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2008
THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA
HOUSE OF REPRESENTATIVES
TAX LAWS AMENDMENT (TAXATION OF FINANCIAL ARRANGEMENTS) BILL 2008
EXPLANATORY MEMORANDUM
(Circulated by the authority of the
Treasurer, the Hon Wayne Swan MP)
Table of contents
Glossary 1
General outline and financial impact 3
Chapter 1 Background and framework 5
Chapter 2 Definition of 'financial arrangement' 27
Chapter 3 Tax treatment of gains and losses from financial arrangements
95
Chapter 4 The compounding accruals and realisation methods 129
Chapter 5 Elective Subdivisions: common requirements 203
Chapter 6 The elective fair value method 225
Chapter 7 The elective foreign exchange retranslation method 239
Chapter 8 The elective hedging financial arrangements method 261
Chapter 9 The elective financial reports method 299
Chapter 10 Balancing adjustment on disposing of financial arrangements
315
Chapter 11 Interaction and consequential amendments (other than
consolidation) 341
Chapter 12 Consolidation interactions 387
Chapter 13 Commencement, transitional and implementation issues 409
Chapter 14 Case studies 425
Chapter 15 Regulation impact statement 463
Index 485
Glossary
The following abbreviations and acronyms are used throughout this
explanatory memorandum.
|Abbreviation |Definition |
|AAS 25 |Australian Accounting |
| |Standard AAS 25 Financial |
| |Reporting by Superannuation |
| |Plans |
|AASB 7 |Australian Accounting |
| |Standard AASB 7 Financial |
| |Instruments: Disclosures |
|AASB 101 |Australian Accounting |
| |Standard AASB 101 |
| |Presentation of Financial |
| |Statements |
|AASB 108 |Australian Accounting |
| |Standard AASB 108 Accounting |
| |Policies, Changes in |
| |Accounting Estimates and |
| |Errors |
|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 |
|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 |
General outline and financial impact
Taxation of financial arrangements
This Bill amends the Income Tax Assessment Act 1997 by inserting
Division 230. 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 reports - 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 2010, unless a taxpayer elects to
apply the amendments to income years commencing on or after 1 July
2009.
Proposal announced: This proposal was announced in the then
Treasurer's Press Release No. 074 of 11 November 1999, the then
Minister for Revenue and Assistant Treasurer's Press Release No.
002 of 5 August 2004 and the Treasurer's Media Releases No. 53 and
No. 54 of 13 May 2008. 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, the then Minister for Revenue and Assistant
Treasurer's Press Release No. 001 of 3 January 2007 and the
Assistant Treasurer and Minister for Competition Policy and
Consumer Affairs' Media Release No. 082 of 1 October 2008.
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.
1. Chapter 1
Background and framework
Outline of chapter
2. Division 230 contains new rules for the taxation treatment of
financial arrangements.
3. 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?
4. 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.
5. 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.
6. 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 account the time value of money or provide for an
appropriate allocation of economic income over time.
7. 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. The current tax 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.
8. 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
9. 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 previous government's in-principle
support for those earlier TOFA recommendations.
10. 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
previous government introduced Division 974 of the Income Tax
Assessment Act 1997 (ITAA 1997).
11. 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.
12. In 2003, in response to uncertainty over the taxation of foreign
currency gains and losses, the previous 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.
13. 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 previous 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
14. The two overarching objectives underpinning Division 230 are
greater efficiency and the lowering of compliance costs.
15. 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.
16. 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.
17. 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.
18. 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 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.
19. 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), Australian Accounting
Standard AASB 127 Consolidated and Separate Financial Statements
(AASB 127) and Australian Accounting Standard AASB 137 Provisions,
Contingent Liabilities and Contingent Assets (AASB 137).
Summary of new law
20. 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.
21. 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.
22. 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
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.
23. This legislation does not apply to:
. financial arrangements of individuals 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;
. financial arrangements of superannuation funds (both
regulated and self managed), approved deposit funds,
pooled superannuation funds or an entity that is a managed
investment scheme for the purposes of the Corporations
Act 2001 where the value of the entity's assets are 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;
. 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 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; or
. financial arrangements of other entities:
- with an aggregated annual turnover of less than
$100 million;
- where the value of the entity's financial assets are
less than $100 million; and
- where the value of the entity's assets is less than
$300 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 |
|comprehensive set of |provisions exists for |
|principles and rules for|the taxation of |
|the tax-timing and |financial arrangements. |
|character treatment of |Comprehensive hedging |
|gains and losses from |rules and a general |
|financial arrangements. |retranslation treatment |
| |do not exist. There is |
|There are six tax |no fair value tax |
|methods: |treatment in the current|
|elective reliance on |law except in the |
|financial reports; |trading stock provisions|
|elective fair value; |which have limited |
|elective retranslation; |application. Rules of |
|elective hedging; |an ad hoc and relatively|
|accruals; and |limited nature apply to |
|realisation. |certain specific |
|There is a general |financial arrangements, |
|balancing adjustment for|namely to: |
|when an entity ceases to|accrue gains and losses |
|have a financial |of discounted and |
|arrangement. |deferred interest |
|Generally gains are |securities; |
|assessable and losses |assess gains and losses |
|are deductible. |on the disposal of |
|Not all taxpayers will |'traditional securities'|
|be subject to Division |such as bonds and |
|230. |debentures; |
| |allow a deduction for |
| |bad debts in certain |
| |circumstances; |
| |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
24. 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.
25. The Division 230 framework more closely aligns the recognition of
gains and losses on financial arrangements with commercial norms.
26. 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
27. 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
so-called 'mixed model' approach in financial accounting is an
inherent feature of the Division 230 framework.
28. 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).
29. 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.
30. 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.
31. 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.
32. 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.
33. Similarly, Division 230 allows elective tax treatment for
retranslation and hedging (see Chapters 7 and 8 respectively).
34. 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).
35. 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 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
36. 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.
37. 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 230-80]
38. 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
39. 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
40. 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);
. 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
41. A financial arrangement is the core unit upon which a tax liability
is determined under Division 230.
42. Subdivision 230-A provides the test for determining whether an
arrangement is a financial arrangement [Schedule 1, item 1, section
230-45]. In this context an arrangement consists of all the rights
and obligations (including contingent rights or obligations
[Schedule 1, item 1, section 230-85]), that are appropriately
considered to be part of the same arrangement. Section 230-55 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 230-55]. Importantly,
whether there is one or more arrangements takes into account normal
commercial understandings.
43. 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 230-45(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 230-45(2)].
44. 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.
45. An equity interest (such as an ordinary share) is also a financial
arrangement [Schedule 1, item 1, paragraph 230-5(2)(b) and section
230-50], 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 230-40(4)(e)].
46. 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 230-450]. More complex financial arrangements
include hybrid financial arrangements.
47. 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 and arrangements, 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), means that most construction contracts,
contracts for the provision of services and arrangements known as
farm-out arrangements will generally be excluded from the operation
of Division 230.
48. 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-J. These are:
. foreign currency;
. non-equity shares; and
. commodities and offsetting commodity contracts held by
traders.
[Schedule 1, item 1, Subdivision 230-J]
49. Chapter 2 explains what arrangements meet the definition of a
'financial arrangement' or are otherwise treated as financial
arrangements.
Determine whether an exclusion applies to the arrangement
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 230-455];
. financial arrangements held by entities whose business is
essentially financial in nature with less than $100
million in assets or $20 million aggregated annual
turnover;
. or other entities (other than individuals) with:
- less than $100 million aggregated annual turnover;
- less than $100 million in financial assets; and
- less than $300 million in assets;
. 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-
455];
. short-term financial arrangements where a non-monetary
amount (property, goods or services) is involved [Schedule
1, item 1, section 230-450]; and
. gains on the forgiveness of commercial debts [Schedule 1,
item 1, section 230-470].
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 of the ITAA 1936 applies,
arrangements to which section 121EK of the ITAA 1936 applies, a
right to receive (or obligation to provide) a farm management
deposit where the taxpayer is the owner of that deposit and
interests in forestry-managed investment schemes which are
deductible under Division 394 of the ITAA 1997. The list of
specific exclusions may be added to by regulation. [Schedule 1,
item 1, section 230-460 and subsections 230-475(3) and (4)]
52. If an arrangement is excluded, other provisions of the tax law may
apply to the arrangement.
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
54. One or more of the following tax methods applies to every financial
arrangement that is subject to Division 230:
. Non-elective 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 [Schedule 1, item 1,
Subdivision 230-F].
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.
Diagram 1: Hierarchy of tax treatments (excluding balancing
adjustments)
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 230-245, 230-290 and 230-430].
57. The tax methods determine the basis for calculating what amounts
are assessable or deductible in each income year. [Schedule 1,
item 1, section 230-40]
Elective fair value method
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 elected, the method applies to all
financial arrangements 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 230-245].
59. Chapter 6 explains the fair value method in more detail.
Elective foreign exchange retranslation method
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, are reported in a relevant financial report
prepared and audited in accordance with relevant
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].
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.
62. The foreign exchange retranslation method only applies where the
taxpayer elects to apply it.
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
retranslation election ceases to have effect [Schedule 1, item 1,
section 230-290]. 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.
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 of the ITAA 1997.
Elective hedging method
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 can 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.
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 230-440(2)]
67. Chapter 8 explains the elective hedging method in detail.
Election to rely on financial reports
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.
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.
70. Further, the election can only apply to a financial arrangement if
it is reasonably expected that the difference between the amount of
the 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]
71. A balancing adjustment is required when the election to rely on
financial reports ceases to apply. [Schedule 1, item 1, section
230-430]
72. Chapter 9 explains the financial reports election in detail.
Compounding accruals and realisation methods
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
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 230-100, 230-105, 230-115 and 230-
135]
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 230-185
and 230-190]
76. These are special accruals rules in respect of premiums, discounts
and fees associated with certain financial arrangements where the
arrangements are part of a portfolio of similar financial
arrangements where the net amount of the premium, discount of fees
is not significant. [Schedule 1, item 1, sections 230-150, 230-160
and 230-165]
77. 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 230-175]
78. Chapter 4 explains the compounding accruals method in more detail.
Realisation method
79. 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 230-40(4)
and 230-100(5) and section 230-180]
80. Chapter 4 explains the realisation method in more detail.
Available choices among the tax treatments
81. 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 230-40(1), Subdivision 230-G]
82. 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 230-40(1)]
83. 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, subsections 230-40(2) and (7)]
84. 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 230-40(5)]
85. 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 230-235]
86. 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 230-40(6)]. If
the retranslation method and other elective methods do not apply,
the foreign currency gain or loss may be taxed on a realisation
basis.
87. 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 230-40(4)]
88. 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 230-50(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 230-40(4)(e) and sections 230-270 and 230-330]
89. 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 230-100(5)]
If the year is the final holding year, work out any gain or loss from
ceasing to have the financial arrangement
90. 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 230-435 and subsection 230-40(1)]. Chapter 10 addresses
the treatment of gains and losses from ceasing to hold a financial
arrangement.
Integrity rules
Consistency
91. 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 230-80]
Value shifting
92. Broadly, the value shifting rules prevent inappropriate tax
consequences where, under a scheme, value is shifted from equity or
loan interests. Gains which are reduced, or losses which are
increased, in this manner are to be disregarded under Division 230
in determining tax outcomes for financial arrangements. [Schedule
1, item 1, section 230-520]
Arm's length rules
93. Broadly, Division 230 will incorporate arm's length rules that are
consistent with those that apply to arrangements not covered by the
Division. [Schedule 1, item 1, sections 230-510 and 230-515]
Application and transitional provisions
94. The rules will apply to financial arrangements acquired on or after
the first day of the first income year starting on or after 1 July
2010. A taxpayer may also elect to apply the rules to financial
arrangements acquired on or after the first day of the first income
year starting on or after 1 July 2009.
95. 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. There are also special transitional balancing
adjustment rules for arrangements subject to Subdivision 775-F (see
Chapters 7 and 13). 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 102 to 105]. 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 104(10)].
Chapter 13 explains the application and transitional provisions in
more detail.
Chapter 2
Definition of 'financial arrangement'
Outline of chapter
96. 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.
97. This chapter sets out:
. the meaning and scope of the term 'financial arrangement';
. which financial arrangements are specifically excluded
from the operation of Division 230; and
. the additional operation of Division 230 to certain
things.
Overview of the definition of 'financial arrangement'
98. A Division 230 financial arrangement is an arrangement where the
rights and obligations under that arrangement are cash settlable.
99. Besides financial arrangements, Division 230 will also apply to
certain arrangements that are not financial arrangements but have
very similar characteristics. For example, foreign currency and
non-equity shares.
100. However, the gains and losses from certain financial arrangements,
such as some short term arrangements arising out of the provision
of goods or services, and arrangements held by individuals and
small business, where there is no significant deferral of gains,
will generally not be subject to tax under Division 230.
101. Often, the time to determine whether an arrangement is a financial
arrangement will be at the time the arrangement comes into
existence or commences to be held. However, Division 230 also
provides for testing throughout the life of arrangements.
Cash settlable rights and obligations
102. In the context of Division 230, obligations and rights are cash
settlable where they may be settled by money or money equivalent.
103. Basically, money is cash or a unit of Australian currency. A money
equivalent typically sounds in money and has a liquidity that is
similar to that of cash. Examples of money equivalent include
bonds and loans.
104. However, an arrangement will not be a financial arrangement if the
cash settlable rights and obligations are insignificant compared to
other rights and obligations under the arrangement or if the cash
settlable rights and obligations no longer exist.
Additional operation of Division 230
105. Division 230 extends to certain assets and contracts that would not
ordinarily come within the definition of a Division 230 financial
arrangement. While these assets and contracts may not be cash
settlable financial arrangements, they share some of the key
characteristics of such arrangements, for example because of their
money-like nature or the way they are dealt with by relevant
parties to the arrangement.
106. The additional operation of Division 230 applies to:
. equity interests;
. foreign currency;
. non-equity shares in companies; and
. certain commodities and offsetting commodity contracts.
107. Equity interests that are financial arrangements are only subject
to either the elective fair value method or the election to rely on
financial reports and in limited circumstances the elective tax
hedge method.
Specifically excepted gains and losses of certain financial arrangements
108. Division 230 does not apply to certain gains or losses made from a
financial arrangement for compliance cost or other policy reasons.
Such arrangements include:
. short term arrangements where amounts that are not money
for example, short term trade credit; and either:
- a financial arrangement that is given in exchange for
property or services;
- an arrangement where there is 12 months or less delay in
payment after receipt of property or services;
- arrangement is not a cash settlable financial
arrangement;
- arrangement is not a derivative financial arrangement;
or
- a fair value election does not apply to the arrangement;
or
. arrangements held by individuals and entities that satisfy
the threshold tests where there is no significant deferral
of tax.
109. There are also exceptions for various rights and/or obligations
including those in respect of:
. leasing arrangements;
. an asset to which Division 250 of the Income Tax
Assessment Act 1997 (ITAA 1997) applies;
. interests in partnerships and trust;
. life insurance policies;
. general insurance policies;
. certain worker's compensation arrangements;
. certain guarantees and indemnities;
. personal arrangements and personal injury:
- personal services;
- deceased estates;
- gifts under deed;
- personal injury; or
- injury to reputation;
. superannuation and pension income;
. interests in a foreign investment fund, foreign life
policy or a controlled foreign company;
. proceeds from certain business sales including 'earn-
outs';
. infrastructure borrowings;
. farm management deposits;
. deemed interest payments to owners of offshore banking
units;
. forestry managed investment schemes;
. ceasing to hold financial arrangements in certain
circumstances;
. forgiveness of commercial debts; or
. franked distributions.
110. Gains and losses from certain financial arrangements are excluded
from Division 230 for the avoidance of doubt. They include
retirement village residence contracts, retirement village services
contracts and provision of residential or flexible care.
Context of amendments
What is a financial arrangement?
111. Financial innovation has created an endless variety of arrangements
under which finance is provided or risk is shifted. The
characteristics of such arrangements can mean that arrangements
similar in 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.
112. 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 ITAA 1997.
113. 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.
114. 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.
115. 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.
116. 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.
117. 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.
118. 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 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.
119. 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.
120. Collectively, these rights and obligations are described in
Division 230 as 'cash settlable'.
121. 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.
122. 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.
Additions and exceptions
123. 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.
124. 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 and offsetting commodity contracts in
certain circumstances.
125. 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.
126. 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.
127. 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.
128. The Board of Tax's 'review of foreign source income anti-tax
deferral rules' is currently considering the operation of the tax
law in relation to interests held in controlled foreign companies
as well as foreign investment funds and non-resident trusts more
widely. Consequently, how Division 230 should apply in relation to
interests in these entities will receive further consideration in
the light of outcomes of that review.
Unit of taxation
129. 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).
130. A financial arrangement is an arrangement which at the relevant
time satisfies the definition of financial arrangement under
Division 230.
131. 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.
132. 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
133. 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).
134. 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
. 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.
135. 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.
136. Division 230 also provides for various exceptions which take gains
and losses from certain financial arrangements outside the scope of
the Division.
Comparison of key features of new law and current law
|New law |Current law |
|The definition of |There is no |
|'financial arrangement' |comprehensive definition|
|is based on rights to |of financial |
|receive, or obligations |arrangement, which |
|to pay, financial |creates gaps, |
|benefits that are cash |distortions and |
|settlable. |anomalies in tax |
|Specific additions |treatments. |
|include certain | |
|arrangements that have a| |
|similar effect or | |
|operation to these | |
|financial arrangements. | |
|Some financial |Certain types and |
|arrangements have their |classes of financial |
|gains and losses |arrangements are not |
|excluded from the |specifically addressed. |
|operation of Division | |
|230 for compliance, | |
|administrative or other | |
|policy reasons. | |
|Arrangements comprising |Arrangements are |
|a number of different |generally treated based |
|rights and obligations |on legal form. |
|are generally determined| |
|on a stand-alone | |
|contractual basis where | |
|the form of the contract| |
|is consistent with its | |
|substance. | |
|The ability to cope with|It is inadequate to deal|
|financial innovation is |with financial |
|increased. |innovation. |
Detailed explanation of new law
137. 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 230-45 and 230-50]
The arrangement that is being tested
138. Before it can be decided whether either of the tests for a
financial arrangement are satisfied, the particular arrangement
being tested must be determined.
139. 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.
140. 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 230-55(4)]
141. 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.
142. 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.
143. 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.
144. 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.
145. 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 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 230-55(4)]
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
230-55(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.
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 230-55(4)).
Whether or not Hamish Co's convertible note arrangement is a
financial arrangement is considered later in this chapter,
in Example 2.17.
3. : CPI index-linked bond
At the end of the 2012 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 2017 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 230-55(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 Hope 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.
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-
55(4), be treated as being the one arrangement for the
purposes of Division 230.
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 230-55(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.
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 230-55(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.
. 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-
55(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
146. 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 230-55(1) and (2)]
1. : Interest bearing bank account
Retailer Pty Ltd opens a current account with Bank Ltd on 1
July 2013. 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 30 June 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 each dollar that
comprises the balance of the account (subsection 230-55(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 230-55(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 Division 230.
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?
147. 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 230-45 and 230-50]
Cash settlable financial arrangement
Background
148. 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.
149. 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.
150. 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.
151. 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.
152. 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.
153. 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.
154. 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.
155. 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 230-45, 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?
156. An entity has a cash settlable financial arrangement where, under
an arrangement:
. 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 230-45(1)]
157. 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 arrangement (however, see
paragraph 2.63). 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 230-55.
Additional rights and obligations or financial benefits may be
taken into account
158. The financial arrangement as defined will only comprise the cash
settlable rights to receive, and obligations to provide, financial
benefits under the arrangement. Often, whether the cash settlable
rights or obligations to financial benefits are received or
provided under the particular financial arrangement can be
determined by reference to the contractual terms of the
arrangement. Although, the concept of what is the arrangement can
be modified by the application of subsection 230-55(4). This is
determined on a case by case basis. 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. These rules operate only for the
purpose of assisting in working out any gain or loss from the
financial arrangement and are not intended to broaden what
constitutes the financial arrangement as determined under
section 230-45 or 230-50. The rules are described in more detail
in Chapter 3. [Schedule 1, item 1, section 230-60]
Relevant rights and obligations
159. 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.
160. 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 230-85]
161. 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.
162. 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
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
163. 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
164. 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 230-45(2)(a)]
165. 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)]
166. 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.
167. Money in its simplest form is a unit of Australian 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.
1. : 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 2012. 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'.
2. : 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).
Whether or not Kramer Co's arrangement is a cash settlable
financial arrangement is discussed in Example 2.17.
Non-monetary financial benefits
168. 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)
169. 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. The test of the taxpayer's intention is an objective
one, and confirms the economic substance of such an arrangement.
[Schedule 1, item 1, paragraph 230-45(2)(c)]
170. 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 230-45(2)(b)]
171. 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-
45(2)(b) and (c)]
172. 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 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
173. 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, 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. [Schedule 1,
item 1, paragraph 230-45(2)(d)]
1. : 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.
2. : 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 four
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
174. 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).
175. 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 230-45(2)(e)]
176. 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.
177. 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 230-45(2)]
Highly liquid rights and/or obligations readily convertible into
money or money equivalent
178. 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
. 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-
45(2)(f) and subsection 230-45(3)]
179. 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,
paragraphs 230-45(3)(a) and (b)]
Purpose of converting
180. 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 230-45(3)(c)(ii)]
Set value
181. 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 230-45(3)(c)(i)]
1. : 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. This is
because 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 230-45(2)(f)
and subparagraph 230-45(3)(c)(ii)).
Example 2.17 explains that Henry Group Ltd's arrangement
under the forward contract is a cash settlable 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 230-45(2)(f) and subparagraph 230-
45(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
182. 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, 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 230-45(2)(g)]
183. 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. The test of the
taxpayer's intention is an objective one. [Schedule 1, item 1,
paragraph 230-45(2)(g)]
1. : An obligation is not cash settlable merely due to an ability to
cash settle
On 1 June 2011, Cereal Co enters into a forward contract
with Corn Co-operative to deliver on 20 June 2012, 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.
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.
2. : 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 230-45(2).
As explained in Example 2.17, this has the effect that
Commercial Textile Co's arrangement is not a cash settlable
financial arrangement.
184. 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.
1. : 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 under subsection 230-455(7)).
In addition to her main business transactions, Yvonne is
awarded points as part of a consumer loyalty program ('the
program') of which she is a member. Under the terms of the
program, 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 program.
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 program 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 program (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 program, 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
185. An arrangement (as determined under section 230-55) 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 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 230-45(1)(d) to (f)]
186. 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. [Schedule 1, item 1,
subsection 230-45(1) and section 230-60]
187. 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 settlable, rights or obligations under the
arrangement subsist and are not insignificant when compared to the
cash settlable 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-
45(1)(d) to (f)]
188. 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'.
1. : No financial arrangement where there is an outstanding non-
monetary benefit
Bill Co enters into an agreement on 1 July 2011 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.
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.
189. 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.
190. 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.
Testing time for the existence of a financial arrangement
191. 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.
192. 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, but at a later point in
time only the monetary or non-monetary financial benefits exist.
193. 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.
1. : 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 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
(refer to discussion on exemptions from Division 230 for
certain financial arrangements).
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.
2. : 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 settlable 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-
45(1) and paragraph 230-45(2)(g)).
If Hamish Co's convertible note is also an equity interest,
it will satisfy the definition of an 'equity financial
arrangement' (see subsection 230-50(1)), and therefore will
only be subject to a limited operation of Division 230
(refer to discussion on the limited operation of Division
230 to 'equity financial arrangements').
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 230-45).
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 230-45).
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 230-45).
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 settlable' right to a
financial benefit because the benefit is money (paragraph
230-45(2)(a)).
Retailer Pty Ltd's rights under its bank account therefore
comprise a cash settlable financial arrangement (section 230-
45).
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 230-45).
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-
45).
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 230-45).
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 230-45(1)(d) to (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 230-45, 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 230-45).
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 230-45(1)(d) to (f)).
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 230-45).
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 230-45.
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
194. An 'equity interest', as defined in the ITAA 1997, is also a
financial arrangement. [Schedule 1, item 1, subsection 230-50(1)]
195. 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)]
196. Once determined under these other provisions of the ITAA 1997, an
equity interest in its entirety will constitute a relevant
financial arrangement under subsection 230-50(1). [Schedule 1,
item 1, subsection 230-50(1)]
197. An equity interest will comprise a financial arrangement under
subsection 230-50(1), even if it comprises an arrangement that
fails to satisfy the definition of a financial arrangement under
section 230-45. 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.
Financial arrangements consisting of a right or obligation to an
equity interest
198. 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 230-45. [Schedule 1,
item 1, subsection 230-50(2)]
199. 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 subsection 230-45(1). [Schedule 1, item 1, paragraph 230-
50(2)(b)]
200. 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. [Schedule 1, item 1, subsection 230-50(2)
and section 230-60]
Limited scope of Division 230 to equity financial arrangements
201. 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.
202. 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, paragraphs 230-
5(2)(b) and 230-40(4)(e)];
. a foreign exchange retranslation election in
Subdivision 230-D [Schedule 1, item 1, subsection 230-
270(1), paragraph 230-5(2)(b))]; 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, subsections 230-300(7) and
(8) and 230-330(1), paragraph 230-5(2)(b)].
203. In addition, an equity financial arrangement will only be subject
to a fair value election under Subdivision 230-C (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) and/or, in very limited circumstances, the
hedging financial arrangement election under Subdivision 230-E
(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 (except where
the equity financial arrangement is a foreign currency
hedge under subsections 230-300(7) and (8).
[Schedule 1, item 1, paragraphs 230-220(1)(c) and 230-410(1)(d),
subsections 230-225(1), 230-300(7) and (8) and 230-415(1)]
204. 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 230-440(1)]
205. 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
206. 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-
530(1)];
. non-equity shares in companies [Schedule 1, item 1,
subsection 230-530(2)];
. 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-
530(3)]; and
. offsetting commodity contracts that are entered into for
the purpose of dealing in a commodity through the
performance of offsetting contracts, and fair valued
through profit or loss for accounting purposes [Schedule
1, item 1, subsection 230-530(4)],
as though these assets were a right that constituted a financial
arrangement or, with respect to offsetting commodity contracts, the
contracts were a financial arrangement.
207. The extended operation of the Division to these assets and
offsetting contracts is directed at ensuring that these
arrangements are not inappropriately excluded from the scope of
Division 230. While they may not be cash settlable financial
arrangements, they share some of the characteristics of such
arrangements, for example because of the money-like nature of the
way in which they are dealt with by the relevant party to the
arrangement.
208. These specific inclusion provisions operate to treat:
. foreign currency as a right that constituted a financial
arrangement [Schedule 1, item 1, subsection 230-530(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 Income
Tax Assessment Act 1936 (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 230-530(2)]; and
. a commodity as if the commodity were a right that
comprised a financial arrangement where all of the
following are satisfied [Schedule 1, item 1, subsection
230-530(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).
209. Division 230 also applies to a contract to which a taxpayer is a
party as if the contract were a financial arrangement if:
. the taxpayer has a right to receive or an obligation to
provide a commodity under the contract;
. the taxpayer has a practice of dealing in the commodity
using offsetting contracts of that nature;
. the taxpayer does not have, as their sole or dominant
reason for entering into the contract, the purpose of
receiving or delivery the commodity as part of the
taxpayer's expected purchase, sale or usage requirements;
. the fair value method or the financial reports method
applies to financial arrangements that a taxpayer starts
to have when they enter into the contract; and
. the contract is an asset or liability that the taxpayer is
required by accounting standards or comparable foreign
accounting standards to classify or designate in their
financial reports as at fair value through profit or loss.
[Schedule 1, item 1, subsection 230-530(4)]
Specific disaggregation provisions
210. 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-
235]
Exceptions for certain financial arrangements
211. 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
212. 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 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
213. 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.
[Schedule 1, item 1, paragraph 230-450(b)]
No more than 12 months delay in payment
214. 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 230-450(c)]
The arrangement is not a derivative financial arrangement
215. The financial arrangement is not a derivative financial arrangement
for any income year [Schedule 1, item 1, paragraph 230-450(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.
[Schedule 1, item 1, subsection 230-350(1)]
The fair value election does not apply
216. The fair value election does not apply to the financial arrangement
[Schedule 1, item 1, paragraph 230-450(e)]. For a discussion of
the fair value election, see Chapter 6.
1. : 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 230-45).
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, the
gains or losses arising from these financial arrangements
will be disregarded for Division 230 purposes (pursuant to
section 230-450).
2. : 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.
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 are involved, unless it is a
derivative financial arrangement (section 230-450).
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 230-450(d) and subsection 230-350(1)).
217. 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.)
Entities that satisfy relevant threshold test where there is no
significant deferral
218. For compliance cost reasons, gains and losses from financial
arrangements of individuals and those entities that satisfy the
relevant threshold test will not be subject to Division 230, except
to the extent that:
. the financial arrangement is a qualifying security with a
remaining term of more than 12 months at the time the
taxpayer started to have it; or
. the taxpayer has made an election to have Division 230
apply to all their financial arrangements, and the
taxpayer started to have the financial arrangement in or
after the year of making that election.
219. To have gains and losses from financial arrangements subject to
this exception, the taxpayer must be :
. an individual;
. a superannuation entity (within the meaning of section 10
of the Superannuation Industry (Supervision) Act 1993), a
managed investment scheme (within the meaning of the
Corporations Act 2001) or an entity with a similar status
to such a scheme under a *foreign law relating to
corporate regulation with assets of less than $100
million;
. 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 (hereafter referred to as financial entities); or
. any other entity whose:
- aggregated turnover is less than $100 million; and
- financial assets are worth less than $100 million; and
- assets (including both financial and non-financial
assets) are worth less than $300 million.
[Schedule 1, Part 1, section 230-455]
220. The following paragraphs elaborate on the meaning of the threshold
tests as they apply to particular entities.
Superannuation entities and managed investment schemes
221. Superannuation funds or managed investment schemes or similar
entities are required to apply a threshold test based on the value
of assets reported in their financial statements in accordance with
Australian Accounting Standard 25 Financial Reporting by
Superannuation Plans (AAS 25).
222. To have gains and losses from financial arrangements subject to
this exception, the entity must:
. be a superannuation entity (within the meaning of section
10 of the Superannuation Industry (Supervision) Act 1993);
or
. be a managed investment scheme (or similar entity under a
foreign law related to corporate regulation); and
. hold assets with a total value of less than $100 million,
determined in accordance with AAS 25, other relevant
accounting standards or commercially accepted valuation
principles.
223. For the purpose of this exception, the timing of the assets test is
specified, and may vary for different entities. An entity
determines whether or not it meets this assets test for a
particular income year (the relevant income year) for the purpose
of this exception based on:
. its assets as reported at years end in the immediately
preceding income year, (worked out at the end of that
income year); or
. where the entity only came into existence during the
particular income year, the value of its assets is worked
out at the end of that relevant income year.
[Schedule 1, Part 1, subparagraph 230-455(1)(a)(ii), paragraph 230-
455(1)(b), subsection 230-455(2)]
Financial entities
224. Financial entities are required to apply a threshold test based on
that entity's aggregated turnover as defined in Division 328 of the
ITAA 1997.
225. To have gains and losses from financial arrangements subject to
this exception, the entity must:
. be a financial entity (see above for entities included in
this category); and
. have aggregated turnover of less than $20 million worked
out under Division 328 of the ITAA 1997.
[Schedule 1, Part 1, subparagraph 230-455(1)(a)(iii), paragraph 230-
455(1)(c), subsection 230-455(3)]
What is an entity's aggregated turnover?
226. '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 is
based on the ordinary income the entity derives for an income year
in the ordinary course of carrying on a business plus the sum of
the relevant annual turnovers (adjusted in particular
circumstances) of the entity, its connected entities and
affiliates.
227. This definition also ensures that where an entity does not carry on
a 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.
Timing for the application of the aggregated turnover test
228. 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); 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, Part 1, section 230-455]
Other entities
229. All other entities of a type that have not been discussed above
(and are not individuals) are required to apply a threshold test
based on their aggregated turnover, financial assets they hold, and
all assets they hold (including both financial and non-financial
assets).
230. To have gains and losses from financial arrangements subject to
this exception, the entity must:
. not be an entity of the kind discussed above (and not be
an individual);
. have aggregated turnover of less than $100 million worked
out under Division 328 of the ITAA 1997 (see above for a
discussion on the meaning of aggregated turnover);
. hold financial assets with a total value of less than
$100 million, determined in accordance with AAS 25, other
relevant accounting standards or commercially accepted
valuation principles; and
. hold assets (including both financial and non-financial
assets) with a total value of less than $100 million,
determined in accordance with AAS 25, other relevant
accounting standards or commercially accepted valuation
principles.
[Schedule 1, Part 1, section 230-455]
Timing for the application of the threshold tests
231. 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 threshold test
for a particular (the relevant income year) for the purpose of this
exception based on:
. it meeting the threshold in the immediately preceding
income year, (worked out at the end of that income year);
or
. where the entity only came into existence during the
particular income year, it meeting the threshold test as
worked out at the end of that relevant income year.
[Schedule 1, Part 1, section 230-455]
Qualifying securities of more than 12 months
232. Gains and losses from a financial arrangement of an individual or
entity falling below the relevant threshold test may still be
subject to Division 230 where that arrangement is a 'qualifying
security' within the meaning of Division 16E of the ITAA 1936.
[Schedule 1, item 1, paragraph 230-455(1)(e)]
233. 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.
234. Where an individual or entity falling below the relevant threshold
test 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 230-455, 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 230-455(1)(e)]
Irrevocable election to have Division 230 apply to all financial
assets and liabilities
235. Taxpayers 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 230-455(6) to (8)]
236. Entities (other than individuals) who become subject to
Division 230 in respect of all of their gains and losses from
financial arrangements will continue to have Division 230 apply
notwithstanding that the entities turnover or assets may fall below
the thresholds set out in subsections 230-455(2), (3) or (4)
[Schedule 1, Part 1, subsection 230-455(9)]. Where this happens,
Division 230 will continue to apply to all of that entities
existing and new financial arrangements. The object of this
provision is to ensure that, once the entity becomes subject to
Division 230, it does not have to continually test whether Division
230 continues to apply to its financial arrangements. In addition,
it will ensure that entities whose turnover or assets fluctuate
above or below the relevant thresholds over time are not exposed to
balancing adjustment and other consequences that otherwise arise as
a consequence of having financial arrangements subject to Division
230 one year and not the next.
Exceptions for various rights and/or obligations
237. 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.
Leasing or property arrangement
238. 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-
460(2)(a)];
. sale and loan arrangements to which Division 240 of the
ITAA 1997 applies [Schedule 1, item 1, paragraph 230-
460(2)(b)];
. an arrangement dealing with assets put to tax preferred
use to which Division 250 of the ITAA 1997 applies
[Schedule 1, item 1, paragraph 230-460(2)(c)]; 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, real property, or intellectual property
[Schedule 1, item 1, paragraphs 230-460(2)(d) and (e)].
239. 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.
240. 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 for tax purposes. Division
230 will not disturb the tax treatment of arrangements subject to
Division 240.
241. Division 250 of the ITAA 1997 operates to deny or reduce certain
capital allowance deductions that would otherwise be available in
relation to an arrangement that relates to an asset where the asset
is put to a tax-preferred use. For Division 250 to apply to an
asset, the taxpayer does not have a predominant economic interest
in the asset at the test time and:
. the asset must be put to a tax-preferred use;
. the arrangement period for the preferred use is greater
than 12 months;
. the financial benefits in relation to the preferred use
will be provided to the taxpayer by a tax-preferred end-
user, or a tax-preferred entity, or a non-resident;
. there will be an entitlement to a capital allowance
deduction for the decline in value of the asset or for
expenditure in relation to the asset; and
. the taxpayer lacks a predominant economic interest in the
asset at the time.
Where Division 250 applies to an arrangement in relation to an
asset, the arrangement is treated as a loan and Division 230
will not disturb the tax treatment of that arrangement.
242. The fourth category under this exclusion broadly covers licences
and leases over goods (other than money or a money equivalent),
real property, and intellectual property.
243. 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
244. A right 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, or the
right or obligation relating to a trust is managed by a funds
manager, custodian or 'responsible entity' of a registered scheme
[Schedule 1, item 1, subsection 230-460(3)]. 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.
245. 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).
246. 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 the same funds manager, custodian or responsible entity.
[Schedule 1, item 1, paragraph 230-460(3)(c)]
247. 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 230-460(4)]
Certain insurance policies
248. 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 230-460(5) and (6)]
249. 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.
250. 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.
251. The exception, preventing Division 230 from applying, 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.
Exception for life insurance policies
252. 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 230-460(5)].
253. 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 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.
254. 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 the ITAA 1936 (as these annuities are
not qualifying securities).
255. 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.
1. : A life insurance policy that is subject to exception
Bianca is an individual who has elected under subsection 230-
455(7) 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 230-460(5),
Division 230 will not apply to any gain or loss that Bianca
makes under the policy.
Exception for general insurance policies
256. 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-
460(6)]
257. 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.
258. 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, injury, accidental damage,
negligence, storm and professional indemnity insurance.
259. 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
260. 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 230-460(7)]
261. 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
262. 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-
460(8)(a)];
. the financial arrangement is a derivative financial
arrangement for any income year [Schedule 1, item 1,
paragraph 230-460(8)(b)]; or
. the actual guarantee or indemnity is itself given in
relation to another financial arrangement [Schedule 1,
item 1, paragraph 230-460(8)(c)].
263. 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.
1. : Cash settlable guarantee
On 1 September 2012 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
2012. 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 230-45(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.
264. 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-
460(8)(c)]
Personal arrangements and personal injury
265. 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
266. 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-
460(9)(a)]. Personal services are broadly the provision of
personal effort, labour or skill of an individual.
Deceased estates
267. 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 230-460(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
268. 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 230-460(9)(c)]
Maintenance amounts
269. 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-
460(9)(d)]
270. 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
271. 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-
460(9)(e)]. Personal injury includes any injury or disease
sustained to an individual's person.
272. 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 230-460(10)]
Injury to reputation
273. 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-
460(9)(f)]. Such rights or obligations may arise, for example,
from defamation actions.
Superannuation and pension income
274. 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, an
approved deposit fund or a retirement savings account. [Schedule
1, item 1, subsection 230-460(11)]
275. 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
276. 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 230-460(12)]
277. 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.
278. These relevant interests in foreign investment funds and controlled
foreign companies are in a broad sense akin to equity interests.
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
279. 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 230-460(13)]
280. This exception applies to exclude arrangements commonly known as
'earn-outs'.
281. 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 230-55(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
282. 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 respect of previously issued certificates can be
traded or novated, so can start to become new arrangements in the
hands of different taxpayers.
283. 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.
284. 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.
285. 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.
286. 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 of the ITAA 1936, as appropriate. [Schedule 1, item
1, subsection 230-460(14)]
Farm management deposits
287. 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 230-460(15)]
288. 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 set aside income from profitable years for subsequent
'draw-down' in low-income years.
289. 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 of the ITAA 1936
applies
290. 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-
460(16)]
Forestry managed investment schemes
291. 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).
292. 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 of the ITAA 1997. [Schedule 1, item 1, subsection 230-
460(17)]
Regulation-making power for exceptions
293. Subsection 230-460(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-
460(18)]
Ceasing to hold financial arrangements in certain circumstances
294. Section 230-465 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.
295. Section 230-465 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);
. if the financial arrangement is a marketable security
within the meaning of section 70B of the ITAA 1936:
- the taxpayer did not acquire the marketable security 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;
- the taxpayer did not dispose of the marketable security
arrangement in the course of trading on a securities
market; and
. it would be concluded that the taxpayer ceased to have the
financial arrangement (whether a marketable security or
not) 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 230-465(1)]
296. 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.
297. 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 230-465(3)]
298. Where section 230-465 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 capital gains tax provisions of the ITAA 1997. [Schedule
1, item 1, subsection 230-465(2)]
Forgiveness of commercial debts
299. 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 of the ITAA 1936 - 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 230-470]
Exceptions by way of clarification only
300. 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 230-475(3)]
301. 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 230-45(1).
Retirement village residence contracts
302. A right or obligation arising under a 'retirement village residence
contract' is the subject of an exception. [Schedule 1, item 1,
paragraph 230-475(3)(a)]
303. 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 230-475(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
. 'commercial residential premises' as defined in
section 195-1 of the A New Tax System (Goods and Services)
Act 1999.
Retirement village services contracts
304. A right or obligation arising under a 'retirement village services
contract' is the subject of an exception [Schedule 1, item 1,
subsection 230-475(1), paragraph 230-475(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-
475(4)(b)].
Provision of residential or flexible care
305. 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 230-475(1),
paragraph 230-475(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.
306. '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.
Exception for gains in the form of franked distributions
307. Division 230 does not apply to gains to the extent they are gains
in the form of a franked distribution or a right to receive a
franked distribution. [Schedule 1, item 1, section 230-480]
308. Chapter 3
Tax treatment of gains and losses from financial arrangements
Outline of chapter
309. This chapter explains:
. why Division 230 recognises gains and losses rather than,
for example, receipts and outgoings;
. the revenue character of those gains and losses;
. the elements of a gain or loss; and
. which gains and losses are disregarded.
Overview of taxation of financial arrangements gains and losses
310. This overview summarises the tax treatment of gains and losses from
financial arrangements.
311. Gains and losses from financial arrangements are important for the
purposes of Division 230 because the tax treatment of financial
arrangements depends on gains and losses made from them and not,
for example, on receipts and outgoings. Thus, a taxpayer subject
to Division 230 may be required to include a gain in their
assessable income and may be allowed a deduction for a loss where
it is made in deriving or producing assessable income or in
carrying on business for the purpose of deriving assessable income.
312. This means that a net amount, for example, the money received (the
proceeds) minus the money provided (the cost) under a financial
arrangement may be included as assessable income when that net
amount is a gain and claimed as an allowable deduction when that
net amount is a loss.
313. Basically, the cost of a financial arrangement will be the total of
the financial benefits provided, or to be provided, to acquire such
an arrangement. Conversely, the proceeds from a financial
arrangement will be the total of the financial benefits received
from having such an arrangement including those at maturity of the
arrangement or the disposal of the arrangement.
314. There are special rules that ensure that where a financial
arrangement is received as consideration or provided as
consideration for the provision of a thing (eg, this could be
trading stock or a capital gains tax (CGT) asset) the thing is
taken to have been received or provided for its market value.
These special rules are intended to provide an appropriate value
for determining the tax consequences of transactions relating to
the thing under provisions of the Income Tax Assessment Act 1936
(ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997)
(including Division 230).
315. Division 230 will not apply to all gains and losses from financial
arrangements. In particular, Division 230 will not apply to gains
and losses in respect of financial arrangements that are not
subject to Division 230 nor to the gains and losses of financial
arrangements held by taxpayers that are not subject to Division
230.
316. Some of these specific exceptions are to put it beyond doubt that
Division 230 will not apply to those financial arrangements while
others have been included to ensure that Division 230 does not
apply to taxpayers with relatively simple tax affairs for reasons
of compliance costs, or for other administrative or policy reasons.
317. Division 230 will not contain a definition of a 'gain' or a 'loss'.
However, as a general rule a 'gain' or a 'loss' from a financial
arrangement may be calculated as follows:
. Step 1 - calculate the money received from a financial
arrangement including that received at maturity or upon
disposal.
. Step 2 - calculate the cost of the financial arrangement
including those expenses at maturity or upon disposal.
. Step 3 - deduct the amount at step 2 from the amount at
step 1.
318. There will be a gain from a financial arrangement if the amount at
step 3 is positive. On the other hand, there will be a loss from a
financial arrangement if the amount at step 3 is negative.
319. Division 230 will contain rules for determining the amount at step
2 and allocating it to the amount in step 1 so as to ensure that
the appropriate amount of gain or loss is subject to Division 230.
320. The amount of this gain or loss that is assessable or deductible in
a particular income tax year will be determined by the tax-timing
treatment (accruals/realisation, fair value, hedging, retranslation
or financial reports) and the balancing adjustment, where
applicable, that applies to a particular financial arrangement.
321. Some losses made from a Division 230 financial arrangement are not
deductible. Examples are losses made to the extent they are in
gaining or producing exempt income or non-assessable non-exempt
income. Other non-deductible losses are those of a private or
domestic in nature. These losses are not deductible for any income
tax purposes.
322. A gain made from a Division 230 financial arrangement will continue
to be exempt income or non-assessable non-exempt income to the
extent the gain would have been exempt income or non-assessable non-
exempt income by a provision outside Division 230 on the assumption
Division 230 was not enacted. Also, a gain made on a Division 230
financial arrangement will be exempt income if, instead, the gain
had been a loss and the loss would have been made gaining or
producing exempt income. A similar rule is provided in respect of
gains that are to be treated as non-assessable non-exempt income.
For example, if a taxpayer subject to Division 230 makes a loss on
a financial arrangement where the arrangement was entered into in
gaining or producing exempt income, that loss would not be
deductible; paragraph 230-30(3)(a). Therefore, to provide
symmetry, if a taxpayer had made a gain from a financial
arrangement, such as a forward contract, as part of an activity
that produces exempt income, and instead had that gain had been a
loss that would have been denied deductibility under paragraph 230-
30(3)(a), the gain is taken to be exempt income: paragraph 230-
30(2)(a).
323. Finally, Division 230 will not apply to gains in the form of
franked distributions or rights to franked distributions. This
allows the existing tax law to apply in respect of such franked
distributions. Also, Division 230 does not apply to gains that are
of a private and domestic nature made from a financial arrangement.
324. Under Division 230 the general rule is that gains and losses from
financial arrangements will be on revenue account. This treatment
will simplify the law by removing the need to determine the revenue
or capital nature of such gains and losses.
325. Division 230 will contain anti-overlap rules to ensure that gains
and losses from financial arrangements are not double-counted for
income tax purposes. However, these rules will not prevent
Division 230 gains and losses being used to calculate other amounts
for income tax purposes. For instance, such amounts may be used in
calculating thresholds where appropriate.
Context of amendments
Gains and losses from financial arrangements
326. 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 ITAA 1997), the
general deduction provision (section 8-1 of the ITAA 1997) and
various specific provisions.
327. 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.
328. 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. Therefore, in determining the
gain or loss from the financial arrangement, the financial
benefits to be received or provided under the arrangement
should be taken into account at the value they have at the
time they are received or provided, and should not be
discounted to their present values when a taxpayer first
starts to have the arrangement.
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 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
329. 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.
330. 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 ITAA 1936, in relation to the
disposal of traditional securities;
. Division 3B of Part III 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).
331. 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.
332. 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
333. 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
334. 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.
335. Losses from financial arrangements made in gaining or producing
exempt or non-assessable non-exempt income are not deductible.
Gains made from financial arrangements will be exempt income or non-
assessable non-exempt income to the extent that they reflect
amounts that would be treated or would reasonably be expected to be
treated as exempt or non-assessable non-exempt income under a
provision outside Division 230 if Division 230 were not enacted.
Division 230 does not apply to gains to the extent they are gains
in the form of a franked distribution or a right to receive a
franked distribution.
336. Losses made from borrowings used for private or domestic purposes
or by individuals from derivative financial arrangements held or
used for private or domestic purposes are not deductible while
Division 230 does not apply to gains made from such borrowings.
337. 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 |There is lack of clarity|
|specified exemption, or |as to whether the basis |
|as provided for under |for taxation is gains |
|the hedging financial |and losses made under an|
|arrangement method, all |arrangement, or receipts|
|gains and losses from |and outgoings, or some |
|financial arrangements |combination thereof. |
|are on revenue account. |There is a complex |
|Unless subject to |mixture of revenue and |
|specified exemption, all|capital account |
|gains from financial |treatment for gains and |
|arrangements are |losses from many |
|assessable. |financial arrangements, |
|Unless subject to |often involving |
|specified exemption, all|uncertainty as to |
|losses from financial |appropriate treatment. |
|arrangements made in |Gains and losses on |
|deriving assessable |disposal of liabilities |
|income are deductible. |are not systematically |
| |addressed. |
Detailed explanation of new law
Determining the gain or loss from a financial arrangement
338. 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 230-40]
339. 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 230-40]
340. The concept of gain or loss connotes the appropriate offsetting of
the cost (financial benefits provided or to be provided, or rights
to 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 230-70 and 230-75]
341. 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 or the
amount of such gain or loss).
[Schedule 1, item 1, sections 230-60, 230-70 and 230-75]
Costs and proceeds of a financial arrangement
342. 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.
343. 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.
344. 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 or the amount of such a gain or loss. What is considered
essential or integral will be determined by the nature or purpose
of the financial benefit that is taken to be provided or received
under the financial arrangement. The quantum of the particular
financial benefit in this respect is not determinative as to
whether it is considered 'integral'. For example an application
fee paid on a home loan provided by a bank may be 'integral' to
determining whether the bank makes a gain or loss from the home
loan even though it would be a much smaller amount than the
interest income that is to be received by the bank from the
borrower.
345. 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
230-60]
1. : Continuation of Example 2.16, 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 230-60(2)).
Note, however, the amount taken to have been provided for
the train for the purposes of this Act (eg, determining a
deduction for a depreciating unit) may be affected by
section 230-505. Section 230-505 will treat the amount of
the benefit provided for the train as the market value of
the train at the time it was acquired.
346. 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 230-60]
347. It is possible that a financial benefit could be considered
integral to more than one financial arrangement. An example would
be where a fixed and indivisible fee is to be provided to acquire
either one or more financial arrangements. In this circumstance,
it will be necessary to apportion on a reasonable basis the actual
amount of the financial benefit between the financial arrangements.
This will ensure that the gain and loss from each financial
arrangement reflects the proper apportionment of the financial
benefit. [Schedule 1, item 1, section 230-65]
348. Also a financial benefit may be provided or received as
consideration for starting or ceasing to have one or more things
which themselves are not financial arrangements. Where this occurs
the amount of financial benefit needs to be apportioned, between
the financial arrangement and other things on a reasonable basis.
This means that only that part of the amount of the financial
benefit that plays an integral role to the financial arrangement is
taken to be received or provided under the arrangement. [Schedule
1, item 1, section 230-65]
1. : Financial benefit provided as consideration for a financial
arrangement and services
Deb Co enters into an arrangement where it agrees to provide
a train worth $1 million in return for a bond worth $700,000
and services worth $300,000. The financial benefits
provided, the train, is integral to determining Deb Co's
gain or loss from the bond. Section 230-65 therefore
applies for the purpose of Division 230 causing the
$1 million financial benefit provided to be apportioned and
the services on a reasonable basis. Therefore, Deb Co is
taken to have provided $700,000 worth of financial benefits
under the financial arrangement to acquire the bond.
349. The above paragraphs have outlined the basic case of how the cost
and proceeds from a financial arrangement are determined. It can
be 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
350. As mentioned in paragraph 3.37, the costs or proceeds of a
financial arrangement include financial benefits provided or
received in satisfaction of the obligations or rights comprising
the financial arrangement. If a financial arrangement is started
or ceased as consideration for the provision or acquisition of
something else (whether money or not) the financial benefits may
include that thing but, if they do not, section 230-60 would
operate to deem the thing (the something else) to be provided or
received under the financial arrangement. The costs of, or
proceeds from, a financial arrangement that started or ceased to be
held as consideration for providing or acquiring something is (or
includes) the market value of the relevant thing when it is
provided or acquired.
1. : Cost of widgets
White Co manufactures widgets. The cost to White Co of
manufacturing each widget is $80, and they retail for their
market value of $90. White Co enters into a deferred
payment arrangement to sell a widget to Black Co for $100,
to be paid in 18 months. The cost to White Co of the
financial arrangement represented by the deferred payment
arrangement is the market value of the widget provided $90,
rather than the cost to it of the widget ($80).
351. The primary function of section 230-505 is to provide appropriate
interaction between the provisions of Division 230 and the other
provisions of the ITAA 1936 and the ITAA 1997 (including Division
230 if the thing is also a financial arrangement) where a financial
arrangement (or part of a financial arrangement) whose gains and
losses are subject to Division 230 is provided or received as
consideration for a thing. In a broad sense, the provision ensures
that the amount of the benefit taken to be obtained or provided for
the thing is, for the purposes of this Act, the market value of the
thing at the time it is provided or acquired. This will result in
symmetry between the cost or proceeds of the financial arrangement
started or ceased and the amount for which the thing is taken to
have been acquired or disposed of. [Schedule 1, item 1,
section 230-505]
352. Section 230-505 will not apply where gains and losses from the
relevant financial arrangement which is consideration for the thing
are not subject to Division 230. For example, where a taxpayer
provides an asset to another party as consideration 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 230-455 because of the taxpayer's traits, or under section
230-450 because of the period for which the right will be
outstanding), section 230-505 will have no application in resetting
the amount taken to have been received for that asset for tax
purposes. Section 230-505 only applies in respect of dealings with
financial arrangements that are themselves dealt with under
Division 230. [Schedule 1, item 1, subsection 230-505(1)]
353. The impact of the operation of section 230-505 upon the tax
treatment of a thing for which a relevant financial arrangement is
consideration is discussed in detail in Chapter 11.
354. Section 230-505 ensures that there is symmetry between the cost or
proceeds of the financial arrangement and the acquisition or
disposal consideration for the thing. In other words, section 230-
505 ensures symmetry between the following two amounts for tax
purposes:
. the cost or proceeds of the financial arrangement that is
either started or ceased as consideration for the thing
acquired or provided under the relevant transaction (these
costs or proceeds are used to determine the amount of the
gain or loss on the financial arrangement); and
. the amount for which the thing is taken to have been
acquired or disposed of (eg, the cost base of, or capital
proceeds for, a CGT asset, used to determine the amount of
the capital gain or loss on that asset).
355. This symmetry is required to ensure that, where both Division 230
and another provision of the income tax law apply to a particular
transaction, there is no overlap or gap between the operation of
the Division and the operation of that other provision. Symmetry
is also required to ensure that, where Division 230 applies to a
financial arrangement whose acquisition or disposal is part of
another financial arrangement also taxed under Division 230, each
financial arrangement is (separately and cumulatively with the
other financial arrangement) treated appropriately: see the
discussion below under the heading Things that are financial
arrangements.
356. The effect of section 230-505 is that, for all income tax
purposes, the cost of the financial arrangement is taken to be the
market value of the thing provided. Similarly, the proceeds of
the financial arrangement is taken to be the market value of the
thing acquired. [Schedule 1, item 1, subsection 230-505(2)]
1. : 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 Moore Co in exchange
for receiving a five-year zero coupon bond, with a face
value of $3 million. At the date of sale, Saint Co's
factory has an estimated market value of $2.5 million.
Assume that any gain on sale of the factory would be subject
to CGT.
The bond is a cash settlable financial arrangement.
In terms of subsection 230-505(1), Saint Co starts to have
the bond (a Division 230 financial arrangement) as
consideration for providing the factory.
Because of the operation of section 230-505, for the
purposes of the ITAA 1936 and the ITAA 1997, the proceeds
Saint Co receives for the sale of the factory will be taken
to be the market value of the factory, that is, $2.5 million
(subsection 230-505(2)).
