derivative
financial arrangement) is held, the following conditions must be met:
· for the period the hedging financial arrangement is expected
to be held, the entity must expect the arrangement to be
highly effective (within the meaning of the accounting
standards) in achieving offsetting changes in fair value or
cash flows attributable to the hedged risk [Schedule 1, item 1,
paragraph 230-320(a)];
· the effectiveness of the hedge can be reliably measured, that
is, the fair value or cash flows of the hedged item that are
attributable to the hedged risk and the fair value of the
hedging instrument can be reliably measured [Schedule 1,
item 1, paragraph 230-320(b)]; and
· the hedge is assessed on a regular basis in accordance with
the accounting standards -- at least once in each 12-month
period. The assessment is directed at determining that the
hedge will be highly effective in reducing fair value or cash
flow exposure in respect of the hedged item or items
attributable to the hedged risk for the remainder of the period
for which the entity expects to have the hedging financial
arrangement [Schedule 1, item 1, paragraph 230-320(c)].
8.56 The last test does not preclude risk management in relation to a
particular item or particular portfolio of items. However, it does require
an assessment of effective risk reduction in relation to an identified item
or items for the purposes of helping to establish upfront the basis of
allocation of gains or losses from the hedging financial arrangement.
8.57 What is `highly effective' for the purposes of section 230-320
depends on the meaning of this term in AASB 139. Thus, the hedge
effectiveness must be within the range of 80 per cent -- 125 per cent, as
set out in paragraph AG105 of AASB 139.
8.58 If the hedge is not highly effective, item 1(c) in the table in
section 230-265 will operate in conjunction with section 230-260 to
provide that:
· the arrangement ceases to be held for its fair value when the
effectiveness requirement is no longer met;
248
The elective hedging financial arrangements method
· the gain or loss is allocated over income years according to
the basis set out in the determination required by
subsection 230-315(1); and
· Division 230 is re-applied to any future gain or loss made
from the arrangement as if it had been acquired for its fair
value at that time.
8.59 Note, however, that if the hedge is highly effective but not
100 per cent effective, the ineffective portion is not treated differently by
Subdivision 230-E. That is, unlike financial accounting, the ineffective
portion of an otherwise highly effective hedging financial arrangement is
not disqualified from hedge tax treatment under Subdivision 230-E.
Can a financial arrangement be a hedging financial arrangement if it is
not an accounting hedging instrument?
8.60 The purposive nature of hedging rules and the volume of
hedging transactions makes the administration of the rules relatively
difficult. As indicated above, the existing income tax law does not
contain comprehensive tax-hedge rules. Further, the tax-hedge rules will
cover not just commodity hedging (as recommended by the Review of
Business Taxation (the Ralph Review)) but all sectors of the economy.
Also, they extend beyond tax-timing hedging to tax-status hedging. Thus,
the introduction of tax-hedge rules raises potentially significant
administrative implications.
8.61 Against this background, the requirements that the derivative
financial arrangement satisfies the hedging requirements of the financial
accounting standards, and is recorded as a hedging instrument for the
purposes of the standards, represents an important administrative
safeguard.
8.62 At the same time, it is understood that some entities' hedging
practices will not satisfy the financial accounting hedge rules in
AASB 139 because of some technical aspect of those rules and
notwithstanding that the substance of the requirements -- particularly the
risk management purpose, the nature of the hedge transaction and
appropriate record keeping and other safeguards -- are met.
8.63 Accordingly, Subdivision 230-E contains a list of situations in
which those practices may, subject to certain requirements, nevertheless
attract tax-hedge treatment. In particular, a derivative financial
arrangement or foreign currency hedge may, in the circumstances listed
below, qualify as a hedging financial arrangement even though it does not
qualify, or it is not recorded, as a hedging instrument under the applicable
249
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
financial accounting standards. In these circumstances, certain additional
record keeping requirements have to be met (see paragraphs 8.67
and 8.68).
8.64 The only circumstances in which the tax-hedge rules may apply,
despite such financial arrangements being denied hedging instrument
status for accounting purposes are:
· the hedging of a foreign currency risk relating to an
anticipated dividend from a connected entity where the
dividend is non-assessable non-exempt income under
section 23AJ of the ITAA 1936 [Schedule 1, item 1,
subsection 230-290(3)];
· entering into a financial arrangement with a connected entity
that is not part of the same tax consolidated group but is part
of the same financial accounting consolidated group for
which the accounting standards require a consolidated
financial report (even though that report ignores the
arrangement), provided that the arrangement is created,
applied or acquired for the purpose of hedging a risk or risks
in relation to a hedged item and would satisfy the accounting
hedge requirements but for the consolidated financial report
ignoring it [Schedule 1, item 1, paragraph 230-290(4); and
· the period for which the risk or risks are hedged does not
straddle two or more income years, that is, the hedge is an
intra-income year hedge, provided that the arrangement is
created, applied or acquired for the purpose of hedging a risk
or risks in relation to a hedged item and would be recorded as
a hedging instrument in a relevant financial report if it had
straddled two or more income years [Schedule 1, item 1,
subsection 230-290(5)].
8.65 The list of circumstances in which a financial arrangement may
be treated as a hedging financial arrangement -- and thus potentially be
able to attract tax-hedge treatment -- even though it does not qualify as a
hedging instrument, or is not recorded as a hedging instrument for
financial accounting purposes, can be added to by regulations [Schedule 1,
item 1, subsection 230-290(6)]. Those regulations can require that particular
conditions be met before the financial arrangement can qualify as a
hedging financial arrangement.
8.66 Where the derivative financial arrangement or foreign currency
hedge is not an accounting hedging instrument, neither the financial
accounting nor external audit systems provide a platform for recognition
250
The elective hedging financial arrangements method
of the financial arrangements as hedges for tax purposes. The tax system
therefore has to provide a separate platform, with its separate
requirements. These are that:
· meeting the requirements of accounting standards for
obtaining hedge treatment, or the recording as a hedging
instrument for accounting purposes, is not possible due to
requirements of the relevant accounting standards, rather than
any act or omission on the entity's part to deliberately fail
these requirements [Schedule 1, item 1, paragraph 230-290(2)(c)];
· certain additional record keeping requirements are met
(see paragraphs 8.67 and 8.68) [Schedule 1, item 1,
subsection 230-310(5)]; and
· any requirements prescribed by the regulations are met
[Schedule 1, item 1, paragraph 230-290(2)(e)].
Additional record keeping requirements if a financial arrangement is
not an accounting hedging instrument
8.67 As noted above, there are circumstances in which a financial
arrangement can qualify as a hedging financial arrangement even where
the arrangement cannot be a hedging instrument for financial accounting
purposes or is not classified as a hedging instrument in the entity's
financial report. Because there is no requirement to create a financial
accounting record of the arrangement as a hedging instrument, the entity's
financial records cannot be relied upon to demonstrate, for example, the
purpose of the arrangement. Accordingly, separate tax requirements need
to be met. The requirements, which are important administrative
safeguards, are in addition to those in respect of financial arrangements
that are hedging instruments for financial accounting purposes.
[Schedule 1, item 1, section 230-290 and subsection 230-310(5)]
8.68 The additional requirements are:
· that the entity make or have in place at, or soon before or
after, the time that it creates, acquires or applies the hedging
financial arrangement, a record that explains why and how
the financial arrangement operates commercially or
economically, as a hedge of the hedged item or items
[Schedule 1, item 1, subparagraph 230-310(5)(a)(i)]. This
requirement has regard to those situations in which it appears
that the strict requirements of AASB 139 prevent a derivative
(or non-derivative hedging a foreign currency risk) from
being classified as a hedging instrument, even though
251
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
commercially or economically the instrument reduces the
entity's exposure to financial risk;
· that the entity make a record of the reasons why the financial
arrangement cannot qualify as a hedging instrument for
financial accounting purposes [Schedule 1, item 1,
subparagraph 230-310(5)(a)(ii)]. It is envisaged that the normal
situation in which a financial arrangement is a hedging
financial arrangement is when it is a hedging instrument for
financial accounting purposes. The financial accounting
record provides a basis for establishing the purpose of the
financial arrangement in question. It is important that, when
the arrangement is not a hedging instrument for financial
accounting purposes, hedge tax treatment is only applied
when there are sound and appropriate reasons why such
financial accounting treatment could not be obtained. A
purpose of this requirement, in conjunction with the
requirement in paragraph 230-310(5)(a), is to establish that
there are such reasons. For example, as indicated above, it
should not be because the entity deliberately failed to meet
the requirements of AASB 139;
· that the entity have a record that sets out its risk management
policies and practices at the time the financial arrangement in
question is created, acquired or applied [Schedule 1, item 1,
paragraph 230-310(5)(c)];
· that, at the time the entity creates, acquires or applies the
hedging financial arrangement, it has in place internal risk
management systems and controls that record the
arrangement and the hedged item or items. This additional
requirement is intended to link the arrangement and the
hedged item or items together in terms of the former hedging
the risk in respect of the latter. It is also to confirm that the
financial arrangement is created, acquired or applied for
commercial purposes and not for tax reasons [Schedule 1,
item 1, paragraph 230-310(5)(d)]; and
· that where a hedging financial arrangement that qualifies for
tax-hedge treatment under subsection 230-290(2), the
taxpayer keeps a record of the accumulated hedge gain or
loss that is yet to be allocated in accordance with that of the
hedged item(s). This requirement is intended to be an
analogue of the financial accounting equity reserve. This is
in the sense that, for financial accounting purposes, even
though the hedge gain or loss may not be reflected in that
252
The elective hedging financial arrangements method
period in the income statement, there is a record in an equity
reserve of the balance sheet of an amount that has been
deferred and is yet to be recognised in profit or loss. It also
reflects the fact that the matching of a gain or loss on a
hedged item can mean that a gain or loss from a hedging
financial arrangement can be deferred for a long time. The
requirement is for an ongoing record of the accumulated gain
or loss, whether realised or unrealised, that is yet to be
matched for income tax purposes to a hedged item or items
[Schedule 1, item 1, paragraph 230-310(5)(b)].
Example 8.2: Accumulation of gains and losses
Gold Coast Co, which has an Australian dollar functional currency,
has a firm commitment to sell a fixed quantity of gold in four years
for a fixed amount of United States of America (US) dollars.
To hedge its exposure to unfavourable movements in the A$/US$
currency exchange rate, Gold Coast Co enters into a series of four
rolling one year forward foreign currency contracts. Gold Coast Co
has made a valid hedging election under subsection 230-275(1).
Assume that the forward foreign currency contracts qualify as hedging
financial arrangements to which the hedging financial arrangement
election applies. The hedging financial arrangements hedge the
foreign currency risks in relation to the firm commitment to sell gold in
four years time. Accordingly, Gold Coast Co is able to defer the gains
and/or losses from the arrangements until the sale of gold is due to take
place.
Assume that the gains or losses that are made on a year-by-year basis
in relation to each of the forward contracts are as set out in Table 8.1.
Table 8.1: Gains and losses made on a year-by-year basis
Year A$ gain/(loss)
1 150,000
2 (200,000)
3 70,000
4 (50,000)
For the purposes of paragraph 230-310(5)(b), Gold Coast Co must
make a record of the accumulated gains/losses as at the end of each
income year from each of the arrangements relating to the hedged item,
namely the firm commitment to sell the gold. Thus the record would
be along the lines of that in Table 8.2.
253
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Table 8.2: Accumulated gain/loss
Year A$ accumulated
gain/(loss)
1 150,000
2 (50,000)
3 20,000
4 (30,000)
Allocation of gains and losses from hedging financial arrangements
8.69 Tax-hedge rules reduce post-tax mismatch by allocating gains
and losses from hedging financial arrangements on a timing basis that is
consistent with the tax recognition time for the gains or losses made from
the hedged item or items. The way that Subdivision 230-E does this is to
require the entity to determine the basis of allocation when the various
hedging requirements are met.
8.70 The allocation basis must be objective [Schedule 1, item 1,
paragraph 230-315(2)(b)]. That is, the basis cannot be subjective. The
basis must also fairly and reasonably correspond with the basis on
which the gains, losses or other amounts from the hedged item or
items are allocated or recognised for income tax purposes [Schedule 1,
item 1, paragraph 230-315(2)(a)]. Further, the record must be sufficiently
precise and detailed so that it can be determined from that record the
time at which the gain or loss from the hedging financial arrangement is
to be taken into account for the purposes of Division 230, and the way in
which the gain or loss will be dealt with from a tax-status point of view
[Schedule 1, item 1, paragraph 230-315(2)(c)]. These requirements are designed
to be both consistent with the commercial purpose of hedging and to
support the integrity of the recording process.
Example 8.3: A forward foreign currency contract hedging forward
purchase
Assume that Southern Exposure Co, which has an Australian dollar
functional currency, has a firm commitment to buy an item of
machinery for US$10 million, which at that time is equal to
A$14 million. The company wants to hedge against the US$/A$
exchange rate by buying under a forward contract US$10 million.
The forward contract will be delivered at the settlement date for the
machinery which is six months hence.
The effective life of the machinery is 10 years. When
Southern Exposure Co enters into the forward foreign currency
contract, in relation to the timing of when the relevant gains or losses
254
The elective hedging financial arrangements method
from that contract will be recognised, it records that it determines that
the gain or loss on the contract is to be allocated over 10 years. This
allocation fairly and reasonably corresponds with the basis on which
the cost of the machinery is to be recognised for income tax purposes.
It is also an objective basis of allocation which, from the record,
clearly and precisely determines how the hedging gain or loss is to be
treated for income tax purposes.
If Southern Exposure Co makes an A$1 million gain on the forward
foreign currency contract and the machinery is acquired as planned, it
could allocate the gain over 10 years on a basis that effectively meant
that the cost of the machinery was A$13 million. This outcome
enables the gain on the hedging financial arrangement to be allocated
on a similar timing basis as that used for capital allowances purposes.
Although, it should be noted that the gain itself is not to be integrated
into the cost base of the machinery for capital allowance purposes,
however the outcome of the allocation of the hedge gain under
section 230-315 effectively achieves this.
Example 8.4: Basis of the allocation: re-estimation of the effective
life
Assume that in Example 8.3, the hedging arrangement is a future
arrangement such that the machinery will be acquired after
21 September 1999 and is not subject to accelerated depreciation rates.
Accordingly, its effective life is able to be re-estimated for income tax
purposes (section 40-110 of the Income Tax Assessment Act 1997
(ITAA 1997)).
Is it permissible, if Southern Exposure Co anticipates that it may
re-estimate the effective life of the machinery, for it to provide in the
record for the allocation of the hedging financial arrangement gain or
loss to be either 10 years, or the period corresponding to the effective
life of the machinery as re-estimated in terms of section 40-110 of the
ITAA 1997?
The allocation on the basis of the re-estimation of the effective life
would be fair, objective and reasonable if its purpose is to continue to
effectively integrate the hedging financial arrangement gain or loss into
the cost base of the machinery for capital allowance purposes.
However, paragraphs 230-310(1)(c) and section 230-315 of the
ITAA 1997 require that the record must contain a determination of the
allocation basis which is precise and detailed enough that, when the
gain or loss or other amount from the hedged item is taken into account
for tax purposes, it will be clear from the record the time at which the
hedging financial arrangement gain or loss is to be taken into account
under Division 230. To satisfy this requirement, there must be a
mechanism for the hedge record to be appropriately linked to the
choice Southern Exposure Co makes to re-estimate the effective life of
the machinery. In this regard, it would be permissible for the company
255
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
to append, at the time it makes this choice, a record of the choice to the
hedge record.
Example 8.5: Hedging future mineral production
Miner Co uses sold futures contracts to hedge against future sales of
the mineral it produces. However, because the futures contracts are for
a shorter period than the projected sale date, a series of futures
contracts are used as part of a `rollover strategy'.
Provided the futures contracts are otherwise the subject of a hedging
financial arrangement election -- which includes the documentation of
an objective, fair and reasonable basis for allocating the gains and
losses from the particular hedging financial arrangement, and sufficient
linking between the contracts and the hedged item(s) -- the gains and
losses from each contract can be deferred and allocated to the income
year in which the underlying mineral sale is made.
Example 8.6: Hedging the forward purchase of trading stock
On 1 May 2010, Green Co enters into a firm commitment to acquire
solar panels worth US$1 million for delivery on 1 June 2010. The
solar panels to be acquired by Green Co will be trading stock from the
time of acquisition.
On 1 May 2010, Green Co enters into a forward exchange contract to
hedge its foreign currency risk exposure. The terms of the forward
contract provide that Green Co will purchase US$1 million in
exchange for Australian dollars on 1 June 2010 at an agreed forward
rate.
Green Co is eligible to make a hedging financial arrangement election
and has complied with all hedging and documentation requirements
under Subdivision 230-E. Green Co designates the forward contract as
the hedging financial arrangement in respect of the firm commitment
to acquire the solar panels. The hedged item is the firm commitment to
acquire the solar panels (paragraph 230-290(9)(c)).
Green Co determines at the inception of the hedge to allocate any gain
or loss on the hedging financial arrangement to the time of sale of the
solar panels. The gain or loss should be allocated equally over the
solar panels acquired by Green Co. Any gain or loss on the forward
contract will be aligned with the treatment of the trading stock. While
the gain or loss is not integrated into the cost of the trading stock for
tax purposes (ie, Division 70 of the ITAA 1936), this basis of
allocation effectively enables the gains or losses on the hedge to be
allocated so as to achieve the same tax outcome as if the gain was
integrated into the tax cost of the panels sold.
256
The elective hedging financial arrangements method
On 1 June 2010 Green Co receives and pays for the solar panels in full.
On that day it realises a US$43,000 loss on the forward contract.
Despite the fact that the forward contract is settled on that day, the loss
on the arrangement will be deferred and allocated for tax purposes to
the income year in which the solar panels are sold.
8.71 The allocation will not be fair and reasonable unless, in terms of
the overall nominal gain or loss, it produces the same outcome as, for
example, the accruals/realisation Subdivision and the balancing
adjustment Subdivision of Division 230 would produce. This is
particularly important as the other Subdivisions of Division 230 do not
apply to the extent that the hedging Subdivision does. [Schedule 1, item 1,
subsection 230-260(2)]
8.72 This is subject to the situations covered by
subsections 230-260(3) and (6). The first situation is with respect to a
hedging financial arrangement that is a foreign currency hedge that is a
debt interest. In this situation, only that part of the gain or loss from the
arrangement -- that represents a currency exchange rate effect attributable
to the outstanding balance in respect of a debt interest -- can be allocated
under the hedging financial arrangement Subdivision [Schedule 1, item 1,
paragraph 230-260(3)(a)]. Therefore, the difference between this amount and
the entire gain or loss made from the financial arrangement is to be
brought to account under other provisions of Division 230 -- namely, the
accruals or realisation method, the election to rely on financial reports or
the balancing adjustment under Subdivision 230-G [Schedule 1, item 1,
paragraph 230-260(3)(b)].
8.73 The second situation is with respect to a hedging financial
arrangement that is an equity interest issued by the taxpayer, is covered by
section 230-55, and is a foreign currency hedge. Only that part of the gain
or loss from the arrangement that represents a currency exchange rate
effect can be allocated under the hedging financial arrangement
Subdivision. The remainder is to be dealt with in accordance with the
other Subdivisions appropriate to the arrangement. [Schedule 1, item 1,
subsection 230-260(6)]
Tax classification of a hedging financial arrangement
8.74 As well as determining the basis on which gains and losses from
a hedging financial arrangement are allocated on a timing basis, in certain
circumstances Subdivision 230-E provides for the gain or loss to be
classified in a way for income tax purposes that corresponds with the way
that the hedged item is classified for tax purposes. In this situation, the
tax classification (or status) of the hedging financial arrangement gain or
loss is matched to that of the associated hedged item. Tax classification
matching is available only for hedging financial arrangements to which a
257
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
hedging financial arrangement election applies [Schedule 1, item 1,
sections 230-260 and 230-270].
It is not possible to obtain tax classification
matching without tax-timing matching. While tax-status matching is
available under section 230-270 (subject to meeting the requirements of
the section) the allocation of the hedging financial arrangement gain or
loss to an income year or years is determined by reference to
section 230-260.
8.75 To facilitate tax classification matching, the table in
section 230-270 sets out the treatment of a gain or loss on a hedging
financial arrangement to the extent it is reasonably attributable to a
hedged item referred to in the table [Schedule 1, item 1, subsection 230-270(4)].
In the absence of tax-status matching, there may be a mismatch between
the treatment of the hedging financial arrangement and the hedged item.
For example, a hedged item may be a capital gains tax (CGT) asset in
relation to which there is a CGT event and, if it turns out that there is a net
capital gain in respect of the asset, the gain would be assessable under
Parts 3-1 and 3-3 of the ITAA 1997. Without tax-status matching, it is
possible that a tax mismatch will arise because the gain or loss on a
hedging financial arrangement, which hedges the asset will be on revenue
account. Based on the table in subsection 230-370(4), the gain or loss on
the hedging financial arrangement may be treated as a capital gain or
capital loss respectively, where the requisite conditions are met [Schedule 1,
item 1, subsection 230-270(4), item 1 in the table].
8.76 Similarly, a hedged item may produce non-assessable
non-exempt income. If the tax-hedge criteria are met, a gain on a
hedging financial arrangement hedging that item would also be treated as
non-assessable non-exempt income. Any loss would not be deductible.
[Schedule 1, item 1, subsection 230-270(4), item 5 in the table]
8.77 Other items in the table in subsection 230-270(4) facilitate tax
classification matching by setting out the tax classification of a gain or
loss on a hedging financial arrangement which is reasonably attributable
to a hedged item that is:
· a CGT asset that is a taxable Australian property [Schedule 1,
item 1, subsection 230-270(4), item 2 in the table];
· a CGT asset in respect of which the capital gains and losses
are disregarded, or reduced by a particular percentage under
Division 855 of the ITAA 1997 [Schedule 1, item 1,
subsection 230-270(4), item 3 in the table];
· exempt income [Schedule 1, item 1, subsection 230-270(4), item 4 in
the table];
258
The elective hedging financial arrangements method
· a share in a company that is a foreign resident if the capital
gain or loss made from a CGT event that happens to the
share is reduced by a particular percentage under
Subdivision 768-G of the ITAA 1997 [Schedule 1, item 1,
subsection 230-270(4), item 6 in the table];
· ordinary or statutory income from an Australian source, and
losses or outgoings incurred in earning that income
[Schedule 1, item 1, subsection 230-270(4), items 7 and 10 in the table];
· ordinary income or statutory income from a source out of
Australia, and a loss or outgoing incurred in gaining or
producing that income from a source out of Australia
[Schedule 1, item 1, subsection 230-270(4), items 8 and 9 in the table];
· a loss or outgoing that is not allowed as a deduction
[Schedule 1, item 1, subsection 230-270(4), item 11 in the table];
· a net investment in a foreign operation (within the meaning
of the accounting standards) that is not carried on through a
subsidiary or a company in which the taxpayer has shares
(ie, a foreign branch or permanent establishment), but only to
the extent that the hedge gain or loss does not relate to a
hedged item covered by another item in the table [Schedule 1,
item 1, subsection 230-270(4), item 12 in the table]; and
· a net investment in a foreign operation (within the meaning
in the accounting standards) that is carried on through a
subsidiary or a company in which the taxpayer has shares.
The hedged item will be taken to be (or deemed to be) the
interest the taxpayer has in the shares of the foreign
subsidiary or company for the purpose of applying the table
only [Schedule 1, item 1, subsection 230-270(5)]. This does not,
however, affect hedge effectiveness testing of the net
investment in the foreign operation being in respect of the
underlying carrying value of the net assets in the subsidiary.
Typically, the relevant item in the table will be item 6, but
this will depend on the particular circumstances.
8.78 The items in the table relate to both the type of gain or loss made
(ie, a capital gain or loss or an amount of assessable income or an
allowable deduction) and the source of the gain or loss. Accordingly,
more than one item in the table may be relevant to the hedged item
identified in the record.
259
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
8.79 Where alternative items in the table can apply to the hedging
financial arrangement, the taxpayer must apply that item to which the gain
or loss on the hedging financial arrangement is most relevant. Where
no item in the table applies, subsection 230-270(3), together with
subsection 230-15(1), has the effect of including any gain on the hedge in
assessable income. Any loss may be deductible in accordance with
subsections 230-15(2) and (3).
8.80 Unlike the situation with respect of tax-timing matching, a
determination is not required for tax classification matching that
pre-specifies the tax classification treatment of the hedging financial
arrangement. Although importantly the record must still show, at
inception of the hedging financial arrangement, the relevant hedged item
in respect of which the hedging financial arrangement relates. An
up-front specification of the tax classification of gains or losses from the
hedging financial arrangement is not required because the tax
classification treatment of gains or losses made from the hedged item may
change between the time that the hedging relationship starts and the time
that those gains or losses from the hedged item are recognised for income
tax purposes. Accordingly, where a hedging financial arrangement
election applies, a gain or loss made from the hedging financial
arrangement, to the extent to which it is reasonably attributable to a
hedged item listed in the table in subsection 230-270(4), is dealt with in
the way indicated by that table.
8.81 At the same time, the recorded determination must be
sufficiently precise and detailed such that, when the hedged item is
recognised for income tax purposes, it will be clear from the record how
the hedge gain or loss will be dealt with under section 230-270 [Schedule 1,
item 1, subparagraph 230-315(2)(c)(ii)]. The purpose of this requirement, like
that of the tax-timing aspect of the recorded determination, is to prevent
determination of the tax treatment of the hedging financial arrangement
gains and losses in hindsight. It is therefore a central requirement of the
tax-hedge rules. Establishing the tax classification of the hedging gains or
losses with the benefit of hindsight is prevented by requiring that the
hedged item, to which the hedging financial arrangement relates, be
specified in the record up-front. Hence, the tax classification of the
hedged item will then automatically apply to the gains or losses made
from the hedging financial arrangement. Hence, if the tax classification of
the former changes, so too will the latter.
Example 8.7: Cross currency interest rate swap
AGM Co uses a cross currency interest rate swap to hedge its exposure
to currency exchange rates in respect of a net investment in a foreign
operation consisting of shares in a foreign subsidiary (SA Co).
Assume that all the hedge tax criteria are met. AGM Co designates the
260
The elective hedging financial arrangements method
notional principal on the swap, which is exchanged at the beginning
and end of the arrangement, as the hedge of the foreign currency risk in
respect of the capital value of the shares.
AGM Co determines that an objective, fair and reasonable basis on
which to allocate any gain or loss on the hedge is to allocate the gain
or loss to the time when it ceases to have the net investment in SA Co.
AGM Co also sets out in the record at the inception of the hedging
relationship that the interest in the shares in SA Co is the relevant
hedged item (subsection 230-270(5)).
Assume that AGM Co sells the shares in SA Co in three years and at
that time the gain or loss on the sale of the shares turns out to be
subject to Subdivision 768-G of the ITAA 1997; accordingly item 6 in
the table would govern the tax classification of the hedge gain or loss
on the notional principal on the swap.
Example 8.8: Net investment in a foreign operation
Oz Co has a New Zealand subsidiary, Fern Co. At 1 January 2012,
Oz Co has a net investment of NZ$20 million in Fern Co and Oz Co
expects that the value of the investment will not fall below that
amount. The net investment satisfies the definition of `net investment
in a foreign operation' as per the accounting standards. On that date,
Oz Co borrows NZ$20 million and designates the borrowing as a
hedge of the net investment in Fern Co. The borrowing satisfies the
definition of a `foreign currency hedge'.
Oz Co determines that the basis on which it seeks to allocate any gain
or loss on the hedge of the principal component of the borrowing is to
allocate the gain or loss to the time when it ceases to have the net
investment in Fern Co. Oz Co sets out in the record at the inception of
the hedging relationship that the interest in the shares in Fern Co is the
relevant hedged item (subsection 230-270(5)).
Assume that Oz Co meets all the tax-hedge tests required by
Division 230, that subsection 230-290(1) is satisfied and that Oz Co's
shares in Fern Co are CGT assets subject to Subdivision 768-G.
The tax deductibility of the interest on the borrowing, together with
any foreign currency gains and losses attributable to that interest, is
determined by section 230-15 and Division 960 and not under the
hedging tax rules (subsection 230-260(3)).
The taxation of any accumulated foreign currency gain or loss
attributable to the principal component of the borrowing is deferred
until Oz Co ceases to have its net investment in Fern Co (whether by,
for example, disposal of the shares in Fern Co or disposal of the assets
and liabilities comprising the net investment in Fern Co). This deferral
would occur even if the borrowing was repaid before then.
261
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Oz Co disposes of the shares on 1 January 2013. At that time (for the
purposes of determining the tax classification of any accumulated
foreign currency gain or loss attributable to the principal component of
the borrowing) Oz Co will have regard to the tax treatment of the
shares it holds in Fern Co. At the time of disposal the shares are CGT
assets subject to Subdivision 768-G. Therefore the gains or losses on
the hedging financial arrangement are treated (ie, classified) as a
capital gain or a capital loss made from a CGT event to the extent to
which the gain or loss is reasonably attributable to the CGT event
that would have happened in respect of its shares in Fern Co
(subsection 230-270(4), item 1 in the table). Further, pursuant to
item 6 in the table in subsection 230-270(4), that capital gain or capital
loss (on the hedging financial arrangement) that was made on the
borrowing is reduced by the same percentage which the capital gain or
capital loss on net investment is reduced.
The Commissioner's discretion in relation to `tax tests'
8.82 The Commissioner can treat the record keeping requirements in
section 230-310, the requirements in section 230-315 about tax allocation
of the gains and losses, and the requirements about hedge effectiveness in
section 230-320, as having been met notwithstanding that the hedging
financial arrangement does not meet the tests. [Schedule 1, item 1,
section 230-335]
8.83 In deciding whether the Commissioner should exercise this
discretion, he or she must have regard to the respects in which the
requirements would not be met, the extent to which they would not be
met, the reasons why they would not be met, and the objects of
Subdivision 230-E. As indicated, the objects are to facilitate the efficient
management of financial risk by reducing after-tax mismatches where
hedging takes place, and to minimise tax deferral. [Schedule 1, item 1,
section 230-255]
8.84 The requirements in sections 230-310 to 230-320 seek to
prevent after-the-event selectivity of tax allocation and/or tax
classification of gains and losses from hedging financial arrangements.
The requirements are particularly important given the potentially wide
differences in timing and tax-status for the particular hedging financial
arrangement. The requirements promote robust audit trails and hedging
activity that is objectively consistent with the aim of reducing after-tax
mismatches. The discretion should be considered against this
background.
The relevant entity
8.85 In a tax consolidation context, the tax-hedge rules are intended
to be limited to the risk of the tax consolidated group of which the entity
262
The elective hedging financial arrangements method
carrying out the hedging activity is part. This is consistent with the single
entity rule in section 701-1 of the ITAA 1997, where all the subsidiaries
of the consolidated tax group are taken to be parts of the one entity -- the
head company of the tax consolidated group. That is, the tax-hedge rules
do not extend to financial arrangements entered into between members of
the same consolidated tax group. At the same time, the head entity of a
tax consolidated group can enter into a hedging financial arrangement
with an external party to the consolidated tax group in relation to the risks
of another entity within the same tax consolidated group.
Consequences if the hedging financial arrangement is disposed of early
8.86 To the extent that the hedging financial arrangement is disposed
of, or ceases before the gains and losses in respect of the hedged item or
items are recognised for income tax purposes, the gains or losses on the
hedging financial arrangement should be allocated to the income year in
which the gains or losses on the hedged item or items are recognised
[Schedule 1, item 1, subsection 230-260(4)]. The fact that the hedging financial
arrangement ceases before the gains or losses on the hedged item are
recognised does not prevent a deferral of the recognition of the gains or
losses made from the hedging financial arrangement until a later time.
Consequences if the hedged item is disposed of before the hedging
financial arrangement is disposed of, or is not likely to occur
8.87 To the extent that the hedged item or one or more of the hedged
items are disposed of before the hedging financial arrangement is
disposed of, or there is a forecast transaction that is no longer expected to
occur, the hedging financial arrangement is deemed to have been disposed
of at that time for its then fair value and, to the extent that it would
otherwise not have been disposed of, is deemed to have been reacquired
or entered into at that fair value. [Schedule 1, item 1, subsection 230-260(4) and
section 230-265, item 2 in the table]
Consequences if the entity revokes the designation of, redesignates or
disposes of, the hedging financial arrangement
8.88 After an entity has a hedging financial arrangement to which the
hedging financial arrangement election applies, the entity may decide that
it should no longer be treated as such (ie, a revocation occurs), but the
entity does not actually terminate or otherwise dispose of the financial
arrangement. One reason for this may be that the entity wants to classify
the financial arrangement as a hedge of another hedged item.
8.89 Where there is a revocation or redesignation of a hedging
financial arrangement, any realised or unrealised gain or loss on the
263
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
hedging financial arrangement, as at the time of revocation or
redesignation, is allocated to the income year or years in which the gains
or losses on the hedged item are recognised.
8.90 Any gain or loss on the hedging financial arrangement from the
time of revocation or redesignation is to be treated in accordance with the
classification of the financial arrangement. For example, if it meets the
hedge tax criteria in respect of another hedged item or transaction, there
should be a corresponding allocation. [Schedule 1, item 1, section 230-265,
subitems 1(a) and (b) in the table]
8.91 A bona fide revocation of a hedging financial arrangement will
not constitute a deliberate failure to meet a record keeping requirement or
allocation determination under subsection 230-340(1).
Example 8.9: Firm commitment to purchase trading stock on
deferred settlement
On 1 July 2009, Green Co enters into a firm commitment to acquire
solar panels worth US$1.5 million for delivery on 1 August 2009 with
full payment deferred until 1 September 2009. The solar panels to be
acquired by Green Co will represent trading stock from the time of
delivery.
On 1 July 2009, Green Co enters into a forward contract to hedge its
foreign currency US dollar exposure. The terms of the forward
contract provide that Green Co will purchase US$1.5 million in
exchange for A$2 million on 1 September 2009.
For accounting purposes Green Co designates the forward contract as a
hedge of the firm commitment to acquire the solar panels and the
resulting accounts payable of US$1.5 million.
Assume that for the scenarios discussed below, Green Co
complies with all hedging and documentation requirements in
Subdivision 230-E.
It determines at the inception of the hedging relationship to allocate
any gains or losses from the hedging financial arrangement (the
forward contract) measured at the time the solar panels are delivered to
the income year in which the panels are sold. Any subsequent gain or
loss on the forward contract will be brought to account on settlement of
the accounts payable.
264
The elective hedging financial arrangements method
The solar panels are delivered on 1 August 2009. At that date, the fair
value of the forward contract is $5,000. The gain will be allocated to
the income year in which the solar panels are sold. The gain should be
allocated equally over the acquired panels. The effect of this allocation
is to effectively `integrate' the hedge gain into the cost of the panels
sold.
Green Co makes full payment for the trade liability on
1 September 2009 and realises the forward contract. At that time, it
has made a gain on the contract of $15,000. The gain that is assessable
to Green Co at that time is $10,000. The gain at that time is calculated
by deducting $5,000, being the value of the forward contract at the
time of delivery of the trading stock, from the gain of $15,000 at
settlement of the accounts payable. The gain brought to account for
tax purposes on settlement of the accounts payable reflects the gain
arising from the change in value of the forward contract following
delivery of the solar panels.
Note that if the trade liability were a financial arrangement -- the gains
or losses in respect of which Division 230 applied on a fair value basis
-- Green Co could determine that the gains or losses in respect of the
forward contract from the time of delivery of the solar panels could
also be allocated on a fair value basis for Division 230 purposes.
As an alternative to the above separate allocation in respect of delivery
and accounts payable, Green Co may determine that the manner in
which the gain or loss on the hedging financial arrangement is to be
determined and allocated is as at the accounts payable date with
deferral until the solar panels are sold.
Whichever manner Green Co chooses, it must apply it consistently to
all of its arrangements that hedge the purchase of its trading stock
(section 230-85).
Consequences if the hedging financial arrangement no longer meets the
hedge tax criteria even though it was originally met
8.92 The outcome where a hedging financial arrangement no longer
meets the hedge tax criteria (eg, if the revenue hedge becomes ineffective)
is similar to that of a revocation of a designation or a redesignation of the
hedging financial arrangement.
