BILLS DIGEST NO. 95, 2015–16              1 March 2016

Tax Laws Amendment (Norfolk Island CGT Exemption) Bill 2016

Jaan Murphy
Law and Bills Digest Section 

Date introduced: 11 February 2016

House:  House of Representatives

Portfolio: Treasury

Commencement: Sections 1 to 3 commence the day the Bill receives the Royal Assent. Schedule 1 will commence on 1 July 2016 immediately after the commencement of the Tax and Superannuation Law Amendment (Norfolk Island Reforms) Act 2015

Links: The links to the Bill, its Explanatory Memorandum and second reading speech can be found on the Bill’s home page, or through the Australian Parliament website.

When Bills have been passed and have received Royal Assent, they become Acts, which can be found at the ComLaw website.

Purpose of the Bill

The purpose of the Tax Laws Amendment (Norfolk Island CGT Exemption) Bill 2016 (the Bill) is to amend the Income Tax Assessment Act 1997 (the ITAA 1997) and the Income Tax (Transitional Provisions) Act 1997 (the ITTPA 1997) to exempt assets acquired before 24 October 2015 by Norfolk Island resident taxpayers from Capital Gains Tax (CGT).[1]

Background

Norfolk Island was accepted as an Australian external territory in 1913. Under arrangements introduced in 1979 Norfolk Island has had partial self-government in which the Norfolk Island Government is required to deliver many federal, state and local services. Historically, Australian taxation, migration, health and welfare services did not extend (or only partially extended) to Norfolk Island.[2]

As noted in the Minister’s second reading speech, various ‘longstanding issues’ faced by the residents of Norfolk Island have been explored in various reports and parliamentary inquiries over a 35-year period.[3] The most recent of such reports was the report by the Joint Standing Committee on the National Capital and External Territories (the Committee) titled ‘Same Country: Different World’ tabled in October 2014 (the Report).[4] The Report’s recommendations were made on a bipartisan basis.

Background information to the recommendations made by the Committee and the first tranche of reforms designed to give effect to them is discussed in the Bills Digests to the Norfolk Island Legislation Amendment Bill 2015 and the Tax and Superannuation Laws Amendment (Norfolk Island Reforms) Bill 2015.[5] Importantly, a previously proposed reform of integrating Norfolk Island into the Australian tax and social security systems was accepted by both the Norfolk Island Government and the Committee.[6] In addition, during the 2013 election campaign the Coalition made an election commitment to integrate Norfolk Island into Australia’s taxation, social security and health arrangements.[7]

Committee consideration

Senate Standing Committee for the Scrutiny of Bills

The Senate Standing Committee for the Scrutiny of Bills had no comment on the Bill.[8]

Policy position of non-government parties/independents

The Labor Opposition has previously indicated support for integrating Norfolk Island into the Australian taxation system. The Shadow Parliamentary Secretary for External Territories has previously stated:

You have rightly pointed out that the Australian government will not be introducing welfare benefits without the obligation of the Australian taxation system, and we concur with your position. We also concur with your observation that Australians should be treated the same, no matter where they live.[9]

The policy position of other non-government parties/independents was not known at the time of writing.

Position of major interest groups

In relation to the Bill, no public statements by major interest groups have been found. However, the Norfolk Island Government, members of the Legislative Assembly and Norfolk Island residents and business people previously provided their views on the Report. Most agreed in principle on the need for reform, particularly in the areas of the economy, infrastructure and the extension of Australian taxation, social security and health benefits to Norfolk Island.[10]

Financial implications

The Government notes that the financial impact of the Bill will be ‘negligible cost to revenue over the forward estimates period’.[11]

Statement of Compatibility with Human Rights

As required under Part 3 of the Human Rights (Parliamentary Scrutiny) Act 2011 (Cth), the Government has assessed the Bill’s compatibility with the human rights and freedoms recognised or declared in the international instruments listed in section 3 of that Act. The Government considers that the Bill is compatible.[12]