As a result the difference between Saint Co's cost of the
factory ($1.1 million) and the market value of the factory
that was received ($2.5 million) will be taken into account
under Parts 3-1 and 3-3 of the ITAA 1997 (a $1.4 million
capital gain). In accordance with the general principles
for determining the cost of a financial arrangement, the
market value of the factory (financial benefit provided)
would be included as the cost of the financial arrangement
(the bond). As a result the difference between the market
value of the factory ($2.5 million) and the proceeds Saint
Co receives from the bond on redemption ($3 million), that
is, a $500,000 gain, will be taken into account under
Division 230.
357. In the example above, section 230-505 has ensured symmetry between
the proceeds received for the sale of the factory and the cost of
the financial arrangement such that the appropriate amount is
recognised for the purposes of CGT and Division 230.
1. : Deferred settlement
Bill Co had an agreement to sell land to Jim Co for $100,000
and agreed to allow Jim Co 18 months from the settlement
date to pay.
In the hands of Bill Co, the land (a CGT asset), is held on
capital account with CGT tax treatment.
At the settlement date, the market value of the land is
$87,000.
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 230-45). The
financial benefit provided under the financial arrangement
is the land, whose value is $87,000 (subsection 230-60(1)).
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 the land, being $87,000 (subsection 230-
505(2)).
Assuming the cost base of the land is $50,000, Bill Co will
make a $37,000 capital gain. Given that the cost of the
financial arrangement (being the market value of the land)
is $87,000 and the proceeds of the financial arrangement are
$100,000, Bill Co will make a $13,000 gain on the financial
arrangement.
In the absence of the rule in section 230-505, assuming the
whole of the deferred settlement amount is included as
capital proceeds, the capital gain would have been $50,000
($100,000 capital proceeds less $50,000 cost base) in
addition to the $13,000 gain made on the financial
arrangement. As a result, section 230-505 will ensure there
is no duplication of gains or losses in respect of the
transaction for all tax purposes.
Things that are financial arrangements
358. Section 230-505 will apply 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. The effect of section 230-505 is to treat this
financial arrangement (which is the relevant thing for the purposes
of the section) as having been dealt with for its market value.
[Schedule 1, item 1, subsection 230-505(2)]
1. : Exchange of bonds under a forward contract
On 1 July 2010 Money Co enters into a forward contract with
Option Co to exchange its Bond A for Options Co's Bond B on
30 June 2012 (the date on which the exchange takes place).
At the time of exchange, Bond A has a market value of $100
and Bond B has a market value of $110. Assume that Money Co
acquired Bond A for $80 and Bond B has a face value of $130
with maturity at 30 June 2013.
In this bond swap there are three financial arrangements:
the two financial arrangements being exchanged as
consideration for each other, and an overarching financial
arrangement, being the forward contract (a financial
arrangement under section 230-45). Each bond is also a
thing for whose acquisition or disposal the relevant part of
the forward contract (ie, the obligation to deliver, or
right to receive, the other bond) is started as
consideration. (Alternatively, the consideration for each
bond is the bond for which it is exchanged: in other words,
starting to hold the other bond is the consideration for the
provision of the bonds as things to which section 230-505
applies.) Because Division 230 applies to the overarching
financial arrangement, the exclusion in subsection 230-
505(3) does not apply. Therefore, subsection 230-505(2)
ensures that the amount of the proceeds received by Money Co
for disposing of Bond A is its $100 market value (which is
also the cost provided by Option Co for acquiring Bond A)
while the cost provided by Money Co for acquiring Bond B is
taken to be its $110 market value (which would also be the
proceeds by Option Co for disposing of Bond B).
When the exchange occurs two balancing adjustment events
arise for Money Co:
1 - Rights/obligations under the forward contract ceases
. The general financial arrangement cost and proceeds
principles apply to determine the gains or losses made from
the forward contract ceasing.
. Financial benefit provided: Bond A with market value of
$100.
. Financial benefit received: Bond B with market value of
$110.
. Division 230 gain under section 230-445: $10.
2 - Bond A is transferred
. Financial benefit provided: $80.
. Financial benefit received: $100 (deemed amount under
section 230-505).
. Division 230 gain under section 230-445: $20.
. At 30 June 2012 Money Co has a total Division 230 gain of
$30.
Assuming that Money Co holds Bond B until 30 June 2013 when
Bond B matures, a balancing adjustment event will arise:
. Financial benefit provided: $110 (deemed amount under
section 230-505).
. Financial benefit received: $130.
. Division 230 gain under section 230-445: $20.
. At 30 June 2013 Money Co has a Division 230 gain of $20.
Overall, Money Co has made a Division 230 gain of $50. This
matches the economic outcome because Money Co provided $80
(for Bond A) and received $130 (on maturity of Bond B).
359. The following example shows the symmetry between the proceeds
received for Bond A (paragraph 230-505(2)(a)) and the cost of the
forward contract being the financial benefits provided in
satisfaction of the obligation under the forward contract.
Similarly the example shows the symmetry between the cost of Bond B
(paragraph 230-505(2)(b)) and the proceeds received under the
forward contract being the financial benefits received in
satisfaction of the right to receive $120.
1. : Forward sale of a bond
On 1 July 2010 Share Co enters into a forward contract with
Delta Co to sell its Bond A for $120 on 30 June 2012. At
the time of the sale, Bond A has a market value of $130.
Share Co acquired Bond A for $100.
For the purposes of applying Divisions 230 to Share Co,
there are two financial arrangements being the forward
contract and Bond A.
Forward contract financial arrangement
For the purposes of determining Share Co's gain or loss on
the forward contract, Division 230 picks up the financial
benefits provided and received in satisfaction of the
obligation and right under the forward contract. In this
example, the financial benefits provided and received are
Bond A and $120 respectively. The value of these financial
benefits is determined by the general financial arrangement
cost and proceeds principles. Therefore Share Co will make
a $10 loss on the forward contract comprising the financial
benefits provided (being the market value of the bond at
the time it was provided) and the financial benefit
received (being $120).
Bond financial arrangement
Section 230-505 applies to Bond A as a thing because Share
Co starts to have part of the forward contract (the right
to receive $120) as consideration for providing Bond A
(subsection 230-505(1)). Share Co will be taken to have
obtained an amount for providing Bond A equal to the market
value of Bond A at the time it is provided (ie, $130)
(subsection 230-505(2)). Therefore Share Co makes a $30
gain on Bond A.
Overall, Share Co has made a net gain of $20. This gain is
consistent with the economic substance of the two financial
arrangements. That is, Share Co provided $100 for
acquiring Bond A and received $120 for ceasing to hold Bond
A.
Where an overarching financial arrangement is not a Division 230
financial arrangement
360. The purpose of section 230-505 is to ensure appropriate
interactions through symmetry between the cost and proceeds of
both the relevant thing and the financial arrangement started or
ceased as consideration. A thing for the purposes of section 230-
505 may be a financial arrangement whose gains and losses are the
subject of Division 230. The value of this thing may not be
reflected in either the cost of, or the proceeds from, an
overarching arrangement that is itself a financial arrangement
whose gains and losses are the subject of Division 230. In such a
case, no symmetrical outcome is required and section 230-505 is
prevented from applying to the thing. [Schedule 1, item 1,
subsection 230-505(3)]
1. : Exchange of shares
On 1 July 2010 Finance Co enters into an arrangement with
Business Co to exchange its Share A with Business Co's Share
B on 30 June 2012. Finance Co fair values both Share A and
Share B, but not the agreement (the overarching financial
arrangement).
Both Share A and Share B are financial arrangements to which
Division 230 applies pursuant to subsection 230-50(1).
However, the exchange contract is not a Division 230
financial arrangement because it is not fair valued nor
subject to the financial reports election (and the shares
are not cash settlable). In other words, the overarching
financial arrangement is not subject to Division 230.
Here there is no overarching financial arrangement to which
section 230-505 needs to apply to ensure appropriate
interaction between the arrangements. Therefore, subsection
230-505(3) operates to prevent the application of subsection
230-505(2) to Share A and Share B. Instead the ordinary
cost and proceeds rules in the income tax law will apply so
that, absent unusual features of the arrangement, the value
of Share B will constitute the proceeds for the disposal of
Share A, and vice versa.
361. Sometimes a financial arrangement may be started or ceased not as
consideration (in a direct or contractual sense) for a thing, but
nevertheless in circumstances where it is necessary to provide
symmetry between the cost/proceeds of both the financial
arrangement and the thing. If section 230-505 is not triggered in
such circumstances, the gains or losses that arise under other
provisions of the Act in relation to the thing may duplicate the
gains or losses generated from the financial arrangement.
362. An example of this type of situation is an entity acquiring a right
to do something (which is the 'thing' for section 230-505 purposes)
as consideration for a payment (deductible under section 8-1 of the
ITAA 1997) and that payment obligation being subsequently satisfied
by the issue of a financial arrangement. Although the financial
arrangement is issued as consideration for satisfaction of the
payment (or the extinguishment of an obligation) there is a clear
causal connection between the acquisition of the thing and the
issue of the financial arrangement. This is because the payment is
consideration for the thing and this payment is satisfied by the
issue of the financial arrangement. In terms of the substance or
effect, the financial arrangement is issued in exchange for the
acquisition of the thing.
363. Subsection 230-505(8) applies to ensure that, in this situation,
the deduction available for the payment and the gain or loss
available under Division 230 properly reflects the economic gain or
loss on the total transaction. In this example, the benefit deemed
to have been provided for the thing (the deductible payment) will
be taken by subsection 230-505(2) to be the market value of the
thing at the time it is acquired. Subsection 230-505(8) requires a
determination of what, in effect, the entity acquiring the thing
starts or ceases to have the financial arrangement for.
Allocation of costs to proceeds
364. 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 (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.
365. 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 230-70(3) and 230-75(3)]
366. 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, sections 230-
70 and 230-75]
367. 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.
1. : 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 start 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.
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 230-60).
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, after one year, 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.
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 230-60(1)).
The financial benefit that 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 230-60. Subsection 230-75(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.
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, no gain or
loss is made as Cat Co also received $100 under the
arrangement. Such an approach is not permissible under
sections 230-70 and 230-75.
368. Example 3.10 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.
369. If 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.
370. The following example provides an illustration of the valuation
rule where a financial benefit is received or provided in the form
of a waiver.
1. : Value of a financial benefit in the form of a waiver
LA Co has an outstanding debt owing to AH Co of $200 which
is to be paid in two years time. The debt has a current
market value of $150. At the same time it holds a bond (a
separate financial arrangement) issued by AH Co that has a
market value of $150 (and face value of $250). In an
agreement between the parties LA Co agrees to waive its
right to receive payment under the bond in full satisfaction
of the amounts it owes on the outstanding debt of $200.
In determining any gain or loss on the extinguishment of the
debt owed by LA Co, it will be taken to have provided a
financial benefit (being the waiving of its right to receive
payment on the bond of $250 in the future) which is equal to
the market value of the bond at the time of the waiver (see
note at end of subsection 230-60(2)). The valuation rule
will ensure that LA Co takes into account the market value
of the waived bond ($150) and not its nominal value ($250)
when calculating the gain or loss it makes on the
extinguishment of the debt.
Allocation of cost and proceeds may also occur within a particular
tax-timing method
371. 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.
Note that 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.
A special rule for interest for particular gains and losses, and
realised gains and losses
372. 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. 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.
373. 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 or are returns
in the form of dividends paid or provided on a debt 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. It is therefore intended that
in a broad sense the current treatment of these cash flows not be
disturbed in these circumstances. Special rules are contained in
sections 230-70 and 230-75 to clarify this point. These rules
provide 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 or are returns in the form of dividends
paid or provided on a debt 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, sections 230-70 and 230-75]
374. 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, sections 230-70, 230-
75, 230-200 and 230-445]
375. 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 the relevant taxpayer, these payments in isolation
are not interest, interest in nature, or in substitution for
interest. [Schedule 1, item 1, section 230-70]
General rule for the taxation of gains and losses made from financial
arrangements
376. Under Division 230, gains from financial arrangements are
assessable income unless otherwise specified. [Schedule 1, item 1,
subsection 230-15(1)]
377. 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 ITAA 1997). Apart from some specific rules for
determining a gain or loss on a financial arrangement where there
is a change of residence during an income year (see Chapter 11),
Division 230 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 foreign residents are
only taxed on their gains from financial arrangements that have an
Australian source. [Schedule 1, item 1, subsection 230-15(7)]
378. 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)]
379. 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 generally ignore
distinctions between capital and revenue. [Schedule 1, item 1,
subparagraph 230-10(b)(ii)]
Dividends paid on debt interests
380. 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 mandatory 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).
381. 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 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.
382. In respect of section 8-1 of the ITAA 1997, 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 section
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)]
383. 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
Gains
384. To the extent that a gain made from a financial arrangement is
reflected by an amount which a provision in the income tax law
outside Division 230 would have considered as exempt income or non-
assessable non-exempt income, if Division 230 were not enacted, the
gain, or that part of the gain, will maintain its status as either
exempt income or non-assessable non-exempt income (as the case may
be). The gain will also be either exempt income or non-assessable
non-exempt income to the extent that, if it had instead been a
loss, the loss would have been denied deductibility on the basis it
would have been made in gaining or producing exempt income or non-
assessable non-exempt income. [Schedule 1, item 1, section 230-30]
Losses
385. A Division 230 loss from a financial arrangement will not be
deductible if it is made in gaining or producing exempt income or
non-assessable non-exempt income. [Schedule 1, item 1,
subsection 230-30(3)]
386. 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, subsection 230-
15(3)]. This treatment maintains the current treatment of such
costs under section 25-90 of the ITAA 1997.
Gains and losses of a private or domestic nature
387. Under Division 230, losses from certain financial arrangements
having a private or domestic purpose will not be deductible.
Division 230 will not apply to gains from such arrangements that
are private or domestic in nature.
388. 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, section 230-35]
Private or domestic borrowings
389. A 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 not be deductible to the extent the
finance is used for a private or domestic purpose. Division 230
will not apply to gains made from such an arrangement.
[Schedule 1, item 1, section 230-35]
390. The intended operation of this exception is to exclude gains and
losses from assessable Division 230 gains or deductible Division
230 losses where they are made in respect of borrowings and other
forms of raising finance used to fund private or domestic
arrangements. It does not include an arrangement under which the
taxpayer is the provider, rather than the recipient, of the
finance.
391. 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.
392. 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.
1. : A loss made where finance is raised 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 230-455). However, Hoa makes an election to have
all financial arrangements subjected to Division 230
(subsection 230-455(7)).
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 section 230-35.
(Note that it is not necessary for Hoa to make a subsection
230-455(7) 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
393. Division 230 will not apply to a gain made by an individual from a
derivative financial arrangement, to the extent that it is held or
used for private or domestic purposes. Losses from such an
arrangement will not be deductible. [Schedule 1, item 1, section
230-35]
394. 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 230-455(7)]
395. 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 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 230-350(1)]
396. 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 in effect
be disregarded under Division 230.
Gains and losses to which Division 230 does not apply
397. Division 230 will not apply to gains from financial arrangements to
the extent that they are in the form of a franked distribution, or
a right to a franked distribution, whether received directly by the
taxpayer or indirectly through a partnership or trust.
[Schedule 1, item 1, section 230-480]
398. Division 230 will also not apply to certain gains and losses from
specified financial arrangements or where specific provisions
operate to reduce gains and losses from particular financial
arrangements. [Schedule 1, item 1, note to subsections 230-15(1)
and (2)]
399. 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
400. 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.
401. 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.
402. 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 3.22).
403. However, a different character may be attributed to the gains and
losses from 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 230-310]
404. 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 230-300(1) and 230-310(3), section 230-40]
405. For a more comprehensive discussion of the hedging financial
arrangement method (including what are hedging financial
arrangements and hedged items), refer to Chapter 8.
406. 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
407. 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 provision of the ITAA 1936 or the ITAA 1997 outside of
Division 230. [Schedule 1, item 1, sections 230-20 and 230-25]
408. 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 76, section
118-27]
409. 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 230-310(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 230-310(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,
section 230-20]
410. For example, this means for foreign residents that where a hedged
item is ordinary or statutory income from an Australian source the
hedge gain or loss will be subject to tax in Australia. On the
other hand, where a hedged item is ordinary or statutory income
from a non-Australian source, the hedge gain or loss will not be
subject to tax in Australia.
411. 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 230-310(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)]
Relevance for other parts of the Act
412. 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)]
413. Further, the rules do not prevent the application of the provisions
of Division 13 of Part III of the ITAA 1936 to financial
arrangements and/or their financial benefits where they are, or are
used as consideration for, the supply of property or services in
cross-border transactions/dealings. In the relevant circumstances,
the Commissioner may adjust the amount of the consideration (if
any) given or received to an arm's length amount. Such an
adjustment might be made to the amount of a financial benefit
provided or received under a financial arrangement. If an
adjustment is made, the adjusted amount would then be used to
determine the amount of a gain or loss that would be brought
to account under Division 230. Section 230-15 remains the only
provision under which the gain is assessable or the loss is
deductible or, if relevant, the arm's length gain or loss remains
to be dealt with by subsection 230-310(4).
Financial arrangements used as consideration in other dealings
414. 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 3.6, 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). Section 230-25 clarifies this point for
the avoidance of doubt. [Schedule 1, item 1, section 230-25]
Bad debts
415. Where a financial arrangement arises in respect of the provision of
goods, services or other property on deferred payment terms (and
section 230-450, dealing with certain short-term arrangements, does
not apply), a special rule is required to allow a deduction under
section 25-35 of the ITAA 1997 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, 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.
416. The value that is included in assessable income in respect of the
provision of the goods, services or other property is determined
under section 230-505. For the special rule to apply, the
financial benefit (as determined under section 230-505) must have
been brought to account as assessable income under a provision
outside of Division 230 [Schedule 1, item 1, paragraph 230-
25(3)(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(3)].
417. 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.
418. 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 of the ITAA 1997, 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 is to be taken into account under step
1(b) in the method statement in section 230-445 (see Chapter 10)
[Schedule 1, item 1, subsection 230-445(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
419. Subsection 6-20(2) of the ITAA 1997 provides that amounts
of ordinary income that are excluded from being assessable income,
are exempt income. However, merely because a provision in Division
230 prevents a gain or part of a gain from being assessable under
Division 230 (in order to avoid that gain or part of that gain from
being included in assessable income more than once under the tax
law) the carving out of the gain from being assessable under
Division 230 does not of itself cause the gain to be exempt income.
This is because the gain, while not included in assessable income
under Division 230, is ultimately included in assessable income
under another provision of the tax law. Subsections 230-20(5) and
230-25(4) put it beyond doubt that such a gain excluded from being
assessable under Division 230 is not exempt income merely because
of that exclusion. [Schedule 1, item 1, subsections 230-20(5) and
230-25(4)]
Threshold calculations
420. 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.
Chapter 4
The compounding accruals and realisation methods
Outline of chapter
421. This chapter explains:
. the rationale for compounding accruals and realisation tax
treatment;
. what compounding accruals and realisation are;
. the basis for determining when taxpayers apply the
compounding accruals or the realisation method to a
financial arrangement;
. the manner in which the compounding accruals and
realisation methods are applied;
. when a re-assessment of the compounding accruals or
realisation method should apply to a gain or loss arising
from a financial arrangement; and
. the application of the re-estimation and running balancing
adjustment provisions.
Overview of compounding accruals and realisation methods
422. The compounding accruals and realisation methods are the default
methods of taxation under Division 230. These tax-timing methods
will apply to those financial arrangements that are not subject to
any of the elective tax-timing methods. The compounding accruals
tax-timing method ('accruals method') will apply where there is a
sufficiently certain overall gain or loss or a sufficiently certain
particular gain or loss in respect of a financial arrangement. If
there is neither a sufficiently certain overall gain or loss nor a
sufficiently certain particular gain or loss in respect of a
financial arrangement then it will be subject to the realisation
tax-timing method ('realisation method').
423. An example of a sufficiently certain particular gain is where a
contingency under an interest rate swap becomes settled, that is,
it becomes certain that a payment is to be made that will give rise
to a certain gain.
424. If neither a sufficiently certain overall gain or loss nor a
sufficiently certain particular gain or loss arises in respect of a
financial arrangement, the gains and losses in respect of that
financial arrangement will be calculated using the realisation
method.
Accruals method
425. There are two circumstances which require the spreading of gains
and losses under the accruals method. The first applies where
there is a sufficiently certain overall gain or loss. The second
applies where there is a sufficiently certain particular gain or
loss.
426. A sufficiently certain 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), measured in nominal
terms.
427. When a sufficiently certain overall gain or loss does not arise in
respect of a financial arrangement, the accruals method will apply
if there is a sufficiently certain particular gain or loss under
that financial arrangement in respect of a particular financial
benefit or financial benefits, measured in nominal terms.
428. A sufficiently certain particular gain or loss 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.
429. The accruals method is intended to bring to account sufficiently
certain overall gains or losses and sufficiently certain particular
gains or losses to prevent inappropriate tax deferral in relation
to the recognition of that gain or loss.
Way in which gains and losses are to be spread
430. The core method for spreading sufficiently certain gains or losses
uses compounding accruals. This is conceptually identical to the
'effective interest rate' method required by Australian Accounting
Standard AASB 139 Financial Instruments: Recognition and
Measurement (AASB 139) in so far as they both reflect the concept
of interest on interest. 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). It is also the same as the internal rate of return.
431. There are specific rules in the accruals method with respect to
certain gains or losses from fees and costs ('portfolio fees') and
premiums and discounts ('portfolio premium/discount') arising from
a financial arrangement that are part of a portfolio of similar
financial arrangements. If eligible, a taxpayer can make an
irrevocable election to spread the portfolio fees and portfolio
premium/discount over a period that equals the expected life of the
portfolio of which the financial arrangement is a part.
Spreading using other methods
432. It is possible to use another type of accruals for sufficiently
certain gains or losses but the outcome under the alternative
method (such as straight line spreading) must approximate the
outcome under compounding accruals.
The realisation method
433. The realisation method brings 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 is provided or
is to be provided, that is, when the gain or loss comes home to the
taxpayer.
Reassessment of application of accruals or realisation method
434. A 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.
Whether a change is a material change depends on the facts and
circumstances of the relevant arrangement.
Re-estimation of accrued gain or loss
435. Generally, for many financial arrangements, the accruals method
will apply to the relevant gain or loss for the term of the
financial arrangement. However, it may be necessary to re-estimate
the accrued gain or loss during the term of the financial
arrangement. An example is where circumstances change such that
certain financial benefits are no longer contingent which changes
the amount of the gain or loss that is sufficiently certain.
436. It will be necessary 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.
Running balancing adjustments
437. Running balancing adjustments are needed because the accruals
method applies to estimated cash flows which may differ from the
actual cash flows. The running balancing adjustments are to ensure
that the correct amount of gain or loss is subject to tax over the
life of the financial arrangement.
438. When 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. A running balancing adjustment is the
difference between the estimated value of a financial benefit and
the amount that a taxpayer receives or provides. The running
balancing adjustment may be included in assessable income if the
estimated value of the financial benefit is less than the actual
financial benefit or may be allowed as a deduction if the estimated
value of the financial benefit exceeds the actual financial
benefit.
Context of amendments
439. 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. The application of the
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 for it to operate in a generally
consistent manner for both traditional arrangements and hybrid
financial arrangements.
440. 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.
441. 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?
442. 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.
443. 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.
444. 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.
445. 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, or compound interest.
For the purpose of Division 230, this form of accrual is referred
to as 'compounding accruals'.
446. Insofar as they both incorporate the concept of interest on
interest 'compounding accruals' allocation methodology is
conceptually identical to the 'effective interest method' adopted
by 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?
447. 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.
448. 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.
449. 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?
450. 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.
451. Apart from Division 16E of the ITAA 1936, 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'.
452. 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
453. Division 16E of the ITAA 1936 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.
454. In general, Division 16E of the ITAA 1936 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.
455. Division 16E of the ITAA 1936 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.
456. 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.
457. The incomplete coverage of Division 16E of the ITAA 1936 creates
complexity, anomalies and opportunities for tax deferral, avoidance
and manipulation.
What is realisation?
458. Realisation tax treatment has been a common and traditional basis
for recognising gains and losses from financial arrangements under
the current law.
459. 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.
460. 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.
461. 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 at least some of the 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
462. 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 made, the compounding accruals method or the realisation
method will apply.
463. 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
464. 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 'sufficiently certain particular
gain or loss').
465. 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.
466. A sufficiently certain particular 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.
467. 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 method will continue to apply to a gain or
loss, or if the realisation method becomes more appropriate.
468. Individuals and entities (other than an individual) which fall
below the threshold test in section 230-455, 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).
469. 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.
470. 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
471. 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.
472. 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 (to the extent that the
existing law operates in respect of gains and losses rather than
receipts and outgoings). 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 calculating the gain or loss received or provided -
or the income year in which the financial benefit is actually
received or provided (that is, the time at which the gain or loss
occurs for Division 230 purposes).
Accruals Diagram 1:
Application (Part 1)
This diagram provides an overview of how to determine
whether the compounding accruals or realisation methods
should apply to a gain or loss made under a financial
arrangement.
Accruals Diagram 1:
Application (Part 2)
Comparison of key features of new law and current law
|New law |Current law |
|If one of the elective |To use an accruals |
|tax-timing methods does |method under Division |
|not apply to a financial|16E of the ITAA 1936 a |
|arrangement, the |'qualifying security' |
|compounding accruals tax|requires an 'eligible |
|treatment will apply if |return'. |
|the financial |An 'eligible return' on |
|arrangement has a |a security is, at the |
|sufficiently certain |time of the security's |
|gain or loss. The |issue, either known (in |
|sufficiently certain |the case of a fixed |
|gain or loss may include|return security) or the |
|both periodic (such as |payments to be made - |
|interest-like amounts) |other than periodic |
|and non-periodic amounts|interest - to the holder|
|(such as discounts or |are reasonably likely |
|premiums). |(in the case of a |
|A method that |variable return |
|approximates the results|security) to exceed the |
|of the compounding |issue price of the |
|accruals method can be |security. |
|used. |Other requirements of a |
| |qualifying 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. |
|An election can be made |No equivalent rule. |
|to spread portfolio fees| |
|or a portfolio | |
|premium/discount arising| |
|from financial | |
|arrangements which are | |
|part of a portfolio of | |
|similar financial | |
|arrangements, over a | |
|period that equals the | |
|expected life of the | |
|portfolio. The election| |
|is irrevocable. | |
|The realisation |The realisation |
|tax-timing treatment |treatment applies where |
|applies where other |an accruals treatment |
|basic tax-timing |does not apply. |
|treatments (compounding | |
|accruals, 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
473. 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 230-95(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-
95(b)].
474. The compounding accruals method is also intended to minimise tax
deferral, which could occur under a realisation method [Schedule 1,
item 1, paragraph 230-95(c)]. This is reflected in the main object
of Subdivision 230-B, as proper allocation of gains and losses to
the periods to which they relate also reduces tax deferral.
475. 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
476. Generally, Division 230 does not apply to the financial arrangement
gains or losses of individuals, or to entities that satisfy the
relevant threshold tests in section 230-445, unless an election to
have the Division apply has been made [Schedule 1, item 1,
subsection 230-455(7)]. However, if such an individual or an
entity which has not made an election under subsection 230-455(7)
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 method under Division 230 may apply to that financial
arrangement [Schedule 1, item 1, subsection 230-455(1)]. The
application of Division 230 to individuals and to entities that
satisfy the threshold test is further discussed in Chapter 2.
477. 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 230-105(1)].
The compounding accruals method will not apply to a sufficiently
certain particular gain or loss from a financial arrangement held
by such an entity [Schedule 1, item 1, subsection 230-100(4)].
478. The exclusion of individuals and those relevant entities from the
sufficiently certain particular 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 230-105(1)]. Hence,
under the overall gain or loss concept, all of the 'cost' of the
financial benefits that are to be provided under the financial
arrangement will be automatically attributed to those sufficiently
certain financial benefits that are to be received at the start of
the arrangement.
479. 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 230-100(5)]
480. However, if the individual, or the entity that satisfies the
threshold test, makes an election under subsection 230-455(7) 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 230-100(4)(c)]
When to use the compounding accruals method?
481. 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 230-40(4)]. 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 4.97 to 4.117).
482. 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 230-40(4)(b)]
483. If the hedging financial arrangement method applies to a 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
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, subsections 230-
300(7) and (8)]. The gain or loss that may arise from the foreign
currency hedge, other than 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 230-40(4)(c)].
Sufficiently certain gain and loss - an overview
484. 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.
485. 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.
486. 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.
487. 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) 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 230-105(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)].
488. The concept of an overall gain or loss of at least a particular
amount is important in the accruals provisions for two reasons:
. first, it is intended 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.
489. 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.
490. 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, paragraph 230-95(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
491. 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 230-100(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-
100(2)(b)].
492. 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 subsection 230-105(1)]
493. 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
230-105(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.
494. The accruals provisions dealing with overall gains and losses are
modified in circumstances where the financial arrangement that
gives rise to the overall gain or loss is part of a portfolio of
similar financial arrangements. In order to access portfolio
treatment the taxpayer will need to make an irrevocable election
and meet certain eligibility requirements. [Schedule 1, item 1,
sections 230-150 and 230-155]. Where an irrevocable election is
made, the portfolio fees from and the portfolio premium/discount on
the financial arrangement are spread over the expected life of the
portfolio rather than under the general accruals rules for overall
gains and losses [Schedule 1, item 1, subsections 230-160(3) to
(5) and 230-165(3) to (5)]. The portfolio treatment of fees and
premiums/discounts is discussed in detail in paragraphs 4.153 to
4.167.
495. 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 230-105(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 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 sufficiently certain particular gain or loss, as discussed in
paragraphs 4.82 to 4.85.)
496. 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'.
497. 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 4.174 to 4.206).
498. 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 sufficiently certain particular gain or loss
(where the financial benefit becomes sufficiently certain
before it is received or provided) [Schedule 1, item 1,
subsection 230-100(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
230-100(5)].
499. 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.
500. 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 230-115(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 4.170 to 4.173).
501. Example 4.3 provides further guidance on when an overall gain or
loss may arise.
Sufficiently certain particular gain or loss
502. 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 230-100(3)]. The
accruals method is intended to apply to bring to account
sufficiently certain particular 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 230-95(a)
and (c)].
503. A sufficiently certain particular 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 230-110(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 230-110(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. Depending on the circumstances, some part of
the financial benefits the taxpayer has provided under the
arrangement may be said to be reasonably attributable to the
financial benefits that the taxpayer is to receive. This principle
is encapsulated in sections 230-70 and 230-75 (about apportionment
of financial benefits on receipt or payment of particular financial
benefits), which will apply to calculate the amount of a
sufficiently certain particular gain or loss [Schedule 1, item 1,
note to subsection 230-110(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).
504. In order for the accruals method to apply, the amount of the
sufficiently certain particular gain or loss will be a particular
amount or at least a particular amount [Schedule 1, item 1,
paragraphs 230-110(1)(a) and (b)]. Therefore, in working out
whether, at a particular time, there is a sufficiently certain
particular 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 230-110(2)(a)]. For
the same reasons as outlined in paragraph 4.75, 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.
505. 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 230-110(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 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?
506. 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 sufficiently certain particular gains or
losses under the same financial arrangement. Both a sufficiently
certain overall gain or loss and sufficiently certain particular
gains or losses can arise from a single financial arrangement.
507. 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 4.71 to 4.81). 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 sufficiently certain particular gain or loss may arise.
This sufficiently certain particular 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-
110(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. [Schedule 1, item 1, subsection 230-
110(2)]
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
threshold test in section 230-455.
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 230-115(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 at least some of the amount or value of
the financial benefit is fixed or determinable with
reasonable accuracy (subsection 230-115(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 230-60(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 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 sufficiently certain
particular 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
sufficiently certain particular 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 sufficiently particular 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 financial arrangements with a
'notional' principal
508. Subdivision 230-B applies so as to characterise and apply to
notional principal arrangements in the following way.
509. A notional principal arrangement is a financial arrangement under
which financial benefits to be provided or received are calculated
by reference to a notional, rather than actual, principal amount,
whether that amount is actually paid or received or not.
510. The notional principal amount, and the financial benefits that are
calculated by reference to it, is referred to commercially as a
'leg' of the arrangement. There are two legs to such an
arrangement.
511. A note explains that a swap contract is an example of a notional
principal arrangement.
512. Subdivision 230-B applies to notional principal arrangements by
calculating the gains and losses on each leg separately as if the
notional principal amount is a financial benefit that is actually
paid or received at a time, and in a manner, that properly reflects
the way in which the other financial benefits in respect of that
leg are calculated. [Schedule 1, item 1, subsection 230-120(1) and
subparagraph 230-120(3)(c)(i)]
513. 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.
It is this exchange, as reflected in the mutual and corresponding
rights to receive financial benefits and obligations to provide
financial benefits over time, that makes opposite the separate gain
or loss calculation for each leg of a swap. The value of the cash
flows is often calculated based on a notional principal. Basic or
'plain vanilla' swaps will have no upfront or backend or other
lumpy payments. Such payments, where they are present in a
notional principal arrangement, will not be treated as a leg of the
arrangement. Gains or losses in respect of these other things will
also be calculated separately. [Schedule 1, item 1, subparagraph
230-120(3)(b)(i)]
514. 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 230-55(4)]
515. 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 230-55(4), a swap financial arrangement (comprising all
of the taxpayer's rights and obligations) generally 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 230-55]. This conclusion is not,
however, inconsistent with the notion of calculating the gains or
losses from the two legs of a notional principal arrangement
separately - in the same way that, as explained earlier, there can,
at a particular time, be more than one sufficiently certain gain or
loss in respect of the one financial arrangement. Chapter 14
contains a number of examples of swaps to illustrate how the
separate calculation rules operate.
516. 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 method or the realisation method.
When is a financial benefit sufficiently certain?
517. The compounding accruals method only applies to bring to account a
sufficiently certain overall gain or loss or a sufficiently certain
particular 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. That particular time
includes the time when the taxpayer starts to have the arrangement
[Schedule 1, item 1, subsection 230-115(1)]. In this sense, the
borderline between the compounding accruals and realisation methods
is encapsulated in the 'sufficiently certain' concept.
518. 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
4.73 [Schedule 1, item 1, paragraph 230-115(2)(a)]; and
. at least some of the amount or value of the financial
benefit is, at that time, fixed or determinable with
reasonable accuracy [Schedule 1, item 1, paragraph 230-
115(2)(b)].
519. 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.
520. Requiring the taxpayer to apply the accruals method would be
inappropriate where a gain or loss can be estimated but there
exists a real 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.
521. 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 none of 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.
522. 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 230-115(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 28,
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?
523. 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 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.
524. 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.'
525. 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.
526. 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 230-115(3)(a)]
527. 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).
528. 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 may be argued that the terms and
conditions of the financial arrangement constitute the 'legal form'
of the arrangement.
529. 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 230-115(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.
530. Generally, subsection 230-115(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 230-115(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 requirement
that the substance and effect of the terms and conditions of a
financial arrangement 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 230-115(3)(a)(iv),
paragraph 230-115(3)(b)]
531. The economic or commercial substance and effect of the financial
arrangement should also be taken into account [Schedule 1, item 1,
subparagraph 230-115(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.
532. 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-
115(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.
533. 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'?
534. 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 at least some of the
amount or value of the financial benefit is fixed or determinable
with reasonable accuracy [Schedule 1, item 1, paragraph 230-
115(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 230-115(3)]
535. 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 4.103 to 4.113, may also be relevant in determining if
the financial benefit is fixed or determinable with reasonable
accuracy.
536. 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.
537. 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 230-115(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 230-115(2)(b) are
satisfied.
Holding certain variables constant
538. In applying the 'sufficiently certain' test in subsection 230-
115(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 230-115(4) and (5)]
539. 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 230-115(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 230-115(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 sufficiently certain overall or
sufficiently certain particular gain or loss. [Schedule 1, item 1,
subsection 230-115(6)]
540. 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
230-115(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.
541. Only those variables referred to in subsections 230-115(4) and (5)
are required to be held constant. These variables should 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
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
542. By way of further guidance, the following examples provide
illustrations of the sufficiently certain overall gain or loss, and
the sufficiently certain particular gain or loss, concepts and
consider - for some of the more common type examples - whether the
accruals or realisation methods are appropriate.
1. : 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 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 230-45(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 sufficiently certain particular gain or loss, made from
the financial arrangement (section 230-100). The
sufficiently certain gain or loss is calculated by reference
only to financial benefits that are sufficiently certain
(subsection 230-115(1)) (see paragraphs 4.97 to 4.102 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 230-115(2)(a)); and
. the amount, or value, of the financial benefit is fixed or
determinable with reasonable accuracy (paragraph 230-
115(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 230-115(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-
115(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 230-115(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 230-115(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 230-105(1).
2. : Sufficiently certain particular gain or loss - exchangeable note
On 1 January 2011 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.
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 230-55(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 230-55(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-
55(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 230-45(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 230-85(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 230-45(1) and paragraph 230-45(2)(g)).
Hence, each of the exchangeable notes is a cash settlable
financial arrangement for the purposes of Division 230.
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 sufficiently certain
particular gain or loss made from the arrangement
(section 230-100). The sufficiently certain gain or loss is
calculated by reference only to financial benefits that are
sufficiently certain (subsection 230-115(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 230-115(2)(a)); and
. the amount or value of the financial benefit is fixed or
determinable with reasonable accuracy (paragraph 230-
115(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 230-115(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 230-115(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 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 230-115(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 230-70(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 230-70(4). 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.
543. 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.
544. 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 230-40(4)(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, would ordinarily not be subject to the
compounding accruals methodology.
545. 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
546. 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 the 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').
547. The comparison recognises that a gain or loss, for the purposes of
Division 230, is a net concept. As 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 230-115(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 230-115(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 230-115(9)]
548. As noted in paragraph 4.72, 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 230-70 and 230-75]. Whether the attribution of
those financial benefits provided is reasonable is determined by
taking into account the factors listed in subsection 230-70(3).
The attribution is to be calculated as at the time when a taxpayer
respectively receives or provides the relevant financial benefit
respectively. Chapter 3 further discusses the attribution process.
549. 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 sufficiently certain particular gain
or loss [Schedule 1, item 1, paragraph 230-110(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
550. The compounding accruals method spreads gains or losses that are
sufficiently certain to occur [Schedule 1, item 1, section 230-
100]. 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]
Period over which the gain or loss is to be spread
Relevant period for a sufficiently certain overall gain or loss
551. 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)]
552. 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.
553. The period stated in paragraph 4.131 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 sufficiently certain particular 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 sufficiently certain particular 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 230-105(2)(a).
The relevant period for a sufficiently certain particular gain or
loss that arises from a financial benefit
554. 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(3)]. 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
sufficiently certain particular 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.
555. 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(5)(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(5)(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(5)(b)(ii)].
1. : Calculation of relevant period for debt interest
Spices Ltd invests $1,000 into a three-year debt interest on
30 June 2011. The terms provide that if the profits in Tech
Co are at a certain level on 30 June 2013, then on 30 June
2014, $2,000 is payable on redemption.
Assume that the profits of Tech Co achieve the levels
required on 30 June 2013.
In the present case, there is a sufficiently certain gain
for Spices Ltd under the financial arrangement determinable
at 30 June 2013. On 30 June 2013, 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 2013. Hence, at that time
it is sufficiently certain that Spices Ltd will make a
particular gain of $1,000.
Consistent with the period specified in subsection 230-
130(5), the period will end on 30 June 2014 - 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
sufficiently certain particular gain of $1,000 is to be
allocated will commence on 1 July 2012 (the start of the
income year in which the gain becomes sufficiently certain
(paragraph 230-130(4)(b)) and end on 30 June 2014
(paragraph 230-130(5)(b)).
Overall gain or loss may be spread in accordance with the
particular gain or loss rule
556. Where the sufficiently certain gains or losses from the financial
arrangement in effect represent both an overall gain or loss and a
particular gain or loss, the taxpayer may choose to spread gains or
losses as if they were the latter [Schedule 1, item 1, subsection
230-130(2)]. The choice must be applied consistently [Schedule 1,
item 1, subsection 230-80(3)].
557. The purpose of this choice is to reduce complexity and compliance
costs.
How the gain or loss is spread
558. Once the 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. Where the accruals method
applies to gains or losses the taxpayer makes from a financial
arrangement, the gain or loss is spread using:
. compounding accruals [Schedule 1, item 1, paragraph 230-
135(2)(a)]; or
. a different method, the results of which approximates
those obtained using compounding accruals [Schedule 1,
item 1, paragraph 230-135(2)(b)].
Compounding accruals method
559. Under compounding accruals, the gain or loss must be allocated to
intervals that are the same length and do not exceed 12 months.
However, the first and last interval may be shorter than the other
intervals. [Schedule 1, item 1, subsection 230-135(4)]
Fixing of amount and rate for interval
560. In allocating the gain or loss to an interval it is necessary to
determine the rate of return and the amount to which the rate of
return is to be applied for a given interval. [Schedule 1, item 1,
subsection 230-135(5)]
561. The amount to which the rate of return is to be applied can be
adjusted for reasons other than a fresh allocation of the gain or
loss under paragraph 230-190(5)(a). In determining the amount it
is necessary to have regard to both the amount (or value) and
timing of the financial benefits that are to be taken into account
in working out the gain or loss that is to be allocated to each
interval and were provided or received by you during the interval
[Schedule 1, item 1, subsection 230-135(6)]. An example of the
application of this is rule is where a borrower has made an early
repayment of part of the principal on a loan that has the effect of
reducing the current outstanding amount to which the interest rate
on the loan is to be applied in allocating the gain or loss for
that interval.
562. 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(7)]. An exception to
this rule applies to 'portfolio fees' and 'portfolio premiums or
discounts' as discussed in paragraphs 4.153 to 4.167.
563. 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 230-70(1) and 230-75(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(8)]. If there are a number of financial
benefits that are to be provided at the start of the arrangement,
and those financial benefits give rise to an overall gain, the
allocation of parts of that overall gain to all of the relevant
intervals should take into account the fact that these payments
will be made in the intervals towards the start of the arrangement.
564. For the purposes of applying the compounding accruals method, the
length of a particular compounding interval is not prescribed, but
it cannot exceed 12 months [Schedule 1, item 1, paragraph 230-
135(4)(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(4)(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 part way
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.
1. : 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' in Division 16E of 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
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 value (section 230-115). 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).
1. Accrual of sufficiently certain overall gain
|Year |Amortise|Accrued|Cash |Amortised cost|
| |d cost |interes|flows |(year end) |
| |(year |t due | | |
| |start) | | | |
| |(a) |(b) |(c) |(a) + (b) -|
| | | | |(c) |
|0 |$0.00 |$0.00 |-$100.0|$100.00 |
| | | |0 | |
|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
565. 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.
566. 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)]
Effective interest method
567. For the purposes of a method of spreading gains and losses that
approximates the compounding accruals method, the effective
interest method described in AASB 139 (or a comparable standard)
will satisfy this requirement provided the financial arrangement
does not have significant deferral characteristics and it is
appropriately determined and reported in the taxpayer's audited
financial accounts [Schedule 1, item 1, section 230-140]. This
'safe harbour' method seeks to minimise compliance costs for
taxpayers without opening up tax deferral opportunities.
568. 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
(often 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.
569. 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.
570. For the effective interest rate method under AASB 139 to satisfy
paragraph 230-135(2)(b) for a particular financial arrangement it
must satisfy these requirements:
. when the taxpayer starts to have the arrangement, the
annually compounded rate of return applicable to any
discount or premium under the arrangement does not exceed
1 per cent [Schedule 1, item 1, paragraph 230-140(3)(a)];
. neither the expected life nor the maximum life of the
arrangement is more than 30 years when the taxpayer
first starts to have the arrangement (or a different time
as prescribed by regulations) [Schedule 1, item 1,
paragraph 230-140(3)(b)];
. the financial benefits the taxpayer has an obligation to
provide or right to receive - that give rise to a gain or
loss from the arrangement not attributable to any discount
or premium - relates to a period not exceeding 12 months
and will be provided or received within that period
[Schedule 1, item 1, paragraph 230-140(3)(c)]; and
. the gains or losses under the financial arrangement are
spread in a way provided for under AASB 139 (or a
comparable standard) in audited financial accounts of the
taxpayer [Schedule 1, item 1, paragraphs 230-140(3)(d) to
(f)].
571. The taxpayer's accounts for the purposes of section 230-140 will be
taken to be audited financial reports if they satisfy the
requirement of subsection 230-210(2) in relation to, and in a way
that is relevant to, the spreading.
572. If the financial arrangement that would otherwise satisfy the
requirements of section 230-140 has features that require the
interest rate on the arrangement to be re-set at least annually and
the new rate applies no later than the reset date, the re-
estimation requirements in section 230-190 permits the re-
estimation to be done at the re-set date.
Election to spread portfolio fees/premium/discount
573. Generally, 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 over a period that commences when the
taxpayer starts to have the financial arrangement and ends when the
taxpayer ceases to have the financial arrangement (as discussed in
paragraphs 4.71 to 4.73). [Schedule 1, item 1, subsections 230-
105(1) and 230-130(1)]
574. However, this rule is modified by way of an irrevocable election in
circumstances where the overall gain or loss from the financial
arrangement arises in part from fees referred to as 'portfolio
fees', or from a discount/premium, in respect of a portfolio of
similar financial arrangements and the financial arrangement is
part of a portfolio of similar financial arrangements.
[Schedule 1, item 1, sections 230-150, 230-160 and 230-165]
575. In these cases, the portfolio fees from, and any premium or
discount, in respect of the financial arrangement are spread over
the expected life of the portfolio rather than from the period the
financial arrangement started and ceased to be held [Schedule 1,
item 1, subsections 230-160(3) and (5) and 230-165(3) and (5)]. An
example of a portfolio of similar financial arrangements is a
portfolio of similar home loans held by a bank. An application or
establishment fee payable on the home loan is an example of a
portfolio fee to which the modified accruals rule applies. A
portfolio of loans purchased for an amount less than its face value
may represent a portfolio discount to which the modified accruals
rule may also apply. The election can only be made in the
following circumstances:
. where the taxpayer has prepared audited financial reports
in accordance with the accounting standards (or comparable
standards) [Schedule 1, item 1, subsection 230-150(1)]; or
. all the following criteria are satisfied:
- a connected entity of the taxpayer has prepared an
audited financial report;
- the report of the connected entity is a consolidated
financial report that deals with both the taxpayer's
affairs and the affairs of the connected entity; and
- the report properly reflects the taxpayer's affairs
(discussed below and in Chapter 5).
576. The election applies to financial arrangements that the taxpayer
starts to have in the year of the election or subsequent years
following the election [Schedule 1, item 1, paragraphs 230-
160(1)(a) and (b) and 230-165(1)(a) and (b)]. Once made an
election it is irrevocable (subsection 230-150(2)).
577. The election applies only to portfolio fees or discount/premiums
arising from a financial arrangement that is part of a portfolio of
similar financial arrangements [Schedule 1, item 1, subsections 230-
160(3) and 230-165(3)]. What is meant by 'similar' in the context
of a portfolio of financial arrangements is to be determined by
reference to the terms, conditions such as tenure, pricing and risk
profile of the financial arrangements. An example could be a
portfolio of similar home mortgages or credit card receivables held
by a bank or financial institution.
578. The 'portfolio fees' are those fees that (in the absence of the
'portfolio fee' election) would form part of the gain or loss from
the financial arrangement under subsection 230-105(1) [Schedule 1,
item 1, paragraph 230-160(1)(c)]. The discount/premium is that
part of the gain or loss that arises as a result of the
discount/premium on the loan portfolio. Specifically, for the
purpose of the election, that part of the gain or loss arising from
the fees, and the part relating to the discount/premium, are
treated as separate gains or losses from the financial arrangement
[Schedule 1, item 1, subsection 230-160(2)].
579. In the case of fees, in order for the election to apply they must
play an integral role in determining the amount of the gain or loss
from the financial arrangement. What is integral is determined by
the nature and role of the fee in relation to the financial
arrangement that gives rise to the overall gain or loss.
[Schedule 1, item 1, paragraph 230-160(1)(e)]
580. The net amount of these fees should not be significant relative to
the gain or loss on the arrangement [Schedule 1, item 1, paragraph
230-160(1)(f)]. In relation to the fee gain or loss, the net fee
is used because portfolio fees include both fee (income) and costs
(expenses). Examples of typical fees that would be included in a
portfolio of fees are establishment fees, legal fees, search fees,
brokerage commission (costs), and valuation (costs). In the case
of discounts and premiums, the premium or discount should not be
significant relative to the gain or loss on the portfolio of which
the financial arrangement is a part [Schedule 1, item 1, paragraph
230-165(1)(e)].
581. As the portfolio treatment of discounts/premiums will modify the
general rule relating to the period over which the gain or loss is
spread (in some cases shortening the 'spread' period) it is a
requirement that the fees and the discount/premium must be
insignificant relative to the gain or loss (that excludes the net
portfolio fee) from the portfolio of which the financial
arrangement is a part (which typically mainly consist of interest
income).
582. What is not significant is determined on an objective basis
depending on the facts and circumstances, for example it could be
said that net fees of $1000 on a home loan which gives rise to
interest income of $100,000 would not be significant relative to
the overall gain on the loan. The testing time for determining
whether the net fee is insignificant is at the start of the
financial arrangement. [Schedule 1, item 1, paragraphs 230-
160(1)(f) and 230-165(1)(e)]
1.
An entity acquires from a vendor a portfolio of loans that
include a right to receive $120 in two years time. However,
the entity provided $110 to acquire this arrangement,
notwithstanding that the market value of the right to
receive $120 in two years time is $100.
The gain on the arrangement is $10. The gain of $10 is
split into one gain and another loss. The part of the gain
which relates to the premium is a loss of $10, and the part
not relating to the premium is a $20 gain.
The entity spreads the $20 gain using the standard
accruals/realisation method.
The entity spreads the $10 loss in accordance with the
determination referred to below.
How is the expected life of the portfolio determined
583. The period over which the fees are spread is the expected life of
the portfolio. In the case of fees, the period is to be determined
before the fee is payable or receivable and must be reasonable and
objective. Further, the period is to be determined prior to the
entity starting to have the arrangement [Schedule 1, item 1,
paragraphs 230-165(3)(b) to (d) and 230-160(3)(b) to (d)]. What is
considered reasonable and objective would depend on the facts and
circumstances of each portfolio, and would include the assumptions
made and methodology used to determine the average life of the
portfolio, for example quantitative data or analysis (based on
historical data) on the expected early repayment of similar
financial arrangements.
584. The basis of determining the period over which to spread the
portfolio must accord with the spreading of the discount premium
for the purposes of the profit and loss statement in the audited
financial reports of the taxpayer [Schedule 1, item 1, paragraphs
230-160(3)(a) and 230-165(3)(a)]. It would be considered that the
basis of determining the period for spreading the portfolio
discount premium accords with the audited financial reports if the
basis determined does not result in a qualification to the audited
report of the taxpayer with respect to the period determined.
585. In the case of fees, the method of spreading the fee must also be
reasonable and objective and be determined before the fee is
payable or receivable [Schedule 1, item 1, subsection 230-160(4)].
In the case of portfolio premiums and discounts, the method of
spreading the premium or discount must also be reasonable and
objective and be determined before the entity starts to have the
arrangement [Schedule 1, item 1, subsection 230-165(4)]. Further,
the method of spreading the portfolio fees discounts or premiums
must accord with the spreading of the fees in the profit and loss
statement in the audited financial reports.
586. What is considered reasonable and objective would depend on the
facts and circumstances of each type of fee, and would include the
assumptions made or methodology used to determine what portion of
the fee (income or expense) is to be spread. For example, it may
be that expenses that relate in part to unsuccessful loans such as
legal or valuations expenses may be spread on a percentage basis as
determined by historic loan success rate data. It would be
considered that the method of spreading of portfolio fee accords
with the audited financial accounts if the method used does not
result in a qualification of the audited accounts because of the
manner in which the portfolio fees have been spread.
Transitional election to apply Division 230 to existing financial
arrangements - application of portfolio treatment to existing
financial arrangements
587. A taxpayer will not be prevented from applying the 'portfolio'
treatment (to spread the fees) arising from a financial arrangement
that existed prior to the first income year in which Division 230
applies to the taxpayer, and that the taxpayer still has at the
time the Division first applies to the taxpayer. In these cases,
the election in section 230-150 is able to be made despite the fact
that the taxpayer started to have the financial arrangement before
the first income year in which the Division applies to the
taxpayer. [Schedule 1, Part 3, subitem 104(7)]
Allocating gain or loss to income years
588. 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
. 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 230-170(1)]
589. 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 230-170(2)]
Running balancing adjustment
590. 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.
591. 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 230-175]
592. 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 than the estimated amount of the
financial benefit [Schedule 1, item 1, subsection 230-
175(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 230-175(4)].
593. 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 230-175(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 230-175(3)].
Re-estimation of gain or loss
594. 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 sufficiently certain particular 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.
When is re-estimation necessary?
595. 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-
190(2)]
596. 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 230-190(3)(a)];
. the cash flow or flows which were previously estimated
become known [Schedule 1, item 1, paragraph 230-
190(3)(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 230-190(3)(c)]; and
. a re-assessment of the gains or losses to which the
compounding accruals method should apply (pursuant to
section 230-185) 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 230-190(3)(d)].
597. 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 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 230-175.
598. Under section 230-190, 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.
599. 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. [Schedule 1, item 1,
subsection 230-190(3)]
600. 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 TR 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 230-190(3)(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.
Annual or more frequent reset date
601. Where the gain or loss qualifies for spreading under the above rule
and:
. the financial arrangement has an interest reset date or
dates which occur at least annually; and
. a new interest rate (if any) applies to the arrangement
from no later than the date at which the rate is set,
the re-estimation of the gain or loss may be done at the reset date
instead of at the time at which the taxpayer becomes aware of the
relevant change in circumstances referred to in paragraph 230-
190(1)(b). [Schedule 1, item 1, subsection 230-190(2)]
Re-estimation where there is a partial disposal
602. 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 230-200(1)]. In
such a situation, only the method prescribed under section 230-200
should be used to re-estimate the relevant gain or loss that will
be made from the financial arrangement.
603. 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 230-190 were to
apply without adjustment.
604. 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 230-70(4) and 230-75(4) 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 230-200(2)]
Nature of a re-estimation
605. 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 230-190(5)]
606. 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 the re-estimated values where relevant (see
paragraphs 4.126 to 4.129 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 subsection 230-
195(5) 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.
607. 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 230-200(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 230-200(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
608. As noted in paragraph 4.185, 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 230-190(6)]
609. 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 230-190(6)(a)]
610. 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 230-190(6)(b)]. The
application of these methods is demonstrated in Example 4.7.
611. It is arguable that in accordance with paragraph 230-190(6)(b) -
under which the fresh allocation can be made on the basis that the
rate of return is adjusted while the amount to which that rate is
to be applied is maintained - there is an implication that the
amount cannot be changed other than under the alternative basis of
fresh allocation found in paragraph 230-190(6)(a). That will not
be the case.
