Newsletter - March 2006

An Introduction To The Proposed New T.O.F.A. Law

TOFA stands for Taxation Of Financial Arrangements and its new incarnations, TOFA 3 and 4, have been some of the biggest tax changes proposed this year. If you’ve been around business for the last few years you should be well aware of its effect on the way certain financial transactions are taxed.

The government has released draft versions of this new law for comment. You may be affected if you can answer yes to all these tests:

• You have a legal/equitable right to receive/ provide something of economic value in the future that is not short term;
• You are not an individual;
•  You are an entity with more than $20,000,000 of turnover.

If you’ve answered no to all of these, breathe a sigh of relief. If you haven’t, read on for a recap of past changes to this area of the tax law that have caused some companies significant grief, as well as an outline the new changes.

The first version of the law, TOFA 1, can potentially affect a corporation’s funding decisions by changing the tax treatment of dividend and interest payments:

• If your liabilities fail the debt tests, the interest payments paid on them could be classed as non-deductible;
• If your company’s equity interests fail the equity tests, you may not be able to attach imputation credits to your dividend payments.

TOFA 2 was the second round of TOFA law, clarifying how foreign exchange transactions would be accounted for tax purposes. It set out 5 clear events that determine when you realise foreign currency gains/losses.

Now to the new TOFA 3 and 4, which treasury seeks to introduce on 1 July 2006. The legislation will apply accrual accounting principles to the taxation of financial instruments. Its release coincides with Australia ’s adoption of new International Accounting Standards, including new standards on financial instruments. See the trend? The ATO wants to align the tax law to the new standards, thereby reducing mischief and any tax effect that could “impede commercial decisions” or “stimulate tax deferral”.

TOFA 3 and 4 seeks to group financial instruments into categories in line with the new standards, so that they can be treated similarly.

1)       Fair value – if you have classified the item as fair value according to the accounting standards, the taxable gain/loss at the end of the income year will be your accounting gain/loss on the instrument. That is, the movement in the value of the instrument which could be, for example, an option.

2)       Compounding accruals – if you know with reasonable certainty that the result of a transaction involving a financial instrument will be a gain or loss you will have to apportion it over the instruments life. For example, if you sell something which will be paid over a period greater than 12 months, your profit on sale could be reduced and an interest receipt taxed over the period of the loan (vendor finance).

3)       Retranslation – you retranslate your foreign currency at the end of the financial year and take the gain or loss, less any amount calculated using the second approach, to profit and loss. Say you issue a bond in $US; the movement in the bonds value will need to be taken up.

4)       Realisation – where none of the above apply, you calculate the gain or loss on a realisation basis.

5)       Hedging – new hedging rules apply to allocate gains/losses on specific hedges, such as hedges entered into to purchase specific items, over the life of the asset.

Keep in mind that this has just been an introduction to the key concepts included in the proposed new legislation and has not contained all the specific exceptions, elections and conditions that may apply. In short, watch this space.

Having TOFA issues? Just a little confused? Please contact your nearest Avenir office, or if you would like to read up more on the subject of TOFA please refer to the main sources of this newsletter:

• TOFA 1 – www.ato.gov.au
  (Business - Large Corporate)
• TOFA 2 – www.ato.gov.au (Business - Large Corporate)
• TOFA 3/4 – www.tofa.treasury.gov.au (Consultation)
• Accounting Standards – www.aasb.com.au