Key issues and provisions

Previous exemptions for Norfolk Island residents from income and capital gains tax

In simple terms, under the existing CGT regime any net capital gain:

•       arising from a CGT event and

•       related to a CGT asset acquired (generally) after 20 September 1985

is included in a taxpayer’s assessable income for the income year, and taxed at the prevailing rate set by the Income Tax Rates Act 1986.[13]

Currently Division 1A of Part III of the Income Tax Assessment Act 1936 (ITAA 1936), exempts certain Norfolk Island residents from income tax for their income sourced from Norfolk Island and from outside Australia.[14]

As a result of being exempted from income tax, Norfolk Island residents are also currently exempted from CGT (at least in relation to capital gains sourced from the sale of CGT assets from Norfolk Island or from outside Australia).

Recent reforms

The Tax and Superannuation Laws Amendment (Norfolk Island Reforms) Act 2015 (the 2015 Act) will repeal Division 1A of Part III of the ITAA 1936 on 1 July 2016.[15] The 2015 Act also amended the ITTPA 1997 and ITAA 1997 to provide that the Australian CGT regime will fully apply to capital gains or losses on CGT assets made by Norfolk Island residents. However, implementing a CGT for Norfolk Island residents required a nominated start date, so that capital gains or losses can be calculated from that date. The 2015 Act provides that that date is 1 July 2016.[16]

As a result, all CGT assets held by Norfolk Island residents at the end of 30 June 2016 were to be taken on 1 July 2016 to have been acquired for their market value on that day.[17]

Concerns raised by the recent reforms

The Government notes in the Explanatory Memorandum that concerns about the CGT reforms were raised by the Norfolk Island community.[18] As a result, the Government ‘announced that it would exempt assets held by Norfolk Island resident taxpayers from CGT if they were acquired before 24 October 2015’.[19]

The new CGT exemption from capital gain tax

Under the current Australian CGT regime, capital gains or losses made on assets acquired before 20 September 1985 (commonly referred to as ‘pre-CGT assets’) are usually disregarded in determining a taxpayer’s net capital gain or loss for an income year. In other words, pre-CGT assets are generally exempt from CGT.[20]

The Bill continues to impose CGT on Norfolk Island residents from 1 July 2016, but modifies the circumstances in which it will apply from those proposed by the 2015 Act.

Items 3 to 5 of Schedule 1 of the Bill provide that any capital gains or losses on CGT assets acquired by Norfolk Island residents before 24 October 2015 will be disregarded in determining their income tax liability. In other words, the proposed amendments will mean that, as is the case with pre-CGT assets on the Australian mainland, generally any such capital gain or loss will not be included in a taxpayer’s assessable income.

In addition however, the Bill will provide another exemption to Norfolk Island residents not available to Australian taxpayers, in relation to recording keeping requirements (discussed below).

Exemption from recording keeping requirements

Subject to certain limited exceptions, Division 121 of the ITAA 1997 imposes a requirement on every taxpayer to ‘keep records of every act, transaction, event or circumstance’ that could ‘reasonably be expected to be relevant’ to working out whether a capital gain or loss was made from a CGT event.[21]

Put simply, in order to prove that an asset is a pre-CGT asset (and therefore exempt from CGT) a taxpayer must be able to produce relevant records or documentation that prove when that asset was acquired.[22] As noted by the Australian Tax Office:

You need to establish exactly when you acquired your CGT asset because:

•CGT doesn't apply if you owned it before CGT started on 20 September 1985 (though major improvements to a property since may be subject to CGT)

•the rules about how you work out the cost base have changed over time

•how long you have had it may affect how you work out your capital gain.

