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TOFA Stages 3&4
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12 January 2010 - Government to provide certainty on the TOFA transitional balancing adjustment 
 
The Assistant Treasurer, Senator the Hon Nick Sherry, today, announced that the Government would act to provide certainty about the intent of the Taxation of Financial Arrangements (TOFA) transitional balancing adjustment provisions. 
 
A TOFA transitional balancing adjustment may arise where a taxpayer elects to bring their pre-existing financial arrangements into Division 230 of the Income Tax Assessment Act 1997 (provisions dealing with the taxation of financial arrangements). The primary method of transitioning pre-existing financial arrangements into Division 230 requires the taxpayer to calculate the difference between the pre-Division 230 outcomes and Division 230 outcomes for the pre-Division 230 period and spread it as a transitional balancing adjustment in taxable income over four years.  
 
For taxpayers who have elected to rely on their financial reports and bring their pre-existing financial arrangements into Division 230, another method involving the deferred tax amounts in the financial report is used to calculate the transitional balancing adjustment. The uncertainty arises where a financial arrangement is measured at fair value through equity as the deferred tax amounts would be recognised directly through equity and not the profit and loss for accounting purposes.  
 
27 November 2009 - Institute TOFA sub-committee meeting with Treasury and ATO 
 
On 27 November, the Institute hosted a confidential meeting between the Institute's Taxation of Financial Arrangements (TOFA) subcommittee, Treasury and the ATO to discuss priority TOFA issues. 
 
Update 4 September 2009 - Amendments to the tax laws relating to TOFA 
 
The Assistant Treasurer announced several amendments to the income tax law relating to the Taxation of Financial Arrangements (TOFA). Some of the amendments include:

  • Amending Division 230 (TOFA stages 3 and 4 are encompassed in this Division) to clarify that a dividend paid on a share that is a debt interest may be deductible under Division 230
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  • Ensuring that an interest in a partnership or trust that is otherwise excluded from Division 230 is subject to Division 230 if a fair value or financial reports election is made in respect of the interest
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  • Amending the Taxation Administration Act 1953 (TAA) to reverse the changes that the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009 (TOFA Act) made to the Pay As You Go (PAYG) instalments system, which means that rather than including TOFA gains on a net basis in PAYG instalment income, TOFA gains will be included on a gross basis.
In respect of the above amendments to the TAA which covers the interaction of TOFA and PAYG instalment system, Treasury has released the exposure draft legislation for this measure for public comment in view of the exposure draft legislation being introduced immediately in the current sittings of Parliament. Consultation on the exposure draft legislation is being undertaken over the coming days.  
 
Update 26 March 2009 - TOFA Bill receives Royal Assent 
 
On 26 March 2009, Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 received Royal Assent as the Tax Laws Amendment (Taxation of Financial Arrangements) Act 2009, Act No 15 of 2009.  
 
Update 26 February 2009 - Senate committee's report on inquiry into the TOFA Bill  
 
The Senate Standing Committee on Economics has tabled a report on its inquiry into Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008.  
 
The Committee recommended that the Senate pass the Bill. The report stated that there is a general consensus for supporting the Bill to be passed in its current form. It also noted that many submitters commented that there may be a need for some 'fine-tuning' of some aspects of the legislation after it is implemented. The possible need for later technical amendment was acknowledged by both the Government and the Opposition.  
 
Coalition senators also commented that the aggregated turnover threshold test contained in the current Bill has been broadened considerably from that developed by the previous government. The concern is that the expansion of this test into three threshold tests may unintentionally burden small to medium sized entities (SMEs) with increased compliance burden. (This issue was raised by the Institute in its supplementary submission lodged on 16 February 2009). Despite this concern the Coalition Senators support passage of the Bill.  
 
Update 20 January 2009 - Submission on Inquiry into TOFA Bill  
 
On 20 January 2009, the Institute lodged a submission with the Senate Standing Committee on Economics on its Inquiry into Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008, which was introduced into Parliament on 4 December 2008. The Committee is due to report back by 20 February 2009 (since extended to 26 February 2009). 
 
Submissions received are available on the Committee’s website, including a copy of the Institute’s submission.  
 
Update 4 December 2008 - TOFA Stages 3&4 introduced 
 
The Assistant Treasurer Chris Bowen MP has announced the introduction into parliament of the Taxation of Financial Arrangements (TOFA) Stages 3 and 4 measures. 
 
