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TOFA Stages 3 & 4 - Draft legislation released
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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.