8.93 That is, any gain or loss on the hedging financial arrangement up
to the time of the non-compliance (in the case of tax-hedge
ineffectiveness) or the event (in the case of a revocation of the designation
or redesignation) is allocated to the income year (or years) in which the
hedged item's gains or losses are recognised. Any gain or loss on the
hedging financial arrangement from the time of non-compliance or event
265
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
is to be treated in accordance with the classification of the financial
arrangement at that time. [Schedule 1, item 1, section 230-265, item 1 in the table]
Consequences if the hedged item(s) or risk arising from the hedged
item(s) ceases to exist
8.94 In certain circumstances cessation of a hedging relationship may
occur where the entity ceases to have the hedged item, or one or more of
the hedged items, or the risk that was being hedged in relation to the
hedged item or items (eg, terms of a variable rate loan are altered to a
fixed rate loan) no longer exists. In these circumstances as the hedged
item or items or hedged risk no longer exist, hedging from that time
would not be appropriate. As a result gains and losses on the hedging
financial arrangement are to be bought to account at that time [Schedule 1,
item 1, section 230-265, items 2(a), 2(b), and (3) in the table]. Regulations may also
be made to determine the treatment of gains and losses up to the time that
the taxpayer ceases to have some, but not all, of the hedged items or item
under a hedging financial arrangement [Schedule 1, item 1,
subsection 230-265(5)].
Where requirements for election are no longer satisfied
8.95 Although an election under the hedging financial arrangement
election is irrevocable [Schedule 1, item 1, subsection 230-275(3)], the election
may cease to apply for the start of the income year if the taxpayer ceases
to meet the eligibility requirements under subsection 230-275(2)
[Schedule 1, item 1, subsection 230-325(1)].
The making of a new election
8.96 The taxpayer is not prevented from making a new election at a
later time if the conditions in subsection 230-275(2) are satisfied for an
income year. [Schedule 1, item 1, subsection 230-325(2)]
8.97 The new election, however, will only apply to new financial
arrangements after the start of the income year in which the new election
is made. Refer to Chapter 5 for further discussion as to when an election
will cease to apply.
Balancing adjustment if an election ceases to apply
8.98 Where a hedging financial arrangement election ceases to apply
the taxpayer is taken to have disposed of each hedging financial
arrangement for its fair value, immediately before an election ceases to
apply (ie, at the start of the relevant income year) and to have been
266
The elective hedging financial arrangements method
reacquired for its fair value immediately after the election ceases to have
effect [Schedule 1, item 1, section 230-330]. The gain or loss arising from the
disposal (ie, the `balancing adjustment') is brought to account in the year
of income according to the record made under section 230-315 and not
under Subdivision 230-G [Schedule 1, item 1, subsections 230-330(3), 230-260(2)
and 230-390(2)].
Consequences of deliberate failure to meet the hedge tax requirements
8.99 Tax-hedge treatment introduces the potential for considerable
selectivity of tax-timing and/or tax classification if the requirements
relating to the making of determinations or recording are not met. For
example, the hedging financial arrangement could effectively become an
arrangement-by-arrangement election, making the administration of the
hedging rules more difficult, if there was a deliberate failure -- perhaps of
a minor or technical nature -- to meet one or more of the requirements.
8.100 Accordingly, a deliberate failure to meet one of these
requirements leads to the result that hedge tax treatment does not apply to
hedging financial arrangements that start to be held after the failure
[Schedule 1, item 1, subsection 230-340(2)] unless the Commissioner determines
that, after a specified date, this cessation no longer applies. To make this
determination, the Commissioner must be satisfied that the taxpayer is
unlikely to deliberately fail again to meet the abovementioned
requirements [Schedule 1, item 1, subsection 230-340(4)] and must take into
account various factors. Specific factors relate to the entity's record
keeping practices, its compliance history and whether there have been
appropriate changes to its accounting systems, controls and governance
processes [Schedule 1, item 1, subsection 230-340(5)].
267
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Hedging requirements process
8.101 Diagram 8.1 describes the process by which hedging financial
arrangements should be determined.
Diagram 8.1
Has the taxpayer made
a hedging financial
election?
No
(section 230-275)
Yes
Is the financial The rules for hedging
arrangement a hedging financial arrangements
financial arrangement? do not apply.
No
(sections 230-280,
230-285
and 230-290)
Yes
The gain or loss on the
hedging financial
arrangement is worked
out under
sections 230-260 and
230-270
268
Chapter 9
The elective financial reports method
Outline of chapter
9.1 This chapter outlines how the election to rely on financial
reports applies to relevant financial arrangements. The chapter explains:
· when the taxpayer may make the election;
· the effect of the election;
· the timing and quantum of gains and losses that are brought
to account for tax purposes from financial arrangements to
which the election applies;
· the circumstances where an election ceases to apply; and
· the effect of an election ceasing to apply.
Context of amendments
9.2 Compared to the current tax law, the other tax-timing methods
in Division 230 (discussed in earlier chapters) closely correspond with the
financial accounting treatment of financial arrangements. This close
correspondence provides opportunities for compliance cost savings.
Subdivision 230-F (the elective financial reports method) provides further
opportunities to lower compliance costs by, in effect, allowing taxpayers,
in certain circumstances, to rely on their financial reports to determine the
tax outcomes from their financial arrangements to which Division 230
applies.
Summary of new law
9.3 This chapter is to be read in conjunction with Chapter 5.
Chapter 5 outlines a number of the common requirements and criteria that
apply to all elective regimes, including the regime in Subdivision 230-F,
the subject of this chapter.
269
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
9.4 Before a taxpayer is able to make an election to rely on their
financial reports, the taxpayer must satisfy a number of criteria in addition
to the common criteria referred to in Chapter 5. These criteria are
designed to ensure a high degree of integrity in the systems, controls and
procedures behind the financial reports that the taxpayer seeks to rely on
for tax purposes.
9.5 An intention of Subdivision 230-F is to further reduce
administration and compliance costs. This is achieved by allowing
taxpayers to calculate the gains and losses from financial arrangements by
reference to relevant accounting standards. In effect, a taxpayer who
makes a valid financial reports election can rely on their financial reports
for the purposes of complying with their tax obligations in respect of
relevant Division 230 financial arrangements.
9.6 The main requirements that a taxpayer must satisfy in order to
make an election to rely on financial reports are:
· accounting and auditing requirements -- discussed as
common requirements (common to all elective methods) in
Chapter 5; and
· unqualified financial reports -- the financial reports which
the taxpayer relies upon must not have been subject to a
relevant qualification in the auditor's report in the current
year or in any of the previous four financial years. This
requirement, which is specific to the elective financial reports
method, is discussed later in this chapter. Where this
requirement is not satisfied, the Commissioner of Taxation
(Commissioner) may waive the audit requirement for specific
income years after consideration of certain factors.
9.7 Once an election has been made by a taxpayer, their financial
arrangements will be subject to Subdivision 230-F if:
· the financial arrangement is one to which Division 230
applies;
· the taxpayer's financial reports recognise the financial
arrangement;
· it is reasonably expected that the overall gain or loss made on
the financial arrangement is the same, using the financial
reports election, as it would have been had the gain or loss
been calculated under the provisions of Division 230 with the
exception of Subdivision 230-F;
270
The elective financial reports method
· it is reasonably expected that the gain or loss will be
recognised at approximately the same time as it would have
been recognised had Subdivision 230-F not applied; and
· it is a financial arrangement which the taxpayer starts to have
in the income year in which the election is made or a later
income year (or that is subject to a transitional election which
is discussed in Chapter 12).
9.8 Where the financial reports election is made, Subdivision 230-F
will determine the tax treatment of relevant financial arrangements except
where Subdivision 230-E (hedging) applies. Hedging is excluded from
Subdivision 230-F because the tax classification of gains and losses on
hedges cannot be ascertained from the taxpayer's financial reports.
9.9 An election made under this Subdivision has effect from the
income year in which it is made and to all future income years. It is
irrevocable.
9.10 An election will, however, cease to apply to a financial
arrangement if any of the requirements for making the election are no
longer satisfied. The election will cease to apply from the start of the
income year in which this occurs. In these circumstances, the taxpayer
will be required to calculate a balancing adjustment gain or loss amount
for each financial arrangement that is subject to the election.
9.11 Where an election ceases to apply, the taxpayer is able to make a
new election when the requirements for making the election are once
more satisfied, but this election will only apply to those arrangements the
taxpayer starts to have in, or after, the year in which the election is
remade.
Comparison of key features of new law and current law
New law Current law
Subdivision 230-F effectively allows Under the current law, there is no
a taxpayer to use the amounts in their basis for electing to use financial
financial reports for the purposes of reports to calculate gains and losses
calculating their assessable income from financial arrangements for tax
and allowable deductions under purposes.
Division 230 of the ITAA 1997.
Taxpayers are able to elect to
calculate their income and
deductions using this method subject
271
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
New law Current law
to satisfying certain criteria.
The election under this Subdivision
is irrevocable. Where certain criteria
are no longer satisfied the election
may cease or it may cease to apply to
a financial arrangement. In certain
circumstances the Commissioner
may waive the audit requirement.
Where an election ceases, a new
election may be made in relation to
new financial arrangements if the
requirements for making the election
are met.
Detailed explanation of new law
Conditions for making an election
9.12 Subdivision 230-F contains a number of specific requirements
relevant to the financial reports election, in addition to those requirements
outlined in the `common requirements chapter' (Chapter 5). Both the
generic and specific requirements must be satisfied prior to making an
election. This chapter outlines the particular requirements that are
specific to Subdivision 230-F.
9.13 For a discussion of the accounting and auditing requirements,
refer to Chapter 5. Chapter 5 also discusses which taxpayers are eligible
to make a valid election.
Unqualified audit report
9.14 The requirement to have unqualified auditor reports for the
current and four previous income years is unique to Subdivision 230-F.
An auditor's report in this context is the year end report of an external
auditor.
9.15 For an auditor's report to affect eligibility to make a financial
reports election, the qualification must be in a respect that is relevant to
the taxation treatment of financial arrangements. [Schedule 1, item 1,
paragraph 230-350(2)(c)]
9.16 Thus, it is possible for a taxpayer to have an auditor's report on
the taxpayer's financial reports that is qualified, but still be able to elect to
272
The elective financial reports method
rely on the financial reports so long as the qualification is not relevant to
the taxation treatment of a financial arrangement.
9.17 Relevance in this context is, however, not confined to a
qualification made about the timing and quantification of gains and losses.
For example, a relevant qualification may relate to the reliability of the
recording of financial arrangements. This, in turn, can affect what is
reported in profit or loss, which the financial reports election relies upon
for the purpose of determining the taxation treatment of financial
arrangements.
Example 9.1: Qualified accounts
The auditor's report on the financial reports of Scruffy Ltd has been
qualified in relation to the amount of directors' fees that have been
recognised. As these fees have no impact on the recognition and
measurement of gains or losses on relevant financial arrangements, the
qualification will not prevent Scruffy Ltd from electing to rely on its
financial reports for the purposes of Subdivision 230-F.
9.18 Where an auditor's report is qualified in a relevant respect in the
current or four prior income years, the taxpayer cannot make the election
to rely on their financial reports.
Accounting systems
9.19 The degree of integrity of a taxpayer's accounting systems and
controls is relevant in determining the appropriateness of making an
election under this Subdivision. The election under this Subdivision is
designed to assist taxpayers in reducing their compliance costs without
providing inappropriate tax outcomes. As such, there is a requirement
that, in order to make a valid election, a taxpayer should have robust
accounting systems in place which are reliable. Accounting systems with
reliable controls and internal governance processes help to ensure
compliance with accounting and (other) tax obligations. In the tax
context, therefore, the systems, controls and processes must be reliable for
the purpose of preparing the entity's tax return. Remedial action that has
been taken in relation to processes that do not impinge on matters relevant
to the preparation of the tax return would, for example, typically not lead
to the conclusion that the processes are not reliable. Overall, reliance on
such systems, controls and processes will reduce tax compliance costs and
provide amounts for tax purposes which do not provide an inappropriate
tax benefit. [Schedule 1, item 1, paragraph 230-350(2)(d)]
9.20 External auditors or a regulatory authority or agency may
provide opinions on the quality of the accounting systems used by a
taxpayer in an audit. Where an adverse assessment has been provided by
273
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
an external auditor or a regulatory authority or agency on the quality of
the accounting systems, this could indicate a system deficiency which
may impact on the reliability of the gains or losses brought to tax under
Subdivision 230-F. Accordingly, where an external audit, or a review,
conducted in the financial year in which the election is proposed to be
made or any of the four financial years prior to that year, has included
such an adverse assessment of the taxpayer's accounting systems, the
taxpayer cannot make the election to rely on their financial reports.
[Schedule 1, item 1, paragraph 230-350(2)(e)]
9.21 It should be noted that internal audits and reviews (or an audit
or review of a kind prescribed by regulation) are to be disregarded for this
purpose. [Schedule 1, item 1, subsection 230-350(3)]
9.22 In determining whether accounting systems, controls and
internal governance processes are reliable regard should be had to the
current accounting definition of `reliable'. The Framework for the
Preparation and Presentation of Financial Statements issued by the
AASB states, in paragraph 31, that:
`To be useful, information must also be reliable. Information has the
quality of reliability when it is free from material error and bias and
can be depended upon by users to represent faithfully that which it
either purports to represent or could reasonably be expected to
represent.'
Commissioner discretion
9.23 Subsection 230-355(1) provides the Commissioner with a
discretion to disregard a relevant qualified audit report, or relevant
adverse audit or review relating to the accounting systems, for the purpose
of determining whether a taxpayer is eligible to make the financial reports
election. In exercising this discretion, the Commissioner must take
account of the following factors:
· the reason for non-compliance with the particular accounting
standard;
· what remedial action (such as changes to accounting systems
and controls and internal processes) has been undertaken to
address the non-compliance with the accounting standards;
· whether the taxpayer is subject to any regulatory oversight
(eg, by the Australian Securities and Investment Commission
or the Australian Prudential Regulatory Authority) and, if so,
any opinions prepared by those regulators in respect of
changes to accounting systems and, controls and internal
governance processes; and
274
The elective financial reports method
· any other relevant matter.
[Schedule 1, item 1, subsections 230-355(1) and (2)]
9.24 While Subdivision 230-F provides the Commissioner with
a discretion to disregard paragraphs 230-350(2)(c) and (e), the
purpose of the discretion is not to reduce the level of integrity and
reliability of financial reports which are required for the purposes of
Subdivision 230-F. Rather, the discretion is designed to provide a basis to
ensure that the compliance cost saving in Subdivision 230-F will be
available to a taxpayer despite not technically being able to satisfy
paragraphs 230-350(2)(c) and (e) -- refer to paragraphs 5.11 and 5.20 to
5.26 for discussion of these factors.
9.25 Particular emphasis is to be placed on what, if any, external
regulation or review the taxpayer is subject to. That is, independent
verification by an external regulator as to the quality of the accounting
systems and any remedial action undertaken will be an important factor.
9.26 Where a relevant qualification is in respect of a minor matter
in an auditor's report, it will be possible for the Commissioner to
determine that the audit requirements under paragraphs 230-350(2)(c)
and (e) have been satisfied in the income year in which an auditor's report
is qualified. What is minor will depend on the context and the
circumstances of the particular case. Depending on the circumstances, it
may be important for the Commissioner to be satisfied that appropriate
remedial action has been undertaken by the taxpayer.
Overall gain or loss requirement
9.27 Once an election has been made to apply Subdivision 230-F, it
only applies to those financial arrangements where, over the life of the
financial arrangement, it could reasonably be expected that the same
overall gain or loss is recognised for tax purposes as would have been
recognised if Subdivision 230-F did not apply, but the other relevant
methods under the provisions of Division 230 (including the elective
method) had been chosen and had applied. [Schedule 1, item 1,
paragraph 230-360(1)(e) and subsection 230-360(2)]
Substantially the same methods
9.28 A further requirement for an election under Subdivision 230-F
to apply, is that the results of the method used to determine the gain or
loss on a financial arrangement for each income year in the financial
reports is substantially the same as the results from the methods that
would have applied under the provisions of Division 230 assuming the
relevant methods (including the elective methods), except for
275
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Subdivision 230-F, had been chosen and had applied [Schedule 1, item 1,
paragraph 230-360(1)(f) and subsection 230-360(2)].
The results from each of
these methods would be expected to be substantially the same if the
financial reports method spreads the gains or losses arising on the
financial arrangement in the financial report in such a way that the gains
or losses brought to account in each income year were similar to the
spread of gains and losses brought to account under the other Subdivisions
of Division 230 (assuming that the other relevant elective methods had
been chosen and had applied).
9.29 In determining whether the results of the method are
substantially the same, taxpayers are (in respect of financial arrangements
that are not fair valued) to disregard the impact of impairment testing
(ie, the possibility of making a provision for doubtful debts) from an
accounting perspective, when they first start to hold the relevant financial
arrangement. [Schedule 1, item 1, subsection 230-360(2)]
Assume other elections made
9.30 For the purposes of determining whether an entity reasonably
expects to make the same overall gain or loss on a financial arrangement
and for determining whether the differences in methods applied under
Division 230 (other than Subdivision 230-F), an entity is able to assume
that a fair value election under Subdivision 230-C and a general foreign
exchange retranslation election under Subdivision 230-D have been made.
This prevents taxpayers from having to have valid elections in place
solely for the purpose of being able to make a valid election under
Subdivision 230-F. [Schedule 1, item 1, subsection 230-380(7)]
Which entities can elect the financial reports method?
9.31 Any entity that prepares audited financial reports and that
satisfies the preconditions discussed above is able to make a financial
reports election. [Schedule 1, item 1, section 230-350]
Making the election
9.32 Any taxpayer may make a financial reports election, but it will
only be valid for those taxpayers which meet the entry requirements.
9.33 In the case of a tax consolidated group or a multiple entry
consolidated group (MEC group), elections are made by the head
company of the group. Generally, an election under Division 230 will
apply to all the relevant transactions of all members of the consolidated
group or MEC group. However, there is an exception to this where a tax
consolidated group or MEC group includes a member that carries on a
276
The elective financial reports method
`life insurance business'. Where a member of the group carries on a life
insurance business, the head company can specify whether or not the
election will apply to the life insurance business carried on by that
member of the group. [Schedule 1, item 1, subsection 230-365(10)]
9.34 A regulation-making power allows for regulations to be made
specifying other types of businesses for which the fair value election in
respect of financial arrangements will not apply.
[Schedule 1, item 1, subsection 230-365(11)]
9.35 The making of a valid election and its application to a member
of a consolidated group that carries on life insurance business is discussed
in more detail in Chapter 5.
9.36 It is important to note, however, that an election under
Subdivision 230-F does not in fact result in elections being made under
Subdivisions 230-C and 230-D.
Financial arrangements subject to the election to adopt the financial
reports method, and the effect of that election
To what financial arrangements does the election to adopt the financial
reports method apply?
9.37 For a discussion of the common application of this election to
financial arrangements, refer to Chapter 5.
9.38 An election under Subdivision 230-F applies to all financial
arrangements first held in the income year in which the election is made
and all future income years, providing they each satisfy the relevant
conditions in subsection 230-360(1). For example, the overall gain or loss
in the financial reports must reasonably be expected to be equivalent to
that which would otherwise arise under Division 230 (apart from
Subdivision 230-F).
9.39 Where a financial arrangement is an intra-group transaction for
the purposes of Australian Accounting Standard AASB 127 Consolidated
and Separate Financial Statements (or comparable), the financial
arrangement is deemed to be an arrangement that is recognised in a set of
audited financial reports and classified as at fair value through profit or
loss [Schedule 1, item 1, subsection 230-360(3)]. For further discussion of this,
refer to Chapter 5.
9.40 An election under this Subdivision does not apply to financial
arrangements that are held by a taxpayer in any income year prior to the
making of the election under this Subdivision, except where a further
277
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
election is made under the transitional arrangements (refer to Chapter 12).
[Schedule 1, item 1, paragraph 230-360(1)(b)]
9.41 Where a taxpayer has made an election under
Subdivision 230-F, separate fair value and retranslation elections are not
necessary for any financial arrangement which are subject to the election
(though they can still be made and will apply if a financial reports election
ceases to apply in circumstances where the requirements for those other
elections continue to be satisfied). Where a taxpayer is unable to, or does
not want to, make an election under Subdivision 230-F, they may still able
to make separate elections under Subdivisions 230-C and 230-D as
appropriate.
Financial arrangements to which the elective Subdivisions do not apply
9.42 An election under Subdivision 230-F cannot apply to a financial
arrangement where the arrangement is an equity interest and where:
· the taxpayer is the issuer of the equity interest [Schedule 1,
item 1, subsection 230-365(1)]; or
· the equity interest is not classified or designated as at fair
value through profit or loss [Schedule 1, item 1,
subsection 230-365(1)].
For these purposes an `equity interest' includes an interest in a trust or a
partnership that satisfies the requirements of subsection 820-930(1).
[Schedule 1, item 7, subsection 820-930(1)]
9.43 Where a member of a tax consolidated group or MEC group
carries on a life insurance business, the head company is able to specify
that an election under Subdivision 230-F will not apply to financial
arrangements of the member of the consolidated group or MEC group to
the extent that the financial arrangement relates to the life insurance
business, as discussed in Chapter 5. [Schedule 1, item 1, subsection 230-350(5)]
9.44 An election under Subdivision 230-F does not apply to
transactions that are subject to Subdivision 230-E (hedging). The reason
for this is that the tax hedge rules allow for tax classification hedging,
which is not reflected in financial reports. To preserve the after-tax
symmetry in respect of hedging financial arrangements, it is essential that
Subdivision 230-E take precedence over Subdivision 230-F. [Schedule 1,
item 1, subsection 230-45(5)]
Effect of relying on financial reports
9.45 For a discussion of the common application of this election to
financial arrangements refer to Chapter 5.
278
The elective financial reports method
9.46 Where an election made under Subdivision 230-F applies to a
financial arrangement, the gain or loss required by the relevant accounting
standard to be included in profit or loss in the financial report for that
financial arrangement will represent the gain or loss for income tax
purposes.
9.47 In particular, the effect of making an election under this
Subdivision is that the taxpayer relies on their financial reports to
determine whether they have, and the amount of, a gain or loss from a
relevant financial arrangement and when the gain or loss is regarded as
arising. [Schedule 1, item 1, section 230-370]
9.48 However, some specific adjustments are made to the amount of
the gain or loss that is recognised for Division 230 purposes. The first of
these adjustments relate to franked distributions and the second relates to
amounts arising on impairment of certain financial arrangements.
Adjustment for franked distributions
9.49 In respect of financial arrangements that are fair valued under
Subdivision 230-F, any franked distributions (received either directly or
indirectly) and rights to receive franked distributions (either directly or
indirectly) are not to be included as a gain or loss that is brought to
account in accordance with this Subdivision. The effect of excluding
franked distributions from the scope of the financial reports election is to
ensure that these distributions will remain assessable in accordance with
section 44 of the Income Tax Assessment Act 1936 (ITAA 1936).
Assessing the distribution under section 44 of the ITAA 1936 rather than
under Division 230 will ensure that the imputation system works
appropriately in respect of distributions such that franking credits
allocated to such distributions are available to the recipient in the income
year in which the distribution is taxed to the recipient.
9.50 Absent a specific rule, a dividend (distribution) may be
declared in favour of a shareholder and the accounting standards
(eg, Australian Accounting Standard AASB 118 Revenue) would have
required the taxpayer to recognise revenue (ie, a gain) in respect of the
declared distribution. At this time, however, the dividend could not be
franked. Later when the dividend is actually paid, that payment would not
be assessed to the taxpayer because of the operation of the anti-overlap
rule (section 230-20) and, accordingly, franking benefits would not be
allowed to the shareholder. In such cases, the right to receive the franked
distribution (that would arise at the time the dividend is declared) is also
excluded from the scope of the financial reports election [Schedule 1, item 1,
subsection 230-370(2)]. To the extent that the distribution is an unfranked
distribution, the differences between the time the distribution is declared
and paid will not cause any imputation issues to arise. Therefore, if the
279
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
distribution is unfranked, it is still within the scope of the fair value
election and will be recognised in accordance with the accounting
standards.
9.51 The exclusion in subsection 230-370(2) will apply equally to
distributions received directly by the taxpayer from a corporate tax entity
or received indirectly by the taxpayer as a beneficiary of a trust or through
a partnership. In these cases, a beneficiary of a trust (and equally a
taxpayer that will receive franked distributions through a partnership) will
only recognise a dividend either when it is received through the trust or
when the dividend is declared but not paid and the beneficiary knows how
much it will actually receive. If this cannot be determined by the
beneficiary, then the exclusion in subsection 230-370(2) will not apply.
Example 9.2: Dividend payment
On 1 July 2008 Barri Co acquires ordinary shares in UE Co for
$50 million and makes the fair value election in respect of all its
financial arrangements. At 30 June 2009 the shares in UE Co have a
market value of $65 million. On 1 May 2009 UE Co pays dividends
of $6 million. Barri Co's taxable income for the 2008-09 year includes
the fair value gain of $15 million ($65 million $50 million) and a
dividend of $6 million (ignoring grossing-up for franking credits).
However, Division 230 will only assess the fair value gain
of $15 million. The dividend paid by UE Co will be assessed
under section 44 of the ITAA 1936.
At 30 June 2010 the shares in UE Co have a market value of
$90 million. No dividends have been paid for this income year.
Barri Co's taxable income for the 2009-10 income year includes the
fair value gain of $25 million ($90 million $65 million).
Adjustment for impairment of financial arrangement
9.52 Where a debt arrangement that is subject to the financial reports
election subsequently becomes impaired (as determined under the
Accounting Standards), the arrangement ceases to be subject to
Subdivision 230-F, except where the arrangement is fair valued. This
is because the arrangement ceases to satisfy the requirements of
paragraph 230-360(1)(f) -- that is, it cannot be said that the differences in
the results of the accounting method and the compounding accruals
method in Subdivision 230-B are reasonably expected to be not
substantial. The reason for this is that the compounding accruals method
does not recognise a provision for doubtful debts. Hence, the relevant
financial arrangement will become subject to the remainder of
Division 230 other than Subdivision 230-F. If the financial arrangement
falls within the scope of Subdivision 230-B (accruals and realisation
method) and the impairment is later written-off as a bad debt, the
280
The elective financial reports method
provisions within Subdivision 230-B will apply to allow a deduction for
amounts previously recognised as gains from the arrangement. Also, if at
some future time, the debt arrangement ceases to be impaired, it cannot be
subject to Subdivision 230-F again. [Schedule 1, item 1, subsection 230-375(4)]
9.53 Where a debt arrangement that is subject to Subdivision 230-F
becomes impaired, and the financial reports election ceases to apply to it,
the arrangement is specifically precluded from being subject to a
balancing adjustment [Schedule 1, item 1, subsection 230-380(4)]. The reason
for this is that if a balancing adjustment were applied at the time the
financial arrangement becomes impaired, the taxpayer would receive an
immediate deduction for the impairment of the debt arrangement. Such a
result is contrary to the general policy in relation to doubtful debts for
financial arrangements that are not subject to the fair value election (as
described in Chapter 4).
Interaction with other tax-timing elections under Division 230
9.54 Where a taxpayer has made elections under Subdivision 230-C
and or Subdivision 230-D, and subsequently elects to apply Subdivision
230-F, the Subdivision 230-F election will apply to all financial
arrangements entered into in the income year in which this election was
made or a later income year, even if they would otherwise have been
subject to Subdivision 230-C and/or Subdivision 230-D.
Where requirements for election are no longer satisfied
9.55 Although an election to rely on financial reports is irrevocable,
the election may cease to apply, depending on the circumstances of either:
· all of a taxpayer's financial arrangements; or
· one or more particular financial arrangements of the
taxpayer.
[Schedule 1, item 1, section 230-375]
9.56 If an election to rely on financial reports ceases to apply to a
particular financial arrangement, that election cannot subsequently
reapply to it. [Schedule 1, item 1, subsection 230-375(4)]
9.57 Refer to Chapter 5 for further information as to when an election
to rely on financial reports will cease to apply.
281
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Balancing adjustment if an election ceases to apply
9.58 Where an election to rely on financial reports ceases to have
effect in relation to, or ceases to apply to, a particular financial
arrangement, from the start of a particular income year, a balancing
adjustment is made at that time in respect of the arrangement [Schedule 1,
item 1, subsections 230-380(1) and (3)]. A balancing adjustment does not apply
to a financial arrangement where it becomes impaired (see
paragraphs 9.52 and 9.53). [Schedule 1, item 1, subsection 230-380(4)]
9.59 The balancing adjustment is to be made in accordance with the
balancing adjustment requirements as set out in Subdivision 230-G
(see Chapter 10). The balancing adjustment made is the balancing
adjustment the taxpayer would have made if the taxpayer disposed of each
relevant arrangement at the start of the income year in which the election
ceased to apply for its market value and immediately reacquired it at that
time for that value. [Schedule 1, item 1, section 230-380]
9.60 In some limited circumstances, it is possible that no amount
will be bought to account as a result of the application of the balancing
adjustment where a financial arrangement ceases to be subject to
Subdivision 230-F.
Example 9.3: Hierarchy of elections and balancing adjustment
Bill Co has made valid elections under Subdivisions 230-C, 230-D and
230-F that apply to its income year that commences on 1 July 2008.
As a result of the operation of Division 230, Bill Co relies on the
operation of Subdivision 230-F to quantify its fair value and foreign
exchange retranslation gains and losses -- as opposed to relying
on Subdivisions 230-C and 230-D.
In respect of the financial reports for the year ended 30 June 2011, the
auditor's report is relevantly qualified such that Bill Co can no longer
rely on Subdivision 230-F to determine its gains and losses. As the
qualification is in respect of the accounting systems and controls,
Bill Co is able to rely on Subdivisions 230-C and 230-D to determine
the value of its relevant gains and losses in respect of relevant financial
arrangements.
As a result of this, and the fact that Subdivision 230-F ceases to apply
from the start of the income year, the balancing adjustment would be
calculated as follows for a financial arrangement that is being fair
valued:
Assume the following:
· Acquired financial arrangement for $200 at 1 September 2009.
282
The elective financial reports method
· Fair value as at 30 June 2010 is $250.
· Amount included in assessable income for year ended
30 June 2010 is $50.
Step 1 -- the total of financial benefits received under the financial
arrangement.
$250
Step 2 -- the total of the financial benefits provided under the financial
arrangement (ie, $200 for the acquisition) and the total of the amounts
that have been included in assessable income before the transfer or
cessation, as gains from the arrangement ($50 gain attributable to the
change in fair value).
$250
Step 3 -- compare the step 1 amount with the step 2 amount. If the
amounts are equal, as they are in this example, no balancing
adjustment is made.
9.61 Chapter 5, in respect of the elective Subdivisions, and
Chapter 10 more generally, provide further detail as to the operation of the
balancing adjustment rules contained in Subdivision 230-G.
Making of a new election
9.62 Where a taxpayer has made an election which ceases to have
effect, they may later make a new election where the conditions for
making an election are once more satisfied (refer Chapter 5). With
respect to an election under Subdivision 230-F, if it ceased to have effect
because of a qualified audit in respect of the treatment of a financial
arrangement or an adverse assessment of the taxpayer's accounting
systems in a report of an audit or review, the election can only be
remade four years following the income year in which these particular
requirements were first failed. [Schedule 1, item 1, paragraph 230-350(2)(c) and
subsection 230-375(2)]
283
Chapter 10
Balancing adjustment on disposing of
financial arrangements
Outline of chapter
10.1 This chapter explains when a financial arrangement (or part of a
financial arrangement) is transferred or otherwise ceases to be held, and
the consequences following these events.
10.2 For convenience, the expression `disposal' is used to refer to a
financial arrangement (or part of a financial arrangement), ceasing to be
held or being transferred.
Context of amendments
10.3 Under the current income tax law, there are several provisions
dealing with the tax consequences of disposing of financial arrangements
which would qualify as financial arrangements under proposed
Division 230. They include both general and specific provisions such as:
· sections 26BB and 70B of the Income Tax Assessment
Act 1936 (ITAA 1936);
· section 159GS of the ITAA 1936;
· sections 6-5 and 8-1 of the Income Tax Assessment Act 1997
(ITAA 1997); and
· Part 3-1 of the ITAA 1997.
10.4 These provisions apply in different circumstances and in
different ways. For example:
· sections 26BB and 70B generally operate when an
`arrangement' is `redeemed' or `disposed of'. While
`redeemed' is not defined, `dispose' is defined in
subsections 26BB(1) and 70B(1);
285
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· section 159GS operates when an arrangement is `transferred'.
The definition of `transfer' (in subsection 159GP(1)) is
similar to, but not the same as, the definition of `dispose' in
subsections 26BB(1) and 70B(1);
· sections 6-5 and 8-1 generally rely on the concept of
realisation to bring to account gains and losses on disposal;
and
· Part 3-1 of the ITAA 1997 relies on the concept of capital
gains tax (CGT) events.
10.5 Thus, there is an amalgam of general and specific provisions
without any common or uniform treatment applicable to the disposal of
financial arrangements. There is no explicit principled framework for
considering what is disposed of, when it is disposed of, and how to
quantify the amount to be recognised for tax purposes as a result of the
disposal.
10.6 More specifically, the current law does not contain a
comprehensive provision dealing with the tax consequences of disposing
of financial arrangements that are liabilities in a non-forgiveness context.
This means, for example, that it is not clear whether the tax treatment of
the defeasance of debt instruments falls under the general deduction and
income provisions, under the CGT provisions or under a specific
provision. In addition, it is not clear to what extent gains and losses on
such defeasances are recognised under the current income tax law.
10.7 In specifying how much gain or loss is to be brought to account
at the time of disposal, it is necessary to determine how much has already
been brought to account, in respect of the financial arrangement or
relevant part of it. Any allocation of gain or loss from the financial
arrangement prior to that time (eg, under the accruals provisions), is taken
into account to ensure that only the actual net gain or loss from the whole,
or part, of the financial arrangement is recognised for income tax
purposes. That is, an adjustment is made on disposal for any previous
under-allocation or over-allocation. This adjustment on disposal is
referred to as a `balancing adjustment'.
Summary of new law
10.8 Proposed Subdivision 230-G provides that a balancing
adjustment is made when all the rights and/or obligations under a financial
arrangement cease or are transferred to another person. In certain
circumstances, a balancing adjustment is also made when there is a partial
transfer.
286
Balancing adjustment on disposing of financial arrangements
10.9 In broad terms, the balancing adjustment gain or loss is
calculated by netting the financial benefits received and provided under
the arrangement -- including the consideration received or provided in
relation to the cessation or transfer -- and any amounts that have been (or
would have been) brought to account for income tax purposes from the
arrangement until the cessation or transfer.
10.10 This balancing adjustment gain or loss is made in the income
year in which the cessation or transfer occurs.
Comparison of key features of new law and current law
New law Current law
The new law contains a single A number of separate and ad hoc
provision covering the tax provisions govern the tax
consequences (including the consequences of the disposal of
balancing adjustment) arising from different types of financial
the disposal of different types of arrangements.
financial arrangements other than
arrangements to which the hedging
rules apply.
The provision covers gains and It is not clear to what extent gains
losses from the disposal of liabilities and losses from the disposal of
in a non-forgiveness context. liabilities (in a non-forgiveness
context) are recognised for tax
purposes.
Specific rules clarify the tax It is not clear how margining and
treatment of margining and historic historic rate roll-over arrangements
rate roll-over arrangements for for derivatives are treated for tax
derivatives. purposes.
Detailed explanation of new law
10.11 In broad terms, gains and losses from financial arrangements can
be made in one of two ways:
· having a financial arrangement; or
· disposing of a financial arrangement.
10.12 Gains from having a financial arrangement can flow from, for
example, the right to receive interest or an amount represented by
discount, while losses from having a financial arrangement can flow from,
287
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
for example, the obligation to provide interest or an amount represented
by discount. The interest is paid or received under the arrangement in
question. Guidance on how the taxpayer should treat these gains and
losses is not addressed in this chapter. Relevant guidance on these gains
and losses, and other gains and losses which arise from the expiry or
performance of rights and/or obligations while the financial arrangement
continues in operation, is set out in other Subdivisions of Division 230
and in other relevant chapters of this explanatory memorandum.