612. The amount can be adjusted for reasons other than a fresh
allocation under paragraph 230-190(6)(a)). Indeed, this adjustment
is often an essential element of working out, under section 230-
135, the compounding accruals gain or loss for a given interval.
Subsection 230-135(6) in particular clarifies that the amount to
which the rate of return is applied should have regard to financial
benefits provided or received during the interval. Accordingly,
this amount can change because of, for example, a partial repayment
of a loan or the non-payment of interest during the interval.
613. 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 230-195].
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 4.170 to
4.173). Any amounts previously recognised under the running
balancing adjustment rule in section 230-175 are taken to have been
allocated to intervals ending before the re-estimation was done.
614. Taxpayers who prepare audited financial reports in accordance with
the Australian accounting standards, or comparable standards, may
apply the methods under paragraph 230-190(6)(a) or (6)(b), so long
as the taxpayer continually and consistently applies the methods in
accordance with the accounting standards. Taxpayers who do not
prepare audited financial reports in accordance with the Australian
accounting standards, or comparable standards, may only apply
paragraph 230-190(6)(b). However, where a taxpayer's application
of paragraph 230-190(6)(b) - due to the rule for impaired financial
arrangements in subsection 230-190(9) - is in conflict with the
requirements of the accounting standards, this does not cause the
taxpayer to fail to satisfy the requirements of subsection 230-
190(7). [Schedule 1, item 1, subsection 230-190(7)]
615. 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
230-200(3)]
616. If there is an impairment (within the meaning of the accounting
standards) of the financial arrangement or financial asset or
financial liability that forms part of the financial arrangement, a
re-estimation is required to be made in accordance with paragraph
230-190(6)(b) [Schedule 1, item 1, subsections 230-190(8) and (9)].
A loss that arises because of the impairment is not deductible for
that income year nor able to be accrued in a later interval
[Schedule 1, item 1, subsection 230-190(10)].
Balancing adjustment if the rate of return maintained
617. 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 230-195(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).
618. 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 230-195(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 230-195(1)(d)].
619. 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 a result of the re-estimation. The amount of the
loss is equal to that decrease [Schedule 1, item 1,
paragraph 230-195(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 230-195(1)(c)].
620. The gain or loss that is made on applying the balancing adjustment
provision in subsection 230-195(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.
621. 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 4.182.
1. : 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.
1. : Summary of cash flows
|Year |Fixed cash |Estimated |Total cash |
| |flows |cash flows |flow 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 |$1,000.00 |$100.00 |$1,100.00 |
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
annum[1].
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 230-190(3)(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.
2. : The amounts that would have been accrued if there was no re-
estimation
|Year |Amortised |Gain |Cash |Amortised |
| |cost (year| |flows |cost (year |
| |start) | | |end) |
| |(a) |(b) |(c) |(a) + (b) |
| | | | |- (c) |
|0 |$0.00 |$0.00 |-$1,000.0|$1,000.00 |
| | | |0 | |
|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 230-190(5)); and
. a reapplication of the accruals method to the re-determined
gain to make a fresh allocation of that re-determined gain.
The reallocation of the re-determined 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 230-190(5)).
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-
190(6)(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 re-determined 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 re-
determined 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 re-determined 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.
3. : Amounts to be accrued using the method in paragraph 230-
190(6)(a)
|Year |Amortised |Gain |Cash |Amortised |
| |cost (year| |flows |cost (year |
| |start) | | |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 230-195(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 230-195(1)(b)).
Calculation required where method under paragraph 230-
195(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 230-190(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 re-
determined gain that has not already been allocated to
intervals ending before the re-estimation is made. Hence
the remaining amount of the re-determined 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 $1,043.37, and the expected future
cash flows of $60 in year 3 and $1,070 in year 4.
The adjusted rate of return for these future cash flows will
be 4.18 per cent[2].
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 230-190(6)(b), be:
4. : Amounts to be accrued using method in paragraph 230-190(6)(b)
|Year |Amortised |Gain |Cash |Amortised |
| |cost (year | |flows |cost (year |
| |start) | | |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 re-determined 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
622. 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.
623. 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 adjustment under section 230-195 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-
190(8)(b)]
624. 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 230-190(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 230-195(3)]. The limit to the
deduction allowed under subsection 230-195(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 230-195(2)]
625. 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 230-195(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 intention is to provide a deduction, limited to the
cost of acquiring the right [Schedule 1, item 1, subsection 230-
195(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 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).
626. 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 230-195(6)]
When to use the realisation method
627. 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.
628. 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 fair value method;
. the elective retranslation method - in respect of foreign
currency gains and losses;
. the elective financial reports method; and
. the elective hedging regime.
[Schedule 1, item 1, subsection 230-40(4)]
629. 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 reasonable accuracy. A discussion as to whether
a financial benefit will be sufficiently certain is contained in
paragraphs 4.97 to 4.125.
630. 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).
631. 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 230-435(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
632. 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
230-235]. Further discussion in relation to this bifurcation rule
is contained in Chapter 6.
633. 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.
634. It should be noted that a hybrid financing arrangement which is an
'equity interest' under Division 974 of the ITAA 1997 is excluded
from the realisation method applied under Division 230. [Schedule
1, item 1, paragraph 230-40(4)(e)]
How is a gain or loss calculated under the realisation method
635. 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
636. 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-
180]. 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-
180(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 230-180(2)(b)]. Similar considerations in
respect of the test in section 230-115, 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.
637. 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 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.
638. Further, the rules in relation to the apportionment of financial
benefits in sections 230-70 and 230-75 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
639. 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
230-180(3)]. 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.
640. The realisation method principle is contained in subsection 230-
180(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 230-180(6)].
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 230-180(2).
641. 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 230-180(3)(a)]. The amount of the loss is equal
to so much of the gain which was attributable to the right
to the financial benefit which was written off as bad
[Schedule 1, item 1, paragraph 230-180(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 230-180(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 230-180(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 230-180(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 230-180(5)(c)].
642. As was stated in paragraph 4.206, 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 230-180(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).
Reassessment of whether to apply an accruals or realisation method
643. 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 230-185(1)]
What constitutes a material change that triggers a reassessment?
644. 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 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 reassessment
under section 230-185.
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 230-185(3)]
Change to the terms or conditions that alters the essential nature
of an interest
645. 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-
185(2)(a)]. The test for reassessment under section 230-185 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 of the ITAA 1997. 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 230-185 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
646. 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 230-185(2)(b)]. The relevant obligations or rights which
are affected must be significant, in the context of the financial
arrangement.
647. 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 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.
648. 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.
649. 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 230-190(3)(d)]
A change in circumstances that materially affects the contingencies
in respect of significant rights or obligations
650. 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 230-185(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
651. 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
230-185(2)(d)]
652. 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.
A change to the terms or conditions or circumstances that are
sufficient to treat a financial arrangement, or a part of the
arrangement that is a financial asset or financial liability as
impaired
653. A reassessment is required if the financial arrangement is, or
includes, a financial asset or financial liability 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
financial arrangement - such that it would be treated as impaired
for the purposes of those standards [Schedule 1, item 1, paragraph
230-185(2)(e)]. The outcome of the reassessment can result in
either the accrual method no longer applying to the financial
arrangement and instead the realisation method applying from the
time of reassessment, or the impairment requiring a re-estimation
of the gain from the financial arrangement. However, a taxpayer
cannot deduct a loss because of impairment when it occurs nor
accrue a deduction for the loss in a later interval [Schedule 1,
item 1, subsections 230-190(8) to (10)].
654. This particular trigger for a reassessment will not apply to
individuals or entities which satisfy the threshold test in section
230-455. It may apply to entities satisfying that threshold 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.
655. '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.
656. 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.
657. 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.
Chapter 5
Elective Subdivisions: common requirements
Outline of chapter
658. 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.
659. 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'.
Overview of common elective requirements
660. There are four main elective tax timing methods under Division 230,
namely:
. the fair value method (Subdivision 230-C);
. the foreign exchange retranslation method (Subdivision 230-
D);
. the hedging financial arrangements method (Subdivision 230-
E); and
. the reliance on financial reports method (Subdivision 230-
F).
661. This chapter looks at the common features of each of the elective
tax-timing methods including common requirements for making an
election and outcomes. In particular, it discusses the
requirements that taxpayers must prepare audited financial reports
before being able to elect to apply the elective Subdivisions.
662. The chapter also discusses the practical implications of having to
satisfy these requirements, such as who is to prepare the audited
financial reports and the impact of not being required to prepare a
financial report because of a Class Order.
Context of amendments
663. 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 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
664. 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.
665. Once an election has been made, the elective Subdivisions allow 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 to determine gains and losses for tax purposes for relevant
financial arrangements.
666. 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 |There is no basis under |
|to access the treatments|the current law for |
|provided for in the |electing to use |
|elective Subdivisions, |accounting standards |
|they must meet |concepts, methods and |
|requirements common to |valuations (as |
|all the elective |appropriate) to |
|Subdivisions. These |calculate gains and |
|requirements are that |losses for tax purposes |
|financial reports be |and, as a result, no |
|prepared in accordance |comparable common |
|with relevant accounting|elective requirements. |
|standards and | |
|appropriately audited. | |
Detailed explanation of new law
The elective Subdivisions
667. 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 using the:
. fair value method (Subdivision 230-C);
. retranslation method (Subdivision 230-D) - (this chapter
discusses the general foreign exchange retranslation
election only);
. method that is consistent with the tax treatment of the
hedged item (Subdivision 230-E); or
. method which relies on the relevant accounting standards
more broadly (Subdivision 230-F).
668. 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.
669. 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
670. 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 230-210(2), 230-255(2), 230-315(2)
and 230-395(2)]
671. In certain circumstances a taxpayer will be taken to have prepared
an audited financial report even though it is in fact prepared by
someone else. The relevant circumstances that must be satisfied
before this can occur are:
. a connected entity of the taxpayer has prepared an audited
financial report;
. the report of the connected entity is a consolidated
financial report that deals with both the taxpayer's
affairs and the affairs of the connected entity; and
. the report properly reflects the taxpayer's affairs (see
discussion below on financial reports of a connected
entity).
[Schedule 1, item 1, section 230-525]
672. As listed 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. Accordingly, 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 in relation to 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. That integrity will work to ensure that
opportunities for tax avoidance or tax deferral are minimised.
Financial reports
673. The term financial report is used in a number of provisions
throughout Division 230. This term is not defined and instead
takes its meaning from ordinary commercial usage. It would be
expected that the contents of financial reports will generally be
governed by the accounting standards applied in the relevant
jurisdiction together with any relevant statutory requirements.
For example, the Australian Accounting Standard AASB 101
Presentation of Financial Statements (AASB 101) prescribes the
documents which together constitute what will, from 1 July 2009, be
called financial statements (before recent amendments to this
standard the term used was financial reports). The documents that
constitute the financial statements for the taxpayer under AASB 101
will therefore satisfy the meaning of the term financial reports
where it is used in Division 230. Paragraph 10 of AASB 101 sets
out the documents that comprise a complete set of financial
statements:
. a statement of financial position (currently referred to
as a balance sheet);
. a statement of comprehensive income (currently referred to
as a profit or loss statement);
. a statement of changes in equity;
. a cash flow statement; and
. notes, comprising a summary of significant accounting
policies and other explanatory notes.
674. The Corporations Act 2001 also has a definition in section 295 of
financial reports which essentially mirrors the requirements of the
accounting standards, but which also has certain additional
requirements including a declaration of directors. Compliance with
that section would similarly meet the ordinary meaning of financial
report, but it would not be necessary that the additional
requirements over and above that required under the relevant
accounting standards be satisfied.
Prepared in accordance with accounting standards
675. 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.
676. In the case of financial reports not prepared in accordance with
the accounting standards, there may not be sufficient integrity
associated with the preparation of such reports to allow them to be
relied upon for tax purposes.
677. 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 - which covers
recognition and measurement of financial assets and
liabilities;
. Australian Accounting Standard AASB 121 The Effects of
Changes in Foreign Exchange Rates - 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.
678. While these are the most relevant accounting standards for the
methodologies contained within the elective Subdivisions, other
Australian accounting standards may also be relevant (such as those
Australian accounting standards mentioned in Chapter 1).
679. 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 5.46
to 5.48.)
680. 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.
Financial reports of a connected entity
681. A financial report prepared by another entity is treated as though
it is prepared by the taxpayer where the other entity is a
connected entity of the taxpayer and the financial report is a
consolidated financial report that properly reflects the affairs of
both the taxpayer and the connected entity [Schedule 1, item 1,
section 230-525]. What is meant by the term 'properly reflects' is
a question of fact and degree; the term seeks to underline the
importance of the accounting and auditing requirements being
substantively met in respect of the particular taxpayer.
682. It may be possible that a taxpayer's affairs are reflected in more
than one set of audited financial reports, for example in the
context of a multiple entry consolidated group (MEC group) there
could be more than one relevant audited financial report prepared
for different levels of relevant interposed holding entities.
683. There may also be circumstances where an entity that prepares a
financial report (or for whom the report is prepared) may not make
an election under any of the elective Subdivisions (because, for
example, it is not an Australian resident taxpayer) while an entity
it controls (in the corporations law sense) may make an election to
apply one of the elective Subdivisions. There is also the
possibility that a controlled entity (in the corporations law
sense) may seek to make the election in respect of itself because
it is a separate taxpayer from the taxpayer that has prepared the
financial report.
684. In this regard, any entity that is a controlled entity (in the
corporations law sense) is eligible to make an election under the
elective Subdivisions where a financial report properly reflects
the affairs of the taxpayer making the election, that is, the
controlled entity. The availability of this election is on the
proviso that the audited financial report is a consolidated
financial report for the reporting group of which the controller
and the controlled entity are members.
685. This provision allows an entity to make an election under the
elective Subdivisions where the entity's financial arrangements are
dealt with in a set of audited financial reports of an accounting
consolidated group of which it is not the parent entity. For
example, the entity could be the head company of a tax
consolidated/MEC group or a subsidiary of an accounting
consolidated group.
More than one financial report
686. It is expected that taxpayers who are able to rely on one set of
financial reports for the purpose of calculating their Division 230
gains and losses will have significantly reduced compliance costs.
This will be the ordinary case where the taxpayer's accounting year
and income year align.
687. However, in cases where accounting and income years do not align,
taxpayers will still be able to rely on financial reports to
calculate their Division 230 gains and losses. In those
circumstances it will be possible for taxpayers to rely on more
than one set of financial reports. Where this arises, taxpayers
will need to reasonably and properly allocate gains and losses from
their financial reports to the income year in which those gains and
losses are properly referable.
688. It must be noted, however, that the operation of Division 230, and
the application of this exception where accounting and income years
do not align, does not, of itself, provide a rationale for changing
income years to align with accounting years.
689. If the taxpayer's accounting and income tax years do not align, it
will be necessary to determine whether more than one set of audited
financial reports will satisfy the requirements for making an
election under the respective elective Subdivisions.
690. In order to satisfy those requirements, the taxpayer must be able
to identify and use two or more sets of financial reports, each of
which:
. covers at least part of the income year for which the
election is being made;
. is prepared in accordance with relevant accounting
standards;
. is audited in accordance with relevant auditing standards;
and
. is unqualified by the auditor.
[Schedule 1, item 1, subsections 230-215(1), 230-260(1), 230-320(1)
and 230-400(1)]
691. Where a taxpayer can demonstrate that they have multiple audited
financial reports that cover the relevant income year, they are
able to treat themselves as eligible to make an election under the
elective Subdivisions. [Schedule 1, item 1, subsections 230-
215(2), 230-260(2), 230-320(2) and 230-400(2)]
692. The reports that are relied upon must also cover at least the
entire income year. As with financial reports for accounting and
income years that align, the financial reports of a connected
entity can, in certain circumstances, be relied on (see above).
693. Examples of where non-alignment of accounting and income years may
occur, and the relevant financial reports that may be used include:
. the accounting year is to 31 December and the income year
is to 30 June - the taxpayer may use an audited interim
financial report prepared in accordance with Australian
Accounting Standard AASB 134 Interim Financial Reporting
and an audited full year financial report prepared in
accordance with AASB 101; and
. the accounting year is for 52 weeks - the taxpayer may use
the audited full year financial reports prepared in
accordance with AASB 101 for two years.
Reasonably attributing the gain or loss
694. Where more than one financial report satisfies the requirements for
making a valid election under the elective Subdivisions for an
income year (and in fact the election is then made), it will be
necessary to determine how much of each gain or loss worked out
under the relevant accounting standards in each of the reporting
periods for relevant financial arrangements is attributable to the
income year. Where multiple financial reports are used, it may be
the entire gain or loss for a period worked out under the standard
that is attributable to the relevant income year (eg, where the
reporting period is for six months), and for other periods (eg,
where the reporting period is for 12 months) only part of the gain
or loss will be attributable to the relevant income year.
695. When undertaking this attribution process it is important to note
that it will not always be acceptable to simply attribute gains or
losses for a reporting period on a pro-rated time basis. This is
especially so in respect of gains and losses that arise on an
unsystematic basis. In addition, it is expected that taxpayers
will use the same basis for attributing gains and losses in
relation to one period as they do for other periods that relate to
an income year. Further, that basis should be consistent with that
used under the relevant accounting standards. For example, it will
be inappropriate to apply an accruals type calculation to a
financial arrangement that is being fair valued for accounting
purposes.
1. : Attribution process
ABC Co has an income tax year that ends on 30 September and
an accounting year that ends on 30 June. ABC Co has made a
valid election under Subdivision 230-C (using more than one
financial report) and wishes to determine the amount of its
assessable income and deductions under Division 230 for
relevant financial arrangements. The following example
illustrates how ABC Co should attribute gains and losses on
a financial arrangement that is subject to an election under
Subdivision 230-C:
Financial arrangement - variable rate bond.
1 February 2013 - acquire bond for $1,000,000 (its fair
value).
Its fair value over time is as follows:
30 June 2013[3] $987,500
30 September 2013 $876,900
30 December 2013 $870, 000
31 March 2014 $913,500
30 June 2014 $978,400
For the accounting period ending 30 June 2013 the change in
fair value on the bond worked out in accordance with the
accounting standards is a loss of $12,500 and is wholly
attributable to the income year ended 30 September 2013.
For the accounting period ending 30 June 2014 the change in
fair value on the bond worked out in accordance with the
accounting standards is a loss of $9,100. If ABC Co were to
allocate this loss to the 2013 income year on a pro-rated
time basis it would allocate the loss as follows:
$9,100 × 273/365 = $9,100 × 0.7479 = $6,806.30
However, this is an inappropriate attribution because the
actual change in fair value that occurred during the
relevant part of the income year, (ie, from 1 July 2013 to
30 September 2013), is:
Value at 1 July 2013 $987,500
Value at 30 September 2013 $876,900
Change in fair value ($110,600)
[Schedule 1, item 1, subsections 230-215(3) to (5), 230-260(3) to
(5) and 230-400(3) to (5)]
Class Orders
696. Some entities within an accounting consolidated group may not be
required to prepare financial reports because of, for example, an
Australian Securities and Investment Commission Class Order.
However, if a particular financial asset or liability is held by
such an entity and that 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 230-220(1)(b), 230-265(1)(b), 230-
335(1)(c) and 230-410(1)(c)]
Audited in accordance with auditing standards
697. 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.
698. 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.
699. For the purposes of the 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.
700. 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 5.46 to 5.48.
701. 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). An entity that falls into this category 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.
702. The auditing requirement in the elective Subdivisions is 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 230-210(2)(b), 230-255(2)(b), 230-
315(2)(b) and 230-395(2)(b)]
Comparable accounting and auditing standards
703. 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.
704. 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 230-210(2)(a)(ii) and (b)(ii),
230-255(2)(a)(ii) and (b)(ii), 230-315(2)(a)(ii) and (b)(ii) and
230-395(2)(a)(ii) and (b)(ii)]
705. 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 230-500]
706. 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 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).
Effect of change of accounting standards
707. Generally, the elective methods apply by relying on figures that
are included in the profit or loss statement in the financial
report. However, there are circumstances where, as a result of a
change in the application of an accounting standard, an amount that
would otherwise be recorded in profit or loss may be taken directly
to equity. From a Division 230 perspective this amount may be a
gain or a loss made from a financial arrangement but for the change
in accounting standard. Given this, there is a requirement that
amounts that go directly to equity, as a result of the change in
application of an accounting standard, are to be included as
Division 230 gains or losses in the year of the restatement.
708. These provisions ensure that taxpayers are not required to amend
prior year tax returns when such an accounting change is made.
That is, these amendments are designed to reduce compliance and
administration costs by providing that the restated amount is a
gain or loss that is made in the year in which the restatement
occurs.
Australian Accounting Standard AASB 108
709. Where there is a change in either the relevant accounting standard
or its application, accounting standard Australian Accounting
Standard AASB 108 Accounting Policies, Changes in Accounting
Estimates and Errors (AASB 108) requires that certain restated
amounts (gain or loss amounts) go directly and permanently to
equity instead of going through the profit or loss statement. The
adjustment amount, reflecting amounts not brought to account in
previous years (which, based on the changes to the accounting
standard, would have been brought to account in profit or loss had
the new approach applied since the inception of the financial
arrangement), will go directly to equity. As a result, the amount
cumulatively returned from an accounting perspective through profit
or loss will no longer align with the amount returned for tax
purposes (if the accounting change had not been made).
710. Paragraph 22 of AASB 108 states that:
'Subject to paragraph 23, when a change in accounting policy
is applied retrospectively in accordance with paragraph
19(a) or (b), the entity shall adjust the opening balance of
each affected component of equity for the earliest prior
period presented and the other comparative amounts disclosed
for each prior period presented as if the new accounting
policy had always been applied.'
711. Paragraph 42 states that, subject to paragraph 43, an entity shall
correct material prior period errors retrospectively in the first
financial report authorised for issue after their discovery by:
'restating the comparative amounts for the prior period(s)
presented in which the error occurred; or...'
712. Finally, paragraph 46 states that the correction of a prior period
error is excluded from profit or loss for the period in which the
error is discovered.
713. As can be seen from the AASB 108 extracts, the accounting standards
do not include the restated amount in profit or loss. In a
Division 230 context, the restated amount is to be considered as a
relevant gain or loss notwithstanding that the amount is not
included in profit or loss. [Schedule 1, item 1, section 230-495]
Making an election under the elective Subdivisions
Who may make an election
714. 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).
715. However, individuals and entities that fall below the relevant
threshold tests specified in subsections 230-455(2) to (4), 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 230-455(7) to have Division 230 apply to all of their
financial arrangements (apart from those excluded in
Subdivision 230-H).
1. : Individual excluded
Nik is an individual who is in the business of trading
securities. As Nik has not made an election under
subsection 230-455(7) for Division 230 to apply to all of
his financial arrangements any election(s) Nik may make
under any of the elective Subdivisions will be invalid (see
subsections 230-225(2), 230-270(2), 230-330(3) and 230-
415(2)).
Elections where a consolidated or MEC group contains a life
insurance company
716. In the case of a consolidated group or a 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. This is
discussed in detail in Chapter 12.
717. However, there is an exception to this where a consolidated group
or MEC group includes a member that carries on a 'life insurance
business' (as defined in subsection 995-1(1) of the Income Tax
Assessment Act 1997 (ITAA 1997). The member running the life
insurance business will be a life insurance company that is
registered under the Life Insurance Act 1995.
718. 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.
719. Consolidated groups and MEC groups may wish to elect to apply one
of the elective Subdivisions. However, for 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 consolidated group or MEC group. For this reason
the head company of a 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 230-225(3), 230-270(3), 230-330(4)
and 230-415(3)]
Remaking an election - life insurance company as a joining entity
720. The amendments to subsection 715-660(1) of the ITAA 1997 (discussed
in Chapter 12) 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.
721. 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
. the life insurance company's election is inconsistent with
the existing Division 230 election of the head company.
722. 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.
723. 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.
724. 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 230-225(3), 230-270(3), 230-330(4) and 230-415(3)]
The manner in which elections are to be made
725. 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
726. An election made under one of the elective Subdivisions is
irrevocable. [Schedule 1, item 1, subsections 230-210(3), 230-
255(5), 230-315(3) and 230-395(4)]
Financial arrangements that are subject to the election, and the effect of
the election
Financial arrangements to which the elective Subdivisions apply
727. 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 audited financial
reports.
[Schedule 1, item 1, subsections 230-220(1), 230-265(1) and 230-
410(1), section 230-325]
728. 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 13).
Financial arrangements to which the elective Subdivisions do not
apply
729. 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 [Schedule 1, item 1,
subsections 230-225(1) and 230-415(1)]; and
. franked distributions. The assessability of these
distributions, to the degree that they are franked, will
remain outside Division 230. For example, dividends, to
the degree that they are franked, will remain assessable
in accordance with section 44 of the Income Tax Assessment
Act 1936 [Schedule 1, item 1, subsections 230-225(1) and
230-480].
Refer to Chapters 2, 3, 6 and 9 for more information on these
exceptions.
730. 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 230-225(3),
230-270(3), 230-330(4) and 230-415(3)]
731. Regulations may also exclude other financial arrangements
associated with a business of a specified kind. [Schedule 1, item
1, subsections 230-225(4), 230-270(4), 230-330(5) and 230-415(4)]
732. Note that although individuals and other entities not subject to
Division 230 under the threshold tests contained in section 230-455
can elect to apply the elective Subdivisions, the election will be
invalid unless the taxpayer has also made an election under
subsection 230-455(7) - refer to paragraph 5.58. [Schedule 1, item
1, subsections 230-220(1), 230-265(1), 230-325(3) and 230-410(1)]
Effect of relying on elective Subdivisions
733. 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.
734. 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 230-230(1), 230-280(1) and 230-420(1)]
735. 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 230-230(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 230-280(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 230-420(1)].
Intra-group transaction for the purposes of AASB 127
736. Where an election is made by a member of an accounting 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, the
requirement that the financial arrangement be recognised in the
financial reports is deemed to have been satisfied in relation to
that financial arrangement. Financial arrangements between members
of a consolidated group or MEC group are not covered by this
subsection because the single entity rule in subsection 701-1(1) of
the ITAA 1997 operates to treat them as not being financial
arrangements for all income tax purposes.
737. This provision is intended to allow taxpayers to rely on entity
accounts for the purposes of satisfying this requirement. 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.
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, subsections 230-220(2), 230-265(2) and
230-410(3), paragraphs 230-230(1)(b) and 230-420(1)(b),
subparagraph 230-280(1)(b)(ii)]
738. For a discussion of the application of elective Subdivisions to
intra-group transactions of foreign bank branches and offshore
banking units, see Chapter 11.
Financial arrangement leaving a consolidated group
739. The elective Subdivisions may apply in a modified manner where an
entity joins or leaves a consolidated group. For details about the
application of elective Subdivisions in relation to the
consolidation regime, see Chapter 12.
The order in which the elections under the elective Subdivisions
apply
740. 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 230-40]
Where requirements for an election are no longer satisfied
741. 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
742. 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.
743. If the taxpayer relies on more than once financial report for an
income year (because the financial and income years do not align),
then ceasing to satisfy the accounting or auditing requirements in
relation to any one of the financial reports relied on will result
in the election ceasing to apply. [Schedule 1, item 1, subsections
230-240(1), 230-285(1), 230-370(1) and 230-425(1)]
Where an election ceases to apply to particular financial
arrangements
744. The elections will cease to apply to one or more particular
financial arrangements in the following circumstances:
. it is no longer recognised in audited 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.
745. As with an election ceasing to apply to all financial arrangements,
it will similarly cease to apply to a particular financial
arrangement if the taxpayer relies on more than one financial
report for an income year (because the financial and income years
do not align), and the particular financial arrangement is no
longer recognised in any one of the audited financial reports
relied on. [Schedule 1, item 1, subsections 230-240(3), 230-285(3)
and 230-425(3)]
When does the election cease to apply?
746. Where an election made under the elective Subdivisions ceases to
apply to a financial arrangement, that election ceases to apply
from the start of the income year in which the circumstances
described above occur. [Schedule 1, item 1, subsections 230-240(1)
and (3), 230-285(1) and (3), 230-370(1) and 230-425(1) and (3)]
747. 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 230-240(2) and (4), 230-285(2) and
(4), 230-370(2) and 230-425(1) and (4)]
A balancing adjustment if an election ceases to apply
748. 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 230-245(1), 230-290(1) and 230-
430(1)]
749. 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 230-245(3), 230-290(3) and 230-430(3)]
750. 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 230-245(2), (4) and (5),
230-290(2), (4) and (5) and 230-430(2), (5) and (6)]
751. 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).
752. 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
753. 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 230-240(2), 230-285(2), 230-370(2)
and 230-425(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 230-240(4), 230-285(4), 230-325(1), 230-425(4) and the
note to subsection 230-370(2)].
754. Chapter 6
The elective fair value method
Outline of chapter
755. 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.
Overview of the elective fair value method
The fair value tax-timing method
756. The elective fair value method is a tax-timing method that measures
gain or loss as the change in the value of a financial arrangement
between two points in time. Under this tax-timing method 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. For example, assuming there are no amounts paid or
received during the period, if the value of a financial arrangement
is $100 on 1 July 2010 and $125 on 30 June 2011, there is a fair
value gain of $25 for that particular period.
757. Where a fair value election applies, the gains or losses for an
income year will be determined by relevant accounting standards.
Accordingly, 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.
758. Distributions, to the degree that they are franked (received either
directly by the taxpayer or indirectly through a partnership or
trust), and rights to receive distributions, to the degree that
they are franked (either directly or indirectly), are not to be
included as a gain or loss under the fair value method.
Valuations
759. The term fair value is defined in Australian Accounting Standard
AASB 139 Financial Instruments: Recognition and Measurement (AASB
139) as '...the amount for which an asset could be exchanged or a
liability settled, between knowledgeable, willing parties in arm's
length transactions'. The valuation methods used for the elective
fair value method ought to generally be the same as those used for
the fair value valuation in relevant accounting standards.
Election to apply fair value tax-timing method
760. Broadly, the fair value tax-timing method will apply to a financial
arrangement where a taxpayer makes a valid election to use the fair
value election in respect of a Division 230 financial arrangement.
761. Generally, for a taxpayer to make a valid election to apply the
fair value tax-timing method, the taxpayer must prepare financial
reports in accordance with relevant accounting standards and have
those financial reports audited in accordance with relevant
auditing standards.
762. The taxpayer must also:
. classify the financial arrangement in the financial report
as an asset or liability at fair value through profit or
loss, except for intra-group financial arrangements not
required to be recognised in the financial reports
referred to above because of the application of the
relevant accounting standard dealing with consolidated and
separate financial statements; and
. treat the asset or liability (or that part of the asset or
liability) that is classified at fair value through profit
or loss as if it is the whole of the relevant financial
arrangement (with any balance being treated as a separate
financial arrangement).
763. Once the fair value election is made a taxpayer must apply the fair
value tax-timing method to financial arrangements described in the
previous paragraph that start to be held in that income year and
any subsequent income year.
Balancing adjustment if a fair value election ceases to apply
764. Where a fair value election ceases to have effect, or ceases to
apply to a particular financial arrangement, a balancing adjustment
is made in respect of any financial arrangement that is no longer
subject to the election. This balancing adjustment has the effect
of a disposal of that financial arrangement for its fair value at
the start of the income year in which the election ceases to apply,
followed by an immediate reacquisition for that fair value.
Context of amendments
765. The current income tax law does not specifically provide for gains
and losses to be recognised using a fair value tax-timing method.
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.
766. 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.
767. 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 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.
768. 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.
769. 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
770. 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 that they issue) 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.
771. 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.
Comparison of key features of new law and current law
|New law |Current law |
|Taxpayers who prepare |Only limited fair value |
|financial reports in |tax treatment is |
|accordance with the |available for financial |
|relevant financial |arrangements. |
|accounting 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 ceases to be | |
|satisfied. | |
Detailed explanation of new law
772. To apply the elective fair value method to a financial arrangement,
the taxpayer must:
. elect the method [Schedule 1, item 1, subsection 230-
210(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 Subdivisions refer to Chapter 5) [Schedule 1,
item 1, subsection 230-210(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, paragraph 230-
220(1)(c) and subsection 230-220(2)];
. 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 Division 230 being treated as a
separate financial arrangement) [Schedule 1, item 1,
section 230-235]; 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 230-220(1)(d)]; and
- it is not subject to certain exceptions [Schedule 1,
item 1, section 230-225].
Which entities can elect the fair value tax-timing method?
773. Any entity that prepares audited financial reports is able to make
a fair value election [Schedule 1, item 1, section 230-210].
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.
774. 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 from substantial economies in
record-keeping and data management. Overall compliance costs are
expected to be reduced as a result.
775. 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
776. Broadly speaking, a taxpayer whose financial arrangement gains and
losses Division 230 applies to may make a fair value election, but
an election will only be valid for those taxpayers who meet the
requirements of Subdivision 230-C.
777. 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 230-225(3)]
778. 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 230-225(4)]
779. 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
780. 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 that the elective fair value method
apply. An election will only be valid if the accounting and audit
requirements listed in subsection 230-210(2) are met. There are
elective requirements common to the elective Subdivisions
(Subdivisions 230-C, 230-D, 230-E 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 profit or loss
781. 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 and in later income years and which
are fair valued through profit or loss [Schedule 1, item 1,
paragraphs 230-220(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 104(8) and (11)]. The transitional election
requirements are discussed in Chapter 13.
782. 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,
subsection 230-220(2)]. For further discussion of this, see
Chapter 5.
783. Arrangements that fall within the extended operation of
Division 230, as set out in section 230-530 (eg, foreign currency,
non-equity shares, and commodities and offsetting commodity
contracts 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 230-530]
784. Financial arrangements which are fair valued, and which are not
classified as at 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. This means that a company
cannot apply the fair value method to an equity issued by that
company. [Schedule 1, item 1, subsection 230-220(1)]
Financial assets and liabilities that comprise the whole or part of the
financial arrangement
785. 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
230-220(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
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 230-235].
786. 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 and
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 230-55]. 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 230-235].
Consequences of making a fair value election
787. 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 13) or a later
income year so long as the election remains valid and continues to
apply. [Schedule 1, item 1, paragraph 230-220(1)(d)]
788. 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 230-240(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 6.43 to 6.45). For those financial
arrangements which were previously being fair valued, a balancing
adjustment is required to be made (see paragraphs 6.46 to 6.49 and
Chapter 10) when the election ceases to be valid.
The application of fair value to financial arrangements that are equity
interests
789. 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,
subject to the satisfaction of the fair value tax-timing
requirements and the exclusion set out below.
790. A taxpayer that has issued its own equity interests is not
permitted to fair value those equity interests [Schedule 1, item 1,
subsection 230-225(1)]. This rule is directed at ensuring, for
example, that an entity does not obtain a tax deduction for
dividends paid.
Gains and losses taken into account where a fair value election is made
791. 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. Chapter 11
explains how this applies in respect of fair value gains or losses
that are made from a financial arrangement arising from intra-
entity/group dealings that are recognised by Part IIIB (foreign
bank branches) of the Income Tax Assessment Act 1936 (ITAA 1936) or
Division 9A of the ITAA 1936 (offshore banking units). [Schedule
1, item 1, subsection 230-230(1)]
Franked distributions
792. 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 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.
793. Without 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 based on the individual facts and
circumstances relating to that dividend declaration. 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.
794. The exclusion of distributions to the extent that they are franked
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 will not apply.
[Schedule 1, item 1, section 230-480]
1. : Dividend payment
On 1 July 2010 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 2011
the shares in Company B have a market value of $65 million.
On 1 May 2011 Company B pays dividends of $6 million.
Company A's taxable income for the 2010-11 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 2012 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 2010-12 income
year includes the fair value gain of $25 million
($90 million - $65 million).
Valuation issues
795. 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 or a liability settled, between knowledgeable, willing
parties in arm's length transactions'.
796. 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
797. 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.
798. If an election under any of the elective Subdivisions ceases to
apply to a particular financial arrangement, that election cannot
subsequently apply to it again. [Schedule 1, item 1, subsection
230-240(4)]
799. Refer to Chapter 5 for further information as to when an election
will cease to apply.
Balancing adjustment if election ceases to apply
800. 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 230-245(1) and (3)]
801. The balancing adjustment is to be made in accordance with the
balancing adjustment requirements 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 230-245]
802. 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.
1. : Balancing adjustment when fair value ends
On 22 April 2010 Spice Co makes a fair value election under
section 230-210. Assume Spice Co has a balance date for tax
purposes of 30 June.
After the financial year ending 30 June 2011, Spice Co
ceases to have its financial reports audited.
From the financial year beginning 1 July 2013, 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 230-210.
The consequences of Spice Co ceasing to maintain audited
financial reports from 1 July 2011 results in Spice Co not
being able to apply the elective fair value method to the
financial arrangements it holds at 1 July 2011, as its
election ceases to apply from this time. A balancing
adjustment will be required to be made on 1 July 2011 for
those financial arrangements which were being fair valued
through profit or loss subject to the fair value election.
On 1 July 2013, 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.
803. 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
804. 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 230-240(2)]
805. Chapter 7
The elective foreign exchange retranslation method
Outline of chapter
806. This chapter outlines how the elective foreign exchange
retranslation election (retranslation method) rules operate. The
chapter explains:
. when the retranslation method may be applied;
. the effect of the retranslation method;
. the difference between a general retranslation election
and an election in relation to qualifying forex accounts;
and
. the interaction of the retranslation method with the other
elective methods under Division 230.
Overview of the foreign exchange retranslation method
Application of the retranslation method
807. Taxpayers who prepare audited financial reports in accordance with
Australian accounting standards or comparable foreign accounting
standards may make:
. an election to apply the retranslation method to all
'financial arrangements' under Division 230 and those
arrangements subject to Subdivision 775-F of the Income
Tax Assessment Act 1997 (ITAA 1997) (general retranslation
election); or
. an election to only apply the foreign exchange
retranslation method to one or more of their financial
arrangements that meet the definition of a 'qualifying
forex account' (qualifying forex account election).
808. Once made, an election is irrevocable.
809. Where the retranslation method applies, any gain or loss due to
changes in currency exchange rates will be generally determined by
the amount which is required under Australian Accounting Standard
AASB 121 The Effects of Changes in Foreign Exchange Rates
(AASB 121) (or a comparable foreign accounting standard) to be
recognised in profit or loss in the financial reports.
810. Broadly, where a general retranslation election is made, all gains
and losses attributable to changes in currency exchange rates
arising from financial arrangements will be brought to account
under Subdivision 230-D.
811. The retranslation method is similar to the fair value method in
recognising unrealised gains and losses in the period in which they
occur. However, the retranslation method only recognises gains and
losses that are 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 and
losses that are attributable to movements in foreign currency
exchange rates.
812. The retranslation method will not apply to a financial arrangement
if any of the following elections have been made in relation to
that financial arrangement:
. a fair value election under Subdivision 230-C;
. a financial reports election under Subdivision 230-F; or
. a hedging financial arrangement election under
Subdivision 230-E to the extent it applies to that
financial arrangement.
813. Where the retranslation method applies to a financial arrangement,
any gains and losses not attributable to changes in currency
exchange rates will be brought to account under the accruals and/or
realisation methods.
814. If none of the elective tax-timing methods (including the
retranslation method) apply to a financial arrangement, gains and
losses including those attributable to changes in currency exchange
rates will be brought to account under the accruals and/or
realisation methods.
815. A qualifying forex account election can only be made where a
general retranslation election has not already been made.
Context of amendments
816. The retranslation method measures the gain or the loss arising from
different prevailing exchange rates at different points in time, on
translating a given number of units of one currency into another
currency.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 ITAA 1997,
a non-functional currency.
817. The scope of the retranslation method is determined by the two
foreign exchange retranslation elections available. A taxpayer can
make either:
. a general election to use the retranslation method, the
scope of which is determined by the amounts required by
AASB 121 to be recognised in the profit or loss statement
in a taxpayer's set of financial reports. A general
election is made in respect of all financial arrangements
and other arrangements where those amounts have not
previously been recognised in the taxpayer's set of
financial reports; or
. a qualifying forex account election to use the
retranslation method only in respect of one or more
financial arrangements that meet the definition of a
'qualifying forex account'. A qualifying forex account is
defined in the ITAA 1997 as an account denominated in
foreign currency which is used for the primary purpose of
facilitating transactions or is a credit card account.
818. Under AASB 121, certain annual gains and losses attributable to
changes in foreign exchange rates are required to be recognised in
profit or loss in an entity's financial reports. The retranslation
method is intended to apply only to these gains and losses.
819. These gains and losses, 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. An initial translation is made when the relevant
item is first recognised for financial accounting purposes. At
subsequent reporting dates, another translation, sometimes referred
to as 'retranslation', is made. The difference between these
amounts is recognised for accounting purpose in profit or loss,
despite typically being unrealised.
820. Gains and losses attributable to changes in currency exchange rates
may also arise under AASB 121 on the settlement or maturity of the
relevant item.
821. Where the retranslation method applies it may result in the
recognition of unrealised gains and losses attributable to changes
in currency exchange rates. If an entity continues to hold a
financial arrangement under Division 230 or an arrangement subject
to Subdivision 775-F of the ITAA 1997, the 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 in an entity's taxable income. Taxpayers
will need to determine whether this method is suitable for
determining these gains and losses for tax purposes.
822. For some taxpayers, recognising gains and losses 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.
823. Other taxpayers may see benefits in recognising for tax purposes
foreign exchange gains and losses as determined under AASB 121 only
in respect of one or more of their 'qualifying forex accounts'.
824. To a limited extent, the election to use the retranslation method
for qualifying forex accounts is similar to the retranslation
election currently available under Subdivision 775-E of the ITAA
1997. Under Subdivision 775-E, 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.
825. 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.
Summary of new law
826. Where audited financial reports are prepared in accordance with
Australian accounting standards or comparable foreign accounting
standards, a taxpayer may elect to use the retranslation method to
determine gains and losses from financial arrangements to the
extent they are attributable to changes in currency exchange rates.
827. If made, the general retranslation election will also bring to
account gains and losses attributable to changes in currency
exchange rates made from arrangements which are subject to
Subdivision 775-F of the ITAA 1997.
828. The general retranslation election will apply to all relevant
arrangements which are first held in the income year in which the
election is made. In subsequent income years, it will apply to all
arrangements in respect of which the relevant accounting standards
recognise in profit or loss, an amount attributable to foreign
currency exchange rate changes. This includes intra-group
transactions that are financial arrangements which would not
normally be recognised by the Australian Accounting Standard AASB
127 Consolidated and Separate Financial Statements (AASB 127), or a
comparable foreign accounting standard.
829. The head company of a consolidated group may choose that the
general retranslation election will not apply to the financial
arrangements or arrangements subject to Subdivision 775-F of the
ITAA 1997 in relation to the life insurance business of the head
company of a consolidated group or a MEC group. Regulations may
also be made to allow the head company of a consolidated or MEC
group to choose to elect to exclude these financial arrangements in
relation to other businesses of the group.
830. Taxpayers who do not make a general retranslation election may make
an election in respect of one or more of their qualifying forex
accounts, essentially any transactional account. In certain
circumstances they will be able to elect their qualifying forex
accounts with effect from 1 July 2003.
831. The gain or loss recognised for an income year under the
retranslation method will generally be the same as that which is
required to be recognised under AASB 121 or its foreign equivalent
in an entity's profit or loss. However, the retranslation method
will not recognise an amount in an entity's profit or loss if that
amount has previously been recognised in equity.
832. Both the general retranslation election and the qualifying forex
account election are irrevocable.
833. 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.
Comparison of key features of new law and current law
|New law |Current law |
|Taxpayers that adopt |There is no general |
|relevant accounting |retranslation tax |
|standards and have |treatment available for |
|audited financial |financial arrangements |
|accounts are able to |under the existing |
|elect to have gains and |tax law except for |
|losses from all relevant|certain qualifying forex|
|arrangements which are |accounts under |
|attributable to changes |Subdivision 775-E of the|
|in currency exchange |ITAA 1997. |
|rates taxed under the |Under the current law a |
|retranslation method. |qualifying forex account|
|Alternatively, taxpayers|is limited to an account|
|may elect to use the |held with, broadly, a |
|retranslation method |financial institution in|
|only in relation to one |Australia or overseas. |
|or more of their | |
|qualifying forex | |
|accounts. | |
|The definition of a | |
|'qualifying forex | |
|account' has been | |
|extended by | |
|retrospectively removing| |
|the requirement that it | |
|must be held with a | |
|financial institution in| |
|Australia or overseas. | |
Detailed explanation of new law
When can the foreign exchange method be used?
834. The retranslation method will only apply in respect of an
arrangement if a foreign exchange retranslation election validly
applies to that arrangement.
835. 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 230-255(1) and (2), item 6, section
775-295]; or
. to financial arrangements that are qualifying forex
accounts, in respect of which an election has been made
(qualifying forex account election) [Schedule 1, item 1,
subsections 230-255(3) and (4)].
General retranslation election
Election requirements
836. Only taxpayers whose financial reports are prepared and audited in
accordance with Australian accounting and auditing standards or
comparable foreign accounting and auditing standards can make the
general retranslation election. This includes taxpayers whose
results are properly reflected in a set of audited financial
reports of a connected entity. [Schedule 1, item 1, subsection 230-
255(2)]
837. Chapter 5 explains what is meant by financial reports, financial
reporting requirements, accounting standards and auditing standards
(including comparable foreign accounting and auditing standards).
Scope of general retranslation election
838. If the general retranslation election is made, the retranslation
method will apply to determine all gains and losses attributable to
currency exchange rate changes which arise from all arrangements to
which the election applies.
839. A general 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 230-265(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 230-265(1)(b),
item 6, paragraph 775-295(1)(b)];
. in respect of which an amount attributable to changes in
currency exchange rates 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 a comparable foreign accounting standard
[Schedule 1, item 1, paragraph 230-265(1)(c), item 6,
paragraph 775-295(1)(c)];
. where the amount attributable to changes in currency
exchange rates is recognised in profit or loss in the
taxpayer's financial reports and 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 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 AASB 127 or a
comparable foreign accounting standard [Schedule 1, item
1, subsection 230-265(2)].
840. Under AASB 121 (or comparable foreign accounting standards) certain
gains and losses attributable to changes in currency exchange rates
are recognised in profit or loss in an entity's financial reports.
For the general retranslation election to apply to an arrangement,
AASB 121 or a comparable foreign accounting standard must require
the recognition in profit or loss of 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 it has earlier been recognised in
equity.
841. In respect of this requirement, the regulations may prescribe that
gains and losses attributable to changes in currency exchange rate
fluctuations 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. Gains and losses
attributable to changes in currency exchange rates which arise from
relevant arrangements will be required to be recognised under such
a replacement standard. To the extent to which comparable foreign
accounting standards require these gains and losses from financial
arrangements to be recognised in profit or loss, and those amounts
have not previously been recognised in an equity reserve, this
requirement will also be satisfied.
842. Where a general retranslation election applies to an arrangement,
gains and losses from that arrangement which are attributable to
changes in currency exchange rates will be recognised under either
Subdivision 230-D or 775-F of the ITAA 1997.
843. Whilst Division 775 of the ITAA 1997 could potentially
apply whenever there is a cessation of an obligation to pay or
receive foreign currency (or right to receive or pay foreign
currency), subsection 230-20(2) has the effect of disregarding
gains and losses arising under Division 775 to the extent they are,
or will be, included in assessable income or allowable as a
deduction under Division 230. A note, following subsections 775-
15(4) and 775-30(4), clarifies this point. [Schedule 1, items 2
and 3]
Division 230 retranslation arrangements
844. Where a general retranslation election applies to a financial
arrangement, 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 by
subsection 230-270(3) or (4), from having the general
retranslation method under Division 230 apply to it.
845. 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. That gain or loss 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 230-280(1)]
Retranslation method under Division 775 of the ITAA 1997
846. An arrangement to which the general retranslation election applies
will have those gains and losses attributable to currency exchange
rate changes subject to Subdivision 775-F of the ITAA 1997 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); 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]
847. Where Subdivision 775-F of the ITAA 1997 applies to an arrangement
to which the general retranslation election applies, the amount
taken to be a forex 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 changes in currency exchange rates 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 gain or loss will be recognised
under new forex 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
Cease to meet eligibility requirements
848. The general retranslation election ceases to have effect in respect
of all relevant arrangements from the start of any income year
during which the taxpayer ceases to be eligible under subsection
230-220(2) to make the election. 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 230-285(1)]
849. The cessation of the general retranslation election in these
circumstances does not prevent a fresh election being made should
the eligibility requirements once again be satisfied. However, a
subsequent general 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 230-285(2)]
Cease to meet recognition requirements
850. The general retranslation election will cease to apply to a
particular arrangement from the start of any income year where:
. the arrangement is no longer recognised in financial
reports that meet the relevant accounting and auditing
requirements discussed in Chapter 5; or
. in relation to the arrangement, amounts attributable to
changes in currency exchange rates are no longer required
by the relevant accounting standard to be recognised in
profit or loss in the financial reports.
[Schedule 1, item 1, subsection 230-285(3), item 6, subsection 775-
310(1)]
851. Where the general retranslation election ceases to apply to an
arrangement, the election cannot subsequently reapply to such an
arrangement, even where the arrangement later satisfies the
relevant recognition requirements. [Schedule 1, item 1, subsection
230-285(4), item 6, subsection 775-310(2)]
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, an arrangement that has previously had amounts in
respect of currency exchange changes recognised under AASB
121 diminished in value such that it was no longer
recognised in the financial reports, under the accounting
practice regarding materiality.
From the start of the income year in which the financial
arrangement was no longer recognised in the financial
reports, the elective retranslation method ceased to apply
to this particular arrangement of Yvee. Although the
retranslation method no longer applies to this arrangement,
any gains and losses attributable to currency exchange rate
changes will be recognised under the accruals or realisation
methods.
Note: Yvee will continue to apply the retranslation method
to the remainder of its arrangements that satisfy the
relevant criteria.
Balancing adjustment under Division 230 where the general
retranslation election ceases to apply
852. When the general retranslation election ceases to apply to a
Division 230 financial arrangement, a balancing adjustment is
required to be made in respect of that financial arrangement.
[Schedule 1, item 1, subsections 230-290(1) and (3)]
853. The balancing adjustment is to be made in accordance with the
balancing adjustment requirements 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 fair
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 230-290(2) and (4)]
854. 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 230-290(5)]
855. 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 gains and losses attributable to changes in currency exchange
rates are taken into account at the time of the deemed disposal
when the general retranslation election ceases to apply to the
relevant financial arrangement.
856. 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.
Consequences under Division 775 of the ITAA 1997 where the general
retranslation method ceases to apply
857. When the general retranslation method ceases to apply to an
arrangement that is being retranslated under Subdivision 775-F of
the ITAA 1997, 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 fair value at that time; and
. reacquired the arrangement immediately after the time the
general retranslation election is taken to cease to have
effect or ceases to apply to it for that same value.
[Schedule 1, item 6, section 775-315]
858. 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
'forex realisation event 9'. [Schedule 1, item 6, sections 775-305
and 775-315]
859. For the purposes of Division 775 of the ITAA 1997, any future forex
realisation gains or losses arising from the reacquired arrangement
will be determined under the general provisions of Division 775.
Qualifying forex account election
Election requirements
860. Instead of making a general retranslation election, a taxpayer may
elect to apply the retranslation method to one or more of its
financial arrangements that meet the definition of a qualifying
forex account. This qualifying forex account election can only be
made where a general retranslation election does not apply to that
financial arrangement. [Schedule 1, item 1, subsection 230-255(3)]
861. Existing elections that apply to qualifying forex accounts under
Subdivision 775-E of the ITAA 1997 will cease to apply to any
account to which a general retranslation election or a qualifying
forex account election applies. [Schedule 1, item 5, subsection
775-270(1A)]
Qualifying forex account
862. A qualifying forex account is a foreign currency denominated
account which has the primary purpose of facilitating transactions
or is a credit card account. [Schedule 1, item 112, definition of
'qualifying forex account' in subsection 995-1(1)]
863. The current restriction which limits 'qualifying forex accounts' to
accounts held with an 'ADI' (authorised deposit-taking institution)
as defined in the ITAA 1997 will be removed [Schedule 1, item 112,
definition of 'qualifying forex account' in subsection 995-1(1)].
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.
864. The effect of this change, which is to have effect (in certain
circumstances) from 1 July 2003, 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. Refer to Chapter 11
for more detail on the changed application of the retranslation
election under Division 775.
The scope of the qualifying forex account election
865. Where a qualifying forex account election is made in respect of a
financial arrangement that is a 'qualifying forex account', it will
apply to determine all gains and losses attributable to changes in
currency exchange rates from that account.
866. If a taxpayer makes a qualifying forex account election before they
start to have the financial arrangement that is a qualifying forex
account, then the retranslation method applies from the time the
taxpayer starts to hold that account. [Schedule 1, item 1,
paragraph 230-255(4)(a)]
867. If the taxpayer already held the financial arrangement prior to
making the election, the retranslation method will apply from the
start of the year in which the taxpayer made that election
[Schedule 1, item 1, paragraph 230-255(4)(b)]. In these
circumstances, the taxpayer will be required to make a balancing
adjustment in accordance with Subdivision 230-G calculated as if
the taxpayer had ceased to have the arrangement for its fair value
at the time when the election started to apply to the arrangement.
However, the balancing adjustment will only recognise an amount to
the extent it is reasonably attributable to a currency exchange
rate effect [Schedule 1, item 1, section 230-275].
Qualifying forex accounts which are held prior to the commencement
of Division 230
868. Until the lodgment date of the first income year in which Division
230 first applies, a taxpayer can elect to have Division 230 apply
to all existing financial arrangements. For more information on
this refer to Chapter 13. [Schedule 1, Part 3, subitem 104(2)]
869. A balancing adjustment is required for all existing financial
arrangements where this transactional election is made. This
includes existing financial arrangements which meet the definition
of a qualifying forex account. [Schedule 1, Part 3, subitem
104(12)]
870. Generally, there will be only a small (if any) balancing adjustment
required for most taxpayers already retranslating their existing
qualifying forex accounts under Subdivision 775-E of the ITAA 1997.
This is because the retranslation calculation under Subdivision
775-E should have already brought to account gains and losses
attributable to changes in currency exchange rates arising from the
account up until the end of the immediately preceding income year.
871. A balancing adjustment for an existing qualifying forex account
that has not been subject to the retranslation election under
Subdivision 775-E of the ITAA 1997 may consist of an amount which
is due to currency exchange rate changes as these gains and losses
may not have been previously recognised under Division 775 of the
ITAA 1997. [Schedule 1, Part 3, subitem 104(12)]
When a qualifying forex account election will cease to apply
872. A qualifying forex account election will cease to apply to a
financial arrangement from the start of an income year during
which:
. the financial arrangement stops being a qualifying forex
account; or
. the taxpayer makes a general retranslation election under
subsection 230-255(1) that applies to that account.
