TOFA

The scope of TOFA, explained within Division 230, is not confined to a narrow set of financial arrangements. Instead, it encompasses a wide array of financial instruments and contracts. This includes, but is not limited to:

• Loans: Any type of lending arrangement, whether between individuals or entities, falls under this definition.
• Bonds: Both government and corporate bonds, representing debt instruments, are encompassed.
• Derivatives: This includes a comprehensive array of financial derivatives, such as forwards, futures, options, swaps, and similar contracts.
• Promissory Notes: Promissory notes, which are written promises to pay a specified amount, are also included.
• Bills of Exchange: Bills of exchange, which are negotiable instruments used in trade transactions, are regarded as financial arrangements.
• Shares: Various types of shares in companies, be they equity or non equity, fall within TOFA’s scope.

In addition to these instruments, TOFA, within Division 230, extends its applicability to specific categories, treating them as if they were rights constituting financial arrangements. These categories encompass:

• Foreign Currency Transactions: Transactions involving foreign currencies for exchange or trade purposes are incorporated.
• Non Equity Shares in Companies: Any transactions involving non equity shares in companies are considered financial arrangements.
• Commodity Contracts: Certain commodity contracts held by traders are subject to TOFA’s provisions.
• Offsetting Commodity Contracts: Similarly, specific offsetting commodity contracts held by traders are also included.

Even internal derivatives used by multinational banks may potentially fall within the definition of financial arrangements under TOFA in particular circumstances.

There are certain financial arrangements that are not governed Division 230 provisions. Here’s a breakdown of the financial arrangements that are exempt from TOFA:

• Short Term Cash Settlable Arrangements: This exclusion applies to financial arrangements related to the acquisition or provision of goods, property, or services that can be settled in cash within a year, excluding derivative financial arrangements. For instance, short term trade credit arrangements are included in this category.
• Leasing and Licencing Arrangements: Most leasing and licencing agreements are not governed by TOFA. This includes luxury car leases, hire purchase agreements, and assets utilised for tax preferred purposes.
• Interests in Partnerships and Trusts: Financial arrangements linked to interests in partnerships and trusts are exempt from TOFA.
• Certain Insurance Policies: This exemption covers specific rights or obligations under life insurance policies and general insurance policies.
• Worker’s Compensation Arrangements: Certain worker’s compensation arrangements are not subject to TOFA.
• Guarantees and Indemnities: Unless a fair value or financial reports election is made, guarantees and indemnities are excluded. Notably, a term deposit provided as security for a performance bond does not fall under guarantees or indemnities.
• Personal Arrangements and Personal Injury: Financial arrangements related to personal matters, such as receiving maintenance payments, and those associated with personal injury are not governed by TOFA.
• Superannuation and Pension Benefits: TOFA does not apply to superannuation and pension benefits.
• Controlled Foreign Companies: Specific interests in controlled foreign companies are exempt from TOFA.
• Proceeds from Business Sales: This exemption covers proceeds from certain business sales, including earn outs.
• Farm Management Deposits: Farm management deposits that are deductible under the Division 394 are outside the scope of TOFA.
• Deemed Interest Payments: Deemed interest payments to owners of offshore banking units are not regulated by TOFA.
• Forestry Managed Investment Schemes: TOFA does not extend to forestry managed investment schemes.
• Mining Sector Exploration Benefits: Exploration benefits provided under farm in farm out arrangements in the mining sector are not covered by TOFA.
• Other Arrangements as Specified by Regulation: Any other arrangement specified by regulation is also exempt.

Additionally, TOFA does not apply in specific scenarios:

• When losses result from ceasing to hold a marketable security due to the belief that the other party cannot fulfil its obligations.
• When gains arise from the forgiveness of commercial debts, which are regulated by Div 245.
• Gains in the form of franked distributions or rights to receive such distributions remain taxable.
• When gains or losses are subject to the value shifting regime.
• To gains and losses arising from retirement village residence contracts, retirement village services contracts, or arrangements for residential or flexible care, as these typically involve non insignificant non cash settlable rights and obligations.
• To former registered emissions units.

Division 230 financial arrangements include arrangements where there are legal or equitable rights to receive or obligations to provide a financial benefit, and these rights or obligations can be settled in cash. A financial benefit is considered cash settlable when:

• The benefit is in the form of money or a money equivalent.
• The entity intends to settle the right or obligation using money, a money equivalent, or by initiating or terminating another financial arrangement (excluding equity interests).
• The entity has a history of settling similar rights or obligations as mentioned in (b), whether or not the intention is to settle them in that manner.
• The entity engages with the right or obligation, or similar ones, to profit from short term price fluctuations or dealer margins or both.
• The entity has the capability to settle the right or obligation mentioned in (b), regardless of whether the intention is to settle it that way, and the primary or dominant purpose for entering into the arrangement is not to receive or deliver the financial benefit as part of its usual purchase, sale, or usage requirements.
• The financial benefit is readily convertible into money or a money equivalent, there exists a highly liquid market for it, and either:
• The financial benefit is not significantly at risk of losing value for the recipient.
• One of the entity’s intentions for entering the arrangement is to raise or provide finance or to convert it into money or a money equivalent (except as part of regular purchase, sale, or usage requirements).
• Cash settlable financial arrangements under TOFA include various financial instruments such as derivatives and debt instruments like bonds, loans, bills of exchange, and promissory notes, regardless of whether they are denominated in Australian or foreign currency.

