TOFA rules to be simplified
The Government is proposing broad reforms to the Taxation of Financial Arrangements (TOFA) legislation to improve certainty and reduce compliance costs. The changes will apply to income years commencing on or after 1 January 2018.
The law currently provides rules that calculate the amount and timing of gains and losses on financial arrangements. While designed for the largest taxpayers, in practice, these rules have tended to apply to a significant group of smaller taxpayers, often adding substantial complexity in interpreting how they should be applied.
The changes relate to four key components:
- A ‘closer link to accounting’ to better align tax and accounting treatments
- Simplified accruals and realisation rules that limit their application to reduce spreading gains and losses, and simplify the calculations
- A new tax hedging regime which is easier to access, encompasses more types of risk management arrangements and removes the direct link to financial accounting
- Simplified rules relating to how foreign currency gains and losses are taxed.
This announcement also confirmed that the Government will continue with previously announced measures that have not yet been legislated. These include:
- Amendments to tax hedging rules to ensure they operate as intended (as announced in the 2011-12 Budget)
- Extending the range of entities that can use a functional currency. This will allow certain trusts and partnerships that keep accounts predominantly in a foreign currency to use that currency to calculate net income ( which was also announced in the 2011-12 Budget)
- Amendments relating to foreign currency regulations to provide technical and compliance cost savings measures (as per the 2004-05 Mid-Year Economic and Fiscal Outlook).
The impact of these changes includes a reduction in the scope of the law (by removing the majority of taxpayers from the TOFA rules), improving the certainty of its application and, in turn, an anticipated reduction in compliance costs.
The TOFA rules often create unnecessary complexity for smaller taxpayers. This results in significant costs to those taxpayers and can create delays in the decision-making process when entering into financial arrangements. Any attempts by the Government to reduce the complexity and uncertainty of the TOFA legislation is welcomed. However, it’s a concern that the Government still has not legislated previous announcements on TOFA reforms made in 2004 and 2011. The wait for draft legislation on these announcements continues and the situation remains uncertain for affected taxpayers.