10.13 Gains and losses from disposing of a financial arrangement (or a
part of it) may, however, arise from a transfer to another person of
relevant rights and/or obligations under the arrangement. Gains and
losses from disposing of a financial arrangement can also be made when
all the rights and/or obligations which exist under the arrangement cease.
Both of these types of gains and losses (ie, from transfer or disposal) are
the gains and losses that Subdivision 230-G apply to.
10.14 The design of the disposal provisions in Subdivision 230-G
takes into account the derecognition criteria adopted by Accounting
Standard AASB 139, Financial Instruments: Recognition and
Measurement.
What constitutes a disposal?
General rule
10.15 The general rule is that disposal of a whole financial
arrangement, that is, a disposal of all the rights and/or obligations
under the financial arrangement, occurs if those rights and/or
obligations cease or are transferred to another person. [Schedule 1, item 1,
paragraphs 230-385(1)(a) and (b)]
10.16 A cessation of the relevant rights and/or obligations can occur in
different ways, for example, through their discharge (of obligations) or
satisfaction, expiry, close out, forfeiture or maturity.
10.17 A transfer of a right or obligation (which is a form of cessation)
can itself occur in different ways, for example, as a result of a sale, under
a legal defeasance (of obligations), or an assignment (of rights). If a
financial arrangement is an asset, however, a transfer is effectively taken
not to occur unless its effect is to transfer to another entity substantially all
the risks and rewards of ownership of the asset [Schedule 1, item 1,
paragraph 230-385(3)(a)]. Thus, for example, the security subject of the
`repo' in Example 2.5 would be treated as having not been transferred for
Subdivision 230-G purposes.
288
Balancing adjustment on disposing of financial arrangements
10.18 A partial disposal of a financial arrangement can occur only if
there is a transfer of one of the following types:
· a proportionate share of all the rights and/or obligations
under the financial arrangement [Schedule 1, item 1,
subparagraph 230-385(1)(c)(i)];
· a right or obligation under the financial arrangement to a
specifically identified financial benefit [Schedule 1, item 1,
subparagraph 230-385(1)(c)(ii)]; or
· a proportionate share of a right or obligation under the
financial arrangement to a specifically identified financial
benefit [Schedule 1, item 1, subparagraph 230-385(1)(c)(iii)].
Special rules or exceptions
10.19 The general rules outlined above are overridden by special rules
and exceptions dealing with equity interests, hedging, margining,
historical rate roll-over, conversion or exchange and commercial debt
forgiveness.
Equity interests
10.20 A balancing adjustment is not made if the financial arrangement
is an equity financial arrangement (as described in Chapter 2) -- and
neither Subdivision 230-C nor Subdivision 230-F apply to the financial
arrangement [Schedule 1, item 1, subsection 230-390(1)]. The effect of this is
that, unless the elective fair value method or the election to rely on
financial reports applies to an equity financial arrangement, the disposal
gain or loss in respect of that equity financial arrangement will not be
worked out under Subdivision 230-G, but rather will be determined by
provisions outside of Division 230. Accordingly, the disposal gain or loss
from such an arrangement will not necessarily be on revenue account.
Hedging
10.21 As explained in Chapter 8, the tax hedging provisions are
designed to provide appropriate tax matching between the hedging
financial arrangement and the hedged item or items. To establish this
matching, it may be necessary to defer a gain or loss on the hedging
financial arrangement past the time at which it would otherwise be
recognised for income tax purposes, due to its disposal. In addition, an
equity interest which is a hedging financial arrangement may have that
part of the gain or loss which is attributable to a currency exchange rate
effect worked out under the hedging provisions. Hence, the balancing
289
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
adjustments otherwise required by Subdivision 230-G are subject to the
operation of the tax hedging provisions in Subdivision 230-E.
Bad debts
10.22 Although the writing off of a bad debt would not constitute a
transfer or cessation of a financial arrangement, Subdivision 230-G makes
it clear that a balancing adjustment is not made when a financial
arrangement is written off as a bad debt [Schedule 1, item 1,
paragraph 230-390(3)(a)]. Specific rules for bad debt deductions are included
in the accruals method and realisation method. To permit the ongoing
operation of the bad debt provision in section 25-35, there is an exception
to the anti-overlap rule in section 230-25.
Margining
10.23 Exchange traded derivatives typically are subject to margining
requirements. Thus, on a daily basis, the party carrying a loss on the
contract is required to settle it by making a payment. It is arguable that
the settlement of the contract means that the rights and obligations under
it come to an end because they are satisfied and that there is therefore a
disposal.
10.24 However, it appears that upon payment, under margining
requirements, a new contract equivalent to the settled contract (other than
as to price) is created to replace the settled contract. The effect, therefore,
is that the parties to the contract are in the same economic position as
before the settlement but for the margin payment and the new price.
10.25 Except for the margining requirement, there would not have
been a settlement of the old contract. In these circumstances, it is
appropriate for the settlement of the exchange traded derivative, due to
any margining requirements, not to give rise to a balancing adjustment.
This is what paragraph 230-390(3)(b) gives effect to, although the
provision is not limited to exchange traded derivatives. This exclusion
from having the balancing adjustment apply extends to any financial
arrangement that is a derivative financial arrangement, which is settled or
closed out for margining purposes.
10.26 As explained in Chapter 8, derivative financial arrangements
are financial arrangements that:
· change in value in response to a change in a specified
variable or variables; and
· require little or no net investment, in that the net investment
is smaller than that required for other types of financial
290
Balancing adjustment on disposing of financial arrangements
arrangements -- that is, other than derivative financial
arrangements -- which would be expected to have similar
results to changes in market factors (see Chapter 8).
[Schedule 1, item 1, subsection 230-305(1)]
10.27 It should be noted that the margining process is different to the
process which occurs when an entity does not wish to maintain its
exposure under the derivative contract. In this case, it appears that under
clearing house rules there is a close-out, but no creation of an equivalent
contract (but for price). A close-out in this situation, which is not for
margining purposes, would constitute a disposal because the rights and
obligations under the contract are extinguished and there is no exception
which provides otherwise.
Historic rate roll-over
10.28 The term of a derivative financial arrangement may be able to be
extended or `rolled over' at a non-market or `off market' rate which
reflects the original or `historic' rate at which the financial arrangement
was entered into, and the extension of credit by the party that has a gain in
relation to the financial arrangement, at that time, to the other party. This
is commonly referred to as an `historic rate roll-over'.
10.29 In substance, at the roll-over date, there is a cessation by way of
expiry of the rights and/or obligations under the derivative financial
arrangement. Whether there is an expiry as a matter of contract law may
not be clear. Accordingly, to avoid doubt, there is a specific rule in
Subdivision 230-G to provide that an historic rate roll-over of a derivative
financial arrangement is taken to be a ceasing of all the rights and/or
obligations under the arrangement. [Schedule 1, item 1, subsection 230-385(4)]
10.30 As mentioned above, this and other disposal situations are
subject to the operation of the tax hedging rules in Subdivision 230-E.
Accordingly, the gain or loss on disposal of an historic rate roll-over
derivative contract (used in a hedging context) may be able to be deferred
and matched to timing and treatment of the gain or loss on a hedged item
for tax purposes; this will depend on the application of the tax hedging
rules (see Chapter 8).
291
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Conversion or exchange
10.31 A balancing adjustment will not arise by virtue of the conversion
or exchange, as the case may be, of a traditional security into ordinary
shares if it was issued on the basis that it will, or may:
· convert into ordinary shares of the issuer of the security or a
connected entity of the issuer, and the ceasing of the rights or
obligations under the financial arrangement that is the
security, is because it is converted into such shares [Schedule 1,
item 1, paragraph 230-390(3)(c)]; and
· exchange into the ordinary shares of an entity other than the
issuer of the security or a connected entity, and:
- it is exchanged for such shares; and
- if the ceasing of the rights or obligations occurs because
of a disposal, the disposal is to the issuer of the
traditional security or a connected entity of the issuer
[Schedule 1, item 1, paragraph 230-390(3)(d)].
Subsidiary member leaving a consolidated group
10.32 The provisions make clear that a balancing adjustment is
not made under Subdivision 230-G in relation to the financial
arrangement of a subsidiary member which ceases to be a member
of a consolidated group, or a multiple entry consolidated group
(MEC group), as a result of ceasing to be a member of that group.
[Schedule 1, item 1, subsection 230-390(4)]
Commercial debt forgiveness
10.33 It should be noted that a cancellation, or other discharge of
obligations under a financial arrangement, which qualifies as commercial
debt forgiveness would fall to be considered under Division 245 of
Schedule 2C to the ITAA 1936. The gain which would be subject to the
proposed Division 230 is reduced, to the extent that the gain is captured
by Division 245 (see discussion in Chapter 2 also). [Schedule 1, item 1,
section 230-420]
292
Balancing adjustment on disposing of financial arrangements
What amount is recognised for income tax purposes as a result of the
disposal?
10.34 The amount to be recognised for income tax purposes, as a result
of a disposal (ie, the disposal balancing adjustment), is that amount which
ensures that the entity's overall gain or loss from having the financial
arrangement (or the relevant part of it) is recognised.
10.35 Thus, amounts recognised prior to the disposal are taken into
account in working out the amount of any disposal gain or loss. This
process corrects for any under-allocation or over-allocation prior to the
disposal point.
10.36 As explained in Chapter 3, which deals with gains and losses
from financial arrangements, the concept of a gain or loss is a net concept.
In order to work out the gain or loss, relevant costs must be taken into
account. So, the gain or loss in respect of the disposal of rights and/or
obligations comprising the whole or part of a financial arrangement must
factor in the costs (if any) in respect of the arrangement or the relevant
part of the arrangement, at the time of disposal.
Complete cessation or transfer
10.37 In broad terms, the way in which the balancing adjustment for
cessation or transfer of the whole financial arrangement is worked out for
a financial arrangement can be summarised in a formula, thus:
Disposal balancing adjustment = (a + b + c) (d + e + f) where:
a = total of all financial benefits received under the financial arrangement
(subsection 230-395(1), step 1(a) in the method statement).
b = total of amounts that, because of circumstances which occurred before
the transfer or cessation, have been allowed as deductions for losses from
the financial arrangement, or would have been allowed as deductions, if
all the losses from the arrangement were allowable as deductions
(subsection 230-395(1), steps 1(b) and (c) in the method statement).
c= total of amounts that, because of circumstances that occurred after the
transfer or cessation, will be allowed as deductions to the entity because
of the transitional balancing adjustment (refer Chapter 12), to the extent
to which those amounts are attributable to the financial arrangement
(subsection 230-395(1), step 1(d) in the method statement).
d = total of all financial benefits provided under the financial arrangement
(subsection 230-300(1), step 2(a) in the method statement).
293
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
e = total of amounts that, because of circumstances which occurred before
the transfer or cessation, have been included in the entity's assessable
income as gains from the financial arrangement, or would have been
included in assessable income if all the gains from the arrangement were
amounts of assessable income (subsection 230-300(1), steps 2(b) and (c)
in the method statement).
f = total of amounts that, because of circumstances which occurred after the
transfer or cessation, will be included in the entity's assessable income
because of the transitional balancing adjustment (refer Chapter 12), to the
extent to which those amounts are attributable to the arrangement
(subsection 230-395(1), step 2(d) in the method statement).
10.38 It is the intention that, where running balancing adjustments
(generally relevant for gains or losses subject to the accruals method) have
been made over the period before disposal, these adjustments are taken
into consideration when calculating the disposal balancing adjustment
under the method statement for the disposal balancing adjustment.
[Schedule 1, item 1, subsection 230-395(1), steps 1(b) and (c) and 2(b) and (c) in the
method statement]
10.39 If the disposal balancing adjustment is positive (ie, when the
total of the step 1 amount exceeds the step 2 amount), the amount is a gain
made from the financial arrangement. If the disposal balancing
adjustment is negative (ie, when the total of the step 2 amount exceeds the
step 1 amount), the amount is a loss made from the arrangement.
[Schedule 1, item 1, subsection 230-395(1), step 3 in the method statement]
Example 10.1: Sale of a fixed interest bond
Investor Co buys a five-year bond carrying a fixed annual coupon of
10 per cent per annum. The bond is bought for $1,000 and is to be
redeemed for $1,000 in five years.
Assume that, after receiving two coupons of $100 each and including
in its assessable income $200, Investor Co sells the bond for $1,050.
The overall gain from having the bond is:
$250 = $1,050 + (2 × $100) $1,000
Since $200 gain has already been included in Investor Co's assessable
income, only $50 has to be included as a disposal gain.
Under the balancing adjustment formula, (a + b + c ) less (d + e + f),
set out in paragraph 10.37 (though c and f are not relevant in this
circumstance), the gain or loss is determined as follows:
294
Balancing adjustment on disposing of financial arrangements
($1,250 (per section 230-65, the $1,050 received on disposal is taken to
have been received under the financial arrangement that is the bond) +
$0 + $0) = $1,250
less
($1,000 (per section 230-65, the $1,000 is taken to have been provided
under the financial arrangement that is the bond) + $0 + $200) =
$1,200
= $50 gain on disposal.
Partial transfer
10.40 As mentioned in paragraph 10.18, there can be a balancing
adjustment for a partial disposal in certain circumstances. In these
circumstances, the variables in the above formula are adjusted to take into
account the nature of the partial disposal, as discussed in the following
paragraphs.
10.41 Where there is a disposal of a proportionate share of all the
rights and/or obligations under a financial arrangement, all the variables
are reduced by that proportion. [Schedule 1, item 1, subsection 230-395(2)]
10.42 Where there is a disposal of a right or obligation under a
financial arrangement of a specifically identified financial benefit, it is
necessary to determine what has happened in relation to that right or
obligation -- for example, in terms of the cost already allocated -- in
order to determine the gain or loss to be brought to account as a balancing
adjustment. This is done by determining, in relation to the particular
variable, what is reasonably attributable to the right or obligation.
[Schedule 1, item 1, subsection 230-395(3)]
10.43 This attribution of a right to receive or obligation to provide, or
a proportion of such a right or obligation, a financial benefit to a particular
financial benefit, must reflect appropriate and commercially accepted
valuation principles. These principles must take into account the nature
of the rights and obligations under the financial arrangement, the risks
associated with each of the financial benefits, rights and obligations
under the arrangement, and the time value of money. [Schedule 1, item 1,
subsection 230-395(5)]
10.44 Where there is a disposal of a proportionate share of a right to
receive or obligation to provide to a financial benefit under the financial
arrangement, to a specifically identified financial benefit, the two types of
adjustment discussed above both apply. That is, the starting point for
each of the variables in the formula is the amount reasonably attributable
to the particular right or obligation. These amounts are then reduced, by
295
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
the disposal proportion, to arrive at the amounts actually used for
the variables in the formula [Schedule 1, item 1, subsection 230-395(4)].
This attribution must reflect the valuation principles discussed in
paragraph 10.43 [Schedule 1, item 1, subsection 230-395(5)].
Example 10.2: Assignment of rights to future amounts
Assignor Co makes a 10 year loan of $5 million to Borrower Co. The
loan pays a fixed annual coupon. The rate is 8 per cent per annum.
Assume that this is also the prevailing market interest rate.
Assignor Co immediately assigns the right to all the interest payments
to Assignee Co for $2,684,033. This payment is the present value of
the future interest payments discounted at 8 per cent per annum.
While the assigned payments are equal in amount to the interest on the
loan, the assignment effects a partial disposal of the asset, being the
right to a stream of future payments. In Assignee Co's hands,
economically, each payment is equivalent to `principal' and `interest'
(ie, each payment economically has a portion of Assignor Co's
$5 million cost attributed to it -- see discussion in Chapter 3). The
rules in section 230-75 requiring no attribution of a cost to interest
payments, do not apply for the purpose of Subdivision 230-G.
To calculate the gain or loss on the partial disposal of the loan, it is
necessary to determine the cost of assigned interest payments at that
time. Commercially, this is done by allocating an amount, sometimes
referred to as the `carrying amount', to the part which is disposed of.
The partial disposal is done by allocating the carrying amount of the
whole financial arrangement between the part disposed of, and the part
retained, on the basis of the fair value of the part disposed of, relative
to the fair value of the whole thing.
The fair value, at the time of the partial disposal, of the part disposed
of is $2,684,033 and the fair value of the whole loan, is $5 million.
The carrying amount of the whole loan is $5 million.
Therefore, the carrying amount of the part disposed of is $2,684,033,
which is the cost of the right to the 10 future annual payments of
$400,000. Since $2,684,033 is also the amount of proceeds from the
assignment, there is no gain or loss.
Under the balancing adjustment formula, (a + b + c) less
(d + e + f) (though b, c, e and f are not relevant in this
circumstance), set out in paragraph 10.37, this is determined as
follows:
($2,684,033 (per section 230-65, this amount received on disposal is
taken to have been received under the financial arrangement that is the
296
Balancing adjustment on disposing of financial arrangements
loan, and it is entirely attributable to the portion of the arrangement,
the interest income stream, disposed of) + $0 + $0) = $2,684,033
less
($2,684,033 (per section 230-65, the $5 million lent is taken to be an
amount Assignor Co had an obligation to provide, and did provide
under its financial arrangement, and $2,684,033 of this cost is
attributable to its right to receive interest payments that were disposed
of) + $0 + $200) = $2,684,033
= $0 gain or loss on disposal.
Alternatively, if, for example, Assignor Co assigns these payments for
$3 million, it would make an immediate gain of $315,967 (Step 1(a) in
the above calculation would be $3 million).
When does the disposal occur?
10.45 The gain or loss produced by the disposal balancing adjustment
described above is made in the year in which the relevant cessation or
transfer occurs. [Schedule 1, item 1, subsection 230-395(6)]
10.46 Thus, for example, if there is a disposal because of an
assignment of certain rights under a financial arrangement, the gain or
loss is made under the balancing adjustment when the assignment occurs.
10.47 In another case, when a financial arrangement is sold, disposal
occurs (and the balancing adjustment gain or loss is made) when the
relevant rights and obligations are given up or transferred.
297
Chapter 11
Interaction and consequential
amendments
Outline of chapter
11.1 This chapter explains various amendments made to provisions of
the:
· Income Tax Assessment Act 1936 (ITAA 1936);
· Income Tax Assessment Act 1997 (ITAA 1997);
· New Business Tax System (Taxation of Financial
Arrangements) Act 2003 (NBTS (TOFA) Act 2003); and
· Taxation Administration Act 1953 (TAA 1953),
which are required as a result of the introduction of Division 230 into the
ITAA 1997.
Context of amendments
11.2 Several provisions in the ITAA 1936, the ITAA 1997 and the
TAA 1953 currently deal with the taxation of arrangements that may
satisfy the definition of `financial arrangement'. The intended operation
of those provisions may be affected by the introduction of Division 230
into the ITAA 1997. Amendments to the other provisions of the tax laws
were required to ensure that they operate as intended in the context of the
introduction of Division 230. These are the `consequential amendments'
which are required to adjust the operation of the current provisions of the
tax laws as a consequence of the introduction of Division 230.
11.3 Further, a number of provisions were included in Division 230
which will affect the operation of other provisions of the Act. Generally,
these amendments will affect the amount or value of a financial benefit
for the purposes of the other provisions of the tax laws (eg, capital gains
tax (CGT) or capital allowance purposes) or the amount or value of a
financial benefit for the purposes of calculating a gain or loss for
299
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Division 230 purposes (eg, in the context of a consolidated group). These
types of amendments are the `interaction amendments' as they provide
rules which deal with the interaction of the other provisions of the tax
laws with Division 230.
Summary of new law
11.4 Generally, the consequential and interaction amendments that
are explained in this chapter fall into five categories:
· ordering rules: a financial arrangement may fall within the
scope of provisions of the tax laws other than Division 230.
This category of amendment ensures that it is clear which
provision will prevail in such circumstances;
· value setting rules: financial benefits are recognised in
Division 230 for a number of purposes. One such purpose is
to calculate a gain or loss that will then be brought to account
under Division 230. Those financial benefits may also be
relevant for other purposes of the tax laws. This category of
amendments operates to provide rules which set the values of
those financial benefits for the purposes of the tax laws
(including Division 230);
· recognition of gains and losses: this category of amendments
provides rules which go to whether an amount is assessable
or deductible where a Division 230 financial arrangement is
involved;
· definitional: this category of amendments is required
because certain definitions in the tax laws may change as a
result of the introduction of Division 230; and
· referencing: this category of amendments comprises
technical changes which either introduces signposts to
Division 230 in other provisions of the tax laws or updates
the relevant finding tables in the ITAA 1997.
11.5 Further, amendments have been made to ensure that
Division 775 of the ITAA 1997 (foreign currency gains and losses) will
start to apply to authorised deposit-taking institutions (ADIs), non-ADI
financial institutions and securitisation vehicles. The intention to have
Division 775 apply to those types of taxpayers when the retranslation
module of the taxation of financial arrangements reforms comes into
effect was stated in the explanatory memorandum to the NBTS (TOFA)
300
Interaction and consequential amendments
Act 2003. The retranslation module of the taxation of financial
arrangements reforms is contained in Subdivision 230-D of this Bill.
11.6 As a result of the Division 775 amendments, some amendments
were required to the NBTS (TOFA) Act 2003. Those amendments were
announced in the then Minister for Revenue and Assistant Treasurer's
Press Release No. 073 of 2 September 2005 (Securitisation vehicles and
foreign currency rules).
Detailed explanation of new law
11.7 As outlined above, the consequential and interaction
amendments can be grouped into five categories. Each of the
amendments that fits into a particular category is explained below.
Ordering rules
11.8 In situations where a number of different provisions may apply
to an arrangement that is also a `financial arrangement' for Division 230
purposes, these amendments provide rules which determine which
provision should take precedence over the other.
12-month prepayment rule
11.9 Subdivision 3-H of Part III of the ITAA 1936 sets out the timing
of the deduction that may be allowable when such expenditure is prepaid.
These rules alter the normal effect of section 8-1 of the ITAA 1997, which
otherwise may have allowed a deduction in full in the year in which the
expenditure is incurred.
11.10 Division 230 does not apply to gains or losses made from
short-term financial arrangements that arise in respect of the prepayments
for goods, property or services [Schedule 1, item 1, section 230-400].
Subdivision 3-H generally applies to certain prepaid expenditure where
that expenditure relates to a period which extends beyond the income year
in which the expenditure is incurred. That period may be less than
12 months. In such situations, Division 230 will not apply to the gain or
loss that arises under the same set of facts. However, the relevant
prepayment period may be more than 12 months -- where this is the case,
there may still be situations where the rules in Subdivision 3-H of the
ITAA 1936 and Division 230 overlap.
11.11 Where the rules do overlap, Division 230 will take precedence
over Subdivision 3-H of the ITAA 1936. [Schedule 1, item 33,
paragraph 82KZLA(a) of the ITAA 1936]
301
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Consideration from the transfer of a right to receive income from
property
11.12 Section 102CA of the ITAA 1936 includes any consideration
received from the transfer of a right to receive income from property in
the transferor's assessable income in the income year in which the right is
transferred. The consideration is included in the transferor's income in
the year in which the right is transferred even if the consideration is, in
whole or in part, not actually received until a later income year.
11.13 Such a result is inconsistent with the intended operation of
Division 230 in respect of such transactions -- that is to bring to account
gains (or losses) where there is a delay in time between the disposal of an
asset and actual payment of the consideration. This amendment will
ensure that section 102CA of the ITAA 1936 will not apply where the
right to receive income from property comprises a financial arrangement
to which Division 230 also applies. In such situations, the relevant gain or
loss that arises from the transfer of such rights is instead brought to
account under Division 230. [Schedule 1, item 35, paragraph 102CA(2)(c) of the
ITAA 1936]
Complying superannuation funds, complying approved deposit funds
and pooled superannuation trusts
11.14 As part of the re-write of the provisions contained in Part IX of
the ITAA 1936, Part 3-30 was introduced into the ITAA 1997. In
particular, section 295-85 was introduced to ensure that only the CGT
provisions (and not the general income provisions) apply if a CGT event
happens involving a CGT asset owned by a complying superannuation
fund, a complying approved deposit fund or a pooled superannuation
trust. Paragraph 295-85(2)(a) of the ITAA 1997 will be amended to add a
reference to Division 230 to ensure that where a CGT event happens to a
CGT asset that is also a financial arrangement, the relevant gain or loss is
brought to account under the CGT provisions and not Division 230.
However, the exceptions to the rule in subsection 295-85(2) that are
contained in subsection 295-85(3) will still operate to apply Division 230
where there is a gain or loss made in respect of foreign currency
fluctuations or there is a disposal of certain types of securities. [Schedule 1,
item 80, paragraph 295-85(2)(a)]
Life insurance companies
11.15 Section 320-45 operates to apply the same treatment for CGT
assets that are a virtual pooled superannuation trust asset of a life
insurance company, as that described above, for those entities subject to
section 295-85. A subsection is proposed to be added to section 320-45 of
the ITAA 1997 to ensure that, where relevant, section 320-45 will apply
302
Interaction and consequential amendments
rather than Division 230 to bring to account gains or losses from financial
arrangements that are also a virtual pooled superannuation trust asset of a
life insurance company. [Schedule 1, Part 2, items 81 and 82]
Foreign trusts, controlled foreign companies and foreign investment
funds
11.16 Instead of Division 230 applying, the current provisions of the
tax laws will apply to bring to account gains or losses made from
arrangements that would otherwise be classified as `financial
arrangements' for the purposes of the Division. More specifically, in
relation to each of these entities:
· for non-resident trusts: the amendment is relevant for the
purposes of both Division 6 of Part III of the ITAA 1936 and
Division 6AAA of Part III of the ITAA 1936 in calculating
the amount to be attributed to a transferor [Schedule 1, Part 2,
item 34, paragraph 96C(5A)(aa) of the ITAA 1936];
· for controlled foreign companies: the amendment will ensure
that attributable income is calculated with reference to the
current law (including Division 775 (foreign currency gains
and losses) and Subdivision 960-C (translation of foreign
currency) and Subdivision 960-D (functional currency) of the
ITAA 1997) [Schedule 1, Part 2, item 43, paragraph 389(ba) of the
ITAA 1936]; and
· for foreign investment funds: the amendment will ensure
that foreign investment fund income is calculated under the
current law [Schedule 1, Part 2, item 44, paragraph 557A(c) of the
ITAA 1936].
Deductions for returns on debt interests
11.17 To avoid doubt, where a debt interest (as per Division 974 of the
ITAA 1997) is also a financial arrangement for the purposes of
Division 230, the gains or losses on those debt interests are brought to
account or allowable as a deduction under Division 230. [Schedule 1, Part 2,
item 48, subsection 25-85(4A)]
11.18 To avoid doubt, a note has been added to section 25-90 which
deals with deductions relating to foreign non-assessable non-exempt
income to provide a signpost for the reader that the provisions of
Division 230 prevail over section 25-90 when the relevant loss is made in
respect of a financial arrangement. [Schedule 1, Part 2, item 49]
303
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Trading stock
11.19 Division 70 of the ITAA 1997, which deals with the taxation of
trading stock, will not apply to trading stock that is a financial
arrangement to which Division 230 applies. Rather, all financial
arrangements that are subject to Division 230 should have the gains or
losses made on those arrangements recognised under Division 230. In
some situations this will allow taxpayers to align the tax treatment of the
gains or losses made on their financial arrangement, that otherwise satisfy
the definition of `trading stock', with their financial accounting treatment.
11.20 To avoid doubt, an amendment is made to the definition of
`trading stock' such that financial arrangements that are subject to
Division 230 cannot be trading stock for the purposes of Division 70.
This means, for example that, while the cost of trading stock which is a
financial arrangement will not be an allowable deduction under
section 8-1 of the ITAA 1997, that amount will be taken into account in
calculating a gain or a loss that may be an allowable deduction under
subsection 230-15(2). [Schedule 1, Part 2, item 57, section 70-10 of the ITAA 1997]
Capital gains tax -- anti-overlap rule
11.21 Section 118-27 provides that, where Division 230 applies to a
financial arrangement, a capital gain or a capital loss that is made:
· from a CGT asset;
· in creating a CGT asset; or
· from the discharge of a liability,
is disregarded if, at the time of the CGT event from which the gain or loss
is made, the asset or liability is, or is part of, a `Division 230 financial
arrangement' [Schedule 1, item 62, subsection 118-27(1)]. A Division 230
financial arrangement is one where the gains or losses from the
arrangement are brought to account under Division 230 [Schedule 1, item 11,
definition of `Division 230 financial arrangement' in subsection 995-1(1) of the
ITAA 1997].
11.22 Where Division 230 applies to gains and losses from a financial
arrangement that is a CGT asset (or where a CGT asset forms part of that
arrangement), a capital gain or a capital loss that is made from CGT
events that happen to that CGT asset is disregarded.
304
Interaction and consequential amendments
11.23 The further references to creating a CGT asset and discharging a
liability are intended to reflect the fact that a gain or loss from a financial
arrangement:
· that is or includes a CGT asset, may arise in respect of the
creation of that CGT asset, in circumstances that would also
give rise to a capital gain or loss; and
· that is or includes a liability, may arise on the discharging or
extinguishment of that liability in circumstances that would
also give rise to a capital gain or loss.
This may be relevant for a CGT asset that forms part of a taxpayer's
financial arrangement that the taxpayer has created in another entity,
giving rise to CGT event D1; or where a discharge of a liability that forms
part of a financial arrangement also gives rise to CGT event L7.
[Schedule 1, item 62, subsection 118-27(1)]
11.24 It is intended that the introduction of section 118-27 will
significantly reduce compliance costs by removing the requirement for a
CGT calculation to be made for transactions that are wholly covered by
Division 230. Such a calculation would still have been required under
section 118-20, because that provision requires that any capital gain or
capital loss be reduced to the extent to which a gain or loss is brought to
account under another provision of the ITAA 1936 or the ITAA 1997,
because of the CGT event.
Example 11.1: Where CGT provisions are not applicable
On 30 June 2011, Scruffy Co acquires a zero coupon bond from
Nik Co for its net present value as at that date of $8,944.32.
Nik Co acquired the bond when it was originally issued on 1 July
2009. The terms of the bond are:
· Issue price: $8,000.
· Maturity date: 1 July 2012.
· Amount payable at maturity: $10,000.
· Internal rate of return: 11.804 per cent.
When it acquired the bond, Nik Co determined that it would make an
overall gain on the financial arrangement and was required to return
that gain on an accruals basis in accordance with Subdivision 230-B.
305
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
A gain of $944.32 has been accrued up until the time of disposal and is
required to be included in assessable income in accordance with
Division 230.
For CGT purposes, the bond is a CGT asset which has been subject to
CGT event A1 upon its disposal. Section 118-27 provides that any
capital gain or loss from this CGT event is disregarded. Accordingly,
Nik Co is not required to undertake a separate calculation to determine
whether there was an amount of any capital gain or capital loss that
would otherwise have to have been calculated on the disposal of the
financial arrangement. Without section 118-27, the capital gain or
capital loss would have been calculated and then reduced under
section 118-20 of the ITAA 1997 to the extent to which that gain or
loss was brought to account under Division 230.
11.25 Where a taxpayer has elected to align the tax characterisation of
a gain or loss from a hedging financial arrangement with the tax
characterisation of the hedged item, then the rule in subsection 118-27(1)
that disregards relevant capital gains or losses is switched off.
This ensures that taxpayers are able to better align their after tax hedging
position. [Schedule 1, item 62, subsection 118-27(2)]
Value setting rules
11.26 This category of amendments operates to provide rules which
set the values of financial benefits in certain situations where a
Division 230 financial arrangement is involved.
Section 230-440 and its interaction with Divisions 40, 104, 110 and 112
of the ITAA 1997
11.27 In a general sense, financial arrangements may be acquired or
disposed of as a consideration for the acquisition or disposal of an asset or
some other thing. Where this occurs, Division 230 changes the ordinary
operation of the provisions of the ITAA 1936 and the ITAA 1997, broadly
to ensure that this other thing is taken to have been acquired or disposed
of for the market value of the financial arrangement that is used as
consideration.
11.28 Where a taxpayer provides or acquires a tax relevant thing in
consideration for the creation, acquisition, or cessation of a financial
arrangement, Division 230 will operate to determine the amount for which
that tax relevant thing is taken to have been acquired or disposed of. For
example, where the tax relevant thing used as consideration for starting or
ceasing to have a financial arrangement is a CGT asset, Division 230 will
operate to determine the cost base or capital proceeds of the CGT asset as
306
Interaction and consequential amendments
relevant. Where it is a depreciating asset, Division 230 will operate to
work out the termination value and cost of the depreciating asset.
11.29 The object of section 230-440 is to ensure appropriate proceeds
and cost base interaction rules between the provisions of Division 230 and
the rest of the ITAA 1997 and the ITAA 1936 in circumstances where:
· Division 230 applies to a taxpayer's gains and losses from a
financial arrangement (ie, none of the exceptions discussed in
Chapter 2 apply in respect of that arrangement); and
· that financial arrangement is either received or provided, or
the taxpayer otherwise starts or ceases to have it (it is dealt
with) as consideration for something else that is either
provided or received (dealt with) in return.
11.30 Dealing with a financial arrangement as consideration for
dealing with something else may or may not take place as part of a larger
transaction. In addition, the taxpayer may deal with only part of the
relevant financial arrangement as consideration for dealing with
something else, and still be subject to the operation of section 230-440.
[Schedule 1, item 1, section 230-440]
11.31 For the purposes of section 230-440, the relevant thing used as
consideration for starting or ceasing to have the financial arrangement is
not limited to tangible things and may include services, the conferring of a
right, incurring an obligation or extinguishing a right or obligation.
Examples of a `thing' subject to section 230-440
11.32 For the purposes of section 230-440, the relevant thing that a
taxpayer may deal with as consideration for starting or ceasing to have all
or part of a financial arrangement may include:
· assuming the obligation of another party to make payments
on a loan (acquiring a thing that is an obligation);
· assuming the right to receive interest payments on a loan
(acquiring a thing that is a right);
· receiving a right to exercise a right to acquire shares, for
example, an option (acquiring a thing that is a right);
· receipt or disposal of property (acquiring or providing a thing
that is property);
307
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· assuming the right of another to deliver equity interests under
a forward contract (acquiring a thing that is a right);
· receiving services (acquiring a thing that is the provision of
services); and
· having a liability waived or otherwise extinguished
(acquiring something that is a financial benefit, being the
waiver or extinguishment of a liability).
11.33 The relevant thing that the taxpayer deals with as consideration
for starting or ceasing to have the financial arrangement may or may not
itself be, or form part of, another financial arrangement. However, where
the thing dealt with is a tax relevant thing that is not, and does not form
part of, a financial arrangement that has its gains and losses subject to
Division 230, section 230-440 will have implications for other relevant
provisions of the ITAA 1997 outside of Division 230 and of the
ITAA 1936. [Schedule 1, item 1, subsections 230-440(1) and (4), items 50 to 56 and
60 and 61]
Consideration is taken to be received or provided for the `thing'
11.34 Where you start to have a financial arrangement that has its
gains and losses subject to Division 230 (a Division 230 financial
arrangement), or a part of such an arrangement, as consideration for:
· providing (giving) something to someone else (including by
transferring it to someone else or by its extinguishment); or
· acquiring (receiving) something from someone else
(including by acquiring it from someone else or by creating
it),
and the thing you provide or acquire is not money, then the value of the
benefit that you relevantly give or receive for providing or acquiring that
thing is taken to be the market value of the financial arrangement (or
relevant part) at the time you start to have the financial arrangement (or
relevant part). [Schedule 1, item 1, subsection 230-440(1)]
11.35 Where you cease to have a Division 230 financial arrangement
(or part of such an arrangement) in consideration for:
· acquiring (receiving) something from someone else
(including by acquiring it from someone else or by creating
it); or
308
Interaction and consequential amendments
· providing (giving) something to someone else (including by
transferring it to someone else or by its extinguishment),
and the thing you acquire or provide is not money, then the value of the
benefit that you relevantly give or receive for providing or acquiring that
thing is taken to be the market value of the financial arrangement (or
relevant part) at the time you cease to have the financial arrangement (or
relevant part). [Schedule 1, item 1, subsection 230-440(4)]
Interaction with capital gains tax provisions
11.36 To the extent that Division 230, on the one hand, and Parts 3-1
and 3-3, on the other, of the ITAA 1997 interact, section 230-440 will
operate to ensure that there is alignment between the cost base and
proceeds rules that are used for the purposes of this Division and those
Parts.
