Chapter 2 - Taxation of Financial Arrangements
Aligning accounting and taxation treatment of transactions
2.1
The bill aims to minimise the extent to which taxation rules
distort decisions, and to lower compliance costs.[1]
One way in which compliance costs would be reduced is by aligning the treatment
of transactions for tax purposes with that in accounting standards.
Accordingly, the bill reflects the adoption in Australia of International
Financial Reporting Standards in 2005.
2.2
However, the bill does not completely align the calculation of
profit for taxation purposes with that for accounting purposes, which might be
argued to be the most efficient and simple approach. As Treasury put it:
...tax and accounting do have different purposes, and there are
lots of reasons why the tax in the TOFA bill does not follow the accounting in
all the cases.[2]
2.3
In general the bill aims to treat all gains and losses on
financial arrangements as revenue rather than capital items. This implies that
gains will be assessable income and losses will generally be deductible.[3]
It aims to align the tax treatment of derivatives with underlying assets, so
that a hedge which is effective in pre-tax terms is also effective in post-tax
terms.[4]
2.4
However, the bill only allows the use of 'fair value'[5]
accounting. It does not require it, on the grounds that it 'could result
in taxpayers being required to pay tax on large, unsystematic, unrealised gains
which do not eventuate, potentially causing cash flow difficulties' and
'excessive volatility' in required tax payments.[6]
Provisions of the bill
2.5
In simple terms, 'financial arrangements' include loans, bonds,
equities (shares) and derivatives (forwards, options and swaps). Where payment
for a purchase of goods occurs more than a year after their delivery, this is
also covered. Provisions in the bill mean that foreign currency and commodities
held by traders are also covered.[7]
Insurance policies and retirement village contracts are not included.[8]
2.6
However, there are limits on the deductibility of interest on
some 'debt-equity hybrids', in order to prevent companies disguising dividends
as tax-deductible interest payments.[9]
2.7
The bill provides a range of elective methods for determining
gains and losses from financial arrangements:
-
fair value method, where the taxpayer prepares their books using
relevant accounting standards;
- retranslation method, applying 'fair value' to gains and losses
attributable to movements in foreign currency exchange rates;
- elective hedging method, more closely aligning the tax treatment
of the 'hedging financial arrangement' (i.e. a derivative or a forex hedge)
with that of the item it hedges (and therefore allowing the deferral of tax on
gains from a string of rolling hedges until the underlying event occurs);
- financial reports method, only available to taxpayers with
unqualified financial reports and robust accounting systems;
- compounding accruals method (the default option where there is a sufficiently
certain gain or loss that can be calculated with reasonable accuracy),
involving amortising using an 'effective interest rate' (the same thing as the
internal rate of return) which smoothes gains or losses in comparison to the
'fair value' approach; or
- realisation method (the default option when there is not a
sufficiently certain gain or loss).
2.8
However, there are safeguards to avoid taxpayers using different
methods for different assets or in different years just to allow them to pay
the least tax.
2.9
The legislation generally does not apply to the following
(although there are exceptions):
- individuals;
- superannuation funds with assets under $100 million;
- authorised deposit-taking institutions with annual turnover under
$20 million; and
-
other entities with annual turnover under $100 million, financial
assets under $100 million and total assets under $300 million.
2.10
CPA Australia suggests that the latter turnover test be raised
from $100 million to $250 million, pointing out that $250 million is the Tax
Office's large business benchmark.[10]
The Government rejected this view 'because of the potential for increased tax
arbitrage'.[11]
2.11
The Institute of Chartered Accountants do not object to the $100
million threshold, but think it should be the sole threshold, not combined with
thresholds related to assets.[12]
Costs
2.12
The ATO estimates there are around 1,800 businesses with turnover
exceeding $100 million. While they may incur some initial costs in
changing software and paying advisers, they should reap gains from aligning tax
and accounting reporting and from hedging arrangements being less subject to
disruption from tax effects. The Taxation Institute believes that 'there should
be massive compliance cost savings'.[13]
2.13
The Government has not commented on revenue implications but the
Taxation Institute believe it would bring forward some tax receipts.[14]
The Treasury submission gives an example of how the current treatment of
interest rate swaps gives rise to a 'potential tax mischief', an anomaly which
the bill would resolve.[15]
Education arrangements
2.14
The bill is complex. However, it only affects large taxpayers and
there has been a long consultation process during which these taxpayers will
have gained some familiarity with it. Furthermore, the Australian Tax Office is
putting in place procedures to advise and assist taxpayers on complying with
the new requirements.[16]
Timing of implementation
2.15
The new provisions will apply to all financial arrangements
started from July 2010. Taxpayers may also choose for it to apply to
arrangements in place at July 2009.[17]
Where this gives rise to a transitional balancing adjustment, this can be
spread over four years.
2.16
The current period is one of unusually large falls in asset
values. Treasury did not regard this as a reason to defer introducing the bill:
I am not sure whether it will facilitate it or make it more
difficult for them to come in. [18]
Technical comments on the bill
2.17
Deloittes suggested two technical amendments to the bill. One
would 'make it clear that an accrued gain or loss should only be brought to
account in the year in which the election or withdrawal of the election has
effect'. Treasury believe this will be addressed in other legislation.[19]
The other proposal by Deloittes would amend a transitional arrangement, to
address a concern that 'the term “have”, as used in Item 104 of the
transitional provisions is not a defined term'.[20]
Treasury regard this as something to be monitored once the bill is passed.[21]
General attitude towards the bill
2.18
PriceWaterhouseCoopers 'supports the immediate passage of the
ToFA bill in its current form through parliament'[22],
as does the Taxation Institute of Australia; the Investment and Financial
Services Association; the Institute of Chartered Accountants; the Australian
Bankers' Association; the Australian Financial Markets Association; the
Property Council of Australia and Deloittes.[23]
2.19
Many submitters commented that after the legislation is
implemented, there may be a need for some 'fine-tuning' of some aspects.[24]
But it is impossible to predict these beforehand, and the submitters argue this
is no reason to delay passing the bill. Instead there should be some
post-implementation review process. The possible need for later technical
amendments is acknowledged by both the Government and Opposition:
There will be reason to monitor its implementation and to make
minor amendments as we go...there are likely to be finetuning issues that arise,
and we stand ready to implement those on a case-by-case basis...[25]
...it is also recognised that there will be future amendments,
once this bill is passed, dealing with technical issues.[26]
Recommendation
2.20
The committee recommends that the Senate pass the bill.
Senator Annette Hurley
Chair
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