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New Business Tax System (Miscellaneous) Bill 1999
Bills Digest No. 118 1999-2000
New Business Tax System (Miscellaneous) Bill 1999
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official l egal status. Other sources should be consulted to determine the subsequent official status of the Bill.
- deny the intercorporate dividend for unfranked dividend payments between resident companies that are not members of a company group
- allow a refund of excess dividend imputation credits
- exempt from tax franked dividends paid to resident complying superannuation funds and similar bodies by Pooled Development Funds, and
- allow items with a value of less than $1 000 to be pooled for the calculation of depreciation deductions.
As there is no central t heme to the Bill the background to the various measures will be discussed below.
Simplistically, the intercorporate dividend rebate (ICDR) is available to resident companies which may claim a rebate in respect of dividends received by them, effectively making the exchange of dividends between resident companies tax free when the full rate of company tax is paid. (The rate of the ICDR is equivalent to the rate of tax paid by the receiving company.) Without the ICDR, tax would be payable by each company receiving a dividend payment, resulting in double or greater tax on the amount of the dividend when passing to a resident company.
While the ICDR may appear to be easily implemented, in practice, the ICDR is a great deal more complex to take account of the various company structures that exist and structures and devices that may be used to take advantage of the ICDR in circumstances in which it was not intended to apply (ie by disguising other income or capital gains as a dividend to secure tax free status). Principally, the ICDR as described above is only available to public companies, and even in this case, only for genuine dividends that are not part of a scheme aimed to take advantage of the ICDR, such as a debt arrangement process (ie where one company lends money to another and the repayments are disguised as dividends rather than an interest or principal payment) or a dividend stripping scheme. The distinction between the different payments can be very complex as various schemes are designed to take advantage of the ICDR, specific anti-avoidance rules are introduced to counter those schemes and yet more complex schemes are evolved.
The anti-avoidance provisions connected with the ICDR in the Income Tax Assessment Act 1936 (ITAA36) are longer and more complex than those allowing the ICDR and to prevent avoidance the availability of the ICDR is already restricted. For example, resident private companies will generally not be able to claim the ICDR for unfranked dividend payments (franking refers to the allocation of paid company tax to dividends as part of the imputation process), so that no rebate will be available unless the company paying the dividend has allocated tax paid to those dividends.
The operation of the ICDR was considered by the Review of Business Taxation (Ralph Report) as part of measures to maintain integrity. Integrity in this area was considered in the context of acceptance of the entity taxation regime, which was subsequently accepted by the government, so that dividend payments between members of a company group would not be affected by the proposals (such payments would be inter-group and so disregarded under the entity taxation regime). In regard to dividend payments between different resident entities, the Ralph Report suggested 3 options:
- deferred company tax
- resident dividend withholding tax, and
- tax on unfranked inter-entity distributions, and noted that
Each option would help address the unintended loopholes created by the way the existing section 46 [which implements the ICDR] rebate frees from tax most unfranked dividends between entities as well as the added complexity of a wide range of associated and other specific anti-avoidance provisions relating to the availability of the section 46 rebate. (1)
The first two of these options were not recommended because of implications extending beyond the integrity of the tax system. (2) The third option was recommended. By their nature, no tax has been paid in respect of unfranked dividends and removing the rebate in respect of such dividends will reduce the chances of the rebate being used as a tax minimisation tool.
In respect of 100% foreign owned entities, it was recommended that where dividend withholding tax applies the tax on unfranked dividends should be refunded. (3)
The recommendations of the Ralph Report were accepted by the government and this was announced in the Treasurer’s Press Release dated 21 September 1999 which outlined the Stage 1 response to the Ralph Report. The main reasons for acceptance of the recommendations were the desire to remove ‘unintended loopholes’ and an associated simplification of tax law by removing the need for the specific anti-avoidance rules associated with the ICDR. The changes were announced to commence from 1 July 2000. (4)
The explanatory memorandum to the Bill estimates that the measure will cost $35 million in 2000-01 and result in savings of $70 million in 2001-02, $120 million in 2002-03, $155 million in 2003-04 and $125 million in 2004-05.
Item 1 of Schedule 1 of the Bill will amend section 46F of the ITAA36 which currently disallows the ICDR in respect of unfranked dividends paid to private companies. Proposed subsection 46F(2) provides that any unfranked dividend paid to a shareholder will not give rise to the ICDR unless it involves dividends between exempting companies (ie. between members of a wholly owned company group).