Example 11.2: Disposal of a capital asset with a deferred delivery and
settlement -- the consideration received/provided for the asset
Buddy Co enters into a contract on 1 July 2009 to sell a CGT asset
(which is not a depreciating asset and not a financial arrangement) to
Fee Co. The terms of the contract are:
· delivery of the asset in six months (ie, on 1 January 2010); and
· the sale price of $120,000 is to be paid 24 months after the
contract date on 1 July 2011 (ie, 18 months after delivery of the
asset).
Background and assumptions
· Buddy Co acquired the CGT asset for $80,000.
· The market value, measured at 1 January 2010, of a right to
receive $120,000 in 18 months time (using the method set out in
subsections 230-440(8) to (10)) on 1 July 2011 is $105,000.
· Both Buddy Co and Fee Co hold the CGT asset on capital
account.
· Both Buddy Co and Fee Co are subject to proposed
Division 230.
Buddy Co -- disposal of a CGT asset
On 1 January 2010 when Buddy Co delivers the asset to Fee Co, it will
start to have a financial arrangement. This is because at the time of
309
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
delivery, the only rights and/or obligations Buddy Co has remaining
under its arrangement to dispose of its CGT asset to Fee Co, is its right
to receive $120,000 in 18 months time from Fee Co. This right is a
cash settlable right to receive a financial benefit, as it is a right to
receive a financial benefit that is money. Buddy Co's financial
arrangement is entirely constituted by this cash settlable right
(subsection 230-50(1) and paragraph-230-50(2)(a)).
Buddy Co therefore starts to have a financial arrangement as
consideration for ceasing to have its CGT asset.
Subsection 230-440(1) provides that Buddy Co is taken to have
received the market value of the financial arrangement it starts to have,
measured at the time it started to have that financial arrangement using
the method set out in subsections 230-440(8) to (10), as consideration
for ceasing to have its CGT asset. This means that for the purpose of
Parts 3-1 and 3-3 of the ITAA 1997, Buddy Co is taken to have
received capital proceeds on disposal of its CGT asset equal to the
market value of the financial arrangement it started to have as
consideration, at the time it started to have that financial arrangement.
That is, Buddy Co is taken to have received the market value of its
right to receive $120,000 from Fee Co, as determined under
section 230-440 at 1 January 2010. As this value is $105,000, Buddy
Co is taken to have received capital proceeds of $105,000 on disposal
of its CGT asset (subsections 230-440(1), (8) and (9) and items 60 and
61).
Pursuant to section 104-10 of the ITAA 1997, CGT event A1 occurs in
respect of Buddy Co's CGT asset, on 1 July 2009. From the facts, the
cost base of the CGT asset is $80,000. As Buddy Co will be taken to
have received capital proceeds of $105,000 (as set out above), it will
make a capital gain of $25,000 on disposal of its CGT asset, (being
$105,000 less $80,000).
Example 11.4 explains the tax treatment of Buddy Co's financial
arrangement constituted by its right to receive $120,000 from Fee Co.
Fee Co -- acquisition of a CGT asset
On 1 January 2010 when Fee Co receives the CGT asset from
Buddy Co, it will start to have a financial arrangement. This is
because after the time of delivery, the only rights and/or obligations
Fee Co has remaining under its arrangement to acquire the CGT asset
from Buddy Co, is its obligation to pay $120,000 in 18 months time to
Buddy Co. This obligation is a cash settlable obligation to provide a
financial benefit, as it is an obligation to pay a financial benefit that is
money. Fee Co's financial arrangement is entirely constituted by this
cash settlable obligation (subsection 230-50(1) and
paragraph 230-50(2)(a)).
310
Interaction and consequential amendments
Fee Co therefore starts to have a financial arrangement as
consideration for starting to have the CGT asset.
Subsection 230-440(1) provides that Fee Co is taken to have provided
the market value of the financial arrangement it starts to have,
measured under section 230-440 at the time it started to have that
financial arrangement, as consideration for starting to have the CGT
asset. This means that for the purpose of Parts 3-1 and 3-3 of the
ITAA 1997, Fee Co's cost of the CGT asset is taken to be equal to the
market value of the financial arrangement it started to have as
consideration for acquiring this asset, at the time it started to have that
financial arrangement. That is, Fee Co is taken to have paid the market
value of its obligation to pay $120,000 to Buddy Co, as determined
under section 230-440 at 1 January 2010. As this value is $105,000,
Fee Co is taken to have paid $105,000 to acquire this CGT asset
(subsections 230-440(1) and (8) to (10) and items 60 and 61).
This $105,000 cost will form part of Fee Co's cost base of the CGT
asset (depending on any subsequent facts, it may be the only element
in Fee Co's cost base for this asset).
Example 11.4 explains the tax treatment of Fee Co's financial
arrangement constituted by its obligation to pay $120,000 to
Buddy Co.
Note -- the time of valuation of financial arrangements
Apart from the operation of Division 230, the capital proceeds from a
CGT event include the market value of property that is received in
respect of the event, calculated as at the time of the event. Where the
relevant property is a financial arrangement to which Division 230
applies, the amount that would otherwise be calculated for the
purposes of working out the capital gain or loss from the CGT event is
replaced by the market value of the financial arrangement on the date
the taxpayer starts to have the financial arrangement. This date will
not always coincide with the date of the CGT event.
Similarly, the CGT rules provide that the cost base of a CGT asset
includes the market value of property given in respect of the
acquisition of the asset worked out at the time of the acquisition of the
asset. Where the property given is a financial arrangement to which
Division 230 applies, this amount is replaced by the market value of
the financial arrangement as at 1 July 2010. Again, this date will not
always coincide with the date on which the arrangement would
otherwise be valued for CGT purposes.
311
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Division 230 interaction with capital allowance provisions
11.37 To the extent that Divisions 230 and 40 of the ITAA 1997
interact, section 230-440 will operate to ensure that there is alignment
between the cost and proceeds rules that are used for the purposes of
Division 230, on the one hand, and the cost and termination value rules
that are used in the uniform capital allowances provisions in Division 40
of the ITAA 1997, on the other.
11.38 The interaction of the capital allowance provisions and the
Division 230 measures is similar to that for CGT, in that where a financial
arrangement is used as consideration for acquiring or providing a
depreciating asset, the market value of the financial arrangement must
first be determined before the cost and termination value of the
depreciating asset (as relevant) can be worked out.
Example 11.3: Disposal of a depreciating asset with a deferred
delivery and settlement -- the consideration received/provided for the
asset
Smith Co enters into a contract on 1 September 2009 to sell its
depreciating asset (which is not a Division 230 financial arrangement)
to Jones Co. The terms of the contract are:
· delivery of the asset in 12 months (ie, on 1 September 2010);
· the sale price of $250,000 is to be paid 27 months after the
contract date, on 1 January 2012 (ie, 15 months after delivery of
the depreciating asset); and
· notwithstanding the application of section 230-440, Division 40
of the ITAA 1997 would operate such that the liability to pay
the sale price does not arise until delivery of the depreciating
asset.
Background and assumptions
· Smith Co used the depreciating asset wholly for a taxable
purpose and claimed decline in value deductions for it in
accordance with Division 40.
· The adjustable value of the depreciating asset in the hands of
Smith Co at the time of delivery was $100,000.
· The market value, measured at 1 September 2010 using the
method set out in subsections 230-440(8) to (10), of a right to
receive $250,000 in 15 months time, on 1 January 2012, is
$150,000.
· Both Smith Co and Jones Co are subject to proposed
Division 230.
312
Interaction and consequential amendments
Smith Co -- disposal of the depreciating asset
On 1 September 2010 when Smith Co delivers the depreciating asset to
Jones Co, Smith Co will start to have a financial arrangement. This is
because, after the time of delivery, the only rights and/or obligations
Smith Co has remaining under its arrangement to dispose of its
depreciating asset to Jones Co is its right to receive $250,000 in
15 months time from Jones Co. This right is a cash settlable right to
receive a financial benefit, as it is a right to receive a financial benefit
that is money. Smith Co's financial arrangement is entirely constituted
by this cash settlable right (subsection 230-50(1) and
paragraph 230-50(2)(a)).
Smith Co therefore starts to have a financial arrangement as
consideration for ceasing to hold its depreciating asset.
Under the terms of the contract, Smith Co will stop holding the
depreciating asset on 1 September 2010 when it delivers the asset to
Jones Co. A balancing adjustment event will occur for the asset at that
time and Smith Co will need to work out a balancing adjustment
amount for it.
Subsection 230-440(1) provides that Smith Co is taken to have
received the market value of the financial arrangement it starts to have,
measured using the method set out in subsections 230-440(8) to (10) at
the time it started to have that financial arrangement, as consideration
for ceasing to hold its depreciating asset. This means that for the
purpose of working out the balancing adjustment amount for the
depreciating asset, Smith Co is taken to have received an amount equal
to the market value of the financial arrangement it started to have
(determined under section 230-440 at the time it started to have that
financial arrangement), in consideration for disposing of the
depreciating asset. That is, under section 230-440 Smith Co is taken to
have received the market value of its right to receive $250,000 from
Jones Co, as determined at 1 September 2010 as consideration for
disposing of its depreciating asset. As this value is $150,000, under
the provisions of Division 40 of the ITAA 1997 Smith Co is taken to
have a termination value of $150,000 for its depreciating asset
(subsection 230-440(1) and items 50 to 56).
Smith Co's adjustable value for its depreciating asset was, as set
out in the facts, $100,000 just before the time of the balancing
adjustment event (1 September 2010). As Smith Co's termination
value of its depreciating asset will be taken to be $150,000 (as set out
above), its assessable balancing adjustment amount under Division 40
will be $50,000 (being $150,000 less $100,000).
Example 11.5 explains the tax treatment of Smith Co's financial
arrangement constituted by its right to receive $250,000 from
Jones Co.
313
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Jones Co -- acquisition of the depreciating asset
On 1 September 2010 when Jones Co receives the depreciating asset
from Smith Co, Jones Co will start to have a financial arrangement.
This is because at the time of delivery, the only rights and/or
obligations Jones Co has remaining under its arrangement to acquire
the depreciating asset from Smith Co, is its obligation to pay $250,000
in 15 months time to Smith Co. This obligation is a cash settlable
obligation to provide a financial benefit, as it is an obligation to pay a
financial benefit that is money. Jones Co's financial arrangement is
entirely constituted by this cash settlable obligation
(subsection 230-50(1) and paragraph 230-50(2)(a)).
Jones Co therefore starts to have a financial arrangement as
consideration for starting to hold the depreciating asset.
Subsection 230-440(1) provides that Jones Co is taken to have
provided the market value of the financial arrangement it starts to have,
measured under section 230-440 at the time it started to have that
financial arrangement, as consideration for starting to have the
depreciating asset. This means that for the purpose of Division 40 of
the ITAA 1997, Jones Co's cost of the depreciating asset is taken to be
equal to the market value of the financial arrangement it started to have
as consideration for acquiring this asset, at the time it started to have
that financial arrangement. That is, Jones Co is taken to have paid the
market value of its obligation to pay $250,000 to Smith Co, as
determined at 1 September 2010, for starting to hold the depreciating
asset. As this value is $150,000, Jones Co is taken to have paid
$150,000 to acquire this depreciating asset, for all purposes of the
ITAA 1936 and the ITAA 1997 (subsections 230-440(1) and 230-50(1)
and items 51 to 56).
Example 11.5 explains the tax treatment of Jones Co's financial
arrangement constituted by its obligation to pay $250,000 to Smith Co.
Consideration is taken to be received or provided for the financial
arrangement
11.39 As discussed above, where a taxpayer starts to have a financial
arrangement (or part of a financial arrangement) as consideration for
ceasing or starting to have another thing, subsection 230-440(1) will set
the amount that is taken to have been received or provided for that thing.
In addition, as explained in Chapter 3, the taxpayer will be taken to have
given or received an amount equal to the market value of this financial
arrangement (or relevant part) at the time it starts to be held, as
consideration for starting to hold it in these circumstances. [Schedule 1,
item 1, subsection 230-440(2)]
11.40 Likewise, where a taxpayer ceases to have a financial
arrangement (or part of a financial arrangement) as consideration for
314
Interaction and consequential amendments
starting or ceasing to have another thing, subsection 230-440(4) will set
the amount that is taken to have been provided or received for that thing.
Similarly, as also explained in Chapter 3, the taxpayer will be taken to
have received or provided an amount equal to the market value of this
financial arrangement (or relevant part) at the time when it ceases to be
held, as consideration for ceasing to have it in these circumstances.
[Schedule 1, item 1, subsection 230-440(5)]
Example 11.4: The disposal of a capital asset with a deferred delivery
and settlement -- the consideration which is received/provided for the
financial arrangement
This example is a continuation of Example 11.2 and relates to the same
factual situation. It discusses the impact of section 230-440 on both
Buddy Co and Fee Co in respect of the financial arrangements which
they start to have under their arrangement to transfer Buddy Co's CGT
asset to Fee Co, under which payment is deferred.
The financial arrangement each starts to have on 1 January 2010 is as
set out in Example 11.2. As in Example 11.2, the references to the
value of the financial arrangements in this example are references to
the market value as determined using the method set out in
subsections 230-440(8) to (10).
Buddy Co -- the amount provided to start to have a financial
arrangement
As discussed in Example 11.2, the amount Buddy Co receives for
disposing of its CGT asset is taken by subsection 230-440(1) to be the
market value of the financial arrangement that it receives on delivery
of the CGT asset (comprising its right to receive $120,000 in
18 months time from Fee Co).
Buddy Co will be further taken to have provided an amount equal to
the market value of its financial arrangement (its right to receive
payment from Fee Co) when it started to have it (1 January 2010), as
consideration for acquiring this financial arrangement. As such,
Buddy Co will be taken to have paid $105,000 to acquire its financial
arrangement on 1 January 2010 (subsection 230-440(2)).
Under this financial arrangement, Buddy Co will receive $120,000
from Fee Co on 1 July 2011. Accordingly, Buddy Co will make a
$15,000 gain from its financial arrangement (section 230-75).
As this $15,000 overall gain is sufficiently certain (within the meaning
of Subdivision 230-B) at the time Buddy Co starts to have the financial
arrangement (1 January 2010), if Buddy Co has not made any elections
under Division 230, this $15,000 overall gain will be accrued over the
18-month life of the financial arrangement (subsection 230-105(2),
section 230-110 and subsection 230-130(1)).
315
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Buddy Co -- the overall tax treatment from disposing of the CGT
asset
The net effect of Buddy Co's arrangement to dispose of its CGT asset
is that it has made an overall gain of $40,000 (a $25,000 capital gain as
set out in Example 11.2 and a $15,000 assessable gain under
Division 230 as set out above), as a result of the interaction between
the capital gains provisions and Division 230.
Fee Co
As discussed in Example 11.2, the amount Fee Co is taken to have paid
to acquire the CGT asset is, pursuant to subsection 230-440(1), the
market value of its financial arrangement that it starts to have on
receipt of the CGT asset (comprising its obligation to pay $120,000 in
18 months time to Buddy Co).
Fee Co will be further taken to have received an amount equal to the
market value of its financial arrangement (its obligation to pay
Buddy Co) when it started to have it (1 January 2010), as consideration
for starting to have this financial arrangement. As such, Fee Co will be
taken to have received $105,000 for starting to have its financial
arrangement (its obligation to pay $120,000) on 1 January 2010
(subsection 230-440(2)).
Fee Co will pay $120,000 under this financial arrangement to
Buddy Co on 1 July 2011. Accordingly, it will make a $15,000 loss
from its financial arrangement (section 230-80).
As this $15,000 overall loss is sufficiently certain (within the meaning
of Subdivision 230-B) at the time Fee Co starts to have the financial
arrangement (1 January 2010), if Fee Co has not made any elections
under Division 230 this $15,000 overall loss will be accrued over the
18-month life of the financial arrangement (subsection 230-105(2),
section 230-110 and subsection 230-130(1)).
Fee Co -- the overall tax treatment from acquiring the CGT asset
The net effect of Fee Co's arrangement to acquire a CGT asset from
Buddy Co is that it has acquired a CGT asset with a cost base of
$105,000 (without anything further) as set out in Example 11.2, and
made a deductible $15,000 loss from the financial arrangement, under
which it has to pay Buddy Co $120,000, as a result of the interaction
between the capital gains provisions and Division 230.
316
Interaction and consequential amendments
Example 11.5: The disposal of a depreciating asset with a deferred
delivery and settlement -- the consideration received/provided for the
financial arrangement
This example is a continuation of Example 11.3 and relates to the same
factual situation. It discusses the impact of section 230-440 on both
Smith Co and Jones Co in respect of the financial arrangements which
they start to have under their arrangement to transfer Smith Co's
depreciating asset to Jones Co, under which payment is deferred.
The financial arrangement each starts to have on 1 September 2010 is
as set out in Example 11.3. As in Example 11.3, the references to the
value of the financial arrangements in this example are references to
the market value as determined using the method set out in
subsections 230-440(8) to (10).
Smith Co -- the amount provided to start to have the financial
arrangement
As discussed in Example 11.3, the amount Smith Co receives for
disposing of its depreciating asset is taken (by subsection 230-440(1))
to be the market value of its financial arrangement that it receives on
delivery of the depreciating asset (comprising its right to receive
$250,000 in 15 months time from Jones Co).
Smith Co will be further taken to have provided an amount equal to the
market value of its financial arrangement (its right to receive payment
from Jones Co) when Smith Co started to have it (1 September 2010),
as consideration for acquiring this financial arrangement. As such,
Smith Co will be taken to have paid $150,000 to acquire its financial
arrangement on 1 September 2010 (subsection 230-440(2)).
Under this financial arrangement, Smith Co will receive $250,000
from Jones Co on 1 January 2012. Accordingly, it will make a
$100,000 gain from its financial arrangement (being these proceeds of
$250,000 less the $150,000 taken to be its cost) (section 230-75).
As this $100,000 overall gain is sufficiently certain (within the
meaning of Subdivision 230-B) at the time Smith Co starts to have the
financial arrangement (1 September 2010), if Smith Co has not made
any elections under Division 230 this $100,000 overall gain will be
accrued over the 15-month life of the financial arrangement
(subsection 230-105(2), section 230-110 and subsection 230-130(1)).
Smith Co -- the overall tax treatment from disposing of its
depreciating asset
The net effect of Smith Co's arrangement to dispose of its depreciating
asset is that it has made an assessable balancing adjustment amount of
$50,000 on disposal of its depreciating asset as set out in Example 11.3
317
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
and an assessable gain of $100,000 under Division 230 (as set out
above), as a result of the interaction between the capital allowance
provisions and Division 230.
Jones Co
As discussed in Example 11.3, the amount Jones Co is taken
to have paid to acquire the depreciating asset is, pursuant to
subsection 230-440(1), the market value of its financial arrangement
which it starts to have on receipt of the depreciating asset (comprising
its obligation to pay $250,000 in 15 months time to Smith Co).
Jones Co will be further taken to have received an amount equal to the
market value of its financial arrangement (its obligation to pay
Smith Co) when it started to have it (1 September 2010), as
consideration for starting to have this financial arrangement. As such,
Jones Co will be taken to have received $150,000 for starting to have
its financial arrangement (its obligation to pay $250,000) on
1 September 2010 (subsection 230-440(2)).
Jones Co will pay $250,000 under this financial arrangement to
Smith Co on 1 January 2012. Accordingly, it will make a $100,000
loss from its financial arrangement (being the $250,000 paid less the
$150,000 it is taken to have received) (section 230-85).
As this $100,000 loss is sufficiently certain (within the meaning of
Subdivision 230-B) at the time Jones Co starts to have the financial
arrangement (1 September 2010), if Jones Co has not made any
elections under Division 230 this $100,000 overall loss will be accrued
over the 15-month life of the financial arrangement
(subsection 230-105(2), section 230-110 and subsection 230-130(1)).
Jones Co -- the overall tax treatment from acquiring the
depreciating asset
The net effect of Jones Co's arrangement to acquire a depreciating
asset from Smith Co is that it has acquired a depreciating asset with a
cost of $150,000 (without anything further) as set out in Example 11.3,
and made a deductible loss of $100,000 from the financial arrangement
under which it has to pay Smith Co $250,000, as a result of the
interaction between the capital allowance provisions and Division 230.
Where one financial arrangement (or part thereof) is dealt with as
consideration for another financial arrangement (or part thereof)
11.41 As explained in Chapter 3, a tie-breaker rule is included in
section 230-440 for where the relevant `thing' that the financial
arrangement is used as consideration for providing or acquiring, is itself a
financial arrangement. [Schedule 1, item 1, subsections 230-440(3) and (6)]
318
Interaction and consequential amendments
11.42 For an illustration of when this tie-breaker rule may arise and
how it applies, see Case study 4 in Chapter 13.
Financial arrangements of consolidated groups
11.43 Division 230 applies to consolidated groups and multiple entry
consolidated groups (MEC groups) as if the head company of the group is
the relevant taxpayer. It does not alter the general effect of the rules about
consolidated groups in Part 3-90 of the ITAA 1997. In particular, the
single entity rule applies to ensure that gains or losses arising from
financial arrangements between group members are not recognised.
Taxation of gains or losses in respect of financial arrangements up until
the joining and leaving time
11.44 When an entity joins a consolidated group or MEC group during
an income year, gains and losses made on financial arrangements up until
the joining time are brought to account because an entity that is not a
subsidiary member of a group for the whole of an income year is required
to calculate its taxable income for each such period as if it were an income
year (section 701-30 of the ITAA 1997).
11.45 The gain or loss on a financial arrangement is also recognised by
the head company of a consolidated group or MEC group when a
subsidiary leaves the group. The gain or loss is allocated to the income
year of the head company in which the gain or loss occurred.
11.46 This ensures that the gain or loss that relates to the period during
which the head company held the asset is brought to account for tax
purposes. Thus, gains and losses on Division 230 financial arrangements
are recognised consistently when they cease to be held by the joining
entity or the head company. However, it does not affect the actual income
year of the head company -- it is required so that the amount of the gain
or loss, that would have otherwise been accrued if the leaving time had
been the end of the income year, can be brought to account in that income
year.
11.47 Where a leaving entity takes a financial arrangement that, when
held by the head company, was subject to the accruals method under
Subdivision 230-B, the head company is required to bring to account for
the purposes of applying the accruals method, the part of the gain or loss
that has been allocated to intervals that occur before and up to the leaving
time. [Schedule 1, item 1, subsection 230-140(3)]
11.48 Where a leaving entity takes a financial arrangement that was
subject to the fair value election, the foreign exchange retranslation
election or the financial reports election when held by the head company,
319
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
the gain or loss that the head company is taken to have made from the
financial arrangement is calculated on the basis that the circumstances that
existed at the leaving time remain unchanged until the end of the income
year.
11.49 Consistent with the principles contained in the Australian
accounting standards, the circumstances are taken to remain static for the
purposes of establishing the gain or loss on the financial arrangement at
the leaving time.
11.50 For financial arrangements subject to the fair value election, the
gain or loss recognised by the head company for that income year will be
the difference between its fair value at the start of the income year, and its
fair value at the leaving time. That difference is taken to be the amount
which the Australian accounting standards require the head company to
recognise in profit or loss for the income year from the asset that was
subject to the fair value election. [Schedule 1, item 1, subsections 230-195(3) and
(4)]
11.51 For financial arrangements subject to the foreign exchange
retranslation election, the gain or loss the head company makes from the
financial arrangement is calculated with reference to the gain or loss that
the relevant standard would require the group to recognise in profit or loss
in that income year up until the leaving time. [Schedule 1, item 1,
subsections 230-240(3) and (4)]
11.52 For financial arrangements subject to the financial reports
election, the gain or loss the head company makes from the financial
arrangement is calculated with reference to the relevant values of the
financial arrangement at the leaving time rather than the value at the end
of the head company's income year. [Schedule 1, item 1, subsections 230-370(3)
and (4)]
What happens to a Division 230 election made by an entity when it joins
or leaves a consolidated group or MEC group?
11.53 An election made under Division 230 will affect the amount of a
gain or loss that is recognised for tax purposes and the timing of when that
gain or loss is brought to account. Where the election is made by an
entity that joins a consolidated group or MEC group, or the head company
of a group in relation to a leaving entity, the application of the entry
history rule and the exit history rule may not be consistent.
11.54 Where a joining entity had made an election (choice) under
Division 230 prior to the joining time, the head company of the
consolidated group or MEC group can override the entry history rule by
making a fresh choice under Division 230 in relation to financial
320
Interaction and consequential amendments
arrangements of the joining entity that become assets of the head
company. [Schedule 1, item 83, subsection 715-660(1), item 3A in the table]
11.55 The head company can also make a choice when an entity joins
a consolidated group or MEC group where an inconsistency exists
between the choice (or absence of choice) of the joining entity and the
choice made by the head company. [Schedule 1, item 84, subsection 715-665(1),
item 1A in the table]
11.56 An entity that leaves a consolidated group or MEC group can
also make an election under Division 230. This is achieved under
sections 715-700 and 715-705 of the ITAA 1997. Hence, provided the
requirements of the relevant provisions are met, a leaving entity may be
able to make a fresh election that will apply from the leaving time or, if
the election relates to an income year, the income year in which the
leaving time occurs.
Financial arrangements denominated in a foreign currency
11.57 For the purposes of the ITAA 1997 and the ITAA 1936,
subsection 960-50(1) requires that any amount or value that is
denominated in a foreign currency be translated (converted) into
Australian currency. In particular, if there are amounts that are elements
in the calculation of other amounts those elements are to be translated into
Australian currency first and then the other amounts are calculated. An
exception to this general rule applies where those other amounts are a
`special accrual amount'. Amounts under Division 16E of the ITAA 1936
were such `special accrual amounts' (see definition of `special accrual
amount' in subsection 995-1(1) of the ITAA 1997).
11.58 A similar exception to the general translation rule is required for
gains or losses that are subject to the accruals method under
Subdivision 230-B. An amendment is made to the definition of `special
accrual amount' to include a reference to gains or losses that are subject to
the accruals method in Subdivision 230-B where all the financial benefits
that are provided and received under the financial arrangement are
denominated in a particular foreign currency [Schedule 1, item 29, definition of
`special accrual amount' in subsection 995-1(1) of the ITAA 1997]. If the financial
arrangement is comprised of financial benefits that are denominated in
more than one currency, the exception for special accrual amounts will
not apply to calculating the gains or losses from that arrangement.
11.59 The application of the special accrual amount rule means that
the sufficiently certain overall or particular gain or loss that is made from
the financial arrangements in the circumstances specified is to be
calculated in the foreign currency. Further, the spreading of that overall
or particular gain or loss over the relevant accrual period is to be done in
321
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
the foreign currency. Only the amounts allocated to the relevant
accruals intervals are to be translated using the relevant table in
subsection 960-50(6) of the ITAA 1936.
Recognition of gains and losses
11.60 The following amendments relate to the manner in which gains
or losses are recognised for tax purposes where a Division 230 financial
arrangement is involved.
Foreign bank branches
11.61 Part IIIB of the ITAA 1936 establishes a regime for recognising
transactions between foreign banks and their Australian branches. Under
section 160ZZW of Part IIIB, the branch is effectively treated as a
separate legal entity for certain financial dealings (such as the notional
payment of interest by the branch to the bank, notional derivative
transactions and notional foreign exchange transactions between the
branch and the bank -- see sections 160ZZZA, 160ZZZE and 160ZZZF
of Part IIIB, respectively). These sections apply where the foreign bank
applies Part IIIB in calculating that part of its taxable income that is
referable to certain activities of its Australian branch (see
section 160ZZVB of the ITAA 1936).
11.62 Section 160ZZZK of Part IIIB extends the application of
Part IIIB to foreign financial entities and their Australian permanent
establishments. For convenience, the following discussion refers only to
foreign banks and their Australian branches, but it should be borne in
mind that the amendments will apply more broadly.
11.63 Generally, Division 230 will apply to include gains or losses
made on financial arrangements held by the Australian branch of a foreign
bank in the calculation of its taxable income, including any gains or losses
arising from intra-bank dealings between the Australian branch and the
rest of the bank. To avoid doubt, an amendment is made to
section 160ZZW of Part IIIB, to provide that gains or losses from
financial arrangements entered into between the foreign bank and its
Australian branch will be brought to account under Division 230
[Schedule 1, item 40, subsection 160ZZW(1A)]. Division 9A of Part III of the
ITAA 1936 could also be relevant to this outcome if the foreign bank is a
registered offshore banking unit.
11.64 Section 160ZZZA, relating to the notional payment of interest
by the branch to the bank, provides that the rate of interest may not exceed
the London Inter Bank Offered Rate. The amendment to section 160ZZW
is not intended to affect the operation of this requirement.
322
Interaction and consequential amendments
11.65 Further, an amendment will be made to section 160ZZX of
Part IIIB to specify that gains made through the Australian branch of a
foreign bank, from financial arrangements to which Division 230 applies,
are taken to be sourced in Australia. This will treat these gains in the
same way as income from other transactions of the branch. [Schedule 1,
Part 2, items 41 and 42, subsection 160ZZX(2 of the ITAA 1936)]
Deductions for expenditure incurred for capital gain
11.66 Section 51AAA of the ITAA 1936 denies certain deductions
where, broadly, the deduction would otherwise only be allowable because
of its connection to a capital gain.
11.67 With the introduction of Division 230, subsection 230-15(2) will
allow a deduction for a loss from a financial arrangement where the loss is
made in gaining or producing assessable income or is necessarily made in
carrying on a business for the purpose of gaining or producing assessable
income.
11.68 Section 51AAA is amended to deny a deduction that would
otherwise be allowable under subsection 230-15(2) only because it was
incurred in making a capital gain. [Schedule 1, item 32, subsection 51AAA(2) of
the ITAA 1936]
Offshore banking units -- the loss of special treatment where there is
excessive use of non-offshore banking money
11.69 An offshore banking unit will not be taken to have breached the
rule limiting its use of non-offshore banking money in section 121EH of
the ITAA 1936 where it has made a transitional election under
subitem 82(2) to have Division 230 apply to all of the financial
arrangement it has at the start of the first applicable income year
(see Chapter 12 -- Commencement, transitional and implementation
issues) and a balancing adjustment arises under those provisions. Where
the offshore banking unit makes this election, the balancing adjustment
amount is brought to account as assessable income or an allowable
deduction over the first four years of Division 230 applying to the
offshore banking unit. Such additional assessable income may in various
ways cause the offshore banking unit to breach the 10 per cent limit set in
section 121EH. Any balancing adjustment is also not to be taken into
account in determining the effects of breaching the limit nor should it
mean that the offshore banking unit would not breach the limit when it
would otherwise do so. [Schedule 1, Part 3, subitem 99(16)]
323
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Tax-exempt asset financing
11.70 Proposed Division 250 contained provisions which had the same
effect as certain provisions in Division 230. As Division 250 commences
at an earlier time than Division 230, the amendments required necessarily
referred to Division 250. It is intended that once Division 230
commences, Division 250 will then refer to the relevant provisions in
Division 230. As a consequence of this, further amendments are required
to change references from Division 250 to Division 230. [Schedule 1,
items 65 to 79]
Pay as you go instalments -- Taxation Administration Act 1953
11.71 Subsection 45-120(1) of the TAA 1953 states that instalment
income for a period includes amounts of ordinary income that are derived
during that period, but only to the extent that it is assessable income in the
income year. Ordinary income in this sense takes its meaning from
section 6-5 of the ITAA 1997.
11.72 Subsection 45-120(2B) operates to include additional amounts
within the definition of `instalment income' by including a new category
of statutory income within the definition of `instalment income'. To the
extent that an amount of income is both ordinary income and statutory
income, it will only be included as instalment income once. That is, the
amount of income will not be double counted.
11.73 Generally, gains made on certain financial arrangements that are
subject to Division 230 will be subject to the pay as you go (PAYG)
instalments system. The amendment made in this Bill ensures that the
PAYG instalment system recognises the gain or loss, or the part of the
gain or loss, on a financial arrangement that is attributable to each income
year. This is achieved by including gains and losses made from
Division 230 financial arrangements within the definition of
`instalment income'.
11.74 The amendment further provides that only the net result of the
relevant gains and losses made on financial arrangements, that are subject
to Division 230 for a particular income year, will be included as the
instalment income amount. That is, the net result of the gains must
exceed the losses made in an income year in respect of a financial
arrangement under Division 230 to be recognised for PAYG purposes.
[Schedule 1, item 96, subsection 45-120(2B) in Schedule 1 to the TAA 1953]
11.75 Where the amount of losses exceeds the amount of gains made
in an income year in respect of Division 230 financial arrangements, no
amount is included in the entity's instalment income under
subsection 45-120(2B).
324
Interaction and consequential amendments
The effect of a change of residence of the taxpayer
A taxpayer becomes an Australian resident
11.76 A special deeming rule applies where a taxpayer becomes an
Australian resident and immediately before this time neither the gains are
assessable nor the losses are deductible in relation to a financial
arrangement the taxpayer has. Becoming an Australian resident is the
trigger event for the first time the taxpayer needs to account for that
financial arrangement for Australian income tax purposes. To deal with
this situation a rule has been included whereby the taxpayer is taken, for
the purposes of Division 230, to start to have the arrangement when the
taxpayer becomes an Australian resident. The taxpayer is also taken to
have acquired the interest in the arrangement for its market value at that
time. [Schedule 1, item 1, subsection 230-430(1)]
A taxpayer ceases to be an Australian resident
11.77 For similar reasons to the rule outlined above, there is also an
equivalent rule for when a taxpayer ceases to be an Australian resident.
The rule only applies if, immediately after the taxpayer ceases to be an
Australian resident, neither the gains are assessable nor the losses are
deductible in relation to a financial arrangement.
11.78 Where the rule applies the taxpayer is taken, for the purposes of
Division 230, to cease to have that financial arrangement and to have
disposed of the interest in the arrangement for its market value at that
time. The relevant time for these events is the time the taxpayer ceases to
be an Australian resident (which may be at the end of an income year or
may be some time during an income year). [Schedule 1, item 1,
subsection 230-430(2)]
11.79 Where there is a deemed disposal of the interest in the financial
arrangement there may be a balancing adjustment under proposed
Subdivision 230-G of the ITAA 1997 (which is discussed in Chapter 10).
Certain cases where the change of residence rules do not apply
11.80 Under Division 6 of the ITAA 1997, a foreign resident will only
need to include gains made from a financial arrangement where those
gains have an Australian source. By comparison, whether or not a foreign
resident is allowed a deduction for a loss on a financial arrangement
depends not on any source rules, but on the purpose for which the loss
was incurred. [Schedule 1, item 1, subsection 230-15(2)]
325
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Definitional and referencing changes
11.81 These amendments are required because the existing definitions
contained in the tax laws have been affected by the introduction of
Division 230. Further, some amendments have been included to update
checklists in the legislation.
Exchangeable interests
11.82 The effect of Subdivision 130-E of the ITAA 1997 is that any
capital gain or capital loss from the disposal or redemption of an
exchangeable interest to the issuer of the interest or to a connected entity
of the issuer, will be disregarded. Subdivision 130-E of the ITAA 1997
also modifies the cost base of the shares acquired as a result of the
exchange or redemption.
11.83 Section 130-100 of the ITAA 1997 previously defined an
`exchangeable interest' as a traditional security issued on the basis that it
will or may be:
· disposed to the issuer of the traditional security or a
connected entity of the issuer; or
· redeemed,
in exchange for shares in a company that is neither the issuer of the
traditional security or in a connected entity of the issuer.
11.84 Broadly, a traditional security, as defined in
subsection 26BB(1) of the ITAA 1936, is a security that is not issued at a
deep discount, does not bear significant deferred interest and is not capital
indexed. A traditional security may be, for example, a bond, a debenture,
a deposit with a financial institution or a secured or unsecured loan.
11.85 Amendments to section 130-100 broaden the application of this
provision such that an exchangeable interest will now extend to
`qualifying securities' within the meaning of that term in Division 16E of
the ITAA 1936.
