Chapter 1

Inquiry into the provisions of Schedule 2 – Tax Laws Amendment (2010 Measures No. 5) Bill 2010

The referral

1.1        Tax Laws Amendment (2010 Measures No. 5) Bill 2010 was introduced into the House of Representatives on 25 November 2010. The bill, which will amend various tax laws to implement a range of improvements, contains seven schedules.[1] Of the bill's seven schedules however, only the provisions of Schedule 2 were referred to the Senate Economics Legislation Committee for inquiry and report, by 24 March 2011.[2]

1.2        In referring the provisions of Schedule 2 to the committee, the Selection of Bills Committee specified that the rationale and consequences of the benchmark interest rate be investigated.[3]

Conduct of the inquiry

1.3        The committee advertised the inquiry in The Australian and on its website. A comprehensive list of stakeholders were also identified and invited to make submissions.

1.4        The committee received two submissions (listed in Appendix 1 and available for viewing on the committee's website[4]) and held one public hearing, in Sydney on 9 March 2011. The organisations that appeared before the committee are listed in Appendix 2.

1.5        The committee thanks all those submitters and witnesses for their contribution and participation in the inquiry process.

Overview of Schedule 2

1.6        Schedule 2 of the bill concerns capital protected borrowings. CPBs are financial products that enable an investor to obtain credit to purchase shares, units or stapled securities which then become security for the loan. If the shares, units or stapled securities fall in value, the investor can transfer them back to the lender in satisfaction of their obligations under the loan.[5] It is this feature that protects the borrower's capital.

1.7        As a result of this capital protection feature, investors in CPBs pay more than the standard interest rate they would face on a loan to buy shares as they are effectively buying two products; a loan and some insurance against a fall in the price of the shares (or equivalently a loan and a put option). But as they buy them together from the same financial institution, the cost is combined.

1.8        For income tax purposes, interest expenses on borrowings are treated differently to the 'insurance' or 'capital protection fee', so the combined cost must be allocated between the two. This is done by applying a benchmark interest rate.[6]

Scrutiny of bills comment

1.9        The Scrutiny of Bills Committee raised concerns with the retrospectivity of the amendments contained in Schedule 2; particularly as they take effect from 13 May 2008, at which time a ministerial announcement alerted taxpayers to the change in treatment for these products.[7] The Scrutiny of Bills Committee noted that:

...reliance on Ministerial announcements and the implicit requirement that persons arrange their affairs in accordance with such announcements, rather than in accordance with the law, tends to undermine the principle that the law is made by Parliament, not by the Executive...[and although]...the Committee has regularly been prepared to accept that amendments proposed in the Budget will have some retrospective effect when the legislation is introduced, this is usually limited to publication of a draft bill within 6 calendar months after the date of that announcement. Proposed legislation introduced outside this timeframe is at particular risk of the Senate amending the commencement date to the date of introduction of the bill (see Senate Resolution 40).[8]

1.10      Although that Committee is concerned by the period of time that has lapsed between the original announcement and the introduction of Schedule 2, they left the question of whether or not the proposed changes amount to an undue trespass on individual rights and liberties to the Senate as whole.[9]

 Structure of the report

1.11      This report is comprised of two chapters:

• Chapter 2 examines the rationale for the benchmark interest rate and the detail of the proposed changes. It then sets out the committee's recommendations.

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