[Schedule 1, item 1, subsection 230-285(5)]
873. Where a qualifying forex account election ceases to apply to a
particular financial arrangement, it cannot subsequently reapply to
that arrangement even if the relevant requirements begin to be
satisfied once more in relation to that arrangement. (Refer to
Chapter 5 for further discussion of this point.) [Schedule 1, item
1, subsection 230-285(6)]
A balancing adjustment under Division 230 where the qualifying
forex account election ceases to apply
874. When a qualifying forex account election ceases to apply, a
balancing adjustment is required to be made in the same manner and
with the same consequences as for those financial arrangements for
which a general retranslation election ceases to apply under
Division 230 (see paragraphs 7.47 to 7.51). [Schedule 1, item 1,
subsections 230-290(3) to (5)]
Foreign exchange retranslation elections are irrevocable
875. A general retranslation election or qualifying forex account
election cannot be revoked. [Schedule 1, item 1, subsection 230-
255(5)]
876. However, a general retranslation election may cease to apply (as
discussed in paragraphs 7.43 and 7.46). Where this happens, a
taxpayer may make a new election when the conditions for making a
general retranslation election are subsequently satisfied. The new
election will only apply to those arrangements the taxpayer starts
to have in, or after, the year in which the election is remade that
were not previously subject to such an election (see Chapter 5).
[Schedule 1, item 1, subsection 230-285(2)]
877. Once a qualifying forex account election ceases to apply to a
financial arrangement, it cannot subsequently reapply to that
arrangement.
Interaction with other tax-timing methods in Division 230
878. If a financial arrangement is subject to a fair value election, any
gains or losses attributable to changes in currency exchange rates
will be brought to account under that method [Schedule 1, item 1,
paragraph 230-40(6)(a)]. The retranslation method will not apply
(despite any election that has been made) because the fair value
method recognises changes in fair value between two points in time.
Any changes attributable to currency exchange rate movements are
also recognised under the fair value method.
879. To the extent to which a hedging financial arrangement election
applies to a financial arrangement (see Chapter 8), the
retranslation method has no application [Schedule 1, item 1,
paragraph 230-40(6)(b)]. Gains and losses from that financial
arrangement will be determined under the hedging financial
arrangements method.
880. If an election to rely on financial reports applies to a financial
arrangement, the retranslation method does not apply [Schedule 1,
item 1, paragraph 230-40(6)(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 those amounts. To the extent to which AASB 121 applies
to a financial arrangement, gains and losses required to be
recognised under that standard will be recognised under the
financial reports method. As a result the retranslation method
will have no application.
881. In a hierarchical sense, these are the most fundamental exclusions
from the retranslation method, other than the exceptions specified
within the method itself which have been detailed above.
882. In the absence of any elective tax-timing method (including the
retranslation method) applying to a financial arrangement, any gain
or loss attributable to changes in currency exchange rates will 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.
883. Where the accruals method applies, financial benefits provided or
received under a financial arrangement which are denominated in a
particular foreign currency are not translated into Australian
currency before calculating the sufficiently certain overall gain
or loss from the arrangement. 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. Therefore,
any amounts attributable to changes in currency exchange rates will
be included in the running balance adjustment under section 230-175
or the balancing adjustment under section 230-445. For further
discussion see Chapter 11. [Schedule 1, item 28, definition of
'special accrual amount' in subsection 995-1(1)]
884. The retranslation method is intended to work in tandem with the
accruals and realisation methods. The retranslation method
operates to recognise gains and losses attributable to changes in
currency exchange rates. The accruals and realisation methods will
apply to recognise those gains and losses that may arise from the
financial arrangement which are not due to currency exchange rate
fluctuations. See Examples 7.2 and 7.3.
1. : 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 230-45).
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).
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 230-100(2) and 230-105(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 ITAA 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 230-435(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 230-445(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 230-60(1)).
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$98,550 paid plus any assessable gains made from the
financial arrangement, (ie, the accrual amounts) (step 2)
(subsection 230-445(1)).
| | |Exchang| |
|Balancing adjustment (section |US$ |e rate |A$ |
|230-445) | |US$/A$ | |
|step 1 |Financial benefit |100,00|0.78 |128,20|
| |received under |0 | |5 |
| |arrangement (face value | | | |
| |of note). | | | |
|step 2 |Financial benefit taken |98,550|0.75 |131,40|
| |to be provided under | | |0 |
| |arrangement (cost of | | | |
| |note) | | | |
| |plus | | | |
| |assessable gains from | | | |
| |arrangement (accrual | | | |
| |gains) | | | |
| |year 1 | | |659 |
| |year 2 | | |636 |
| | | | | |
| | | | |132,69|
| | | | |5 |
|step 3 |Excess of step 2 over | | |(4,490|
| |step 1 is a loss made | | |) |
| |from the financial | | | |
| |arrangement. | | | |
This loss of A$4,490, calculated under the balancing
adjustment, is taken to be a loss made from the financial
arrangement, and deductible in year 3 (subsections 230-
445(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$4,490 allowable deduction;
comprised of:
A$623 assessable gain and A$5,113 allowable
deduction.
. NET - A$3,195 deductible loss.
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$128,205).
2. : Foreign exchange retranslation election
Assume the facts are the same as for Example 7.2, but that A
Co has made a valid retranslation election.
The calculation of the gain or loss to be accrued will be
the same.
In addition, any foreign exchange gains and losses will be
calculated each year under the retranslation method. Under
AASB 121, the carrying amount of A Co's promissory note will
be translated into Australian dollar currency at the date it
was acquired, and at subsequent recording dates, with any
exchange differences required to be recognised in profit or
loss. Under the retranslation method, these amounts will be
taken to be gains or losses made from the financial
arrangement (subsection 230-280(1)).
It is assumed that A Co has been discounting its promissory
note for financial accounting purposes using the effective
interest rate method, on the same basis as the accrual
calculations discussed in Example 7.2.
In the relevant years, the amount required by AASB 121 to be
recognised in profit or loss is therefore:
| | |Foreign exchange |
|Year |Carrying value (US$) |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 accrual|(US$99,031 × (1/0.76 |
| |gain from year 1 - see |- 1/0.73)) |
| |Example 7.2) | |
|3 |99,514 |(3,357) |
| |(99,031 plus 483 accrual|(US$99,514 × (1/0.78 |
| |gain from year 2 - see |- 1/0.76)) |
| |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 230-280(1) and 230-15(1) and (2)).
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$98,550 paid plus any assessable gains made from
the financial arrangement, (ie, any accrual gains plus any
foreign exchange retranslation gains) (step 2)
(subsection 230-445(1)).
| | | |Exchange| |
|Step |Balancing adjustment |US$ |rate |A$ |
| |(section 230-445) | |US$/A$ | |
|step 1 |Financial benefit received |100,00|0.78 |128,20|
| |under arrangement (face |0 | |5 |
| |value of note) | | | |
| |plus | | | |
| |Deductible losses from | | | |
| |arrangement: | | | |
| |year 2 retranslation loss | | |5,355 |
| |Total of step 1 | | |133,56|
| | | | |0 |
| | | | | |
|step 2 |Financial benefit taken to |98,550|0.75 |131,40|
| |be provided under | | |0 |
| |arrangement (cost of note) | | | |
| |plus | | | |
| |Assessable gains from | | | |
| |arrangement | | | |
| |year 1 retranslation gain | | |3600 |
| |year 1 accrual gain (per | | |659 |
| |Example 7.2) | | | |
| |year 2 accrual gain (per | | |636 |
| |Example 7.2) | | | |
| |Total of step 2 | | |136,29|
| | | | |5 |
|step 3 |Excess of step 2 over step | | |(2,735|
| |1 is a loss made from the | | |) |
| |arrangement | | | |
The A$2,735 is deductible to A Co in year 3 (subsections 230-
445(1) and 15(2)).
The combined effect for A Co of an application of both the
accrual and retranslation methodologies, and the balancing
adjustment is that the total gain or loss calculated in the
relevant years from the promissory note is:
. year 1 - A$4,259 gain
(comprised of a A$3600 retranslation gain, plus A$659
accrual gain, per Example 7.2);
. year 2 - A$4,719 loss
(comprised of a A$5,355 retranslation loss, plus A$636
accrual gain, per Example 7.2);
. year 3 - A$2,735 loss
(comprised of a A$3,357 notional retranslation loss, plus
A$623 notional accrual gain, per Example 7.2, plus A$1
balancing adjustment loss);
. NET - A$3,195 deductible loss.
As in Example 7.2, A Co's net position is a deductible loss
of A$3,195.
885. Chapter 8
The elective hedging financial arrangements method
Outline of chapter
886. This chapter outlines the elective tax-hedge rules. The chapter
explains:
. the eligibility requirements that entities need to satisfy
if they wish to make use of the elective tax-hedge rules;
and
. the rationale, structure and operation of the tax-hedge
rules.
Overview of the elective hedging method
887. Broadly, a financial arrangement is hedged to offset an adverse
financial impact arising out of a movement in a price or other
financial variable.
888. The hedging financial arrangements method is intended to
facilitate, subject to safeguarding requirements, pre-tax hedging
decisions.
889. The approach used to achieve this is to more closely align the tax
treatment of the hedging financial arrangement with that of the
item it hedges, thereby improving the degree of post-tax matching
compared to that under the current tax law.
890. The elective hedging method seeks to remove distorting tax mismatch
effects on pre-tax hedging activity by changing the tax-timing and
tax-status of the hedging financial arrangement and more closely
matching it with that of the hedged item.
891. Broadly, the tax hedge rules reduce post-tax mismatch by ensuring
that gains and losses from hedging financial arrangements are
included in taxable income at the same time that the gains or
losses made from the hedged item or items are included in taxable
income.
892. Similarly, the tax classification or status of a hedging financial
arrangement gain or loss is matched to that of the hedged item.
For example, if the hedged item is subject to capital gains tax
(CGT) the hedging financial arrangement will also be subject to CGT
rather than being on revenue account.
Context of amendments
893. 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.
894. 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.
895. 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, 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.
896. 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).
897. 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.
898. 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.
899. The tax-hedge rules broadly align with the purpose of the hedging
activity. At the same time, if the tax treatment of a hedging
financial arrangement depends only on the purpose of the taxpayer
without safeguards, 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, tax-
hedge rules based solely on purpose have the potential to create
administrative difficulties. Without adequate safeguards, the
ability to administer tax-hedge rules would be severely
constrained.
900. 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 management will be enhanced, and there will be less
scope for deferral possibilities arising from adverse selection.
901. 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.
902. Further, financial accounting does not have some of the
distinctions found in the income tax law, 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.
903. 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
904. 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.
905. 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 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.
906. 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').
907. 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|There are no |
|will potentially be |comprehensive tax-hedge |
|available to all |rules in the existing |
|entities that adopt and |law. |
|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
908. Tax-hedge treatment is limited to 'hedging financial arrangements'
to which the hedging financial arrangement election apply [Schedule
1, item 1, sections 230-300 and 230-325]. 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,
subsections 230-335(1) and (3)].
909. Generally, to be a hedging financial arrangement, the arrangement
must be a hedging instrument for financial accounting purposes
[Schedule 1, item 1, subsection 230-335(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 230-335(3)], provided
that the taxpayer meets certain record-keeping requirements
[Schedule 1, item 1, subsection 230-355(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 230-345]
or to treat certain requirements as having been met [Schedule 1,
item 1, section 230-380].
910. 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 230-335(10)]
911. 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 230-335(11)] and the regulations
may prescribe something to be a hedged item [Schedule 1, item 1,
paragraph 230-335(10)(f)].
912. 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 230-315 and
230-325]. As the election requirements are common to various
elective regimes in Division 230, Chapter 5 explains these
requirements in more detail.
913. 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
914. 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, subsection 230-315(2)]:
. the entity, or a connected entity of that 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
915. Once a valid hedging financial arrangement election has been made,
it applies to relevant hedging financial arrangements which are
first held in the income year in which the election is made or in
later income years. [Schedule 1, item 1, section 230-325]
916. For the hedging financial arrangement method to apply, the hedging
financial arrangement must also satisfy requirements in relation to
the following three matters:
. documentation of the hedging relationship [Schedule 1,
item 1, section 230-355];
. determining the basis of the tax allocation of the gains
and losses from the hedging financial arrangement
[Schedule 1, item 1, section 230-360]; and
. effectiveness of the hedge [Schedule 1, item 1, section
230-365].
Arrangements to which the election does not apply
917. Generally, the election will not apply to financial arrangements
that are equity interests or rights to receive or provide such
equity interests [Schedule 1, item 1, subsection 230-330(1)].
However, there is an exception to this rule, namely where the
taxpayer is the issuer of a hedging financial arrangement that is
an equity interest and a foreign currency hedge [Schedule 1, item
1, subsection 230-330(2)].
918. Further, if no election is made under subsection 230-455(7) (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 threshold test in
subsections 230-455(2), (3) or (4) and the arrangement is a
qualifying security that has a remaining term, after acquisition,
of more than 12 months [Schedule 1, item 1, subsection 230-330(3)].
919. 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 230-330(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 230-330(5)]. See Chapter 5 for further discussion on
this.
Allocating gains or losses
920. 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:
. 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 230-300(3), 230-360(1)
and (2)]; and
. where the tax classification of the hedged item is listed
in the table in subsection 230-310(4), the gain or loss is
treated in accordance with that table [Schedule 1, item 1,
subsection 230-310(4)].
921. This tax allocation and tax classification is subject to certain
exceptions. In particular, the treatment specified above may not
continue to apply where there is an 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 230-300(5) and section
230-305]
Transitional election
922. Transitional election rules are explained in Chapter 13.
Essentially, the elective hedging financial arrangements method 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. However, tax-status matching is not available to hedging
arrangements that the taxpayer has at the time of commencement of
Division 230. What this means is that section 230-310 does not
apply to hedging financial arrangements that exist at the time the
taxpayer first commences to apply the Division. [Schedule 1,
subitems 104(9) and (10)]
923. The rest of this chapter explains the tax-hedge method in more
detail.
Hedging financial arrangements
924. To be a 'hedging financial arrangement', the arrangement has to be
either a 'derivative financial arrangement' or a 'foreign currency
hedge'. [Schedule 1, item 1, section 230-335]
What is a derivative financial arrangement?
925. 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 230-350(1)]
926. The note to paragraph 230-350(1)(a) includes as specified variables
(without limiting the term) an interest rate, credit rating, a
financial instrument or commodity price, a foreign exchange rate
and an index.
927. The Division 230 definition of a derivative financial arrangement
is very similar to the definition of 'derivative' in AASB 139.
However, the tax definition of 'derivative financial arrangement'
also explicitly caters for the situation where there is a
subsequent net investment in relation to the financial arrangement.
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 AASB 139 definition of a derivative where a
subsequent (substantial) investment made after the start of the
arrangement is not a disentitling matter. 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.
928. Where there is a requirement for a net investment, the financial
arrangement will be a derivative financial arrangement only where
the amount of the net investment is smaller than that required for
other types of financial arrangements that are expected to have
similar responses to changes in market forces. This means that the
particular comparison is to be done in relation to the financial
arrangement being tested under the definition in subsection 230-
350(1) and contracts or arrangements of a type other than
derivative financial arrangements.
929. Typical derivative financial arrangements that are used as hedging
financial arrangements are swaps, options, futures and forward
contracts.
What is a foreign currency hedge?
930. A foreign currency hedge for the purposes of Division 230 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 to have a similar response to changes in market
factors (ie, paragraph 230-350(1)(b) is not satisfied);
and
. that hedges a risk in relation to movements in currency
exchange rates.
[Schedule 1, item 1, subsection 230-350(2)]
931. 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 230-335(1)(a)]
932. 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?
933. 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 230-335(1)]. 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 230-335(3)] (explained in paragraphs 8.72 to
8.78).
934. 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
all or part of an existing asset or liability or, in terms
of the accounting standards, a firm commitment, a highly
probable forecast transaction or a net investment in a
foreign operation [Schedule 1, item 1, paragraph 230-
335(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 230-335(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 230-335(1)(c)].
935. 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. 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.
936. It is also important to note that the link between the hedging
financial arrangement and the hedged item 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).
937. Where, in terms of paragraph 230-335(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. 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 which the
accounting standards and the recording requirements are met, and
the objects of Subdivision 230-E. [Schedule 1, item 1, section 230-
345]
938. 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 230-335(3) (including the
possibility of inclusion by regulation).
What constitutes the hedging financial arrangement?
939. 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 230-340].
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 parts of the hedging financial arrangement
(represented by the relevant financial benefits) satisfy the
requirements in subsections 230-335(1) or (3), the variations are:
. the intrinsic value of an options contract can be
designated as the hedging financial arrangement ('partial
hedges') [Schedule 1, item 1, subsection 230-340(2)];
. the spot price element of a forward contract that also has
an interest element can be designated as the hedging
financial arrangement [Schedule 1, item 1, subsection 230-
340(3)]; or
. a specified proportion of a financial arrangement can be
designated as the hedging financial arrangement
('proportionate hedges') [Schedule 1, item 1,
subsection 230-340(4)].
940. 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 230-335(5) and (6)]. It is therefore possible,
for example, for the remaining proportion itself to 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.
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 230-335(1)
or (3) in accordance with subsection 230-340(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 230-340(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.
941. 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 230-335(8)]
942. 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 230-335(9)]
943. It should be noted that the conditions in subsections 230-335(8)
and (9) must be satisfied whether the financial arrangement is one
that satisfies the financial accounting hedge requirements or is
one which satisfies the extended rules in subsection 230-335(3).
[Schedule 1, item 1, subsections 230-335(8) and (9)]
The hedged item
944. 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 230-335(10)]
945. 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.
A firm commitment or highly probable future transaction might, for
example, be in regard to prospective crops (eg, in future crop
years) or prospective resources or output (eg, expected gold
production in a future year).
946. 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-
335(11)]
Record-keeping requirements
947. 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 230-355(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-
355(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 230-355(1)]. An example is where a hedging
arrangement occurs within a financial reporting period and
which is not captured in the financial reports as a
hedging arrangement. The record must contain details for
that arrangement that would be required had it been
recorded in the financial reports for the relevant period
as a hedging arrangement.
. The record 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 230-355(1)(c)]. This determination
forms the basis of the tax-timing and tax classification
of the hedging financial arrangement gains and losses, as
discussed in further detail below.
. The record 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-
355(4)(a)];
- the extent to which the risk was hedged [Schedule 1,
item 1, paragraph 230-355(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 230-355(4)(c)].
948. 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 230-355(3)] unless
regulations provide otherwise [Schedule 1, item 1, paragraph 230-
355(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 230-355(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 financial arrangement to
be determined, with the benefit of hindsight, by reference to
whether it creates a favourable outcome.
949. The record may consist of one or more documents [Schedule 1, item
1, subsection 230-355(2)]. One of those documents may have been
brought into existence before the hedging financial arrangement is
created, acquired or applied. 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 230-355.
Hedge effectiveness requirement
950. 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 relevant accounting standards) in achieving offsetting
changes in fair value or cash flows attributable to the
hedged risk [Schedule 1, item 1, paragraph 230-365(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 230-365(b)]; and
. the hedge is assessed on a regular basis in accordance
with the relevant 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 230-365(c)].
951. 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.
952. Where a hedging financial arrangement ceases to be a highly
effective hedging financial arrangement then, consistent with
paragraph AG113 of AASB 139, the taxpayer will discontinue hedging
the hedged item from the last date on which compliance with hedge
effectiveness was last demonstrated. Consistent with paragraph
AG113, in circumstances where a taxpayer is able to identify an
event or change in circumstance that caused the hedging
relationship to fail the effectiveness test, and demonstrate that
the hedge was effective before the event or change in circumstance
occurred, the taxpayer may discontinue hedging the hedged item from
the date of the event or change in circumstance.
953. What is 'highly effective' for the purposes of section 230-365
depends on the meaning of this term in AASB 139. Thus, the hedge
effectiveness must be within the range of 80 per cent to 125 per
cent, as set out in paragraph AG105 of AASB 139.
954. If the hedge is not highly effective, item 1(c) in the table in
section 230-305 will operate in conjunction with section 230-300 to
provide that:
. the arrangement ceases to be held for its fair value when
the taxpayer makes the assessment that the effectiveness
requirement is no longer met;
. the gain or loss is allocated over income years according
to the basis set out in the determination required by
subsection 230-360(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.
955. 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.
956. Although the effectiveness test can be satisfied for tax purposes
by reference to compliance with the effectiveness test in the
relevant accounting standards, there will be times when this will
not be sufficient. One example is where the taxpayer accounting
and income tax years do not align. Where this is the case
taxpayers will be required to undertake additional effectiveness
testing so as to satisfy the effectiveness test in section 230-365.
Can a financial arrangement be a hedging financial arrangement if it is not
an accounting hedging instrument?
957. 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.
958. 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.
959. 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 -
is met.
960. 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 financial accounting
standards. In these circumstances, certain additional record-
keeping requirements have to be met (see paragraphs 8.79 and 8.80).
961. 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 230-335(4)];
. 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, subsection 230-335(5)]; 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 230-335(6)].
962. 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 230-335(7)]. Those
regulations can require that particular conditions be met before
the financial arrangement can qualify as a hedging financial
arrangement.
963. 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 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 230-335(3)(c)];
. certain additional record-keeping requirements are met
(see paragraphs 8.79 and 8.80) [Schedule 1, item 1,
subsection 230-355(5)]; and
. any requirements prescribed by the regulations are met
[Schedule 1, item 1, paragraph 230-335(3)(e)].
Additional record-keeping requirements if a financial arrangement
is not an accounting hedging instrument
964. 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 230-335 and subsection 230-355(5)]
965. 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' (as defined
in the Acts Interpretation Act 1901) 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 230-355(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 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 230-355(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 may provide support in
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 requirements in
paragraph 230-355(3)(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 230-355(5)(c)];
. that, at the time the entity creates, acquires or applies
the 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 will assist
in confirming that the financial arrangement is created,
acquired or applied for commercial risk management
purposes and not for tax reasons [Schedule 1, item 1,
paragraph 230-355(5)(d)]; and
. that where a financial arrangement that qualifies for tax-
hedge treatment under subsection 230-335(3), 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 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 230-355(5)(b)]. When recording the accumulated
gains and losses at the end of each income year, taxpayers
must assume that all gains from the hedging financial
arrangement would be assessable income and that all losses
from the hedging financial arrangement would be allowable
deductions [Schedule 1, item 1, subsection 230-355(6)].
1. : 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 financial arrangement election under subsection 230-
315(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.
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 230-355(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.
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
966. 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.
967. The allocation basis must be objective. That is, the basis cannot
be subjective. Objectivity should be read to be consistent with
the matching objective of hedging.
968. 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 230-360(2)(a)]. Further, the basis must be
sufficiently precise and detailed so that it can be determined from
the record the taxpayer makes under section 230-355 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 classified for tax purposes
[Schedule 1, item 1, paragraph 230-360(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.
1. : 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 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. It should be noted that the gain itself is not
part of the cost of the machinery for capital allowance
purposes; however, the outcome of the allocation of the
hedge gain under section 230-360 effectively achieves this.
2. : Basis of the allocation: re-estimation of the effective life
Assume that in Example 8.3 the hedging arrangement is in
respect of machinery that 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 of
the machinery for capital allowance purposes.
However, paragraph 230-355(1)(c) and section 230-360 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 to append, at the time it
makes this choice, a record of the choice to the hedge
record.
3. : Hedging future mineral production
Cienna Co uses sold futures contracts to hedge against
future sales of the mineral it produces (a highly probable
forecast transaction). However, because the futures
contracts are for a shorter period than the period to 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.
4. : 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 230-335(10)(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 1997), 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.
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.
969. 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, subsections 230-300(1) and (2)]
970. The treatment of the overall gain or loss discussed in the
preceding paragraph is subject to the situations covered by
subsections 230-300(4) and (7). 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 230-300(4)(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 230-300(4)(b)].
971. The second situation is with respect to a hedging financial
arrangement that is an equity interest issued by the taxpayer, is
covered by section 230-50, 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 will not be dealt
with under Division 230 as none of the Subdivisions apply to equity
interests of which the taxpayer is the issuer. [Schedule 1, item
1, subsection 230-300(7)]
Tax classification of a hedging financial arrangement
972. 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
hedging financial arrangement election applies [Schedule 1, item 1,
sections 230-300 and 230-310]. It is not possible to obtain tax
classification matching without tax-timing matching. While tax-
status matching is available under section 230-310 (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 230-300.
973. To facilitate tax classification matching, the table in section 230-
310 sets out the treatment of a gain or loss on a hedging financial
arrangement. To the extent the gain or loss is reasonably
attributable to a hedged item referred to in the table, it is
broadly given the same classification. [Schedule 1, item 1,
subsection 230-310(4)]
974. 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 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 net 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 230-310(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 230-310(4), item 1 in the
table]
975. 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 230-310(4), item 5 in
the table]
976. Other items in the table in subsection 230-310(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, or that produces:
. a CGT asset that is a taxable Australian property
[Schedule 1, item 1, subsection 230-310(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 230-310(4), item 3 in the table];
. exempt income [Schedule 1, item 1, subsection 230-310(4),
item 4 in the table];
. non-assessable non-exempt income of an Australian resident
[Schedule 1, item 1, subsection 230-310(4), item 5 in the
table];
. 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 230-310(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 230-310(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 230-310(4), items 8 and 9
in the table];
. a loss or outgoing that is not allowed as a deduction
[Schedule 1, item 1, subsection 230-310(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
230-310(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. (This item arises because 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 in
subsection 230-310(4) only [Schedule 1, item 1, subsection
230-310(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.
977. 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.
978. 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.
979. Where no item in the table applies, subsection 230-310(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).
980. Unlike the situation with respect to tax-timing matching, a
determination is not required for tax classification matching that
pre-specifies the tax classification treatment of the hedging
financial arrangement. Importantly, though, 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-
310(4), is dealt with in the way indicated by that table.
981. 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 230-310
[Schedule 1, item 1, subparagraph 230-360(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.
1. : 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 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 230-310(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.
2. : 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 230-310(5)).
Assume that Oz Co meets all the tax-hedge tests required by
Division 230, that subsection 230-335(1) is satisfied and
that Oz Co's shares in Fern Co are CGT assets subject to
Subdivision 768-G of the ITAA 1997.
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 of the ITAA 1997 and not under the
hedging tax rules (subsection 230-300(4)).
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.
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 of the ITAA 1997.
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 230-310(4), item 1 in the table).
Further, pursuant to item 6 in the table in subsection 230-
310(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'
982. The Commissioner can make a determination to treat the record-
keeping requirements in section 230-355, the requirements in
section 230-360 about tax allocation of the gains and losses, and
the requirements about hedge effectiveness in section 230-365, as
having been met notwithstanding that the hedging financial
arrangement does not meet the tests. [Schedule 1, item 1,
section 230-380]
983. In deciding whether the Commissioner should exercise this
discretion to make this determination, 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-
295]
984. The requirements in sections 230-355 to 230-365 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.
985. The Commissioner can make the determination that the requirements
of sections 230-355 to 230-365 have been met, conditional on the
taxpayer keeping records in addition to those required by
section 230-355 [Schedule 1, item 1, subsection 230-380(2)]. If
those further record-keeping requirements are breached, the
determination ceases to have effect. The Commissioner can, in
certain circumstances, make a further determination that has the
effect that the original determination is reinstated, by
determining that the cessation provision not apply. In making the
further determination, the Commissioner is to have regard to the
taxpayer's record-keeping practices, compliance history, changes to
the taxpayer's record-keeping and governance procedures, and other
relevant matters [Schedule 1, item 1, subsections 230-380(3) to
(5)].
986. Where the Commissioner does make a determination under subsection
230-355(1), the basis for allocating the gains or losses from the
hedging financial arrangement may be determined by the taxpayer.
However, if the taxpayer fails to do this, or if the basis on which
the taxpayer determines the gains or losses are to be allocated is
not in accordance with the requirements of subsection 230-360(2),
the Commissioner may make a further determination as to that
matter. [Schedule 1, item 1, subsection 230-380(6)]
The relevant entity
987. 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 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
988. 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 230-300(5)].
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
989. 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, or the entity ceases to expect that it will have
the hedged item(s), 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 re-entered into at that fair
value. [Schedule 1, item 1, subsection 230-300(5) and section 230-
305, item 2 in the table]
Consequences if the entity revokes the designation of, redesignates or
disposes of, the hedging financial arrangement
990. 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.
991. Where there is a revocation or redesignation of a hedging financial
arrangement, any realised or unrealised gain or loss on the 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.
992. 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 230-305, subitems 1(a) and (b) in the
table]
993. 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-
385(1).
1. : 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.
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 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 230-80).
Consequences if the hedging financial arrangement no longer meets the hedge
tax criteria even though it was originally met
994. 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.
995. 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 is to be treated in accordance with the
classification of the financial arrangement at that time.
[Schedule 1, item 1, section 230-305, item 1 in the table]
Consequences if the hedged item(s) or risk arising from the hedged item(s)
ceases to exist
996. 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 or you no
longer expect to hold the hedged item. 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 230-305, items
2(a) to (c) 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 230-300(6)].
Where requirements for election are no longer satisfied
997. Although an election under the hedging financial arrangement
election is irrevocable [Schedule 1, item 1, subsection 230-
315(3)], the election will cease to apply from the start of the
income year in which the taxpayer ceases to meet the eligibility
requirements under subsection 230-315(2) [Schedule 1, item 1,
subsection 230-370(1)].
The making of a new election
998. The taxpayer is not prevented from making a new election at a later
time if the conditions in subsection 230-315(2) are satisfied for
an income year. [Schedule 1, item 1, subsection 230-370(2)]
999. The new election, however, will only apply to new financial
arrangements you start to have 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
1000. 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 reacquired for its fair value immediately after the
election ceases to have effect [Schedule 1, item 1, section 230-
375]. 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 230-375 and not under
Subdivision 230-G [Schedule 1, item 1, subsections 230-375(3), 230-
300(1), 230-300(2) and 230-440(2)].
Consequences of deliberate failure to meet the hedge tax requirements
1001. 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 method
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.
1002. 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 230-385(2)]
1003. Despite subsection 230-385(2), the Commissioner may determine that,
after a specified date, this cessation no longer applies, that is
that the hedging financial arrangements Subdivision reapplies to
the particular entity [Schedule 1, item 1, subsection 230-385(3)].
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-
385(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 230-385(5)].
Hedging requirements process
1004. Diagram 8.1 summaries in schematic form the hedging financial
arrangement election.
Diagram 8.1
Chapter 9
The elective financial reports method
Outline of chapter
1005. This chapter outlines how the election to rely on financial reports
operates. 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.
Overview of the elective financial reports method
Financial reports method
1006. The financial reports method allows taxpayers to calculate the
gains and losses from financial arrangements by reference to
relevant accounting standards. Accordingly, a taxpayer who makes a
valid financial reports election can effectively rely on their
financial reports (to the extent that they are in accordance with
relevant aspects of accounting standards) for the purposes of
complying with their tax obligations in respect of relevant
Division 230 financial arrangements.
1007. The purpose of this election is to reduce administration and
compliance costs relating to the taxation of financial
arrangements.
Election to rely on financial reports
1008. The requirements that a taxpayer must satisfy in order to make an
election to rely on financial reports include:
. accounting and auditing requirements discussed in Chapter
5;
. 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; and
. accounting systems - 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.
Commissioner's discretion
1009. Both the audit and accounting requirements are subject to the
Commissioner of Taxation's (Commissioner) discretion that allows
the Commissioner 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.
Gains and losses from financial arrangements using financial reports
1010. A taxpayer who makes a valid election to rely on financial reports
will be able to calculate the gains and losses from financial
arrangements by reference to relevant accounting standards. In
other words, 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.
Election ceases to apply
1011. An election will 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. Where this happens the taxpayer
will make a balancing adjustment gain or loss amount for the
financial arrangement.
Context of amendments
1012. Compared to the current tax law, the other tax-timing methods in
Division 230 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
1013. 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 various elective regimes in Division 230, including the
regime in Subdivision 230-F, the subject of this chapter.
1014. 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.
1015. 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.
1016. 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 may waive the audit requirement for
specific income years after consideration of certain
factors.
1017. 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;
. 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 13).
1018. 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.
1019. 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.
1020. 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.
1021. 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 |Under the current law, |
|effectively allows a |there is no basis for |
|taxpayer to use the |electing to use |
|amounts in their |financial reports to |
|financial reports for |calculate gains and |
|the purposes of |losses from financial |
|calculating their |arrangements for tax |
|assessable income and |purposes. |
|allowable deductions | |
|under Division 230. | |
|Taxpayers are able to | |
|elect to calculate their| |
|income and deductions | |
|using this method | |
|subject 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
1022. Subdivision 230-F contains a number of specific requirements
relevant to the financial reports election that are 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.
1023. 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
1024. 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.
1025. 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 230-395(2)(c)]
1026. 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 rely on the financial reports so long as the
qualification is not relevant to the taxation treatment of a
financial arrangement.
1027. 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.
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.
1028. 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
1029. 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 inappropriate tax outcomes being obtained.
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 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 230-395(2)(d)]
1030. 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 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 230-395(2)(e)]
1031. 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 230-395(3)]
1032. 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
Australian Accounting Standards Board 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
1033. Subsection 230-405(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, or to internal governance processes; and
. any other relevant matter.
[Schedule 1, item 1, subsections 230-405(1) and (2)]
1034. While Subdivision 230-F provides the Commissioner with a discretion
to disregard paragraphs 230-395(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 230-395(2)(c) and (e) - refer to Chapter
5 for discussion of these factors.
1035. 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.
1036. 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-
395(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
1037. 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, where appropriate, the elective methods) had been
chosen and had applied. [Schedule 1, item 1, paragraph 230-
410(1)(e) and subsection 230-410(2)]
Substantially the same methods
1038. 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, where appropriate,
the elective methods) except for Subdivision 230-F had been chosen
and had applied [Schedule 1, item 1, paragraph 230-410(1)(f) and
subsection 230-410(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).
1039. 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 230-410(2)]
Assume other elections made
1040. 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 230-410(7)]
Which entities can elect the financial reports method?
1041. 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 230-395]
Making the election
1042. Any taxpayer may make a financial reports election, but it will
only be valid for those taxpayers which meet the entry
requirements.
1043. 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 230-415(3)]
1044. 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 230-415(4)]
1045. 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.
1046. 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?
1047. For a discussion of the common application of this election to
financial arrangements, refer to Chapter 5.
1048. 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 230-410(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).
1049. 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 230-410(3)].
For further discussion of this, refer to Chapter 5.
1050. 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 election is made under the transitional arrangements
(refer to Chapter 13). [Schedule 1, item 1, paragraph 230-
410(1)(b)]
1051. 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 is 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 be able to make
separate elections under Subdivisions 230-C and 230-D as
appropriate.
Financial arrangements to which the elective Subdivisions do not
apply
1052. 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 230-415(1)]; or
. the equity interest is not classified or designated as at
fair value through profit or loss, that is, the exclusion
carves out equity interests that are fair valued through
equity [Schedule 1, item 1, paragraph 230-410(1)(d)].
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)]
1053. 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 230-415(3)]
1054. 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
230-40(7)]
Effect of relying on financial reports
1055. For a discussion of the common application of this election to
financial arrangements refer to Chapter 5.
1056. 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.
1057. 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 230-420]
1058. 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
1059. Division 230 will not apply to franked distributions (received
either directly or indirectly) and rights to receive franked
distributions (either directly or indirectly). 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.
1060. 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 based on the individual facts and
circumstances relating to that dividend declaration. 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.
1061. The exclusion of distributions to the extent that they are franked
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 will not apply.
[Schedule 1, item 1, section 230-480]
1. : Dividend payment
On 1 July 2010 Barri Co acquires ordinary shares in UE Co
for $50 million and makes the financial reports election in
respect of all its financial arrangements. At 30 June 2011
the shares in UE Co have a market value of $65 million. On
1 May 2011 UE Co pays fully franked dividends of $6 million.
Barri Co's taxable income for the 2010-11 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 2012 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 2011-12 income year
includes the fair value gain of $25 million ($90 million -
$65 million).
Adjustment for impairment of financial arrangement
1062. 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 230-410(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, that is to a
Subdivision 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 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-
425(4)]
1063. 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
230-430(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
1064. 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
1065. Although an election to rely on financial reports is irrevocable,
the election may cease to apply, depending on the circumstances, to
either:
. all of a taxpayer's financial arrangements; or
. one or more particular financial arrangements of the
taxpayer.
[Schedule 1, item 1, section 230-425]
1066. 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 230-425(4)]
1067. Refer to Chapter 5 for further information as to when an election
to rely on financial reports will cease to apply.
Balancing adjustment if an election ceases to apply
1068. 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 230-430(1) and (3)].
A balancing adjustment does not apply to a financial arrangement
where it becomes impaired (see paragraphs 9.58 and 9.59) [Schedule
1, item 1, subsection 230-430(4)].
1069. 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 fair value and immediately
reacquired it at that time for that value. [Schedule 1, item 1,
section 230-430]
1070. 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.
1. : 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.
. 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.
1071. 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
1072. 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 230-395(2)(c) and
subsection 230-425(2)]
Chapter 10
Balancing adjustment on disposing of financial arrangements
Outline of chapter
1073. 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.
1074. 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.
Overview of balancing adjustments on disposal
A balancing adjustment
1075. A balancing adjustment is an additional amount of gain or loss
brought to account on the disposal of a financial arrangement to
ensure the correct amount of gain or loss is brought to account
from holding and disposing of the financial arrangement. Amounts
recognised prior to disposal are taken into account in working out
any gain or loss on disposal. This corrects any previous under-
allocation or over-allocation of a gain or loss before disposal.
Gains and losses from disposal of a financial arrangement
1076. Gains and losses from disposing of a financial arrangement (or a
part of it) may 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 gains and losses from either transfer or cessation
require a balancing adjustment.
Disposal of a financial arrangement
General rule - disposal of all rights and obligations
1077. 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 end or are transferred to another entity.
1078. The ending 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.
1079. A transfer of a right or obligation (which is a form of a right or
obligation ceasing) can also occur in different ways, for example,
as a result of a sale, under a legal defeasance of obligations, or
an assignment of rights.
1080. Where a financial arrangement is an asset, a transfer is
effectively taken not to have occurred unless the effect of the
transfer is to transfer substantially all the risks and rewards of
ownership of the asset to another entity.
Partial disposal
1081. 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;
. a right or obligation under the financial arrangement to a
specifically identified financial benefit; or
. a proportionate share of a right or obligation under the
financial arrangement to a specifically identified
financial benefit.
Special rules or exceptions to the general rule
1082. 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
1083. A balancing adjustment is not made if the financial arrangement is
an equity financial arrangement and neither the fair value method
nor the elective financial reports method applies to it. Such a
financial arrangement will be outside the scope of Division 230;
rather any disposal may be subject to the capital gains tax (CGT)
measures (where the asset is not held on revenue account).
Hedging
1084. The tax hedging provisions provide tax matching between the hedging
financial arrangement and the hedged item or items. To allow this
matching, it may be necessary to defer a gain or loss on the
hedging financial arrangement past the time of its disposal.
Bad debts
1085. The writing off of a bad debt is taken not to be a disposal of a
financial arrangement. Therefore, a balancing adjustment is not
made when a financial arrangement is written off as a bad debt.
Margining
1086. A balancing adjustment is not required for exchange traded
derivatives that are subject to margining.
Historic rate roll-over
1087. A specific rule provides that an historic rate roll-over of a
derivative financial arrangement is taken to be a disposal of all
the rights and/or obligations under the arrangement. Accordingly,
a balancing adjustment may be required on disposal.
1088. However, this will be subject to the operation of the tax hedging
rules. Accordingly, the gain or loss on disposal of an historic
rate roll-over derivative contract (used in a hedging context) may
be deferred and matched to the timing and treatment of the gain or
loss on a hedged item for tax purposes.
Conversion or exchange
1089. A balancing adjustment will not be required by a conversion or
exchange 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 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; or
. exchange into the ordinary shares of an entity other than
the issuer or a connected entity of the issuer, 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 or
a connected entity of the issuer.
Subsidiary member leaving a consolidated group
1090. A balancing adjustment is not made 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 as a
result of ceasing to be a member of that group.
Commercial debt forgiveness
1091. A cancellation or other discharge of obligations under a financial
arrangement which qualifies as commercial debt forgiveness will be
subject to the commercial debt forgiveness provisions. The gain
which would be subject to Division 230 is reduced to the extent
that the gain is covered by the commercial debt forgiveness
provisions. Accordingly, to the extent that the commercial debt
forgiveness provisions apply no balancing adjustment is required.
What amount is recognised as a result of the disposal?
1092. The amount to be recognised as a result of a disposal (ie, the
disposal balancing adjustment amount), 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.
1093. To ensure this outcome amounts recognised prior to the disposal are
taken into account in working out the amount of any disposal gain
or loss.
1094. 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
1095. In broad terms, the balancing adjustment on disposal of a whole
financial arrangement is worked out as (a + b + c) - (d + e
+ f) where:
a = the total of the financial benefits received;
b = the total of amounts that have been allowed as
deductions and would have been allowable deductions before
the disposal;
c = the total of amounts that will be allowed as
deductions (such as deductions due to the transitional
balancing adjustment);
d = the total of all financial benefits provided;
e = the total of amounts that would have been included in
assessable income and have been included in assessable
income before the disposal; and
f = the total of amounts that will be included in
assessable income (such as income due to the transitional
balancing adjustment).
1096. If the disposal balancing adjustment is positive (ie, the sum of a,
b and c exceeds the sum of d, e and f) the amount is a gain made
from the financial arrangement and is included in assessable
income. Conversely, if the disposal balancing adjustment is
negative, the amount is a loss made from the arrangement and may be
an allowable deduction.
1097. If a balancing adjustment is required for a partial disposal in
certain circumstances the variables in the balancing adjustment
formula are adjusted to take into account the nature of the partial
disposal.
Disposal balancing adjustment made in year of disposal
1098. The gain or loss produced by the disposal balancing adjustment is
made in the year in which the disposal occurs.
Context of amendments
1099. 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
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.
1100. These provisions apply in different circumstances and in different
ways. For example:
. sections 26BB and 70B of the ITAA 1936 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);
. section 159GS of the ITAA 1936 operates when an
arrangement is 'transferred'. The definition of
'transfer' (in subsection 159GP(1) of the ITAA 1936) 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 of the ITAA 1997 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 CGT
events.
1101. 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 express 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.
1102. 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.
1103. 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 calculation is made at the time of the disposal to take
account of any previous under-allocation or over-allocation. This
calculation is referred to as a 'balancing adjustment'.
Summary of new law
1104. 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.
1105. 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.
1106. 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 |A number of separate and|
|single provision |ad hoc provisions govern|
|covering the tax |the tax consequences of |
|consequences (including |the disposal of |
|the balancing |different types of |
|adjustment) arising from|financial arrangements. |
|the disposal of | |
|different types of | |
|financial arrangements | |
|other than arrangements | |
|to which the hedging | |
|rules apply. | |
|The provision covers |It is not clear to what |
|gains and losses from |extent gains and losses |
|the disposal of |from the disposal of |
|liabilities in a |liabilities (in a |
|non-forgiveness context.|non-forgiveness context)|
| |are recognised for tax |
| |purposes. |
|Specific rules clarify |It is not clear how |
|the tax treatment of |margining and historic |
|margining and historic |rate roll-over |
|rate roll-over |arrangements for |
|arrangements for |derivatives are treated |
|derivatives. |for tax purposes. |
Detailed explanation of new law
1107. 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.
1108. 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, 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.
1109. 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.
1110. 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
1111. The general rule is that a 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 230-435(1)(a) and (b)]
1112. 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.
1113. 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 have occurred unless its
effect is to transfer to another entity substantially all the risks
and rewards of ownership of the asset [Schedule 1, item 1,
subsection 230-435(3)]. 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.
1114. 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 230-435(1)(c)(i)];
. a right or obligation under the financial arrangement to a
specifically identified financial benefit [Schedule 1,
item 1, subparagraph 230-435(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-
435(1)(c)(iii)].
Special rules or exceptions
1115. 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
1116. 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 230-440(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 calculated under
Subdivision 230-G, but rather will be determined by provisions
outside of Division 230.
Hedging
1117. 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 designated as a
hedging financial arrangement may have that part of the gain or
loss which is attributable to a currency exchange rate effect
calculated under the hedging provisions. Hence, the balancing
adjustments otherwise required by Subdivision 230-G operates
subject to the tax hedging provisions in Subdivision 230-E.
Bad debts
1118. 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, in part or whole, is written off as a bad
debt [Schedule 1, item 1, paragraph 230-440(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 of the ITAA 1997, there is an
exception to the anti-overlap rule in section 230-25 [Schedule 1,
item 1, subsection 230-25(3)].
Margining
1119. 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.
1120. It appears that upon payment (under the 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.
1121. 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 230-440(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 that is settled or closed out for margining
purposes.
1122. 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 arrangements - that is, other than derivative
financial arrangements - which would be expected to have
similar results to changes in market factors.
[Schedule 1, item 1, subsection 230-350(1)]
1123. 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, 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
1124. 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'.
1125. 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 is unclear. 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 230-435(5)]
1126. 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 the timing and treatment of the gain or
loss on a hedged item for tax purposes. This depends on the
application of the tax hedging rules (see Chapter 8).
Conversion or exchange
1127. 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 230-440(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 230-440(3)(d)].
Commercial debt forgiveness
1128. A cancellation, or other discharge of obligations under a financial
arrangement, which qualifies as commercial debt forgiveness is
considered under Division 245 of Schedule 2C to the ITAA 1936. The
gain which would be subject to 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 230-470]
What amount is recognised for income tax purposes as a result of the
disposal?
1129. 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.
1130. 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.
1131. 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
1132. 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 |
| |230-445(1), step 1(a) in the method statement).|
| | |
| |The note to step 1(a) states that financial |
| |benefits received on cessation or transfer (of|
| |the financial arrangement) that play an |
| |integral role in determining whether a gain or |
| |loss (or the amount) are also to be included at|
| |this step (as per paragraph 230-60(2)(c)). |
|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 230-445(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 to Chapter 13) or the |
| |portfolio treatment of fees, discounts and |
| |premiums to the extent to which those amounts |
| |are attributable to the financial arrangement |
| |(subsection 230-445(1), steps 1(d) and (e) in |
| |the method statement). |
|d |total of all financial benefits provided under |
|= |the financial arrangement (subsection |
| |230-445(1), step 2(a) in the method statement).|
| | |
| |The note to step 2(a) states that financial |
| |benefits provided on cessation or transfer (of |
| |the financial arrangement) that play an |
| |integral role in determining whether a gain or |
| |loss (or the amount) are also to be included at|
| |this step (as per paragraph 230-60(1)(c)). |
|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 230-445(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 13), or the portfolio|
| |treatment of fees, discounts and premiums to |
| |the extent to which those amounts are |
| |attributable to the arrangement |
| |(subsection 230-445(1), step 2(d) and (e) in |
| |the method statement). |
1133. The notes to step 1(a) and step 2(a) of the method statement for
balancing adjustments at section 230-445 make clear that financial
benefits that are taken to be provided or received under the
financial arrangement (because of the operation of section 230-65)
are to be included in the balancing adjustment calculation. These
are financial benefits that play an integral role in determining
whether a gain or loss (or the amount) is made from the financial
arrangement within the meaning of paragraphs 230-60(1)(c) and 230-
60(2)(c). To illustrate the application of this rule in the
context of the balancing adjustment, consider a loan between two
parties. If the amount owed under the loan is 'waived' by the
creditor then it could be said that the debtor has received a
benefit in the form a 'waiver' being the release from payment under
the loan. However, in applying the balancing adjustment
calculation to this simple example the 'waiver' benefit itself
would not be considered integral (in the context of section 230-60)
to working out whether the debtor has made a gain or loss on the
financial arrangement. The amount included in the balancing
adjustment calculation in this situation would be the actual loan
proceeds received by the debtor which is compared to any amounts
provided by the debtor which in this example would be nil.
1134. It is intended 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 230-445(1), steps 1(b)
and (c) and 2(b) and (c) in the method statement]
1135. 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 230-445(1), step
3 in the method statement]
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 $100 coupons that were
included in its assessable income $200, Investor Co sells
the bond for $1,050.
Investor Co's overall gain from having the bond is:
$250 = $1,050 + (2 × $100) - $1,000
Given that $200 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 10.60 (though c and f
are not relevant in this circumstance), the gain or loss is
determined as follows:
($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 230-60, the $1,000 is taken to have
been provided under the financial arrangement that is the
bond) + $200 + $0) = $1,200
= $50 gain on disposal.
Partial transfer
1136. As mentioned in paragraph 10.9, there are circumstances where a
balancing adjustment arises in respect of 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.
1137. 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 230-445(2)]
1138. 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 230-445(3)]
1139. The 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-
445(5)]
1140. 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 the
disposal proportion, to arrive at the amounts actually used for
the variables in the formula [Schedule 1, item 1, subsection 230-
445(4)]. This attribution must reflect the valuation principles
discussed in paragraph 10.67 [Schedule 1, item 1, subsection 230-
445(5)].
1. : 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 gives rise to 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 230-70 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 10.60, 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 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 +
$0) = $2,684,033
= $0 gain or loss on disposal.
Alternatively, if, for example, Assignor Co assigns these
payments for $3 million, it would make a gain of $315,967
(step 1(a) in the above calculation would be $3 million).
When does the disposal occur?
1141. The gain or loss produced by the disposal discussed in this chapter
is made in the year in which the relevant cessation or transfer
occurs. [Schedule 1, item 1, subsection 230-445(6)]
1142. So, 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.
1143. In another case, when a financial arrangement is sold, a disposal
occurs (and the balancing adjustment gain or loss is made) when the
relevant rights and obligations are given up or transferred.
Arm's length value adjustment for financial benefits received or provided
where the parties are not dealing at arm's length
1144. To preserve the integrity of Division 230, the amount of a
financial benefit received or provided under certain non-arm's
length financial arrangement dealings is to be substituted for the
amount of the financial benefit that would reasonably be expected
to be received or provided had the parties been dealing at arm's
length. Without such a rule, parties not dealing at arm's length
could, as a result of those dealings, obtain inappropriate tax
advantages.
1145. Under various provisions of the ITAA 1936 and the ITAA 1997, where
a financial asset or liability ceases to be held as a result of a
non-arm's length dealing those provisions generally require the
Commissioner of Taxation to substitute an arm's length value if the
amounts provided for the acquisition, transfer or cessation are not
at arm's length. Examples include:
. subsections 26BB(3) and 70B(3) of the ITAA 1936 dealing
with gains and losses arising from the disposal or
redemption of traditional securities; and
. section 775-120 of the ITAA 1997 dealing with the
calculation of foreign exchange gains and losses.
1146. In addition, there are a number of provisions in the ITAA 1936 and
the ITAA 1997 that either reduce the holding costs of a financial
arrangement (eg, excessive interest payments claimed as a
deduction) where the parties are not dealing at arm's length or,
alternatively, require the substitution of a market value
regardless of whether or not the parties are dealing at arm's
length. Examples include:
. section 52A of the ITAA 1936, which limits a deduction to
the arm's length amount on monies borrowed and used to
acquire 'prescribed property' where the parties are not
dealing at arm's length;
. subsection 73B(31) of the ITAA 1936 which limits excessive
interest payments associated with research and development
activities to their arm's length amount where there is a
non-arm's length dealing;
. subsection 159GZZZQ(2) of Division 16K of the ITAA 1936
which deems the market value to have been received for the
disposal of a share in an off-market share buy-back
arrangement;
. section 775-40 of the ITAA 1997 which deems a market value
where the proceeds from the disposal of foreign currency
is more or less than market value; and
. subsection 245-65(2) of Subdivision 245-C, Schedule 2C to
the ITAA 1936 which substitutes the market value as the
consideration provided by a debtor in respect of debt
forgiveness where no consideration is provided or the
consideration (in whole or part) cannot be valued.
1147. To ensure that the intention of the above mentioned provisions is
preserved, Division 230 contains corresponding integrity measures.
Ensuring symmetry in the operation of these integrity measures
between arrangements subject to Division 230 and those not subject
to Division 230 would also operate to prevent inappropriate tax
arbitrage opportunities.
1148. The paragraphs below set out the situations when the non-arm's
length dealing rule in Division 230 will apply to financial
arrangements.
Non-arm's length dealings in relation to the complete or partial transfer,
cessation or from starting to have a financial arrangement
1149. Consistent with the existing tax rules dealing with the disposal or
redemption of traditional securities contained in sections 26BB and
70B of the ITAA 1936, the intent of section 230-510 is to ensure
that, upon the cessation or transfer of a financial arrangement,
arm's length values are used to calculate the balancing adjustment
if there has been a non-arm's length dealing in relation to the
cessation or transfer, or the starting to hold the arrangement, or
the holding of the arrangement. This prevents the creation of a
loss, a greater loss or reduction of a gain as a result of the
parties not dealing at arm's length.
1150. Also consistent with the application of the existing tax law
dealing with the taxation of traditional securities, section 230-
510 does not apply to non-arm's length cessations or non-arm's
length dealings that arose prior to the cessation of loan-like
financial arrangements (eg, when the taxpayer started to hold the
financial arrangement). This prevents a time-value-of-money
financial benefit (eg, interest) being deemed to have been received
or provided as a result of those dealings. [Schedule 1, item 1,
paragraph 230-510(1)(b)]
1151. Accordingly, subject to the exception discussed below, the non-
arm's length dealing rule would apply where:
. a balancing adjustment is made under section 230-435 in
respect of the financial arrangement;
. the parties to the financial arrangement did not deal at
arm's length in relation to the cessation or complete or
partial transfer of the financial arrangement, or in
relation to an earlier time (including starting to have
the financial arrangement); and
. the amount of the financial benefit received or provided
under the financial arrangement at any time from (and
including) starting to hold the financial arrangement
until (and including) a complete or partial transfer or
cessation is more or less than the financial benefit that
might be reasonably expected to have been received or
provided if the parties were dealing at arm's length.
1152. In such circumstances, unless a specific exception applies (see
below), the amount of the financial benefit received or provided
(including where it is nil) is taken, for the purposes of Division
230, to be the amount of the financial benefit that would have been
received or provided if the parties were dealing at arm's length.
[Schedule 1, item 1, section 230-510]
1. : Non-arm's length dealing
Hamish Co and Lucky Co entered into a financial arrangement
on 1 July 2010 whereby Hamish Co agreed to provide Lucky Co
with a financial benefit of $100 in return for Lucky Co
providing periodic financial benefits based on arm's length
rates of interest of 10 per cent per annum and a repayment
of the original $100 financial benefit in five years from
the date the financial benefit was provided. Hamish Co
disposes of the rights to receive the financial benefits
under the financial arrangement to a related entity, Bert
Co, for $90 when its arm's length value is $100.
Having regard to the relationship between the parties to the
transfer and the fact that Hamish Co transferred the
financial arrangement to Bert Co, a related entity, for a
non-arm's length amount, it would be concluded that Hamish
Co and Bert Co are not dealing at arm's length in relation
to the transfer.
In these circumstances, Hamish Co would be taken to have
received a financial benefit equal to the arm's length value
of $100 as a result of the disposal.
Bert Co will be taken to have acquired the financial
arrangement for $100.
