After the many detailed leaks in the last few days and the obvious political imperatives of an election year, this year’s Budget held few surprises for business.
The substantial Budget surplus led principally to significant increases in Government spending programs, accompanied by a disparate collection of modest tax measures. The headline tax items were obviously the personal tax measures. The significance of the other tax measures can be adequately grasped from the fact that many announcements, even though retrospective, are estimated to carry almost no tax cost or generate almost no revenue.
Along with the handful of new measures, the Government also continued its tradition of using the Budget as an opportunity to re-announce existing proposals, now even re-announcing measures that are already in Bills before Parliament!
II. Personal Tax Measures
The Budget, once again, announced significant reductions to personal tax, this time by increasing the relevant thresholds. The increased thresholds will apply in two stages, commencing on 1 July 2007 and on 1 July 2008.
The current and the new tax rate schedules for Australian resident individuals are set out below:
Table 1 - Current tax rates and income thresholds 2006-07
|Tax Rate (%)||Income level ($)|
|0||0 – 6,000|
|15||6,001 – 25,000|
|30||25,001 – 75,000|
|40||75,001 – 150,000|
|45||150,001 and above|
Table 2 - Proposed tax rates and income thresholds for 2007-08
|Tax Rate (%)||Income level ($)|
|0||0 – 6,000|
|15||6,001 – 30,000|
|30||30,001 – 75,000|
|40||75,001 – 150,000|
|45||150,001 and above|
Table 3 - Proposed tax rates and income thresholds for 2008-09
|Tax Rate (%)||Income level ($)|
|0||0 – 6,000|
|15||6,001 – 30,000|
|30||30,001 – 80,000|
|40||80,001 – 180,000|
|45||180,001 and above|
From 1 July 2007, a range of other changes for individuals will also be made:
• The Medicare levy low income threshold will increase to $16,740 for individuals, $28,247 for families and $21,637 for pensioners.
• There will be a $445 increase in the maximum dependent spouse rebate to $2,100 for the 2007-08 and later income years. It will be completely phased out when the spouse has a separate net income of $8,681 or more.
III. Business Tax Measures
A. Changes to company loss recoupment rules
There are three aspects to these proposed amendments:
• first, the $100m cap on access to the same business test (SBT) will be removed with retrospective effect from 1 July 2005;
• secondly, there will be some relatively minor improvements and clarifications to technical aspects of the company loss recoupment rules, again with retrospective effect; and
• thirdly, an amendment is proposed to the loss duplication rules.
1. Removal of the $100m SBT cap
A company can utilise certain tax attributes (including revenue losses, capital losses and bad debts) if the company passes the continuity of ownership test (COT), or, in cases where the COT might be failed, the company passes the SBT.
However, in 2005 a cap was imposed so that companies were unable to utilise the SBT if the company’s “total income” for the income year exceeded $100m. The imposition of this cap was seen as a trade-off for the simultaneous relaxation of various aspects of the COT.
But now its “back to the future” and the $100m cap is to be removed with effect from 1 July 2005. The retrospective application of this amendment indicates that the $100m cap will, in effect, never have had any application. This may lead some companies to revisit the availability of losses (and other tax attributes) in the intervening income years.
2. Improvements and clarificationsThree amendments are proposed “to reduce uncertainty and ensure that outcomes under the rules are consistent with policy intent”.
(a) COT and multiple classes of shares
Broadly, a company will pass the COT if a majority of the rights to voting, dividends and capital are held by the same persons during the tested period.
Applying the COT (ie, quantifying the percentage of voting, dividends and capital rights held by a particular person) is often difficult if the tested company has more than one class of shares on issue, as rights may vary between share classes. For example, it is difficult to identify where the majority of rights to dividends are held if there are shares carrying preferential rights to dividends.
Clarification of these issues is long overdue. Whether the amendments will ultimately make COT easier to pass will depend on the detail of the amending legislation. The proposed amendments are to apply retrospectively from 1 July 2002. Again, this may lead some companies to revisit the availability of losses (and other tax attributes) in the intervening income years, provided they are not out of time to amend.
(b) Measuring voting power
Certain shareholders may have differential voting rights in relation to particular matters. In those circumstances, it is difficult to assign a single percentage to their voting rights for the purposes of applying the COT. The proposed amendment will clarify that the only relevant matter for COT purposes is the person’s right to vote in a poll for the election of directors of the company. This proposed amendment is to apply from 1 July 2007.
