Alert

Who does this affect?

Taxpayers who hold or issue financial instruments and products.

What do you need to do?

Review the proposed new rules and determine whether your current tax treatment of financial instruments will be affected and which elective methods may be relevant.

Author
Richard Snowden  
Partner

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Richard Snowden  
Partner
T +61 2 9296 2193

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Sydney
John King  
Judy Sullivan  

Melbourne
Andrew Clements  
David Wood  

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The Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008 (TOFA) was today introduced into the House of Representatives following the previous release of the exposure draft legislation in October. The Bill contains a comprehensive set of principles and rules for the tax-timing and character treatment of gains and losses from financial arrangements and represents Stages 3 and 4 of the TOFA legislative provisions.

TOFA Stages 3 &4

Stage 3 governs the tax treatment of hedges while stage 4 deals with the tax-timing in respect of other financial arrangements. The new Bill introduces a new Division 230 into the Income Tax Assessment Act 1997 which in essence seeks to recognize the gains and losses, as appropriate, over the life of a financial arrangement and ignore distinctions between income and capital unless specific rules apply. As such gains and losses arising out of financial arrangements coming under the regime will generally be assessed on revenue account. The provisions effectively replace the previous Division 16E which was much narrower in its scope of operation. The proposed legislation does not apply to certain categories of taxpayer (such as short term arrangements held by individuals, certain small ADIs and entities generally with less than $100M turnover).

Elective Methods

The new Division 230 contains a number of “elective” and “non-elective” methodologies. There are six tax methods for calculating gains and losses arising in respect of a financial arrangement. These are:

• reliance on financial reports (elective)

• fair value (elective)

• retranslation (elective)

• hedging (elective)

• accruals (non-elective), and

• realisation (non-elective).

There is a “hierarchy” in terms of which method applies with the final “default” position being a realisation basis. Generally gains and losses arising from financial arrangements are assessable or deductible on revenue account for tax purposes and a “balancing adjustment” is calculated when the arrangement ceases or the financial arrangement is transferred. The provisions are very broadly drafted and may for example, in limited circumstances, extend to equity interests.

When will TOFA apply?

The new Division 230 will apply to financial arrangements acquired on or after the first day of the income year starting on or after 1 July 2010, however a taxpayer may elect to apply the TOFA rules to an earlier start date namely income years commencing on or after 1 July 2009. This should give issuers and investors some time to understand the operation of the new provisions.

A Copy of the Assistant Treasurer’s press release can be accessed here.