Exception for non-arm's length dealings arising from the cessation of
financial arrangements that are debt interests or loans
1153. In certain circumstances, applying an arm's length rule as a result
of a cessation event may give rise to inappropriate tax outcomes
and impute a time-value-of-money financial benefit where no
financial benefit is to be paid. Therefore the measures exclude
from the operation of the arm's length rule, non-arm's length
dealings arising in respect of debt interests and loans (whether
they are loans in legal form or economic substance) that cease to
be held other than by transfer (eg, by repayment). This outcome is
achieved, in part, by excluding non-arm's length dealings in
respect of commencing to hold or the cessation of a 'debt interest'
as defined for the purposes of the debt/equity rules in Division
974 of the ITAA 1997 and other financial arrangements that are
loans. Financial arrangements that are loans would include, for
the purposes of Division 230, those financial arrangements that
would normally be considered to have debt-like features such as the
existence of debtor and creditor relationship. One such example
would be an interest-free loan with a term greater than 10 years.
1154. Without such an exclusion, a cessation event in relation to a debt
interest or loan would result in the imputing of a gain to the
lender and a loss to the issuer because the financial benefit
amount repaid by a related party borrower would be less than the
arm's length value (which would be the loan amount and the time-
value-of-money as compensation for use of funds).
1. : Acquisition and cessation of a non-arm's length dealing
financial arrangement
Hamish Co and a related entity, Lucky Co, entered into an
arrangement on 1 July 2010 whereby, Hamish Co agreed to
provide Lucky Co with a financial benefit of $100 (interest-
free) repayable in full in 15 years from the date the
financial benefit was provided. On 1 July 2010 the market
value of the right to receive the $100 financial benefit in
15 years time is $70.
On entering into the arrangement Hamish Co has a financial
arrangement being the right to receive a cash settlable
financial benefit of $100 in 15 years time. Lucky Co also
has a financial arrangement being the obligation to provide
a cash settlable financial benefit of $100 in 15 years time.
Having regard to the relationship between the parties to the
financial arrangement and the fact that, had Hamish Co
provided the financial benefit of $100 to a non-related
entity the financial benefits or benefits that Hamish Co
would have been entitled to would have included a financial
benefit or benefits calculated by reference to the 15 years
that the $100 cash has been provided for, it would be
concluded that the parties are not dealing at arm's length.
The financial arrangement would be treated as a loan for the
purposes of Division 230 given that there is an obligation
to repay the amount after 15 years.
If the non-arm's length rule applied to this situation,
Hamish Co would make a $30 gain on the cessation of the
financial arrangement which would have had the effect of
imputing or deeming a time-value-of-money gain on the
financial arrangement. Paragraph 230-510(1)(b) operates so
as to prevent the application of the arm's length rule to
these circumstances and hence no gain or loss arising from
the non-arm's length dealing would be bought to account.
From Lucky Co's perspective, when it commences to hold the
non-arm's length financial arrangement its market value
would be $70, which, if it had been substituted for the
actual amount received, would have resulted in a loss on
providing the financial benefit for Lucky Co at the end of
the term of the financial arrangement (because Lucky Co is
required to provide $100 at the end of the term of the
financial arrangement). Consistent with the tax treatment
of Hamish Co, the loss from the related party non-arm's
length dealing would not be recognised by not requiring the
arm's length value to be substituted in the calculation of
Lucky Co's balancing adjustment. On cessation of the loan,
Lucky Co's financial benefits provided would be taken to be
$100 rather than the market value of $70.
Exception for the transfer of non-arm's length debt interests or loan-like
arrangements
1155. In certain circumstances, the measures operate where there is a
complete or partial transfer of a debt interest or loan and a loss,
or gain, arises under the method statement as set out in
subsection 230-445(1). In such a case, the loss or the gain is
adjusted by the difference between the amount of any financial
benefits provided under the financial arrangement and the amount
that would have been provided if the parties were dealing at arm's
length. That is, the loss or the gain is adjusted only to the
extent that it is attributable to the non-arm's length dealing as
distinct from other factors.
1. : Transfer of a non-arm's length financial arrangement
Tony Co enters into an arrangement with related entity
Teresa Co on 1 July 2012 whereby Tony Co agrees to provide
Teresa Co with a financial benefit of $100. Teresa Co is
required to repay the $100 in five years time. At the time
the arrangement is entered into, market interest rates are
at 6 per cent per annum resulting in arm's length value for
the arrangement of $74.73.
On 1 July 2013, Tony Co transfers the right to receive the
financial benefit of $100 in three years' time (being five
years from the original date of the arrangement) for its
market value of $72 (interest rates have risen).
On entering into the arrangement, Tony Co has a financial
arrangement, being the right to receive a cash settlable
financial benefit of $100 in five years' time. Teresa Co
also has a financial arrangement, being the obligation to
provide a cash settlable financial benefit of $100 in five
years' time. The financial arrangement is a debt interest
as defined in Division 974 of the ITAA 1997.
Having regard to the relationship between the parties to the
financial arrangement and the fact that, had Tony Co
provided the financial benefit of $100 to a non-related
entity the financial benefits that would have been received
by Tony Co would have included a financial benefit or a
series of financial benefits for the use of the $100 cash
provided for a term of five years, it would be concluded
that the parties are not dealing at arm's length.
Upon transfer of the financial arrangement, a loss of $25.27
would ordinarily arise under the balancing adjustment method
statement contained in subsection 230-445(1) (total of all
financial benefits received under the financial arrangement
of $74.73 less the total of all financial benefits provided
under the financial arrangement of $100).
However, had the parties been dealing at arm's length in
relation to the original acquisition, the loss would have
been limited to $2.73 (the difference between $74.73 and
$72). Subsection 230-510(3) operates to reduce the loss on
transfer of the financial arrangement to this amount.
Arm's length dealings in relation to certain financial arrangements
1156. As mentioned above, in certain circumstances the existing tax law
under the ITAA 1936 or the ITAA 1997 operates to:
. substitute an arm's length amount where the parties are
not dealing with each other at arm's length and excessive
deductions are claimed under a financial arrangement to
amounts; or
. substitute a market value for the relevant financial
benefit where the parties are dealing with each other at
arm's length but the relevant financial benefit is not at
market value.
1157. To ensure symmetry and prevent opportunities for tax arbitrage
between those provisions in the ITAA 1936 and the ITAA 1997 that
require the use of an arm's length or market value rule, the
Division 230 arm's length rules will, where the circumstances
specified in the relevant provisions apply, operate to substitute
an arm's length value or market value for the relevant financial
benefit. The provisions in subsection 230-442(2) are provisions in
the income tax law that effectively provide a market value
substitution rule irrespective of whether or not the relevant
transaction is at arm's length, namely:
. section 52A of the ITAA 1936;
. section 73B of the ITAA 1936;
. Division 16J of the ITAA 1936;
. Division 16K of the ITAA 1936;
. subsection 245-65(2) of Subdivision 245-C, Schedule 2C to
the ITAA 1936; and
. section 775-40 of the ITAA 1997.
1158. In certain circumstances, both the arm's length dealing rules in
section 230-510 and section 230-442 can have application in respect
of a financial arrangement. In such cases, section 230-510 will
operate to specify the amount of the financial benefit that is to
be substituted for the purposes of Division 230 in a non-arm's
length dealing.
Chapter 11
Interaction and consequential amendments (other than consolidation)
Outline of chapter
1159. This chapter explains various amendments made to provisions of the:
. Income Tax Assessment Act 1936 (ITAA 1936);
. Income Tax Assessment Act 1997 (ITAA 1997);
. Income Tax (Transitional Provisions) Act 1997;
. New Business Tax System (Taxation of Financial
Arrangements) Act 2003 (NBTS (TOFA) 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
1160. 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.
1161. 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 Division 230 purposes.
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
1162. Generally, the consequential and interaction amendments that are
explained in this chapter fall into six 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;
. 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; and
. record-keeping: this section outlines how the record-
keeping requirements have been modified as a result of the
introduction of Division 230.
1163. 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) 2003. The retranslation module of the taxation
of financial arrangements reforms is contained in Subdivision 230-D
of this Bill.
1164. As a result of the Division 775 amendments, some amendments were
required to the NBTS (TOFA) 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
1165. As outlined above, the consequential and interaction amendments can
be grouped into six categories. Each of the amendments that fit
into a particular category is explained below.
Ordering rules
1166. 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
1167. Subdivision 3 of Division 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.
1168. 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 230-450].
Subdivision 3 of Division 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 of Division H of the ITAA 1936 and Division 230
overlap.
1169. Where the rules do overlap, Division 230 will take precedence over
Subdivision 3 of Division H of the ITAA 1936. [Schedule 1, item
33, paragraph 82KZLA(a) of the ITAA 1936]
Qualifying securities
Deferred interest and discounted securities
1170. Division 16E of Part III of the ITAA 1936 taxes gains and losses on
certain discounted and deferred interest securities on an accruals
basis.
1171. Provisions throughout the ITAA 1936, the ITAA 1997, the Income Tax
(Transitional Provisions) Act 1997 and the TAA 1953 rely on or
build on the taxing outcomes and concepts of Division 16E in order
to achieve their intent.
1172. Division 230 of the ITAA 1997 will provide the tax treatment for
most of the gains and losses on discounted and deferred interest
securities that are acquired or issued on or after 1 July 2010, or
1 July 2009 should the taxpayer so elect, that would otherwise have
been taxed under Division 16E.
1173. To ensure the appropriate operation of provisions that rely or
build on the taxing outcomes and concepts in Division 16E where a
taxpayer holds a Division 230 financial arrangement, particularly
one taxed under the accruals method in Subdivision 230-B, the
consequential amendments discussed below are necessary.
Tainted interest income
1174. The ITAA 1936 deals with the attributable income of controlled
foreign companies. The definition of tainted interest income,
relies on the taxing outcome under Division 16E of the ITAA 1936.
In particular under paragraph 317(1)(b) tainted interest income
includes amounts that would have been assessable income under
Division 16E had the controlled foreign company been a resident.
To ensure that Division 230 does not expand the scope of tainted
interest income before it is decided whether Division 230 should be
applied in calculating attributable income as part of the Board of
Tax's 'review of foreign source income, the definition is amended
to include amounts that would have been assessable under Division
16E had Division 230 not been introduced.
Land transport facilities offset
1175. Division 396 allows a lender a tax offset for certain interest
(land transport facilities interest) it derives on approved
borrowings for the construction of land transport facilities.
'Land transport facilities interest' is defined by paragraphs 396-
30(1)(b) and 396-30(2)(b) of the ITAA 1997 to include amounts that
would either be assessable income or allowable deductions under
Division 16E. To ensure that Division 230 does not expand the
scope of what is land transport facilities interest, the amendments
to paragraphs 396-30(1)(b) and 396-30(2)(b) ensure that only those
amounts assessable or deductible under Division 230 that would also
have been assessable or deductible under Division 16E, had it
applied, are land transport facilities interest.
Fixed interest complying approved deposit fund
1176. Subsection 295-390(5) of the Income Tax (Transitional Provisions)
Act 1997 defines what a fixed interest complying approved deposit
fund is. A complying approved deposit fund will be a fixed
interest complying approved deposit fund if 90 per cent or more of
its income is comprised of amounts which, amongst other things, are
included in its assessable income under Division 16E of the ITAA
1997. In order to preserve the existing scope of these measures,
the amendment ensures that where Division 230 financial
arrangements are required to be taken into account in determining
whether an approved deposit fund is a complying fixed interest
fund, only those amounts that would have been bought to account
under Division 16E, had it applied, are taken into account.
Special accrual amount
1177. Under section 960 of the ITAA 1997, amounts that are denominated in
a foreign currency are required to be translated into Australian
currency. Generally where these amounts are used in calculating
another amount, subsection 960-50(4) of the ITAA 1997 requires each
of those amounts to be translated from a foreign currency to
Australian currency before the calculation is done. The exception
to this is where the amount is a 'special accrual amount' as
defined in subsection 995-1(1) of the ITAA 1997.
1178. Where an amount is a 'special accrual amount' it is calculated
without translating the amounts used to calculate it. The special
accrual amount is then translated into Australian currency. The
definition of 'special accrual amount' includes the accruals
taxation of Division 16E securities.
1179. To ensure that 'special accrual amount' includes amounts calculated
under Division 230 that are consistent with its intent, the
definition has been amended to ensure that only those gains and
losses under Subdivision 230-B that would be accounted for under
Division 16E are subject to the 'special accrual amount' rules.
Subsection 57-25(6) of the Income Tax Assessment Act 1936
1180. Division 57 of Schedule 2D of the ITAA 1936 sets out the income tax
treatment of an entity that ceases to be wholly exempt from income
tax. In particular, subsection 57-25(2) of the ITAA 1936 treats
assets to which section 57-25 applies to have been sold by the
taxpayer immediately before the transition time and re-acquired by
the taxpayer at the transition time for an amount equal to the
asset's adjusted market value for the purposes of determining
future tax consequences. However, the deemed re-acquisition rule
does not invoke the operation of certain provisions of the ITAA
1936 and the ITAA 1997 if the asset was acquired prior to the
commencement of certain provisions listed in subsection 57-25(6).
1181. To ensure that there is no inadvertent retrospective application of
Division 230 to assets acquired prior to the commencement of
Division 230 in the circumstances described above, subsection 57-
25(6) includes it in its listed provisions Division 230.
Consideration from the transfer of a right to receive income from
property
1182. 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.
1183. 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
1184. 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
1185. 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 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, item 82, subsection 320-45(2)]
Foreign trusts, controlled foreign companies and foreign investment
funds
1186. The Board of Tax's 'review of foreign source income anti-tax
deferral rules' is currently considering the operation of the tax
law in relation to interests held in controlled foreign companies
as well as foreign investment funds and non-resident trusts more
widely. Consequently, how Division 230 should apply in relation to
interests in controlled foreign companies, foreign investment funds
and non-resident trusts will receive further consideration in the
light of the outcomes of that review.
1187. Pending the finalisation of that review, 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: will be made to ensure Division
230 is disregarded in working out the net income of a non-
resident trust estate for certain purposes. This
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, item 34, paragraph
96C(5A)(aa) of the ITAA 1936];
. for controlled foreign companies: an amendment to
section 389 of the ITAA 1936 will be made to ensure
Division 230 is disregarded in working out the
attributable income of an eligible controlled foreign
company. This amendment will ensure that attributable
income is calculated with reference to the current law
(including Division 775 (foreign currency gains and
losses), Subdivision 960-C (translation of foreign
currency) and Subdivision 960-D (functional currency) of
the ITAA 1997) [Schedule 1, item 49, paragraph 389(ba) of
the ITAA 1936]; and
. for foreign investment funds: an amendment to section
557A of the ITAA 1936 will be made to ensure Division 230
is disregarded in working out calculated profit or
calculated loss of a foreign investment fund. The
amendment will ensure that foreign investment fund income
is calculated under the current law [Schedule 1, item 50,
paragraph 557A(c) of the ITAA 1936].
Deductions for returns on debt interests
1188. 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, item 59, subsection 25-85(4A)]
1189. 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, item 60,
note to section 29-90]
Withholding tax
1190. Where a financial arrangement is held (as an asset) by a foreign
resident, any gain or part thereof from the financial arrangement
that is income (eg, interest) to which section 128B of the ITAA
1936 applies is not to be assessable under Division 230. Those
gains are to be subject to withholding tax as per Division 11A of
Part III of the ITAA 1936. Any other gain/loss made from the
financial arrangement, including a balancing adjustment gain/loss,
is to be dealt with in accordance with Division 230. This policy
approach leads to two conclusions in the extreme cases. First,
where the only gains that have been or can be made from the
financial arrangement are amounts to which section 128B applies or
will apply (or would apply but for certain exceptions in that
section that are discussed in the next paragraph) and no loss can
be made, Division 230 will effectively not apply at all to those
gains while the financial arrangement is held by, or when it ceases
to be held by, a foreign resident. Second, if no such payments are
made/are to be made to a foreign resident in respect of a financial
arrangement it holds, Division 230 will apply to determine what
gain/loss is made and whether it is assessable or deductible.
1191. The gains to be disregarded for the purposes of section 230-15 are
amounts that are income to which section 128B applies, or would
apply but for the exclusions in Division 11A, other than exclusions
that deal with situations where the income is intended to be taxed
by assessment (if it has an Australian source) rather than by
withholding tax. In the current law these latter exclusions are
those in paragraphs 128B(3)(d), (e), (gb), and (j), subparagraph
128B(3)(h)(ii) and subsection 128B(3E) or in section 17A of the
International Tax Agreements Act 1953. The disregarded gains, or
more correctly the payments by which the gains are realised, are to
be subject to withholding tax or in some cases (eg, amounts covered
by paragraph 128B(3)(jb) or section 128F) exempt from withholding
tax. These gains are hereafter referred to as 'Division 11A
payments'.
1192. Normally, section 128D would result in these Division 11A payments
being non-assessable non-exempt income. However, in many cases
where the gains from a financial arrangement are dealt with by
Division 230 the amount otherwise assessable under that Division
will be different from that which is dealt with by Division 11A and
so section 128D may not apply. A similar issue arises under the
existing law in relation to the eligible return on a qualifying
security where some or all of the payments are interest. In that
case, an exemption from treatment under Division 16E of Part III of
the ITAA 1936 for non-residents is provided by subsection 159GW(1)
of the ITAA 1936.
1193. A payment that is subject to withholding tax is non-assessable non-
exempt income and so to that extent a gain from the financial
arrangement that would otherwise be assessable will not be
[Schedule 1, item 1, subsection 230-30(1)]. To the extent that
gains reflect payments that are exempt from withholding tax but are
nevertheless non-assessable non-exempt income under section 128D
(eg, interest that is exempt from withholding tax by section 128F)
they also will not be assessable under Division 230. Clearly,
these amounts are not intended to be taxed in Australia. However,
in relation to amounts that are exempt from withholding tax but are
not made non-assessable non-exempt income by section 128D (eg,
interest paid to an Australian permanent establishment of a foreign
resident), gains will still be determined in accordance with
Division 230 and they will be assessable if they have an Australian
source.
1. : Withholding tax and accruals
In Example 4.2 assume that Hristina Co, the holder of the
bond, is a foreign resident and that all the payments are
interest to which section 128B applies and on which
withholding tax would be payable. In that example, it is
determined that the accruals method would apply to the
overall gain from the bond. However, because all the gain
reflects amounts that will be subject to withholding tax and
so are non-assessable non-exempt income (on the assumption
that Hristina Co is a foreign resident), each annual gain
calculated using the accruals method would be non-assessable
non-exempt income. In practice, Hristina Co would probably
not even calculate the annual accrual amounts.
Nevertheless, Division 230 may still be used by the issuer
to calculate its annual losses from the bond and to
determine whether they are deductible or not.
1194. Unlike Division 16E, Division 230 could still apply to other gains
or losses from the financial arrangement held by a foreign
resident. In particular, any retranslation gain/loss would still
be dealt with under Division 230 (if a retranslation election
applies to the financial arrangement). If the financial
arrangement were subject to a fair value or financial reports
election and not all gains are Division 11A payments, the amount
recognised in the accounts which would otherwise be used for these
methods would be reduced by the amounts of the Division 11A
payments. If a loss would otherwise arise for an income year under
either method (due to changing interest rates and therefore prices
for the financial arrangement), the adjustment for the Division 11A
payments would increase that loss.
1. : Withholding tax and forex loss
In Example 7.2 assume that A Co, the holder of the note, is
a foreign resident and that the gain on maturity is subject
to withholding tax. The amount on which withholding tax
would be payable is A$1,859 ( = US$1,450/0.78). Because
that amount is therefore non-assessable non-exempt income,
to that extent the annual gains calculated using the accrual
method are non-assessable non-exempt income (or are
disregarded). That leaves only the foreign exchange loss
caused by the change in A$/US$ exchange rate over the three
years. In the absence of a retranslation election, the
balancing adjustment calculation on maturity picks up this
foreign exchange loss. The balancing adjustment loss would
be as calculated in the same manner as in that example
except the interest amount captured in step 2 would be
A$1,859 rather than the annual assessable gains totalling
A$1,295, resulting in a loss of A$5,054. Deductibility
would be determined according to section 230-15.
1195. When it comes to calculating a balancing adjustment under
Subdivision 230-G, these Division 11A amounts fall within step 2(c)
in the method statement in section 230-395. This is illustrated in
the preceding example with the deduction of the interest amount
received on maturity of the note. It includes gains that are
exempt or non-assessable non-exempt income. This would effectively
extend to gains of a foreign resident that are not assessable
because they do not have an Australian source or because they are
payments that are dealt with by Division 11A. [Schedule 1, item 1,
note to paragraph (c) of step 2 in the method statement in
subsection 230-445(1)]
Trading stock
1196. 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.
1197. 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, item 68,
section 70-10 of the ITAA 1997]
Capital gains tax - anti-overlap rule
1198. 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 76,
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].
1199. 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.
However, where a foreign resident makes a gain or loss from a CGT
event happening in relation to taxable Australian property but the
gain is not assessable or the loss is not deductible under Division
230, the capital gain or loss will still be counted in determining
the foreign resident's net capital gain/loss for the year [Schedule
1, item 76, subsection 118-27(3)].
1200. 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 76, subsection 118-
27(1)]
1201. 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.
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.
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.
1202. 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 76,
paragraph 118-27(2)(a)]
1203. Paragraph 118-27(2)(b) also provides an exception to subsection 118-
27(1) in circumstances where a capital loss is made from ceasing to
have a financial arrangement that is a marketable security (within
the meaning of section 70B of the ITAA 1936). The rationale for
this is because where subsection 230-415(1) applies, a deduction is
not allowable under Division 230 to the extent that the loss is of
a capital nature. This loss is a capital loss for the purposes of
the CGT provisions.
Foreign currency gains and losses - anti-overlap rule
1204. A note, following subsections 775-15(4) and 775-30(4), inserted by
this Schedule, clarifies that where foreign currency gains and
losses are brought to account under either Division 230 or
Subdivision 775-F of the ITAA 1997, 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.
Value setting rules
1205. 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 230-505 and its interaction with Divisions 40, 104, 110 and
112 of the ITAA 1997
1206. 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.
1207. 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 relevant.
Where it is a depreciating asset, Division 230 will operate to work
out the termination value and cost of the depreciating asset.
1208. The object of section 230-505 is to provide appropriate proceeds
and cost base interaction rules between the provisions of Division
230 and the rest of the ITAA 1997 and the ITAA 1936 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.
1209. 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 230-505. [Schedule 1, item 1, section 230-505]
1210. For the purposes of section 230-505, 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 230-505
1211. For the purposes of section 230-505, 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 including CGT assets, depreciating
assets or trading stock);
. 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).
1212. 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 230-505 will
have implications for other relevant provisions of the ITAA 1997
outside of Division 230 and of the ITAA 1936. [Schedule 1, item 1,
subsection 230-505(1)]
Impact of section 230-505 on certain elements of capital proceeds,
cost base, cost of a depreciating asset and termination values
1213. Section 230-505 operates in relation to certain elements of capital
proceeds, cost base, cost of a depreciating asset and termination
values. However, it does not in general affect the modification
rules, special rules and specific rules in the capital gains and
capital allowance regimes (eg, the market value substitution
rules).
1214. You might start or cease to have a Division 230 financial
arrangement (or part of such an arrangement) as consideration for
providing or acquiring a CGT asset. You might also do this as
consideration for providing or obtaining a thing relevant to that
asset (eg, obtaining services resulting in capital improvements to
the asset). In such situations, section 230-505 may apply. The
key interactions of section 230-505 with the CGT provisions and the
capital allowance provisions are as follows:
. Section 230-505 generally operates so that the first
element of the cost base and reduced cost base for the CGT
asset includes the market value of the thing acquired at
the time it is acquired. Section 230-505 can also affect
the other elements of the cost base to the extent that the
financial arrangement represents consideration for
something obtained which is relevant to those elements.
For example, if a Division 230 financial arrangement is
provided as consideration for something acquired that
increases an asset's value for the purposes of the fourth
element of the cost base (see subsection 110-25(5) of the
ITAA 1997), then the market value of the thing acquired at
the time it is acquired will be used to calculate that
element of the cost base.
. Section 230-505 generally operates so that the capital
proceeds include the market value of the thing provided at
the time it is disposed of. The capital proceeds may be
from CGT events that involve providing a CGT asset or the
creation of rights, for example, CGT event D1 (creating
contractual or other rights).
. Section 230-505 does not change the time at which a
CGT event happens under the CGT provisions. The time
section 230-505 is satisfied (when you start or cease to
have the financial arrangement) may be different from the
timing of the CGT event. However, once section 230-505 is
satisfied, then the amount determined as the market value
for the thing provided (at the time it is provided) will
be brought to account in determining the capital proceeds
for the CGT event.
. Section 230-505 generally operates so that the cost of a
depreciating asset includes the market value of the
depreciating asset that starts to be held. This may come
about either because the financial arrangement is started
or ceased as consideration to acquire - or to hold - the
asset (relevant to the first element of cost), or as
consideration for something acquired that goes to the
second element of cost (eg, capital improvements).
. Section 230-505 generally operates so that the termination
value or the amount you are taken to have received under a
balancing adjustment event includes the market value of
the depreciating asset that is disposed of or that is no
longer held.
Consideration is taken to be received or provided for the 'thing'
1215. 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, someone else starting to
have it, or by its extinguishment); or
. acquiring (receiving) something from someone else
(including by acquiring it from someone else, someone else
ceasing to have it, or by creating it),
then the value of the benefit that you give or receive for
providing or acquiring that thing is taken to be the market value
of the thing at the time you provide or acquire it. [Schedule 1,
item 1, subsection 230-505(2)]
1216. 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
. providing (giving) something to someone else (including by
transferring it to someone else or by its extinguishment),
then the value of the benefit that you give or receive for
providing or acquiring that thing is taken to be the market value
of the thing at the time you provide or acquire it. [Schedule 1,
item 1, subsection 230-505(2)]
Interaction with capital gains tax provisions
1217. To the extent that Division 230 and Parts 3-1 and 3-3 interact,
section 230-505 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.
1. : 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 2010 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 2011);
and
. the sale price of $120,000 is to be paid 24 months after the
contract date on 1 July 2012 (ie, 18 months after delivery
of the asset).
Background and assumptions
. Buddy Co acquired the CGT asset for $80,000.
. The market value of the CGT asset as at 1 January 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 Division 230.
Buddy Co - disposal of a CGT asset
On 1 January 2011 when Buddy Co delivers the asset to Fee
Co, it will start to have a financial arrangement. This is
because at the time of 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 constituted by this cash
settlable right (subsection 230-45(1) and paragraph 230-
45(2)(a)).
Under subsection 230-60(1) the market value of the CGT asset
(financial benefit provided) is taken to be provided under
the financial arrangement started, and is effectively its
cost.
Buddy Co therefore starts to have a financial arrangement as
consideration for ceasing to have its CGT asset.
Subsection 230-505(2) provides that for the purpose of
applying the income tax law to the CGT asset Buddy Co is
taken to have obtained the market value of the CGT asset at
the time it is provided. 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 CGT asset at the time it is
provided. That is, Buddy Co is taken to have received the
market value of its CGT asset from Fee Co, as determined
under section 230-505 at 1 January 2011. This value is
$105,000 (subsection 230-505(2)).
Pursuant to section 104-10 of the ITAA 1997, CGT event A1
occurs in respect of Buddy Co's CGT asset, on 1 July 2010.
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).
The general financial arrangement cost and proceeds
principles apply to the tax treatment of Buddy Co's
financial arrangement constituted by its right to receive
$120,000 from Fee Co. The cost of the financial arrangement
will be the market value of the CGT asset at the time it is
provided. The difference between this cost ($105,000) and
the proceeds Buddy Co receives from the financial
arrangement ($120,000), a $15,000 gain, will be taken into
account under Division 230.
Fee Co - acquisition of a CGT asset
On 1 January 2011 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 230-45(1) and paragraph 230-45(2)(a)).
Under subsection 230-60(2) the market value of the CGT asset
(financial benefit received) is taken to be received under
the financial arrangement started, and effectively
constitutes the proceeds from the financial arrangement.
Fee Co therefore starts to have a financial arrangement as
consideration for starting to have the CGT asset.
Subsection 230-505(1) provides that for the purposes of
applying the income tax law to the CGT asset Fee Co is taken
to have provided the market value of the CGT asset at the
time it is acquired. 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 CGT
asset, at the time is acquired. That is, Fee Co is taken to
have provided the market value of the CGT asset being
$105,000.
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).
The general financial arrangement cost and proceeds
principles apply to the tax treatment of Fee Co's financial
arrangement constituted by its obligation to provide
$120,000 to Buddy Co. The proceeds of the financial
arrangement will be the market value of the CGT asset at the
time it is acquired. The difference between these proceeds
($105,000) and the cost Fee Co provides for the financial
arrangement ($120,000), a $15,000 loss, will be taken into
account under Division 230.
Note - the time of valuation of the thing
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 which is started or ceased as consideration for the
CGT asset, 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 asset
on the date the taxpayer provides the asset. This date will
not always coincide with the date of the CGT event. This
may mean that the taxpayer will be required to amend what
otherwise may have been taken into account for the purposes
of the CGT event.
Division 230 interaction with capital allowance provisions
1218. To the extent that Divisions 230 and 40 of the ITAA 1997 interact,
section 230-505 will operate to ensure that there is alignment
between the general financial arrangement cost and proceeds
principles 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.
1219. 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
depreciating asset must first be determined before the cost and
termination value of the depreciating asset (as relevant) can be
worked out.
1. : 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 230-505, 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 of the depreciating asset as at 1 September
2010 is $150,000.
. Both Smith Co and Jones Co are subject to Division 230.
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 230-45(1) and paragraph 230-45(2)(a)).
Under subsection 230-60(1) the market value of the
depreciating asset (financial benefit provided) is taken to
be provided under the financial arrangement started, and
effectively constitutes the cost of the financial
arrangement.
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 230-505(2) provides that for the purposes of
applying the income tax law to the depreciating asset Smith
Co is taken to have obtained the market value of the
depreciating asset at the time it is provided. 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
depreciating asset, at the time it is provided. 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-
505(2)).
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).
The general financial arrangement cost and proceeds
principles apply to the tax treatment of Smith Co's
financial arrangement constituted by its right to receive
$250,000 from Jones Co. The difference between the cost of
the financial arrangement, being the market value of the
depreciating asset ($150,000), and the proceeds Smith Co
receives from the financial arrangement ($250,000), a
$100,000 gain, will be taken into account under Division
230.
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 230-45(1) and paragraph 230-
45(2)(a)).
Jones Co therefore starts to have a financial arrangement as
consideration for starting to hold the depreciating asset.
Subsection 230-505(1) provides that, for the purposes of
applying the income tax law to the depreciating asset Jones
Co is taken to have provided the market value of the
depreciating asset at the time it is acquired. 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 depreciating asset, at the time it
is acquired. 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
(subsection 230-505(2)).
The normal cost and proceeds rules apply to the tax
treatment of Jones Co's financial arrangement constituted by
its obligation to pay $250,000 to Smith Co. The difference
between the proceeds of the financial arrangement, being the
market value of the depreciating asset ($150,000), and the
cost Jones Co provides for the financial arrangement
($250,000), a $100,000 loss will be taken into account under
Division 230.
Financial arrangements of consolidated groups
1220. 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. Chapter 12 contains a detailed
discussion of the application of Division 230 to the consolidation
regime, and specific consolidation-related amendments.
Financial arrangements denominated in a foreign currency
1221. 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).
1222. 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 28, 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.
1223. 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 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 1997.
Recognition of gains and losses
1224. 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 and offshore banking units
1225. 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).
1226. 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.
1227. 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 43, subsection
160ZZW(1A)]
1228. 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.
1229. 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 44 and 45, subsection
160ZZX(2) of the ITAA 1936]
1230. In addition, the permanent establishments in Australia of an
offshore banking unit at or through which the offshore banking unit
carries on offshore banking activities, are treated as one person
for the purpose of the definition of a 'financial arrangement'.
The other permanent establishments of the offshore banking unit
(either in or outside of Australia) are treated as separate
persons. This means that financial arrangements between permanent
establishments of an offshore banking unit can be subject to
Division 230 [Schedule 1, item 37, subsection 121EB(3)]. This
reflects the treatment of permanent establishments of an offshore
banking unit under Division 9A of Part III of the ITAA 1936. In
the absence of making any election made by the foreign financial
entity (foreign banks and other financial entities covered by Part
IIIB of the ITAA 1936) the default provisions of Division 230 (ie,
Subdivision 230-B) will apply to applicable Part IIIB and Division
9A transactions that are financial arrangements.
1231. The amendments are not intended to change how Division 9A applies
to consolidated/MEC groups which contain an offshore banking unit,
either as the head company or as a subsidiary member, nor the scope
of transactions that are recognised for the purposes of Division
9A. But they will mean that Division 230 will apply to financial
arrangements related to the transactions or dealings that are
counted as offshore banking activities by Division 9A.
Application of elections to foreign bank branches and offshore
banking units
1232. Foreign financial entities with one or more permanent
establishments in Australia (foreign banks and other financial
entities covered by Part IIIB of the ITAA 1936) may be eligible to
make the various elections. Part IIIB recognises certain intra-
entity transactions or arrangements in calculating the taxable
income of the foreign financial entity (see sections 160ZZW,
160ZZZ, 160ZZZA, 160ZZZE and 160ZZZF of the ITAA 1936). Where the
foreign financial entity makes an election, the election should
apply to financial arrangements that are/represent these notional
borrowings, notional derivative transactions or notional foreign
exchange transactions, in addition to any other financial
arrangements that the entity has entered into with other entities.
However, the separate-entity rules contained in section 160ZZW does
not lead to the result that a separate set of elections can be made
by the Australian permanent establishments. Nor should the
election apply to any other intra-entity arrangements that are not
recognised under Part IIIB (eg, an arrangement between two
Australian permanent establishments).
1233. There is also a separate entity rule in section 121EB of the
ITAA 1936 for offshore banking units. Again, this rule is not to
be taken to imply that a separate set of elections can be made by
the Australian permanent establishments of the entity that carry on
offshore banking business or by a subsidiary member of a
consolidated/MEC group that is an offshore banking unit. The
taxable entity is the entity that makes the election (or does not
as the case may be), including the head company of a group where
section 717-710 applies. The election applies to all relevant
financial arrangements, including those arrangements that arise in
the course of carrying on offshore banking business. Because the
separate entity rule in section 121EB is only for the purpose of
identifying offshore banking activities, the additional financial
arrangements to which an election might apply should only be those
arising from those offshore banking activities as defined in
Division 9A.
1234. The financial arrangements that are recognised only because of Part
IIIB or Division 9A which the accounting standards would have
required be classified or designated in financial reports as at
fair value through profit or loss if the arrangements had been
between separate legal entities are to be the subject of any
election made by the taxpayer. [Schedule 1, item 1, subsections
230-220(3), 230-265(3), 230-335(2) and 230-410(8)]
1235. The gain or loss that is made from a financial arrangement arising
from dealings that are recognised by Part IIIB or Division 9A and
that is covered by an election is the gain or loss that the
standards would have required to be recognised in the profit and
loss report if they had recognised the arrangement. This will
require some departures from the audited financial reports but they
should be no different in scope to the departures that were
previously required because of the additional 'transactions' that
are recognised for tax purposes by Part IIIB and/or Division 9A.
Adequate records of these departures should be maintained in
accordance with the relevant record-keeping provisions. [Schedule
1, item 1, paragraphs 230-230(1)(c) and 230-420(1)(c),
subparagraph 230-280(1)(b)(iii)]
Deductions for expenditure incurred for capital gain
1236. 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.
1237. 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.
1238. 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]
Pay as you go instalments - Taxation Administration Act 1953
1239. 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.
1240. 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.
1241. 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'.
1242. 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 financial arrangements under Division 230 to be
recognised for PAYG purposes. [Schedule 1, item 100, subsection 45-
120(2B) in Schedule 1 to the TAA 1953]
1243. 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).
1244. Taxpayers are to calculate their instalment income having regard to
what, if any, of the elective Subdivisions (see Chapter 5) apply to
them at the end of the instalment period. Where a taxpayer makes
an election to apply any or all of the elective Subdivisions part
way through an income year, the taxpayer is expected to calculate
their instalment income having regard to elections that have in
fact been made by the end of the relevant instalment period.
1245. The practical consequence of such an approach is that a taxpayer
may have to include an amount in their activity statement that
would have otherwise been included in an earlier activity statement
had an election been made in an earlier instalment period.
The effect of a change of residence of the taxpayer
1246. If a taxpayer changes from being an Australian resident to a
foreign resident (or vice-versa) during an income year, special
rules apply to determine the relevant amount of any gain and/or
loss for that year from the taxpayer's financial arrangements. The
general effect of the rules is to calculate any gain or loss from
the financial arrangement for the income year by specifically
taking into account the change of residence during the income year,
and appropriately apportioning the gain or loss to the periods of
different residency [Schedule 1, item 1, subsection 230-485(1)].
The specifics of how this is done depend on the method that would
otherwise be used to determine the taxpayer's gain or loss for the
income year. While theoretically the gain or loss made for the
part of the year while a foreign resident has to be calculated, in
practice it may not need to be done in many cases because a gain
made while a foreign resident would not be assessable or a loss
would not be deductible.
1247. For financial arrangements subject to the realisation method, the
rule is more prescriptive as it deems a disposal and immediate
reacquisition of the arrangement at the time of the change of
residence. This approach has been adopted because this method
relies on when the relevant financial benefits are due to be
provided, which may not in fact occur in the income year, and
therefore not otherwise result in any gain or loss for the income
year. Deeming these arrangements to be disposed of at the time of
the residence change deals with the tax consequences of the change
of residence in the income year in which it occurs (as is the case
for all other methods). [Schedule 1, item 1, subsections 230-
485(3) and (4)]
1248. Each gain or loss determined in accordance with these rules is
taken to be made for the income year in which residence changes,
and can therefore be appropriately handled under section 230-15.
1249. If the change of residence occurs at the end or beginning of an
income year the proposed rules for calculating any gain or loss
will only have practical relevance for financial arrangements
subject to the realisation method. For other methods the rules,
although technically applying, will not alter the calculation of
the gain or loss.
When the accruals method is used
1250. Where a change of residence occurs during the income year, a
taxpayer that has a financial arrangement subject to the accruals
method should apportion any gain or loss on the arrangement for the
year across each period the taxpayer is an Australian resident and
each period the taxpayer is a foreign resident during the income
year. The gain or loss must be apportioned on a reasonable basis
as between each of those periods which, under the accruals method,
should be determined based on the number of days of each period of
different residency. [Schedule 1, item 1, subsection 230-485(6)]
1251. Whether the gain (or loss) for each of these periods is assessable
(or deductible) is determined by applying Division 6 (or 8) to
these periods as if they were separate income years.
When the fair value, foreign exchange retranslation or financial
reports method is used
1252. A different approach applies for financial arrangements for which
the fair value, foreign exchange retranslation or financial reports
method has been chosen. The taxpayer must work out a gain (or
loss) for both the period of foreign residency and the period of
Australian residency. [Schedule 1, item 1, subsection 230-485(8)]
1253. This rule treats these periods as if they were separate income
years and therefore will require the taxpayer to have recourse to
its financial reports. The taxpayer will have to make appropriate
adjustments to the amounts shown in the relevant accounts for the
relevant accounting periods (those that overlap the deemed income
years). This is consistent with the general rule that applies for
these methods where the accounts are not prepared for the income
year. In those cases the taxpayer can make appropriate adjustments
to the accounts for the overlapping accounting periods.
1254. Treating the periods of residency as if they were separate income
years more accurately determines, in accordance with the specific
methods, a gain or loss for each period of different residency.
1255. Again, whether the gain (or loss) for each of these periods is
assessable (or deductible) is determined by applying Division 6 (or
8) to these periods as if they were separate income years.
1256. The application of this rule may result in a gain for the period of
Australian residency and a loss for the period of foreign residency
(or vice-versa), or other combinations of gain and loss. Further,
the gain may be assessable (eg, a foreign source gain made while an
Australian resident) but the loss not deductible (eg, while a
foreign resident a loss is not made in deriving assessable
Australian source income). To calculate the gain or loss using the
same general apportionment rule that applies to the accruals method
would provide an incorrect outcome as the starting point would be a
gain or loss for the entire income year (rather than allowing for a
gain or loss for each period of residency). Therefore, a daily
apportionment of the gain or loss for the income year would not be
acceptable when these methods are used.
When the realisation method is used
1257. There is also a separate rule for financial arrangements to which
the realisation method applies. If the taxpayer changes residence
during the income year, or at the end of an income year, each such
financial arrangement is deemed to be disposed of and immediately
reacquired at the residence-change time for its fair value at that
time. A gain or loss will accumulate (or be realised throughout
the period) up until the residence-change time (where there is a
deemed disposal and a balancing adjustment gain or loss would be
calculated according to Subdivision 230-G). Similarly, a gain or
loss will accumulate (or be realised throughout the period) from
the residence-change time until the time of actual disposal
(whenever that occurs) or other payments may be made. [Schedule 1,
item 1, subsection 230-485(4)]
1258. Although the deemed disposal treatment may not seem to be strictly
in accordance with the realisation method, its objective is similar
to the treatment provided under the other methods (in that it
effectively divides an overall gain or loss on realisation into two
parts) and is also similar to treatment under the CGT rules where
there is a change of residence.
1259. As there are two times when a gain and/or loss on disposal would be
determined, this rule can advance the recognition of a gain or loss
in situations where the actual disposal of the financial
arrangement is in an income year later than the income year in
which the residence change occurs.
1260. The purpose of dividing the overall gain or loss into component
gains and/or losses before and after the change of residence is to
enable each component to be treated according to residence
immediately before the change of residence and at the time of
actual realisation. The assessability and/or deductibility of each
component gain and/or loss can be determined separately based on
the residency of the taxpayer, the source of any gain and/or the
purpose for which any loss is made.
1261. Further, the rule for deeming a disposal and reacquisition at the
residence-change time avoids the risk of not collecting tax upon
ultimate disposal (or the risk that the taxpayer will not claim a
deductible loss that would otherwise have been allowed).
1262. An example where this rule may apply is to a gain or loss that
arises due to movements in the exchange rate (foreign exchange
gains or losses) on a financial arrangement (where no other
elective method applies). Any realisation gains or losses that
accrue over time will be subject to this rule.
When the hedging financial arrangements method is used
1263. If the hedging financial arrangements method applies to the
financial arrangement, the taxpayer will need to apply the specific
change of residence rules that are relevant to the hedged item
itself. [Schedule 1, item 1, subsection 230-485(5)]
1264. If the hedged item is itself a financial arrangement, the specific
change of residence rules applicable for the method used for that
financial arrangement will determine the relevant change of
residence rules that are relevant for the hedging financial
arrangement (see paragraphs 11.92 to 11.104). If the hedged item
is not a financial arrangement (but some other capital asset) then
(in cases where a gain or loss is relevant) the specific change of
residence rules for the realisation method will apply (see
paragraphs 11.99 to 11.104).
When there is a disposal of the financial arrangement in the same
income year
1265. If the financial arrangement is disposed of after the change of
residence, but before the end of the income year, these rules will
still apply to calculate a gain or loss using the appropriate
method up until the change of residence. This is because
subsection 230-40(2) is disregarded in determining if the change of
residence rules apply [Schedule 1, item 1, paragraphs 230-485(5)(a)
and (7)(a)]. Subsection 230-40(2) gives precedence to taking into
account a gain or loss under the balancing adjustment method over
all other methods, where one of those other methods might otherwise
also apply in an income year. Turning off this rule allows the
change of residence rules to continue to apply for that particular
income year. However, the gain or loss for the second part of the
income year should be calculated using Subdivision 230-G
(ie, subsection 230-40(2) is applied at that stage). That
calculation would take account of the gain or loss calculated for
the first part of the year using the relevant method whether it has
been included in taxable income or not. If the realisation method
otherwise applied to the arrangement, there would be two
applications of the balancing adjustment calculation in
Subdivision 230-G in the income year: one for the change of
residence and one for the actual disposal of the financial
arrangement. Because there is a deemed reacquisition of the
arrangement at the residence-change time in this case, the second
calculation of a balancing adjustment gain or loss should measure
only the gain or loss arising since the residence-change time.
Special rule where a taxpayer ceases to be an Australian resident
1266. When a taxpayer ceases to be an Australian resident and the
financial arrangement has no further connection with Australia
there will be, for the purposes of Division 230 (regardless of the
method used):
. a deemed disposal of the interest in the financial
arrangement immediately before the taxpayer ceases to be
an Australian resident (which may be at the end of an
income year or some time during an income year) for its
fair value at that time; and
. a deemed reacquisition of the financial arrangement
immediately after the change of residence for its fair
value at that time.
[Schedule 1, item 1, subsection 230-490(2)]
1267. The rule only applies if, immediately after the taxpayer ceases to
be an Australian resident, gains and losses that could be made in
relation to the financial arrangement while the taxpayer remains a
foreign resident are neither assessable nor deductible [Schedule 1,
item 1, subsection 230-490(1)]. The deemed disposal and
reacquisition is a special case and is an exception to the general
rule in section 230-485. Its aim is twofold - to ensure that:
. the effective movement of the financial arrangement out of
the application of Division 230 is adequately dealt with;
and
. there is a relevant cost of acquisition for the financial
arrangement should Division 230 apply to any gains and/or
losses on the financial arrangement some time after the
taxpayer ceases to be an Australian resident (eg, if the
taxpayer again becomes an Australian resident).
1268. Where this rule applies, effectively Division 230 will no longer
apply to the financial arrangement and the specific rules in
section 230-485 will have no application to this particular change
of residence. This is because those specific rules only apply if
the taxpayer would, once a foreign resident, otherwise apply a
particular method under Division 230 to determine a gain or loss.
While in practical terms Division 230 will no longer apply in
relation to this financial arrangement, if the taxpayer once again
becomes an Australian resident this section will once more be
triggered.
1269. The deemed disposal rule may result in a balancing adjustment gain
or loss under Subdivision 230-G (which is discussed in Chapter 10).
1270. In other cases where a taxpayer ceases to be an Australian
resident, Division 11A of Part III of the ITAA 1936 (interest
withholding tax) may apply exclusively while the taxpayer is a
foreign resident. The taxpayer would need to know how much gain or
loss was made for the part of the year in which it was an
Australian resident (in accordance with section 230-485). The
assessability and deductibility would be determined according to
Division 230. If Division 11A did not deal with all gains while a
foreign resident (eg, gains that are not interest), or if there
were any losses, the taxpayer would still need to determine the
gain or loss made while a foreign resident (by applying section 230-
485) and then determine the assessability or deductibility of any
gain or loss.
Interaction with withholding tax rules
1271. There is a possible overlap between taxation under Division 230 and
the imposition of withholding tax under Division 11A of Part III of
the ITAA 1936 (see paragraphs 11.32 to 11.37) where the holder of a
financial arrangement changes from an Australian resident to a
foreign resident and an interest payment is subsequently made.
1272. If no withholding tax is payable (eg, if there is an exemption from
withholding tax) then there is no possible overlap and therefore no
adjustment is required. However, in cases where withholding tax is
otherwise payable, there is an overlap and therefore the amount of
withholding tax is reduced by the amount notionally payable on the
net amount that was assessable under Division 230. [Schedule 1,
items 38 to 40, section 128NBA of the ITAA 1936]
1. : Refund of withholding tax when no interest is paid while an
Australian resident
Assume the facts in Example 4.5 but also assume that John
Doe is an Australian resident when he invests $100 in a zero
coupon bond that will pay $120 at maturity in four years
time. Also, the bond is issued by an Australian resident.
At the beginning of year 4 John Doe becomes a resident of
the United States.
The interest (totalling $14.65) that accrues (on a
compounding basis) in years 1, 2 and 3 is included each year
as a gain calculated under the accruals method. John Doe is
paid $120 ($20 of this is interest) at the end of year 4, at
which time he is a foreign resident. Withholding tax of $2
is payable on the $20 interest payment. As $14.65 has
already been included in assessable income under
Division 230 while John Doe was an Australian resident,
section 128NBA will credit, on application, an amount of
$1.47 (withholding tax of 10 per cent payable on the net
Division 230 amount of $14.65). This will mean that
withholding tax is effectively only payable on $5.35 which
is the gain that would have otherwise accrued in year 4.
The gain that would otherwise have been included in
assessable income in year 4 is disregarded because it is
part of an amount that is (or is anticipated will be)
treated as non-assessable non-exempt income under
section 128D of the ITAA 1936.
1273. Further, this rule in section 128NBA to prevent double taxation
also applies to cases where there are periodic interest payments to
the taxpayer over the life of the financial arrangement. [Schedule
1, item 40, subparagraph 128NBA(5)(d)(9)(ii) of the ITAA 1936]
1. : Refund of withholding tax when interest has been paid while an
Australian resident
Assume the facts in Example 4.7 but also assume FLD Finance
Co is an Australian resident when purchasing the security
for $1,000. Also assume the security is issued by an
Australian resident. At the beginning of year 3 FLD Finance
Co becomes a foreign resident.
Although FLD Finance Co changes residence, the deemed
disposal and reacquisition rules in section 230-490 will not
apply because immediately after FLD Finance Co ceases to be
an Australian resident the gains (Australian sourced) remain
assessable. However, rather than Division 230 applying to
assess the gain, any gain that would have otherwise been
included in assessable income in years 3 and 4 is
disregarded because it is part of an amount or amounts (the
interest payments) that will be treated as non-assessable
non-exempt income under section 128D of the ITAA 1936.
At the beginning of year 3, $133.36 has previously been
included in FLD Finance Co's assessable income (as accrual
amounts) under Division 230. Withholding tax is payable on
the interest payment in year 3 of $80. However, by the end
of year 3 the withholding tax payable is reduced to the
amount that would otherwise have been payable on the total
interest paid over the three years ($40 + $50 + $80 =
$170) less the net amount included in assessable income
under Division 230 ($133). The withholding tax payable on
$43 (= $133 - $40 - $50) of the $80 interest payment
would be credited under subsection 128NBA(1). Therefore, of
the $80 interest payment in year 3 withholding tax is
effectively only payable on $37 of that payment. In
practice, withholding tax is payable on the $80 and once the
withholding tax is paid the taxpayer can apply (in the
approved form) to the Commissioner of Taxation for a credit
of the withholding tax payable on the $43.
When the subsequent $100 interest payment is made in year 4,
withholding tax would be payable on that amount. In total,
of the overall gain of $270, $133 would be included in
assessable income (under Division 230) and $137 would be
subject to withholding tax (under Division 11A of the
ITAA 1936).
If, in this example, the difference between the total amount
included in assessable income under Division 230 in the
first two years and the first two interest payments had been
greater than the amount of interest paid in year 3, a credit
for the full amount of withholding tax paid in year 3 could
be claimed and the residual could be claimed after year 4.
Alternatively, the claim for the withholding tax credit
could be delayed until after year 4. On the other hand, if
the first two interest payments had been greater than the
total amount included in assessable income under
Division 230 in the first two years, there would be no
withholding tax credit to be claimed. Instead, the excess
would be recognised as a gain (either on disposal or
maturity of the security, under Subdivision 230-G).
When a taxpayer becomes an Australian resident
1274. Where the holder of the financial arrangement changes from being a
foreign resident to being an Australian resident, it is not
intended that the gains that accrued while that holder was a
foreign resident would be assessable as soon as a payment is made
when the holder is an Australian resident. This is what is done in
relation to qualifying securities covered by Division 16E of
Part III of the ITAA 1936 under subsection 159GW(2) of the
ITAA 1936. Instead, any such gain would be included in assessable
income as a balancing adjustment when the financial arrangement
ceases to be held.
Application of change of residence rules to partnerships and trusts
1275. Where Division 230 applies to a financial arrangement of a
partnership or trust, a change of residence is irrelevant in
determining the net income of the partnership or trust because of
the assumption of residency of the partnership and trust (section
90 and subsection 95(1), respectively, of the ITAA 1936).
1276. However, if a partner, or a beneficiary that is presently entitled
to a share of the trust income, changes residence during the income
year, sections 92 and 97, respectively, of the ITAA 1936 require a
disaggregation of the net income into its Australian and foreign
source components. It is expected that the partner, or
beneficiary, would do that by applying the change of residence
provisions as if it, and not the partnership or trust, were the
entity which held the financial arrangement.
1277. Similarly, in situations where the trustee may be assessed in
respect of some or all of the net income under section 98 of the
ITAA 1936 (eg, the beneficiary is under a legal disability or is a
foreign resident at the end of the income year) any change in the
beneficiary's residence during the year should be taken into
account in determining the trustee's liability to tax.
1278. In situations where the trustee may be assessed in respect of some
or all of the net income under section 99 or 99A of the ITAA 1936,
and the trustee changes residence during the income year, the
change of residence may or may not affect the tax liability of the
trustee. If the trustee ceases to be an Australian resident during
the income year, there will be no effect because the trust is still
held to be a resident trust estate. If the trust becomes a
resident trust because a trustee becomes an Australian resident
during the income year, it will be treated as a resident trust for
the whole income year. In either case, there is no need to
determine how much gain or loss was made on the trust's financial
arrangements for the part of the year in which the trustee was an
Australian resident and how much was made while a foreign resident.
Therefore, there is no need to apply the change of residence
provisions in this case.
Interaction with value shifting rules
1279. Section 230-520 applies such that gains and losses on financial
arrangements that are attributable to a value shift that would have
consequences under the General Value Shifting Regime are
disregarded under Division 230. Similarly, gains and losses in
respect of financial arrangements are disregarded to the extent
that any of the former value shifting rules would have applied in
respect of a financial arrangement.
1280. Broadly, the value shifting rules prevent inappropriate tax
consequences from arising (eg, a tax loss or a reduction in
assessable income) where, under a scheme, value is shifted from
equity or loan interests. Generally, these rules prevent
inappropriate tax outcomes from arising by either requiring the tax
values of the 'losing' interest to be reduced by the same magnitude
of the value shift (note that the tax value of a 'gaining' interest
may be revised upwards to the same extent) or, alternatively,
losses may be denied when the equity or loan interests are finally
realised. Under either approach, correcting the tax outcomes of a
value shift generally occurs upon realisation of the interests -
that is, the value shifting rules effectively correct the result
upon realisation of such interests.
1281. On the other hand, in many cases Division 230 operates to bring to
account gains and losses in respect of a financial arrangement
prior to realisation, for example as the gains or losses accrue.
Consequently, in the absence of special value shifting rules that
apply to Division 230 financial arrangements, where a value
shifting arrangement reduces the value of a financial arrangement
or the expected future cash flows on a financial arrangement,
inappropriate tax consequences from the arrangement could arise in
the income year in which the value shift occurs.
1282. This may occur, for example, where an entity purchases a security
that provides for relatively certain fixed cash flows over several
years and the entity recognises the gains on the security by
applying the accruals method in Subdivision 230-B. During the term
of the arrangement a value shift could result in a reduction in the
estimated cash flows and consequently a reduction in the overall
gain on the arrangement. Without special integrity rules the
entity holding the financial arrangement might, for example, re-
estimate the gain or loss on the arrangement and the subsequent tax
consequences would reflect the re-estimated gain or loss.