Generally, the time you acquire a CGT asset (your acquisition date) is when you become its owner, most commonly because you have bought it or received it as a gift or it was transferred to you.[23] (emphasis added)

The Bill proposes to exempt Norfolk Island residents from the requirement to keep records of when an asset was acquired that applies to Australian mainland taxpayers. Proposed subsection 102-25(3) of the ITTPA 1997 provides that despite Division 121 of the ITAA 1997 (discussed above), a Norfolk Island resident is not required to keep records of when a CGT asset was acquired. Proposed subsection 102-25(4) then provides that Norfolk Island residents may not choose whether or not to apply the record keeping rule. The Explanatory Memorandum notes that:

This is intended to prevent any tax avoidance that may arise by claiming capital losses but disregarding capital gains.[24]

Importantly however, the exemption from the record keeping requirement noted above is not open-ended. This is because proposed paragraphs 102-25(2)(a) and (d) and proposed subsection 102-35(3) of the ITTP 1997 provide that the exemption will only be available to an entity that was a resident of Norfolk Island on or before 23 October 2015 that acquired a CGT asset on or before 23 October 2015 and had a CGT event happen in relation to that asset immediately before 24 October 2015.

As a result, the record keeping requirements imposed by Division 121 of the ITAA 1997 will apply to Norfolk Island residents in relation to CGT assets acquired on or after 24 October 2015.

Is such an exemption justified?

‘Horizontal equity’ is an important concept in designing tax laws. Horizontal equity is the notion that taxpayers in the same position should pay the same amount of tax, or, put another way, ‘horizontal equity demands equal treatment for people in similar circumstances’.[25] The South Australian Department of Treasury and Finance usefully noted that:

Horizontal equity refers to the equal treatment of ‘equals’. It can apply to natural and non-natural persons. The principle can also be expressed the other way around – as the avoidance of arbitrarily different treatment of persons considered ‘equals’. That is, differential treatment of individuals and firms needs to be justified by different circumstances which are compelling on public policy grounds.[26] (emphasis added)

In this regard, the Bill breaches the concept of horizontal equity because an Australian mainland taxpayer seeking to gain the benefits conferred on pre-CGT assets in Australia must be able to prove (via appropriate records) when the relevant asset was acquired whilst a Norfolk Island taxpayer seeking to gain the equivalent benefit in relation to assets on Norfolk Island does not. This leads to the inevitable question: is this differential treatment of individuals justified by different, compelling circumstances?

The Government appears to be of the view that there are such different, compelling circumstances: the ‘historical lack of formal documentation for asset sales, as well as cultural practices relating to inheritance assets’ that the Government considers ‘are likely to inhibit the legislated application of CGT in some instances’.[27]

It is debatable whether a historical tendency to not formally document asset sales and certain cultural practices relating to the inheritance of assets amount to compelling circumstances justifying the differential treatment proposed by the Bill. However, on the assumption that it is, then it is difficult to see why an exemption from the record keeping requirements imposed by Division 121 of the ITAA 1997 should not be made available to other persons, areas or cultures on the Australian mainland that historically did not ‘formally’ document asset sales or have cultural practices relating to the inheritance of types of assets that result in difficulty pinpointing the date an asset was acquired.

That said, perhaps the best explanation as to why a measure that breaches the concept of horizontal equity may be acceptable in this instance is the relatively low number of taxpayers it is likely to impact.

Concluding comments

The Bill will exempt CGT assets acquired by Norfolk Island residents before 24 October 2015 from CGT in the same manner as assets acquired by Australian mainland resident taxpayers before 20 September 1985. However, unlike Australian mainland taxpayers, Norfolk Island residents will not be required to provide records or documentation proving an asset was acquired before 24 October 2015 in order to gain the benefit of the CGT exemption.

Members, Senators and Parliamentary staff can obtain further information from the Parliamentary Library on (02) 6277 2500.

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[1].              Explanatory Memorandum, Tax Laws Amendment (Norfolk Island CGT Exemption) Bill 2016, p. 10, accessed 25 February 2016.

[2].              C Madden, Norfolk Island Legislation Amendment Bill 2015, Bills digest, 102, 2014–15, Parliamentary Library, Canberra, p. 3, accessed 26 February 2016.

