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TOFA Stages 3 & 4 – the revised exposure draft legislation (continued)
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9 May 2007 - draft legislation incorporating TOFA 3 & 4 interactions and consequential amendments  
 
Treasury released another version of the exposure draft for Taxation of Financial Arrangements Stages 3 & 4 (TOFA 3 & 4) to include the provisions dealing with interactions and consequential amendments. The latest exposure draft can be found on Treasury's Taxation of Financial Arrangements website. 
 
Some of the changes to the draft legislation which allow the TOFA 3 & 4 rules to operate and interact with existing tax law include:

  • Provisions dealing with the treatment of offshore banking units and foreign bank branches
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  • Consequential amendments dealing with, amongst other tax areas, 12 month prepayment rules, PAYG instalment income, CGT anti-overlap provisions and consolidated groups provisions.
7 March 2007 - Institute lodges submission on the revised exposure draft legislation 
 
On 7 March 2007, the Institute lodged a submission with Treasury on the revised exposure draft legislation (“ED”) and explanatory memorandum (“EM”) for the Taxation of Financial Arrangements, Stages 3 and 4 (Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007) (“TOFA 3&4”). The Minister for Revenue and Assistant Treasurer released the revised ED and EM on 3 January 2007 for public consultation. These documents are available on the Treasury website. 
 
Some of the major improvements that we sought in our submission include:
  • closer alignment with accounting particularly in relation to determining what constitutes a financial arrangement
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  • clearer and more complete explanation of the application of the compounding accruals regime
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  • clarification and/or policy modification in relation to treatment of hedges with multiple components as well as hedging net investments in foreign subsidiaries
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  • policy adjustments to financial reports and other accounting election methods as well as more clarity being provided in the EM on issues relating to these methods
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  • all leasing type arrangements be excluded from TOFA 3&4 and that leasing be the subject of a separate review
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  • addressing a number of interaction issues such as those with the international tax and consolidation regimes
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  • policy adjustments in respect of a number of small and medium enterprise issues such as the audit requirements and the inability to access the hedging election.
A copy of the submission is available on the Institute’s website. 
 
It is anticipated that Treasury will begin the consultation process for the interactions and consequential amendments arising from TOFA 3&4 shortly, as well as consider the need for any additional integrity rules. 
 
Summary of the revised exposure draft (ED) 
 
The revised ED proposes to introduce a new division, Division 230, into the Income Tax Assessment Act 1997 and contains a number of significant changes from the first version including:
  • The scope of financial arrangements has narrowed by providing two tests for a financial arrangement and using terminology such as “financial benefit” and “monetary nature” instead of “something of economic value”.
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  • The threshold for using this method has changed from the “reasonably likely” test to the “sufficiently certain” test and there is more certainty as to when a taxpayer is to test a financial arrangement for the continual application of the compounding accruals method.
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  • As well as providing for the tax timing of gains and losses from a hedged financial arrangement, the additional hedging rules provide for the gains or losses to be characterised the same way as the underlying hedged item for income tax purposes.
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  • The Commissioner’s discretionary power under the ability to rely on financial reports to determine the tax treatment of financial arrangements has been removed and instead a taxpayer can make an election to rely on financial reports (provided they meet certain requirements).
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  • The small taxpayers exception has been modified so that individuals and small business taxpayers (annual turnover is less than $20 million) can elect to have Division 230 apply to all of their financial arrangements. This election is irrevocable.
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  • Broadly, TOFA 3& 4 will commence from income year beginning on or after 1 July 2008 unless a taxpayer makes an election for it to apply to income years commencing on or after 1 July 2007. Taxpayers can also elect to apply TOFA 3&4, instead of existing law, to pre-existing financial arrangements (this may give rise to a “balancing amount” to be spread over 4 years).
The revised exposure draft legislation has been developed following consultation on the first exposure draft legislation which was released in December 2005. A copy of the Institute’s submission on the first exposure draft legislation can be downloaded from the Institute's website. The Institute was also involved in subsequent confidential consultation which involved lodging a further detailed submission on seven Treasury Papers resulting from the consultation on the first exposure draft.  
 
The Institute is pleased to see significant improvements to the first exposure draft and we look forward to working with Treasury on the further refinement of TOFA 3&4.