Proposed section 46FA deals with the deduction available in respect of tax paid where a dividend is paid on to a non-resident company. The deduction will be available when a number of conditions are satisfied including:
- the dividend is paid by a resident company and is a non-portfolio dividend (ie. the company receiving the dividend has at least 10% of the voting power in the company paying the dividend)
- the dividend paid to the non-resident is not fully-franked
- the ICDR would be available except for the above amendments in item 1
- the resident company paying the dividend declares a percentage (up to 100%) of the unfranked amount to be passed on, and
- the resident company is wholly owned by the non-resident company.
The deduction will be achieved by deeming the relevant franking amount (which will depend on the rate of tax applicable at the time the franking occurred) to have been increased by the declared percentage multiplied by the unfranked amount passed on to the non-resident company, effectively deeming the unfranked amount to be franked.
Application : To dividends paid on or after 1 July 2000 ( item 4 ).
The dividend imputation system was introdu ced in 1987 to remove the double taxation of company profits which could be subject to tax both in the hands of the company and as dividends in the hands of shareholders. To achieve this, the imputation system allows a credit for company tax paid that may be used to offset tax liabilities of a taxpayer during the year received but cannot be carried forward to future years. While this achieves the primary aim for which the imputation was introduced (ie the removal of double taxation), the loss of imputation credits after the year of receipt has been regarded by some as unfair, particularly as it affects low income earners who have a marginal tax rate less than the company rate. It is argued that such taxpayers may lose tax credits where their imputation credits exceed their total amount of tax payable. The contrary argument is that genuine low income earners are very rarely likely to be in this position as their share investments, and hence imputation credits, are likely to be low and any excess credits could be used to offset tax payable on other income (although retired people are more likely to be in this position). Instead, it may be the case that excess credits are more likely to be available to those who have a low taxable income due to arrangements that minimise the amount of tax payable, such as large deductions for negatively geared share investments that return large imputation credits.
The proposal to refund excess imputation credits was raised by the government as part of A New Tax System , a process now associated with the GST although it originally covered a much wider range of matters, details of which were released on 13 August 1998. The refund was proposed to apply to resident individuals and complying superannuation funds. The proposal was endorsed in the Ralph Report which considered that the measure would:
Ensure that such taxpayers [resident individuals and complying superannuation funds] are taxed at their appropriate marginal rates of tax on assessment. (5)
In its response to the Ralph Report, the government’s support for the proposal was reaffirmed on the basis that it would assist self-funded retirees and other low income indiv iduals as well as lessening distortions for investment decisions by complying superannuation funds. (6) The measure was announced to apply from 1 July 2000.
In the revised estimates of the fiscal impact of Stage 1 of the Business Tax Reforms, which was released as part of the Stage 2 announcements, the measure is estimated to be revenue neutral in 1999-2000, 2000-01 and 2002-03 and cost $190 million in 2001-02 and $10 million in each of 2003-04 and 2004-05. The explanatory memorandum to the Bill does not contain the estimated costs to revenue nor explain the abnormality for 2001-02.
Schedule 2 of the Bill will substitute a new Division 67 into the Income Tax Assessment Act 1997 (ITAA97) which deals with rebates for tax offsets. Excess imputation credits will be available to:
- trustees assessed for a resident beneficiaries share of a trust
- superannuation funds, approved deposit funds and pooled superannuation funds
- life assurance companies, and
- registered organisations ( proposed section 67-25 ).
Appl ication : Refunds will be available in relation to dividends paid on or after 1 July 2000 ( item 7 ).
The Ralph Report recommended that an exemption from CGT be allowed for non-resident superannua tion funds and similar bodies (eg US pension funds) which invest in PDF type investments. To be eligible for the concession, the fund or similar body must be tax exempt in its country of residence. The concession was seen as necessary to remove doubt as to the tax status of such investments in Australia. Doubt arises due to the wording of Australia’s double taxation agreements which allow Australia to tax business profits of non-resident entities which have a permanent establishment in Australia. The exemption for non-resident superannuation funds and similar bodies was introduced by the New Business Tax System (Capital Gains Tax) Act 1999 .
In its response to the Ralph Report, the Treasurer announced that the exemption would be extended to Australian superannuation funds and similar bodies which would be able to receive franked dividends from a PDF tax exempt and also be able to claim a refundable credit for any company tax allocated to those dividends under the imputation system that were not used to offset other liabilities.. (7)
For further information on the operation of PDFs and the current tax position regarding investments in PDFs, refer to the Digest for the Pooled Development Funds Amendment Bill 1999 (No. 104 of 1999-2000).