(c) SBT and entry history ruleThis is a highly technical amendment designed to rectify some difficulties in the existing provisions. The purpose of the amendment is to ensure that the “entry history rule” will be turned off in applying the SBT to the head company of a consolidated group. This means that the activities carried on by a joining entity before joining the group will not, of themselves, cause the head company to fail the SBT. This amendment will apply from 1 July 2002.
3. Amendments to the loss duplication rulesTechnical amendments were announced to the inter-entity loss duplication rules. In broad terms, these rules are designed to prevent the duplication of losses within majority owned groups of companies.
At present, the rules assume that the loss company’s losses are also reflected in the value of the shares or debt issued by the loss company and held by the shareholder or creditor. The Budget proposes that, in the case of widely held entities, these rules will now only apply where the entity’s losses are actually reflected in the value of shares or debt held in the widely held entity. The amendments apply from 1 July 2002.
B. Changes to ConsolidationOne of the surprises in the Budget was the smorgasbord of detailed changes to the consolidation system. The Government has obviously taken the opportunity presented by the Budget to release a laundry list of changes, some of which will prove to be quite significant especially in an M&A context.
1. Restructuring of consolidated groups containing an ADITaxation impediments to the restructuring of authorised deposit-taking institutions (ADIs) involving the appointment of a non-operating holding company as the head company of the consolidated group, will be removed with effect from 1 July 2007.
Currently, if a consolidated group headed by an ADI were to restructure and appoint a non-operating holding company as the head company of the group, the ADI would become a subsidiary company and would not be able to issue preference shares outside the group.
The measure will ensure that ADIs, as subsidiary members of a group, can continue to issue certain preference shares to non-group members and maintain their tax position. The measure will also ensure that ordinary shareholders who dispose of their shares in an ADI, in exchange for shares in the non-operating holding company, can obtain a capital gains tax roll-over.
2. Changes to depreciation ratesThe existing consolidation rules provide that a head company of a consolidated group is taken to acquire the depreciable assets of a joining entity at the joining time.
It is proposed to amend the head company’s acquisition time for such assets to the time that the assets were acquired by the joining entity. The change will take effect from 8 May 2007.
A significant consequence of this change is that a head company will not be able to apply the 200% diminishing value uplift to assets of a joining entity that were acquired by the joining entity prior to 10 May 2006.
3. Straddle contractsThe CGT timing rule in relation to disposals of assets under a contract currently applies to the disposal of a CGT asset where the period between the date of contract and settlement straddles the joining or leaving time of that subsidiary. That rule gives rise to the following issues:
• where a subsidiary contracts to sell a CGT asset while a member of the group, but the contract does not settle until after the subsidiary leaves the group (referred to as an exit-sell case), a capital gain would be recognised by the head company even though the head company would not own the subsidiary at the time the sale was completed; and
• where, in a takeover situation, a purchaser did not want to acquire a particular asset of the target and the purchaser contracts, prior to effecting the takeover, for the asset to be sold to a third party, it was unclear whether the cost base of the asset would be reset, as the CGT event would be taken to occur prior to the target’s joining time and the application of the cost-setting rules.
These issues will be addressed by the modifications announced in the Budget.
The CGT rules will be modified so that, where an entity enters into a contract to sell a CGT asset prior to joining or leaving a consolidated group, the CGT event will be taken to occur at settlement.
In the exit-sell case, this will mean that the subsidiary, and not the head company, will make the capital gain or loss. This will remove the need for the concession allowed by the ATO to permit a head company to ignore the duplication of the capital gain made on the sale of the leaving entity’s asset that could arise on the sale of the shares in the leaving entity via the application of the cost setting rules on exit.
In the takeover case, this will ensure that the asset will be treated as being owned by the target when it joins the purchaser’s group, as the group will not be treated as selling the asset until the contract with the third party purchaser settles.
The changes announced in the Budget will only apply to disposals of CGT assets under contracts entered into after 8 May 2007.
4. Modifications to the tax cost setting rules
The Budget measures also include a series of technical changes to the cost setting process.
(a) Use of accounting principles
The tax cost setting rules will be modified with effect from 1 July 2002 to insist that the same accounting policies and principles used in the joining entity’s financial statements must be used in the allocable cost amount calculations (where those calculations refer to accounting concepts). This proposed change is broadly consistent with the approach previously adopted by the ATO in a Taxation Ruling and is generally adopted by the majority of taxpayers.