11.86 As a result of this amendment, the CGT treatment of
exchangeable interests will apply equally to exchangeable interests that
are traditional securities and exchangeable interests that are qualifying
securities. This is similar to the treatment currently afforded to
convertible interests under section 130-60. [Schedule 1, items 63 and 64,
section 130-100]
326
Interaction and consequential amendments
Offshore banking units and foreign bank branches
Hedging activities of offshore banking units
11.87 Financial arrangements of an offshore banking unit are tested in
order to determine if they qualify as offshore banking activities. One of
those tests determines whether the activity, as represented by a financial
arrangement, is a hedging activity. In order to reduce compliance costs,
the definition of `hedging activity' in subsection 121D(8) of the
ITAA 1936 will be amended to use the concept of a `financial
arrangement'.
11.88 The phrase `financial arrangement' will replace the term
`contract' that is currently used in the definition. The Division 230 term
`hedging financial arrangement' has not been adopted because the
accounting requirements involved in that concept could have limited the
meaning of `hedging activity'. [Schedule 1, Part 2, item 36, definition of `hedging
activity' in subsection 121D(8) of the ITAA 1936]
Derivative transaction for foreign bank branches
11.89 An amendment will also be made to the definition of `derivative
transaction' in section 160ZZV of Part IIIB, so that it refers to financial
arrangements to which Division 230 applies. [Schedule 1, items 38 and 39,
definition of `derivative transaction' in section 160ZZV of the ITAA 1936]
Checklists
11.90 The checklists in sections 10-5 and 12-5 of the ITAA 1997 will
be amended to include references to `gains from financial arrangements'
and `losses from financial arrangements'. [Schedule 1, items 45 and 46]
Signposts
11.91 The operation of the value setting rules in section 230-440 have
been described in paragraphs 11.26 to 11.59. Signposts in the form of
notes to provisions have been included in capital allowances [Schedule 1,
items 50 to 56] and CGT provisions [Schedule 1, items 59 and 60] of the
ITAA 1997 to highlight the possible application of section 230-440 to the
relevant assets that are subject to those provisions. A note has been added
to the bad debt provisions to explain that in certain circumstances a loss in
relation to a financial arrangement under subsections 230-150(3), (5) and
(6) and 230-165(3), (5) and (6) will be treated as a bad debt. [Schedule 1,
item 47]
11.92 Signposts have also been added to some CGT provisions to
highlight the effect of the hedging provisions in certain situations.
[Schedule 1, items 58 and 59]
327
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Foreign currency gains and losses -- Division 775 and
Subdivisions 960-C and 960-D
11.93 Amendments to ensure that certain types of securitisation
vehicles and special purpose vehicles were exempt from Division 775
were announced by the then Minister for Revenue and Assistant Treasurer
in Press Release No. 073 of 2 September 2005. That exemption was
provided until the commencement of the retranslation and hedging
regimes as part of the taxation of financial arrangements legislative
framework. Those regimes are to be introduced by this Bill.
11.94 In order to ensure that the law operates as intended in relation to
these types of taxpayers the amendments (as described above) are
included in this Bill.
11.95 The amendments to Division 775 will apply to `securitisation
vehicles' as defined in section 820-942 of the ITAA 1997 and special
purpose vehicles that meet the requirements of subsection 820-39(3) of
the ITAA 1997. Generally, those provisions identify certain entities that
are eligible for special treatment as securitisation vehicles under the thin
capitalisation rules in the income tax law. In particular the following
amendments will be made:
· section 775-170 of the ITAA 1997 will be amended to
provide an exemption from Division 775 in respect of foreign
exchange realisation gains and foreign exchange realisation
losses made by the relevant securitisation vehicles [Schedule 1,
items 85 and 86, subsection 775-170(2)];
· section 775-195 of the ITAA 1997 will be amended to
exclude the relevant securitisation vehicles from being
eligible to make a choice for roll-over relief for facility
agreements held by such entities [Schedule 1, item 88,
subsection 775-195(9)];
· section 960-50 of the ITAA 1997 will be amended to ensure
that the translation rules contained in Subdivision 960-C will
not apply to relevant securitisation vehicles for the purposes
of working out its assessable income, deductions or tax
offsets [Schedule 1, item 90, subsection 960-55(4)]; and
· section 960-60 of the ITAA 1997 will be amended to exclude
relevant securitisation vehicles from being eligible to make a
choice to apply a functional currency [Schedule 1, item 92,
subsection 960-60(6)].
328
Interaction and consequential amendments
11.96 Each of these amendments will take effect from 1 July 2003 --
the date of commencement of Division 775 and Subdivisions 960-C and
960-D.
11.97 It has been intended policy that once the retranslation and
hedging regimes under the taxation of financial arrangements legislative
framework commence, those entities that have been excluded from the
operation of Division 775 and Subdivisions 960-C and 960-D were to
become subject to those provisions. The entities affected will be ADIs,
non-ADI financial institutions and securitisation vehicles. Amendments
are made to ensure that on commencement of Division 230, those entities
will also be subject to Division 775 and Subdivisions 960-C and 960-D.
[Schedule 1, items 87, 89, 91 and 93]
New Business Tax System (Taxation of Financial Arrangements)
Act 2003
11.98 Section 77 of Schedule 4 to the NBTS (TOFA) Act 2003 is a
transitional provision that allowed Division 3B of the ITAA 1936 to
continue to apply:
· to an eligible contract entered into by a taxpayer before the
taxpayer's `applicable commencement date' for Division 775
of the ITAA 1997 (see section 775-155 of the ITAA 1997);
and
· for the purposes of working out the assessable income or
allowable deductions of an ADI or a non-ADI financial
institution.
11.99 Paragraph 77(1)(b) will be amended to extend the transitional
provision as it relates to ADIs and non-ADI financial institutions to those
securitisation vehicles described in paragraph 11.95. [Schedule 1, Part 2,
item 94, paragraph 77(1)(b)]
11.100 Consistent with the policy outlined in paragraph 11.97, the
transitional provisions which allow Division 3B of the ITAA 1936 to have
continued operation in relation to ADI's, non-ADI financial institutions
and relevant securitisation vehicles will be removed on commencement of
Division 230. [Schedule 1, item 95]
Retranslation under Division 775
11.101 Other changes to Division 775 relating to the retranslation
election have been explained in Chapter 7. [Schedule 1, items 5 and 6]
329
Chapter 12
Commencement, transitional and
implementation issues
Outline of chapter
12.1 This chapter explains:
· when the provisions of Division 230 begin to have effect; and
· how financial arrangements that a taxpayer has at the time
Division 230 begins to have effect may be treated under this
Division.
Context of amendments
12.2 Division 230 will apply to income years commencing on or
after 1 July 2009. Taxpayers are also able to elect to apply Division 230
to income years commencing on or after 1 July 2008. At the time
Division 230 first applies, taxpayers may have financial arrangements on
hand which in earlier years were subject to the existing law. Generally,
such arrangements will not be subject to Division 230 unless the taxpayer
elects for the Division to apply.
12.3 Generally, financial arrangements which a taxpayer has prior to
Division 230 commencing will continue to be subject to the current law
(and not be subject to the provisions of the Division) including for income
years after the commencement of the Division. An exception to this
general rule is where a taxpayer elects to have Division 230 apply to all
financial arrangements they have at the time the Division commences.
Summary of new law
12.4 Division 230 will apply to income years commencing on or after
1 July 2009. Taxpayers are also able to elect to apply Division 230 to
income years commencing on or after 1 July 2008.
331
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
12.5 Division 230 will apply to financial arrangements a taxpayer
first starts to have in an income year commencing on or after 1 July 2009
or on an elective basis to financial arrangements first held in held in
income years commencing on or after 1 July 2008.
12.6 A taxpayer may elect to have Division 230 apply to financial
arrangements that would otherwise be the subject of the Division, that
were entered into prior to the first income year in which the Division
applies, and that the taxpayer holds at the start of that year. In respect of
such existing arrangements, a transitional `balancing adjustment' (see
paragraphs 12.17 to 12.32) will be calculated and spread evenly over the
first applicable income year (the taxpayer's first income year commencing
on or after 1 July 2009 -- or on or after 1 July 2008 as appropriate) and
the following three income years.
Comparison of key features of new law and current law
New law Current law
Division 230 applies to income years No equivalent.
commencing on or after 1 July 2009.
Taxpayers are able to elect to apply
Division 230 to income years
commencing on or after 1 July 2008.
Taxpayers may elect that
Division 230 apply to relevant
financial arrangements entered into
in earlier periods. In this case a
transitional balancing adjustment
must be made by the taxpayer.
Detailed explanation of new law
Commencement date
12.7 Division 230 will apply on a mandatory basis to all income
years commencing on or after 1 July 2009. [Schedule 1, Part 3, subitem 98(1)]
12.8 Taxpayers are able to elect to apply Division 230 to income
years commencing on or after 1 July 2008. For consolidated groups it is
the head company that makes this election. Where a taxpayer makes this
election, they must do so on or before the first lodgment date that occurs
on or after 1 July 2008. [Schedule 1, Part 3, subitems 98(2) and (3)]
332
Commencement, transitional and implementation issues
Application to new financial arrangements
12.9 Division 230 applies to all financial arrangements (that are
subject to the Division) that the taxpayer starts to have in the income year
in which the Division first applies to the taxpayer, and to financial
arrangements the taxpayer starts to have in any subsequent income year.
[Schedule 1, Part 3, subitem 99(1)]
Application to existing financial arrangements
12.10 A taxpayer may elect that Division 230 also apply to all
financial arrangements that they started to have prior to the first income
year in which the Division applies to the taxpayer, and which the taxpayer
still has at the time the Division first applies to the taxpayer (`existing
financial arrangements'). [Schedule 1, Part 3, subitem 99(2)]
12.11 The election to bring existing financial arrangements within the
scope of Division 230:
· will apply to all financial arrangements a taxpayer starts to
have prior to the time the Division first applies to the
taxpayer and which the taxpayer still has at that time, other
than financial arrangements (typically a deferred settlement)
which are in existence at that time and arose from a disposal
of property, including a disposal of a capital asset, revenue
asset, depreciating asset or trading stock [Schedule 1, Part 3,
subitems 99(2) and (3)]; and
· must be made by the taxpayer and notified to the
Commissioner of Taxation (Commissioner) on or before the
first date for lodgment of an income tax return of the
taxpayer (lodgment date) that occurs on or after the start of
the first applicable income year to which the Division applies
[Schedule 1, Part 3, sub-subitems 99(4)(a) and (b)].
12.12 Financial arrangements which are brought within the scope of
Division 230 through this election will be subject to the various tax-timing
methods within the Division, including the elective methods of fair value,
foreign exchange retranslation and relying on financial reports for which
the taxpayer has made the necessary elections by the first lodgment date
that occurs on or after the start of the first income year that Division 230
applies to the taxpayer [Schedule 1, Part 3, subitem 99(5)]. In such situations it
is intended that before taxpayers can have any of the elective tax-timing
methods apply to such `existing arrangements', they must have made the
transitional election. It is only by making a transitional election that the
333
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
taxpayer can bring their `existing financial arrangements' within the scope
of an elective tax-timing treatment.
12.13 Taxpayers can also elect to apply the hedging financial
arrangements election method (in Subdivision 230-E) to certain financial
arrangements (`existing hedges') if:
· the hedging financial arrangements election is made by the
first lodgment date that occurs after the start of the first
income year that Division 230 applies to the taxpayer
[Schedule 1, Part 3, sub-subitem 99(6)(a)];
· at the time the existing hedge was created, acquired or
applied, it satisfied the definition of a `hedging financial
arrangement' in section 230-290 (as explained in Chapter 8)
[Schedule 1, Part 3, sub-subitem 99(6)(b)];
· when Division 230 commences, the taxpayer's records in
relation to the existing hedge satisfy the relevant record
keeping requirements in sections 230-310 and 230-315
(ignoring subparagraph 230-315(2)(c)(ii)) explained in
Chapter 8 [Schedule 1, Part 3, sub-subitem 99(6)(c)]; and
· all the effectiveness requirements set out in section 230-320
(explained in Chapter 8) have been met at all times since the
existing hedge was first created, acquired or applied for the
purpose of hedging a risk in relation to a hedged item
[Schedule 1, Part 3, sub-subitem 99(6)(d)].
12.14 However, for existing hedges, the hedging election will only
extend to tax-timing matching. Tax-status hedging cannot, as a result of
the transitional election, extend to existing hedges. That is to say,
tax-status hedging (contained in section 230-270) can only apply to new
hedging financial arrangements entered into in the income year, or later
income years, in which Division 230 first applies to the taxpayer.
[Schedule 1, Part 3, subitem 99(7)]
12.15 Where an election has been made to bring existing financial
arrangements within the scope of Division 230 and where a valid election
have been made under any of the elective Subdivisions (as explained in
Chapter 5), the elective Subdivision(s) will apply to the taxpayer's
existing financial arrangements notwithstanding the fact that the election
under the elective Subdivisions was not made in the income year in which
the taxpayer first started to hold the existing financial arrangement.
[Schedule 1, Part 3, subitem 99(8)].
334
Commencement, transitional and implementation issues
12.16 Where a taxpayer has financial arrangements that were in
existence at the time the Division first commences to apply, and does not
make a transitional election, then those financial arrangements will
continue to be brought to account under the other provisions of the tax
law.
Transitional balancing adjustment
12.17 Where a taxpayer makes an election to bring existing
arrangements into Division 230, a transitional `balancing adjustment' is
calculated using the `method statement' contained in subitem 99(10), at
the time the election takes effect (the time when Division 230 first applies
to the taxpayer) [Schedule 1, Part 3, subitem 99(9)]. The balancing adjustment,
which is designed to compare the amounts which have been brought to
account under the existing law with amounts that would have been
brought to account under Division 230 if it had applied, is calculated as
follows:
· a notional assessable amount (the total of all the amounts
relating to the financial arrangements that would be
assessable under Division 230, if it (and any relevant
elections) applied from the time the taxpayer started to have
the arrangements) [Schedule 1, Part 3, subitem 99(10), step 1 and
subitem 99(15)];
· a notional deductible amount (the total of all the amounts
relating to the financial arrangements that would be
allowable as deductions under Division 230 if it (and any
relevant elections) applied from the time the taxpayer started
to have the arrangements) [Schedule 1, Part 3, subitem 99(10),
step 2 and subitem 99(15)];
· an actual assessed amount (the total of all the amounts
relating to the financial arrangements that have been included
in assessable income from the time the taxpayer started to
have the arrangements) [Schedule 1, Part 3, subitem 99(10), step 3];
· an actual deducted amount (the total of all the amounts
relating to the financial arrangements that have been allowed
as deductions from the time the taxpayer started to have the
arrangements) [Schedule 1, Part 3, subitem 99(10), step 4];
· the step 5 amount (add the notional assessable amount to the
actual deducted amount) [Schedule 1, Part 3, subitem 99(10),
step 5]; and
335
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· the step 6 amount (add the actual assessed amount to the
notional deductible amount) [Schedule 1, Part 3, subitem 99(10),
step 6].
12.18 The final calculation involves comparison of the step 5 amount
with the step 6 amount. A positive amount, which results if the step 5
amount exceeds the step 6 amount, is included in assessable income as a
balancing adjustment while a negative amount, which results if the step 6
amount exceeds the step 5 amount, is allowable as a deduction as a
balancing adjustment. [Schedule 1, Part 3, subitem 99(10), step 7]
12.19 The result from the calculation above (which must take into
account all `pre-existing financial arrangements' to which the transitional
election applies) will be brought to account (as either assessable income
where there is a positive amount or an allowable deduction where there is
a negative amount) in equal instalments over the first income year to
which Division 230 applies to the taxpayer and the following three
income years. That is, one quarter of the balancing adjustment is brought
to account in each of these four years. [Schedule 1, Part 3, subitem 99(14)]
Application of the transitional balancing adjustment to financial
arrangements
12.20 When undertaking a balancing adjustment in respect of existing
financial arrangements, it is important to note that the values that are
included at each step are positive numbers. That is, an amount that is
included at steps 2 and 4 is not a negative amount because it is, or would
be, allowable as a deduction.
12.21 Example 12.1 illustrates how a transitional balancing adjustment
should be calculated.
Example 12.1: Calculating a transitional balancing adjustment
Background
BJ Investments Co is an investment company whose tax and
accounting year ends on 30 June. It holds two portfolios of shares,
details of which are:
· Portfolio No. 1 contains 1,000 shares in Johnny Co. The shares
were acquired for $5 per share, that is, the cost of this portfolio
was $5,000. This portfolio of shares was acquired on
30 January 2006; and
· Portfolio No. 2 contains 2,000 shares in Buddy Co. The shares
were acquired for $10 per share, that is, the cost of this portfolio
336
Commencement, transitional and implementation issues
was $20,000. This portfolio of shares was acquired on
30 March 2004.
Assumptions
· The shares are held on revenue account.
· No dividends are paid during the period in which
BJ Investments Co holds the shares.
· Division 230 applies to BJ Investments Co from 1 July 2008.
· On 30 June 2008:
- BJ Investments Co makes an election under
Subdivision 230-C to fair value Division 230 financial
arrangements that are fair valued in its financial reports
with effect from 1 July 2008;
- BJ Investments Co also makes an election to apply
Division 230 to all existing financial arrangements that
it has at the start of the income year in which
Division 230 first applies to it;
- BJ Investments Co always satisfies the requirements of
Subdivision 230-C to allow it to continue to apply the
fair value election to relevant financial arrangements;
- the shares in Portfolio No. 1 and Portfolio No. 2 are fair
valued in the financial reports of BJ Investments Co;
- the fair value of Portfolio No. 1 had increased to
$7,500 -- that is, $7.50 per share; and
- the fair value of Portfolio No. 2 had decreased to
$8,000 -- that is, $4 per share.
· On 20 June 2009 BJ Investments Co disposes of all shares in:
- Portfolio No. 1 for $8,000 -- that is, $8 per share; and
- Portfolio No. 2 for $10,000 -- that is, $5 per share.
Transitional balancing adjustment calculation
In light of the above facts, the balancing adjustment would be
calculated as follows:
Step 1 -- Amounts that would be included if Division 230 had applied
from the time Portfolio No. 1 was acquired -- that is, the fair value
337
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
gain on Portfolio No. 1 as at 30 June 2008 (notional assessable
amount).
$2,500
Step 2 -- Amounts that would be deductible if Division 230 applied
from the time Portfolio No. 2 was acquired -- that is, the fair value
loss on Portfolio No. 2 as at 30 June 2008 (notional deductible
amount).
$12,000
Step 3 -- Amounts that have been included in assessable income from
the time the taxpayer started to have the financial arrangement (actual
assessed amount).
$0
Step 4 -- Amounts that have been allowable as deductions from the
time the taxpayer started to have the financial arrangement (actual
deducted amount).
$0
Step 5 -- Add the notional assessable amount to the actual deductible
amount.
($2,500 + $0) = $2,500
Step 6 -- Add the actual assessed amount to the notional deductible
amount.
($0 + $12,000) = $12,000
Step 7 -- Compare the step 5 amount with the step 6 amount.
As the step 6 amount exceeds the step 5 amount, the excess ($9,500) is
allowable as a deduction as a balancing adjustment. The balancing
adjustment is spread evenly over the first applicable income year and
the next three years.
12.22 The effect of undertaking a balancing adjustment calculation in
respect of financial arrangements held at the commencement of
Division 230 is to place those financial arrangements in the same position
that they would have been had they been subject to Division 230 from the
time the taxpayer first held the financial arrangement. [Schedule 1, Part 3,
subitem 99(10)]
338
Commencement, transitional and implementation issues
12.23 In Example 12.1 when BJ Investments Co disposes of the shares
that comprise Portfolios No. 1 and 2 they make:
· an overall gain of $3,000 in respect of Portfolio No. 1. The
gain is comprised of the $2,500 that was included in the
transitional balancing adjustment and a further $500 that is
the difference between the proceeds on disposal and the fair
value of the portfolio at the start of the income year in which
the disposal occurred; and
· an overall loss of $10,000 is respect of Portfolio No. 2. The
loss is comprised of the $12,000 that was included in the
transitional balancing adjustment and a $2,000 gain that is
the difference between the proceeds on disposal and the fair
value of the portfolio at the start of the income year in which
the disposal occurred.
Deferred tax liabilities and deferred tax assets
12.24 Where the financial year in which an entity recognises an
amount of income or an expense for tax purposes is different to the year in
which the entity recognises the income or expense for financial
accounting purposes, the entity will record in its financial reports a
deferred tax asset or a deferred tax liability in accordance with Australian
Accounting Standard AASB 112 Income Taxes (AASB 112).
12.25 Where an amount in a deferred tax asset account or a deferred
tax liability account is in respect of a Division 230 financial arrangement,
the taxpayer must disregard steps 1 to 4 of the method statement in
subitem 99(10) for the purposes of determining the balancing adjustment
amount that is attributable to that financial arrangement and instead rely
on the amount recorded in the financial reports as a deferred tax asset or a
deferred tax liability (and grossed up) in respect of that financial
arrangement. [Schedule 1, Part 3, subitems 99(11) and (12)]
12.26 Under AASB 112:
· deferred tax assets are the amounts of income tax recoverable
in future periods in respect of deductible temporary
differences; the carry forward of unused tax losses; and the
carry forward of unused tax credits.
· deferred tax liabilities are the amounts of income tax payable
in future periods in respect of taxable temporary differences.
12.27 An amount that is recorded in a deferred tax asset account that is
attributable to an existing financial arrangement is the attributable
339
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
assessable amount [Schedule 1, Part 3, subitem 99(11)]. Conversely, an
amount that is recorded in a deferred tax liability account that is
attributable to an existing financial arrangement is the `attributable
deductible amount' [Schedule 1, Part 3, subitem 99(12)].
12.28 Deferred tax asset and deferred tax liability amounts are
recorded in the financial reports as the amount of the tax liability (or tax
saving) and not as the amount of the gain or loss that is relevant for
Division 230 purposes. Accordingly, the balancing adjustment operates
such that it is the grossed up amount that is recorded in a deferred tax
asset account or deferred tax liability account in the taxpayer's financial
records which is relevant for the purposes of this provision. [Schedule 1,
Part 3, subitems 99(11) and (12)]
12.29 In respect of a financial arrangement that has an attributable
assessable amount recorded in a deferred tax asset account, the
attributable assessable amount is reduced to the extent that it represents
unused tax credits and is then grossed up in accordance with
subitem 99(13). The grossed up amount is to be added to the step 5
amount. [Schedule 1, Part 3, subitem 99(11)]
12.30 In respect of a financial arrangement that has an attributable
deductible amount recorded in a deferred tax liability account, the
attributable deductible amount is reduced to the extent that it represents
unused tax credits and is then grossed up in accordance with
subitem 99(13). The grossed up amount is to be added to the step 6
amount. [Schedule 1, Part 3, subitem 99(12)]
12.31 In calculating the grossed up amount under subitem 99(13), the
tax rate taken into account in working out the attributable assessable
amount or attributable deductible amount (the relevant tax rate), would
usually be the tax rate prevailing on the day that the amounts in the
deferred tax asset or deferred tax liability were calculated or subsequently
adjusted because of a change in tax rates. Example 2 in Appendix B of
AASB 112 illustrates how a change in tax rate is recorded in the deferred
tax asset account or deferred tax liability account. Any calculations or
adjustments made to these accounts are considered to have been made in
working out the attributable assessable amount or attributable deductible
amount. [Schedule 1, Part 3, subitem 99(13)]
12.32 Where no amount of the deferred tax liability is in respect of a
financial arrangement, the taxpayer must rely on the method statement to
determine whether there is a notional assessable amount or a notional
deductible amount. [Schedule 1, Part 3, subitem 99(10)]
340
Commencement, transitional and implementation issues
Pay as you go -- transitional and application
12.33 The result from the calculation above (which must take into
account all `pre-existing financial arrangements' to which the transitional
election applies) will be brought to account (as either assessable income
where there is a positive amount or an allowable deduction where there is
a negative amount) in equal instalments over the first income year to
which Division 230 applies to the taxpayer and the following three
income years. That is, one quarter of the balancing adjustment is brought
to account in each of these four years.
12.34 Where the taxpayer has calculated the amount of the balancing
adjustment that is to be included in their taxable income for an income
year, they must spread this amount evenly over the relevant income year
for instalment income purposes. That is, during each instalment quarter
they are taken to have made a gain or loss that is equal to one quarter of
the annual balancing adjustment amount -- that is, equal to one sixteenth
of the total balancing adjustment amount. [Schedule 1, Part 3, subitem 99(14)]
Impact of the transitional balancing adjustment on offshore banking units
12.35 In applying section 121EH of the ITAA 1936 (relating to
offshore banking units) the transitional balancing adjustment is to be
disregarded. [Schedule 1, Part 3, subitem 99(16)]
341
Chapter 13
Case studies
Outline of chapter
13.1 This chapter includes case studies which illustrate how
Division 230 will apply to:
· a deferred settlement;
· an interest rate swap;
· a financial arrangement where the retranslation method has
been elected; and
· financial arrangements over which the parties have agreed to
a forward swap.
Case study 1: A deferred settlement
Deferred settlement scenario
Go Co is a transport company with an aggregated turnover of over
$100 million. Go Co has not made any of the elections available under
Subdivision 230-C, 230-D, 230-E or 230-F.
Big Rig Co is a heavy vehicle retail company with an aggregated
turnover of over $100 million. Big Rig Co has not made any of the
elections available under Subdivision 230-C, 230-D, 230-E or 230-F.
On 1 May 2010, Go Co enters into an agreement with Big Rig Co to
purchase a refrigerated truck for its fleet, with the payment of $100,000
for the vehicle to occur on 30 June 2013. Under the arrangement,
Go Co will take delivery of the vehicle from Big Rig Co on
1 June 2010.
1. Application of Division 230 to Go Co
Does Go Co have a financial arrangement under the agreement to
purchase the truck?
Under the agreement to purchase the truck Go Co has a right to receive
a financial benefit (the truck) on 1 June 2010 and an obligation to
provide a financial benefit (the payment of $100,000) on 30 June 2013.
343
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
For the purpose of Division 230 the right and the obligation are one
arrangement (subsection 230-60(4)).
At the inception of the arrangement (1 May 2010), Go Co does not
have a financial arrangement as:
· although the $100,000 payment is a cash settlable financial
benefit (paragraph 230-50(2)(a)) and an obligation to provide
such a benefit can constitute a financial arrangement
(paragraph 230-50(1)(b)); and
· the right to receive the truck, which is under the same
arrangement, is:
- not a cash settlable financial benefit; and
- not insignificant in comparison with the obligation to
pay the $100,000 (subparagraphs 230-50(1)(d) to (f)).
However, from 1 June 2010, assuming the vehicle is delivered on time,
Go Co will have a financial arrangement as the only right or obligation
existing under the arrangement from that time is to a cash settlable
financial benefit, that is the obligation to provide $100,000 on
30 June 2013 (paragraph 230-50(1)(b) and section 230-50, note 1).
What are the gains and losses under the financial arrangement?
As Go Co has started to have a financial arrangement from 1 July 2010
in respect of the delayed consideration for acquiring the truck, for the
purposes of Division 230 Go Co is taken to have received financial
benefits equal to the market value of the financial arrangement at the
time when Go Co started to have the financial arrangement
(subsection 230-440(2)). These financial benefits which Go Co is
taken to have received are to be taken into account in calculating any
gain or loss from the financial arrangement. The practical application
of this rule will involve Go Co determining the present value (ie, the
value on 1 June 2010) of the obligation to pay $100,000 on
30 June 2013.
Assuming an interest rate of 10 per cent and daily compounding, the
value of Go Co's obligation to pay $100,000 on 30 June 2013 is
$74,546.58 at 1 June 2010. Under subsection 230-440(2), this amount
is the value of the financial benefit taken to be received by Go Co.
Taking into account the financial benefit of $74,546.58 which is taken
to be received and the financial benefit of $100,000 which is to be
provided under the financial arrangement, Go Co will have a loss of
$25,453.42 from the financial arrangement.
344
Case studies
As it is reasonable to expect that Go Co will provide a financial benefit
on 30 June 2013 (paragraph 230-120(2)(a)) and the amount of that
financial benefit is fixed at $100,000 (paragraph 230-120(2)(b)), there
is a sufficiently certain overall loss (subsection 230-110(1)) which is
required to be accrued (subsection 230-105(2)).
As the loss of $25,453.42 is required to be accrued, the loss will be
spread:
· over the period starting when Go Co starts to have the
financial arrangement, that is 1 June 2009, and ending when
Go Co will cease to have the arrangement assuming that it
will be held for the rest of its life, that is, until 30 June 2013
(subsection 230-130(1)); and
· using a compounding accruals method with compounding
intervals of not more than 12 months (subsections 230-135(2)
and (3)).
In spreading the loss Go Co uses compounding periods (or intervals) of
12 months. However, as the term of the financial arrangement is
37 months, Go Co uses a compounding period or interval of one month
for the period between 1 June 2010 and the 30 June 2010
(subsection 230-135(3)).
As each of the remaining compounding intervals fall wholly within one
income year the accrued loss from each interval is taken to have been
made in the income year in which the interval falls (section 230-140).
Table 13.1: Loss for each compounding interval
Year ending Amortised Accrued Cash flows Amortised
cost (year loss for tax cost
start) purposes (year end)
(a) (b) (c) (a) + (b) (c)
30 June 2010 $0.00 $586.26 $74,546.58 $75,132.85
30 June 2011 $75,132.85 $7,513.28 $0.00 $82,646.13
30 June 2012 $82,646.13 $8,264.61 $0.00 $90,910.75
30 June 2013 $90,910.75 $9,091.07 $100,000.00 $0.00
What is the cost of the truck?
In addition to the loss on the financial arrangement, and on the
assumption that Go Co uses the truck for the purpose of producing
assessable income, the company is also entitled to claim a deduction
for the decline in value on the truck acquired under the agreement.
345
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Although Go Co pays $100,000 under the purchase contract, the cost
of the truck for the purposes of calculating the deduction under
Division 40 of the ITAA 1997 is the market value of the financial
arrangement at the time the financial arrangement is first held
(subsection 230-440(1)). Therefore, the cost of the truck
is $74,546.58.
2. Application of Division 230 to Big Rig Co
Does Big Rig Co have a financial arrangement under the
agreement to purchase the truck?
Under the agreement to sell the truck, Big Rig Co has an obligation
to provide a financial benefit (the truck) and a right to receive a
financial benefit (the payment of $100,000). For the purpose of
Division 230, the right and the obligation are one arrangement
(subsection 230-60(4)).
At the inception of the arrangement (1 May 2010), Big Rig Co does
not have a financial arrangement as:
· although the $100,000 payment is a cash settlable financial
benefit (paragraph 230-50(2)(a)) and a right to receive such a
benefit can constitute a financial arrangement
(paragraph 230-50(1)(a)); and
· the obligation to provide the vehicle which is under the same
arrangement is:
- not a cash settlable financial benefit; and
- not insignificant in comparison with the right to receive
the $100,000 (subparagraphs 230-50(1)(d) to (f)).
However, from 1 June 2010 when the vehicle is delivered, Big Rig Co
will have a financial arrangement as the only right or obligation
existing under the arrangement from that time is to a cash settlable
financial benefit, that is the right to receive $100,000 on 30 June 2013
(paragraph 230-50(1)(a) and section 230-50, note 1).
What are the gains and losses under the financial arrangement?
As Big Rig Co has started to have a financial arrangement at
1 July 2010 in relation to the delayed consideration for providing the
vehicle, for the purposes of Division 230 Big Rig Co is taken to have
provided financial benefits equal to the market value of the financial
arrangement at the time when Big Rig Co started to have the financial
arrangement (1 July 2010) (subsection 230-440(2)). These financial
benefits which Big Rig Co is taken to have provided are to be taken
into account in calculating any gain or loss from the financial
346
Case studies
arrangement. The practical application of this rule will involve
Big Rig Co determining the present value (ie, the value on
1 June 2010) of the right to receive $100,000 on 30 June 2013.
Assuming an interest rate of 10 per cent, the value of Big Rig Co's
right to receive $100,000 on 30 June 2013 is $74,546.58 at
1 June 2010. Under subsection 230-440(2), this amount is the value of
the financial benefit taken to have been provided by Big Rig Co.
Taking into account the financial benefit of $74,546.58 which is taken
to be provided and the financial benefit of $100,000 which is to be
received under the financial arrangement, Big Rig Co will have a gain
of $25,453.42 from the financial arrangement.
As it is reasonable to expect that Big Rig Co will receive a financial
benefit on 30 June 2013 (paragraph 230-120(2)(a)) and the amount of
that financial benefit is fixed (at $100,000) (paragraph 230-120(2)(b)),
there is a sufficiently certain overall gain (subsection 230-110(1))
which is required to be accrued (subsection 230-105(2)).
As the gain of $25,453.42 is required to be accrued, the gain will be
spread:
· over the period starting when Big Rig Co starts to have the
arrangement, that is 1 June 2010, and ending when Big Rig Co
will cease to have the arrangement assuming that it will be held
until maturity, that is 30 June 2013 (subsection 230-130(1));
· using a compounding accruals method with compounding
intervals of not more than 12 months (subsections 230-135(2)
and (3)).
In spreading the gain Big Rig Co uses compounding periods (or
intervals) of 12 months. However, as the term of the financial
arrangement is 37 months, Big Rig Co uses a compounding period or
interval of one month for the period between 1 June 2010 and
30 June 2010 (subsection 230-135(3)).
As each of the remaining compounding intervals fall wholly within one
income year the accrued gain from each interval is taken to have been
made in the income year in which the interval falls (section 230-140).
What are the proceeds of the sale of the truck?
In addition to the gain on the financial arrangement, Big Rig Co has
also sold a truck. Although Big Rig Co is entitled to $100,000 under
the sale contract, the amount of the benefit that Big Rig Co is taken to
have obtained for the truck is the market value of the financial
arrangement at the time it started to have the financial arrangement
(subsection 230-440(1)).
347
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Accordingly, if the truck is trading stock in Big Rig Co's hands, the
amount for which it is treated as having sold trading stock is
$74,546.58.
Table 13.2: The gain for each compounding interval
Year ending Amortised Accrued Cash flows Amortised
cost (year gain for cost
start) tax (year end)
purposes
(a) (b) (c) (a) + (b) (c)
30 June 2010 $0.00 $586.26 $74,546.58 $75,132.85
30 June 2011 $75,132.85 $7,513.28 $0.00 $82,646.13
30 June 2012 $82,646.13 $8,264.61 $0.00 $90,910.75
30 June 2013 $90,910.75 $9,091.07 $100,000.00 $0.00
Case study 2: An interest rate swap
An interest rate swap scenario
On 1 July 2011 Spendid Co entered into an interest rate swap
agreement with Big Bank Co. Under the swap the notional principal is
$100 million. The term of the swap is three years. Both fixed rate
payments and floating rate payments are due on 30 June 2012,
30 June 2013, and 30 June 2014. Under the swap, Spendid Co makes
fixed rate payments and receives floating rate payments and
Big Bank Co makes floating rate payments and receives fixed rate
payments.
Fixed rate payments are determined by the fixed interest rate prevailing
at the commencement of the swap. Floating rate payments are
determined by the floating interest rate prevailing on the day
12 months prior to the payment date.
Floating rate payments are determined by the floating interest rate
prevailing:
· on 1 July 2011 for the payment due on 30 June 2012; and
· on the day 12 months prior to the payment date for the
remaining floating rate payments.
The agreement allows for payments and receipts, which are payable or
receivable on the same day, to be netted off.
348
Case studies
Table 13.3: Relevant interest rates during the term of the swap
Date Fixed rate per annum Floating rate per
annum
1 July 2011 5.75% 6.25%
30 June 2012 5.75% 5.74%
30 June 2013 5.75% 5.21%
Table 13.4: Spendid Co cash flows under the swap agreement
Date Spendid Co Spendid Co Net cash flow
pays fixed receives floating (Spendid Co)
30 June 2012 $5,750,000 $6,250,000 $500,000
30 June 2013 $5,750,000 $5,740,000 $10,000
30 June 2014 $5,750,000 $5,210,000 $540,000
Overall loss $50,000
Table 13.5: Big Bank Co cash flows under the swap agreement
Date Big Bank Co Big Bank Co Net cash flow
pays floating receives fixed (Big Bank Co)
30 June 2012 $6,250,000 $5,750,000 $500,000
30 June 2013 $5,740,000 $5,750,000 $10,000
30 June 2014 $5,210,000 $5,750,000 $540,000
Overall gain $50,000
Spendid Co has not made any of the elections under Division 230 and
has an annual turnover of more than $100 million. Big Bank Co has an
annual turnover of more than $1 billion and has made a fair value
election under Subdivision 230-C.
