Exposure Draft Tax Laws Amendment (Transfer of Provisions) Bill 2009

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1 Level 2 95 Pitt Street Sydney, NSW 2000 Telephone Facsimile tia@taxinstitute.com.au Website ABN December 2009 Manager Tax Design and Administration Unit Tax Design Unit The Treasury Langton Crescent PARKES ACT actrewrites@treasury.gov.au Dear Manager Exposure Draft Tax Laws Amendment (Transfer of Provisions) Bill 2009 This submission addresses the issues raised by the Exposure Draft Tax Laws Amendment (Transfer of Provisions) Bill 2009 (Exposure Draft) and the accompanying Explanatory Material (EM). The Taxation Institute of Australia (Taxation Institute) welcomes the transfer of the re-written provisions into the Income Tax Assessment Act 1997 (the 1997 Act) and the resultant consolidation and simplification of the legislation. However, in relation to the proposed provisions set out in the Exposure Draft, the Taxation Institute does have a number of submissions. In this regard, the Taxation Institute has no comments on Schedules 1, 4 and 5, and only minor comments in relation to Schedule 3 (included in paragraph 5 below). The Taxation Institute s main submissions are in relation to Schedule 2 and the commercial debt forgiveness provisions. These relate primarily to changes between the current provisions and the drafting of the proposed provisions and issues that arise as a result. The Taxation Institute also has some submissions in relation to leases of luxury cars. Unless otherwise indicated, all references to "current" provisions are to provisions of the relevant Schedules of the Income Tax Assessment Act 1936 (the 1936 Act). References to "proposed" provisions are to the proposed amendments set out in the Exposure Draft. General comments As the intention in transferring the provisions is not to change their meaning, notwithstanding any language changes, the Taxation Institute suggests that it may be appropriate to add a "note" at the end of the Guide to each of the proposed Divisions to the effect that the relevant Division represents a re-write of the former Schedule to the 1936 Act. This would assist in interpretation of the new provisions and in applying section 1-3 of the 1997 Act.

2 Forgiveness of commercial debts Definition of commercial debt The re-written provisions do not re-produce the definition of debt in current section (1). The reason provided in the EM is that the 1997 Act uses "debt" in its ordinary sense and therefore that general definition should be adopted for the purposes of the debt forgiveness provisions. Similarly, the term "commercial debt" is not defined (but is used in the heading to section Division and proposed section ). The Taxation Institute submits that, for the purposes of the debt forgiveness provisions, some guidance should be given to the meaning of the term debt. This could be by expanding section to reflect the previous wording of the definition of "debt" or by providing further guidance. In this respect, the Taxation Institute submits that the following amendment to proposed section would be appropriate: " Commercial debts (1) Subdivisions 245-C to 245-G apply to an enforceable obligation imposed by law on you to pay an amount to another entity if: (a) the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the obligation has been deducted, or can be deducted, by you; or (b) interest, or an amount in the nature of interest, is not payable by you in respect of the obligation but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or (c) interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-1(2)(a), (b) and (c)) that has the effect of preventing a deduction. Note: Paragraphs 8-1(2)(a), (b) and (c) prevent deductions for capital, private or domestic outgoings and for outgoings relating to exempt income or nonassessable non-exempt income. (2) An obligation to which Subdivisions 245-C to 245-G apply is a commercial debt. " Corresponding amendments to the remainder of the provisions would also be necessary to change the term "debt" to "commercial debt", and a definition included in section of the 1997 Act referring to proposed section Including the former definition as set out above is consistent with other provisions of the 1997 Act (see for example the definition of limited recourse debt in section ). It is also consistent with the objective of transferring the provisions in a manner that does not alter the meaning of the provisions but allows consistency with the drafting principles of the 1997 Act. In particular, it would allow for reliance on recent case law, including FCT v Tasman Group Services Pty Ltd 2009 ATC which gave due consideration to the meaning of the terms "debt" and "commercial debt" pursuant to the existing law. An exclusion of the definition of "debt" and "commercial debt" raises a number of concerns as to a potential change in the application of the provisions. The EM notes that the removal of the definition means that there is a possibility of unenforceable obligations coming within the 2