(b) Valuation of liabilities
A number of technical amendments to the treatment of liabilities under the tax cost setting rules have been proposed, some with effect from 1 July 2002. The proposed changes address long standing uncertainties and given the technical nature of the amendments, the draft legislation will be keenly awaited to determine its impact.
(c) Treatment of inherited deductions
The tax cost settings rules will be modified with effect from 1 July 2002 to ensure that inherited deductions, most commonly building allowance, relating to expenditure on certain assets acquired on, or constructed before, 13 May 1997 will not affect the cost calculations on entry or exit. This proposed change is consistent with the administrative relief previously provided by the ATO in the Consolidation Reference Manual.
(d) Phasing out over-depreciation adjustments
The over-depreciation adjustment to the allocable cost amount will be modified so that a joining entity will need to look only at the 5 years of dividend history immediately prior to the joining time to determine whether the adjustment should apply. This change will apply to entities that join a consolidated group or MEC group after 8 May 2007. The effect of this change is to phase out the over-depreciation adjustment so it will cease to apply from 1 July 2009.
(e) Units held in cash management trusts
Units held by a joining entity in a cash management trust that have a market value equal to their face value will be treated as retained cost base assets, with effect from 1 July 2002. The tax cost setting amount will be the face value of the units just before the joining time.
This proposed change reverses the position stated in an existing Taxation Determination and will avoid the unnecessary compliance costs associated with daily cash withdrawals triggering capital gains and losses.
5. Doubtful Debts
Currently, a capital gain arises when an entity joins a consolidated group if the allocable cost amount (ACA) for the joining entity is less than the sum of the tax cost setting amounts (generally the face value) of the entity’s retained cost base assets (including doubtful debts). For example, assume a joining entity whose only asset is an AUD receivable of $100 which has a market value of $80. If the shares in the joining entity are acquired for $80, a capital gain of $20 arises.
A modification will be made to reduce the capital gain by the difference between the market value and the face value of doubtful debts held at the joining time, but not beyond nil.
The tax cost setting amount for the doubtful debt will be reduced by an equivalent amount.
This change will apply to entities that join a consolidated group or MEC group after 8 May 2007.
6. Removal of capital gain arising from discharging liabilities
A capital gain arises where a liability that was taken into account in the ACA calculation for a joining entity at the joining time is realised for a different amount at a later time. The difference between the amount recognised in the accounts and the realised amount would give rise to capital gains and losses. This rule caused a significant compliance burden for taxpayers as all accounting provisions had to be monitored.
The rule which necessitates monitoring liabilities has been removed. The changes apply from 8 May 2007.
7. Trusts entering and leaving groups
Under current law, there are no rules to apportion the net income of a trust where the trust joins or leaves a consolidated group during an income year. Therefore, it is possible for the head company of a consolidated group to be taxed on the entire net income of a trust for an income year even though the trust has only been in the head company’s consolidated group for part of the year.
The consolidation rules will be amended so that the proportion of the trust’s net income that the head company of a consolidated group will be taxed on will reflect an appropriate share of that trust income.
These changes will apply from the commencement of the 2007-08 income year.
8. Companies with substituted accounting periodsUnder the concessional rules operating during the transition to consolidation, the ACA of certain entities was increased to include untaxed undistributed profits at the formation time. The concession was available for consolidated groups that formed before 1 July 2003, or on the first day of the first income year of the head company starting after 30 June 2003 (provided that day was before 1 July 2004).
Therefore, some companies with a substituted accounting period (SAP) of greater than 12 months could miss out on the concession, even if they formed a consolidated group prior to 1 July 2004, as the first day of their first income year starting after 30 June 2003 did not fall within the period 1 July 2003 to 30 June 2004.
The announcement in the Budget will allow companies with a SAP that elected to form a consolidated group in the period 1 July 2003 to 30 June 2004 to have access to the concession. This measure will apply from 1 July 2002.
9. Extension of single entity rule and entry history rule
Currently, the single entity rule and the entry history rule only apply for the specified “core purposes”. Broadly, these core purposes are calculating the income tax liability and tax losses of the head company and the subsidiary members of the consolidated group.
The single entity rule and the entity history rule will be extended to the shareholders of the head company for the purpose of applying:
• the CGT discount rule – the amendment will modify the current rule which removes the CGT discount on a disposal of membership interests in an entity if a majority of the underlying assets of the entity have not been held for 12 months; and
• pre-CGT membership interests – the amendment will modify the current rule which treats pre-CGT membership interests in an entity as acquired post-CGT if the entity owns predominantly post-CGT assets.