1. Application of Division 230 to Spendid Co
Does Spendid Co have one or more arrangements under the swap
agreement?
Under the swap agreement Spendid Co has a number of rights to
receive, and obligations to provide, financial benefits which are
represented by the cash flows under the arrangement. Whether these
rights and obligations are to be considered one arrangement, or
two or more arrangements, is a matter of fact and degree
(subsection 230-60(3)). In making such a determination, regard
must be had to the:
· nature of the rights and obligations;
349
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· terms and conditions of the rights and obligations;
· circumstances surrounding the creation or performance
(including the purpose of the relevant parties);
· rights and obligations and whether they must be dealt with
separately or together;
· normal commercial understandings and practices in relation to
the rights and obligations (including whether those rights and
obligations are viewed commercially as separate things or as a
group or as a whole); and
· objects of the Division.
Spendid Co has both contractual rights to receive annual payments --
calculated by a notional principal amount and a prevailing floating
interest rate -- and an obligation to provide annual payments --
calculated by multiplying a notional principal amount by a fixed
interest rate. Under the agreement, each year Spendid Co has a right
and an obligation in relation to the payments which arise at the same
time and are netted off, so that in a particular year Spendid Co will
either have to make a payment or will receive a payment (unless the
two payments netted off to nil).
This does not mean that under the agreement, the requirement to pay or
receive the net value of the fixed and floating interest payments is not
in itself a right or obligation that replaces the initial right to receive
floating payments and its obligation to pay floating payments.
However, it appears to be industry practice to consider that both
Spendid Co's right to receive the floating interest payment is satisfied
and the obligation to pay fixed interest payments is discharged by the
payment or receipt of that netted off amount (paragraph 230-60(4)(e)).
Such a practice can also be identified in the circumstances surrounding
the creation of the relevant rights and obligations and the proposed
manner in which those rights and obligations are to be exercised or
performed (paragraph 230-60(4)(c)).
Taking into account each of these factors, it is concluded that the rights
and obligations that arise in each annual period under the swap do not
represent separate arrangements but rather all the rights and obligations
should be viewed in combination as constituting one arrangement.
Is the swap agreement a `financial arrangement'?
Spendid Co will have a financial arrangement if, under the swap
agreement, there is a combination of one or more cash settlable rights
to receive and cash settlable obligations to provide financial benefits.
However, the swap agreement will not be a financial arrangement if
there are rights and obligations that are not cash settlable and those
350
Case studies
rights and obligations are not insignificant in comparison with the cash
settlable rights and obligations (paragraph 230-50(1)(c)).
A right to receive, or an obligation to provide, a financial benefit is
cash settlable if one of the requirements in subsection 230-50(2) is
satisfied. In the case of the swap agreement, all of the rights and
obligations are in relation to a benefit that is money or a money
equivalent (paragraph 230-50(2)(a)). There are no other rights and
obligations under the swap agreement, so there are no financial
benefits which are not cash settlable. Hence, the swap agreement
satisfies the definition of `financial arrangement' for the purposes of
Division 230.
How are the gains and losses calculated?
Spendid Co has not made a fair value election (Subdivision 230-C), a
hedging financial arrangements election (Subdivision 230-E) or a
financial reports election (Subdivision 230-F) and therefore
Subdivision 230-B will apply to calculate the gains and losses from the
swap arrangement (as the financial arrangement is not denominated in
a foreign currency, whether Spendid Co has made a retranslation
election under Subdivision 230-D is not relevant). Spendid Co
must determine under Subdivision 230-B if accruals or realisation
treatment will apply to the gains or losses it will make from the
financial arrangement (ie, the swap agreement). The accruals method
will apply where there is a sufficiently certain gain or loss
(subsections 230-105(2) and (3)). If the accruals method does not
apply, then the realisation method will apply (subsection 230-105(5)).
In determining whether there is in fact a sufficiently certain gain or
loss at a particular time under section 230-110, Spendid Co can only
take into account those financial benefits under the financial
arrangement which are sufficiently certain (section 230-120).
Section 230-120 tells Spendid Co whether or not a financial benefit
is sufficiently certain at a particular time. In applying the test in
section 230-120 at the time at which Spendid Co entered into the swap
arrangement, Spendid Co determines that it is sufficiently certain to
receive and provide all the financial benefits under the swap
arrangement (paragraphs 230-120(1)(a) and (b)) as:
· it is reasonably expected that all the financial benefits under the
swap will be received or provided, assuming the swap continues
to be held for the rest of its life (paragraph 230-120(2)(a)); and
· the amount or value of the benefits are, at the time that
Spendid Co is making the determination, fixed or determinable
with reasonable accuracy (paragraph 230-120(2)(b)). The
floating rate payments are determinable with reasonable
accuracy because of the assumption in subsection 230-120(4)
351
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
that the interest rate will continue to have the value that it has at
the time.
Spendid Co determines the amount or value of the financial benefits
and the overall gain at the time that Spendid Co begins to have the
financial arrangement (see Table 13.4). Spendid Co is required
to assume that it will hold the arrangement until maturity
(paragraph 230-110(2)(a)). Maturity in this case occurs at the
time the last payment is made at the end of Year 3.
Table 13.6: Spendid Co's estimated cash flows at 1 July 2011
Date Spendid Co Spendid Co Net cash flow
pays fixed receives floating (Spendid Co)
30 June 2012 $5,750,000 $6,250,000 $500,000
30 June 2013 $5,750,000 $6,250,000 $500,000
30 June 2014 $5,750,000 $6,250,000 $500,000
Overall gain $1,500,000
Spendid Co has a sufficiently certain overall gain of $1.5 million
(subsection 230-110(1)) and therefore should apply the accruals
method to the swap arrangement (subsection 230-105(2)).
Section 230-130 tells Spendid Co that it should spread the sufficiently
certain overall gain from the time at which Spendid Co starts to have
the arrangement to the time at which Spendid Co will cease to have
the arrangement. Spendid Co is required to assume that it will cease
to have the arrangement when the arrangement matures
(subsection 230-130(1)).
Section 230-135 tells Spendid Co to spread the gain or loss using
compounding accruals or a method which approximates compounding
accruals (subsection 230-135(2)). The swap payments are periodic in
nature and the notional principal does not change during the term of
the swap. Accordingly, Spendid Co uses a straight line method to
allocate the overall gain or loss, $1.5 million, across the three-year
term of the swap arrangement.
What is the gain or loss from the swap for the income year ending
30 June 2012?
In the first income year (ie, the year ended 30 June 2012) Spendid Co
brings to account $500,000.
What is the gain or loss from the swap for the income year ending
30 June 2013?
On 30 June 2012 the interest rate decreases to 5.74 per cent.
Spendid Co had estimated its overall gain based on an interest rate of
352
Case studies
6.25 per cent. Because the interest rate changes and because of
subsection 230-120(3), Spendid Co re-estimates the amounts or values
of the financial benefits which rely on the floating interest rate
(section 230-160). On 1 June 2012 Spendid Co's re-estimated
financial benefits are as follows.
Table 13.7: Re-estimated financial benefits on 25 June 2013
Date Spendid Co Spendid Co Net cash flow
pays fixed receives floating (Spendid Co)
30 June 2012 $5,750,000 $6,250,000 $500,000
30 June 2013 $5,750,000 $5,740,000 $10,000
30 June 2014 $5,750,000 $5,740,000 $10,000
Overall gain or $480,000
loss
For the remaining term of the swap (ie, from 1 July 2012 to
30 June 2014) Splendid Co has a re-estimated loss of $20,000. As
explained above, Splendid Co spreads the gains and losses from the
swap on a straight line basis. The $20,000 is spread on that basis over
the remaining two years of the swap.
For the income year ending 30 June 2013, Spendid Co brings to
account a loss of $10,000.
What is the gain or loss from the swap for the income year ending
30 June 2014?
On the 30 June 2013 the floating interest rate is 5.21 per cent
per annum. Based on this, Spendid Co again re-estimates the
remaining financial benefits as follows.
Table 13.8: Re-estimated financial benefits on 30 June 2014
Date Spendid Co pays Spendid Co Net cash flow
fixed receives floating (Spendid Co)
30 June 2012 $5,750,000 $6,250,000 $500,000
30 June 2013 $5,750,000 $5,740,000 $10,000
30 June 2014 $5,750,000 $5,210,000 $540,000
Overall gain or $50,000
loss
For the remaining term of the swap (ie, from 1 July 2013 to
30 June 2014) Splendid Co has a re-estimated loss of $540,000. As
explained above Splendid Co spreads the gains and losses from the
swap on a straight line basis. The $540,000 loss is spread on that basis
over the remaining one year of the swap.
353
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
In the income year ending 30 June 2014, Spendid Co brings to account
a loss of $540,000.
The overall gain or loss brought to account by Splendid Co
The overall gain or loss that Spendid Co has brought to account is a
loss of $50,000 over the three-year term of the arrangement.
Table 13.9: The overall gain or loss brought to account by Splendid Co
Year ending Gain or loss
30 June 2012 $500,000
30 June 2013 $10,000
30 June 2014 $540,000
2. Application of Division 230 to Big Bank Co
Does Big Bank Co have one or more arrangements under the swap
agreement?
As discussed above in relation to Spendid Co, whether the rights and
obligations under the interest rate swap are to be considered to be one
arrangement or two or more arrangements is a matter of fact and
degree (subsection 230-60(4)). The same facts that were considered in
making such a determination in relation to Spendid Co will also be
considered in relation to Big Bank Co.
Big Bank Co has both contractual rights to receive annual payments --
calculated by notional principal amount and a fixed interest rate -- and
an obligation to provide annual payments -- calculated by multiplying
a notional principal amount by a prevailing floating interest rate.
Under the agreement, each year Big Bank Co has a right and an
obligation in relation to the payments that arise at the same time and
are netted off, so that in a particular year Big Bank Co will either have
to make a payment or will receive a payment.
It is concluded that the rights and obligations of Big Bank Co that arise
in each annual period under the swap do not represent separate
arrangements but rather all the rights and obligations should be viewed
in combination as constituting one arrangement.
Is the swap agreement a `financial arrangement'?
Big Bank Co will have a financial arrangement if, under the swap
agreement, there is a combination of one or more cash settlable rights
to receive and cash settlable obligations to provide financial benefits.
However, the swap agreement will not be a financial arrangement if
there are rights and obligations that are not cash settlable and those
354
Case studies
rights and obligations are not insignificant in comparison with the cash
settlable rights and obligations (paragraph 230-50(1)(c)).
A right to receive, or an obligation to provide, a financial benefit is
cash settlable if one of the requirements in subsection 230-50(2) is
satisfied. In the case of the swap agreement, all of the rights and
obligations are in relation to a benefit that is money or a money
equivalent (paragraph 230-50(2)(a)). There are no other rights and
obligations under the swap agreement, so there are no rights or
obligations which are not cash settlable. Hence, the swap agreement
satisfies the definition of `financial arrangement' for the purposes of
Division 230.
How are the gains and losses calculated?
Big Bank Co has made a fair value election (Subdivision 230-C);
therefore the fair value method will apply to calculate Big Bank Co's
gains and losses from the swap arrangement. Under the fair value
method Big Bank Co will include in its assessable income the change
in the present value of the swap between the start of a tax year and the
end of that tax year and any net cash flows made under the swap (net
cash flows made under the swap do not represent excluded gains, such
as financial benefits which are gains in the form of a distribution by a
corporate tax entity (subsection 230-160(2)).
Big Bank Co will need to calculate the present value of Big Bank Co's
remaining net cash flows under the swap at the end of each year. The
present value of Big Bank Co's cash flows as at 1 July 2011 is nil
because there are no remaining cash flows.
What is the gain or loss from the swap for the income years ending
30 June 2012, 2013 and 2014?
Table 13.10: Present value of remaining cash flows at 30 June 2012
Year ending Opening Closing Net cash Gain or loss
value value flows
30 June 2012 $0 $18,400 $500,000 $481,599
30 June 2013 $18,400 $153,259 $10,000 $504,858
30 June 2014 $153,259 $0 $540,000 $26,741
Overall gain $50,000
or loss
The overall gain that Big Bank Co makes from the swap agreement is
$50,000. Note that this corresponds to the overall loss of $50,000 that
Spendid Co makes from the agreement. However, the year-by-year
gains and losses of Big Bank Co and Spendid Co do not correspond
because of the different tax-timing methods that they adopt.
355
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Table 13.11: Calculation of closing value of swap as at 30 June 2012
Date Net cash Discount Present value of
flow factor3 net cash flows
30 June 2013 $10,000.00 0.9457164 $9,457.16
5 6
30 June 2014 $10,000.00 0.894379 $8,943.79
Total of present value $18,400.95
of the remaining net
cash flows
Table 13.12: Calculation of closing value of swap as at 30 June 2012
Date Net cash Discount Present value of
flow factor net cash flows
30 June 2014 $540,000.00 0.9504807 $513,259.20
Total of present value $513,259.20
of the remaining net
cash flows
Case study 3: Balancing adjustment for the qualifying foreign
exchange account
Qualifying foreign exchange account scenario
Kwala Co is a toy company, with an annual turnover of over
$100 million. Kwala Co is subject to Division 230 on a mandatory
basis from 1 July 2009 and chooses not to make a transitional election
to bring existing financial arrangements which it holds within the
operation of Division 230.
Kwala Co has an account denominated in US dollars (US$) which it
elects to retranslate under the qualifying foreign exchange accounts
election (subsection 230-220(5)). Kwala Co does not elect to make the
general retranslation election. If it had, Kwala Co would not have been
3
For the purposes of simplicity the discount factor has been calculated using the floating rates
used to calculate the floating leg cash flows.
4
1 ÷ (1 + 0.0574)
5
This is an estimated cash flow calculated assuming the interest rate prevailing at 30 June 2012
will be the rate prevailing at 30 June 2013.
6
1 ÷ (1 + 0.0574)2, where 0.0574 is the interest rate prevailing at 30 June 2012
(see Table 13.3).
7
1 ÷ (1 + 0.0521), where 0.0521 is the interest rate prevailing at 30 June 2013 (see
Table 13.3).
356
Case studies
able to make a separate qualifying foreign exchange accounts election
because the relevant qualifying foreign exchange account is a foreign
currency denominated financial arrangement and would have been
subject to the operation of the general election. The qualifying foreign
exchange accounts election applies from 1 July 2009, the beginning of
the income year in which the election is made. The account was
opened on 7 July 2008.
In order for the qualifying foreign exchange accounts election to apply,
Kwala Co must apply a balancing adjustment calculation under
Subdivision 230-G to capture the foreign exchange gain or loss not
already brought to account under another method available in the
ITAA 1936 or the ITAA 1997 for bringing to account foreign
exchange gains and losses. Prior to making the qualifying foreign
exchange accounts election, Kwala Co was bringing foreign exchange
gains and losses to account under Division 775 of the ITAA 1997.
Kwala Co was using the weighted average rate to determine the foreign
currency gain or loss.
Table 13.13: Qualifying foreign exchange account in US$
Date Transaction Debit Credit Balance
7 July 2008 Open account 0.00
7 July 2008 Deposit 380.00 380.00 CR
20 July 2008 Deposit 250.00 630.00 CR
30 August 2008 Interest 9.45 639.45 CR
7 September 2008 Withdrawal 75.00 564.45 CR
15 October 2008 Withdrawal 50.00 514.45 CR
2 December 2008 Deposit 234.00 748.45 CR
14 January 2009 Deposit 1,693.40 2,441.85 CR
30 June 2009 Interest 36.63 2,478.48 CR
30 June 2009 Closing balance 2,478.48 CR
11 July 2009 Deposit 360.00 2,838.48 CR
12 August 2009 Withdrawal 240.00 2,598.48 CR
30 October 2009 Deposit 38.98 2,637.46 CR
15 March 2010 Deposit 456.00 3,093.46 CR
30 June 2010 Interest 46.40 3,139.86 CR
357
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Table 13.14: US$/A$ exchange rates
Date Exchange rate
7 July 2008 0.755
7 July 2008 0.760
20 July 2008 0.706
30 August 2008 0.740
7 September 2008 0.752
15 October 2008 0.760
2 December 2008 0.789
14 January 2009 0.770
30 June 2009 0.740
30 June 2009 0.740
11 July 2009 0.720
12 August 2009 0.751
30 October 2009 0.770
15 March 2010 0.766
30 June 2010 0.780
Table 13.15: Division 775 weighted average
Date Weighted Debit Credit Balance Foreign
average exchange
A$ A$ A$
gain or loss
7 July 2008 0.00
7 July 2008 0.760 500.00 500.00 CR
20 July 2008 0.737611940 338.93 854.11 CR
30 August 2008 0.737647120 12.81 866.88 CR
7 September 2008 0.737647120 101.67 765.20 CR 1.94
15 October 2008 0.737647120 67.78 697.42 CR 1.99
2 December 2008 0.752969212 310.77 994.00 CR
14 January 2009 0.764698587 2,214.47 3,193.22 CR
30 June 2009 0.764321564 47.92 3,242.72 CR
30 June 2009 3,349.30 CR
11 July 2009 0.758400526 474.68 3,742.72 CR
12 August 2009 0.758400526 316.46 3,426.26 CR 3.12
30 October 2009 0.758569414 51.39 3,476.89 CR
15 March 2010 0.759655668 600.27 4,072.19 CR
30 June 2010 0.759948582 61.06 4,131.67 CR
358
Case studies
Table 13.16: Division 775 foreign exchange gain or loss for the 2008-09 tax
year
Year end summary 2008-09 tax year as at 30 June 2009
Foreign exchange (a) $3,424.90
Total debits (b) $169.46
Cash flow total (c) = (a) (b) $3,255.45
Closing balance (d) $3,349.30
Total foreign exchange gain or loss
Closing balance cash flow total (e) = (d) (c) $93.85
Foreign exchange loss (f) $1.94
Foreign exchange loss (g) $1.99
Foreign currency gain for 2008-09 income year $89.92
(e) (f) (g)
Using the weighted average method available under the Division 775
income tax regulations, Kwala Co brings to account a foreign currency
gain of $89.92 for the 2008-09 income year.
Table 13.17: Subdivision 775-E foreign exchange gain or loss (retranslation
election)
Closing balance $3,349.30
Less opening balance 0
Less deposits $3,412.18
Add withdrawals $165.52
Foreign exchange gain $102.64
The foreign currency gain or loss which would have been brought to
account using a retranslation method would have been $102.64.
Table 13.18: Balancing adjustment required on qualifying foreign exchange
election commencement
Division 775 foreign exchange gain/loss $3.93
Division 230 foreign exchange gain/loss $102.64
(retranslation balancing adjustment)
Balancing adjustment $106.57
The additional foreign currency gain required to be brought to account
under the balancing adjustment provisions in Subdivision 230-G
(section 230-395) is therefore $106.57.
359
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Case study 4: Forward contract to swap bonds
Forward contract scenario
PV Enterprises is an Australian resident company with an annual
aggregated turnover in excess of $100 million. It has not made any
elections under Division 230. It currently holds a number of bonds
which, due to its business practices, it typically accrues gains and
losses over intervals equal to its income years.
For both taxation and accounting purposes, the functional currency for
PV Enterprises is Australian dollars.
PV Enterprises enters into the following transactions.
Acquisition of an Aussie bond
On 1 July 2008 PV Enterprises acquires a zero coupon bond with a
face value of $1,600 on the secondary market for $1,000 (the Aussie
bond). At the time of acquisition, the Aussie bond has five years
remaining of its term (ie, it is due to mature on 30 June 2013).
Forward contract to swap the Aussie bond for a US bond
On 1 July 2009 PV Enterprises enters into a forward contract under
which it agrees to exchange its Aussie bond on 1 July 2012 for a bond
with a face value of US$1,300 due to mature on 30 June 2014
(the US bond).
At the time of entering into this contract, prevailing market rates have
fallen somewhat so the value of the Aussie bond is $1,164.
A US bond carrying a right to receive US$1,300 on 30 June 2014 has a
market value at 1 July 2009 of US$850. Also at this time, the
prevailing US$/A$ exchange rate is 0.73, so that in Australian dollar
terms the US bond has a market value of $1,164.
Settlement of the forward contract
On 1 July 2012 PV Enterprises disposes of its Aussie bond under the
forward contract in exchange for receiving the US bond.
At this time its Aussie bond is worth A$1,500.
The US bond at this time is worth US$1,100. The US$/A$ exchange
rate prevailing at this time is 0.80. Accordingly, at this time the
US bond has a market value of A$1,375.
360
Case studies
Redemption of the US bond
On 30 June 2013 PV Enterprises is still holding the US bond. The
prevailing US$/A$ exchange rate at this time is 0.625.
On 30 June 2014 PV Enterprises redeems the US bond for its face
value of US$1,300. At this time the US$/A$ exchange rate has fallen
to 0.75, so PV Enterprises is taken to have received A$2,080 on
redemption of the US bond.
Economic summary
Under the entirety of this arrangement, PV Enterprises has paid out
$1,000 for the Aussie bond and is taken to have received A$2,080
under the US bond, making an overall economic gain of A$1,080.
PV Enterprises' Aussie bond
Financial arrangement
The Aussie bond held by PV Enterprises is a financial arrangement
consisting of a cash settlable right to receive a financial benefit (the
A$1,600 on redemption) (section 230-50). Moreover, as the amount
PV Enterprises paid for the bond (A$1,000) is integral to calculating
any gain or loss on the financial arrangement, it is taken to be an
amount PV Enterprises provided under its Aussie bond financial
arrangement (subsection 230-65(1)).
Application of accruals methodology
As outlined above, the only financial benefits under the
arrangement are PV Enterprises' $1,000 payment for the
Aussie bond (taken to be provided under the arrangement pursuant
to section 230-65), and the $1,600 it has a right to receive on
maturity. The $1,000 acquisition cost, having already been provided
by PV Enterprises, and the right to receive $1,600 on maturity,
being reasonably expected and for a fixed amount, are both
sufficiently certain (subsections 230-120(2) and (9)). Therefore,
PV Enterprises has, from the time it acquires the Aussie bond, a
sufficiently certain overall gain from the financial arrangement of $600
(subsection 230-110(1) and paragraph 230-110(2)(a)). This $600
overall gain is subject to the accruals method in Subdivision 230-B
(subsection 230-105(2)).
Under the accruals method, PV Enterprises will spread the $600 over
the entire five-year remaining term of the bond using a compounding
accruals method, or a method whose results reasonably approximate
this method (subsection 230-130(1) and section 230-135).
Because of the circumstances of its business and how it treats its other
bonds for tax purposes, PV Enterprises will accrue any gains and
361
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
losses it makes on its Aussie bond over 12-month intervals ending on
30 June each year (subsections 230-85(3) and 230-135(3)).
The gain or loss from PV Enterprises' Aussie bond under a
compounding accruals method can therefore be calculated as follows
(this calculation reveals a 9.86 per cent effective interest rate for the
Aussie bond).
Table 13.19: Gain for each compounding interval
Year ending Amortised Accrued gain Cash Amortised
cost (year for tax purposes flows cost (year
start) end)
(a) (b) (c) (a) + (b) (c)
30 June 2009 $0.00 $98.56 $1,000 $1,098.56
30 June 2010 $1,098.56 $108.27 $1,206.83
30 June 2011 $1,206.83 $118.95 $1,325.78
30 June 2012 $1,325.78 $130.67 $1,456.45
30 June 2013 $1,456.45 $143.55 $1,600 $0.00
The accrual amounts will be assessable to PV Enterprises under
section 230-15 in the year they are accrued (sections 230-15 and
230-140).
Year ended 30 June 2009
Based on the accrual calculation in Table 13.19, on 30 June 2009,
PV Enterprises will accrue a $98.56 gain in respect of the Aussie bond.
Year ended 30 June 2010
At the start of the year ending 30 June 2010 PV Enterprises
entered into the forward contract to dispose of the Aussie bond
(on 1 July 2009).
At this time, PV Enterprises now knows it will only hold the
Aussie bond until 1 July 2012. However, it will continue to accrue the
overall gain it has calculated on the Aussie bond (as set out in
Table 13.19) as if it will continue to hold the Aussie bond for the rest
of its life, that is, until 30 June 2013 (subsection 230-135(4)).
At the time of entering into the forward contract, PV Enterprises'
outstanding rights and obligations under the Aussie bond are still the
same. That is, entering into the forward contract has not changed the
terms and conditions of the Aussie bond.
Further, the fact that PV Enterprises has entered into the forward
contract does not of itself necessarily cause a material change to the
362
Case studies
circumstances affecting the Aussie bond at the time the forward
contract is entered into. Although subsection 230-155(2) does not
limit the scope of what is considered to be a material change in these
circumstances, it provides further context as to the types of changes
that would be considered to be material. Entering into the forward
contract does not, for example, (taking into account the requirement
under paragraph 230-120(2)(a) for PV Enterprises to assume it will
hold the Aussie bond for the rest of its life) cause a contingency to
arise in respect of the financial benefits under the Aussie bond, such
that would cause those financial benefits to cease to be sufficiently
certain.
Because of this, it is also relevant to note that even if entering into the
forward contract was to be considered to materially alter the
circumstances affecting the Aussie bond, and materially affect the
amount and timing of the financial benefits PV Enterprises will receive
under the Aussie bond (thus triggering a reassessment under
section 230-155 and, assuming the Aussie bond is still subject to
accruals, a re-estimation of the gain or loss to be accrued under
section 230-160), there will be no difference in outcome. As
mentioned above, the rights and obligations under the Aussie bond
have not changed. In determining whether the financial benefits under
such rights and obligations are sufficiently certain to be received or
provided, PV Enterprises must continue to assume that it will have
the Aussie bond for the rest of its life, that is, until 30 June 2013
(paragraph 230-120(2)(a)). This means that following entry into the
forward contract, PV Enterprises is still sufficiently certain to
receive A$1,600 on 30 June 2013. The same gain or loss, even
following a re-estimation, would continue to have to be accrued
(subsection 230-160(4)).
This means that based on the accrual calculation in Table 13.19, on
30 June 2010, PV Enterprises will still accrue a $108.27 gain in respect
of the Aussie bond.
Year ended 30 June 2011
Based on the accrual calculation in Table 13.19, on 30 June 2011,
PV Enterprises will accrue a $118.95 gain in respect of the
Aussie bond.
Year ended 30 June 2012
Based on the accrual calculation in Table 13.19, on 30 June 2012,
PV Enterprises will accrue a $130.67 gain in respect of the
Aussie bond.
363
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Year ended 30 June 2013
The balancing adjustment on disposal of the Aussie bond
Upon settlement of the forward contract on 1 July 2012,
PV Enterprises transfers the Aussie bond to the counterparty in
exchange for receiving the US bond. As a result of this transfer, the
balancing adjustment in Subdivision 230-G applies
(paragraph 230-385(1)(a)).
The method statement in section 230-395 results in the following
balancing adjustment (under the relevant steps):
· Step 1 (a) (amounts received): as PV Enterprises ceased to have
(disposed of) the Aussie bond as consideration for starting to
have (acquiring) the US bond:
- subsection 230-440(1) provides that PV Enterprises is
taken to have received the market value of the US bond
(A$1,375), determined at the time PV Enterprises
started to have it (acquired it), as consideration for
ceasing to have (providing) the Aussie bond
(subsection 230-440(1));
- subsection 230-440(5) instead provides that
PV Enterprises is taken to have received the market
value of the Aussie bond, determined at the time it
ceased to have it (A$1,500), as consideration for
ceasing to have the Aussie bond
(subsection 230-440(5)); and
- as two different amounts are taken to have been
received by PV Enterprises for ceasing to have its
Aussie bond, subsection 230-440(6) provides that
subsection 230-440(5) applies to the exclusion of the
other subsections (subsection 230-440(6)).
Accordingly, PV Enterprises is taken to have received A$1,500
upon disposing of its Aussie bond under the forward contract
(section 230-440).
364
Case studies
Less the sum of:
· Step 2 (a) (amounts paid): PV Enterprises is taken to have
provided the $1,000 cost of the Aussie bond under the
Aussie bond (subsection 230-65(1));
and
· Step 2 (b) (amounts previously taken into account): the amounts
previously accrued and included in PV Enterprises' assessable
income in respect of the reacquired Aussie bond total $456.45
($98.56 + $108.27 + $118.95 + $130.67)
(subsection 230-395(1), sections 230-15 and 230-140),
which results in a balancing adjustment of a $43.55 gain being made
from the Aussie bond (paid $1,456.45 and received $1,500).
Total gains and losses made by PV Enterprises from the
Aussie bond
Under the Aussie bond, the following amounts will be assessable under
Division 230:
· $456.45 accrued over the years ended 30 June 2009 to
30 June 2012 ($98.56 + $108.27 + $118.95 + $130.67)
(accrual amount); and
· $43.55 gain assessable in the year ended 30 June 2013 (gain on
actual disposal).
This amounts to a total gain on the Aussie bond of exactly $500.
PV Enterprises' forward contract
Financial arrangement
The forward contract is a financial arrangement in the hands of
PV Enterprises consisting of a cash settlable right to receive the
US bond (being a right to receive a `money equivalent' as defined),
and a cash settlable obligation to provide the Aussie bond (being an
obligation to provide a `money equivalent' as defined) (section 230-50,
definition of `money equivalent' in subsection 995-1(1) of the
ITAA 1997).
Application of accruals methodology
The US bond that PV Enterprises has a right to receive under the
forward contract arrangement is not a financial benefit that it is
sufficiently certain to receive for the purpose of applying the accruals
methodology. This is because, whilst PV Enterprises may reasonably
365
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
expect to receive the US bond under the forward contract, the amount
or value of the US bond is not fixed or determinable with reasonable
accuracy (paragraph 230-120(2)(b)).
The reason for this is because the financial benefits to be provided and
received under the forward contract are not all denominated in the
same currency -- the value of the US bond must be translated into
Australian dollars using the rules in section 960-50 of the ITAA 1997
(subsection 230-120(8) and paragraph (aa) of the definition of `special
accrual amount' in subsection 995-1(1) of the ITAA 1997). The value
of the US bond in Australian dollar terms, determined at the time it is
to be translated, cannot be known until such time as it is received. As
such, it is not sufficiently certain that PV Enterprises will make either
an overall or a particular gain or loss under the forward contract, so it
does not have a sufficiently certain gain or loss under its forward
contract that can be subject to the accruals methodology
(sections 230-105, 230-110, 230-115 and 230-120).
Balancing adjustment on settlement
In the year a financial arrangement ceases to be held, a gain or loss
made in that year can only be determined under Subdivision 230-G
(subsection 230-45(1)). On settlement of the forward contract,
a balancing adjustment will therefore be made
(paragraph 230-385(1)(b)).
The method statement in section 230-395 results in the following
balancing adjustment (under the relevant steps):
· Step 1 (a) (amounts received): PV Enterprises received the
US bond, worth A$1,375, under its financial arrangement
comprising its cash settlable rights and obligations under the
forward contract.
Note: Even though PV Enterprises could be said to have ceased
to have its right to receive the US bond as consideration for
ceasing to have its obligation to provide the Aussie bond under
the financial arrangement, the effect of section 230-440 would
not alter the amount taken to have been received under the
arrangement. This is because subsection 230-440(5) would
apply to substitute this value of the US bond received (upon
ceasing to have the right to receive this bond -- A$1,375) with
the market value of the right to receive the US bond at the time
this right ceased, which would also be A$1,375
(section 230-440).
Less
· Step 2 (a) (amounts paid): PV Enterprises paid the Aussie bond,
worth A$1,500 under its forward contract financial arrangement.
366
Case studies
Note: Similarly to above, even though PV Enterprises could be
said to have ceased to have its obligation to provide the
Aussie bond as consideration for ceasing to have its right to
receive the US bond under the financial arrangement, the effect
of section 230-440 would not alter the amount taken to have
been provided under the arrangement. This is because
subsection 230-440(5) would apply to substitute the value of this
Aussie bond provided (upon ceasing to have the obligation to
provide this bond -- A$1,500) with the market value of the
obligation to provide the Aussie bond at the time this obligation
ceased, which would also be A$1,500 (section 230-440).
The method statement results in a balancing adjustment of a $125 loss
being made by PV Enterprises from the forward contract (paid $1,500
and received $1,375).
This loss will be deductible to PV Enterprises in the income year ended
30 June 2013.
PV Enterprises' US bond
Financial arrangement
The US bond is a financial arrangement consisting of a cash settlable
right to receive a financial benefit (the US$1,300 on redemption)
(section 230-50).
In addition, the amount PV Enterprises paid for the US bond is integral
to calculating the gain or loss on the financial arrangement, and thus is
taken to be an amount PV Enterprises provided under the arrangement
(subsection 230-65(1)).
PV Enterprises paid the Aussie bond (worth A$1,500 at the time it was
provided under the forward contract) as consideration for starting to
have the US bond. However, because PV Enterprises ceased to have
the Aussie bond as consideration for starting to have the US bond:
· subsection 230-440(4) provides that PV Enterprises is taken to
have provided the market value of the Aussie bond (A$1,500),
determined at the time PV Enterprises ceased to have it
(disposed of it), as consideration for starting to have (receive)
the US bond (subsection 230-440(4));
· subsection 230-440(2) instead provides that PV Enterprises is
taken to have provided the market value of the US bond,
determined at the time it started to have it (US$1,100, worth
A$1,375), as consideration for starting to have the US bond
(subsection 230-440(2)); and
367
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· as two different amounts are taken to have been received by
PV Enterprises for ceasing to have its Aussie bond,
subsection 230-440(3) provides that subsection 230-440(2)
applies to the exclusion of the other subsections
(subsection 230-440(3)).
Accordingly, PV Enterprises will be taken to have paid US$1,100
(or A$1,375) under its financial arrangement constituted by its right to
receive US$1,300 under the US bond.
Application of the accruals methodology
PV Enterprises' financial benefits under its US bond financial
arrangement are known. As they are all in a particular foreign
currency (US$), they are not to be translated into Australian currency
before the relevant gain or loss is determined for the purpose of
applying the accruals methodology (subsection 230-120(8) and
paragraph (aa) of the definition of `special accrual amount' in
subsection 995-1(1) of the ITAA 1997).
As outlined above, the only financial benefits under the US bond
arrangement are the US$1,100 PV Enterprises' is taken to have paid
to start to have the US bond on 1 July 2012 (subsection 230-65(1)
and section 230-440), and the US$1,300 it has a right to receive
on maturity. The acquisition cost, having been provided by
PV Enterprises, and the right to receive payment on maturity,
being reasonably expected and for a fixed amount (in the relevant
particular foreign currency), are both sufficiently certain
(subsections 230-120(2), (8) and (9)). Therefore, PV Enterprises has,
from the time it acquires the US bond, a sufficiently certain overall
gain from the financial arrangement of US$200 (subsection 230-110(1)
and paragraph 230-110(2)(a)). This US$200 overall gain is subject to
the accruals method in Subdivision 230-B (subsection 230-105(2)).
Under the accruals method, PV Enterprises will spread the US$200
over the two year remaining term of the US bond using a compounding
accruals method, or a method whose results reasonably approximate
this method (subsection 230-130(1) and section 230-135).
Because of the circumstances of its business and how it treats its other
bonds for tax purposes, PV Enterprises will accrue any gains and
losses it makes on its US bond over 12 month intervals ending on
30 June each year (subsections 230-85(3) and 230-135(3)).
The gain or loss from PV Enterprises' US bond under a compounding
accruals method can therefore be calculated as follows (this calculation
reveals a 8.71 per cent annually compounded effective interest rate for
the US bond).
368
Case studies
Table 13.20: Gain for each compounding interval
Year ending Amortised cost Accrued Cash flows Amortised
(year start) gain for tax cost (year
purposes end)
(a) (b) (c) (a) + (b) (c)
30 June 2013 $0 $95.83 $1,100.00 $1,195.83
30 June 2014 $1,195.83 $104.17 $1,300.00 $0
The accrual amounts will be assessable to PV Enterprises under
section 230-15 in the year they are accrued, and translated into
Australian dollars at that time (sections 230-15 and 230-140 and
paragraph (aa) of the definition of `special accrual amount' in
subsection 995-1(1) of the ITAA 1997).
