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Taxation of Financial Arrangements

The Government has announced major reforms to the taxation of financial arrangements (TOFA) rules reduce their scope, decrease compliance costs and increase certainty through the redesign to the TOFA framework. The new simplified rules will apply to income years commencing on or after 1 January 2018, and represent the culmination of two years of work by the Board of Taxation and Treasury to overhaul the TOFA framework.

The existing TOFA provisions were introduced in two tranches in 2003 (in relation to foreign exchange gains and losses) and in 2009 in respect of a broader range of financial arrangements. Since their introduction, these rules have been broadly criticised for increasing complexity and uncertainty for both small and large taxpayers. In this Budget announcement, the Government has acknowledged that the 2009 amendments failed to deliver the anticipated compliance and simplification benefits, and has framed these changes up as 'regulation reform'.

The proposed new rules will contain four key components:

  • A ‘closer link to accounting’ which will strengthen and simplify the existing link between tax and accounting in the TOFA rules
  • Simplified accruals and realisation rules, which will significantly reduce the number of taxpayers in the TOFA rules, will reduce the arrangements where spreading of gains and losses is required under TOFA and simplify the required calculations
  • A new tax hedging regime which is easier to access, encompasses more types of risk management arrangements (including risk management of a portfolio of assets), and removes the direct link to financial accounting
  • Simplified rules for the taxation of gains and losses on foreign currency to preserve the current tax outcomes but streamline the legislation.

The simplified accruals and realisation rules will be welcomed by most taxpayers, which should see a simpler basis of taxation for many interest bearing securities and remove the need for complex accruals calculations in many cases, whilst the closer link to accounting will assist more sophisticated taxpayers with complex financial arrangements. It is also pleasing to see an acknowledgement of the limitations of the current hedging regime with plans to introduce a more flexible regime that should be accessible to a wider range of taxpayers. It is hoped that this will include fund managers and superannuation funds that have had difficulties accessing the current regime.

According to the Budget announcement, it will result in lower compliance costs, and provide simpler rules and more certainty whilst maintaining the objectives of reducing costs and minimising distortions in decision making.

As part of this reform, Government has also indicated that it will incorporate the policy reflected in a number of measures which have previously been announced, but are not yet legislated. These are:

  • Taxation of financial arrangements — amendments to tax hedging rules; first announced in the 2011-12 Budget
  • Functional currency rules — extending the range of entities that can use a functional currency; first announced in the 2011-12 Budget
  • Taxation of financial arrangements — foreign currency regulations — technical and compliance cost savings amendments; first announced in the Mid-Year Economic and Fiscal Outlook 2004-05.

Whilst the start date is nearly two years away, it remains to be seen if the Government can meet this ambitious time frame, considering that the previous iterations of TOFA were nearly 20 years in the making. As with any changes to the tax law of this extent, the devil will be in the detail. We will need to 'watch this space' closely as it unfolds over the next two years.

Removing barriers to the use of asset backed financing

The Government has also announced that it will remove key barriers to the use of asset-backed financing arrangements, that is, financing arrangements which are supported by assets such as deferred payment arrangements and hire purchase arrangements. These amendments will ensure that these arrangements are treated in the same way as financing arrangements based on interest bearing loans or investments, and improve access to more diverse sources of capital in Australia. This measure will apply from 1 July 2018. 

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Matt Osmond

Partner, PwC Australia

Tel: 613 8603 5883

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