The change will apply from 8 May 2007.
10. Blackhole expenditure of MEC groups
CGT rules currently include in the cost base of an asset certain expenditure incurred by the head company of a consolidated group arising from disregarded intra-group transactions. This rule will be extended to apply to expenditure incurred by a head company of a MEC group.
This change will apply to CGT events which happen on or after 1 July 2005, which is the commencement of the revised blackhole rules.
C. Corporate finance
1. Finance leases
The Government announced that it will not proceed with the proposed reforms to the taxation treatment of finance leases between taxable entities.
The Final Report of the Review of Business Taxation (RBT) had recommended in 1999 that some types of finance leases should be treated as loans for tax purposes. The consequence of such treatment would have been that the lessor would split lease receipts into principal and interest, with any tax depreciation allowances to be claimed by the lessee, who would be regarded as the owner for tax purposes. For assets with relatively high tax depreciation allowances, the lessor’s tax position would be worse from a timing perspective, but the lessee would be in a better position – assuming it could actually use the tax deductions.
The Government gave “in-principle” support, in 1999, to many of the RBT’s recommendations. However, the details of just how finance leases were to be treated did not emerge until January this year, when the Government released a revised exposure draft (ED) of proposed legislation dealing with the remaining reforms to the Taxation of Financial Arrangements (TOFA). As regards finance leases, two things became clear in the ED. First, the ED evidenced an intention to actually change the rules in this area. After a hiatus of more than 7 years from the time of the “in-principle” support of the RBT recommendations, it wasn’t clear, before the ED was released, whether or when there would be any changes at all. Secondly, the leasing proposals in the ED were in fact much more wide-sweeping than those recommended by the RBT. That is, a significantly wider range of lease transactions would have been impacted by the ED’s proposals than had been anticipated in the RBT’s report.
The Budget announcement can be seen as a response to the strenuous lobbying which has been in train since the release of the TOFA ED in January. As a result, lessors will remain the tax owners of assets leased to taxable lessees. (Different rules have always applied to some types of leases involving tax exempt lessees.) Accordingly, apart from hire purchase contracts (see below), lessors and not lessees will continue to claim tax depreciation and other tax allowances referable to asset ownership. In a competitive leasing market, the benefits of the tax allowances claimed by the lessor should flow through to a lessee through lower leases rentals.
If the Government had persisted with the finance lease proposals in the TOFA ED, this may have disadvantaged small business and start-up companies. Such entities may not have had sufficient taxable income so as to have been able to immediately use any tax deductions arising, should they have been deemed to the tax owners of the assets.
Although the Budget is silent on this point, presumably the Government intends to retain the current distinction between finance leases and hire purchase contracts. That is, tax law already treats the financier under a hire purchase arrangement as a lender, and therefore not entitled to tax depreciation and other tax allowances. The distinction between hire purchase and finance leasing contracts depends on the precise terms of the arrangement, including whether the party receiving the benefit of the finance (e.g. the lessee or hirer) has a right or option to acquire the relevant assets.
2. Thin capitalisation
The Budget includes two measure that will affect the application of the thin capitalisation rules.
(a) Amendment to the application of “excluded equity interests”
First, the Budget provides that the definition of “excluded equity interest” will be amended to ensure that the rules operate as intended with effect for income years beginning on or after 1 July 2002.
“Excluded equity interests” are deducted from the assets of an entity for the purpose of calculating its safe harbour for thin capitalisation. An entity’s maximum allowable debt is therefore decreased to the extent that it holds excluded equity interests.
The concept of an “excluded equity interest” was an “integrity measure” to ensure that issuers could not artificially inflate their allowable debt amounts by issuing equity interests before the relevant valuation day and redeeming them shortly thereafter. The intention behind “excluded equity interests” was not to prevent genuine long term equity interests from inclusion in an entity’s safe harbour calculation, however, the wording of the definition fails to distinguish between long-term and short-term equity interests.
The Budget proposes to remedy this technical failing. It may also provide some relief to start-up companies for whom the current provision makes all new equity issued by the entity “excluded equity interest” in the entity’s first year of existence.
b) Extension of accounting standard transitional arrangements
The transitional period during which thin capitalisation reporting entities may elect to use accounting or prudential standards that applied prior to 1 January 2005 in lieu of the Australian International Financial Reporting Standards (A-IFRS) has been extended by one additional year. Affected entities may now make up to four consecutive annual elections to use the pre-existing accounting or prudential standards commencing in the first income year beginning on or after 1 January 2005. For entities with a 30 June year end, this would be for income years up to and including the tax year ending 30 June 2009.