Year ended 30 June 2013
Based on the accrual calculation in Table 13.20, on 30 June 2013,
PV Enterprises will accrue a US$95.83 gain in respect of the
Aussie bond. Based on prevailing exchange rates, the gain that is
included in PV Enterprises' assessable income under section 230-15,
will be A$153.33.
Year ending 30 June 2014
Balancing adjustment
On maturity of the US bond, PV Enterprises will be paid US$1,300
and all of its rights and obligations under this arrangement will cease.
This will trigger a balancing adjustment under Subdivision 230-G
(paragraph 230-385(1)(b)). The method statement in section 230-395
results in the following balancing adjustment (under the relevant
steps):
· Step 1 (a) (amounts received): PV Enterprises will receive
US$1,300 under the bond, which translates under the translation
rules in section 960-50 (and as set out in the facts) to A$2,080;
less the sum of
· Step 2 (a) (amounts paid): as set out in the analysis for the
financial arrangement that is the US bond, PV Enterprises is
taken to have paid A$1,375 to acquire the US bond
(subsection 230-65(1) and section 230-440);
and
· Step 2 (b) (amounts previously taken into account):
the A$153.33 previously accrued and included in
PV Enterprises' assessable income (subsection 230-395(1),
369
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
sections 230-15 and 230-140 and the definition of `special
accrual amount' in paragraph (aa) of the definition of `special
accrual amount' in subsection 995-1(1) of the ITAA 1997),
which results in a balancing adjustment of a $551.67 gain being made
from the US bond (paid $1,375, assessed on $153.33 and
received $2,080).
Total amount brought to tax from the US bond
The total amount brought to tax from the US bond is a $705 gain
($153.33 accrual amount and $551.67 gain on maturity).
Summary of gains and losses for PV Enterprises under its
arrangement to swap bonds
Under the entirety of this arrangement, PV Enterprises has made the
following gains and losses under Division 230:
· a $500 gain made from the Aussie bond ($456.45 accrued over
the years ended 30 June 2009 to 30 June 2012, and a $43.55
gain on disposal, assessable in the year ended 30 June 2013);
· a $125 loss made from the forward contract (deductible in the
year ended 30 June 2013); and
· a $705 gain made from the US bond ($153.33 accrual gain at
30 June 2013 and $551.67 gain on maturity in the year ended
30 June 2014).
This amounts to a total overall gain on the entirety of the arrangements
of $1,080. This equals the overall economic gain PV Enterprises made
on the entirety of these arrangements.
370
Chapter 14
Regulation impact statement
Background
14.1 In August 1998, the Government announced the Review of
Business Taxation (the Ralph Review) as part of the broader New Tax
System. The major objective of the Ralph Review was to design a
taxation system that would best contribute to economic growth. The
backdrop for the review featured issues including the impact of
globalisation on the Australian economy, the increasing sophistication of
financial dealings, and the ability of the Australian Government to raise
revenue in the face of the future impact of an aging population and
increasing costs of health care.
· Review chairman John Ralph AO noted: `Meeting the
demands upon it [the tax system] in the decades immediately
ahead poses significant challenges for the Australian
Government and the Australian community. Increased
globalisation will translate into an increasingly competitive
environment for Australian business. The impact of the
telecommunications revolution and associated technologies,
in diminishing the significance of national boundaries, will
make more businesses feel the chill wind of stiff competition.
We may remain an island geographically but we will not be
able to hide from the forces generated by globalisation.'
14.2 Among the recommendations arising from the Ralph Review
was a series of reforms to the taxation of financial arrangements. The
final stages of these reforms, Taxation of Financial Arrangements (TOFA)
Stages 3 and 4, broadly give effect to the recommendations contained in
Chapter 9 of A Tax System Redesigned (the Ralph Report). The
recommendations seek to address the tax issues associated with the
increasing sophistication of financial markets and transactions.
· The Treasurer announced the Government's broad support
for the recommendations in the Ralph Report on
11 November 1999 (Press Release No. 074 of 1999).
371
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
14.3 TOFA Stages 3 and 4 will implement the final stages of reforms
to the taxation of financial arrangements. Stages 1 and 2 of TOFA have
already been implemented:
· Stage 1 of TOFA (debt/equity reforms) was legislated in
2001 as Division 974 of the Income Tax Assessment Act 1997
(ITAA 1997).
· Stage 2 (foreign currency reforms) was legislated in 2003 as
Division 775 of the ITAA 1997.
14.4 Stages 3 and 4 of the TOFA reforms will be introduced into
Parliament as Division 230 of the ITAA 1997. These stages of the TOFA
reforms cover tax-timing treatments of financial arrangements.
Policy objective
14.5 The objectives of the proposed legislation are to increase clarity
of the tax treatment of financial arrangements, to reduce uncertainties and
anomalies in the current law, to reduce tax-induced distortions to
investment and financing, to facilitate efficient risk management, and to
reduce compliance and administration costs.
14.6 The context of these objectives is that the current taxation of
financial arrangements is largely based on standard income tax concepts
that give significant weight to legal form rather than economic substance.
Two aspects are particularly important. First, the current law often
focuses on particular cash flows, makes a distinction on a legal basis
between capital and revenue, and largely taxes financial arrangements on
a realisation basis. This often leads to effective tax rates in present value
terms differing across economically similar transactions. This is
particularly important in the financial sector where the timing of cash
flows is a key driver of profitability. It is also important because
economically similar financial arrangements can take different forms or
have different cash flow profiles. Second, the current law may inhibit
appropriate risk management and risk transfer.
14.7 Despite extensive consultation on TOFA Stages 3 and 4
(see paragraphs 14.63 to 14.71), the principles underpinning the Ralph
recommendations have been largely unchallenged. The particular point of
discussion during the consultation process has been the best way to
articulate the policy objectives of TOFA Stages 3 and 4.
372
Regulation impact statement
Implementation options
14.8 Three options are considered in this regulation impact statement
for meeting the policy objectives of TOFA.
· Option 1: Financial accounting concepts. Under this option,
the measure will have a common theme of incorporating
relevant financial accounting concepts where possible into
the relevant income tax law principles relating to financial
arrangements and applying economic gain and loss concepts
otherwise.
· Option 2: Direct link. This option allows taxpayers to
determine their income tax liability in relation to financial
assets and liabilities as determined by their financial
accounting treatment, subject to specified income tax law
adjustments.
· Option 3: Maintain current arrangements.
Option 1: Financial accounting arrangements
14.9 Option 1 has a number of elements. Under this option the key
concept is the calculation of gains and losses. The default position is that
all gains and losses are treated on revenue account, meaning that there is
(with some exceptions) no longer a revenue/capital distinction in
Division 230. In addition, gains and losses are assessed in terms of all the
cash flows associated with one financial arrangement, rather than
focussing on each individual cash flow. The identification of a financial
arrangement takes account of normal commercial understandings.
14.10 Once gains or losses have been identified, the default
methodology is to apply an accruals regime to economic gains and losses.
The accruals regime (Subdivision 230-B) will ensure that any gain or loss
that is sufficiently certain to occur is allocated on a time value of money
basis. This will reduce tax-induced distortions by reducing the ability of
taxpayers to gain tax advantage through income deferral. Where
sufficiently certain gains and losses vary from previous estimates, a
balancing adjustment may be applied to over- or under-taxation of the
actual gain or loss (Subdivision 230-G).
14.11 Where the amount of a gain or loss on a financial arrangement is
considered to lack sufficient certainty, the gain or loss will be taxed on a
realisation basis (Subdivision 230-B) as long as no elective regime
applies. The realisation regime will bring a gain or loss to account in the
income year in which it occurs. This approach reduces the compliance
373
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
costs that might occur if the accruals regime were more extensive and
there were consequent frequent re-estimation of gains and losses with
resulting balancing adjustments.
14.12 In addition to the default arrangements, the new regime allows a
number of options. The options fall into two different groups, one that
has the effect of expanding accruals treatment, and one that further
enhances risk management by better dealing with volatility. The fair
value, financial reports and foreign exchange retranslation elections allow
taxpayers to adopt a closer link to financial accounting. These options
result in non-realisations tax treatment for an even broader class of
transactions than would be the case under the core rules of Division 230.
The hedging election allows taxpayers to reduce their post-tax volatility.
All four elections are on a voluntary basis due to the potentially adverse
consequences that may arise for taxpayers with particular affairs.
14.13 The elective fair value regime (Subdivision 230-C) will permit
the taxpayers, who make the election to be taxed on the basis of the gains
and losses arising from changes in the fair value of financial
arrangements. The fair value regime provides improved price neutrality
for financial arrangements and compliance cost savings to taxpayers who
make the election. The compliance cost savings are due to the fact that
some taxpayers already fair value financial transactions for accounting
purposes, reducing the necessity of making separate tax calculations. The
fair value election is likely to only appeal to taxpayers which are able to
avoid liquidity problems associated with taxing unrealised gains under the
fair value taxation.
14.14 Subdivision 230-F allows taxpayers to elect to rely on their
financial reports for the purposes of calculating their tax liability with
respect to financial arrangements. This option will reduce compliance
costs for taxpayers, particularly those with complex financial
arrangements that already must be recorded and audited for accounting
purposes.
14.15 Taxpayers which elect to apply the foreign exchange
retranslation regime (Subdivision 230-D) to their financial arrangements
may bring to account changes in value attributable to foreign currency
movements. The retranslation election will provide compliance cost
savings to taxpayers who are not concerned with dealing with potential
tax payment volatility associated with foreign exchange movements and
who make the election.
14.16 Finally, taxpayers may also elect to make use of the tax-timing
hedging regime (Subdivision 230-E). The new rules will allow
after-tax-timing matching to occur, removing the tax distortions caused by
tax-timing mismatches under the current tax law. Taxpayers who make
374
Regulation impact statement
the hedging election will also be permitted to match the character of their
hedges with the revenue/capital designation of the hedged item, removing
distortions arising from character mismatches.
Option 2: Direct link
14.17 A significant element of the discussions during the consultation
process is the debate regarding the appropriateness of accounting
standards as a basis for tax law.
14.18 Option 2 (referred to as the direct link or formal link approach)
involves relying comprehensively on Australian accounting standards to
determine the scope and benchmark for taxation of financial
arrangements. For example, Australian Accounting Standard AASB 132
Financial Instruments: Disclosure and Presentation (AASB 132) and
Australian Accounting Standard AASB 139 Financial Instruments:
Recognition and Measurement (AASB 139) describe `financial
instruments' which are similar in nature to the arrangements intended to
be covered by TOFA Stages 3 and 4. Under option 2, Division 230 would
refer to the relevant sections of AASB 132 and AASB 139 in order to
define the arrangements to which the TOFA Stages 3 and 4 rules will
apply (with additions and subtractions as necessary). This regulation
impact statement analyses a mandatory direct link.
Option 3: Maintain current arrangements
14.19 Option 3 is the current tax law with respect to financial
arrangements. With a few exceptions this relies on the normal rules of the
income tax system, in particular the distinction (under income tax law)
between revenue and capital and income and deductions. In general, tax
is paid on a realisation rather than an accruals basis and the timing of tax
can differ substantially from the timing of commercial gain, resulting in
tax planning and arbitrage opportunities and potentially biasing the
allocation of resources to financial instruments that are relatively
tax-favoured. In other circumstances, the tax disadvantaged treatment
may either inhibit the use of a particular financial arrangement or
interfere, in a non-neutral way, with its pre-tax pricing.
14.20 As noted above, the current tax law may also inhibit efficient
risk management practices in the financial sector and the corporate sector
more broadly. For example, a fund manager may invest in an offshore
investment and hedge the foreign currency exposure to reduce earnings
volatility. Under the current law the earnings of the investment may be
exempt from income tax, but the gains or losses of the hedge may be
subject to tax. Accordingly, even though the hedge may be effective in
pre-tax terms, it may not be effective in post-tax terms.
375
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Assessment of impacts
Impact group identification
Taxpayers
14.21 TOFA Stages 3 and 4 is intended to apply to financial
arrangements held by sophisticated taxpayers with systems in place to
meet tax and accounting requirements. Unsophisticated taxpayers will not
generally be expected to apply the TOFA Stages 3 and 4 rules.
14.22 With this taxpayer coverage in mind, Division 230 will apply to
the financial arrangements of all entities with aggregated turnover greater
than $100 million, and to the financial arrangements of all authorised
deposit-taking institutions (ADIs), securitisation vehicles or entities which
are required (or would be required if the entity were a corporation) to
register under the Financial Sector (Collection of Data) Act 2001 with
aggregated turnover greater than $20 million.
· The Australian Taxation Office (ATO) estimates that there
are approximately 1,800 businesses with aggregated turnover
greater than $100 million.
· The ATO estimates that there are a further 6,200 businesses
with aggregated turnover between $20 million and
$100 million, although not all of these businesses will meet
the registration requirement.
· Although no estimates are available, it is possible that other
taxpayers may opt into the regime to benefit from the
compliance cost savings and utilise some of the elective
regimes for other reasons (eg, by using the hedging regime to
preserve true economic hedges).
14.23 The Division will not apply to the financial arrangements of
individuals or to entities which fall below the turnover thresholds unless
those taxpayers hold financial arrangements which allow significant
deferral of income.
Tax advisors
14.24 The tax advisors employed by entities which hold financial
arrangements have been heavily involved in the design of the TOFA
Stages 3 and 4 rules and will be similarly involved in the implementation
and application of the TOFA Stages 3 and 4 rules. As the TOFA Stages 3
376
Regulation impact statement
and 4 rules affect sophisticated taxpayers, it is expected that larger tax
advice and accounting firms will mainly be affected.
14.25 It is also anticipated that tax advisors will initially bear much of
the transitional costs associated with the introduction of Division 230.
Whether they ultimately bear these costs will depend on their capacity to
charge their clients fully for the time and effort associated with learning
the new regime. The Division contains a number of irrevocable elections
which taxpayers are expected to seek advice on.
· The ATO anticipates that first and second tier advisory firms
will be affected by TOFA Stages 3 and 4. There are
approximately 400 such firms.
Systems developers
14.26 The TOFA Stages 3 and 4 rules will necessitate some changes to
the accounting and taxation reporting systems used by taxpayers which
hold financial arrangements. Systems developers employed by these
taxpayers will be involved in developing new systems and refining the
interactions between existing accounting and tax reporting systems, and
operating and maintaining these reporting systems from year to year. It is
anticipated that systems developers will also be heavily involved during
the transitional phase associated with the introduction of Division 230.
· The ATO estimate that up to 150 commercial software
developers may be involved with TOFA Stages 3 and 4.
Australian Taxation Office
14.27 The ATO will be responsible for the administration of the TOFA
Stages 3 and 4 rules. Collection of tax revenue under Division 230 will
occur through the pay as you go (PAYG) system. As well as revenue
collection under Division 230, the ATO may also be required to provide
tax rulings, practice statements and interpretive decisions to interested
taxpayers.
Analysis of costs/benefits
14.28 This section outlines the costs and benefits of the three options.
The analysis indicates that option 1 is the superior option. To ensure that
the discussion is as succinct as possible the regulation impact statement
compares all three options at the same time. As a guide to the reader it
should be noted that the analysis indicates that option 1 is superior to
option 2. The relative merits of option 2 compared to option 3 are less
clear as the impact on different groups of taxpayers is quite different. For
377
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
some taxpayers it is anticipated that option 1 and option 2 will lead to
very similar practical outcomes. For these parties, the major differences
between the two options is largely confined to the impact on compliance
costs. Consequently, particular attention is paid to the compliance savings
and costs, both transitional and ongoing, of the two options. However, for
some taxpayers, option 1 will have quite different effects, mainly due to
the treatment of unrealised gains and losses.
14.29 The revenue impact of the TOFA Stages 3 and 4 rules is
unquantifiable.
Benefits
General
14.30 The core rules of option 1 are based on accruals where possible,
and realisation otherwise. Unless taxpayers opt for one of the relevant
elections they will not be exposed to taxation of uncertain unrealised
gains.
14.31 This contrasts with option 2 which would have this outcome due
to the construction of financial accounting. The reason for this divergence
is that tax and accounting rules are designed for different purposes.
Financial accounting is designed to provide relevant stakeholders
information about the performance of the entity. Whilst this is relevant
for tax, it is not the only consideration. For example, the ability to pay
concept underlying the equity principle of tax policy has been interpreted
in practice to have regard to liquidity considerations.
14.32 In addition, option 1 is designed to incorporate relevant financial
accounting concepts into tax law principles while retaining taxation
terminology and phraseology. In essence, this option is a translation of
appropriate accounting principles into tax principles. Option 1 offers
greater tax revenue integrity compared to option 2.
· Tax terminology: importing, defining and comprehension of
accounting terminology and phraseology will not be
necessary under this option.
· Principle based outcomes: option 1 will be based on a
principled tax framework and may also permit single
outcomes, rather than multiple outcomes which may be
possible under accounting standards.
· Objective: the accounting standards are designed to provide
a particular quality of financial reporting, an objective which
378
Regulation impact statement
does not always align with the goals of the tax law. Option 1
can avoid any conflict arising from this difference.
· Control: the international accounting standards are
sometimes amended to achieve superior accounting
outcomes. The interpretations and applications of these
standards may be different to that of a separate tax law.
Option 1 may reduce or remove the impact of these decisions
on tax revenue.
14.33 A substantial benefit of options 1 and 2 is that they align more
closely the tax-timing of transactions with their underlying commercial
substance compared to option 3. This has benefits for resource allocation
in the economy. First, it improves the likelihood that the appropriate level
of resources are allocated to the financial sector (and financial activities
within the non-financial sector) than under the current rules compared to
the non-financial sector. Second, it improves the likelihood that resources
within the financial sector are allocated to the highest value uses.
14.34 Whether option 1 or option 2 improves resource allocation more
than the other depends on the particular treatment of individual
transactions under the two options. Where a taxpayer elects to use
financial reports under option 1, then there would be little difference
between the two options. Similarly, the differences under fair value are
likely to be small.
14.35 Where the core rules are in operation, option 1 may result in
poorer resource allocation than under option 2. For example, transactions
treated on a realisation basis may have a tax treatment that diverges from
underlying commercial values further than would be the case under the
accounting treatment (which is often fair valued or at least accrued).
14.36 The capacity to hedge for tax purposes under option 1 is a
significant economic benefit. Hedging allows economic agents to reduce
volatility with associated benefits. Under current law (option 3) an
economically effective pre-tax hedge may not be an effective post-tax
hedge where the tax-timing or tax character of the hedged item and the
hedging instrument differ. In addition, option 1 is superior to option 3 for
two reasons. First, option 1 allows all hedges for accounting purposes to
be hedges for tax purposes. It also allows some other hedges to be
recognised. The broader scope of hedges covered increases the economic
benefits from hedging. Second, option 1 allows character matching in
addition to timing matching. Option 2 does not allow this as accounting
does not deal with tax character. Without tax character matching post-tax
hedges are not effective.
379
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
14.37 A substantial benefit for taxpayers under option 1 is that a
number of the elections which have the potential to tax uncertain
unrealised gains are optional. This recognises that tax policy has always
been mindful of liquidity constraints and has been reluctant to require
involuntary disposals of assets.
14.38 Another consideration between option 1 and 2 is the issue of
`reverse pollution'. Accounting bodies have expressed concern that a
direct link between financial reports and tax would result in pressure to
amend the accounting standards to ensure more favourable tax outcomes.
This may reduce the quality of information available to investors which
may in turn result in capital not being directed to the most productive
sectors of the economy. Adoption of option 1 limits the extent of reverse
pollution. Option 3 would not involve any reverse pollution.
Taxpayers
14.39 In terms of transitional compliance benefits, there are not
expected to be any specific benefits for taxpayers under option 1. This
would also be true of the direct link approach (option 2). While there are
no compliance benefits from option 3, the cost would be zero.
14.40 In terms of ongoing compliance benefits, there is not expected to
be any noticeable difference between option 1 and option 2. If anything,
there may be a marginal compliance cost benefit in favour of option 2 as
option 1 contains elections that will require taxpayers to consider whether
one approach is better than the other for their particular circumstances
(noting of course that the lack of choice under the direct link may have
non-compliance costs for taxpayers). The extent of these additional
compliance costs is limited by the fact that most elections in option 1 are
irrevocable.
14.41 However, the TOFA Stages 3 and 4 rules themselves should
allow significant compliance cost savings for taxpayers in terms of policy
coherency, legislative complexity, record-keeping, and enquiries and
rulings compared with the current rules (option 3). Division 230 will
effectively replace Division 16E of the Income Tax Assessment Act 1936
(ITAA 1936) and require accruals taxation on a less frequent basis, and
will partially replace the tax treatment under Division 775 of the
ITAA 1997. Tax compliance costs should be reduced through the
relatively close alignment with accounting for the fair value, retranslation
and hedging regimes.
· The ATO estimate that taxpayers affected by TOFA Stages 3
and 4 will experience a medium decrease in compliance costs
during the ongoing stage.
380
Regulation impact statement
· The reduction in compliance costs is expected to be
particularly important for large financial institutions which, if
they elect to, will be able to rely on their financial accounting
systems without the need to build and maintain duplicate tax
systems.
Tax advisors
14.42 In terms of transitional compliance benefits, there are not
expected to be any specific benefits for tax advisors under option 1.
14.43 In terms of ongoing compliance benefits for tax advisors, there
is not expected to be any noticeable difference between option 1 and
option 2. As for taxpayers, there may be a marginal compliance cost
benefit in favour of option 2 as option 1 contains elections that will
require taxpayers to consider whether one approach is better than the other
for their particular circumstances (noting of course that the lack of choice
under the direct link may have non-compliance costs for taxpayers).
14.44 However, as for taxpayers, the TOFA Stages 3 and 4 rules may
provide some compliance cost relief for tax advisors relative to option 3
on an ongoing basis through the effective replacement of Division 16E of
the ITAA 1936 and partial replacement of Division 775 of the
ITAA 1997.
· The ATO estimate that tax advisors affected by TOFA Stages
3 and 4 will have nil or minimal change in compliance costs
during the ongoing stage compared with option 2.
Systems developers
14.45 In terms of transitional compliance benefits, there are not
expected to be any specific benefits for systems developers under
option 1.
14.46 In terms of ongoing compliance benefits for systems developers,
there is not expected to be any noticeable difference between option 1 and
option 2. There is expected to be a significant compliance cost benefit
compared with option 3 as the need to build and maintain tax specific
systems will be reduced for those taxpayers who make the fair value or
financial reports election.
· The ATO estimate that systems developers affected by
TOFA Stages 3 and 4 will have nil or minimal compliance
costs during the ongoing stage.
381
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Australian Taxation Office
14.47 In terms of transitional administrative benefits, there are not
expected to be any specific benefits for the ATO under option 1.
14.48 In terms of ongoing administrative benefits for the ATO, there is
not expected to be any noticeable difference between option 1 and
option 2. There will be ongoing compliance benefits for the ATO
compared with option 3 due to the fact that the ATO may in part be able
to rely on taxpayers' financial accounting systems and controls.
Costs
General
14.49 Option 1 is expected to be more difficult, initially, to relate to
accounting outcomes, and higher compliance costs compared to option 2
are expected for stakeholders for the transitional period. Both options 1
and 2 will provide greater ongoing certainty than option 3.
Taxpayers
14.50 The TOFA Stages 3 and 4 rules will create significant
transitional compliance costs for sophisticated taxpayers subject to the
rules. The new rules will expand accruals taxation and introduce
sophisticated taxation treatments to many financial arrangements which
were previously taxed simplistically. Particular areas where transitional
compliance costs are expected to be realised are formal training of staff,
comprehension of new obligations, enquiries and rulings, and review of
tax planning strategies. It should be noted that the compliance impact will
differ for specialists involved in the process. Tax specialists will face
costs in understanding the new concepts. This will be less of an issue for
finance and accounting specialists as the new approach uses concepts
familiar to them.
· The ATO estimate that taxpayers affected by TOFA Stages 3
and 4 will incur a medium increase in compliance costs
during the transitional stage.
14.51 The transitional costs for taxpayers are expected to be relatively
higher under option 1 compared to option 2. The concepts and principles
articulated under option 1 are expected to take more time for taxpayers to
unravel compared to the direct reference to accounting under option 2.
382
Regulation impact statement
· The ATO anticipates that option 1 will result in more rulings
and disputes than option 2, and consequentially has a higher
transitional compliance cost for taxpayers.
14.52 Although the TOFA Stages 3 and 4 rules are expected to provide
overall ongoing compliance cost savings for taxpayers, some taxpayers
are likely to bear increased ongoing compliance costs. Under the current
tax law, a limited number of taxpayers may be required to tax financial
arrangements on an accruals basis under Division 16E. The introduction
of Division 230 is expected to significantly expand the number of
taxpayers who are required to apply accruals taxation. While taxpayers
who were previously subject to accruals taxation under Division 16E will
enjoy compliance cost savings due to the simplification of the accruals
calculations under TOFA Stages 3 and 4, taxpayers forced to shift from
realisation to accruals taxation can expect increased compliance costs, due
to the relative complexity of accruals tax calculations.
14.53 In terms of ongoing compliance costs for taxpayers, there is not
expected to be any noticeable difference between option 1 and option 2.
14.54 Option 2 would have significantly higher costs in terms of
potential tax liabilities and tax volatility than either option 1 or option 2
due to the mandatory use of financial accounts. Some taxpayers would be
required to bring to account unrealised gains under the direct link
approach. Option 2 also provides less flexibility than option 1, reducing
the capacity of taxpayers to match their tax and accounting needs.
Tax advisors
14.55 The TOFA Stages 3 and 4 rules will create significant
transitional compliance costs for tax advisors. As with taxpayers, the
general areas where transitional compliance costs are expected to be
realised for tax advisors are formal training of staff and comprehension of
new obligations. A particular cost on tax advisors will be to advise
individual clients on the various elections available under Division 230.
· The ATO estimate that tax advisors affected by TOFA
Stages 3 and 4 will incur a medium increase in compliance
costs during the transitional stage.
14.56 The transitional costs for tax advisors are expected to be higher
under option 1 compared to option 2. Transitional costs are higher under
both option 1 and option 2 than option 3. While the concepts and
principles articulated under option 1 are expected to provide similar
outcomes, tax advisors may have greater difficulty in confirming this
compared to option 2.
383
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· The ATO anticipates that option 1 will result in more rulings
and disputes than option 2, and consequentially has a higher
transitional compliance cost for tax advisors.
14.57 In terms of ongoing compliance costs for tax advisors, there is
not expected to be any noticeable difference between option 1 and
option 2.
Systems developers
14.58 Systems developers employed by taxpayers affected by TOFA
Stages 3 and 4 are expected to bear the costs of reviewing tax reporting
systems and processes during the transitional period. However, these
transitional costs are expected to be lower than those associated with the
design/implementation of brand new reporting systems as the process
should require refinement and alignment between existing accounting and
tax reporting systems.
· The ATO estimate that systems developers affected by
TOFA Stages 3 and 4 will incur a medium increase in
compliance costs during the transitional stage.
14.59 The transitional costs for systems developers are expected to be
higher under option 1 compared to option 2. The principled and
conceptual nature of the TOFA Stages 3 and 4 rules when articulated
under option 1 may not, initially, be easily translated into linkages
between accounting and tax reporting systems.
· The ATO anticipates that option 1 will result in more rulings
and disputes than option 2, but has not suggested that this
will necessarily result in higher transitional compliance costs
for systems developers.
14.60 In terms of ongoing compliance costs for systems developers,
there is not expected to be any noticeable difference between option 1 and
option 2.
Australian Taxation Office
14.61 The transitional administrative costs for the ATO are expected
to be relatively higher under option 1 compared to option 2. These higher
costs are expected to be in the form of increased rulings, disputes and
litigation between the tax office and taxpayers.
14.62 In terms of ongoing administrative costs for the ATO, there is
not expected to be any noticeable difference between option 1 and
option 2. The ongoing administrative costs of option 1 are expected to be
384
Regulation impact statement
higher as there is a greater degree of uncertainty regarding the treatment
of financial arrangements due to the mismatch between underlying
commercial concepts and tax concepts.
Consultation
14.63 The Ralph Review, comprising Mr John Ralph AO, Mr Bob Joss
and Mr Rick Allert AM who were assisted by a secretariat consisting of
officers from the Department of the Treasury, the ATO and the
Department of Industry, Science and Resources, and external advisers,
was undertaken between August 1998 and September 1999. Chapter 9 of
the Ralph Report, released on 21 September 1999, recommended new
rules and regimes for the taxation of financial arrangements. These
recommendations included the introduction of an accruals and realisation
regime, elective regimes for fair value and retranslation taxation, and
recognition of hedging arrangements for tax purposes.
· The Treasurer announced the Government's broad support
for the recommendations in the Ralph Report in
Press Release No. 074 of 11 November 1999.
14.64 Following requests by interested taxpayers for a formal
update on progress in TOFA Stages 3 and 4, Treasury released the
TOFA Stages 3 and 4 Information Paper on a confidential basis in
December 2004. The information paper detailed the broad policy
proposals for TOFA Stages 3 and 4. In response to the information paper,
13 submissions were received from industry, taxpayers, peak bodies and
tax advisors.
14.65 On 16 December 2005, the former Minister for Revenue and
Assistant Treasurer announced the public release of exposure draft
legislation for TOFA Stages 3 and 4 (Press Release No. 107 of 2005). In
response to the exposure draft, a total of 32 submissions were received,
including public submissions from the following industry, taxpayers, peak
bodies and tax advisors:
· Association of Superannuation Funds of Australia;
· Australian Bankers' Association;
· Australian Equipment Lessors Association;
· Australian Financial Markets Association;
385
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· Australian Petroleum Production and Exploration
Association;
· Australian Securitisation Forum;
· Blake Dawson Waldron;
· Corporate Tax Association and Certified Practicing
Accountants Australia (joint submission);
· Ernst & Young;
· Fini Villages;
· Insurance Council of Australia;
· Institute of Chartered Accountants in Australia;
· Investment and Financial Services Association;
· Law Council of Australia;
· Minerals Council of Australia;
· Minter Ellison;
· Namoi Cotton;
· OneSteel;
· PEET & Co;
· Pitcher Partners;
· Property Council of Australia;
· Pricewaterhouse Coopers;
· Retirement Village Association;
· Sydney Futures Exchange;
· Shaddick & Spence;
· Tax Institute of Australia; and
· Walker Group Holding.
386
Regulation impact statement
14.66 The main issues raised in submissions were:
· The scope of arrangement: Submissions considered that the
scope of the TOFA Stages 3 and 4 rules in the 2005 exposure
draft was too wide. This judgment was accepted and the
scope was narrowed by removing the main contentious
element; namely, rights to receive non-monetary assets.
· The accruals/realisation borderline: Submissions argued that
the test for distinguishing accruals/realisation treatments set
the borderline too low. A different test was incorporated in
the 2007 public exposure draft to achieve the appropriate and
intended threshold.
· A direct link election: Some submissions continued to call
for a `direct link' with relevant accounting standards. One
suggestion was that the proposed discretion in the 2005
exposure draft (to accept the accounting treatment in
particular circumstances) could be replaced with an election.
This option was considered in the 2007 public exposure draft.
· Hedging rules: While welcoming the `tax-timing' hedging
rules, submissions requested an extension to allow for
`character' matching. A character matching regime was
included in the 2007 public exposure draft.
14.67 Following the consideration of responses to the December 2005
exposure draft, Treasury released policy papers covering seven areas of
concern raised by the respondents. These papers were released on a
confidential basis in May and June 2006. In response to the policy papers,
a total of 19 submissions were received from industry, taxpayers, peak
bodies and tax advisors.
14.68 On 3 January 2007, the Minister for Revenue and Assistant
Treasurer announced the public release of a second exposure draft in
(Press Release No. 001 of 2007). In response to the exposure draft, a
total of 22 submissions were received, including public submissions from
the following industry, taxpayers, peak bodies and tax advisors.
· Australian Bankers' Association;
· Australian Chamber of Commerce and Industry;
· Australian Financial Markets Association;
· Blake Dawson Waldron;
387
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· Certified Practicing Accountants Australia;
· Corporate Tax Association;
· Deloitte Touche Tohmatsu;
· Ernst & Young;
· General Electric;
· Insurance Council of Australia;
· Institute of Chartered Accountants in Australia;
· Investment and Financial Services Association;
· Minerals Council of Australia;
· Pitcher Partners;
· Property Council of Australia;
· Pricewaterhouse Coopers; and
· Tax Institute of Australia.
14.69 In general, submissions were positive about the 2007 public
exposure draft, and much of the feedback was of a technical nature. The
main policy issues raised in submissions were:
· The tax treatment of finance leases: A number of taxpayer
expressed a preference that finance leases not be treated
under the TOFA Stages 3 and 4 rules. The Government has
since determined that the tax treatment of finance leases will
remain unchanged.
· The threshold for mandatory application of the TOFA Stages
3 and 4 rules to businesses: A number of tax advisory firms
which service medium sized enterprises have contended that
the taxpayer thresholds should be raised as smaller taxpayers
subject to the TOFA Stages 3 and 4 rules will be the least
well equipped to adapt to the new rules, and would be
particularly burdened by the application of accruals taxation.
This proposition has been accepted in part, with the
aggregated turnover test being raised to $100 million from
$20 million for general taxpayers, but the $20 million
threshold has been retained for financial entities.
388
Regulation impact statement
14.70 On 6 August 2007, a final exposure draft was released on a
confidential basis to parties involved in previous consultation process. In
response to the confidential exposure draft, a total of 19 submissions were
received from industry, taxpayers, peak bodies and tax advisors.
14.71 In general, submissions were positive about the 2007
confidential exposure draft, and much of the feedback was of a technical
nature. The main policy issues raised in submissions were:
· The application date of the legislation: A number of
submissions requested that the start date be delayed until
1 July 2008 (optional) and 1 July 2009 (compulsory). This
proposition was accepted for the final Bill.
· The inclusion of TOFA-specific integrity measures: A
number of submissions felt that these integrity rules created
unnecessary compliance costs. This proposition was
accepted for the final Bill.
Conclusion and recommended option
14.72 The Government has decided to implement option 1 in order to
achieve the TOFA Stages 3 and 4 objectives. Option 1 was preferred over
option 2 and the current tax law (option 3) because:
· the current law includes a mismatch between the underlying
commercial substance of transactions and the tax treatment
which leads to the misallocation of resources;
· the current law inhibits the efficient management of risk by
limiting the capacity to achieve post-tax effective hedging;
· the direct link approach achieves some of these objectives
(although not all due to the lack of tax-character hedging),
but would impose costs and raise liquidity issues for
taxpayers due to the taxation of unrealised gains and losses;
· compliance costs for taxpayers will be reduced under
option 1 compared to the current law due to the greater
certainty and the capacity for some taxpayers to rely on their
financial reports;
· under option 1, the tax treatment of financial arrangements
will not automatically change without Government
consideration as it would under the direct link approach;
389
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
· the legislation could apply to a broad range of taxpayers, not
just the relative few (but large taxpayers) who apply all the
relevant accounting standards; and
· option 1 reduces the potential for financial accounting
principles to be influenced by tax considerations (so called
`reverse pollution').
14.73 The Government has also decided to provide an election (the
financial accounts election (Subdivision 230-F)) to allow certain
taxpayers to rely on the outcomes of their financial reports. This
effectively permits some elements of an elective direct link for taxpayers
who make the election. The financial accounts election was included in
Division 230 because:
· the election will provide transitional compliance cost savings
for the taxpayers who make the election;
· eligible taxpayers will be free to weigh the costs and benefits
of the financial accounts election and determine whether
making the election is in their interests, rather than having
the option imposed on certain taxpayers or taxpayer groups;
and
· the application of a direct link to accounting via an election
will not force smaller taxpayers to apply accounting
standards that they have not previously been required to
apply.
14.74 The Treasury and the ATO will monitor these taxation
measures, as part of the whole system, on an ongoing basis.