3 provisions. The Taxation Institute notes that reliance on the general definition of debt will raise questions as to the application of the provisions to: (a) Non-monetary debts: Generally debt is defined as: "An obligation to pay; A sum of money owed: Director of Public Prosecutions v Turner [1973] 3 All ER 124. A debt is a sum of money which is now payable or will become payable in the future by reason of a present obligation: debitum in praesenti, solvendum in futuro. It is a right which a creditor has to enforce by taking action in a court of law against the person who owes the money (the debtor)." (refer Encyclopaedic Australian Legal Dictionary). Refer also to the definition of "debt" provided by Menzies J in G E Crane Sales Pty Ltd v. FC of T (1971) 126 CLR 177: "Debts", in my opinion, mean moneys that the taxpayer is presently entitled to receive"; and to the definition of that term provided in TR 92/18 and GSTR 2002/2. However, doubt has been cast on whether a requirement to pay money is in fact necessary for a debt to exist. See for example GSTR 2001/6 paragraph 224 which extends the term for the purposes of the GST legislation to non-monetary consideration that has not been received. This question arises due to the removal of the words "obligation to pay an amount" in the current definition of debt. The Taxation Institute submits that the application of the provisions in these circumstances should be clarified. (b) Bills of exchange, promissory notes and amounts payable under guarantees and indemnities: Generally, these arrangements would not be considered to create or evidence a debt, notwithstanding they may result in an obligation to pay an amount. It has also been accepted by the ATO that implied contracts of indemnity are not sufficiently "debt like" (refer TR 96/14 at paragraph 31). The Taxation Institute submits that the application of the provisions to these arrangements should be clarified, and in particular, when such arrangements will be considered to be within the ordinary definition of "debt". This may be done by way of example in the EM. Non-equity Shares as Commercial Debts Proposed section extends the application of the provisions to non-equity shares. However, the re-write refers to non-equity shares issued by a company "to a shareholder" and states that the provisions apply as if the share were a debt owed by the company to "the" shareholder. To avoid any risk that this provision could be interpreted only to apply to shares acquired on original issue (as any secondary market purchaser of the shares would not be "the" shareholder to whom the shares were issued by the company) the Taxation Institute recommends that the words "to a shareholder" be removed from this provision. Accrued but unpaid interest The EM indicates that the intention in removing current section is that each outstanding accrued but unpaid interest amount is treated as a separate debt. If this is the intention, the Taxation Institute suggests that a 'note" to this effect be included in proposed section The exclusion of this provision rises a question as to whether a different outcome will arise on forgiveness of a debt in respect of which interest has been capitalised when compared with one in which interest remains outstanding an unpaid at the time of forgiveness. A question is also raised as to whether, if the underlying debt is a non-recourse debt for the purposes of the provision, the separate interest debt would also be non-recourse. In these circumstances, it is unclear whether the incurrence of the interest debt will be incurred "directly" in 3

4 respect of the financing of the acquisition, construction or development of property. This may be clarified by the inclusion of a note to proposed subsection (1). Forgiveness of a debt Proposed section brings forward the time at which the forgiveness of the relevant debt occurs. Under proposed section , forgiveness occurs at the time the entity subscribes for the shares. However, under current section (5), forgiveness occurs at the time the money is applied to reduce the debt. Although in practice this may not be significant, if this is unintended, the language of proposed section should reflect the existing provision in this respect. Further, in relation to this provision, it is our understanding that this provision is not intended to apply to a convertible note. This could be clarified by way of amendment to the provision or the inclusion of a note to that effect. In relation to types of forgiveness that the proposed provisions do not apply, the Taxation Institute acknowledges that proposed provisions re-instate the existing language in the current sections. However, in relation to proposed section (a), the use of the term "waiver" may be misleading. The Taxation Institute submits that it may be more accurate to draft this provision as "the forgiveness represents an act, transaction or event to which section 14 of the Fringe Benefits Tax Assessment Act 1986 applies". Gross forgiven amount - ordinary debts Proposed section calculates the "market value (considered as an asset of the creditor)" of the debt, as opposed to the "value (considered as an asset of the creditor)" under current section Although the current provisions deliberately use "value" in this context, notwithstanding the use of the term "market value" in other parts of current Division 245, from the explanatory memorandum to the original provisions, it appears that this change should have no effect. The Taxation Institute also suggests that the words "other than a non-recourse debt" be removed from the heading to proposed section It is our understanding that this provision is intended to apply to debts other than those to which proposed sections and apply and the amended heading would more accurately reflect this. The Taxation Institute also suggests including a note in proposed section stating that if a debt does not qualify for valuation under that provision proposed section will apply. Gross forgiven amount - non-recourse debts As referred to above, where an interest debt is treated as a separate debt for the purposes of the provisions, proposed section should clarify that it will be treated as a non-recourse debt where the underlying debt is subject to valuation pursuant to that provision. How that interest debt would be valued should however be clarified. Where the interest and underlying loan are treated as a single debt, the value may relatively easily be determined pursuant to proposed subsection (2). However, how the provisions operate where a creditor has recourse to a single asset in respect of multiple debts should be clarified. As a drafting note in relation to proposed section , the Taxation Institute recommends, for completeness, that the words "in respect of financing the acquisition" are replaced with the words "in respect of financing your acquisition" in order to reflect the requirement in current section that it is the acquisition, construction or development of property "by the debtor". The Taxation Institute notes that the redraft of proposed section is particularly effective and overcomes the main issues surrounding the drafting of current section