1283. Similarly, where an entity holds an asset that is subject to fair
value measurement under Subdivision 230-C, changes in the fair
value of such assets recognised in the financial accounts of the
entity are brought to account for tax purposes. Absent special
integrity rules, if a value shift occurs which causes the fair
value of such an asset to decrease, the holder would recognise a
loss or reduced gain on that asset in the income year in which the
value shift occurs.
1284. Where a financial arrangement is not subject to Division 230, the
value shifting rules would ordinarily prevent the taxpayer from
recognising a reduced gain or a tax loss on an arrangement that
would trigger the application of specific provisions within the
value shifting regime (eg, in the case of indirect value shifting,
Division 727-B). As a consequence, a reduction of the adjustable
values (eg, cost base) of the financial arrangement would occur in
respect of the interests from which value has been shifted. A
corresponding adjustment might also be made in respect of the
interests to which value has been shifted. Alternatively, losses
that would otherwise arise on realisation of the financial
arrangement might have been denied to the holder.
1285. The inclusion of section 230-520 is intended to ensure that
inappropriate value shifts that would ordinarily have consequences
under Divisions 723, 725, and 727 of the ITAA 1997 are disregarded
in determining tax outcomes for financial arrangements that are
subject to Division 230. This is accomplished by assuming that a
realisation event is taken to have happened in the income year in
which the value shift is occurred. Given that this realisation
event is assumed to have occurred, consequences are taken to arise
under Divisions 723, 725 and 727. It is the gains or losses on
shifts in value that are taken to have consequences under Divisions
723, 725 and 727 that are disregarded for the purposes of Division
230. In other words the entity applies Division 230 as if the
gains or losses attributable to the value shift never happened.
1286. Where an entity holds financial arrangements before the
commencement of Division 230, Division 230 allows taxpayers to, for
example, apply the elective methods such as fair value to those pre-
existing financial arrangements subject to certain requirements.
Where such an election is made, the taxpayer must make a balancing
adjustment which brings about assessable income or an allowable
deduction which is to be spread over the first applicable income
year and the next three income years. Essentially the balancing
adjustment brings to account the difference between what would have
been the tax result had Division 230 applied to the pre-
commencement financial arrangements from the time the taxpayer
started to hold it and the actual tax results in respect of the
financial arrangements.
1287. If a value shift occurred prior to the commencement of Division 230
in respect of a pre-existing financial arrangement causing the
value of a financial arrangement to be reduced then, absent special
integrity rules, the taxpayer may be able to obtain a tax saving
from that value shift through the balancing adjustment. In these
circumstances, section 230-520 applies such that where a balancing
adjustment is made in respect of existing financial arrangements,
any value shifts that would ordinarily have consequences under
Divisions 723, 725 and 727 of the ITAA 1997 are disregarded in
determining gain or loss determined under the balancing adjustment.
1288. Value shifts that would have had consequences under repealed value
shifting provisions (eg, former Divisions 138, 139 and 140 of the
ITAA 1997) are disregarded in determining gains and losses under
Division 230 - including for the purposes of any balancing
adjustment made in respect of existing financial arrangements.
Definitional and referencing changes
1289. 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
1290. 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.
1291. 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.
1292. 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.
1293. 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.
1294. 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 77 and 78, section 130-100]
Offshore banking units and foreign bank branches
Hedging activities of offshore banking units
1295. 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'.
1296. 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 37,
definition of 'hedging activity' in subsection 121D(8) of the ITAA
1936]
Derivative transaction for foreign bank branches
1297. 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 41 and 42, definition of 'derivative transaction' in section
160ZZV of the ITAA 1936]
Qualifying forex accounts
1298. An amendment will be made to the definition of a 'qualifying forex
account' in subsection 995-1(1) of the ITAA 1997 to extend its
application by repealing the requirement that it must be maintained
with an ADI or a financial institution similar to an ADI in
Australia or overseas. [Schedule 1, Part 4, item 111, definition
of a 'qualifying forex account' in subsection 995-1(1) of the ITAA
1997].
1299. This change will allow inter-company accounts, that are
transactional accounts, to satisfy the definition of qualifying
forex account.
Checklists
1300. 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 53 and 57, sections 10-5 and 12-5]]
Signposts
1301. The operation of the value setting rules in section 230-505 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 62 to 68, subsections 40-180(1), 40-185(1), 40-
300(1) and 40-305(1)] and CGT provisions [Schedule 1, items 70 to
75, subsections 110-25(1) and 116-10(7) and sections 104-5 and 112-
5] of the ITAA 1997 to highlight the possible application of
section 230-505 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 58, subsection 25-35(5)].
1302. Signposts have also been added to some CGT provisions to highlight
the effect of the hedging provisions in certain situations.
[Schedule 1, items 69 and 70, sections 102-20 and 104-5]
1303. Finally, subsection 6(1) of the ITAA 1936 defines a Division 230
financial arrangement to mean a financial arrangement to which
Division 230 applies in relation to your gains and losses from the
arrangement, that is, the definition takes on the same meaning as
contained in subsection 995-1(1) of the ITAA 1997. [Schedule 1,
item 31, subsection 6(1)]
Record-keeping
1304. A number of amendments are being made to section 262A of the ITAA
1936. These amendments will modify the application of section 262A
so as to preserve its intended application in a Division 230
context.
1305. The first amendment modifies subsection 262A(1) so that it applies
to all taxpayers that have Division 230 financial arrangements (ie,
a financial arrangement to which Division 230 applies). This
amendment overcomes the requirement in subsection 262A(1) that a
person be carrying on a business before the subsection has
application. [Schedule 1, item 46, subsection 262A(2AAC)]
1306. The second amendment clarifies the application of
subsection 262A(4). The provision ensures that records relevant to
the calculation of gains and losses from Division 230 financial
arrangements must be kept for at least five years after the
taxpayer includes an amount as assessable income or is entitled to
a deduction in accordance with Division 230.
1307. This amendment does not modify the time at which records must first
be held (or in place). Accordingly, Division 230 will be relevant
when determining the time at which a record must be created or
first held. [Schedule 1, item 46, subsection 262A(2AAD)]
1308. More specifically, in respect of hedging financial arrangements
paragraph 262A(3)(ca) operates to ensure the record must be in
place at, or soon after, the time when a taxpayer creates, acquires
or applies the hedging financial arrangement. [Schedule 1, item
47, paragraph 262A(3)(ca)]
1. : Documentation requirements for a hedging financial arrangement
Jimmy Co, an Australian resident company, enters into a
hedging financial arrangement to hedge against foreign
currency movements on the principal amount of loan that is
denominated in $US. The loan has a 15-year term and has a
nominal value of US$1,000,000.
Jimmy Co enters into a series of six-month forward rate
agreements to hedge the foreign currency movements on the
principal amount of the loan.
Section 230-310 requires that Jimmy Co has the relevant
hedging documentation in place at or soon after the time
when the hedging financial arrangement is entered into.
The modifications to section 262A of the ITAA 1936 operate
to ensure that all documentation relating to the hedging
financial arrangement, including each forward rate
agreement, is retained for at least five years after either
the:
. gain on the hedging financial arrangement is included as an
amount of assessable income; or
. loss is claimed as a deduction in accordance with Division
230.
If the loan is structured such that it is an interest only
loan throughout its term, then all gains and losses from the
hedging financial arrangements will be bought to account at
the end of the loan arrangement as this is the time at which
the principal amount of the loan is repaid.
In this example Jimmy Co will be required to retain certain
records for a period of 20 years, that is, for the 15 years
of the loan plus five years to comply with section 262A of
the ITAA 1936.
1309. Finally, for the purposes of subsection 262A(6), a Division 230
financial arrangement is taken to mean a financial arrangement to
which Division 230 applies in relation to your gains and losses
from the arrangement, that is, the definition takes on the same
meaning as contained in subsection 995-1(1) of the ITAA 1997.
[Schedule 1, item 31, subsection 6(1)]
Foreign currency gains and losses - Division 775 and Subdivisions 960-C and
960-D
1310. Amendments to ensure that certain types of securitisation vehicles
and special purpose vehicles were exempt from Division 775 with
effect from 1 July 2003 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.
1311. 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.
1312. 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 106 and 107, 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 108, subsection 775-195(9)];
. section 960-55 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 110, 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 110, subsection 960-60(6)].
1313. 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 of the ITAA 1997.
1314. 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 of the
ITAA 1997 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 of the ITAA 1997.
[Schedule 1, items 107, 108, 110, 111 and 113]
New Business Tax System (Taxation of Financial Arrangements)
Act (No. 1) 2003
1315. Section 77 of Schedule 4 to the NBTS (TOFA) 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.
1316. 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 referred to in paragraph 11.154.
[Schedule 1, item 113, paragraph 77(1)(b) of the NBTS (TOFA) 2003]
1317. Consistent with the policy outlined in paragraph 11.98, the
transitional provisions which allow Division 3B of the ITAA 1936 to
have continued operation in relation to ADIs, non-ADI financial
institutions and relevant securitisation vehicles will be removed
on commencement of Division 230. [Schedule 1, item 100]
Retranslation for qualifying forex accounts
1318. As a result of the change to the definition of qualifying forex
account an amendment has been made to the retranslation election
contained in Subdivision 775-E of the ITAA 1997 - see
paragraph 11.140 for a discussion of the change. The change
provides for the making of a retranslation election in respect of
qualifying forex accounts, as modified, with effect:
. from 17 December 2003; or
. where you make a choice within 90 days after the
commencement of Part 1 of Schedule 1 to the Tax Laws
Amendment (Taxation of Financial arrangements) Bill 2008
once enacted, from 1 July 2003.
[Schedule 1, Part 4, item 109, subparagraph 775-270(2A)(a)(ii)]
1319. Any existing retranslation election that applies to qualifying
forex accounts under Subdivision 775-E of the ITAA 1997 will cease
to apply to any account to which a general retranslation election
or a qualifying forex account election applies. [Schedule 1, item
5, subsection 775-270(1A)]
1320. Other changes to Division 775 relating to the retranslation
election have been explained in Chapter 7.
Chapter 12
Consolidation interactions
Outline of chapter
1321. This chapter explains:
. amendments to the income tax consolidation regime to
ensure appropriate interactions with Division 230; and
. how the existing law in relation to consolidation will
apply to entities that are taken to hold or cease to hold
a financial arrangement.
Context of amendments
1322. Under the consolidation regime a group of eligible wholly-owned
entities is treated as a single entity for income tax purposes.
When an entity becomes a subsidiary member of a consolidated group
or multiple entry consolidated group (MEC group), the membership
interests held by the group in the joining entity are ignored and
the entity's assets are treated for tax purposes as the assets of
the head company. The tax costs of those assets are reset at an
amount that reflects the group's cost of acquiring the joining
entity.
1323. This chapter outlines the operation of the consolidation regime if
an entity that holds Division 230 financial arrangements joins or
leaves a consolidated group or MEC group. To a large extent, the
existing consolidation provisions will operate appropriately in
these circumstances. However, modifications are required to:
. enhance the interaction between the consolidation regime
and Division 230; and
. reduce compliance costs.
1324. In this chapter, references to assets or liabilities being
financial arrangements include assets or liabilities that form part
of financial arrangements.
Summary of new law
1325. There are four basic propositions outlined in this chapter.
1326. First, where an entity joins a consolidated group or MEC group, the
joining entity will apply Division 230 as if the joining time was
the end of an income year.
1327. Second, the head company will apply the consolidation rules and
Division 230 (depending on whether it is required or has elected to
apply Division 230) as if the head company had directly acquired
assets or assumed liabilities that are, or form part of, financial
arrangements from the joining entity. Certain amendments are made
to this proposition to reduce compliance costs specifically related
to Division 230 interactions.
1328. Third, where an entity leaves a consolidated group or MEC group,
the head company will apply Division 230 as if the leaving time was
the end of an income year.
1329. Finally, a leaving entity which applies Division 230 in relation to
its financial arrangement gains and losses will apply the Division
as if the leaving entity took the financial arrangements with it at
the leaving time.
Comparison of key features of new law and current law
|New law |Current law |
|If an asset that is a |When an entity joins a |
|financial arrangement |consolidated group, the |
|held by a joining entity |tax costs of the joining |
|is subject to the |entity's assets are reset|
|accruals, realisation or |under the tax cost |
|hedging methods, the tax |setting rules. |
|cost setting rules will | |
|apply to determine the | |
|head company's tax cost | |
|for the financial | |
|arrangement. | |
|If an asset that is a | |
|financial arrangement | |
|held by a joining entity | |
|is subject to the fair | |
|value, financial reports | |
|or retranslation | |
|elections, the head | |
|company's tax cost for | |
|the financial arrangement| |
|will be, broadly, its | |
|accounting value. Any | |
|difference between the | |
|accounting value and the | |
|tax cost setting amount | |
|will be included in the | |
|head company's assessable| |
|income, or allowed as a | |
|deduction, over four | |
|years. | |
|If a liability that is a |When an entity joins a |
|financial arrangement |consolidated group, the |
|held by a joining entity |value of the liabilities |
|is subject to the |the head company assumes |
|accruals, realisation or |from the joining entity |
|hedging methods, the |is given by the entry |
|entry history rule will |history rule. |
|apply to determine the | |
|value of any liabilities | |
|a head company assumes | |
|from a joining entity. | |
|If a liability that is a | |
|financial arrangement | |
|held by a joining entity | |
|is subject to the fair | |
|value, financial reports | |
|or retranslation | |
|elections, the head | |
|company will apply | |
|Division 230 on the basis| |
|that it assumed the | |
|liability at the joining | |
|time for an amount equal | |
|to its Division 230 | |
|starting value. | |
|The terminating value of |When an entity leaves a |
|a financial arrangement |consolidated group, the |
|will be the amount of |tax cost setting amount |
|consideration that the |of the membership |
|head company would need |interests the head |
|to receive if it were to |company holds in the |
|dispose of the financial |leaving entity is worked |
|arrangement just before |out by reference to, |
|the leaving time without |among other things, the |
|an amount being included |terminating value of |
|in assessable income, or |assets that the leaving |
|being allowed as a |entity takes with it. |
|deduction, under | |
|Division 230. | |
Detailed explanation of new law
1330. This chapter outlines how the amendments and existing consolidation
provisions will apply:
. if a joining entity holds financial arrangements and
Division 230 applies to work out gains or losses on those
financial arrangements, in relation to:
- the joining entity; and
- the head company at the joining time; or
. if a leaving entity takes financial arrangements with it
and Division 230 applies to work out gains or losses on
those financial arrangements, in relation to:
- the leaving entity; and
- the head company at the leaving time.
1331. This chapter will also outline other consolidation and Division 230
interaction amendments relating to:
. the eligibility of MEC groups to make Division 230
elections; and
. the Division 230 transitional measures.
Treatment of joining entities
1332. Subsection 701-30(3) of the Income Tax Assessment Act 1997 (ITAA
1997) requires a joining entity to work out its taxable income for
the period prior to the joining time as if the joining time were
the end of an income year.
1333. Therefore, a joining entity will apply Division 230 (depending on
whether it is required or has elected to apply Division 230) as it
ordinarily would on the basis that the joining time is the end of
its income year.
1334. There is no Subdivision 230-G balancing adjustment at the end of
this income year as a consequence of the joining event because the
joining entity is not taken by the consolidation rules to have
transferred the financial arrangement or otherwise ceased to have
it.
1.
Joining Co holds a financial arrangement whose gains or
losses are worked out using the compounding accruals method.
The effect of the compounding accruals method is that $333
must be included in the entity's assessable income in 2010-
11, 2011-12, and 2012-13. The intervals to which this gain
is being allocated exactly equate to Joining Co's income
year, which starts on 1 July and ends on 30 June.
On 1 January 2011, Joining Co joins a consolidated group.
Therefore, Joining Co has an end of income year of
31 December 2010. Joining Co will be taken to have made a
gain equal to so much of that part of the gain as is
allocated to the income year 1 July 2010 to 31 December 2010
on a reasonable basis.
For example, a reasonable basis for calculating the part of
the gain to be allocated to the 1 July 2010 to 31 December
2010 period may be to simply divide $333 by two. However,
whether this is a reasonable basis to allocate the gain
entirely depends on the facts and circumstances of the
financial arrangement.
2.
Joining Co holds a financial arrangement whose gains or
losses are worked out using the fair value method.
On 1 July 2010, the fair value of the financial arrangement
according to Joining Co's financial reports is $100.
On 1 January 2011, Joining Co joins a consolidated group.
The market value of the financial arrangement at this time
is $120.
Joining Co will apply the fair value method on the basis
that 31 December 2010 is the end of its income year.
Joining Co makes a gain from this financial arrangement for
the income year 1 July 2010 to 31 December 2010 of $20.
Subdivision 716-A of the ITAA 1997 does not apply even where a
Division 230 spreading method is being used
1335. Subdivision 716-A applies if an entity is a subsidiary member of a
consolidated group for part of an income year and a provision of
the income tax law spreads an amount of assessable income, or the
amount of a deduction, over two or more income years by including
part of the original amount in the same entity's assessable income,
or by allowing the same entity to deduct part of the amount, for
each of those income years.
1336. Under Division 230, gains and losses from a financial arrangement
are recognised over its life. If a Division 230 spreading method
applies to the financial arrangement, the gain or loss that is
recognised in each income year is determined at the end of that
income year. If an entity joins a consolidated group part way
through an income year, the entity applies the Division 230
spreading method to determine its taxable income at the joining
time. Similarly, if an entity leaves a consolidated group part way
through an income year, the head company applies the Division 230
spreading method to the financial arrangement up to the leaving
time to determine its taxable income for that income year. The
Division 230 spreading methods do not spread a pre-determined
amount of assessable income, or the pre-determined amount of a
deduction, between income years. Therefore, if an entity that
holds a financial arrangement is a subsidiary member of a
consolidated group for part of an income year, Subdivision 716-A
does not apply to allocate the gain or loss on that financial
arrangement in that income year between the head company and the
subsidiary member.
Treatment of head companies at the joining time
1337. A head company which commences to hold an asset or liability that
is a financial arrangement will apply Division 230 as if the head
company directly acquired the asset or liability. There are two
implications of this:
. the tax cost of any asset that is a financial arrangement
that the head company is taken to have acquired is equal
to the asset's tax cost setting amount; and
. any election the head company has made in relation to its
existing financial arrangements will apply to the
financial arrangements it has taken to have acquired as a
result of the joining entity becoming a member of the
consolidated group.
[Schedule 1, items 85 and 89, subsections 701-55(5A) and 715-
375(2)]
Setting the tax costs of assets
1338. If a joining entity holds assets that are a financial arrangement,
Division 705 of the ITAA 1997 will apply to set the tax costs of
those assets at their tax cost setting amounts.
1339. Where the asset is a reset cost base asset, section 705-40 of the
ITAA 1997 may apply such that the asset's tax cost setting amount
must not exceed the greater of the asset's market value, or the
joining entity's terminating value for the asset. The section will
apply where the asset that is a financial arrangement is a revenue
asset (as defined in section 977-50 of the ITAA 1997).
1340. Section 701-55 of the ITAA 1997 sets out how the tax cost setting
amount is used as the basis for applying other provisions in the
income tax law. For the purpose of applying Division 230, the use
of the tax cost setting amount for assets that are financial
arrangements varies depending on the method the head company is
applying to work out its gains or losses under Division 230.
Where the head company is using the accrual/realisation method
1341. In relation to assets that are financial arrangements on which
gains or losses are being worked out using the compounding accruals
or realisation method, the effect of the asset's tax cost being set
is that Division 230 will apply as if the financial benefits
provided to acquire the asset were equal to the asset's tax cost
setting amount. [Schedule 1, item 85, paragraph 701-55(5A)(a)]
1342. Consequently, the financial benefits the head company is taken to
have provided for the purposes of step 2(a) in the method statement
in the table at subsection 230-445(1) includes the asset's tax cost
setting amount (rather than its original cost). The asset's tax
cost setting amount will also be relevant in determining whether an
entity has a sufficiently certain gain or loss from the financial
arrangement.
1343. However, the tax cost resetting process will not necessarily cause
a re-estimation to arise. A re-estimation arises in circumstances
that materially affect the amount or value of financial benefits
that were taken into account in working out the amount of a gain or
loss. The reason no re-estimation arises is because the head
company is required to apply Division 230 as though it had acquired
the asset at the joining time for its tax cost setting amount. In
other words, the gain or loss the head company makes from an asset
that is a financial arrangement is worked out on the basis of the
head company's tax cost setting amount for the asset.
1.
Joining Co has an asset that is a financial arrangement
whose gains are worked out using the realisation method.
The market value of the financial arrangement is $100. This
is the only asset or liability held by Joining Co.
Head Co acquires Joining Co for $80. The asset is a reset
cost base asset.
Head Co subsequently sells the financial arrangement for its
market value of $100. As a result, Head Co has a balancing
adjustment under step 2(a) in the method statement in the
table at subsection 230-445(1).
The financial benefits received by Head Co in relation to
the disposal of the financial arrangement are $100, and the
benefits taken to have been provided are $80 (as a result of
the tax cost setting process).
As a result, Head Co is taken to have made a gain from the
financial arrangement for the purposes of Division 230 equal
to $20.
2.
Joining Co has a zero-coupon bond with the right to receive
a financial benefit equal to $200 on 1 July 2021. Joining
Co provided a financial benefit equal to $100 in relation to
the acquisition of the bond on 1 July 2011.
Head Co acquires Joining Co on 1 July 2016 for $150
(representing the market value of the right to receive $200
in five years time). Head Co's allocable cost amount for
Joining Co is therefore $150.
Given that the amount to be received on 1 July 2021
represents a right to receive a specified amount of
Australian currency, the asset is a retained cost base asset
and a qualifying security. Therefore, the tax cost setting
amount of the asset is $150. As the tax cost setting amount
exactly equals the allocable cost amount for Joining Co, CGT
event L3 will not occur.
However, Head Co will take the tax cost setting amount of
$150 into account when working out whether it has a
sufficiently certain overall gain or loss under the accruals
method. Given that the tax cost setting amount is $50 less
than the amount of $200 due to be received on 1 July 2021,
Head Co will make a $50 Division 230 gain from the
arrangement. This gain will be spread in accordance with
the rules in Division 230.
Where the head company has elected to use the hedging method
1344. In relation to assets that are financial arrangements on which
gains or losses are being worked out using the hedging method, the
effect of the asset's tax cost being set is that Division 230 will
apply as if the financial benefits provided to acquire the asset
are equal to the asset's tax cost setting amount. [Schedule 1,
item 96, paragraph 701-55(5A)(a)]
1345. However, this will not affect whether the hedge effectiveness test
in section 230-365 is satisfied, even though the hedge
effectiveness test is in part based on the value of the underlying
asset. The tax cost resetting process only applies to reset the
tax cost of the asset, and not its accounting value. Given that
the hedge effectiveness test relies on the accounting standards to
determine whether it is satisfied, the fact that the tax value of
the hedged item is reset is not relevant.
1.
Joining Co has $1,000 worth of Australian currency and a
hedging financial arrangement with a fair value of $50 and a
hedged item worth $100. The hedging financial arrangement
was initially entered into for a fair value of $0. In
accordance with the hedging documentation, the fair value of
the hedging financial arrangement represents a gain and will
be included in the entity's assessable income when the
hedged item is disposed of.
Head Co acquires the membership interests in Joining Co for
$1,150 (being the $1,000 cash, the fair value $50 hedging
financial arrangement, and the hedged item worth $100).
Head Co's allocable cost amount for the joining entity is
therefore $1,150.
The Australian currency is given a tax cost setting amount
of $1,000. Similarly, the hedging financial arrangement has
a tax cost setting amount of $50 and the hedged item has a
tax cost setting amount of $100.
Head Co applies Division 230 on the basis that it acquired
the financial arrangement for $50. If the Head Co chooses
to apply hedging financial arrangement election in relation
to the arrangement and it is eligible to do so, the method
applies on the basis that the Head Co acquired the hedging
financial arrangement for $50 and the hedged item for $100.
If the Head Co were to immediately dispose of the hedging
financial arrangement after the joining time for its fair
value of $50, it would make a $0 gain from the hedging
financial arrangement.
Where the head company has elected to use the fair value,
retranslation or financial reports method
1346. If the gains or losses in relation to an asset that is a financial
arrangement are calculated using the fair value, retranslation or
financial reports method, the asset's tax cost setting amount is
the asset's Division 230 starting value at the time of joining.
[Schedule 1, item 85, paragraph 701-55(5A)(b)]
1347. Consequently, the financial benefits the head company has taken to
have provided includes the asset's Division 230 starting value
(rather than its original cost) for the purposes of step 2(a) in
the method statement in the table at subsection 230-445(1).
1348. Gains or losses under the fair value, retranslation or reliance on
financial reports methods will be worked out applying the
principles set out in those methods.
What is the Division 230 starting value?
1349. The Division 230 starting value of an asset that is a financial
arrangement depends on which elective method is chosen in relation
to the arrangement.
1350. If the fair value method applies in relation to the arrangement,
the Division 230 starting value is the value of that asset
according to the relevant standards mentioned in section 230-230
that apply in relation to the arrangement. [Schedule 1, item 96,
paragraph (a) of the definition of 'Division 230 starting value' in
subsection 995-1(1) of the ITAA 1997]
1351. If the foreign exchange retranslation method applies in relation to
the arrangement, the Division 230 starting value is the value of
the asset according to the relevant standards mentioned in
section 230-280 that apply in relation to the arrangement.
[Schedule 1, item 96, paragraph (b) of the definition of
'Division 230 starting value' in subsection 995-1(1) of the ITAA
1997]
1352. If the reliance on financial reports method is chosen in relation
to the arrangement, the Division 230 starting value is the value of
the asset according to the relevant standards mentioned in
section 230-420 that apply in relation to the arrangement.
[Schedule 1, item 96, paragraph (c) of the definition of
'Division 230 starting value' in subsection 995-1(1) of the ITAA
1997]
1.
Joining Co holds an asset that is a financial arrangement
and joins Head Co's consolidated group. Head Co has chosen
to apply the fair value method in relation to its financial
arrangements.
The value of the asset according to the relevant standards
mentioned in section 230-230 is $100. However, Head Co's
tax cost setting amount for the asset is $80.
For the purposes of applying Division 230, the value of the
financial benefits Head Co provided to acquire the financial
benefit will be $100. In applying step 2(a) of the
Division 230 balancing adjustment provisions, the financial
benefits provided in relation to the acquisition of the
financial arrangement is $100.
Under the fair value method, the value of the financial
arrangement is also equal to $100.
What happens when there is a difference between an asset's tax cost
setting amount and the Division 230 starting value
1353. The sum of the tax cost setting amounts of the assets of a joining
entity that are financial arrangements may differ from the sum of
the Division 230 starting values for those assets.
1354. If the sum of the Division 230 starting values exceeds the sum of
the tax cost setting amounts, an amount equal to 25 per cent of
that excess is included in the head company's assessable income for
the income year in which the single entity rule commenced to apply,
and each of the subsequent three income years. [Schedule 1,
item 87, subsections 701-61(1) to (3)]
1355. If the sum of the Division 230 starting values is less than the sum
of the tax cost setting amounts, an amount equal to 25 per cent of
that shortfall is allowed to the head company as a deduction for
the income year in which the single entity rule commenced to apply,
and each of the subsequent three income years. [Schedule 1,
item 87, subsections 701-61(1), (2) and (4)]
1356. The rationale for including these amounts in assessable income, or
allowing a deduction for them, is that the head company has
effectively obtained an increase or decrease in the value of the
financial benefits it provided to acquire the financial
arrangement. If a Subdivision 230-G balancing adjustment
subsequently occurs in relation to the financial arrangement, the
step 2(a) amount in the method statement at section 230-445 would
be higher or lower, resulting in the head company having a higher
or lower balancing adjustment that is included in assessable income
or allowed as a deduction under step 3 in that method statement.
Therefore, this difference is appropriately included in assessable
income, or allowed as a deduction, under section 701-61.
1.
Following on from the facts in Example 12.6, the Division
230 starting value of $100 of the asset exceeds its tax cost
setting amount of $80 by $20.
Therefore, Head Co will include $5 in its assessable income
in the year in which it was taken to have acquired the
financial arrangement from the Joining Co, and in each of
the three subsequent income years.
Elections made by the head company apply to financial arrangements
a head company is taken to have acquired
1357. If a joining entity holds financial arrangements, Division 230 will
apply as if the head company had directly acquired those financial
arrangements.
What happens if the joining entity had made a Division 230
election?
1358. If a joining entity had made a Division 230 election in relation to
its financial arrangements prior to the joining time, that election
will not bind the head company. In other words, the entry history
rule does not operate to require the head company to use the
elections the joining entity made in relation to its financial
arrangements. [Schedule 1, items 90 and 91, item 3A in the table
in subsection 715-660(1) and item 1A in the table in subsection 715-
665(1)]
What happens if the head company made a Division 230 election prior
to the joining time?
1359. If a head company had made a Division 230 election prior to the
joining time, the head company applies Division 230 on the basis
that the financial arrangements that it acquired from the joining
entity were directly acquired from the joining entity. Therefore,
the head company must apply any Division 230 election it had made
to the financial arrangements acquired from the joining entity
(assuming the gains or losses on those financial arrangements are
still eligible to be worked out under those elective methods).
1360. Further, the head company will continue to apply any Division 230
election it had made in relation to the financial arrangements it
had prior to the joining time. The head company is not entitled to
make a fresh election in relation to those financial arrangements
because it has acquired additional financial arrangements from the
joining entity.
What happens if the head company had not made a Division 230
election prior to joining time?
1361. If no election has been made by the head company prior to joining
time, the accruals/realisation method will apply to all of the head
company's financial arrangements. This includes both the
arrangements the head company had prior to the joining time, as
well as the arrangements it acquired from the joining entity.
1362. The head company will also be eligible to make a Division 230
election in relation to all of its financial arrangements after the
joining time, unencumbered by any elections that may or may not
have been made by the joining entity. [Schedule 1, items 90 and
91, item 3A in the table in subsection 715-660(1) and item 1A in
the table in subsection 715-665(1)]
1.
Joining Co has 10 financial arrangements, and is applying
the accruals/realisation method in relation to them.
Joining Co becomes a member of Head Co's consolidated group.
Head Co has previously elected to apply the fair value
method to its financial arrangements.
Head Co must apply the fair value method to Joining Co's
financial arrangements (assuming it continues to be eligible
to use the fair value method, and the fair value method
applies in relation to the financial arrangements).
Financial arrangements consisting of liabilities
1363. For liabilities that are or form part of financial arrangements
that are to be subject to the accruals/realisation or hedging
financial arrangement method, the entry history rule will apply to
determine the value of any liabilities a head company assumes from
a joining entity. Generally this will be the original value of the
liability, taking into account such things as repayments of
principal that may have been made in relation to the liability
prior to the joining time.
1364. For liabilities that are or form part of financial arrangements
that are to be subject to the fair value, foreign exchange
retranslation, or reliance on financial reports method, the head
company will apply Division 230 as if the liability were assumed at
the time of joining for an amount equal to the liability's Division
230 starting value (see above for a discussion on Division 230
starting value in the context of assets). [Schedule 1, item 89,
subsections 715-375(3) and (4)]
Financial arrangements consisting of both an asset and a liability
1365. Some financial arrangements may consist of both assets and
liabilities. In this circumstance, the consolidation provisions
may apply separately to these assets and liabilities, depending on
the facts and circumstances of the particular financial arrangement
(section 705-58 of the ITAA 1997). However, if a financial
arrangement contains assets and liabilities that are linked,
section 705-59 of the ITAA 1997 may apply to the financial
arrangement.
Treatment of head companies at the leaving time
1366. If a head company is applying one of the Division 230 spreading
methods to gains and losses for a financial arrangement, the head
company would apply Division 230 as it ordinarily would on the
basis that the leaving time is the end of its income year.
[Schedule 1, item 1, subsections 230-170(3), 230-230(3), 230-
280(4), 230-300(10) and 230-420(3)]
Allocation of gains or losses where the head company ceases to have
a hedging financial arrangement
1367. If a leaving entity takes a financial arrangement with it that was
subject to the hedging financial arrangement election and also
takes the hedged item (or as a result of leaving the head company
ceases to expect that it will have the hedged item), the gain or
loss from the hedging financial arrangement the head company
allocates to the income year in which leaving time occurs is the
amount determined under subsection 230-360(1). [Schedule 1,
item 1, subsection 230-300(10)]
1368. The entire gain or loss is not allocated to the income year in
which leaving occurs, notwithstanding item 2 in the table in
section 230-305. [Schedule 1, item 1, subsection 230-300(11)]
1369. However, where the leaving entity takes the hedged item but not the
hedging financial arrangement with it, section 230-305 will apply
to ensure that any gain or loss is allocated to the income year in
which leaving occurs.
1370. Where the leaving entity takes the hedging financial arrangement
with it but not the hedged item, the head company includes any gain
or loss on that hedging financial arrangement in accordance with
the determination under subsection 230-360(1).
1.
Head Co has $1,000 cash and a hedging financial arrangement
with a fair value of $50 and a hedged item worth $100. The
hedging financial arrangement was initially entered into for
a fair value of $0. In accordance with the hedging
documentation, the fair value of the hedging financial
arrangement represents a gain and will be included in the
entity's assessable income when the hedged item is disposed
of.
On 30 June an entity leaves the consolidated group taking
with it $500 in cash as well as the hedging financial
arrangement and the hedged item. The cost base of the
membership interests the head company holds in the leaving
entity would be $600 (being $500 for the terminating value
of the cash, $100 for the hedged item and $0 for the hedging
financial arrangement). The membership interests in the
leaving entity are sold for $650, taking into account the
hedging financial arrangement with a fair value of $50. In
effect, the $50 fair value gain on the financial arrangement
is brought to tax for the head company in the form of a $50
capital gain from the sale of the membership interests in
the leaving entity.
Subsections 230-300(10) and (11) ensure that the single gain
is only brought to account once for the head company.
Therefore, no Division 230 gain will arise in respect of the
arrangement.
Setting the tax cost of the head company's membership interests in
the leaving entity
1371. Under subsection 701-15(3) of the ITAA 1997, if an entity ceases to
be a subsidiary member of a consolidated group, the membership
interests that the head company holds in that entity has a tax cost
that is set just before the leaving time at the interest's tax cost
setting amount. The tax cost setting amount for these membership
interests is set at an amount based on the old group's allocable
cost amount in the leaving entity and the market value of the
membership interests.
1372. In working out the old group's allocable cost amount for the
leaving entity, the head company must work out the terminating
values of all the assets held by the leaving entity (subsection 711-
25(1) of the ITAA 1997).
1373. If an asset of the head company is a financial arrangement, the
head company's terminating value for the asset is equal to the
amount of consideration that the head company would need to
receive, if it were to dispose of the asset just before the leaving
time without an amount being assessable income of, or deductible
to, the head company under Division 230. [Schedule 1, item 88,
subsection 705-30(3B)]
1374. In other words, the terminating value is the amount of
consideration the head company would need to receive if:
. where the hedging financial arrangement election does not
apply in relation to the asset - a Subdivision 230-G
balancing adjustment occurred just before leaving time in
order for the result in step 3 in the method statement in
subsection 230-445(1) to be nil; or
. where the hedging financial arrangement election does
apply in relation to the asset - the amount of
consideration the head company would need to receive if it
had disposed of the asset just before the leaving time
that would result in no gain or loss arising in respect of
the disposal under the hedging financial arrangement
election in the income year in which leaving occurs or any
subsequent income year.
1.
Head Co has an asset that is a financial arrangement.
Leaving Co is leaving the consolidated group and is taking
the financial arrangement with it. Therefore, the
terminating value of the asset must be worked out for the
purposes of determining the old group's allocable cost
amount.
Head Co provided $100 to acquire the arrangement. It also
received $20 under the arrangement by way of repayment of
principal.
Therefore, the terminating value of the asset is the amount
of consideration that Head Co would need to receive if it
were to dispose of the asset just before the leaving time
without a balancing adjustment arising under section 230-445
- that is, $80. In this regard, applying the method
statement in subsection 230-445(1):
. the step 1(a) amounts would be $20 (being amounts received
under the arrangement) and $80 (being the amount needed to
be received in relation to the disposal of the arrangement
so that there is no balancing adjustment); and
. the step 2(a) amount would be $100 (being the financial
benefits provided in relation to the acquisition of the
arrangement).
2.
Head Co has an asset that is a hedging financial arrangement
that is a forward currency contract to which the hedging
financial arrangement election applies. In accordance with
a determination in subsection 230-360(1), Head Co includes
any gain on the financial arrangement in the income year in
which the hedged item is disposed of.
Head Co provided $0 to acquire the arrangement, and the
current fair value of the arrangement is $50. However, in
accordance with the determination, the $50 gain on the
hedging financial arrangement will only be included in Head
Co's assessable income when the hedged item is disposed of.
Head Co's terminating value of the hedging financial
arrangement is the amount of consideration it would need to
receive if it had disposed of the arrangement just before
the leaving time that would result in no gain or loss
arising in respect of the disposal under the hedging
financial arrangement election in the income year in which
leaving occurs or any subsequent income year.
In this case, Head Co's terminating value for the hedging
financial arrangement would be $0.
Exit history rule not to apply in relation to certain amounts
1375. If a head company includes amounts in its assessable income, or is
entitled to a deduction, as a result of an election for the
portfolio treatment of fees, discounts or premiums under section
230-160, the amounts of assessable income or allowable deductions
will continue to attach to the head company. That is, the exit
history rule does not apply to transfer these amounts to the
leaving entity. [Schedule 1, item 89, subsections 715-380(1) and
(2)]
1376. In addition, if a head company includes amounts in its assessable
income, or is entitled to a deduction, over a four-year period
under section 701-61 and an entity leaves the consolidated group
before the end of the four-year period, the amounts of assessable
income or allowable deductions will continue to attach to the head
company. That is, the exit history rule does not apply to transfer
these amounts to the leaving entity. [Schedule 1, item 89,
subsections 715-380(3) and (4)]
1377. Finally, if a head company includes amounts in its assessable
income, or is entitled to a deduction, over a four-year period as a
result of a transitional balancing adjustment election under item
121 of Schedule 1 to the Tax Laws Amendment (Taxation of Financial
Arrangements) Bill 2008 the amounts of assessable income or
allowable deductions will continue to attach to the head company.
That is, the exit history rule does not apply to transfer these
amounts to the leaving entity. [Schedule 1, item 99, section 715-
380 of the Income Tax (Transitional Provisions) Act 1997]
Treatment of leaving entities
1378. A leaving entity which commences to hold an asset or liability that
is a financial arrangement after the single entity rule ceases to
apply will apply Division 230 as if the leaving entity takes the
financial arrangements with it. As a result:
. the tax cost of an asset that is a financial arrangement
that the leaving entity takes with it will be the asset's
terminating value;
. the value of a liability that is a financial arrangement
that the leaving entity takes with it will be the value of
the liability just before the leaving time; and
. the leaving entity will inherit any election the head
company made to apply Division 230.
Tax cost of the leaving entity's assets
1379. The exit history rule (section 701-40 of the ITAA 1997) will apply
to set the tax cost of an asset that is a financial arrangement
that a leaving entity takes with it at the asset's terminating
value. The leaving entity's terminating value for the asset is the
same as the head company's terminating value.
1380. The leaving entity's tax cost of the asset is not reset to the
Division 230 starting value.
1.
In Example 12.10, Head Co's terminating value for the asset
was worked out to be $80.
Similarly, for the leaving entity the tax cost of the asset
will also be $80. If a Subdivision 230-G balancing
adjustment subsequently occurs in relation to the asset, the
amount provided in relation to the acquisition of the asset
for the purposes of step 2(a) in the method statement in
subsection 230-445(1) will be $80.
Value of liabilities assumed by the leaving entity
1381. The exit history rule in section 701-40 of the ITAA 1997 will apply
to set the value of any liability that is a financial arrangement
that a leaving entity takes with it. As a result, anything that
happened in relation to the liability is taken to have happened to
the liability as if it had been a liability of the leaving entity.
Liabilities and assets that are hedging financial arrangements that
the leaving entity takes with it
1382. Where a leaving entity takes with it an asset or a liability that
is a hedging financial arrangement, and the hedged item, the head
company will apply the hedging financial arrangement election as if
the leaving time is an end of income year. Furthermore, where this
occurs the head company will not be taken to have ceased to have
the hedged item under item 2 in the table in subsection 230-305(1).
Instead, the head company makes a gain or loss on the hedging
financial arrangement equal to the gain or loss the head company
would have made under the hedging financial arrangement Subdivision
had item 2 in the table in subsection 230-305(1) not been
triggered. The tax cost of the asset and the value of the
liability are therefore provided by the exit history rule in
accordance with the discussion above.
Leaving entity may make fresh elections in relation to the elective
methods
1383. An entity that leaves a consolidated group or MEC group can make a
fresh election under Division 230 in relation to the elective
methods (but cannot override an election to apply Division 230).
This is achieved under sections 715-700 and 715-705 of the ITAA
1997. [Schedule 1, items 90 and 91, item 3A in the table in
subsection 715-660(1) and item 1A in the table in subsection 715-
665(1)]
1384. 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.
1385. If the entity makes such a fresh election, the leaving entity does
not need to satisfy the requirement that the entity started to have
the financial arrangement in the income year in which the election
is made or in a later income year. [Schedule 1, item 89, section
715-385]
1386. But for section 715-385, under the exit history rule the leaving
entity would be taken to have started to have the financial
arrangement in the income year in which the head company started to
have it. Therefore, if the leaving entity were to make a fresh
election under sections 715-700 and 715-705 of the ITAA 1997, the
elective methods could not apply in relation to the financial
arrangements the leaving entity took with it because the leaving
entity will be taken to have started to have those arrangements in
an income year prior to the income year in which the election was
made.
Leaving entity inherits head company's election to apply Division
230
1387. If the head company of a consolidated group or MEC group elects to
apply Division 230, the exit history rule will apply such that any
leaving entity that was a subsidiary member of the consolidated
group when the head company made that election will be taken to
have been made by the leaving entity.
Consolidated groups and the elective requirements to rely on financial
reports
1388. An entity will satisfy a requirement that it prepare a financial
report (such as for the purposes of making an election under the
elective Subdivisions) if:
. a financial report is prepared by another entity and that
other entity is a connected entity of the entity; and
. the report is a consolidated financial report that deals
with both the entity and connected entity's affairs; and
. the report properly reflects the entity's affairs.
[Schedule 1, item 1, section 230-525]
1389. If a top company of a MEC group prepares consolidated financial
reports that deals with the affairs of the head company and the top
company, and that report properly reflects the affairs of the head
company, the requirement that the head company prepare a financial
report are satisfied. This is because a top company is a connected
entity of the head company because both are members of the same
wholly-owned group.
1390. A report may properly reflect the affairs of the head company even
where many of the financial arrangements the head company has are
not actually reflected in the financial reports of the top company.
This may occur where the top company and the head company are
members of the same accounting consolidated group and most of the
arrangements the head company has is with the top company.
1391. Financial arrangements the head company holds with entities outside
of an accounting consolidated group will need to be properly
reflected in the top company's consolidated financial reports.
Interactions with the Division 230 transitional measures
Application of Subdivision 716-A to transitional balancing
adjustment amounts
1392. Subitem 104(2) provides for a transitional balancing adjustment for
financial arrangements that are in existence at the time Division
230 commences. Subitem 104(14) provides that a transitional
balancing adjustment is to be spread evenly over four income years
where an entity has made the transitional balancing adjustment
election.
1393. Given that this amount is spread over two or more income years by
including part of the original amount in the same entity's
assessable income, or allowing part of the original amount as a
deduction to the same entity, Subdivision 716-A of the ITAA 1997
may apply in relation to these transitional balancing adjustment
amounts.
1.
Joining Co has made a transitional balancing adjustment
election which would include $250 in that entity's
assessable income every income year from 2010-11 to 2013-14.
On 1 January 2011 Joining Co joins a consolidated group.
Subdivision 716-A of the ITAA 1997 applies in relation to
the $250 to be included in the entity's assessable income
over the current income year. For the purposes of section
716-15 of the ITAA 1997, the spreading period is the period
from 1 July 2010 to 30 June 2011, or 365 days. Joining Co's
non-membership period is 1 July 2010 to 31 December 2010, or
184 days. Joining Co is a subsidiary member of the
consolidated group for the remaining 181 days of the
spreading period.
Joining Co's assessable income for the non-membership period
includes:
$250 × 184/365 = $126.03.
Head Co's assessable income for the 2010-11 income year
includes:
$250 × 181/365 = $123.97.
Exit history rule and the transitional balancing adjustment
election
1394. If a head company makes an election under subitem 104(2) relating
to financial arrangements, the exit history rule will apply such
that any leaving entity that was a subsidiary member of the
consolidated group when the head company made that election will be
taken to have been made by the leaving entity. Where this occurs,
in order to reduce compliance costs, any transitional balancing
adjustment amount will remain with the head company. [Schedule 1,
item 99, section 715-380 of the Income Tax (Transitional
Provisions) Act 1997]
Chapter 13
Commencement, transitional and implementation issues
Outline of chapter
1395. This chapter explains:
. when the provisions of Division 230 begin to have effect;
. how financial arrangements that a taxpayer has at the time
Division 230 begins to have effect may be treated under
this Division; and
. how relevant arrangements that are not Division 230
financial arrangements that a taxpayer has at the time
Division 230 first applies may be treated under
Subdivision 775-F.
Overview of commencement, transitional and implementation issues
Application of Division 230
1396. Division 230 will apply to all financial arrangements that a
taxpayer starts to have during income years commencing on or after
1 July 2010.
1397. The general rule is Division 230 will not apply to financial
arrangements a taxpayer starts to have in an income year prior to
one commencing on or after 1 July 2010 and the arrangement is still
on hand on commencement of Division 230. However, under a
transitional election, a taxpayer can choose that Division 230
applies to their existing financial arrangements.
1398. Taxpayers are also able to elect to apply Division 230 early, that
is to income years commencing on or after 1 July 2009. In this
situation, they will also be able to make the transitional election
in relation to their existing financial arrangements.
Application of Subdivision 775-F
1399. Where a foreign exchange retranslation election (the
'general retranslation election') has been made under
Subdivision 230-D to apply the retranslation method to relevant
financial arrangements, the election also applies to those
arrangements subject to Subdivision 775-F of the ITAA 1997.
Subdivision 775-F will apply to relevant arrangements (Subdivision
775-F arrangements) in the same way that Subdivision 230-D applies
to financial arrangements. This similar treatment extends to
allowing existing arrangements to be brought within the scope of
Subdivision 775-F where a transitional election is made. For
further information on what arrangements are subject to
Subdivision 775-F, refer to Chapter 7.
Consequences of making transitional election
1400. Where a taxpayer makes an election to bring in their existing
financial arrangements (the transitional election) a transitional
balancing adjustment is made. The transitional balancing
adjustment compares the amounts already subject to tax under the
existing tax law with amounts that would have been brought to
account under Division 230.
1401. Similarly, the transitional election may also apply to
Subdivision 775-F arrangements that are not Division 230 financial
arrangements.
1402. If the transitional balancing adjustment is positive, a quarter of
this amount will be included in the taxpayer's assessable income
for the first income year that Division 230 applies and each of the
next three income years. Conversely, if the transitional balancing
adjustment is negative, a quarter of this amount may be allowed as
a deduction for the first income year that Division 230 applies and
each of the next three income years.
Deferred tax liabilities and deferred tax assets
1403. Where a taxpayer has:
. elected to rely on their financial reports for Division
230 purposes; and
. has a deferred tax asset or tax liability amount in
respect of a Division 230 financial arrangement to which
the financial reports method applies,
the amount, as determined immediately before the start of the first
income year that Division 230 applies, is to be used for the
purposes of determining the transitional balancing adjustment
amount. This is to reduce compliance costs compared to undertaking
individual calculations for all existing financial arrangements.
1404. A deferred tax asset or a deferred tax liability is recorded in a
taxpayer's financial reports where the financial year in which a
taxpayer recognises an amount of income or an expense for tax
purposes is different to the year in which the taxpayer entity
recognises the income or expense for financial accounting purposes.
PAYG transitionals
1405. Where the taxpayer has a balancing adjustment amount, the amount
must be spread evenly over the first four income years for
instalment income purposes. During each instalment quarter they
will be taken to have made a gain or loss that is equal to one
quarter of the annual balancing adjustment amount, that is, one
sixteenth of the total balancing adjustment amount.
Offshore banking units
1406. An offshore banking unit will not be taken to have breached the
rule limiting its use of non-offshore banking money where it has
made a transitional election to have Division 230 apply to all of
the financial arrangements it has at the start of the first
applicable income year and a balancing adjustment arises under
those provisions.
Context of amendments
1407. Division 230 will apply to income years commencing on or after 1
July 2010. Taxpayers are also able to elect to apply Division 230
to income years commencing on or after 1 July 2009.
1408. 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, financial arrangements which a
taxpayer has prior to the commencement of Division 230 will
continue to be subject to the current law (and not be subject to
the provisions of the Division). An exception to this general rule
is where a taxpayer elects to have Division 230 apply to all
financial arrangements (and, where relevant, to have Subdivision
775-F apply to Subdivision 775-F arrangements) they have at the
time the Division commences.
Summary of new law
1409. Division 230 will apply to income years commencing on or after 1
July 2010. Taxpayers are also able to elect to apply Division 230
to income years commencing on or after 1 July 2009.
1410. Division 230 will apply to financial arrangements a taxpayer first
starts to have in an income year commencing on or after 1 July 2010
or, on an elective basis, to financial arrangements first held in
income years commencing on or after 1 July 2009.
1411. 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' will be calculated and spread evenly over
the first applicable income year (the taxpayer's first income year
commencing on or after 1 July 2010 - or on or after 1 July 2009 as
appropriate) and the following three income years.
1412. Similarly, where a general retranslation election has been made on
or before the first lodgment date that occurs in the first
applicable income year, Subdivision 775-F will apply to existing
Subdivision 775-F arrangements.
Comparison of key features of new law and current law
|New law |Current law |
|Division 230 applies to |No equivalent. |
|income years commencing | |
|on or after 1 July 2010.| |
|Taxpayers are able to | |
|elect to apply Division | |
|230 to income years | |
|commencing on or after 1| |
|July 2009. | |
|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. | |
|The transitional | |
|election may also apply | |
|to bring existing | |
|arrangements that are | |
|not Division 230 | |
|financial arrangements | |
|within the scope of | |
|Subdivision 775-F. | |
Detailed explanation of new law
Commencement date
1413. Division 230 will apply on a mandatory basis to all income years
commencing on or after 1 July 2010 [Schedule 1, subitem 103(1)].
This means that for a taxpayer with a substituted accounting period
ending on 31 December, Division 230 will apply on a mandatory basis
for the substituted accounting period commencing on 1 January 2011.
1414. Taxpayers are also able to elect to apply Division 230 to income
years commencing on or after 1 July 2009. This means that a
taxpayer with a substituted accounting period ending on 31 December
will be able to elect to apply Division 230 for the substituted
accounting period starting on 1 January 2010. 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 2009. [Schedule
1, subitems 103(2) and (3)]
1415. In respect of taxpayers with a substituted accounting period ending
on 31 December, the income year to which Division 230 will first
apply will be to income years beginning on 1 January 2011, that is,
to the 2011-12 income year.
1416. Where an election is made under subitem 103(2), Division 230 will
apply to income years beginning on 1 January 2010, that is, to the
2010-11 income year.
1. : Commencement date
BJ Investments Co is an investment company whose income year
ends on 31 December in lieu of 30 June. As Division 230
applies to income years commencing on or after 1 July 2010
(or 1 July 2009 where an election is made under subitem
103(2)), the first income year to which BJ Investments Co
will be required to apply Division 230 will commence on 1
January 2011 (or 1 January 2010 if an election is made under
subitem 103(2)).
Application to new financial arrangements
1417. 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, subitem 103(1)]
Application to existing financial arrangements
1418. 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, subitem
104(2)]. Similarly, the transitional election may also apply to
existing arrangements that are not Division 230 financial
arrangements.
1419. 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, subitems 104(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, sub-subitems 104(5)(a) and
(b)].
1420. Taxpayers who are excluded from Division 230 as a result of the
application of subsections 230-455(1) to (5) are able to elect to
have Division 230 apply to all their financial arrangements
(subsection 230-455(7)). Where a valid election is made under
subsection 230-455(7) the taxpayer is also able to elect to have
Division 230 apply to all their existing financial arrangements.
[Schedule 1, subitem 104(6)]
1421. Financial arrangements which are brought within the scope of
Division 230 through the transitional 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) where 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, subitem 104(8)]. In such situations
it is intended that before taxpayers can have any of the elective
tax-timing methods apply to these 'existing arrangements', they
must have made the transitional election. It is only by making a
transitional election that the taxpayer can bring their 'existing
financial arrangements' within the scope of an elective tax-timing
treatment [Schedule 1, subitem 104(2)].
1422. Similarly, where a taxpayer has made an election for portfolio
treatment of premiums, discounts and fees in accordance with
section 230-150 by the first lodgment date that occurs on or after
the applicable income year, the portfolio treatment will extend to
existing financial arrangements that are part of a portfolio of
similar financial arrangements. [Schedule 1, Part 3, subitem
104(7)]
1423. 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, sub-subitem 104(9)(a)];
. at the time the existing hedge was created, acquired or
applied, it satisfied the definition of a 'hedging
financial arrangement' in section 230-335 (as explained in
Chapter 8) [Schedule 1, sub-subitem 104(9)(b)];
. at, or soon after the time when Division 230 commences,
the taxpayer's records in relation to the existing hedge
satisfy the relevant record-keeping requirements in
sections 230-355 and 230-360 (ignoring subparagraph 230-
360(2)(c)(ii)) explained in Chapter 8 [Schedule 1, sub-
subitem 104(9)(c)]; and
. all the effectiveness requirements set out in section 230-
365 (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, sub-subitem 104(9)(d)].
1424. However, for existing hedges, the hedging election will only extend
to tax-timing matching. Tax-status matching cannot, as a result of
the transitional election, extend to existing hedges. That is to
say, tax-status matching (contained in subsection 230-310(4)) can
only apply to new hedging matching arrangements entered into in the
income year, or later income years, in which Division 230 first
applies to the taxpayer.
1425. The result of a taxpayer making an election in accordance with
subitem 103(2) in respect of hedging financial arrangements, and
given that subsection 230-310(4) will not apply to existing
financial arrangements, is that gains and losses from these hedging
financial arrangements will be recognised as 'revenue gains' and
'revenue losses'. [Schedule 1, subitem 104(10)]
1426. 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, subitem 104(11)]
1427. 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
1428. 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
104(13), at the time the election takes effect (the time when
Division 230 first applies to the taxpayer) [Schedule 1,
subitem 104(12)]. 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, subitem 104(13), step
1 and subitem 104(18)];
. 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,
subitem 104(13), step 2 and subitem 104(18)];
. 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, subitem
104(13), 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, subitem 104(13),
step 4];
. the step 5 amount (add the notional assessable amount to
the actual deducted amount) [Schedule 1, subitem 104(13),
step 5]; and
. the step 6 amount (add the actual assessed amount to the
notional deductible amount) [Schedule 1, subitem 104(13),
step 6].
