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Taxation of Financial Arrangements: how will it affect your business?

Taxation of Financial Arrangements effect on business

Tony Morganti and Jake Ward discuss how the Taxation of Financial Arrangements rule may affect your business.

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If you are deferring the payment for an asset, the Taxation of Financial Arrangements (TOFA) rules may require you to recognise a revenue gain or loss to account for the financing of that asset, partly or fully with a TOFA arrangement.

Section 230-505 will apply where an entity starts or ceases to have a Division 230 financial arrangement as consideration for the provision or acquisition of something, such as shares or land, an item of trading stock or a depreciating asset.

The section changes the ordinary operation of certain regimes, such as the capital allowances rules and Capital Gains Tax (CGT) rules, to ensure what you’ve purchased is taken to have been acquired for or disposed for the market value.

The modification will apply even where the starting or ceasing to have the financial arrangement is only part of the consideration for the purchase or acquisition. Therefore, the provision can apply in situations where the payment for an asset is pushed out over a period of greater than 12 months.

Example

'A Co' enters into an agreement on 1 September 2014 to sell a CGT asset to 'B Co'. A Co will deliver the asset in 6 months and will receive $120,000 in 24 months. A Co acquired the asset for $80,000. The market value of the asset at the time of delivery is $105,000.

When B Co receives the asset, it will start to hold a financial arrangement, being the obligation to pay $120,000 in 18 months' time. While B Co will pay $120,000 for the acquisition of the CGT asset, the effect of Section 230-505 is that B Co’s cost base of the CGT asset is equal to the market value of the CGT asset at the time it is acquired, being $105,000.

B Co will recognise a TOFA loss equal to the difference between the market value of the CGT asset acquired and the amount paid to A Co.

Conclusion

Hiding at the back of Division 230, Section 230-505 contains important modifications to the general cost base and proceeds rules which can result in unexpected outcomes and can be easily overlooked. In particular, it can operate to convert what would otherwise be an amount included in the cost of a capital asset into a revenue amount as a TOFA gain or loss.

Therefore, it should not be overlooked by any practitioner advising clients on asset acquisitions where part of the consideration is deferred greater than 12 months.

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