This taxation of financial arrangements (TOFA) overview includes details of the commencement of TOFA stages 1 and 2, and outlines the key proposals for TOFA stages 3 and 4.

On 11 November 1999, the government confirmed its in-principle support for the relevant recommendations contained in Review of Business Taxation – A Tax System Redesigned, and said that the TOFA proposals would be further developed through consultation.

Legislation dealing with both the debt and equity, and the foreign exchange measures (TOFA stages 1 and 2) has since been enacted. These measures have a relatively broad impact.

The major impacts of stages 3 and 4 of the TOFA reforms (which are yet to be enacted) are expected to be on financial institutions, large corporations, superannuation funds, and similar entities.

Stage 1

From 1 July 2001, specific rules apply in relation to the distinction between debt and equity interests. These rules also introduce a definition of ‘debt’ for thin capitalisation and certain consolidation purposes.

Legislation

The debt and equity measures were introduced by the New Business Tax System (Debt and Equity) Act 2001 which received Royal Assent on 1 October 2001. The debt and equity tests are contained in Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997).

Stage 2

Tax reforms relating to foreign currency conversion rules and the realisation of foreign currency gains and losses became effective on 17 December 2003. In general, these ‘foreign exchange’ (forex) measures apply to matters involving foreign currency, and to the realisation of assets, rights, and obligations acquired or assumed on, or after, the commencement date. The commencement date is commonly the first day of the 2003-04 income year (that is, for most taxpayers, 1 July 2003).

If, however, you have an early substituted accounting period and the first day of your 2003-04 income year is earlier than 1 July 2003, your relevant commencement date is the first day of the 2004-05 income year. In some circumstances, the new conversion rules can apply to transactions that occurred before 1 July 2003.

Legislation

The forex measures are contained in Division 775 and Subdivisions 960–C and 960–D of the ITAA 1997. These provisions were inserted into the ITAA 1997 by the New Business Tax System (Taxation of Financial Arrangements) Act (No. 1) 2003. Other TOFA legislation is yet to be enacted by Parliament.

On 5 August 2004, the then Minister for Revenue and Assistant Treasurer announced a number of amendments to Division 775 and Subdivisions 960–C and 960–D of the ITAA 1997 – refer to press release No. 002 of 5 August 2004.

Regulations dealing with some of the issues raised in the former Minister’s press release No. 002 of 5 August 2004 have been addressed. The regulations were registered on 27 April 2005. Most of the regulations have effect from 1 July 2003.

The Treasurer's Taxation of Financial Arrangements media release No. 054/2008 announced that the Australian Government will proceed with previously announced amendments to the foreign currency provisions of the income tax law.

Stages 3 and 4

Legislation to introduce TOFA stages 3 and 4 was contained in the Tax Laws Amendment (Taxation of Financial Arrangements) Bill 2007.

The associated Explanatory Memorandum is also available.

Due to Parliament being dissolved after an election announcement, a new Bill will need to be introduced into Parliament before these measures have effect.

On 13 May 2008, the Australian Government announced it will amend and reintroduce the Taxation of Financial Arrangements Stages 3 and 4 measures with effect from 1 July 2009 – media release No. 054/2008.

Stage 3

Stage 3 of the TOFA reforms will introduce changes to the tax-timing treatment of hedging transactions on an elective basis. This reform will extend beyond the originally announced commodity hedge reforms as set out in the now former Minister for Revenue and the Assistant Treasurer’s press release No. 031 of 10 May 2005 titled Extension of Tax-Timing Hedging Rules.

Stage 4

Stage 4 of the TOFA reforms will introduce new tax-timing provisions, including:

* an elective ‘fair value regime’ (aimed at achieving efficiency in market-making activities)
* an elective ‘retranslation regime’ for certain foreign currency transactions,
* a elective regime to rely on ‘financial reports’, and
* an ‘accruals framework’ to apply where future gains or losses are sufficiently certain (for example, fixed rate debt instruments), and a ‘realisation regime’ to apply where future gains or losses are not reasonably likely (for example, the returns on ordinary shares).