1429. The final calculation involves a comparison between the step 5
amount and the step 6 amount. A positive amount, which will occur
if the step 5 amount exceeds the step 6 amount, is included in
assessable income as a balancing adjustment while a negative
amount, which will occur if the step 6 amount exceeds the step 5
amount, is allowable as a deduction as a balancing adjustment.
Where the step 5 amount and the step 6 amount are equal, there is
no balancing adjustment, that is, no amount is included in
assessable income and no amount is allowable as a deduction.
[Schedule 1, subitem 104(13), step 7]
1430. 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 as 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, subitem 104(17)]
1431. The transitional election may also apply to existing arrangements
that are not Division 230 financial arrangements. Where the
transitional election applies to existing arrangements that are not
Division 230 financial arrangements, the method statement in
subitem 104(13) is modified (see paragraphs 13.56 to 13.58).
Application of the transitional balancing adjustment to financial
arrangements
1432. 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.
1433. Example 13.2 illustrates how a transitional balancing adjustment
should be calculated.
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 2007; 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 was $20,000. This portfolio of shares was
acquired on 30 March 2005.
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 2009.
. On 30 June 2009:
- 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
2009;
- 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 2010 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 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.
1434. 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, subitem 104(13)]
1435. In Example 13.2 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
1436. 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).
1437. Where:
. a taxpayer has made an election to rely on their financial
reports (under Subdivision 230-F); and
. an amount in a deferred tax asset account or a deferred
tax liability account is in respect of a Division 230
financial arrangement that is subject to Subdivision 230-
F,
the taxpayer must, in respect of financial arrangements that are
subject to the election in Subdivision 230-F, disregard steps 1 to
4 in the method statement in subitem 104(13) 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, immediately before the first applicable
income year, as a deferred tax asset or a deferred tax liability
(and grossed up) in respect of those financial arrangements that
are subject to Subdivision 230-F. [Schedule 1, subitems 104(14)
and (15)]
1438. Subitems 104(14) and (15) are designed to reduce the compliance
costs of otherwise having to undertake individual calculations for
all existing financial arrangements. The net deferred tax asset
and deferred tax liability position of a taxpayer, adjusted for
those financial arrangements not subject to Subdivision 230-F, is
considered to provide a reasonable approximation of the amount that
would be calculated as a result of the application of the
transitional balancing adjustment method statement to all existing
financial arrangements.
1439. 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.
1440. When identifying the relevant amounts of deferred tax assets and
deferred tax liabilities, taxpayers are to have regard to their
financial reports immediately before Division 230 is to apply to
them, that is, immediately before their first application income
year.
1441. An amount that is recorded in a deferred tax asset account that is
attributable to an existing financial arrangement is the
attributable assessable amount [Schedule 1, subitem 104(14)].
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, subitem
104(15)].
1442. 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, subitems 104(14) and (15)]
1443. 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 104(13). The grossed up amount is to be added to the
step 6 amount. [Schedule 1, subitem 104(11)]
1444. 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 104(16). The grossed up amount is to be added to the
step 5 amount. [Schedule 1, subitem 104(15)]
1445. In calculating the grossed up amount under subitem 104(16), 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, subitem 104(16)]
1446. Where no amount of the deferred tax asset or 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,
subitem 104(13)]
PAYG - transitional and application
1447. 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.
1448. 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, subitem 104(17)]
Impact of the transitional balancing adjustment on offshore banking units
1449. 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 Income Tax Assessment Act 1936 where it has made a
transitional election under subitem 104(2). 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 could, in
the absence of this special transitional rule, in various ways
cause the offshore banking unit to breach the 10 per cent limit set
in section 121EH. Any balancing adjustment is 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, subitem 104(19)]
Application of transitional election to existing arrangements that are not
Division 230 financial arrangements
1450. If an election has been made to apply the general retranslation
method to Division 230 financial arrangements and to those
arrangements subject to Subdivision 775-F of the ITAA 1997, the
transitional election also applies to existing arrangements that
are not Division 230 financial arrangements in the same way as it
applies to Division 230 financial arrangements. [Schedule 1,
subitem 105(1)]
1451. In working out the balancing adjustment where the transitional
election has been made, the method statement applies to
Subdivision 775-F arrangements as if the reference in step 1 in the
method statement to 'Division 230' were a reference to 'Subdivision
775-F'. Also, the reference in step 2 in the method statement to
'Division' applies as if it is a reference to 'Subdivision'.
[Schedule 1, subitem 105(2)]
1452. The effect of this is that where the transitional election extends
to Subdivision 775-F arrangements, the transitional balancing
adjustment requires the taxpayer to also compare amounts which have
been brought to account under the existing tax law with amounts
that would have been brought to account if Subdivision 775-F of the
ITAA 1997 had instead applied.
Chapter 14
Case studies
Outline of chapter
1453. This chapter includes case studies which illustrate how
Division 230 will apply to:
. a deferred settlement;
. a financial arrangement where the retranslation method has
been elected;
. financial arrangements over which the parties have agreed
to a forward swap;
. a securitisation arrangement;
. a basic interest rate swap;
. an interest rate swap with an upfront payment;
. a cross currency swap; and
. a total return 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 2011, 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 2014. Under the arrangement, Go Co will take
delivery of the vehicle from Big Rig Co on 1 June 2011.
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 2011
and an obligation to provide a financial benefit (the
payment of $100,000) on 30 June 2014. For the purpose of
Division 230 the right and the obligation are one
arrangement (subsection 230-55(4)).
At the inception of the arrangement (1 May 2011), Go Co does
not have a financial arrangement as:
. although the $100,000 payment is a cash settlable financial
benefit (paragraph 230-45(2)(a)) and an obligation to
provide such a benefit can constitute a financial
arrangement (paragraph 230-45(1)(b));
. 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 (paragraphs 230-45(1)(d) to (f)).
However, from 1 June 2011, 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 2014 (paragraph
230-45(1)(b) and section 230-45, note 1).
What are the gains and losses under the financial
arrangement?
For the purposes of Division 230 Go Co is taken to have
received financial benefits equal to the market value of the
truck when it is delivered. This financial benefit which
Go Co is taken to have received under the financial
arrangement is taken into account in calculating any gain or
loss from the financial arrangement. Suppose the truck has
a market value of $73,561 at 1 June 2011. This amount is
the value of the financial benefit taken to be received by
Go Co.
Taking into account the financial benefit of $73,561 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 $26,439 from the
financial arrangement.
As it is reasonable to expect that Go Co will provide a
financial benefit on 30 June 2014 (paragraph 230-115(2)(a))
and the amount of that financial benefit is fixed at
$100,000 (paragraph 230-115(2)(b)), there is a sufficiently
certain overall loss (subsection 230-105(1)) which is
required to be accrued (subsection 230-100(2)).
As the loss of $26,439 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 2011, 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 2014 (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 one month.
As each of the 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 230-170).
1. : Loss for each compounding interval
|Year |Amortise|Accrued |Cash |Amortised |
|ending |d cost |loss for|flows |cost |
| |(year |tax | |(year end) |
| |start) |purposes| | |
| |(a) |(b) |(c) |(a) + (b) -|
| | | | |(c) |
|30 June |$0.00 |-$613 |$73,561 |-$74,174 |
|2011 | | | | |
|30 June |-$74,174|-$7,767 |$0.00 |-$81,941 |
|2012 | | | | |
|30 June |-$81,941|-$8,580 |$0.00 |-$90,521 |
|2013 | | | | |
|30 June |-$90,521|-$9,479 |-$100,000|$0.00 |
|2014 | | | | |
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.
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 Income Tax Assessment Act
1997 (ITAA 1997) is the market value of the truck (the
'thing' in terms of section 230-505) at the time it is
acquired (paragraph 230-505(2)(b)). Therefore, the cost of
the truck is $73,561.
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 230-55(4)).
At the inception of the arrangement (1 May 2011), Big Rig Co
does not have a financial arrangement as:
. although the $100,000 payment is a cash settlable financial
benefit (paragraph 230-45(2)(a)) and a right to receive such
a benefit can constitute a financial arrangement
(paragraph 230-45(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 (paragraphs 230-45(1)(d) to (f)).
However, from 1 June 2011 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 2014 (paragraph 230-
45(1)(a) and section 230-45, 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 2011 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 truck (the 'thing') at the
time when Big Rig Co provided it (1 July 2011) (subsection
230-505(2)). This financial benefit which Big Rig Co has
provided under the financial arrangement is taken into
account in calculating any gain or loss from the financial
arrangement. As stated above, the market value of the truck
is $73,561 at 1 June 2011. 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 $73,561 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 $26,439 from the
financial arrangement.
As it is reasonable to expect that Big Rig Co will receive a
financial benefit on 30 June 2014 (paragraph 230-115(2)(a))
and the amount of that financial benefit is fixed (at
$100,000) (paragraph 230-115(2)(b)), there is a sufficiently
certain overall gain (subsection 230-105(1)) which is
required to be accrued (subsection 230-100(2)).
As the gain of $26,439 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 2011, and ending when Big Rig Co
will cease to have the arrangement assuming that it will be
held until maturity, that is 30 June 2014 (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 one month.
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 230-170).
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 truck (the 'thing' in
terms of section 230-505) at the time it started to have the
financial arrangement (paragraph 230-505(2)(a)).
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 $73,561.
2. : The gain for each compounding interval
|Year |Amortis|Accrued |Cash |Amortised |
|ending |ed cost|gain for |flows |cost |
| |(year |tax | |(year end) |
| |start) |purposes | | |
| |(a) |(b) |(c) |(a) + (b) -|
| | | | |(c) |
|30 June |$0.00 |$613 |$73,561 |$74,174 |
|2011 | | | | |
|30 June |$74,174|$7,767 |$0.00 |$81,941 |
|2012 | | | | |
|30 June |$81,941|$8,580 |$0.00 |$90,521 |
|2013 | | | | |
|30 June |$90,521|$9,479 |$100,000 |$0.00 |
|2014 | | | | |
Case study 2: 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
$100 million. Kwala Co is subject to Division 230 on an
elective basis from 1 July 2009 and chooses not to make a
transitional election to bring existing financial
arrangements which it holds within the operation of
Division 230.
Kwala Co has an account denominated in US dollars (US$)
which it elects to retranslate under the qualifying foreign
exchange accounts election (subsection 230-255(5)). Kwala
Co does not elect to make the general retranslation
election. If it had, Kwala Co would not have been 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 Income Tax
Assessment Act 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.
3. : Qualifying foreign exchange account in US$
|Date |Transaction |Debit |Credit |Balance |
|7 July 2008 |Open account| |380.00 |380.00 CR|
| |with Deposit| | | |
|20 July 2008|Deposit | |250.00 |630.00 CR|
|30 August |Interest | |9.45 |639.45 CR|
|2008 | | | | |
|7 September |Withdrawal |75.00 | |564.45 CR|
|2008 | | | | |
|15 October |Withdrawal |50.00 | |514.45 CR|
|2008 | | | | |
|2 December |Deposit | |234.00 |748.45 CR|
|2008 | | | | |
|14 January |Deposit | |1,693.4|2,441.85 |
|2009 | | |0 |CR |
|30 June 2009|Interest | |36.63 |2,478.48 |
| | | | |CR |
|30 June 2009|Closing | | |2,478.48 |
| |balance | | |CR |
|11 July 2009|Deposit | |360.00 |2,838.48 |
| | | | |CR |
|12 August |Withdrawal |240.00 | |2,598.48 |
|2009 | | | |CR |
|30 October |Deposit | |38.98 |2,637.46 |
|2009 | | | |CR |
|15 March |Deposit | |456.00 |3,093.46 |
|2010 | | | |CR |
|30 June 2010|Interest | |46.40 |3,139.86 |
| | | | |CR |
4. : US$/AUD exchange rates
|Date |Exchange rate |
|7 July 2008 |0.755 |
|7 July 2008 |0.760 |
|20 July 2008|0.706 |
|30 August |0.740 |
|2008 | |
|7 September |0.752 |
|2008 | |
|15 October |0.760 |
|2008 | |
|2 December |0.789 |
|2008 | |
|14 January |0.770 |
|2009 | |
|30 June 2009|0.740 |
|30 June 2009|0.740 |
|11 July 2009|0.720 |
|12 August |0.751 |
|2009 | |
|30 October |0.770 |
|2009 | |
|15 March |0.766 |
|2010 | |
|30 June 2010|0.780 |
5. : Division 775 weighted average
|Date |Weighted |Debit |Credit |Balance |Foreign |
| |average | |AUD |AUD[4] |exchange |
| | |AUD | | |gain or |
| | | | | |loss |
|7 July 2008 |0.760 | |500.00 |500.00 CR| |
|20 July 2008|0.7376119| |338.93 |854.11 CR| |
| |40 | | | | |
|30 August |0.7376471| |12.81 |866.88 CR| |
|2008 |20 | | | | |
|7 September |0.7376471|101.67| |765.20 CR|-1.94 |
|2008 |20 | | | | |
|15 October |0.7376471|67.78 | |697.42 CR|-1.99 |
|2008 |20 | | | | |
|2 December |0.7529692| |310.77 |994.00 CR| |
|2008 |12 | | | | |
|14 January |0.7646985| |2,214.4|3,193.22 | |
|2009 |87 | |7 |CR | |
|30 June 2009|0.7643215| |47.92 |3,242.72 | |
| |64 | | |CR | |
|30 June 2009| | | |3,349.30 | |
| | | | |CR | |
|11 July 2009|0.7584005| |474.68 |3,742.72 | |
| |26 | | |CR | |
|12 August |0.7584005|316.46| |3,426.26 |3.12 |
|2009 |26 | | |CR | |
|30 October |0.7585694| |51.39 |3,476.89 | |
|2009 |14 | | |CR | |
|15 March |0.7596556| |600.27 |4,072.19 | |
|2010 |68 | | |CR | |
|30 June 2010|0.7599485| |61.06 |4,131.67 | |
| |82 | | |CR | |
Using the weighted average method available under the
Division 775 income tax regulations, Kwala Co brings to
account a foreign currency loss of $3.93 for the 2008-09
income year.
6. : 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.
7. : Balancing adjustment required on qualifying foreign exchange
election commencement
|Division 775 foreign exchange |-$3.93 |
|gain/loss | |
|Division 230 foreign exchange |$102.64 |
|gain/loss (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 230-445) is therefore $106.57.
Case study 3: 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 2010 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 2015).
Forward contract to swap the Aussie bond for a US bond
On 1 July 2011 PV Enterprises enters into a forward contract
under which it agrees to exchange its Aussie bond on
1 July 2014 for a bond with a face value of US$1,300 due to
mature on 30 June 2016 (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 2016 has a market value at 1 July 2011 of US$850.
Also at this time, the prevailing US$/AUD 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 2014 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 AUD 1,500.
The US bond at this time is worth US$1,100. The US$/AUD
exchange rate prevailing at this time is 0.80. Accordingly,
at this time the US bond has a market value of AUD 1,375.
Redemption of the US bond
On 30 June 2015 PV Enterprises is still holding the US bond.
The prevailing US$/AUD exchange rate at this time is 0.625.
On 30 June 2016 PV Enterprises redeems the US bond for its
face value of US$1,300. At this time the US$/AUD exchange
rate has fallen to 0.75, so PV Enterprises is taken to have
received AUD 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 AUD 2,080 under the US bond, making an overall
economic gain of AUD 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 AUD 1,600 on redemption) (section
230-45). Moreover, as the amount PV Enterprises paid for
the bond (AUD 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 230-60(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 230-60), 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 230-115(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 230-105(1) and
paragraph 230-105(2)(a)). This $600 overall gain is subject
to the accruals method in Subdivision 230-B (subsection 230-
100(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-
80(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 Aussie bond over
12-month intervals ending on 30 June each year (subsections
230-80(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).
8. : Gain for each compounding interval
|Year |Amortised|Accrued |Cash |Amortised |
|ending |cost |gain for |flows |cost (year |
| |(year |tax | |end) |
| |start) |purposes | | |
| |(a) |(b) |(c) |(a) + (b) -|
| | | | |(c) |
|30 June |$0.00 |$98.56 |-$1,000|$1,098.56 |
|2011 | | | | |
|30 June |$1,098.56|$108.27 |- |$1,206.83 |
|2012 | | | | |
|30 June |$1,206.83|$118.95 |- |$1,325.78 |
|2013 | | | | |
|30 June |$1,325.78|$130.67 |- |$1,456.45 |
|2014 | | | | |
|30 June |$1,456.45|$143.55 |$1,600 |$0.00 |
|2015 | | | | |
The accrual amounts will be assessable to PV Enterprises
under section 230-15 in the year they are accrued (sections
230-15 and 230-170).
Year ended 30 June 2011
Based on the accrual calculation in Table 13.19, on
30 June 2011, PV Enterprises will accrue a $98.56 gain in
respect of the Aussie bond.
Year ended 30 June 2012
At the start of the year ending 30 June 2012 PV Enterprises
entered into the forward contract to dispose of the Aussie
bond (on 1 July 2011).
On 1 July 2011, the elements of subsection 230-505(1) are
satisfied because PV Enterprises starts to have part of a
financial arrangement (being the right to receive the US
bond under the forward contract) as consideration for the
Aussie bond to be provided.
Therefore subsection 230-505(2) will apply to deem the
benefit obtained for providing the Aussie bond to be the
market value of the Aussie bond when it is provided (ie, 1
July 2014).
Also on 1 July 2011, PV Enterprises now knows it will only
hold the Aussie bond until 1 July 2014. 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 2015 (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 circumstances affecting the
Aussie bond at the time the forward contract is entered
into. Although subsection 230-185(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-
115(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 230-185 and, assuming the Aussie bond is still
subject to accruals, a re-estimation of the gain or loss to
be accrued under section 230-190), 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 2015 (paragraph 230-115(2)(a)). This means
that following entry into the forward contract,
PV Enterprises is still sufficiently certain to receive AUD
1,600 on 30 June 2015. The same gain or loss, even
following a re-estimation, would continue to have to be
accrued (subsection 230-190(4)).
This means that based on the accrual calculation in Table
13.19, on 30 June 2012, PV Enterprises will still accrue a
$108.27 gain in respect of the Aussie bond.
Year ended 30 June 2013
Based on the accrual calculation in Table 13.19, on
30 June 2013, PV Enterprises will accrue a $118.95 gain in
respect of the Aussie bond.
Year ended 30 June 2014
Based on the accrual calculation in Table 13.19, on
30 June 2014, PV Enterprises will accrue a $130.67 gain in
respect of the Aussie bond.
Year ended 30 June 2015
The balancing adjustment on disposal of the Aussie bond
Upon settlement of the forward contract on 1 July 2014,
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 230-435(1)(a)).
The method statement in section 230-445 results in the
following balancing adjustment (under the relevant steps):
. step 1 (a) (amounts received): PV Enterprises is taken to
have obtained for disposing of its Aussie bond AUD 1,500
(its market value when it is provided) (paragraph 230-
505(2)(a));
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 230-445(1), sections 230-15 and 230-170),
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).
Note: On 1 July 2014 the elements of subsection 230-505(1)
are satisfied again because PV Enterprises starts to have
the US bond as consideration for ceasing to have the Aussie
bond. However, this will give rise to the same outcome,
being an amount deemed to have been obtained for providing
the Aussie bond equal to the market value of the Aussie bond
at the time this bond was provided.
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 2011 to
30 June 2014 ($98.56 + $108.27 + $118.95 + $130.67)
(accrual amount); and
. $43.55 gain assessable in the year ended 30 June 2015 (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 230-45, 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 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 230-115(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 230-115(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 230-100, 230-105, 230-110 and 230-
115).
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 230-40(1)). On settlement of
the forward contract, a balancing adjustment will therefore
be made (paragraph 230-435(1)(b)).
The method statement in section 230-445 results in the
following balancing adjustment (under the relevant steps):
. step 1 (a) (amounts received): PV Enterprises received the
US bond, worth AUD 1,375, under its financial arrangement
comprising its cash settlable rights and obligations under
the forward contract;
less
. step 2 (a) (amounts paid): PV Enterprises paid the
Aussie bond, worth AUD 1,500 under its forward contract
financial arrangement,
which 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 230-45).
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
230-60(1)).
On 1 July 2011, the elements of subsection 230-505(1) are
satisfied because PV Enterprises starts to have a part of a
financial arrangement (being the obligation to provide
Aussie bond under the forward contract) as consideration for
the US bond to be acquired.
Therefore subsection 230-505(2) will apply to deem the
benefit obtained for acquiring US bond to be the market
value of the US bond when it is acquired.
Upon settlement of the forward contract on 1 July 2014,
PV Enterprises transfers the Aussie bond to the counterparty
in exchange for receiving the US bond. Because of the
operation of subsection 230-505(2), PV Enterprises will be
taken to have paid US$1,100 (or AUD 1,375) for the US bond,
being its market value on 1 July 2014.
Note: On 1 July 2012 the elements of subsection 230-505(1)
are satisfied again because PV Enterprises ceases to have
the Aussie bond as consideration for acquiring the US bond.
However, this will give rise to the same outcome, being an
amount deemed to have been provided for acquiring the US
bond equal to the market value of the US bond at the time
this bond is acquired.
Application of the accruals methodology
PV Enterprises' financial benefits under its US bond
financial arrangement are known. As they are all in a
particular foreign currency (US$), 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 230-115(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 2014 (subsection 230-60(1) and section 230-505), 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 230-115(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 230-105(1) and paragraph
230-105(2)(a)). This US$200 overall gain is subject to the
accruals method in Subdivision 230-B (subsection 230-
100(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
230-80(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).
9. : Gain for each compounding interval
|Year |Amortised |Accrued |Cash |Amortised |
|ending |cost (year|gain for |flows |cost (year|
| |start) |tax | |end) |
| | |purposes | | |
| |(a) |(b) |(c) |(a) + (b) |
| | | | |- (c) |
|30 June |$0.00 |$95.83 |-$1,100.0|$1,195.83 |
|2015 | | |0 | |
|30 June |$1,195.83 |$104.17 |$1,300.00|$0.00 |
|2016 | | | | |
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 230-170 and paragraph (aa) of the definition of
'special accrual amount' in subsection 995-1(1) of the ITAA
1997).
Year ended 30 June 2015
Based on the accrual calculation in Table 13.20, on
30 June 2015, 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 AUD 153.33.
Year ending 30 June 2016
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-
435(1)(b)). The method statement in section 230-445 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 AUD 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 AUD 1,375 to acquire
the US bond (paragraph 230-505(2)(b));
and
. step 2 (b) (amounts previously taken into account):
the AUD 153.33 previously accrued and included in
PV Enterprises' assessable income (subsection 230-445(1),
sections 230-15 and 230-170 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 2014, and a $43.55
gain on disposal, assessable in the year ended
30 June 2015);
. a $125 loss made from the forward contract (deductible in
the year ended 30 June 2015); and
. a $705 gain made from the US bond ($153.33 accrual gain at
30 June 2015 and $551.67 gain on maturity in the year ended
30 June 2016).
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.
Case Study 4: Securitisation
The purpose of this case study is to consider issues related
to the application of Division 230 to a residential mortgage-
backed securitisation (RMBS) structure. The Division 230
treatment will depend on the facts and circumstances of the
particular securitisation structure.
In this case study, the Originator consolidates the special
purpose entity (SPE) into the Originator's consolidated
financial accounts; the assets in the form of the mortgages
are recognised in the financial statements of the
Originator's accounts and for tax purposes the Originator
and the SPE do not form part of the same consolidated tax
group. In this case study, the term 'Originator' refers to
the Head Co and its subsidiaries.
The securitisation structure can be illustrated
diagrammatically as follows.
[pic]
Securitisation fact pattern
An authorised deposit-taking institution (the 'Originator')
provides fixed and variable rate residential home loans to
Australian borrowers backed by mortgages over residential
properties.
On 1 July 2011, to fund its on-going lending activities the
Originator equitably assigns the mortgages and rights to
cash flows from the mortgages to an SPE. The SPE issues
securities to finance the transfer of these mortgages from
the Originator to the SPE. Specifically, the SPE issues a
series of securities (featuring senior and subordinated
tranches) with a total face value of AUD 5 billion to
investors backed by the pool of residential mortgages.
The SPE is in the form of a trust (the 'Trust'). The
residual income unit in the Trust is issued to the
Originator. This entitles the Originator to income of the
Trust that is in excess of what is paid to the holders of
the Securities of the Trust and other parties. In this
particular securitisation arrangement the residual capital
units are issued to the Originator and Charitable Trust.
The Originator is appointed manager of the securitisation.
A floating charge is attached to the assets of the Trust and
administered by a Security Trustee.
A series of credit enhancements are put in place including
subscription by the Originator in the subordinated tranche
of the notes, external mortgage insurance and mortgage
insurance policies (effected via an equitable assignment of
its interest in mortgage insurance policies to the Trust).
Servicing is provided by the Originator whose role is to
collect interest and principal payments and any other
amounts to which the investors are entitled from the
borrowing pool, pass those amounts on to the investors and
pursue collection of delinquent accounts. Liquidity support
is also provided by the Originator.
The Trust enters into a range of hedging arrangements
including interest rate swaps with the Originator.
The structure is a revolving one where the mortgage pool of
AUD 5 billion is topped up with substitute mortgages funded
through repayments of principal.
The Trust issues clean-up call options to the Originator to
facilitate winding up the securitisation structure when an
agreed trigger event occurs.
Securitisation assumptions
Accounting
The Trust is consolidated with the Originator in accordance
with Australian Accounting Standard AASB 127 Consolidation
and Separate Financial Statements and Urgent Issues Group
112 Consolidation - Special Purpose Entities. There is no
de-recognition of the transferred mortgages under Australian
Accounting Standard AASB 139 Financial Instruments:
Recognition and Measurement (AASB 139) as the Originator has
retained, notwithstanding the transfer, substantially all of
the risk and rewards of the home loans through the holding
of the residual income unit and the Originator's exposure
(incorporating features such as credit enhancement
mechanisms, liquidity support and interest rate swaps) to
expected variability in the future net cash flows from the
home loans.
Tax
The Originator and the Trust are not tax consolidated.
The Originator's aggregated turnover for the 2011 year is in
excess of AUD 20 million.
The Originator has not chosen to use any of the elective tax-
timing methods under Division 230.
1. Application of Division 230
Securitisation agreements
The securitisation shown above comprises a number of
agreements including those entered into by the Originator:
. equitable assignment of home loans;
. equitable assignment of home loan mortgage insurance;
. issuance of RMBS securities;
. residual income unit subscription;
. residual capital unit subscription;
. management agreement;
. service agreement;
. subordinated note subscription;
. liquidity facility;
. interest rate swaps; and
. management of the trust.
Does the Originator have one or more arrangements under the
securitisation?
Under the securitisation the Originator has a number of
rights to receive, and/or obligations to provide, financial
benefits by virtue of the agreements listed above.
The question that arises is whether the Originator's rights
and/or obligations under each agreement constitute a single,
aggregate arrangement or two or more separate arrangements.
In accordance with subsection 230-55(4) the answer to this
question is a matter of fact and degree that is determined
having regard to the:
. nature of the rights and/or obligations;
. terms and conditions of the rights and/or obligations;
. circumstances surrounding the creation of the rights and/or
obligations and their proposed exercise or performance
(including the purpose of the relevant parties);
. rights and obligations and whether the rights and/or
obligations must be dealt with separately or together;
. normal commercial understandings and practices in relation
to the rights and obligations (including whether they are
viewed commercially as separate things or as a group or as a
whole); and
. objects of Division 230.
Depending on the particular structure, all or a majority of
the rights and obligations under the separate agreements
could be interdependent and related to each other.
The creation of these rights and obligations and their
proposed exercise or performance predominantly occur at the
same time.
The common purpose of the Originator and the Trust is to
raise and provide cost-effective finance for the Originator
with the timing and pricing of the rights, obligations and
consideration all structured to meet that objective.
Commercial practice indicates that such a securitisation, or
at least most of the components of such a securitisation, is
treated as one arrangement. Depending on the particular
situation, the service agreement could be treated as part of
a loan or treated on a stand-alone basis.
The position under AASB 139 regarding grouping of financial
instruments is not clear. However, specific implementation
guidance provided in item B6 in Implementation Guidance IAS
39 indicates that separate instruments may be bundled into
one transaction provided that they meet certain criteria.
In the context of this particular case study, where the
Trust is consolidated and assets recognised for accounting
purposes, it appears that for accounting purposes this type
of securitisation structure is treated as equivalent to that
of a loan to the Originator from the note holders.
Taking these factors into account indicates that at least a
majority of the rights and obligations that arise from this
type of structure could, in particular circumstances, be
viewed in combination as constituting one arrangement.
Is the securitisation arrangement a 'financial arrangement'?
The Originator will have a financial arrangement if, under
the securitisation, there is a combination of one or more
cash settlable rights to receive and cash settlable
obligations to provide financial benefits. However, in
accordance with subsection 230-45(1), the securitisation
will not be a financial arrangement if there are rights and
obligations that are not cash settable and those rights and
obligations are not insignificant in comparison with the
cash settlable rights and obligations.
A right to receive, or an obligation to provide, a financial
benefit is cash settlable if one of the requirements in
subsection 230-45(2) is satisfied. In the case of this
securitisation most, if not all, of the rights and
obligations are in relation to benefits that are money or a
money equivalent (rights and/or obligations under a service
agreement may not be cash settlable, and may therefore not
be part of the financial arrangement). Hence, at least a
majority of the various agreements comprising the relevant
securitisation arrangement could satisfy the definition of
'financial arrangement' for the purposes of Division 230.
Is a balancing adjustment required?
Whether there would be a balancing adjustment under
Subdivision 230-G for securitisation structures of this type
will depend on the particular facts and circumstances of the
particular structure.
Nevertheless, subsection 230-435(3), by design, provides
that a transfer for the purposes of this Subdivision does
not arise unless there is, in effect, a transfer of
substantially all the risks and rewards of ownership of the
interest in question. Thus, it would be possible, depending
on factors such as the nature of the holding of the residual
income unit and the credit enhancements, for there not to be
a Subdivision 230-G transfer in respect of typical
securitisation arrangements.
Case study 5: A basic interest rate swap
Vanilla Co enters into a five-year interest rate swap
contract with a counterparty on 7 March 2010. Vanilla is to
receive annual floating rate payments, set one year in
advance of the date due for payment, based on the Bank Bill
Swap Rate (BBSW) and is to make annual payments at the fixed
rate of 8 per cent per annum, also set one year in advance
of the due date for payment. Accordingly, the first
floating and fixed rate payments are to be made on 7 March
2011. Payments are calculated by reference to a notional
principal of $100 million.
Vanilla Co has a 30 June income year and makes an election
to have Division 230 apply from 1 July 2009. However, it
does not make any of the Division 230 tax-timing elections.
Assume that the swap contract is a financial arrangement.
This arrangement consists of a floating rate leg and a fixed
rate leg. Further, the financial benefits to be provided or
received in respect of each leg of the arrangement are
calculated by reference to a notional principal amount
(which, in this case, is not paid or received). The value
of the notional principal in relation to both legs is $100
million, that is, they are equal in value. When viewed
separately, the substance, effect and pricing of each leg of
the swap (particularly having regard to the financial
benefits to be provided or received in respect of it) is
such that the notional principal in relation to it is
provided or received at a time. Accordingly, the swap
contract is a financial arrangement to which section 230-120
applies.
In accordance with subsection 230-120(3), the financial
benefits and gains or losses from the swap contract are to
be worked out separately for each leg. Then the gains or
losses from the swap contract are worked out by calculating
them in respect of the floating rate leg separately to those
in respect of the fixed rate leg, before combining them to
work out the gains or losses from the arrangement.
In the case of the fixed rate leg, the fixed rate payments
are calculated as if the notional principal amount of $100
million is received by Vanilla Co on 7 March 2010, and is to
be repaid by Vanilla Co on 7 March 2015. The fixed rate
payments are calculated thus:
$100m × 8% per annum = $8m
Similarly, in the case of the floating rate leg, the
floating rate payments are calculated as if the notional
principal amount of $100 million is paid by Vanilla Co on 7
March 2010, and is to be received by Vanilla Co on 7 March
2015. Assume that BBSW on 7 March 2010 is 7.7 per cent
per annum. Then the first floating rate payment, to be made
on 7 March 2011, is calculated thus:
$100m × 7.7% per annum = $7.7m
Assume the following BBSW rates:
10. : BBSW rates over the term of the interest rate swap
|Date |BBSW rate per annum |
|7 March 2010 |7.7% |
|7 March 2011 |8.2% |
|7 March 2012 |8.1% |
|7 March 2013 |7.9% |
|7 March 2014 |7.6% |
Based on the above BBSW rates, Vanilla Co's financial
benefits (cash flows) including notional financial benefits
(cash flows) for the notional principal in respect of each
leg are as follows, bearing in mind that the notional
principal in respect of the two legs of the swap is viewed
as having been provided or received, and that these rates
are set one year in advance.
11. : Vanilla Co's cash flows under the interest rate swap
|Date |Floating |Floating |Fixed leg |
| |rate |leg cash |cash flows |
| |(p.a.) |flows ($) |($) |
|7 March |Not |-100,000,00|100,000,000|
|2010 |applicabl|0 | |
| |e | | |
|7 March |7.7% |7,700,000 |-8,000,000 |
|2011 | | | |
|7 March |8.2% |8,200,000 |-8,000,000 |
|2012 | | | |
|7 March |8.1% |8,100,000 |-8,000,000 |
|2013 | | | |
|7 March |7.9% |7,900,000 |-8,000,000 |
|2014 | | | |
|7 March |7.6% |107,600,000|-108,000,00|
|2015 | | |0 |
The negative sign for the cash flows signifies a cash
outflow while the remaining figures signify a cash inflow.
As at 7 March 2010, Vanilla Co has a sufficiently certain:
. particular gain in respect of the floating leg of $7.7
million, which relates to the period 7 March 2010 to 7
March 2011; and
. particular loss in respect of the fixed leg of $8 million,
which also relates to the period 7 March 2010 to 7 March
2011.
Vanilla Co applies the accruals method under on a
compounding accruals basis to this and subsequent
gains/losses in respect of the two legs of the swap contract
using a 12-month compounding period and yearly intervals
starting from 7 March 2010. Each interval straddles more
than one income year, so Vanilla Co uses fractional
compounding to allocate gains and losses from intervals to
income years: this is a reasonable allocation for the
purposes of subsection 230-170(2). The results of this
application of the accruals method are as follows:
12. : Fractional compounding to allocate gains and losses
|Income |$ Gain |$ Loss (pay|$ Net gain|
|year |(receive |fixed leg) |or loss |
|ending |floating | | |
| |leg) | | |
|30 June |2,385,491 |-2,476,042 |-90,552 |
|2010 | | | |
|30 June |7,843,808 |-7,993,152 |-149,344 |
|2011 | | | |
|30 June |8,176,890 |-8,006,848 |170,042 |
|2012 | | | |
|30 June |8,039,689 |-8,000,000 |39,689 |
|2013 | | | |
|30 June |7,809,391 |-8,000,000 |-190,609 |
|2014 | | | |
|30 June |5,244,732 |-5,523,958 |-279,226 |
|2015 | | | |
|Total |39,500,000 |-40,000,000|-500,000 |
Straight line accruals for this swap would have produced the
following results:
13. : Straight line accruals to allocate gains and losses
|Income |$ Gain |$ Loss (pay|$ Net gain|
|year |(receive |fixed leg) |or loss |
|ending |floating | | |
| |leg) | | |
|30 June |2,447,123 |-2,542,466 |-95,342 |
|2010 | | | |
|30 June |7,851,784 |-7,993,053 |-141,270 |
|2011 | | | |
|30 June |8,175,339 |-8,006,947 |168,393 |
|2012 | | | |
|30 June |8,036,438 |-8,000,000 |36,438 |
|2013 | | | |
|30 June |7,804,658 |-8,000,000 |-195,342 |
|2014 | | | |
|30 June |5,184,658 |-5,457,534 |-272,877 |
|2015 | | | |
|Total |39,500,000 |-40,000,000|-500,000 |
Comparing the compounding accruals result with the straight
line accruals result on a year-by-year basis illustrates
that, in this swap, the difference is relatively small: see
Table 14.14. Vanilla Co could have used straight line
accruals (as long as it applied this on a consistent basis)
to spread the swap gains and losses because in this
situation it provides a result that approximates the
compounding accruals result.
In this situation, it is to be noted that the notional
principal for the two legs of the swap are the same, do not
change during the term of the swap, there are no upfront or
backend or other lumpy payments under the swap, and the swap
payments are periodic in nature.
14. : Compounding accruals versus straight line accruals[5]
|Income |$ |$ Straight|$ |
|year |Compounding |line |Difference|
|ending |accruals |accruals |[6] |
| |gain or loss|gain or | |
| | |loss | |
|30 June |-90,552 |-95,342 |4,791 |
|2010 | | | |
|30 June |-149,344 |-141,270 |-8,075 |
|2011 | | | |
|30 June |170,042 |168,393 |1,649 |
|2012 | | | |
|30 June |39,689 |36,438 |3,251 |
|2013 | | | |
|30 June |-190,609 |-195,342 |4,733 |
|2014 | | | |
|30 June |-279,226 |-272,877 |-6,349 |
|2015 | | | |
|Total |-500,000 |-500,000 |0 |
Case study 6: An interest rate swap with upfront payment
Neapolitan Co enters into a swap contract on the same terms
and conditions as those entered into by Vanilla Co (and
based on the same assumptions) except that Neapolitan Co
prepays its obligation to make fixed rate payments under the
contract. This upfront payment, assumed to be $31,941,680,
is the present value of all the payments that Neapolitan Co
would otherwise have had to make under the fixed leg of the
swap contract.
The upfront payment is not a leg or part of the leg of the
swap. Subsection 230-120(1) is designed on the basis of a
notional principal arrangement with two legs of equal value
when the entity starts to have the arrangement, with the
possibility of one or more other things. Further, there is
a requirement for the financial benefits to be provided or
received in respect of each leg of the arrangement to be
calculated by reference to, or to be reasonably related to,
a notional principal. However, the upfront payment has the
characteristics of actual rather than notional principal as
it serves a financing function, namely to finance the
financial benefits that would otherwise have had to be
provided by Neapolitan Co under the swap contract.
In these circumstances, the upfront payment is, instead,
another thing: see subparagraph 230-120(1)(a)(iii).
Accordingly, the $31,941,680 payment needs to be taken into
account in working out the gain or loss from that thing
(subparagraph 230-120(3)(b)(i)) which, in turn, is used to
work out the gain or loss from the financial arrangement
comprising the swap contract (subparagraph 230-
120(3)(b)(ii)).
The role of the subparagraph 230-120(1)(a)(iii) thing is to
provide a mechanism for reconciling the actual financial
benefit profile of the financial arrangement with its
economic and commercial substance, including the time value
of money. Thus, for the Neapolitan Co swap:
. The financial benefits from the financial arrangement are
worked out by working out the financial benefits of each
thing separately, namely:
- the two legs of the swap as if there were no other thing;
and
- the other thing, namely the upfront payment.
. The gain or loss from the financial arrangement is worked
out by working out the gains or losses from each of the
three things separately:
- The gains and losses from each of the two legs are worked
out in the way described in the previous (Vanilla Co)
example.
- Working out the gains and losses from the upfront payment
needs to take into account the fact that it is calculated to
finance the annual $8 million amounts which Neapolitan Co,
by making the upfront payment, is discharged from having to
make to meet its mutual obligations under the swap contract.
In effect, Neapolitan Co makes the $31,941,680 payment as
an investment at 8 per cent per annum annually compounded,
receiving $8 million annually in arrears. The gains from
this, which are set out below, are part of the gains and
losses from the swap financial arrangement (subparagraph 230-
120(3)(b)(ii)).
15. : Gains and losses allocated using compounding accruals
|Income year |$ Gain |$ Loss |$ Gain |$ Net |
|ending |(receive |(pay |or loss|gain or|
| |floating |fixed |from |loss |
| |leg) |leg) |upfront| |
| | | |payment| |
|30 June 2010|2,385,491 |-2,476,04|790,890|700,338|
| | |2 | | |
|30 June 2011|7,843,808 |-7,993,15|2,418,7|2,269,3|
| | |2 |08 |63 |
|30 June 2012|8,176,890 |-8,006,84|1,975,9|2,146,0|
| | |8 |78 |20 |
|30 June 2013|8,039,689 |-8,000,00|1,492,0|1,531,7|
| | |0 |97 |86 |
|30 June 2014|7,809,391 |-8,000,00|971,465|780,856|
| | |0 | | |
|30 June 2015|5,244,732 |-5,523,95|409,182|129,956|
| | |8 | | |
|Total |39,500,000 |-40,000,0|8,058,3|7,558,3|
| | |00 |20 |20 |
If straight line accruals were used for this swap, it would
produce the following results:
16. : Straight line accruals to allocate gains and losses
|Income year |$ Gain |$ Loss (pay|$ Net gain |
|ending |(receive |fixed leg) |or loss |
| |floating | | |
| |leg) | | |
|30 June 2010 |2,447,123 |-2,029,154 |417,969 |
|30 June 2011 |7,851,784 |-6,384,838 |1,466,946 |
|30 June 2012 |8,175,339 |-6,402,330 |1,773,009 |
|30 June 2013 |8,036,438 |-6,384,838 |1,651,601 |
|30 June 2014 |7,804,658 |-6,384,838 |1,419,820 |
|30 June 2015 |5,184,658 |-4,355,684 |828,974 |
|Total |39,500,000 |-31,941,680|7,558,320 |
In this case, a comparison between the results of
compounding accruals and straight line accruals shows that
there is a relatively large year-by-year difference.
Neapolitan Co could not use straight line accruals for all
of the things in respect of this swap, although it could use
straight line accruals solely for the two legs. The upfront
payment would have to be accrued as a sufficiently certain
particular gain or loss using compounding accruals.
17. : Compounding accruals versus straight line accruals
|Income year |$ Compounding|$ Straight |$ |
|ending |accruals gain|line |Differenc|
| |or loss |accruals |e |
| | |gain or loss| |
|30 June 2010 |700,338 |417,969 |282,368 |
|30 June 2011 |2,269,363 |1,466,946 |802,417 |
|30 June 2012 |2,146,020 |1,773,009 |373,011 |
|30 June 2013 |1,531,786 |1,651,601 |-119,814 |
|30 June 2014 |780,856 |1,419,820 |-38,964 |
|30 June 2015 |129,956 |828,974 |-699,018 |
|Total |7,558,320 |7,558,320 |0 |
Case study 7: A cross currency interest rate swap
Gelato Co, which has an Australian dollar functional
currency and a 30 June end of income year, enters into a
three-year cross currency interest rate swap under which:
. it will pay a counterparty annual Australian dollar fixed
amounts calculated by reference to a notional principal of
AUD 10 million (6 per cent per annum);
. it will receive from the counterparty annual foreign
currency (FC) fixed amounts calculated by reference to a
notional principal of FC 8 million (5 per cent per annum);
. on 1 January 2012, it will exchange (by receiving) AUD 10
million for (by paying) FC 8 million (at the time AUD 1 = FC
0.8 and the two amounts are equivalent in value to each
other); and
. on 1 January 2015, it will reverse the above exchange by
paying AUD 10 million and receiving FC 8 million.
Assuming that this swap is on arm's length terms, and having
regard to the swap contract as a whole being the relevant
financial arrangement, the exchange and re-exchange amounts
are notional principal rather than actual principal. The
exchange of amounts of equivalent value at 1 January 2012 do
not involve financing, given that each leg is not a separate
financial arrangement (even though each is viewed separately
to work out the gains and losses on the whole swap
contract).
Gelato Co has not made the hedging financial arrangement
election, the retranslation election or the fair value
election. Assume that it has decided to use spot exchange
rates to translate foreign currency amounts into Australian
dollars for the purposes of Subdivision 960-C.
Assume that the periodic swap payments are made on 1 January
2013, 1 January 2014 and 1 January 2015 and that the
exchange rates on those dates and 30 June 2012, 30 June 2013
and 30 June 2014 are as follows:
18. : Assumed exchange rates
|Date |AUD 1 = FC |
|1 January 2012 |0.80 |
|30 June 2012 |0.92 |
|1 January 2013 |0.86 |
|30 June 2013 |0.75 |
|1 January 2014 |0.82 |
|30 June 2014 |0.70 |
|1 January 2015 |0.78 |
In terms of section 230-120, the swap contract consists of
two legs only:
. There is a foreign currency denominated leg which consists
of paying FC 8 million on 1 January 2012 and being entitled
to receive that same amount on 1 January 2015; and being
entitled to receive FC 400,000 on 1 January 2013, 1 January
2014 and 1 January 2015.
. There is an Australian dollar denominated leg which consists
of receiving AUD 10 million on 1 January 2012 and having to
pay that same amount on 1 January 2015; and having to pay
AUD 600,000 on 1 January 2013, 1 January 2014 and 1 January
2015.
The gains and losses from the swap contract are to be worked
out by working out the gains and losses from each of these
legs separately and then aggregating them (paragraph 230-
120(3)(b)). In effect, the gains and losses from this swap
contract are worked out by treating the foreign currency
denominated leg as a foreign currency denominated bond and
the Australian dollar denominated leg as an Australian
dollar denominated bond, and then combining these results.
The application of the compounding accruals rules to each of
the legs of the swap - using annual compounding, annual
intervals commencing 1 January 2012 and fractional
compounding to spread gains and losses over intervals that
straddle the end of the income year - is worked out in the
following way.
Foreign currency denominated leg
In respect of the first receipt under the foreign currency
denominated leg:
. At 30 June 2012, the accrued gain is FC 197,561. Under
Subdivision 960-C, this is translated using the spot rate of
AUD 1 = FC 0.92 to give an accrued gain of AUD 214,740
(see the definition of 'special accrual amount') (Schedule
1, item 28, section 995-1 of the ITAA 1997).
. The accrued gain for the 2013 income year up to the date of
receipt (1 January 2013) of the FC 400,000 is FC 202,439.
Translated at the spot rate of AUD 1 = FC 0.86 produces an
accrued gain of AUD 235,394.
. Because the exchange rate changed between 30 June 2012 and
1 January 2013, the amount accrued up until 30 June 2012 may
be different to the amount actually received. In this case,
there is an under-accrual of AUD 14,982 (reflecting the fact
that FC 197,561 at an exchange rate of AUD 1 = FC 0.92 is
worth less than that amount at an exchange rate of AUD 1 =
FC 0.86). Under subsection 230-175(2), this underestimate
is a gain made by Gelato Co in the 2013 income year.
. On 1 January 2013, Gelato Co receives FC 400,000.
Translated at the spot rate of AUD 1 = FC 0.86 produces an
Australian dollar equivalent of AUD 465,116. Note that this
is the sum of the accrued amounts for the period that the FC
400,000 relates to (1 January 2012 to 31 December 2013) and
the subsection 230-175(2) running balance adjustment
(AUD 214,740 + AUD 235,394 + AUD 14,982).
The gains and losses in respect of the other periodic
payments under the foreign currency leg of the swap contract
are worked out in a similar way.
On 1 January 2015, Gelato Co receives FC 8 million from the
counterparty, being the re-exchange of the notional
principal. The exchange rate at this date is AUD 1 = FC
0.78. Therefore, the foreign currency has an Australian
dollar value of AUD 10,256,410. In the circumstances of
this swap contract, this amount is attributable to the FC 8
million Gelato Co paid on 1 January 2012 (which had an
Australian dollar value of AUD 10 million) and it could not
be said that the gain of AUD 256,410 was sufficiently
certain at the time the swap contract was entered into.
Accordingly, Gelato Co makes a realisation gain of AUD
256,410 in the income year ended 30 June 2015 in relation to
the notional principal exchange.
Accordingly, the Australian dollar compounding accruals
gains and losses in respect of the foreign currency leg of
the swap contract are as follows:
19. : Compounding accruals gains and losses on the foreign currency
denominated leg
|Period |FC |Spot |AUD |AUD |
|ending |denominat|currency |translate|running |
| |ed |exchange |d |balance |
| |gain/loss|rate |gain/loss|adjustme|
| | | | |nt |
|30 June 2012|197,561 |0.92 |214,740 | |
|1 January |202,439 |0.86 |235,394 |14,982[7|
|2013 | | | |] |
|30 June 2013|197,561 |0.75 |263,414 | |
|1 January |202,439 |0.82 |246,877 |-22,486 |
|2014 | | | | |
|30 June 2014|197,561 |0.70 |282,229 | |
|1 January |202,439 |0.78 |259,537 |-28,945 |
|2015 | | |+ | |
| | | |256,410[8| |
| | | |] | |
Australian dollar denominated leg
In respect of the first payment under the Australian dollar
denominated leg:
. At 30 June 2012, the accrued loss is AUD 295,630.
. The accrued loss for the 2013 income year up to the date of
payment (1 January 2013) of the AUD 400,000 is AUD 304,370.
. No translation under Subdivision 960-C is necessary given
that payments are denominated in Australian dollars and
Gelato Co's functional currency is Australian dollars.
There is no gain or loss in relation to the notional
principal exchange on the Australian dollar denominated leg,
as there was a receipt of AUD 10 million and repayment of
AUD 10 million.
Accordingly, application of the compounding accruals rules
to the swap contract is as follows:
20. : Compounding accruals gains and losses on the Australian dollar
denominated leg
|Period ending |AUD gain/loss |
|30 June 2012 |-295,630 |
|1 January 2013 |-304,370 |
|30 June 2013 |-295,630 |
|1 January 2014 |-304,370 |
|30 June 2014 |-295,630 |
|1 January 2015 |-304,370 |
Working out the compounding accruals gains and losses from
the swap contract produces the following results:
21. : Compounding accruals gains and losses for the swap financial
arrangement
|Income year |Foreign |Australian |AUD |
|ending 30 June|currency leg|dollar leg |gain/loss[9|
| |(AUD |(AUD) |] |
| |equivalent) | | |
|2012 |214,740 |-295,630 |-80,890 |
|2013 |513,790[10] |-600,000 |-86,210 |
|2014 |506,620 |-600,000 |-93,380 |
|2015 |487,002[11] |-304,370 |182,632 |
Straight line accruals
For a swap contract of this nature, would straight line
accruals approximate compounding accruals for the purposes
of paragraph 230-135(2)(b)? The answer to this should
generally disregard differences in the results of the two
methods attributable to unexpected foreign currency
movements.
If, however, there was a significant interest rate
differential between the two currencies or there was, as in
Case study 6 above, a significant non-periodic payment under
the swap arrangement, it would be difficult to say that the
results of straight line accruals would approximate
compounding accruals. However, neither of these elements
are present here, there are periodic payments and receipts
under the swap contract, and the notional principal does not
change during the term of the arrangement. Straight line
accruals would, in terms of paragraph 230-135(2)(b), provide
a result that approximates compounding accruals, as
illustrated by a comparison between the compounding accruals
and straight line accruals for this swap. Table 14.25
demonstrates that there is, in the circumstances, only a
relatively small difference between the two types of accrual
on a year-by-year basis.
22. : Straight line accruals gains and losses on foreign currency
denominated leg
|Period |FC |Spot |AUD |AUD |
|ending |denominate|currenc|translate|running |
| |d |y |d |balance |
| |gain/loss |exchang|gain/loss|adjustmen|
| | |e rate |[12] |t |
|30 June |200,000 |0.92 |217,391 | |
|2012 | | | | |
|1 January |200,000 |0.86 |232,558 |15,167[13|
|2013 | | | |] |
|30 June |200,000 |0.75 |266,667 | |
|2013 | | | | |
|1 January |200,000 |0.82 |243,902 |-22,764[1|
|2014 | | | |4] |
|30 June |200,000 |0.70 |285,714 | |
|2014 | | | | |
|1 January |200,000 |0.78 |256,410 |-29,303[1|
|2015 | | |+ |6] |
| | | |256,410[1| |
| | | |5] | |
23. : Straight line accruals gains and losses on the Australian dollar
denominated leg
|Period ending |AUD gain/loss |
|30 June 2012 |-300,000 |
|1 January 2013 |-300,000 |
|30 June 2013 |-300,000 |
|1 January 2014 |-300,000 |
|30 June 2014 |-300,000 |
|1 January 2015 |-300,000 |
Working out the straight line accruals gains and losses from
the swap contract produces the following results:
24. : Straight line accruals gains and losses for the swap financial
arrangement
|Income year |Foreign |Australian|AUD |
|ending 30 June |currency leg |dollar leg|gain/loss|
| |(AUD |(AUD) |[17] |
| |equivalent) | | |
|2012 |217,391 |-300,000 |-82,609 |
|2013 |514,392[18] |-600,000 |-85,608 |
|2014 |506,852 |-600,000 |-93,148 |
|2015 |483,517 |-300,000 |183,517 |
25. : Comparison between compounding and straight line accruals
|Income year |Compounding |Straight |Difference|
|ending 30 June |accruals |line |(AUD) |
| |(AUD) |accruals | |
| | |(AUD) | |
|2012 |-80,890 |-82,609 |1,719 |
|2013 |-86,210 |-85,608 |-602 |
|2014 |-93,380 |-93,148 |-232 |
|2015 |182,632 |183,517 |-885 |
Case study 8: A total return swap
Party A enters into a three-year swap arrangement with Party
B. Assume that it is a notional principal arrangement to
which section 230-120 applies. Under the terms of the swap
arrangement, Party A and Party B are required to make
periodic payments to each other. Party A's periodic
payments are calculated by reference to the amount of
interest payable if the leg under which the payments are to
be made were a bond that it issued. Party B's periodic
payments are calculated by reference to the dividends paid
on a reference share whose value at the time of entering
into the swap arrangement is the same as the value of
Party's A bond leg at that time.
As well, 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 end payment
or receipt is calculated by reference to the movement of the
price of the reference share over the three-year life of the
swap. Such swaps are sometimes referred to as a 'total
return swap'.
Any gains or losses on Party B's share-based leg would have
to take into account financial benefits, the value of which
are dependent on dividends on the reference share, and the
movement in the share price. Under the terms of the swap
arrangement, these amounts will not be known until the time
the relevant payments are due.
No sufficiently certain gain or loss can be calculated on
Party B's leg of this swap at the start of, or during, the
arrangement. This assumes that financial benefits in
respect of this leg are not calculated and set in advance of
when they are payable. Accordingly, gains or losses in
respect of this leg are made on a realisation basis for the
whole term of the swap arrangement.
On the other hand, a sufficiently certain gain or loss can
be calculated in respect of the bond leg. In terms of
working out the gains or losses in respect of this leg for
the purposes of subparagraph 230-120(3)(b)(i), accruals
treatment would therefore apply.
Chapter 15
Regulation impact statement
Background
1454. In August 1998, the then Government announced the Review of
Business Taxation (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.'
1455. 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 the Review of Business Taxation: A Tax
System Redesigned (Ralph Report). The recommendations seek to
address the tax issues associated with the increasing
sophistication of financial markets and transactions:
. The then Treasurer announced the Government's broad
support for the recommendations in the Ralph Report in
Press Release No. 074 of 11 November 1999.
1456. 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.
1457. 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
1458. 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.
1459. 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.