Full details are contained in the Bill and Explanatory Memorandum. 
 
Update 17 October 2008 - Submission on latest TOFA exposure draft legislation 
 
The Institute has lodged a submission with Treasury on the Exposure Draft of Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (ED Bill) and accompanying Explanatory Material. Key submission points include the following:
  • the accruals method is excessively complex and needs financial statements short cuts  
  • additional considerations are required in Division 230 to address emerging issues, such as the proposed carbon emissions trading scheme, and the appropriateness of the exclusion for certain “earnout” arrangements  
  • an alternative framework should be adopted by Treasury, instead of applying the entry history rule to Division 230 liabilities  
  • additional clarification is required as to the notion of a “report [that] properly reflects your affairs” used in the ED Bill.
The Institute also noted in the submission that as the ED Bill is expected to be introduced into Parliament before the end of the Parliamentary Spring sittings on 4 December 2008, there are certain complex issues, such as the interaction of the hedging election and tax consolidation, which may not be adequately addressed before its introduction into Parliament. Thus, the Institute welcomes any future opportunity to work with Treasury on those proposed amendments.  
 
Update - 1 October - Revised exposure draft legislation released 
 
The Assistant Treasurer Chris Bowen MP has announced the release of a revised exposure draft bill and related explanatory material dealing with Taxation of Financial Arrangements (TOFA) Stages 3 and 4. The draft legislation has undergone a number of technical amendments, including the addition of consolidation interaction rules and also incorporates integrity rules to address value shifting and non-arm’s length dealings in relation to financial arrangements. 
 
Submissions on the exposure draft material have been invited and the Institute is currently preparing its response. Submissions are due by 17 October 2008. 
 
The exposure draft material is on the Treasury website. 
 
Update 14 July 2008 - Joint submission on Treasury Discussion Paper “Consolidation and TOFA Interactions” 
 
The Institute, in conjunction with the Taxation Institute of Australia, has lodged a joint submission on the Treasury Discussion Paper of 23 June 2008 entitled “Consolidation and TOFA Interactions”. 
 
Some key comments included:
  • The proposed Division 230 rules should broadly align with the existing consolidation tax cost setting rules (not vice versa), as is the case for all other significant categories of assets.
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  • There is no sound policy reason for excluding deferred tax liabilities (DTLs) on financial arrangements from the consolidation tax cost setting process.
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  • Where the joining entity has chosen to apply Division 230 to pre-Division 230-commencement financial arrangements, further elaboration is required on the position of the joined consolidated group.
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  • The tax cost setting rules in proposed Subordinate Rule 1 produce inappropriate outcomes in terms of tax cost setting amounts, particularly where the joining entity has used the compounding accruals method.
Update 13 May 2008 - TOFA Stage 3 & 4 to proceed with changes 
 
The Government announced in the Budget that it will amend and reintroduce the TOFA Stage 3 & 4 measures with effect from 1 July 2009. The measures were previously introduced into parliament by the former government but lapsed due to the calling of the 2007 federal election. The amendments planned will also address further interactions with other parts of the tax law and remove an elective start date of 1 July 2008. The joint press release from the Treasurer and Assistant Treasurer is here.  
 
3 December 2007 
 
Parliament was prorogued in October after the calling of the Federal election. Prorogation has the effect of terminating all business pending before the houses which included Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007. The Institute will be following up with the new Government on the status of the proposals in due course. 
 
On 20 September 2007, the Minister for Revenue and Assistant Treasurer introduced the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007 (“the Bill”) into Parliament. This Bill introduces a new division, Division 230, into the Income Tax Assessment Act 1997 which will provide for new tax timing rules for financial arrangements and character hedging rules that are designed to minimise tax timing and character mismatches. The introduction of Division 230 represents stages 3 and 4 of the reforms to the taxation of financial arrangements (“TOFA”). The Bill can be viewed here and the EM is available here. 
 
The Institute welcomes the introduction of the Bill into Parliament and is pleased to see that the Treasury and Government have implemented many of our recommendations from our previous submissions. In our most recent confidential submission and discussions with Treasury, we had lobbied heavily for the removal of the provisions dealing with synthetic arrangements from this Bill and recommended that the introduction of the bulk of the provisions dealing with the interactions with tax consolidation regime be withheld pending further consultation between Treasury and the Institute amongst others. Our previous submissions can be viewed here. 
 