5 Offsets for calculation of gross forgiven amount The Taxation Institute considers that proposed section (2)(b) should also list, as an alternative, the situation where any property referred to in column 2 of item 2 of the table cannot be valued. This accurately reflects current section (2)(b) and appears necessary as, without this reference, the conditions for the application of item 3 of the table may not be met, and the calculation for the purposes of Item 2 may not be able to be performed. Application of net forgiven amounts Proposed section sets out the CGT assets relevant for the cost base reduction provisions. This proposed section should be amended to ensure that, as with current section and following, only assets that are CGT assets at the beginning of the forgiveness income year are reduced. Definitions and consequential amendments Consideration should be given to the inclusion of a reference to proposed section in the proposed definition of "forgiveness" in section In relation to the interaction of the proposed Division with the TOFA rules, the Taxation Institute notes that section contains some conceptual problems, as an assessable amount must first be determined in order to calculate the net forgiven amount of the debt. This issue has been raised in the NTLG TOFA working group. This is an issue that requires resolution, and it would be preferable if a solution could be included in the redraft of section as a part of this package of amendments. Consequential amendments may also be required to section (2)(e) to replace the reference to the current provisions. Opportunities for reform The Taxation Institute also notes that the opportunity could be taken in re-writing these provisions to clarify the interaction of these provisions with other parts of the 1997 Act that cause some difficulty or anomalous outcomes. In particular: Thin Capitalisation - where a debt is forgiven part way through a tax year, the amount of the forgiven debt appears to be double counted. Briefly, the opening balance of the debt would normally be taken into account when calculating the "average value" of the taxpayer's debts for the purposes of the thin capitalisation rules in Division 820. Where adverse consequences for a taxpayer arise under proposed Division 245 in respect of the forgiveness of the debt, an adjustment to the calculations for the purposes of Division 820 also seems appropriate. Consolidation - clarifying the interaction of the proposed Division 245 with the consolidation regime in Part 3-90 could be clarified such that the provisions are capable of applying to produce an appropriate outcome on a natural reading of the words. Leases of luxury cars A number of terms are used throughout proposed Division 242 without definition in section These include "accrual amount" and "end time". The EM explains that this is a deliberate course taken as the re-write incorporates those concepts directly into the operative provisions. However, the use of these terms are used in the provisions following those in which the meaning is explained, without reference back to the defining provision, is confusing for practitioners and users of the legislation as there is no immediate indication as to where to look for the definition. For example, when considering only the position of the lessee and deductions allowable to that entity, the amount of the deduction is expressed to be the "accrual amount" (proposed section ). 5

6 This term is used without definition in this proposed provision and it is not immediately obvious to seek out the definition in proposed section It would be preferable to define these terms in section as having the meaning given in the operative provisions or alternatively include a note in the later provisions in which those terms are used that refers to the earlier operative provision containing the definition. If you would like to meet with representatives from the Taxation Institute or require any further information or assistance in respect of our submission, please contact the Taxation Institute s Tax Counsel, Angie Ananda, on Yours faithfully Joan Roberts President 6