However, specific capital support payments made by a parent company to its subsidiary are not deductible under TOFA, as they do not qualify as losses from a financial arrangement due to the subsidiary’s significant non cash settlable right.

Equity interests under TOFA, which include shares in a company or interests in a trust or partnership, are considered financial arrangements.

Rights to receive equity interests and obligations to provide equity interests, or combinations thereof, are also categorised as financial arrangements under TOFA, provided they are not cash settlable financial arrangements or part of such arrangements.

When an arrangement possesses characteristics of both being cash settlable and an equity interest, it is treated as an equity interest for the purposes of applying TOF. This distinction is vital because an equity interest is subject to TOFA only when the taxpayer makes specific tax timing elections:

• A fair value election for equity interests held by the taxpayer (not applicable when the equity interest is issued by the taxpayer).
• A financial reports election for equity interests held by the taxpayer.
• A hedging financial arrangements election concerning an equity interest issued by the taxpayer, particularly when it functions as a foreign currency hedge.

An arrangement under TOFA may consist of one or multiple financial arrangements, or several arrangements may collectively form a single financial arrangement.

For instance, a convertible note that pays coupons throughout its term and converts into shares at maturity is considered a single arrangement. Similarly, a loan facility with multiple drawdown stages is treated as a single arrangement.

The assessment of whether an arrangement qualifies as a financial arrangement is made at the time the arrangement comes into existence or begins to be held. TOFA also allows for periodic assessments throughout the arrangement’s life.

TOFA generally treats gains as assessable income and allows for the deduction of losses from assessable income.

However, there are exceptions, especially in the case of hedging financial arrangements. In such cases, gains and losses are characterised based on the tax characterisation of the underlying hedged item. This means they can be categorised as capital gains, income, assessable, exempt, or non assessable non exempt.

Additionally, gains and losses from financial arrangements related to the generation or production of exempt income or non assessable non exempt income are disregarded under TOFA. This also applies to gains or losses of a private or domestic nature.

In specific situations, a loss made by an Australian resident in deriving non assessable non exempt income under various tax provisions may be deductible, provided it is associated with a debt interest issued by the taxpayer and qualifies as a debt deduction.

For individuals or entities that are not considered tax residents of Australia, TOFA only applies to gains generated from financial arrangements with an Australian source. This means that only income arising from Australian based financial dealings falls under the TOFA regulations.

When a person transitions to becoming an Australian tax resident, TOFA treats this change as if they have acquired existing financial arrangements at their current market value. Conversely, when a person ceases to be an Australian resident for tax purposes, TOFA treats this as if they have disposed of existing financial arrangements at their market value at that point.

Under TOFA, net gains (profits) made on financial arrangements subject to TOFA regulations are included in a taxpayer’s instalment income. However, net losses are not subject to this treatment.

When entities holding financial arrangements subject to TOFA become part of or leave a consolidated group or MEC (Multiple Entry Consolidated) group, specific rules come into play to ensure the interaction between the consolidation rules and TOFA regulations works smoothly. These are known as TOFA consolidation interaction provisions, and they follow four primary principles:

Joining a Consolidated Group: When an entity becomes part of a consolidated group or MEC group, TOFA is applied as if the joining time is the end of an income year.

Treatment by the Head Company: The head company of the consolidated group applies the consolidation rules and TOFA as if it directly acquired assets that are part of financial arrangements from the joining entity.

Leaving a Consolidated Group: If an entity leaves a consolidated group or MEC group, the head company applies TOFA as if the leaving time is the end of an income year.

Treatment of Leaving Entity: A leaving entity, with financial arrangement gains and losses falling under TOFA, applies TOFA as if it took the financial arrangements with it at the leaving time.

Liabilities under different tax timing methods

Retrospective amendments have been introduced to ensure consistent treatment of liabilities subject to various tax timing methods when an entity joins a consolidated group. These amendments specify deemed amounts based on the accounting value of the liability at the joining time.

Tax value for intra group assets or liabilities

When intra group assets or liabilities that are part of Div 230 financial arrangements emerge from a consolidated group because a subsidiary member leaves, specific adjustments are made. These adjustments aim to align the tax treatment with the economic substance of transactions, preventing inappropriate assessments or deductions.