[3].              K O’Dwyer, ‘Second reading speech: the Tax Laws Amendment (Norfolk Island CGT Exemption) Bill 2016’, House of Representatives, Debates, (proof), 11 February 2016, p. 12, accessed 25 February 2016.

[4].              Joint Standing Committee on the National Capital and External Territories (JSCNCET), Same country: different world: the future of Norfolk Island, Canberra, October 2014, accessed 16 April 2015. 

[5].              B Pulle and K Swoboda, Tax and Superannuation Laws Amendment (Norfolk Island Reforms) Bill 2015 [and] A New Tax System (Medicare Levy Surcharge—Fringe Benefits) Amendment Bill 2015, Bills digest, 99, 2014–15 Parliamentary Library, Canberra; C Madden, Norfolk Island Legislation Amendment Bill 2015, Bills digest, op. cit., both accessed 25 February 2016.

[6].              JSCNCET, Same country: different world: the future of Norfolk Island, op. cit., pp. 36–42.

[7].              M Keenan, A better way for Norfolk Island, media release, 5 September 2013, accessed 25 February 2016.

[8].              Senate Standing Committee for the Scrutiny of Bills, Alert digest, 2, 2016, The Senate, 24 February 2016, p. 83, accessed 25 February 2016.

[9].              W Snowdon, ‘Ministerial statements: Australian National Audit Office: Norfolk Island Financial Statements’, House of Representatives, Debates, 27 March 2014, p. 3359, accessed 25 February 2016.

[10].              L Snell (Chief Minister and Minister for Tourism), Self-government of Norfolk Island, media release, 10 April 2015, accessed 25 February 2016.

[11].              Explanatory Memorandum, op. cit., p. 7.

[12].              The Statement of Compatibility with Human Rights can be found at page 13 of the Explanatory Memorandum to the Bill.

[13].              Income Tax Assessment Act 1997, subsection 102-5 ‘Your assessable income includes your net capital gain (if any) for the income year’, accessed 25 February 2016; R Woellner, S Barkoczy, S Murphy, C Evans and D Pinto, Australian taxation law, 26th ed., Oxford University Press, 2016, pp. 273–274.

[14].              Income Tax Assessment Act 1936, Part III Division 1A (Provisions relating to certain external territories), accessed 29 April 2015.

[15].              Tax and Superannuation Laws Amendment (Norfolk Island Reforms) Act 2015, Schedule 1, clause 1, accessed 25 February 2016.

[16].              Ibid., section 2.

[17].              Explanatory Memorandum, op. cit., p. 9.

[18].              Ibid., p. 9.

[19].              Ibid.

[20].              See for example Income Tax Assessment Act 1997, subsection 104-10(5), 104-20(4), and 104-95(2). See also: Wolters Kluwer, Australian Master Tax Guide, 58th ed., CCH Australia, 2016, p. 554.

[21].              Income Tax Assessment Act 1997, subsection 121-20(1).

[22].              Australian Tax Office (ATO), ‘Capital gains tax’, ATO website, 17 February 2016, accessed 25 February 2016.

[23].              Ibid.

[24].              Explanatory Memorandum, op. cit., p. 12.

[25].              P Kenny, ‘Australia’s capital gains tax discount: more certain, equitable and durable?’, Journal of the Australasian Tax Teachers Association, 1(2), 2005, p. 39; A Morgan, ‘The institutional framework of taxation in Australia’, Tax Institute, ConTax Newsletter May 2013, p. 4; Treasury, ‘Australia’s future tax system: what does equitable distribution mean?’, Treasury, May 2010; Prof. C Evans, J Minas and Y Lim, ‘Taxing personal capital gains in Australia: An alternative way forward’, submission to the 2015 Tax White Paper, 2015, p. 7; all accessed 25 February 2016.

[26].              South Australian Department of Treasury and Finance, ‘Horizontal fiscal equalisation and equity’, February 2012, p. 1, accessed 25 February 2016.

[27].              K O’Dwyer, ‘Second reading speech: Tax Laws Amendment (Norfolk Island CGT Exemption) Bill 2016’, op. cit.