Helen Coonan (NSW, Liberal Party, Shadow Minister for Finance, Competition Policy and Deregulation) Share this | Hansard source

I rise to indicate that the coalition will be supporting the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2008. This bill clarifies the tax treatment of financial arrangements such as futures, options and forward contracts which have been developed over the last two decades. This bill is the final part of the former coalition government’s taxation reforms into financial arrangements. The reforms were modelled in four stages. Stages 1 and 2 were legislated under the coalition government. Legislation for stages 3 and 4 was introduced by the coalition government but lapsed due to the 2007 election.

The bill provides certainty on the tax treatment of financial arrangements. Currently the tax treatment of financial arrangements is based on the legal definition rather than the economic reality of the financial arrangement. The differential tax treatment between revenue and capital often causes financial arrangements with a similar economic outcome to in fact be treated differently. This has reduced the efficiency of financial markets as some financial arrangements are more attractive due to their more favourable tax treatment. Currently there are no specific rules for treating financial arrangements for tax purposes. Entities must determine whether a financial arrangement is capital or revenue according to the legal nature of the arrangement. This can often be different to the way the arrangement is treated for accounting purposes. This bill removes the requirement to make such a distinction. This bill introduces rules for treating financial arrangements for tax purposes. As a result of this bill, financial arrangements will be taxed based on their economic substance rather than requiring a complex legal distinction between capital and revenue. This will align the tax treatment of financial arrangements with the accounting treatment of financial arrangements used by entities.

Financial arrangements may be entered into for revenue purposes or capital purposes. To use an example, shares purchased and sold by a bank may be treated as revenue or capital depending on the purpose and legal form of the arrangement. Generally, the shares would be treated as revenue for accounting purposes. However, often the shares are legally determined as capital for tax purposes. This results in a discrepancy between the accounting treatment and the tax treatment of shares. This occurs because the tax law as it currently stands has not accommodated the evolution of financial arrangements and their use. This bill will remove this discrepancy by aligning the tax treatment with the accounting treatment of the shares—that is to say, the shares would be treated as revenue for tax purposes and accounting purposes.

The bill provides six methods for determining the treatment of gains and losses arising from financial arrangements. The bill removes the distinction between revenue and capital as the deciding factor in determining tax treatment of financial arrangements. These are broken down into two general classes: elective and non-elective. There are four elective methods and two non-elective methods. The four elective methods are the elective hedging method, the elective financial reports method, the elective fair value method and, finally, the elective foreign exchange retranslation method. For those who do not choose to make an election, the non-elective methods apply and they are the accruals method or the realisation method. These reforms will be compulsory for some taxpayers, such as approved deposit-taking institutions and superannuation funds and managed investment schemes that have assets over $100 million. Taxpayers who are not required to adopt the TOFA rules may elect to do so voluntarily.

As mentioned previously, these reforms were initiated by the previous coalition government. The whole TOFA process of reform is a decade in the making. Stage 1 of these reforms, which related to debt and equity measures, was legislated back in 2001. Stage 2, which related to foreign currency conversion rules and the realisation of foreign currency gains and losses, was legislated in 2003. The previous coalition government released the draft legislation for the final stages in 2005 and then engaged in an extensive consultation process with relevant taxpayers, industry groups and professional associations.

As the Senate will appreciate, this is a very complex and somewhat esoteric area of the tax law that has taken some time for stakeholders and successive governments to progress to this final stage. The final reforms were introduced in a bill into the other place in September 2007. As mentioned, however, the previous bill lapsed because of the federal election. So there have been a number of years of extensive consultation. They have been necessary and have resulted in the reforms that this bill seeks to finalise. These reforms reflect the coalition’s longstanding commitment to ensuring the integrity of the operation of our tax system.

I will mention very briefly an issue that I know my colleague Senator Joyce may raise further in more detail shortly. The coalition, whilst we are supporting this bill, do flag a concern about the broadening of the aggregated turnover threshold test. As noted in the coalition senators’ additional comments in the report of the Standing Committee on Economics into this bill:

Coalition Senators are concerned that the expansion of this test into three threshold tests may unintentionally burden small to medium sized entities (SMEs) with increased compliance costs. As many SMEs across Australia are currently challenged by the fallout of the Global Financial Crisis, it would be wrong for government to burden them further with inappropriate reporting requirements.

So I do flag these concerns for the attention of the Minister for Superannuation and Corporate Law, Senator Sherry, and ask that during the committee stage he indicate the rationale for broadening the aggregated turnover threshold test. I would also ask him, if he would, to detail for the chamber what assessment of the regulatory burden has been undertaken by the government and/or Treasury in this regard. That being said, and as I have said before, this is a supported piece of legislation and I commend the bill to the Senate.