Item 1 of Schedule 5 will substitute new provisions into section 124ZM of the ITAA36, which deals with the taxation of dividends from PDFs. Proposed subsection 124ZM(1) provides that unfranked dividends paid by a PDF will be tax exempt, which reflects the current position. For the general category of franked dividends, the current position for bodies not eligible for the venture capital franking rebate (VCFR) is reinstated by proposed subsections 124ZM(1B) and (2) , so that if a dividend is franked only the franked amount will be exempt and no rebate will be allowed.
The VCFR will be introduced by proposed Division 12A which will be inserted into the ITAA36 by item 44. The VCFR will be available to:
- trustees of complying superannuation funds (but not a self managed fund)
- trustees of complying approved deposit funds (but not a self managed fund)
- trustees of pooled superannuation trusts
- life assurance companies, and
- registered organisations ( proposed section 160ASEO ).
Taxpayers will be eligible for the VCFR if they satisfy the following major conditions as well as any applicable rules for the taxpa yer described below:
- the taxpayer receives a dividend from a PDF
- the dividend is a VCFR and is not exempt income for the taxpayer
- the dividend is not paid as part of a dividend stripping operation
- the shareholder is a resident at the time the dividend is paid
- the taxpayer is not a partnership or a trustee, other than a trustee referred to above, and
- if the taxpayer is a life insurance company, the dividend forms part of its insurance funds.
The rate of rebate will generally be calculated using a formula bas ed on the amount of the venture capital franked in the dividend and the current method used to calculate class C franked dividends. For life insurance companies and registered organisations different formulas will be used based on their complying superannuation and rolled over annuity income ( proposed section 160ASEP ).
Proposed section 160ASEB will allow a PDF to establish a venture capital sub-account within its class C franking account (companies have different franking accounts to reflect the various changes to the company tax rate since the introduction of the imputation system). As with other franking accounts, the sub-account may be in credit or debit, depending on the amount of credits and debits allocated to the account ( proposed section 160ASEC ). Credits will principally arise from payments of CGT on a qualifying SME investment by a PDF, but may also arise from:
- credits carried forward from the previous year if the sub-account balance is positive ( proposed section 160ASEE )
- an estimated venture capital debt determination (see below) lapsing ( proposed section 160ASEF ), or
- where there is a refund of venture capital deficit tax (see below).
A debit will principally arise from a payment of franked dividends from the sub-account ( proposed section 160ASEG ) and may also arise:
- Where at the end of the year the amount of credits available after debits are subtracted exceeds its limit. The limit will be the less of either an amount calculated by reference to a formula based on the amount of CGT gains from SME activities compared to the PDFs total CGT gains and the amount of tax paid on SME activities. If the amount of credits available exceed the allowable amount calculated using these calculations, a debit equal to the amount of the excess will arise ( proposed section 160ASEH ). (This should ensure that the maximum amount of credits available at the end of the year relates to SME activity).
- From an estimated venture capital debit determination ( proposed section 160ASEI ). Proposed section 160ASEK provides that if a PDF has paid, or taken action to reduce liability, tax which gives rise to a credit, it may request from the Commissioner a determination of the amount of debit which will arise. The debit to be determined will relate to any refund that the company may receive.
If a PDF has a sub-account, it may declare a class C dividend to be a venture capital franked dividend so long as the dividends are paid to all shareholders of the PDF and the dividends are the same (ie there can be no preference in the distributio n of the venture capital dividends)( proposed section 160ASEL ). In determining the extent to which the dividend is venture capital franked, the dividend must be either fully venture capital franked or franked so that the sub-account is reduced to a nil balance or a debit ( proposed section 160ASEM ). If a venture capital sub-account is in deficit at the end of a franking year, the PDF will be liable to pay venture capital deficit tax. The amount of tax payable is to be determined in accordance with the proposed New Business Tax System (Venture Capital Deficit Tax) Act 2000 (see Bills Digest No.119 1999-2000), and the Commissioner will have power to remit all or part of any deficit tax payable. If a subsequent refund of the tax is received by the taxpayer and this creates an additional debit to their sub-account they will receive an offsetting credit ( proposed section 160ASEN ).
Application : The above amendments will apply to CGT events (ie events that trigger CGT liability) relating to SME investments that occur after the Bill receives Royal Assent ( item 45 ).
Currently, income producing p lant and equipment may be depreciated using either the prime cost or depreciating value method with the time over which an item may be depreciated being based on its effective life. As part of the initial legislative response to the Ralph Report, accelerated depreciation was generally removed from 21 September 1999 by the New Business Tax System (Capital Allowances) Act 1999 . Items costing $300 or less may be immediately written off.
Items may currently be pooled where they are subject to the same rate of depreciation and certain other conditions are satisfied, such as the item is used solely for income producing purposes (subdivision 42-L of the ITAA97).