A-IFRS has an impact on the application of the thin capitalisation rules as the result of its more conservative approach to net asset value. In particular, under A-IFRS, the existence of certain assets such as intangibles would be removed and the value of others assets may be significantly reduced as the result of impairments. As well, in certain transactions, the application of business combination accounting may also reduce the value of goodwill. The extended transitional period is meant to provide additional time for Treasury to consult with industry and to prepare financial models to determine an appropriate long term response to the effect of A-IFRS on thin capitalisation outcomes.
In particular, though it is not reflected in the Budget, we understand that Treasury is contemplating broader changes to the thin capitalisation regime in relation to the introduction of A-IFRS which are understood to possibly include a revised ratio to be applied for the purposes of the safe harbour test (currently a ratio of 3:1) and a revision of valuation methods. In addition to the A-IFRS related amendments, it is understood that Treasury is also contemplating changes to the arm’s length debt test to make it more “user-friendly” by aligning the test with market conventions rather than a notional arm’s length borrowing.
D. Research and development
The Budget re-announces that the premium 175% research and development tax concession will be extended to allow the Australian subsidiaries of multinational companies to claim deductions for certain R&D expenditure, even though the resulting intellectual property is held outside Australia. The current 125% R&D concession will not be changed, meaning that the relaxed beneficial ownership provisions will only benefit businesses to the extent that they increase their R&D expenditure.
These measures had already been announced in a Press Release by the Minister for Industry, Tourism & Resources (1 May 2007).
E. Restructuring stapled entities
The Government has reconfirmed a previous announcement by the Assistant Treasurer of the Government’s intention to allow stapled entities (eg Australian listed property groups) to restructure by interposing a head trust between the investors and the stapled entity.
The legislation will be amended to provide for CGT roll-over to investors at the time of the restructure.
In addition, Division 6C will be amended to ensure that the interposed head trust is not taxed as a company.
F. Venture capital
The eligibility requirements for concessional tax treatment for foreign residents investing in “venture capital limited partnerships” (VCLPs) and “Australian venture capital funds of funds” (AFOFs) will be further relaxed, with effect from the 2008 income year. Some of the measures announced in the Budget are already contained in Tax Laws Amendment (2007 Measures No. 2) Bill 2007, which was introduced into the Parliament in March 2007.
The concessional tax treatment for foreign resident investors will be extended so that up to 20% of the capital of a VCLPs or AFOFs may be invested in companies and unit trusts that are not located in Australia. In addition, to ensure that “early stage venture capital limited partnerships” invest in new ventures, they will be precluded from acquiring significant amounts of pre-owned assets.
The Budget proposes several changes to current superannuation law.
A. Extending the small superannuation fund CGT roll-over on marriage breakdown
The Government has announced an extension of the CGT rollover relief for small superannuation funds following a marriage breakdown.
Under the current rules, CGT rollover relief is available where benefits are transferred to another fund pursuant to the Family Law Act. The existing rules provide, subject to satisfaction of the relevant conditions, that a capital gain or loss the transferor trustee makes is disregarded in these circumstances.
The amendments will allow an in-specie transfer of all the assets to which the departing spouse is entitled without triggering a capital gain or loss for the fund at the time of transfer.
Interestingly, the current rules seek to preserve a distinction between pre- and post-20 September 1985 assets, a distinction of no practical relevance to complying superannuation funds. Perhaps the opportunity may be taken to address this anomaly in the amendments introduced to effect this extended concession.
B. Transitional arrangements for non-concessional contributions by 30 June 2007
The Government has reiterated a previously announced measure allowing persons who were aged 64 (or 74 if the work test is met) at any time between 10 May 2006 and 5 September 2006 to make non-concessional contributions toward the $1m limit until 30 June 2007. The ability of these people to make contributions toward the $1m non-concessional limit would have been restricted or precluded after their 65th (or 75th) birthday.
There were a few, minor GST-related amendments announced in the Budget. Two measures involved raising thresholds from 1 July 2007 for:
• compulsory registration - entities will only be required to register when their annual turnover exceeds $75,000 (up from $50,000) or exceeds $150,000 for non-profit bodies (up from $100,000); and
• obtaining tax invoices - tax invoices will only be required for purchases over $75 (excluding GST), up from $50.
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