Overview 
 
Division 230 introduces a closer alignment of the accounting treatment and the tax treatment for the recognition of gains and losses from financial arrangements by incorporating financial accounting concepts and methods and hedging rules into the framework and introducing a specific election to rely on gains and losses determined by relevant accounting standards for tax purposes where certain specified requirements are met. In addition, Division 230 effectively removes the revenue/capital distinction for most financial arrangements by treating the gains and losses on revenue account, except where specific rules apply. 
 
Financial Arrangement 
The core unit upon which a tax liability is determined under Division 230 is ‘a financial arrangement’. The concept of a ‘financial arrangement’ consists of an arrangement to the extent they are ‘cash settlable’ legal or equitable rights or obligations to receive or provide financial benefits, or combinations thereof, and the arrangement does not consist of any other subsisting non-insignificant rights or obligations. Note that an equity interest is also a financial arrangement but not all tax timing methods will apply to the equity interests. 
 
A number of financial arrangements are excluded from Division 230 including those held by certain taxpayers, that is:
  • individuals;  
  • ADIs, securitisation vehicles or other financial sector entities with less than $20 million aggregated turnover; 
  • other entities with less than $100 million aggregated annual turnover;
and the financial arrangements held by such taxpayers:
  • are not qualifying securities; or 
  • are qualifying securities which have a remaining life at the time of acquisition of 12 months or less.
Elective tax methods 
Division 230 provides for four elective tax methods:
  • fair value 
  • election to rely on financial reports 
  • hedging 
  • retranslation.
The use of any of the elective methods requires that the taxpayer have financial reports prepared and audited in accordance with relevant financial accounting and auditing standards. If none of the above methods have been elected then the default treatment of gains and losses from financial arrangements is the accruals method. However, where the gains or losses are not sufficiently certain, the realisation basis is applicable.  
 
Where a taxpayer ceases to have a financial arrangement, transfers part of a financial arrangement to someone else, or where an election ceases to apply to a financial arrangement, a separate balancing adjustment may be required to be calculated. 
 
Start dates 
The Bill includes an elective start date of the 2008-09 income year and a general start date from the 2009-10 income year. For existing financial arrangements that a taxpayer has acquired before the start of the first applicable year, a taxpayer may elect to apply Division 230 these arrangements. Such an election may give rise to an amount in the nature of a transitional ‘balancing adjustment’ if the amount taken into account under the existing tax rules differs from the amount that would have been taken into account under Division 230 had Division 230 applied from the commencement of the arrangement. The transitional ‘balancing adjustment’ is to be spread over the first applicable income year and the next three income years. 
 
Improvements 
The Bill has substantially improved from the exposure draft released at the start of the year. Some big wins under this Bill have been for the small and medium sized businesses which have been largely carved out from TOFA as a result of the increase in the threshold to $100 million aggregated annual turnover and the exclusion of finance leases from TOFA. Other improvements in this Bill include:
  • the removal of the requirement for financial reports be audited by law in order to access the elective methods (this former requirement particularly disadvantaged the small and medium taxpayers that wanted to elect into Division 230) 
  • under the accruals method, the concept of effectively non contingent obligation has been removed from the "sufficiently certain" test thereby removing the complexities experienced so far with the interpretation of this concept  
  • further clarification in relation to the treatment of hedges with multiple components as well as further relaxing of the hedging requirements through the introduction of a Commissioner's discretion to recognise a hedging financial arrangement despite the financial arrangement’s failure to satisfy the accounting standards requirement and/or the audit requirement for the financial report (failure must be due to an honest mistake or inadvertence) 
  • the easing of the requirements to be able to elect to rely on financial reports, including providing the Commissioner with flexibility to relax certain audit requirements for a taxpayer for an income year or certain income years 
  • further clarification regarding the interaction of Division 230 and Division 775, including the insertion of the new foreign exchange realisation event 9 contained in Subdivision 775-F.
However, the Institute will continue working with the Government and Treasury as certain gaps still exist and some improvements are needed before relevant taxpayers either opt to be within the regime by 1 July 2008 or have it mandatorily apply to them from 1 July 2009.