390
Index
Chapter 1: Background and framework
Bill reference Paragraph number
Item 1, Subdivision 230-B 1.54
Item 1, Subdivision 230-C 1.54, 1.58
Item 1, Subdivision 230-D 1.54, 1.60
Item 1, Subdivision 230-E 1.54, 1.65
Item 1, Subdivision 230-F 1.54, 1.70
Item 1, Subdivision 230-G 1.54, 1.80
Item 1, Subdivision 230-H 1.47
Item 1, subsections 230-5(1) and 230-50(1) 1.42
Item 1, paragraph 230-5(2)(a) and section 230-405 1.50
Item 1, paragraph 230-5(2)(b) and section 230-55 1.44
Item 1, section 230-15 1.38
Item 1, section 230-40 1.49
Item 1, section 230-45 1.57
Item 1, subsection 230-45(1) 1.80, 1.81
Item 1, subsection 230-45(2) 1.86
Item 1, subsections 230-45(2) and 230-105(5), section 230-150 1.78
Item 1, paragraph 230-45(2)(e) 1.44
Item 1, paragraph 230-45(2)(e), sections 230-230 and 230-285 1.87
Item 1, subsection 230-45(4) 1.85
Item 1, section 230-50 1.41
Item 1, subsection 230-50(2) 1.42
Item 1, section 230-60 1.41
Item 1, section 230-85 1.36, 1.90
Item 1, section 230-90 1.41
Item 1, sections 230-105, 230-110, 230-120 and 230-135 1.74
Item 1, subsection 230-105(5) 1.88
Item 1, section 230-145 1.76
Item 1, sections 230-155 and 230-160 1.75
391
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, section 230-200 1.84
Item 1, section 230-210 1.58
Item 1, sections 230-210, 230-250 and 230-380 1.56
Item 1, section 230-250 1.63
Item 1, section 230-380 1.71
Item 1, section 230-385 and subsection 230-45(1) 1.89
Item 1, subsection 230-390(1) 1.66
Item 1, section 230-400 1.44, 1.50
Item 1, section 230-410 and subsections 230-425(3) and (4) 1.51
Item 1, section 230-420 1.50
Items 97 to 99 1.94
Subitem 99(7) 1.94
Chapter 2: Definition of `financial arrangement'
Bill reference Paragraph number
Item 1, paragraph 230-45(2)(e) 2.93
Item 1, sections 230-50 and 230-55 2.28, 2.38
Item 1, subsection 230-50(1) 2.47, 2.77
Item 1, paragraphs 230-50(1)(d) to (f) 2.76, 2.78
Item 1, note to subsection 230-50(2) 2.68
Item 1, paragraph 230-50(2)(a) 2.55
Item 1, paragraph 230-50(2)(c) 2.60
Item 1, paragraph 230-50(2)(b) 2.61
Item 1, paragraphs 230-50(2)(b) and (c) and section 230-70 2.62
Item 1, paragraph 230-50(2)(d) 2.64
Item 1, paragraph 230-50(2)(e) 2.66
Item 1, paragraph 230-50(2)(f) and subsection 230-50(3) 2.69
Item 1, paragraph 230-50(2)(g) 2.73, 2.74
Item 1, subparagraph 230-50(3)(c)(i) 2.72
Item 1, subparagraph 230-50(3)(c)(ii) 2.70, 2.71
Item 1, subsection 230-55(1) 2.85, 2.87
Item 1, subsection 230-55(2) 2.89, 2.91
392
Index
Bill reference Paragraph number
Item 1, paragraph 230-55(2)(b) 2.90
Item 1, subsection 230-60(1) 2.37, 2.163
Item 1, subsection 230-60(2) 2.37
Item 1, subsection 230-60(4) 2.31, 2.36
Item 1, section 230-65 2.49, 2.77, 2.91
Item 1, section 230-90 2.51
Item 1, paragraph 230-185(1)(c), subsection 230-190(1), 2.94
paragraph 230-360(1)(d) and subsection 230-365(1)
Item 1, section 230-200 2.100
Item 1, subsection 230-230(1) 2.93
Item 1, subsection 230-285(1) 2.93
Item 1, subsection 230-305(1) 2.106
Item 1, subsection 230-390(1) 2.95
Item 1, paragraph 230-400(a) and section 230-50 2.105
Item 1, paragraph 230-400(b) 2.103
Item 1, paragraph 230-400(c) 2.104
Item 1, paragraph 230-400(d) 2.106
Item 1, paragraph 230-400(e) 2.107
Item 1, subsections 230-405(1) and (4) 2.113
Item 1, paragraph 230-405(1)(a) and subsections 230-405(2) and 2.110
230-405(3)
Item 1, paragraph 230-405(1)(b), definition of `qualifying security' 2.114
in subsection 159GP(1) of the Income Tax Assessment Act 1936
Item 1, paragraph 230-405(1)(b) 2.109, 2.116
Item 1, subparagraphs 230-405(2)(b)(i) and (3)(b)(i) 2.112
Item 1, subparagraphs 230-405(2)(b)(ii) and (3)(b)(ii) 2.112
Item 1, subsection 230-405(4) 2.109, 2.117
Item 1, subsection 230-405(5) 2.117
Item 1, paragraph 230-410(2)(a) 2.120
Item 1, paragraph 230-410(2)(b) 2.120
Item 1, paragraphs 230-410(2)(c) and (d) 2.120
Item 1, subsections 230-410(3)and (4) 2.125
Item 1, paragraph 230-410(3)(c) 2.126, 2.128
Item 1, subsection 230-410(4) 2.129
Item 1, subsection 230-410(5) 2.130, 2.134
Item 1, subsection 230-410(6) 2.130, 2.138
393
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, subsection 230-410(7) 2.142
Item 1, paragraph 230-410(8)(a) 2.144
Item 1, paragraph 230-410(8)(b) 2.144
Item 1, paragraph 230-410(8)(c) 2.144
Item 1, paragraph 230-410(9)(a) 2.148
Item 1, paragraph 230-410(9)(b) 2.149
Item 1, paragraph 230-410(9)(c) 2.150
Item 1, paragraph 230-410(9)(d) 2.151
Item 1, paragraph 230-410(9)(e) 2.153
Item 1, paragraph 230-410(9)(f) 2.155
Item 1, subsection 230-410(10) 2.154
Item 1, subsection 230-410(11) 2.156
Item 1, subsection 230-410(12) 2.158
Item 1, subsection 230-410(13) 2.161
Item 1, subsection 230-410(14) 2.168
Item 1, subsection 230-410(15) 2.169
Item 1, subsection 230-410(16) 2.172
Item 1, subsection 230-410(17) 2.174
Item 1, subsection 230-410(18) 2.175
Item 1, subsection 230-415(1) 2.177
Item 1, subsection 230-415(2) 2.180
Item 1, subsection 230-415(3) 2.179
Item 1, section 230-420 2.181
Item 1, subsection 230-425(1) and paragraph 230-425(3)(b) 2.186
Item 1, subsection 230-425(1) and paragraph 230-425(3)(c) 2.187
Item 1, subsection 230-425(3) 2.182
Item 1, paragraph 230-425(3)(a) 2.184
Item 1, paragraph 230-425(4)(a) 2.185
Item 1, paragraph 230-425(4)(b) 2.186
Item 1, section 230-440 2.108
Item 1, subsection 230-445(1) 2.97
Item 1, subsection 230-445(2) 2.97, 2.99
Item 1, subsection 230-445(3) 2.97, 2.99
Item 7, subsection 820-930(1) 2.86
394
Index
Bill reference Paragraph number
Item 21, subsection 995-1(1) of the Income Tax Assessment 2.56
Act 1997
Chapter 3: Tax treatment of gains and losses from financial
arrangements
Bill reference Paragraph number
Item 1, subparagraph 230-10(b)(ii) 3.56
Item 1, subsection 230-15(1) 3.53
Item 1, note to subsections 230-15(1) and (2) 3.74
Item 1, subsection 230-15(2) 3.55
Item 1, subsection 230-15(3) 3.62
Item 1, subsection 230-15(4) 3.59
Item 1, subsection 230-15(5) and (6) 3.60
Item 1, subsection 230-15(7) 3.54
Item 1, section 230-20 3.83, 3.84
Item 1, subsection 230-20(1) 3.85
Item 1, subsection 230-20(2) 3.87
Item 1, subsection 230-20(3) and (4) 3.85
Item 1, subsection 230-20(5) 3.93
Item 1, section 230-25 3.83, 3.84
Item 1, subsection 230-25(2) 3.86
Item 1, subsection 230-25(3) 3.88
Item 1, subsection 230-25(5) 3.88, 3.90
Item 1, paragraph 230-25(5)(a) 3.90
Item 1, subsection 230-25(6) 3.93
Item 1, subsection 230-30(1) 3.61
Item 1, subsection 230-30(2) 3.62
Item 1, subsection 230-30(3) 3.65
Item 1, paragraph 230-30(3)(a) 3.66
Item 1, paragraph 230-30(3)(b) 3.70
Item 1, section 230-35 3.63
Item 1, section 230-45 3.14, 3.15, 3.80
Item 1, section 230-65 3.17, 3.21, 3.22
395
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, subsection 230-65(2) 3.21
Item 1, section 230-70 3.45
Item 1, section 230-75 3.16, 3.17
Item 1, subsection 230-75(1) 3.42, 3.49
Item 1, subsection 230-75(2) 3.49
Item 1, subsection 230-75(3) 3.50
Item 1, paragraphs 230-75(3)(a) and (b) 3.51
Item 1, paragraph 230-75(3)(c) 3.52
Item 1, subsection 230-75(4) 3.41, 3.42, 3.49
Item 1, section 230-80 3.16, 3.17
Item 1, subsection 230-80(1) 3.42
Item 1, subsection 230-80(3) 3.50
Item 1, paragraphs 230-80(3)(a) and (b) 3.51
Item 1, subsection 230-80(4) 3.41, 3.42
Item 1, subsection 230-170(2) 3.51
Item 1, subsection 230-260(1) 3.80
Item 1, section 230-270 3.79
Item 1, subsection 230-270(3) 3.80
Item 1, subsection 230-305(1) 3.72
Item 1, section 230-395 3.51
Item 1, subsection 230-395(7) 3.92
Item 1, subsection 230-405(4) 3.71
Item 1, section 230-440 3.24
Item 1, subsection 230-440(1) 3.25
Item 1, paragraph 230-440(1)(a) and (2)(a) 3.26
Item 1, subsection 230-440(2) 3.25, 3.28, 3.35
Item 1, paragraph 230-440(2)(a) 3.26
Item 1, subsection 230-440(3) 3.37, 3.38
Item 1, subsection 230-440(5) 3.28, 3.35
Item 1, subsection 230-440(6) 3.37, 3.38
Item 1, paragraph 230-440(8)(a) 3.30, 3.31
Item 1, paragraph 230-440(8)(b) 3.33
Item 1, subsections 230-440(9) and (10) 3.31
Item 62, section 118-27 3.84
396
Index
Chapter 4: The compounding accruals and realisation
methods
Bill reference Paragraph number
Item 1, subsection 230-45(2) 4.163, 4.44
Item 1, paragraph 230-45(2)(b) 4.45
Item 1, paragraph 230-45(2)(c) 4.46
Item 1, paragraph 230-45(2)(e) 4.105, 4.169
Item 1, section 230-60 4.72
Item 1, subsection 230-60(4) 4.71
Item 1, section 230-65 4.126
Item 1, sections 230-75 and 230-80 4.109
Item 1, subsections 230-75(1) and 230-80(1) 4.119
Item 1, section 230-85 4.137
Item 1, paragraph 230-100(a) 4.36, 4.53, 4.64
Item 1, paragraph 230-100(b) 4.123
Item 1, paragraph 230-100(c) 4.37, 4.64
Item 1, section 230-105 4.76, 4.111
Item 1, subsection 230-105(2) 4.54
Item 1, subsection 230-105(3) 4.60, 4.64
Item 1, paragraph 230-105(4)(c) 4.43
Item 1, subsection 230-105(5) 4.42, 4.60
Item 1, subsection 230-110(1) 4.40, 4.41, 4.50
Item 1, paragraph 230-110(2)(a) 4.56
Item 1, paragraph 230-110(2)(b) 4.54, 4.57
Item 1, paragraphs 230-115(1)(a) and (b) 4.66
Item 1, paragraph 230-115(1)(c) 4.65
Item 1, paragraph 230-115(1)(d) 4.65
Item 1, note to subsection 230-115(2) 4.65
Item 1, paragraph 230-115(2)(a) 4.66
Item 1, paragraph 230-115(2)(b) 4.67, 4.110
Item 1, paragraph 230-115(2)(c) 4.67
Item 1, subsection 230-115(4) 4.40
Item 1, subsection 230-120(1) 4.78
Item 1, paragraph 230-120(2)(a) 4.79
Item 1, paragraph 230-120(2)(b) 4.79, 4.95
397
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, subsection 230-120(3) 4.95
Item 1, paragraph 230-120(3)(a) 4.87
Item 1, subparagraph 230-120(3)(a)(ii) 4.93
Item 1, subparagraph 230-120(3)(a)(iii) 4.92
Item 1, subparagraph 230-120(3)(a)(iv) and 4.91
paragraph 230-120(3)(b)
Item 1, subsection 230-120(4) 4.62, 4.74, 4.99
Item 1, subsection 230-120(5) 4.62, 4.99
Item 1, subsection 230-120(6) 4.100
Item 1, subsection 230-120(8) 4.83
Item 1, subsection 230-120(9) 4.108
Item 1, section 230-125 4.111
Item 1, subsection 230-130(1) 4.50, 4.55, 4.112,
4.113
Item 1, subsection 230-130(2) 4.115
Item 1, subsection 230-130(3) 4.116
Item 1, paragraph 230-130(4)(a) 4.116
Item 1, subparagraph 230-130(4)(b)(i) 4.116
Item 1, subparagraph 230-130(4)(b)(ii) 4.116
Item 1, paragraph 230-135(2)(a) 4.117
Item 1, paragraph 230-135(2)(b) 4.117, 4.122
Item 1, paragraphs 230-135(3)(a) and b 4.120
Item 1, subsection 230-135(4) 4.118
Item 1, subsection 230-135(5) 4.119
Item 1, subsection 230-140(1) 4.127
Item 1, subsection 230-140(2) 4.128
Item 1, section 230-145 4.130
Item 1, subsection 230-145(1) 4.131
Item 1, subsection 230-145(2) 4.132
Item 1, subsection 230-145(3) 4.132
Item 1, subsection 230-145(4) 4.131
Item 1, section 230-150 4.171
Item 1, subsection 230-150(2) 4.174
Item 1, paragraph 230-150(2)(a) 4.171
398
Index
Bill reference Paragraph number
Item 1, paragraph 230-150(2)(b) 4.171
Item 1, paragraph 230-150(3)(a) 4.176
Item 1, paragraph 230-150(3)(b) 4.176
Item 1, paragraph 230-150(3)(c) 4.176
Item 1, subsection 230-150(4) 4.175
Item 1, paragraph 230-150(5)(a) 4.176
Item 1, paragraph 230-150(5)(b) 4.176
Item 1, paragraph 230-150(5)(c) 4.176
Item 1, subsection 230-150(6) 4.177
Item 1, subsection 230-155(1) 4.178
Item 1, paragraph 230-155(2)(a) 4.181
Item 1, paragraph 230-155(2)(b) 4.182
Item 1, paragraph 230-155(2)(c) 4.186
Item 1, paragraph 230-155(2)(d) 4.187
Item 1, paragraph 230-155(2)(e) 4.189
Item 1, subsection 230-155(3) 4.180
Item 1, subsection 230-160(1) 4.134
Item 1, paragraph 230-160(1)(c) 4.140
Item 1, paragraph 230-160(2)(a) 4.135
Item 1, paragraph 230-160(2)(b) 4.135
Item 1, paragraph 230-160(2)(c) 4.135, 4.139
Item 1, paragraph 230-160(2)(d) 4.135, 4.185
Item 1, subsection 230-160(3) 4.138
Item 1, paragraph 230-160(3)(b) 4.158
Item 1, subsection 230-160(4) 4.143
Item 1, subsection 230-160(5) 4.146
Item 1, paragraph 230-160(5)(a) 4.147
Item 1, paragraph 230-160(5)(b) 4.148
Item 1, subsection 230-160(6) 4.150
Item 1, section 230-165 4.149
Item 1, subsection 230-165(1) 4.152
Item 1, paragraph 230-165(1)(a) 4.153
Item 1, paragraph 230 165(1)(b) 4.154
Item 1, paragraph 230-165(1)(c) 4.154
Item 1, paragraph 230-165(1)(d) 4.153
399
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, subsection 230-165(2) 4.159
Item 1, subsection 230-165(3) 4.159
Item 1, subsection 230-165(5) 4.160
Item 1, subsection 230-165(6) 4.161
Item 1, subsection 230-170(1) 4.140
Item 1, subsection 230-170(2) 4.142
Item 1, subparagraph 230-170(2)(a)(i) 4.145
Item 1, subparagraph 230-170(2)(a)(ii) 4.145
Item 1, subsection 230-170(3) 4.151, 4.156
Item 1, section 230-195 4.191
Item 1, section 230-200 4.167
Item 1, subsection 230-260(6) 4.46
Item 1, subsection 230-385(1) 4.166
Item 1, subsection 230-405(1) 4.39
Item 1, subsection 230-405(5) 4.39
Item 29, subsection 995-1(1), definition of `special accrual amount' 4.83
Chapter 5: Elective Subdivisions: common requirements
Bill reference Paragraph number
Item 1, section 230-45 5.61
Item 1, subsections 230-180(2), 230-220(2), 230-275(2) and 5.10
230-350(2)
Item 1, subparagraphs 230-180(2)(a)(ii) and (b)(ii), 5.27
230-220(2)(a)(ii) and (b)(ii), 230-275(2)(a)(ii) and (b)(ii) and
230-350(2)(a)(ii) and (b)(ii)
Item 1, paragraphs 230-180(2)(b), 230-220(2)(b), 230-275(2)(b) 5.25
and 230-350(2)(b)
Item 1, subsections 230-180(3), 230-220(5), 230-275(3) and 5.43
230-350(4)
Item 1, subsections 230-185(1) and 230-225(1), section 230-280 5.44
and subsection 230-360(1)
Item 1, paragraphs 230-185(1)(b), 230-225(1)(b), 230-290(1)(c) 5.19
and 230-360(1)(c)
Item 1, paragraphs 230-185(2)(b), 230-225(2)(b), 5.54
400
Index
Bill reference Paragraph number
subsections 230-360(3) to (6), paragraph 230-370(1)(b) and
subparagraph 230-240(1)(b)(ii)
Item 1, subsections 230-185(3), 230-225(3), 230-280(3) 5.49
and 230-360(4)
Item 1, subsections 230-190(1), 230-195(2), 230-365(1) and 5.46
230-370(2)
Item 1, subsections 230-190(3), 230-230(3), 230-285(4) and 5.35, 5.40, 5.47
230-365(3)
Item 1, subsections 230-190(4), 230-230(4), 230-285(5) and 5.48
230-365(4)
Item 1, subsection 230-195(1) 5.52
Item 1, subsections 230-195(1), 230-240(1), 230-260(2) and 5.51
230-370(1)
Item 1, 230-195(3) and (4) 5.57
Item 1, subsections 230-195(3) and (4), 230-240(3) and (4), 5.55
230-370(3) and (4)
Item 1, subsections 230-205(1), 230-245(1), 230-325(1) and 5.63
230-375(1)
Item 1, subsections 230-205(1) and (3), 230-245(1) and (3), 5.65
230-325(1) and 230-375(1) and (3)
Item 1, subsections 230-205(2), 230-245(2), 230-325(2) and 5.72
230-375(2)
Item 1, subsections 230-205(2) and (4), 230-245(2) and (4), 5.66
230-325(2) and 230-375(1) and (4)
Item 1, subsections 230-205(3), 230-245(3) and 230-375(3) 5.64
Item 1, subsections 230-205(4), 230-245(4) and 230-375(4) 5.72
Item 1, subsections 230-210(1), 230-250(1) and 230-380(1) 5.67
Item 1, subsections 230-210(2), (4) and (5), 230-250(2), (4) and (5) 5.69
and 230-380(2), (5) and (6)
Item 1, subsections 230-210(3), 230-250(3) and 230-380(3) 5.68
Item 1, subsection 230-240(1) 5.52
Item 1, subsections 230-240(3) and (4) 5.58
Item 1, subsection 230-370(1) 5.52
Item 1, subsections 230-370(3) and (4) 5.59
Item 1, section 230-435 5.28
401
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Chapter 6: The elective fair value method
Bill reference Paragraph number
Item 1, section 230-60 6.23
Item 1, section 230-180 6.10
Item 1, subsection 230-180(1) 6.9
Item 1, subsection 230-180(2) 6.9
Item 1, subparagraph 230-185(1)(c) 6.9, 6.18, 6.21, 6.22
Item 1, paragraphs 230-185(1)(d) 6.9, 6.18, 6.24
Item 1, subsections 230-185(2) and 230-195(2) 6.19
Item 1, section 230-190 6.9
Item 1, subsection 230-190(1) 6.27
Item 1, subsection 230-190(3) 6.14
Item 1, subsection 230-190(4) 6.15
Item 1, subsection 230-195(1) 6.28
Item 1, subsection 230-195(2) 6.30
Item 1, section 230-200 6.9, 6.23
Item 1, section 230-205 6.35
Item 1, subsection 230-205(1) 6.25
Item 1, subsection 230-205(2) 6.41
Item 1, section 230-210 6.38
Item 1, subsections 230-210(1) and (3) 6.37
Item 1, section 230-445 6.20
Subitems 99(5) and (8) 6.18
Chapter 7: The elective foreign exchange retranslation
method
Bill reference Paragraph number
Item 1, paragraph 230-45(4)(a) 7.65
Item 1, paragraph 230-45(4)(b) 7.66
Item 1, paragraph 230-45(4)(c) 7.67
Item 1, subsections 230-220(1) and (2) 7.22
Item 1, subsection 230-220(2) 7.23
402
Index
Bill reference Paragraph number
Item 1, subsections 230-220(3) and (4) 7.22
Item 1, paragraph 230-220(3)(a) 7.48
Item 1, subsection 230-220(4) 7.54
Item 1, paragraph 230-220(4)(a) 7.55
Item 1, paragraph 230-220(4)(b) 7.57, 7.57
Item 1, subsection 230-220(5) 7.63
Item 1, paragraph 230-225(1)(b) 7.27
Item 1, paragraph 230-225(1)(c) 7.27
Item 1, paragraph 230-225(1)(d) 7.27
Item 1, subsection 230-225(2) 7.27
Item 1, section 230-230 7.34
Item 1, subsection 230-230(1) 7.32
Item 1, subsection 230-230(2) 7.32
Item 1, section 230-235 7.58
Item 1, subsection 230-240(1) 7.33
Item 1, subsection 230-245(1) 7.36
Item 1, subsection 230-245(2) 7.37
Item 1, subsections 230-245(2) and (4) 7.64
Item 1, subsection 230-245(3) 7.38
Item 1, subsection 230-245(4) 7.39
Item 1, subsection 230-245(5) 7.60
Item 1, subsection 230-245(6) 7.61
Item 1, paragraph 230-295(1)(b) 7.27
Item 1, paragraph 230-295(1)(c) 7.27
Item 1, subsections 230-250(1) and (3) 7.40
Item 1, subsections 230-250(2) and (4) 7.41
Item 1, subsections 230-250(3) to (5) 7.62
Item 1, subsection 230-250(5) 7.42
Items 2 and 3 7.30
Item 5, subsection 775-270(1A) 7.49
Item 6, Subdivision 775-F 7.34
Item 6, section 775-295 7.22
Item 6, paragraph 775-295(1)(a) 7.27
Item 6, section 775-305 7.35, 7.46
Item 6, subsection 775-305(4) 7.27
403
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 6, subsection 775-310(1) 7.38
Item 6, subsection 775-310(2) 7.39
Item 6, section 775-315 7.45, 7.46
Item 22, definition of `qualifying forex account' in 7.50, 7.51
subsection 995-1(1) of the Income Tax Assessment Act 1997
Item 29, definition of `special accrual amount' in 7.70
subsection 995-1(1) of the Income Tax Assessment Act 1997
Subitem 99(2) 7.56
Chapter 8: The elective hedging financial arrangements
method
Bill reference Paragraph number
Item 1, section 230-255 8.83
Item 1, section 230-260 8.17, 8.74
Item 1, subsection 230-260(2) 8.71, 8.28
Item 1, paragraph 230-260(3)(a) 8.72
Item 1, paragraph 230-260(3)(b) 8.72
Item 1, subsection 230-260(4) 8.86
Item 1, subsection 230-260(4) and section 230-265 8.29
Item 1, subsection 230-260(4) and section 230-265, item 2 in 8.87
the table
Item 1, subsection 230-260(6) 8.73
Item 1, section 230-265, item 1 in the table 8.93
Item 1, section 230-265, items 1(a) and (b) in the table 8.90
Item 1, section 230-265, items 2(a), 2(b), and (3) in the table 8.94
Item 1, subsection 230-265(5) 8.94
Item 1, section 230-270 8.74
Item 1, subsection 230-270(4) 8.28, 8.75
Item 1, subsection 230-270(4), item 1 in the table 8.75
Item 1, subsection 230-270(4), item 2 in the table 8.77
Item 1, subsection 230-270(4), item 3 in the table 8.77
Item 1, subsection 230-270(4), item 4 in the table 8.77
Item 1, subsection 230-270(4), item 5 in the table 8.76
404
Index
Bill reference Paragraph number
Item 1, subsection 230-270(4), item 6 in the table 8.77
Item 1, subsection 230-270(4), items 7 and 10 in the table 8.77
Item 1, subsection 230-270(4), items 8 and 9 in the table 8.77
Item 1, subsection 230-270(4), item 11 in the table 8.77
Item 1, subsection 230-270(4), item 12 in the table 8.77
Item 1, subsection 230-270(5) 8.77
Item 1, sections 230-275 and 230-280 8.21
Item 1, paragraph 230-275(2) 8.22
Item 1, subsection 230-275(3) 8.95
Item 1, subsection 230-285(1) 8.24
Item 1, subsection 230-285(2) 8.24
Item 1, subsection 230-285(3) 8.25
Item 1, subsection 230-285(4) 8.26
Item 1, subsection 230-285(5) 8.26
Item 1, section 230-290 and subsection 230-310(5) 8.67
Item 1, subsection 230-290(1) 8.18, 8.40
Item 1, paragraph 230-290(1)(a) 8.38, 8.41
Item 1, paragraph 230-290(1)(b) 8.41
Item 1, paragraph 230-290(1)(c) 8.41
Item 1, subsection 230-290(2) 8.18, 8.40
Item 1, paragraph 230-290(2)(c) 8.66
Item 1, paragraph 230-290(2)(e) 8.66
Item 1, subsection 230-290(3) 8.64
Item 1, paragraph 230-290(4) 8.64
Item 1, subsections 230-290(5) and (6) 8.46
Item 1, subsection 230-290(6) 8.65
Item 1, subsection 230-290(7) 8.47
Item 1, subsection 230-290(8) 8.48
Item 1, subsection 230-290(9) 8.19, 8.49
Item 1, paragraph 230-290(9)(f) 8.20
Item 1, subsection 230-290(10) 8.20, 8.51
Item 1, section 230-295 8.45
Item 1, subsection 230-295(2) 8.45
Item 1, subsection 230-295(3) 8.45
Item 1, subsection 230-295(4) 8.45
405
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Item 1, section 230-300 8.18, 8.43
Item 1, subsection 230-305(1) 8.32
Item 1, subsection 230-305(2) 8.37
Item 1, section 230-310 8.27
Item 1, subsection 230-310(1) 8.52
Item 1, paragraph 230-310(1)(b) 8.52
Item 1, paragraph 230-310(1)(c) 8.52
Item 1, subsection 230-310(3) 8.53
Item 1, paragraph 230-310(3)(b) 8.53
Item 1, paragraph 230-310(4)(a) 8.52
Item 1, paragraph 230-310(4)(b) 8.52
Item 1, paragraph 230-310(4)(c) 8.52
Item 1, subsection 230-310(5) 8.66
Item 1, subparagraph 230-310(5)(a)(i) 8.68
Item 1, subparagraph 230-310(5)(a)(ii) 8.68
Item 1, paragraph 230-310(5)(b) 8.68
Item 1, paragraph 230-310(5)(c) 8.68
Item 1, paragraph 230-310(5)(d) 8.68
Item 1, section 230-315 8.27
Item 1, subsection 230-315(1) 8.28
Item 1, paragraph 230-315(2)(a) 8.70
Item 1, paragraph 230-315(2)(b) 8.70
Item 1, paragraph 230-315(2)(c) 8.70
Item 1, subparagraph 230-315(2)(c)(ii) 8.81
Item 1, section 230-320 8.27
Item 1, section 230-335 8.82
Item 1, paragraph 230-320(a) 8.55
Item 1, paragraph 230-320(b) 8.55
Item 1, paragraph 230-320(c) 8.55
Item 1, subsection 230-325(1) 8.95
Item 1, subsection 230-325(2) 8.96
Item 1, section 230-330 8.98
Item 1, subsections 230-330(3), 230-260(2) and 230-390(2) 8.98
Item 1, subsection 230-340(2) 8.100
406
Index
Bill reference Paragraph number
Item 1, subsection 230-340(4) 8.100
Item 1, subsection 230-340(5) 8.100
Subitems 99(6) and 99(7) 8.30
Chapter 9: The elective financial reports method
Bill reference Paragraph number
Item 1, subsection 230-45(5) 9.44
Item 1, section 230-350 9.31
Item 1, paragraph 230-350(2)(c) 9.15
Item 1, paragraph 230-350(2)(c) and subsection 230-375(2) 9.62
Item 1, paragraph 230-350(2)(d) 9.19
Item 1, paragraph 230-350(2)(e) 9.20
Item 1, subsection 230-350(3) 9.21
Item 1, subsection 230-350(5) 9.43
Item 1, subsections 230-355(1) and (2) 9.23
Item 1, paragraph 230-360(1)(b) 9.40
Item 1, paragraph 230-360(1)(e) and subsection 230-360(2) 9.27
Item 1, paragraph 230-360(1)(f) and subsection 230-360(2) 9.28
Item 1, subsection 230-360(2) 9.29
Item 1, subsection 230-360(3) 9.39
Item 1, subsection 230-365(1) 9.42
Item 1, subsection 230-365(10) 9.33
Item 1, subsection 230-365(11) 9.34
Item 1, section 230-370 9.47
Item 1, subsection 230-370(2) 9.50
Item 1, section 230-375 9.55
Item 1, subsection 230-375(4) 9.52, 9.56
Item 1, section 230-380 9.59
Item 1, subsections 230-380(1) and (3) 9.58
Item 1, subsection 230-380(4) 9.53
Item 1, subsection 230-380(7) 9.30
Item 7, subsection 820-930(1) 9.42
407
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Chapter 10: Balancing adjustment on disposing of financial
arrangements
Bill reference Paragraph number
Item 1, subsection 230-305(1) 10.26
Item 1, paragraphs 230-385(1)(a) and (b) 10.15
Item 1, subparagraphs 230-385(1)(c)(i), (ii) and (iii) 10.18
Item 1, paragraph 230-385(3)(a) 10.17
Item 1, subsection 230-385(4) 10.29
Item 1, subsection 230-390(1) 10.20
Item 1, paragraph 230-390(3)(a) 10.22
Item 1, paragraphs 230-390(3)(c) and (d) 10.31
Item 1, subsection 230-390(4) 10.32
Item 1, subsection 230-395(1), steps 1(b) and (c) and 2(b) and (c) in 10.38
the method statement
Item 1, subsection 230-395(1), step 3 in the method statement 10.39
Item 1, subsection 230-395(2) 10.41
Item 1, subsection 230-395(3) 10.42
Item 1, subsection 230-395(4) 10.44
Item 1, subsection 230-395(5) 10.43
Item 1, subsection 230-395(6) 10.45
Item 1, section 230-420 10.33
Chapter 11: Interaction and consequential amendments
Bill reference Paragraph number
Item 1, subsection 230-15(2) 11.80
Item 1, subsection 230-140(3) 11.47
Item 1, subsections 230-195(3) and (4) 11.50
Item 1, subsections 230-240(3) and (4) 11.51
Item 1, subsections 230-370(3) and (4) 11.52
Item 1, subsection 230-430(1) 11.76
Item 1, subsection 230-430(2) 11.78
Item 1, section 230-400 11.10
408
Index
Bill reference Paragraph number
Item 1, section 230-440 11.30
Item 1, subsection 230-440(1) 11.34
Item 1, subsections 230-440(1) and (4) 11.33
Item 1, subsection 230-440(2) 11.39
Item 1, subsections 230-440(3) and (6) 11.41
Item 1, subsection 230-440(4) 11.35
Item 1, subsection 230-440(5) 11.40
Items 5 and 6 11.101
Item 11, definition of `Division 230 financial arrangement' in 11.21
subsection 995-1(1) of the Income Tax Assessment Act 1997
Item 29, definition of `special accrual amount' in 11.58
subsection 995-1(1) of the Income Tax Assessment Act 1997
Item 32, subsection 51AAA(2) of the Income Tax Assessment 11.68
Act 1936
Item 33, paragraph 82KZLA(a) of the Income Tax Assessment 11.11
Act 1936
Item 34, paragraph 96C(5A)(aa) of the Income Tax Assessment 11.16
Act 1936
Item 35, paragraph 102CA(2)(c) of the Income Tax Assessment 11.13
Act 1936
Item 36, definition of `hedging activity' in subsection 121D(8) of 11.88
the Income Tax Assessment Act 1936
Items 38 and 39, definition of `derivative transaction' in 11.89
section 160ZZV of the Income Tax Assessment Act 1936
Item 40, subsection 160ZZW(1A) 11.63
Items 41 and 42, subsection 160ZZX(2 of the Income Tax 11.65
Assessment Act 1936)
Item 43, paragraph 389(ba) of the Income Tax Assessment Act 1936 11.16
Item 44, paragraph 557A(c) of the Income Tax Assessment 11.16
Act 1936
Items 45 and 46 11.90
Item 47 11.91
Item 48, subsection 25-85(4A) 11.17
Item 49 11.18
Items 50 to 56 11.33, 11.91
Item 57, section 70-10 of the Income Tax Assessment Act 1997 11.20
Items 58 and 59 11.92
409
Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007
Bill reference Paragraph number
Items 59 and 60 11.91
Items 60 and 61 11.33
Item 62, subsection 118-27(1) 11.21, 11.23
Item 62, subsection 118-27(2) 11.25
Items 63 and 64, section 130-100 11.86
Items 65 to 79 11.70
Item 80, paragraph 295-85(2)(a) 11.14
Items 81 and 82 11.15
Item 83, subsection 715-660(1), item 3A in the table 11.54
Item 84, subsection 715-665(1), item 1A in the table 11.55
Items 85 and 86, subsection 775-170(2) 11.95
Items 87 and 89 11.97
Item 88, subsection 775-195(9) 11.95
Item 90, subsection 960-55(4) 11.95
Item 91 11.97
Item 92, subsection 960-60(6) 11.95
Item 93 11.97
Item 94, paragraph 77(1)(b) 11.99
Item 95 11.100
Item 96, subsection 45-120(2B) in Schedule 1 to the Taxation 11.74
Administration Act 1953
Subitem 99(16) 11.69
Chapter 12: Commencement, transitional and implementation
issues
Bill reference Paragraph number
Subitem 98(1) 12.7
Subitems 98(2) and (3) 12.8
Subitem 99(1) 12.9
Subitem 99(2) 12.10
Subitems 99(2) and (3) 12.11
Sub-subitems 99(4)(a) and (b) 12.11
410
Index
Bill reference Paragraph number
Subitem 99(5) 12.12
Sub-subitem 99(6)(a) 12.13
Sub-subitem 99(6)(b) 12.13
Sub-subitem 99(6)(c) 12.13
Sub-subitem 99(6)(d) 12.13
Subitem 99(7) 12.14
Subitem 99(8) 12.15
Subitem 99(9) 12.17
Subitem 99(10) 12.22, 12.32
Subitem 99(10), step 1 12.17
Subitem 99(10), step 2 12.17
Subitem 99(10), step 3 12.17
Subitem 99(10), step 4 12.17
Subitem 99(10), step 5 12.17
Subitem 99(10), step 6 12.17
Subitem 99(10), step 7 12.18
Subitem 99(14) 12.19, 12.34
Subitem 99(11) 12.27
Subitems 99(11) and (12) 12.25
Subitem 99(12) 12.30
Subitem 99(13) 12.31
Subitem 99(15) 12.17
Subitem 99(16) 12.35
411
Index]
[Search]
[Download]
[Bill]
[Help]