1460. Despite extensive consultation on TOFA Stages 3 and 4
(see paragraphs 15.64 to 15.75), 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.
Implementation options
1461. 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 concepts
1462. 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.
1463. 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).
1464. 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 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.
1465. 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.
1466. 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.
1467. 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.
1468. 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.
1469. 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 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
1470. 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.
1471. 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
1472. 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.
1473. 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.
Assessment of impacts
Impact group identification
Taxpayers
1474. 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.
1475. With this taxpayer coverage in mind, Division 230 will apply to the
financial arrangements of all entities with aggregated turnover of
$100 million or more, 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 of
$20 million or more:
. The Australian Taxation Office (ATO) estimates that there
are approximately 1,800 businesses with aggregated
turnover of $100 million or more.
. 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).
1476. 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.
1477. Public consultation in October 2008 identified some anomalous and
unintended outcomes of the aggregated turnover tests described
above. The tests look to a taxpayer's ordinary income derived in
the ordinary course of business, but some taxpayers do not account
for ordinary income separately from statutory income (notably
superannuation funds and investment vehicles) and some do not
'carry on a business' for tax purposes. To ensure the TOFA Stages
3 and 4 rules apply to the taxpayers intended, the following
additional threshold tests will apply:
. Division 230 will apply to superannuation funds and
investment vehicles with assets valued at $100 million or
more.
. Division 230 will apply to taxpayers applying the
$100 million turnover test with assets valued at $300
million or more, or financial assets of $100 million or
more.
Tax advisors
1478. 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 and 4 rules affect sophisticated taxpayers, it
is expected that larger tax advice and accounting firms will mainly
be affected.
1479. 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
1480. 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
1481. 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
1482. 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 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 are 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.
1483. The revenue impact of the TOFA Stages 3 and 4 rules is
unquantifiable.
Benefits
General
1484. 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.
1485. 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.
1486. 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 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.
1487. 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.
1488. 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.
1489. 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).
1490. 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.
1491. 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.
1492. 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
1493. 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.
1494. 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.
1495. 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.
. 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
1496. In terms of transitional compliance benefits, there are not
expected to be any specific benefits for tax advisors under option
1.
1497. 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).
1498. 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
1499. In terms of transitional compliance benefits, there are not
expected to be any specific benefits for systems developers under
option 1.
1500. 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.
Australian Taxation Office
1501. In terms of transitional administrative benefits, there are not
expected to be any specific benefits for the ATO under option 1.
1502. 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
1503. 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
1504. 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.
1505. 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:
. 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.
1506. 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.
1507. In terms of ongoing compliance costs for taxpayers, there is not
expected to be any noticeable difference between option 1 and
option 2.
1508. 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
1509. 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.
1510. 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:
. 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.
1511. 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
1512. 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.
1513. 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.
1514. 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
1515. 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.
1516. 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 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
1517. 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 Treasury, the ATO and the then 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 then Treasurer announced the then Government's broad
support for the recommendations in the Ralph Report in
Press Release No. 074 of 11 November 1999.
1518. 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.
1519. On 16 December 2005, the then 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;
. 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.
1520. 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.
1521. 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.
1522. On 3 January 2007, the then 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;
. 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.
1523. 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.
1524. On 6 August 2007, an 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.
1525. 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 2007 TOFA 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 2007 TOFA Bill.
1526. Following the calling of the 2007 Federal election, Parliament was
prorogued and the 2007 TOFA Bill consequently lapsed. As part of
the 2008 Budget, the Treasurer announced on 13 May 2008 that the
TOFA Stages 3 and 4 measures would be re-introduced into Parliament
with a start date of 1 July 2009 and that consultation would occur
on the technical aspects of the measures (Media Release No. 054 of
2008). Subsequently, the Assistant Treasurer and Minister for
Competition Policy and Consumer Affairs announced a 1 July 2009
optional start date and 1 July 2010 compulsory start date.
1527. On 1 October 2008, the Assistant Treasurer and Minister for
Competition Policy and Consumer Affairs announced the release of
exposure draft material for TOFA Stages 3 and 4 (Media Release No.
082 of 1 October 2008). In response to the public exposure draft,
a total of 10 submissions were received from the following
industry, taxpayers, peak bodies and tax advisors:
. Australian Accounting Standards Board;
. Australian Bankers' Association;
. Blake Dawson;
. Institute of Chartered Accountants Australia;
. Investment and Financial Services Association;
. Namoi Cotton;
. Property Council of Australia;
. Pitcher Partners;
. Pricewaterhouse Coopers; and
. Tax Institute of Australia.
1528. Submissions were generally positive about the 2008 public exposure
draft, and much of the feedback was of a technical nature, relating
in particular to consolidations interactions. The main policy
issues raised in submissions were:
. A limit in the scope of the aggregated turnover test.
This may have prevented application of the TOFA rules to
superannuation funds and entities which do not 'carry on a
business'. This was corrected in the 2008 TOFA Bill.
. The level of the general aggregated turnover test: it was
proposed that the turnover test for general taxpayers be
raised to $250 million. This proposal was not accepted in
the 2008 TOFA Bill because of the potential for increased
tax arbitrage between taxpayers subject to the TOFA rules
and those outside the TOFA rules.
. Making the TOFA rules elective: it was proposed that the
TOFA rules only be applied by taxpayers who elect for the
rules to apply to them. This proposal was not accepted in
the 2008 TOFA Bill because the potential for tax arbitrage
is even greater than for the $250 million aggregated
turnover proposal.
Conclusion and recommended option
1529. 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;
. 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').
1530. 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.
1531. The Treasury and the ATO will monitor these taxation measures, as
part of the whole system, on an ongoing basis.
Index
Schedule 1: Amendments
|Bill reference |Paragraph |
| |number |
|Item 1, Subdivision 230-B |1.53 |
|Item 1, Subdivision 230-C |1.53, 1.57 |
|Item 1, Subdivision 230-D |1.53, 1.59 |
|Item 1, Subdivision 230-E |1.53, 1.64 |
|Item 1, Subdivision 230-F |1.53, 1.69 |
|Item 1, Subdivision 230-G |1.53, 1.55 |
|Item 1, Subdivision 230-J |1.47 |
|Item 1, subsections 230-5(1) and 230-45(1) |1.42 |
|Item 1, paragraph 230-5(2)(a) and section |1.49 |
|230-455 | |
|Item 1, paragraph 230-5(2)(b) and section |1.44 |
|230-50 | |
|Item 1, paragraphs 230-5(2)(b) and |2.107 |
|230-40(4)(e) | |
|Item 1, subparagraph 230-10(b)(ii) |3.71 |
|Item 1, section 230-15 |1.38 |
|Item 1, subsection 230-15(1) |3.68 |
|Item 1, note to subsections 230-15(1) and |3.90 |
|(2) | |
|Item 1, subsection 230-15(2) |3.70 |
|Item 1, subsection 230-15(3) |3.78 |
|Item 1, subsection 230-15(4) |3.74 |
|Item 1, subsection 230-15(5) |3.75 |
|Item 1, subsection 230-15(6) |3.75 |
|Item 1, subsection 230-15(7) |3.69 |
|Item 1, section 230-20 |3.101 |
|Item 1, sections 230-20 and 230-25 |3.99 |
|Item 1, sections 230-20 and 230-25, item 76,|3.100 |
|section 118-27 | |
|Item 1, subsection 230-20(2) |3.104 |
|Item 1, subsections 230-20(5) and 230-25(4) |3.111 |
|Item 1, section 230-25 |3.106 |
|Item 1, subsection 230-25(2) |3.103 |
|Item 1, subsection 230-25(3) |3.108, 10.46 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-25(3)(a) |3.108 |
|Item 1, section 230-30 |3.76 |
|Item 1, subsection 230-30(1) |11.35 |
|Item 1, subsection 230-30(3) |3.77 |
|Item 1, section 230-35 |3.80, 3.81, |
| |3.85 |
|Item 1, section 230-40 |1.56, 3.30, |
| |3.31, 5.83 |
|Item 1, subsection 230-40(1) |1.81 |
|Item 1, subsection 230-40(1), |1.80 |
|Subdivision 230-G | |
|Item 1, subsections 230-40(2) and (7) |1.82 |
|Item 1, subsection 230-40(4) |1.86, 4.61, |
| |4.208 |
|Item 1, subsections 230-40(4) and 230-100(5)|1.78 |
|and section 230-180 | |
|Item 1, paragraph 230-40(4)(b) |4.62 |
|Item 1, paragraph 230-40(4)(c) |4.63 |
|Item 1, paragraph 230-40(4)(e) |1.44, 4.124, |
| |4.214 |
|Item 1, paragraph 230-40(4)(e) and |1.87 |
|sections 230-270 and 230-330 | |
|Item 1, subsection 230-40(5) |1.83 |
|Item 1, subsection 230-40(6) |1.85 |
|Item 1, paragraph 230-40(6)(a) |7.73 |
|Item 1, paragraph 230-40(6)(b) |7.74 |
|Item 1, paragraph 230-40(6)(c) |7.75 |
|Item 1, subsection 230-40(7) |9.50 |
|Item 1, section 230-45 |1.41, 1.57, |
| |6.47 |
|Item 1, sections 230-45 and 230-50 |2.42, 2.52 |
|Item 1, subsection 230-45(1) |2.61 |
|Item 1, subsection 230-45(1) and |2.91 |
|section 230-60 | |
|Item 1, paragraphs 230-45(1)(d) to (f) |2.90, 2.92 |
|Item 1, subsection 230-45(2) |1.42 |
|Item 1, note to subsection 230-45(2) |2.82 |
|Item 1, paragraph 230-45(2)(a) |2.69 |
|Item 1, paragraph 230-45(2)(b) |2.75 |
|Item 1, paragraphs 230-45(2)(b) and (c) |2.76 |
|Item 1, paragraph 230-45(2)(c) |2.74 |
|Item 1, paragraph 230-45(2)(d) |2.78 |
|Item 1, paragraph 230-45(2)(e) |2.80 |
|Item 1, paragraph 230-45(2)(f) and |2.83 |
|subsection 230-45(3) | |
|Item 1, paragraph 230-45(2)(g) |2.87, 2.88 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraphs 230-45(3)(a) and (b) |2.84 |
|Item 1, subparagraph 230-45(3)(c)(i) |2.86 |
|Item 1, subparagraph 230-45(3)(c)(ii) |2.85 |
|Item 1, subsection 230-50(1) |2.99, 2.101 |
|Item 1, subsection 230-50(2) |2.103 |
|Item 1, subsection 230-50(2) and section |2.105 |
|230-60 | |
|Item 1, paragraph 230-50(2)(b) |2.104 |
|Item 1, section 230-55 |1.41, 4.95, |
| |6.32 |
|Item 1, subsection 230-55(1) |2.186 |
|Item 1, subsections 230-55(1) and (2) |2.51 |
|Item 1, subsection 230-55(4) |2.45, 2.50, |
| |4.94 |
|Item 1, section 230-60 |2.63, 3.37, |
| |3.38 |
|Item 1, sections 230-60, 230-70 and 230-75 |3.33 |
|Item 1, section 230-65 |3.39, 3.40 |
|Item 1, section 230-70 |3.67 |
|Item 1, sections 230-70 and 230-75 |3.32, 3.58, |
| |3.65, 4.128 |
|Item 1, sections 230-70, 230-75, 230-200 and|3.66 |
|230-445 | |
|Item 1, subsections 230-70(1) and 230-75(1) |4.143 |
|Item 1, subsections 230-70(3) and 230-75(3) |3.57 |
|Item 1, section 230-80 |1.36, 1.90 |
|Item 1, subsection 230-80(3) |4.136 |
|Item 1, section 230-85 |1.41, 2.65 |
|Item 1, paragraph 230-95(a) |4.53, 4.70 |
|Item 1, paragraphs 230-95(a) and (c) |4.82 |
|Item 1, paragraph 230-95(b) |4.53 |
|Item 1, paragraph 230-95(c) |4.54 |
|Item 1, section 230-100 |4.130 |
|Item 1, sections 230-100, 230-105, 230-115 |1.73 |
|and 230-135 | |
|Item 1, subsection 230-100(2) |4.71 |
|Item 1, note to paragraph 230-100(2)(b) |4.71 |
|Item 1, subsection 230-100(3) |4.78, 4.82 |
|Item 1, subsection 230-100(4) |4.57 |
|Item 1, paragraph 230-100(4)(c) |4.60 |
|Item 1, subsection 230-100(5) |1.88, 4.59, |
| |4.78 |
|Item 1, subsection 230-105(1) |4.57, 4.58, |
| |4.67 |
|Bill reference |Paragraph |
| |number |
|Item 1, note to subsection 230-105(1) |4.72 |
|Item 1, subsections 230-105(1) and |4.153 |
|230-130(1) | |
|Item 1, paragraph 230-105(2)(a) |4.73, 4.84 |
|Item 1, paragraph 230-105(2)(b) |4.75 |
|Item 1, paragraphs 230-110(1)(a) and (b) |4.84 |
|Item 1, paragraph 230-110(1)(c) |4.83 |
|Item 1, paragraph 230-110(1)(d) |4.83 |
|Item 1, subsection 230-110(2) |4.87 |
|Item 1, note to subsection 230-110(2) |4.83 |
|Item 1, paragraph 230-110(2)(b) |4.129 |
|Item 1, paragraphs 230-110(2)(b) and (c) |4.85 |
|Item 1, subsection 230-115(1) |4.97 |
|Item 1, paragraph 230-115(2)(a) |4.98 |
|Item 1, paragraph 230-115(2)(b) |4.98, 4.114 |
|Item 1, subsection 230-115(3) |4.114 |
|Item 1, paragraph 230-115(3)(a) |4.106 |
|Item 1, subparagraph 230-115(3)(a)(ii) |4.112 |
|Item 1, subparagraph 230-115(3)(a)(iii) |4.111 |
|Item 1, subparagraph 230-115(3)(a)(iv), |4.110 |
|paragraph 230-115(3)(b) | |
|Item 1, subsections 230-115(4) and (5) |4.80, 4.118 |
|Item 1, subsection 230-115(6) |4.119 |
|Item 1, subsection 230-115(8) |4.102 |
|Item 1, subsection 230-115(9) |4.127 |
|Item 1, subsection 230-120(1) and |4.92 |
|subparagraph 230-120(3)(c)(i) | |
|Item 1, subparagraph 230-120(3)(b)(i) |4.93 |
|Item 1, section 230-125 |4.130 |
|Item 1, subsection 230-130(1) |4.67, 4.131, |
| |4.132 |
|Item 1, subsection 230-130(2) |4.136 |
|Item 1, subsection 230-130(3) |4.134, 4.135 |
|Item 1, paragraph 230-130(5)(a) |4.135 |
|Item 1, subparagraph 230-130(5)(b)(i) |4.135 |
|Item 1, subparagraph 230-130(5)(b)(ii) |4.135 |
|Item 1, paragraph 230-135(2)(a) |4.138 |
|Item 1, paragraph 230-135(2)(b) |4.138, 4.146 |
|Item 1, subsection 230-135(4) |4.139 |
|Item 1, paragraph 230-135(4)(a) |4.144 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-135(4)(b) |4.144 |
|Item 1, subsection 230-135(5) |4.140 |
|Item 1, subsection 230-135(6) |4.141 |
|Item 1, subsection 230-135(7) |4.142 |
|Item 1, subsection 230-135(8) |4.143 |
|Item 1, section 230-140 |4.147 |
|Item 1, paragraph 230-140(3)(a) |4.150 |
|Item 1, paragraph 230-140(3)(b) |4.150 |
|Item 1, paragraph 230-140(3)(c) |4.150 |
|Item 1, paragraphs 230-140(3)(d) to (f) |4.150 |
|Item 1, sections 230-150 and 230-155 |4.74 |
|Item 1, sections 230-150, 230-160 and |1.75, 4.154 |
|230-165 | |
|Item 1, subsection 230-150(1) |4.155 |
|Item 1, paragraphs 230-160(1)(a) and (b) and|4.156 |
|230-165(1)(a) and (b) | |
|Item 1, paragraph 230-160(1)(c) |4.158 |
|Item 1, paragraph 230-160(1)(e) |4.159, 4.160 |
|Item 1, paragraph 230-160(1)(f) |4.160 |
|Item 1, paragraphs 230-160(1)(f) and |4.162 |
|230-165(1)(e) | |
|Item 1, subsection 230-160(2) |4.158 |
|Item 1, subsections 230-160(3) to (5) and |4.74 |
|230-165(3) to (5) | |
|Item 1, subsections 230-160(3) and (5) and |4.155 |
|230-165(3) and (5) | |
|Item 1, subsections 230-160(3) and |4.157 |
|230-165(3) | |
|Item 1, paragraphs 230-160(3)(a) and |4.164 |
|230-165(3)(a) | |
|Item 1, subsection 230-160(4) |4.165 |
|Item 1, paragraphs 230-165(3)(b) to (d) and |4.163 |
|230-160(3)(b) to (d) | |
|Item 1, subsection 230-165(4) |4.165 |
|Item 1, subsection 230-170(1) |4.168 |
|Item 1, subsection 230-170(2) |4.169 |
|Item 1, subsections 230-170(3), 230-230(3), |12.46 |
|230-280(4), 230-300(10) and 230-420(3) | |
|Item 1, section 230-175 |1.76, 4.171 |
|Item 1, subsection 230-175(1) |4.172 |
|Item 1, subsection 230-175(2) |4.173 |
|Item 1, subsection 230-175(3) |4.173 |
|Item 1, subsection 230-175(4) |4.172 |
|Item 1, section 230-180 |4.216 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-180(2)(a) |4.216 |
|Item 1, paragraph 230-180(2)(b) |4.216 |
|Item 1, subsection 230-180(3) |4.219 |
|Item 1, paragraph 230-180(3)(a) |4.221 |
|Item 1, paragraph 230-180(3)(b) |4.221 |
|Item 1, paragraph 230-180(3)(c) |4.221 |
|Item 1, paragraph 230-180(5)(a) |4.221 |
|Item 1, paragraph 230-180(5)(b) |4.221 |
|Item 1, paragraph 230-180(5)(c) |4.221 |
|Item 1, subsection 230-180(6) |4.220, 4.222 |
|Item 1, sections 230-185 and 230-190 |1.74 |
|Item 1, subsection 230-185(1) |4.223 |
|Item 1, paragraph 230-185(2)(a) |4.225 |
|Item 1, paragraph 230-185(2)(b) |4.226 |
|Item 1, paragraph 230-185(2)(c) |4.230 |
|Item 1, paragraph 230-185(2)(d) |4.231 |
|Item 1, paragraph 230-185(2)(e) |4.233 |
|Item 1, subsection 230-185(3) |4.224 |
|Item 1, subsection 230-190(2) |4.175, 4.181 |
|Item 1, subsection 230-190(3) |4.179 |
|Item 1, paragraph 230-190(3)(a) |4.176 |
|Item 1, paragraph 230-190(3)(b) |4.176 |
|Item 1, paragraph 230-190(3)(c) |4.176, 4.180 |
|Item 1, paragraph 230-190(3)(d) |4.176, 4.229 |
|Item 1, subsection 230-190(5) |4.185 |
|Item 1, subsection 230-190(6) |4.188 |
|Item 1, paragraph 230-190(6)(a) |4.189 |
|Item 1, paragraph 230-190(6)(b) |4.190 |
|Item 1, subsection 230-190(7) |4.194 |
|Item 1, subsections 230-190(8) and (9) |4.196 |
|Item 1, subsections 230-190(8) to (10) |4.233 |
|Item 1, paragraph 230-190(8)(b) |4.203 |
|Item 1, subsection 230-190(10) |4.196 |
|Item 1, section 230-195 |4.193 |
|Item 1, subsection 230-195(1) |4.197 |
|Item 1, paragraph 230-195(1)(a) |4.198 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-195(1)(b) |4.199 |
|Item 1, paragraph 230-195(1)(c) |4.199 |
|Item 1, paragraph 230-195(1)(d) |4.198 |
|Item 1, subsection 230-195(2) |4.204 |
|Item 1, subsection 230-195(3) |4.204 |
|Item 1, subsection 230-195(5) |4.205 |
|Item 1, subsection 230-195(6) |4.206 |
|Item 1, subsection 230-200(1) |4.182 |
|Item 1, subsection 230-200(2) |4.184 |
|Item 1, subparagraph 230-200(2)(a)(i) |4.187 |
|Item 1, subparagraph 230-200(2)(a)(ii) |4.187 |
|Item 1, subsection 230-200(3) |4.195 |
|Item 1, section 230-210 |6.19 |
|Item 1, subsection 230-210(1) |6.18 |
|Item 1, subsection 230-210(2) |6.18 |
|Item 1, subsections 230-210(2), 230-255(2), |5.13 |
|230-315(2) and 230-395(2) | |
|Item 1, subparagraphs 230-210(2)(a)(ii) and |5.47 |
|(b)(ii), 230-255(2)(a)(ii) and (b)(ii), | |
|230-315(2)(a)(ii) and (b)(ii) and | |
|230-395(2)(a)(ii) and (b)(ii) | |
|Item 1, paragraphs 230-210(2)(b), |5.45 |
|230-255(2)(b), 230-315(2)(b) and | |
|230-395(2)(b) | |
|Item 1, subsections 230-210(3), 230-255(5), |5.69 |
|230-315(3) and 230-395(4) | |
|Item 1, subsections 230-215(1), 230-260(1), |5.33 |
|230-320(1) and 230-400(1) | |
|Item 1, subsections 230-215(2), 230-260(2), |5.34 |
|230-320(2) and 230-400(2) | |
|Item 1, subsections 230-215(3) to (5), |Example 5.1 |
|230-260(3) to (5) and 230-400(3) to (5) | |
|Item 1, subsection 230-220(1) |6.30 |
|Item 1, subsections 230-220(1), 230-265(1), |5.75 |
|230-325(3) and 230-410(1) | |
|Item 1, subsections 230-220(1), 230-265(1) |5.70 |
|and 230-410(1), section 230-325 | |
|Item 1, paragraphs 230-220(1)(b), |5.39 |
|230-265(1)(b), 230-335(1)(c) and | |
|230-410(1)(c) | |
|Item 1, paragraph 230-220(1)(c) |6.31 |
|Item 1, paragraphs 230-220(1)(c) and (d) |6.27 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraphs 230-220(1)(c) and |2.108 |
|230-410(1)(d), subsections 230-225(1), | |
|230-300(7) and (8) and 230-415(1) | |
|Item 1, paragraph 230-220(1)(c) and |6.18 |
|subsection 230-220(2) | |
|Item 1, paragraph 230-220(1)(d) |6.18, 6.33 |
|Item 1, subsection 230-220(2) |6.28 |
|Item 1, subsections 230-220(2), 230-265(2) |5.80 |
|and 230-410(3), paragraphs 230-230(1)(b) and| |
|230-420(1)(b), | |
|subparagraph 230-280(1)(b)(ii) | |
|Item 1, subsections 230-220(3), 230-265(3), |11.76 |
|230-335(2) and 230-410(8) | |
|Item 1, section 230-225 |6.18 |
|Item 1, subsection 230-225(1) |6.36 |
|Item 1, subsections 230-225(1) and |1.84, 5.72, |
|230-415(1) |2.115, 4.212, |
| |6.31, 6.32 |
|Item 1, subsections 230-225(1) and 230-480 |1.55, 5.72 |
|Item 1, subsection 230-225(3) |6.23 |
|Item 1, subsections 230-225(3), 230-270(3), |5.62, 5.67, |
|230-330(4) and 230-415(3) |5.73 |
|Item 1, subsection 230-225(4) |6.24 |
|Item 1, subsections 230-225(4), 230-270(4), |5.74 |
|230-330(5) and 230-415(4) | |
|Item 1, subsection 230-230(1) |5.78 |
|Item 1, subsections 230-230(1), 230-280(1) |5.77 |
|and 230-420(1) | |
|Item 1, paragraphs 230-230(1)(c) and |11.77 |
|230-420(1)(c), | |
|subparagraph 230-280(1)(b)(iii) | |
|Item 1, section 230-235 |6.18 |
|Item 1, subsection 230-240(1) |6.34 |
|Item 1, subsections 230-240(1), 230-285(1), |5.86 |
|230-370(1) and 230-425(1) | |
|Item 1, subsections 230-240(1) and (3), |5.89 |
|230-285(1) and (3), 230-370(1) and | |
|230-425(1) and (3) | |
|Item 1, subsection 230-240(2) |6.50 |
|Item 1, subsections 230-240(2), 230-285(2), |5.96 |
|230-370(2) and 230-425(2) | |
|Item 1, subsections 230-240(2) and (4), |5.90 |
|230-285(2) and (4), 230-370(2) and | |
|230-425(1) and (4) | |
|Item 1, subsections 230-240(3), 230-285(3) |5.88 |
|and 230-425(3) | |
|Item 1, subsection 230-240(4) |6.44 |
|Bill reference |Paragraph |
| |number |
|Item 1, subsections 230-240(4), 230-285(4), |5.96 |
|230-325(1), 230-425(4) and the note to | |
|subsection 230-370(2) | |
|Item 1, subsections 230-245(1), 230-290(1) |5.91 |
|and 230-430(1) | |
|Item 1, subsections 230-245(1) and (3) |6.46 |
|Item 1, subsections 230-245(2), (4) and (5),|5.93 |
|230-290(2), (4) and (5) and 230-430(2), (5) | |
|and (6) | |
|Item 1, subsections 230-245(3), 230-290(3) |5.92 |
|and 230-430(3) | |
|Item 1, subsections 230-255(1) and (2), item|7.30 |
|6, section 775-295 | |
|Item 1, subsection 230-255(2) |7.31 |
|Item 1, subsection 230-255(3) |7.55 |
|Item 1, subsections 230-255(3) and (4) |7.30 |
|Item 1, paragraph 230-255(4)(a) |7.61 |
|Item 1, paragraph 230-255(4)(b) |7.62 |
|Item 1, subsection 230-255(5) |7.70 |
|Item 1, paragraph 230-265(1)(b), item 6, |7.34 |
|paragraph 775-295(1)(b) | |
|Item 1, paragraph 230-265(1)(c), item 6, |7.34 |
|paragraph 775-295(1)(c) | |
|Item 1, paragraph 230-265(1)(d), item 6, |7.34 |
|paragraph 775-295(1)(a) | |
|Item 1, subsection 230-265(2) |7.34 |
|Item 1, subsection 230-270(1), paragraph |2.107 |
|230-5(2)(b)) | |
|Item 1, section 230-275 |7.62 |
|Item 1, subsection 230-280(1) |5.78, 7.40 |
|Item 1, subsection 230-285(1) |7.43 |
|Item 1, subsection 230-285(2) |7.44, 7.71 |
|Item 1, subsection 230-285(3), item 6, |7.45 |
|subsection 775-310(1) | |
|Item 1, subsection 230-285(4), item 6, |7.46 |
|subsection 775-310(2) | |
|Item 1, subsection 230-285(5) |7.67 |
|Item 1, subsection 230-285(6) |7.68 |
|Item 1, section 230-290 |1.62 |
|Item 1, subsections 230-290(1) and (3) |7.47 |
|Item 1, subsections 230-290(2) and (4) |7.48 |
|Item 1, subsections 230-290(3) to (5) |7.69 |
|Item 1, subsection 230-290(5) |7.49 |
|Item 1, section 230-295 |8.98 |
|Item 1, sections 230-300 and 230-310 |8.87 |
|Item 1, sections 230-300 and 230-325 |8.23 |
|Item 1, subsections 230-300(1) and (2) |8.84 |
|Bill reference |Paragraph |
| |number |
|Item 1, subsections 230-300(1) and |3.96 |
|230-310(3), section 230-40 | |
|Item 1, subsections 230-300(3), 230-360(1) |8.35 |
|and (2) | |
|Item 1, paragraph 230-300(4)(a) |8.85 |
|Item 1, paragraph 230-300(4)(b) |8.85 |
|Item 1, subsection 230-300(5) |8.103 |
|Item 1, subsection 230-300(5) and section |8.36 |
|230-305 | |
|Item 1, subsection 230-300(5) and section |8.104 |
|230-305, item 2 in the table | |
|Item 1, subsection 230-300(6) |8.111 |
|Item 1, subsection 230-300(7) |8.86 |
|Item 1, subsections 230-300(7) and (8) |4.63 |
|Item 1, subsections 230-300(7) and (8) and |2.107 |
|230-330(1), paragraph 230-5(2)(b) | |
|Item 1, subsection 230-300(10) |12.47 |
|Item 1, subsection 230-300(11) |12.48 |
|Item 1, section 230-305, item 1 in the table|8.110 |
|Item 1, section 230-305, items 2(a) to (c) |8.111 |
|and (3) in the table | |
|Item 1, section 230-305, subitems 1(a) and |8.107 |
|(b) in the table | |
|Item 1, section 230-310 |3.95 |
|Item 1, subsection 230-310(4) |8.35, 8.88 |
|Item 1, subsection 230-310(4), item 1 in the|8.89 |
|table | |
|Item 1, subsection 230-310(4), item 2 in the|8.91 |
|table | |
|Item 1, subsection 230-310(4), item 3 in the|8.91 |
|table | |
|Item 1, subsection 230-310(4), item 4 in the|8.91 |
|table | |
|Item 1, subsection 230-310(4), item 5 in the|8.90, 8.91 |
|table | |
|Item 1, subsection 230-310(4), item 6 in the|8.91 |
|table | |
|Item 1, subsection 230-310(4), items 7 and |8.91 |
|10 in the table | |
|Item 1, subsection 230-310(4), items 8 and 9|8.91 |
|in the table | |
|Item 1, subsection 230-310(4), item 11 in |8.91 |
|the table | |
|Item 1, subsection 230-310(4), item 12 in |8.91 |
|the table | |
|Item 1, subsection 230-310(5) |8.91 |
|Item 1, sections 230-315 and 230-325 |8.27 |
|Item 1, subsection 230-315(2) |8.29 |
|Item 1, subsection 230-315(3) |8.112 |
|Item 1, section 230-325 |8.30 |
|Item 1, subsection 230-330(1) |8.32 |
|Bill reference |Paragraph |
| |number |
|Item 1, subsection 230-330(2) |8.32 |
|Item 1, subsection 230-330(3) |8.33 |
|Item 1, subsection 230-330(4) |8.34 |
|Item 1, subsection 230-330(5) |8.34 |
|Item 1, section 230-335 |8.39 |
|Item 1, section 230-335 and subsection |8.79 |
|230-355(5) | |
|Item 1, subsection 230-335(1) |8.24, 8.48 |
|Item 1, subsections 230-335(1) and (3) |8.23 |
|Item 1, paragraph 230-335(1)(a) |8.46, 8.49 |
|Item 1, paragraph 230-335(1)(b) |8.49 |
|Item 1, paragraph 230-335(1)(c) |8.49 |
|Item 1, subsection 230-335(3) |8.24, 8.48 |
|Item 1, paragraph 230-335(3)(c) |8.78 |
|Item 1, paragraph 230-335(3)(e) |8.78 |
|Item 1, subsection 230-335(4) |8.76 |
|Item 1, subsection 230-335(5) |8.76 |
|Item 1, subsections 230-335(5) and (6) |8.55 |
|Item 1, subsection 230-335(6) |8.76 |
|Item 1, subsection 230-335(7) |8.77 |
|Item 1, subsection 230-335(8) |8.56 |
|Item 1, subsections 230-335(8) and (9) |8.58 |
|Item 1, subsection 230-335(9) |8.57 |
|Item 1, subsection 230-335(10) |8.25, 8.59 |
|Item 1, paragraph 230-335(10)(f) |8.26 |
|Item 1, subsection 230-335(11) |8.26, 8.61 |
|Item 1, section 230-340 |8.54 |
|Item 1, subsection 230-340(2) |8.54 |
|Item 1, subsection 230-340(3) |8.54 |
|Item 1, subsection 230-340(4) |8.54 |
|Item 1, section 230-345 |8.24, 8.52 |
|Item 1, subsection 230-350(1) |2.120, 3.87, |
| |8.40, 10.50 |
|Item 1, subsection 230-350(2) |8.45 |
|Item 1, section 230-355 |8.31 |
|Item 1, subsection 230-355(1) |8.62 |
|Item 1, paragraph 230-355(1)(b) |8.62 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-355(1)(c) |8.62 |
|Item 1, subsection 230-355(2) |8.64 |
|Item 1, subsection 230-355(3) |8.63 |
|Item 1, paragraph 230-355(3)(b) |8.63 |
|Item 1, paragraph 230-355(4)(a) |8.62 |
|Item 1, paragraph 230-355(4)(b) |8.62 |
|Item 1, paragraph 230-355(4)(c) |8.62 |
|Item 1, subsection 230-355(5) |8.24, 8.78 |
|Item 1, subparagraph 230-355(5)(a)(i) |8.80 |
|Item 1, subparagraph 230-355(5)(a)(ii) |8.80 |
|Item 1, paragraph 230-355(5)(b) |8.80 |
|Item 1, paragraph 230-355(5)(c) |8.80 |
|Item 1, paragraph 230-355(5)(d) |8.80 |
|Item 1, subsection 230-355(6) |8.80 |
|Item 1, section 230-360 |8.31 |
|Item 1, paragraph 230-360(2)(a) |8.83 |
|Item 1, paragraph 230-360(2)(c) |8.83 |
|Item 1, subparagraph 230-360(2)(c)(ii) |8.96 |
|Item 1, section 230-365 |8.31 |
|Item 1, paragraph 230-365(a) |8.65 |
|Item 1, paragraph 230-365(b) |8.65 |
|Item 1, paragraph 230-365(c) |8.65 |
|Item 1, subsection 230-370(1) |8.112 |
|Item 1, subsection 230-370(2) |8.113 |
|Item 1, section 230-375 |8.115 |
|Item 1, subsections 230-375(3), 230-300(1), |8.115 |
|230-300(2) and 230-440(2) | |
|Item 1, section 230-380 |8.24, 8.97 |
|Item 1, subsection 230-380(2) |8.100 |
|Item 1, subsections 230-380(3) to (5) |8.100 |
|Item 1, subsection 230-380(6) |8.101 |
|Item 1, subsection 230-385(2) |8.117 |
|Item 1, subsection 230-385(3) |8.118 |
|Item 1, subsection 230-385(4) |8.118 |
|Item 1, subsection 230-385(5) |8.118 |
|Item 1, section 230-395 |9.37 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraph 230-395(2)(c) |9.21 |
|Item 1, paragraph 230-395(2)(c) and |9.68 |
|subsection 230-425(2) | |
|Item 1, paragraph 230-395(2)(d) |9.25 |
|Item 1, paragraph 230-395(2)(e) |9.26 |
|Item 1, subsection 230-395(3) |9.27 |
|Item 1, subsections 230-405(1) and (2) |9.29 |
|Item 1, paragraph 230-410(1)(b) |9.46 |
|Item 1, paragraph 230-410(1)(d) |9.48 |
|Item 1, paragraph 230-410(1)(e) and |9.33 |
|subsection 230-410(2) | |
|Item 1, paragraph 230-410(1)(f) and |9.34 |
|subsection 230-410(2) | |
|Item 1, subsection 230-410(2) |9.35 |
|Item 1, subsection 230-410(3) |9.45 |
|Item 1, subsection 230-410(7) |9.36 |
|Item 1, subsection 230-415(1) |9.48 |
|Item 1, subsection 230-415(3) |9.39, 9.49 |
|Item 1, subsection 230-415(4) |9.40 |
|Item 1, section 230-420 |9.53 |
|Item 1, subsection 230-420(1) |5.78 |
|Item 1, section 230-425 |9.61 |
|Item 1, subsection 230-425(4) |9.58, 9.62 |
|Item 1, section 230-430 |1.70, 9.65 |
|Item 1, subsections 230-430(1) and (3) |9.64 |
|Item 1, subsection 230-430(4) |9.59, 9.64 |
|Item 1, section 230-435 and subsection |1.89 |
|230-40(1) | |
|Item 1, subsection 230-435(1) |4.211 |
|Item 1, paragraphs 230-435(1)(a) and (b) |10.39 |
|Item 1, subparagraph 230-435(1)(c)(i) |10.42 |
|Item 1, subparagraph 230-435(1)(c)(ii) |10.42 |
|Item 1, subparagraph 230-435(1)(c)(iii) |10.42 |
|Item 1, subsection 230-435(3) |10.41 |
|Item 1, subsection 230-435(5) |10.53 |
|Item 1, subsection 230-440(1) |2.109, 10.44 |
|Item 1, subsection 230-440(2) |1.65 |
|Item 1, paragraph 230-440(3)(a) |10.46 |
|Item 1, paragraph 230-440(3)(c) |10.55 |
|Item 1, paragraph 230-440(3)(d) |10.55 |
|Bill reference |Paragraph |
| |number |
|Item 1, subsection 230-445(1), steps 1(b) |10.62 |
|and (c) and 2(b) and (c) in the method | |
|statement | |
|Item 1, note to paragraph (c) of step 2 in |11.37 |
|the method statement in | |
|subsection 230-445(1) | |
|Item 1, subsection 230-445(1), step 3 in the|10.63 |
|method statement | |
|Item 1, subsection 230-445(2) |10.65 |
|Item 1, subsection 230-445(3) |10.66 |
|Item 1, subsection 230-445(4) |10.68 |
|Item 1, subsection 230-445(5) |10.67, 10.68 |
|Item 1, subsection 230-445(6) |10.69 |
|Item 1, subsection 230-445(7) |3.110 |
|Item 1, section 230-450 |1.45, 1.49, |
| |11.10 |
|Item 1, paragraph 230-450(b) |2.118 |
|Item 1, paragraph 230-450(c) |2.119 |
|Item 1, paragraph 230-450(d) |2.120 |
|Item 1, paragraph 230-450(e) |2.121 |
|Part 1, section 230-455 |2.124, 2.133, |
| |2.135, 2.136 |
|Item 1, subsection 230-455(1) |4.56 |
|Part 1, subparagraph 230-455(1)(a)(ii), |2.128 |
|paragraph 230-455(1)(b), subsection | |
|230-455(2) | |
|Part 1, subparagraph 230-455(1)(a)(iii), |2.130 |
|paragraph 230-455(1)(c), subsection | |
|230-455(3) | |
|Item 1, paragraph 230-455(1)(e) |2.137, 2.139 |
|Item 1, subsections 230-455(6) to (8) |2.140 |
|Item 1, subsection 230-455(7) |3.86, 4.56 |
|Part 1, subsection 230-455(9) |2.141 |
|Item 1, section 230-460 and subsections |1.50 |
|230-475(3) and (4) | |
|Item 1, paragraph 230-460(2)(a) |2.143 |
|Item 1, paragraph 230-460(2)(b) |2.143 |
|Item 1, paragraph 230-460(2)(c) |2.143 |
|Item 1, paragraphs 230-460(2)(d) and (e) |2.143 |
|Item 1, subsection 230-460(3) |2.149 |
|Item 1, paragraph 230-460(3)(c) |2.151 |
|Item 1, subsection 230-460(4) |2.152 |
|Item 1, subsection 230-460(5) |2.157 |
|Item 1, subsections 230-460(5) and (6) |2.153 |
|Bill reference |Paragraph |
| |number |
|Item 1, subsection 230-460(6) |2.161 |
|Item 1, subsection 230-460(7) |2.165 |
|Item 1, paragraph 230-460(8)(a) |2.167 |
|Item 1, paragraph 230-460(8)(b) |2.167 |
|Item 1, paragraph 230-460(8)(c) |2.167, 2.169 |
|Item 1, paragraph 230-460(9)(a) |2.171 |
|Item 1, paragraph 230-460(9)(b) |2.172 |
|Item 1, paragraph 230-460(9)(c) |2.173 |
|Item 1, paragraph 230-460(9)(d) |2.174 |
|Item 1, paragraph 230-460(9)(e) |2.176 |
|Item 1, paragraph 230-460(9)(f) |2.178 |
|Item 1, subsection 230-460(10) |2.177 |
|Item 1, subsection 230-460(11) |2.179 |
|Item 1, subsection 230-460(12) |2.181 |
|Item 1, subsection 230-460(13) |2.184 |
|Item 1, subsection 230-460(14) |2.191 |
|Item 1, subsection 230-460(15) |2.192 |
|Item 1, subsection 230-460(16) |2.195 |
|Item 1, subsection 230-460(17) |2.197 |
|Item 1, subsection 230-460(18) |2.198 |
|Item 1, subsection 230-465(1) |2.200 |
|Item 1, subsection 230-465(2) |2.203 |
|Item 1, subsection 230-465(3) |2.202 |
|Item 1, section 230-470 |1.49, 10.56, |
| |2.204 |
|Item 1, subsection 230-475(1), paragraph |2.209 |
|230-475(3)(b) | |
|Item 1, subsection 230-475(1), |2.210 |
|paragraph 230-475(3)(c) | |
|Item 1, subsection 230-475(3) |2.205 |
|Item 1, paragraph 230-475(3)(a) |2.207 |
|Item 1, paragraph 230-475(4)(a) |2.208 |
|Item 1, paragraph 230-475(4)(b) |2.209 |
|Item 1, section 230-480 |2.212, 3.89, |
| |6.40, 9.57 |
|Item 1, subsection 230-485(1) |11.88 |
|Item 1, subsections 230-485(3) and (4) |11.89 |
|Item 1, subsection 230-485(4) |11.99 |
|Item 1, subsection 230-485(5) |11.105 |
|Bill reference |Paragraph |
| |number |
|Item 1, paragraphs 230-485(5)(a) and (7)(a) |11.107 |
|Item 1, subsection 230-485(6) |11.92 |
|Item 1, subsection 230-485(8) |11.94 |
|Item 1, subsection 230-490(1) |11.109 |
|Item 1, subsection 230-490(2) |11.108 |
|Item 1, section 230-495 |5.56 |
|Item 1, section 230-500 |5.48 |
|Item 1, section 230-505 |3.43, 11.51 |
|Item 1, subsection 230-505(1) |3.44, 11.54 |
|Item 1, subsection 230-505(2) |3.48, 3.50, |
| |11.57, 11.58 |
|Item 1, subsection 230-505(3) |3.52 |
|Item 1, section 230-510 |10.80 |
|Item 1, sections 230-510 and 230-515 |1.92 |
|Item 1, paragraph 230-510(1)(b) |10.78 |
|Item 1, section 230-520 |1.91 |
|Item 1, section 230-525 |5.14, 5.24, |
| |12.68 |
|Item 1, section 230-530 |6.29 |
|Item 1, subsection 230-530(1) |6.37, 2.111, |
| |2.113 |
|Item 1, subsection 230-530(2) |2.111, 2.113 |
|Item 1, subsection 230-530(3) |2.111, 2.113 |
|Item 1, subsection 230-530(4) |2.111, 2.114 |
|Items 2 and 3 |7.38 |
|Part 2, item 37, definition of 'hedging |11.138 |
|activity' in subsection 121D(8) of the ITAA | |
|1936 | |
|Part 2, items 44 and 45, subsection |11.71 |
|160ZZX(2) of the ITAA 1936 | |
|Part 3, items 102 to 105 |1.94 |
|Part 3, subitem 104(2) |7.63 |
|Part 3, subitem 104(7) |4.167, 13.28 |
|Part 3, subitems 104(8) and (11) |6.27 |
|Part 3, subitem 104(10) |1.94 |
|Part 3, subitem 104(12) |7.64, 7.66 |
|Part 4, item 109, subparagraph |11.160 |
|775-270(2A)(a)(ii) | |
|Part 4, item 111, definition of a |11.140 |
|'qualifying forex account' in | |
|subsection 995-1(1) of the ITAA 1997 | |
|Item 5, subsection 775-270(1A) |7.56, 11.161 |
|Bill reference |Paragraph |
| |number |
|Item 6, Subdivision 775-F |7.41 |
|Item 6, section 775-305 |7.42 |
|Item 6, sections 775-305 and 775-315 |7.53 |
|Item 6, subsection 775-305(4) |7.34 |
|Item 6, section 775-315 |7.52 |
|Item 7, subsection 820-930(1) |2.100, 9.48 |
|Item 11, definition of 'Division 230 |11.40 |
|financial arrangement' in subsection | |
|995-1(1) of the ITAA 1997 | |
|Item 21, subsection 995-1(1) |2.70 |
|Item 28, definition of 'special accrual |4.102, 7.78, |
|amount' in subsection 995-1(1) of the ITAA |11.64 |
|1997 | |
|Item 31, subsection 6(1) |11.145, 11.151|
|Item 32, subsection 51AAA(2) of the ITAA |11.80 |
|1936 | |
|Item 33, paragraph 82KZLA(a) of the ITAA |11.11 |
|1936 | |
|Item 34, paragraph 96C(5A)(aa) of the |11.29 |
|ITAA 1936 | |
|Item 35, paragraph 102CA(2)(c) of the ITAA |11.25 |
|1936 | |
|Item 37, subsection 121EB(3) |11.72 |
|Items 38 to 40, section 128NBA of the ITAA |11.114 |
|1936 | |
|Item 40, subparagraph 128NBA(5)(d)(9)(ii) of|11.115 |
|the ITAA 1936 | |
|Items 41 and 42, definition of 'derivative |11.139 |
|transaction' in section 160ZZV of the ITAA | |
|1936 | |
|Item 43, subsection 160ZZW(1A) |11.69 |
|Item 46, subsection 262A(2AAC) |11.147 |
|Item 46, subsection 262A(2AAD) |11.149 |
|Item 47, paragraph 262A(3)(ca) |11.150 |
|Item 49, paragraph 389(ba) of the ITAA 1936 |11.29 |
|Item 50, paragraph 557A(c) of the ITAA 1936 |11.29 |
|Items 53 and 57, sections 10-5 and 12-5 |11.142 |
|Item 58, subsection 25-35(5) |11.143 |
|Item 59, subsection 25-85(4A) |11.30 |
|Item 60, note to section 29-90 |11.31 |
|Items 62 to 68, subsections 40-180(1), |11.143 |
|40-185(1), 40-300(1) and 40-305(1) | |
|Item 68, section 70-10 of the ITAA 1997 |11.39 |
|Items 69 and 70, sections 102-20 and 104-5 |11.144 |
|Items 70 to 75, subsections 110-25(1) and |11.143 |
|116-10(7) and sections 104-5 and 112-5 | |
|Bill reference |Paragraph |
| |number |
|Item 76, subsection 118-27(1) |11.40, 11.42 |
|Item 76, paragraph 118-27(2)(a) |11.44 |
|Item 76, subsection 118-27(3) |11.41 |
|Items 77 and 78, section 130-100 |11.136 |
|Item 80, paragraph 295-85(2)(a) |11.26 |
|Item 82, subsection 320-45(2) |11.27 |
|Item 85, paragraph 701-55(5A)(a) |12.21 |
|Items 85 and 89, subsections 701-55(5A) and |12.17 |
|715-375(2) | |
|Item 87, subsections 701-61(1), (2) and (4) |12.35 |
|Item 87, subsections 701-61(1) to (3) |12.34 |
|Item 88, subsection 705-30(3B) |12.53 |
|Item 89, subsections 715-375(3) and (4) |12.44 |
|Item 89, subsections 715-380(1) and (2) |12.55 |
|Item 89, subsections 715-380(3) and (4) |12.56 |
|Item 89, section 715-385 |12.65 |
|Items 90 and 91, item 3A in the table in |12.38, 12.42, |
|subsection 715-660(1) and item 1A in the |12.63 |
|table in subsection 715-665(1) | |
|Item 96, paragraph 701-55(5A)(a) |12.24 |
|Item 96, paragraph (a) of the definition of |12.30, 12.31 |
|'Division 230 starting value' in | |
|subsection 995-1(1) of the ITAA 1997 | |
|Item 96, paragraph (c) of the definition of |12.32 |
|'Division 230 starting value' in | |
|subsection 995-1(1) of the ITAA 1997 | |
|Item 99, section 715-380 of the Income Tax |12.57, 12.74 |
|(Transitional Provisions) Act 1997 | |
|Item 100 |11.159 |
|Item 100, subsection 45-120(2B) in Schedule |11.84 |
|1 to the TAA 1953 | |
|Subitem 103(1) |13.19, 13.23 |
|Subitems 103(2) and (3) |13.20 |
|Subitem 104(2) |13.24, 13.27 |
|Subitems 104(2) and (3) |13.25 |
|Sub-subitems 104(5)(a) and (b) |13.25 |
|Subitem 104(6) |13.26 |
|Subitem 104(8) |13.27 |
|Subitems 104(9) and (10) |8.37 |
|Sub-subitem 104(9)(a) |13.29 |
|Sub-subitem 104(9)(b) |13.29 |
|Sub-subitem 104(9)(c) |13.29 |
|Bill reference |Paragraph |
| |number |
|Sub-subitem 104(9)(d) |13.29 |
|Subitem 104(10) |13.31 |
|Subitem 104(11) |13.32, 13.49 |
|Subitem 104(12) |13.34 |
|Subitem 104(13) |13.40, 13.52 |
|Subitem 104(13), step 1 and subitem 104(18) |13.34 |
|Subitem 104(13), step 2 and subitem 104(18) |13.34 |
|Subitem 104(13), step 3 |13.34 |
|Subitem 104(13), step 4 |13.34 |
|Subitem 104(13), step 5 |13.34 |
|Subitem 104(13), step 6 |13.34 |
|Subitem 104(13), step 7 |13.35 |
|Subitems 104(14) and (15) |13.43, 13.48 |
|Subitem 104(14) |13.47 |
|Subitem 104(15) |13.47, 13.50 |
|Subitem 104(16) |13.51 |
|Subitem 104(17) |13.36, 13.54 |
|Subitem 104(19) |13.55 |
|Subitem 105(1) |13.56 |
|Subitem 105(2) |13.57 |
|Items 106 and 107, subsection 775-170(2) |11.154 |
|Items 107, 108, 110, 111 and 113 |11.156 |
|Item 108, subsection 775-195(9) |11.154 |
|Item 110, subsection 960-55(4) |11.154 |
|Item 110, subsection 960-60(6) |11.154 |
|Item 112, definition of 'qualifying forex |7.57, 7.58 |
|account' in subsection 995-1(1) | |
|Item 113, paragraph 77(1)(b) of the NBTS |11.158 |
|(TOFA) 2003 | |
-----------------------
[1] This is the interest rate (r) that satisfies the following
equation:
0 = -$1,000 + 40/(1 + r)1 + $50/(1 + r)2 + $80/1 + r)3
+ $1,100/(1 + r)4.
[2] This is the interest rate (r) that satisfies the following
equation:
0 = -$1,043.37 + $60/(1 + r)1 + $1070/(1 + r)2.
[3] It is assumed that the fair values as at 30 June, 30 September, 31
December and 31 March are the same as at 1 July, 1 October, 1 January and
1 April respectively.
[4] The AUD equivalents in Table 14.5 have been calculated on the basis
of the weighted average costs for each deposit and withdrawal.
[5] The numbers may not add up exactly due to rounding.
[6] This number is calculated by deducting the number in the third column
from the number in the second column.
[7] The section 230-175 running balance adjustment for the 1 January 2013
financial benefit is calculated as follows: AUD 400,000/0.86 - AUD
214,740 + AUD 235, 394 = AUD 14,982.
[8] AUD 256,410 is attributable to the re-exchange of the notional
principal, as explained above.
[9] The AUD gain or loss is calculated by adding the gains and losses
from the foreign currency leg (second column) and the gains and
losses from the Australian dollar leg (third column).
[10] These figures include running balance adjustment.
[11] These figures include running balance adjustment and AUD realisation
gain on the exchange of notional principal ($256,410).
[12] The numbers in this column are calculated by dividing the number in
the first column by the number in the second column.
[13] AUD15,167 = AUD 232,558 - AUD 217,391.
[14] - AUD 22,764 = AUD243,902 - AUD 266,667.
[15] AUD 256,410 is attributable to the re-exchange of the notional
principal, as explained above.
[16] -AUD 29,303 = AUD256,410 - AUD 285,714.
[17] The AUD gain/loss is calculated by adding together the foreign
currency leg gains and losses (column 2) and the Australian dollar leg
gains and losses (column 3).
[18] AUD 514,392 = AUD 266,667 (AUD translated gain 30 June 2013) +
AUD 232,558 (AUD translated gain 1 January 2013) + AUD 15,617 (AUD
running balancing adjustment 1 January 2013).
-----------------------
Elective hedging
Accruals
Elective retranslation
Elective fair value
Elective financial reports
Realisation
Elective methods
Non-elective methods
Step 1: You have a financial arrangement
None of the financial benefits are sufficiently certain.
At a particular time, some of the financial benefits are sufficiently
certain and some of the financial benefits are not sufficiently certain.
Bundle of cash settlable rights and obligations to financial benefits.
Yes
Step 2: What is the classification of the cash flows at this point in
time?
No
No
All financial benefits are sufficiently certain.
Yes
Yes
Yes
Yes
There is no sufficiently certain gain or loss.
There may be sufficiently certain particular gains or losses in addition to
the sufficiently certain overall gain or loss.
OR
There may only be sufficiently certain particular gains or losses.
A sufficiently certain overall gain or loss can be calculated.
It is the difference between the total sufficiently certain financial
benefits and the cost of the arrangement.
There is a sufficiently certain overall gain or loss.
It is the difference between the financial benefits that are received and
the financial benefit that are provided (cost) under the financial
arrangement.
Step 3: Is the gain or loss sufficiently certain or not? What is the gain
or loss?
Step 4: What is the period over which the gain or loss is allocated?
Step 5: What is the basis of allocation?
The sufficiently certain overall gain or loss is allocated over the life of
the arrangement.
The sufficiently certain overall gain or loss is allocated over the life of
the arrangement.
The gains and losses from the other financial benefits that are not
sufficiently certain may be recognised on a realisation basis.
The gains and losses arising from the financial benefits that become
sufficiently certain (ie, sufficiently certain particular gains and losses)
are allocated over the period to which they relate.
The gains or losses arising from the financial benefits which are not
sufficiently certain before they become due and payable or due and
receivable are recognised on a realisation basis.
Divide the period into equal intervals not greater than 12 months.
Allocate gain or loss to those intervals using a compounding accruals
method or another method that approximates the result from that method.
Parts of gains or losses so allocated are brought to account in the income
year in which the interval falls.
Divide the period into equal intervals not greater than 12 months.
Allocate gain or loss to those intervals using a compounding accruals
method or another method that approximates the result from that method.
Parts of gains or losses so allocated are brought to account in the income
year in which the interval falls.
Divide the period to which the gain or loss relates into intervals not
greater than 12 months.
Allocate gains or losses to those intervals using a compounding accruals
method or another method that approximates the result from that method.
Gains for losses so allocated are brought to account in the income year in
which the interval falls.
There is no accrual treatment for gains and losses recognised on a
realisation basis.
Gains or losses are taken into account under the realisation method in the
income year in which the gain or loss occurred.
$
Time
$
Has the taxpayer made a hedging financial election?
(section 230-315)
No
Yes
Is the financial arrangement a hedging financial arrangement?
(sections 230-325, 230-330 and 230-335)
U-The rules for hedging financial arrangements do not apply.
No
Yes
The gain or loss on the hedging financial arrangement is worked out under
sections 230-300 and 230-310.