After what has been an extremely protracted period of consultation on proposed changes to the taxation of financial arrangements (TOFA), the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 received Royal Assent on 26 March 2009.
This Bill was introduced into Federal Parliament in December last year and was passed by both the House of Representatives and the Senate without amendment. The passage of this legislation represents the final stage of the TOFA reforms.
Date of effect
The amendments contained in the Bill will apply to income years commencing on or after 1 July 2010 unless a taxpayer elects to apply the amendments to income years commencing on or after 1 July 2009.
Application to Financial Arrangements
The Bill introduces a new Division 230 into the Income Tax Assessment Act 1997 (ITAA 97). The Bill itself, at some 170 pages in length with the Explanatory Memorandum of some 500 pages, represents a substantial, and complex, addition to Australia's body of tax legislation.
The main thrust of the legislation is to provide a comprehensive
framework for the taxation of financial arrangements and specify
the various methods by which gains and losses from financial
arrangements are to be brought to account for tax purposes.
The new Division 230 will apply to all "financial
arrangements" unless a specific exclusion applies. What
constitutes a "financial arrangement" for these purposes
is central to the operation of the new rules. It is expansively
defined to mean a "cash settleable" legal or equitable
right or obligation to receive or provide financial benefits or a
combination of such rights and obligations. Obligations and rights
are cash settleable where they may be settled by money or money
equivalent.
Debt-type arrangements such as loans, bonds, notes and debentures are common examples of "financial arrangements", as are risk shifting derivatives such as a swaps, forwards and options. Also included in the definition of "financial arrangement" are equity interests, foreign currency, non-equity shares in companies and certain commodities and offsetting commodity contracts.
Exclusions
Certain taxpayers are excluded from the operation of Division 230, namely:
- individuals
- superannuation entities and managed investment schemes with assets under $100m
- authorised deposit taking institutions, securitisation vehicles or other financial sector entities with an aggregated turnover of less than $20m
- other entities with an aggregated turnover of less than $100m, financial assets of less than $100m and assets of less than $300m.
The above exclusions will not apply to qualifying securities which have a remaining life in excess of 12 months or where a taxpayer elects for Division 230 to apply to its financial arrangements.
There are also exclusions for various types of "financial arrangements", for example:
- certain short term arrangements involving property or services that are settled within 12 months
- leasing arrangements
- assets to which Division 250 ITAA 97 applies (Division 250 deals with asset financing arrangements with tax preferred entities)
- interests in partnerships and trusts
- life insurance policies
- superannuation and pension income, and
- proceeds from certain business sales including "earn-outs".
Tax timing rules
Division 230 specifies various tax timing methods that can apply to financial arrangements. There are four elective methods and where these elective methods are not, or cannot, be adopted there are two default methods specified.
The elective methods are:
- the fair value method – which allocates gains and losses to each income year in accordance with changes in the fair value
- the foreign exchange retranslation method – which allocates gains and losses from changes in the value of foreign currency to the income year in which the change occurs
- the hedging method – which allocates gains and losses from a hedging financial arrangement on a basis that corresponds with the gains and losses from the relevant hedged item, and
- financial reports method – which determines gains and losses from financial arrangements by reference to relevant accounting standards and effectively aligns the tax treatment to the accounting treatment.
The default methods are:
- compounding accruals method – which allocates gains and losses to income years according to an implicit rate of return, and
- realisation method – which allocates gains and losses to income years when they occur. The method applies to the extent that the compounding accruals or the elective methods do not apply.
There are also provisions requiring a balancing adjustment to be calculated where a taxpayer ceases to have a financial arrangement or transfers part of a financial arrangement.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.