In relation to low value ($1 000 or less) items, the Ralph Report recommended that:
- all items costing $1 000 or less (the Bill refers to amounts less than $1 000) should be able to be pooled for depreciation and written off at the rate of 18.75% for the year it is acquired and 37.5% for later years using the ‘declining value’ (8) method (see below - proposed section 42-470). (The report states that this is equivalent to a four year write off period under the prime cost method.)
- the pool may include existing items as well as those acquired after commencement of the new arrangements
- if an item from the pool is disposed of, the value of the pool is to be reduced by the proceeds from the disposal, and
- that if a taxpayer does not elect that this method be used, such items be written off over their effective lives.
As a consequence of these recommendations and the favourable treatment to be given to items valued at $1 000 or less, it was also recommended that the current immediate write off for items costing $300 or less be abolished. The main benefit from the changes was seen to be a significant reduction in compliance costs. (9)
For small businesses, ie those with an annual turnover of less than $1 million, the Ralph Report recommended the introduction of a Simplified Tax System (STS) which would affect their depreciation rules. In announcing the Stage 1 response to the Ralph Report, the Treasurer announced that the above recommendations regarding pooling would be adopted from 1 July 2000 but that the introduction of the STS would be delayed until 1 July 2001, the same date as the introduction of the entity taxation regime. For this reason, small businesses will continue to be able to immediately write off assets with a value of $300 or less until 1 July 2001. (10)
The explanatory memorandum to the Bill estimates that the measures will cost $30 million in 2000-01; $410 million in 2001-02; and $40 million in 2002-03 and result in savings of $80 million in 2003-04 and $180 million in 2004-05.
Item 6 of Schedule 6 will substitute a new section 42-167 into the ITAA97 which will provide that the ability to immediately write off items with a value of $300 or less will be maintained in respect of assets: acquired under a contract entered into before 1 July 2000, acquired in some other way before that date, or where construction of the item started before that date. The write off ability will also remain for small business operators (ie those with average turnover of less than $1 million per year).
Provisions for the pooling of low value items are contained in proposed subdivision 42-M which will be inserted into the ITAA97 by item 7 . Taxpayers will have the option of creating such a pool ( proposed section 42-450 ) and may opt to allocate to it items which cost less than $1 000 or which have an undeducted cost at the start of the year of less than $1 000. Once an item has been allocated to a pool it cannot be removed and items valued at $300 or less which fall within the rules for immediate write off noted above cannot be allocated to the pool. Similarly, if an item has already been allocated to a pool under the existing provisions in subdivision 42-L it cannot be in a low value pool ( proposed section 42-460 ).
When an item is added to the pool and it is not to be used exclusively for income producing purposes, the taxpayer must make an estimate of the percentage of non-income producing use and deduct the same percentage from the value of the item before it is ad ded to the pool ( proposed section 42-465 ).
The rate of deductions is dealt with in proposed section 42-470 and will be 18.75% of the cost of an item allocated to the pool in the tax year and 37.5% of: the value of the remainder of the pool at the end of the previous year plus the undeducted cost of any items added to the pool during the year.
Where there is a ‘balancing adjustment event’, usually through the disposal of an item in the pool, the closing balance of the pool at the end of the year is to be reduced by the item’s ‘termination value’ (this term is defined in section 42-205 of the ITAA97 and has many variations depending on the circumstances of the disposal. In the most straightforward cases it will be the sale value of the item less reasonable expenses of disposal). If as a result of the reductions the value of the pool is negative, the negative amount is to be included in assessable income ( proposed section 42-475 ).
Application : The pooling provisions are to apply to the 2000-01 and later years of income ( subitem 15(2)) while those relating to the $300 immediate write off are to apply to years of income in which 1 July 2000 occurs and later years ( subitem 15(1) ).
1. Review of Business Taxation , A Tax System Redesigned, p. 411.
2. Basically, the first option would have led to substantial reductions in reported pre-tax profits, while the second would have achieved much the same result as the third but have been more complex - see section 11.1 of the Ralph Report .
3. ibid, p. 413.
4. Treasurer, Press Release , 21 September 1999, Attachment L.
5. Review of Business Taxation , A Tax System Redesigned, p. 421.
6. Treasure r , Press Release , 21 September 1999, Attachment K.
7. ibid, Attachment H.
8. Review of Business Taxation , A Tax System Redesigned, p. 316.
9. ibid, pp. 316-317.
10. Treasurer, Press Release , 21 September 1999, Attachment B.
11 February 2000
Bills Digest Service
Information and Research Services
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