On 12 October 2018, Treasury draft legislation to progress a measure announced in the 2018-19 Budget, that relates to State and Territory tax exempt entities, that become taxable, after 8 May 2018. This is described as an ‘integrity’ measure and is designed to stop such entities getting tax deductions on repayment of pre-privatising concessional loans.
The deductions currently arise due to the complex interaction between the TOFA rules and the rules dealing with deemed market values for tax exempt entities that become taxable. How this works is explained further below (which is an extract from the Draft EM).
The draft legislation proposes to modify Sch 2D to the ITAA36 (which deals with ‘Tax Exempt Entities That Become Taxable’). The effect would be to:
- specify the basis for working out the market value of TOFA assets and liabilities entered into on concessional terms held at the transition time for the purposes of applying the TOFA provisions (by inserting new s57-32 & s57-33); and
- modify the operation of the TOFA balancing adjustment that is made when the entity ceases to have such a TOFA asset or liability (by inserting a new SubDiv 57-P: Balancing adjustment on ceasing to have a Division 230 financial arrangement).
DATE OF EFFECT: The changes will apply from 8 May 2018 (ie the date of the Budget announcement).
SUBMISSIONS are due by 2 November 2018.
Context of the integrity measure – an explanation (from Draft EM)
1.3 When an entity is government owned, the entity’s income is exempt from income tax under Division 1AB of Part III of the ITAA36 (State and Territory tax exempt entities). If that entity is subsequently transferred to the private sector, the entity’s income ceases to be exempt. When this happens, Division 57 in Schedule 2D to the ITAA36 is triggered.
1.4 Division 57 operates to ensure that any income or expenses are properly allocated between the pre and post-transition time. The income and expenses allocated to the pre-transition time are disregarded for income tax purposes. Income allocated to the post-transition time becomes assessable income of the transition taxpayer. Similarly, the transition taxpayer can deduct expenses allocated to the post-transition time.
1.5 Division 57 also operates to determine the appropriate tax cost of the assets and liabilities of the transition taxpayer.
1.6 An inappropriate outcome arises on the privatisation of a government owned entity that, for example, holds a loan that is provided on more favourable terms than the borrower could obtain in the market place. The favourable terms could be in the form of, for example, concessional interest rates or concessional repayment schedules.
1.7 The effect of the concessional nature of the loan is that the market value of the loan at the transition time will, ordinarily, be less thanthe loan’s face value.
1.8 Under the current TOFA provisions in Division 230 of the ITAA 1997, the financial benefits received by the transition taxpayer (as the borrower) is worked out based on the value of the loan receivable held by the lender — being the market value of the loan at the transition time (as worked out under Division 57). However upon repayment of the concessional loan, the transition taxpayer will have provided financial benefits equal to the face value of the loan. The difference between these amounts will be available as a tax deduction for the transition taxpayer over the life of the loan resulting in a deduction that relates to the repayment of the loan principal.
1.9 The deduction for repaying the principal under a concessional loan in these circumstances is unintended. The excessive deduction arises due to the discounted value placed on a concessional loan that effectively reduces the market value of the loan at the transition time.
1.10 These amendments are necessary to overcome this integrity concern and protect the revenue base.
CPD questions (answers available)
- Does the measure have to do with the interaction of the provisions dealing with entities that become taxable (Div 57 of Sch 2D of the ITAA36) and the Taxation of Financial Arrangements (TOFA)?
- Does this apply to entities that are exempt under Div 1AB of Part III of the ITAA36?
- What sort of entity is that?
- Does Div 57 operate to allocate both income and expenses into pre and post ‘transition time’?
- Does Div 57 also operate to determine the tax value of both assets and liabilities, based on, amongst other things: market value?
- How could a a loan liability be concessional?
- Is the ‘market value’ of a concessional loan above or below its face value?
- Does TOFA give deductions, for the difference between the Div 57 ‘market value’ and the final amount paid?
- What is the effect of repaying this loan, under TOFA?