TOFA bill introduced for 2010 announced changes
Banking on Tax, Issue 9
The Tax and Superannuation Laws Amendment (2013 Measures No. 2) Bill 2013 (the bill) was introduced into Parliament on 20 March 2013. The bill contains various refinements to the taxation of financial arrangement (TOFA) rules that were foreshadowed by the Assistant Treasurer in Media Release No. 145 of 2010, which was issued on 29 June 2010.
If enacted, the amendments, which would apply from the commencement of the TOFA rules almost three years ago, would affect the core rules, accruals and realisation methods, fair value method, hedging financial arrangements method, transitional balancing adjustment provisions, and requirements for making certain elections. Unfortunately, the amendments to the treatment of repurchase agreements/securities lending arrangements and short sale arrangements that were canvassed in the media release are not contained in the bill.
The changes to the core rules in the bill would clarify that the cost attribution rules apply to both certain and uncertain financial benefits. Another change would remove the rule that prevents financial benefits from being attributed to interest and interest-like amounts. However, in most cases, it is expected that no cost would be attributed to such amounts.
Such changes in the application of the attribution rules, insofar as they affect the timing of recognition of gains and losses, may be relevant to financial institutions that have made a financial reports election. This is because one of the conditions for the election to apply to a financial arrangement requires that it be reasonable to expect that differences between the results of the accounting method and the TOFA method that would otherwise apply would not be substantial.
Accruals and realisation methods
The bill includes various amendments to the accruals and realisation methods. Some of the key changes are:
- The amendments would clarify that there can be sufficiently certain particular gains or losses even if there is no sufficiently certain overall gain or loss. Furthermore, precedence is to be given to the particular gains or losses method over the overall gains or losses method
- The amendments would also clarify that a gain or loss arising from a prepayment should be spread across the period to which it relates
- The amendments are intended to ensure consistency in the treatment of impairments and reversals of impairments. Currently, an impairment would not generally give rise to a deductible loss. This treatment would be maintained and would clarify that a reversal of an impairment cannot give rise to an assessable gain. Furthermore, the amendments would ensure that the accruals method applies appropriately to a gain or loss arising from the reversal of an impairment.
Again, these amendments may be relevant to the application of the financial reports election insofar as they affect the timing of gains and losses under the TOFA rules if that election was taken not to apply.
Fair value method
The fair value method would be extended to encompass financial arrangements that are assets and liabilities that are otherwise treated as at fair value through profit or loss even though not classified or designated as such for accounting purposes. Practically, this would provide for changes in the fair value of certain hedging instruments and some hedged items recognised in the profit or loss to be brought to account as gains or losses under TOFA. An example might be a fair value hedge of the interest rate risk on a fixed rate loan.
The changes to the hedging method are meant to ensure that, once adopted, the election would cover all financial arrangements that are hedging financial arrangements on a ‘one-in all-in’ basis (i.e. if the changes are enacted, once an election has been made, taxpayers will not be able to pick and choose arrangements to which it applies). Further, failure to meet the documentation requirements would preclude the method from applying to arrangements a taxpayer commences to hold from the time of failure unless the Commissioner determines a date from which the election recommences to apply.
In the context of the above, however, it should be noted that the documentation requirements for certain hedges would be removed, namely ‘would-be’ accounting hedges (e.g. hedges between entities that are members of the same accounting, but not tax, consolidated group) and hedges of anticipated dividends.
The Commissioner would also be granted a power to determine the basis for allocating gains and losses from a hedging financial arrangement where a taxpayer has not adopted an appropriate basis (e.g. one that does not fairly and reasonably correspond with the basis on which gains and losses on hedged items are allocated).
Finally, the rules applying to hedges of net investments in foreign operations would be changed, if the bill passes, to reflect the fact that the hedged item may be shares or other interests (e.g. a loan).
Transitional balancing adjustments
Where the financial reports election was made, there were two methods available to work out a transitional balancing adjustment on the making of a transitional election to bring pre-TOFA financial arrangements within the scope of the TOFA rules. The amendments seek to amend the ‘short-cut method’, which allowed the balancing gain or loss to be calculated by reference to the deferred tax assets or liabilities recognised in respect of financial arrangements.
However, the deferred tax balances for some financial arrangements, such as those that are cash flow hedges or available-for-sale assets, are not recognised through the profit or loss. The amendments are intended to ensure that, in working out a transitional balancing gain or loss, it would only be possible to take into account deferred tax balances that are recognised in the profit or loss.
Given that the change would have retrospective effect, taxpayers that used the short-cut method may need to revisit their transitional balancing adjustment calculations and, in some cases, amend prior years' tax returns.
The various tax timing elections, and certain other elections, require that the taxpayer have financial reports prepared in accordance with accounting principles and auditing standards. Due to the practical difficulties arising in the use of these reports for Australian branches of foreign authorised deposit-taking institutions, the bill includes amendments to enable these entities to use the Statement of Financial Performance and Statement of Financial Position that they provide to the Australian Prudential Regulation Authority.