Title New Business Tax System (Over-franking Tax) Bill 2002
Database Explanatory Memoranda
Date 18-06-2010 02:42 PM
Source House of Reps
System Id legislation/ems/r1562_ems_5aa5bb72-4127-49f1-9252-581a5d704fb7


New Business Tax System (Over-franking Tax) Bill 2002

2002

 

THE PARLIAMENT OF THE COMMONWEALTH OF AUSTRALIA

 

 

 

HOUSE OF REPRESENTATIVES

 

 

 

NEW BUSINESS TAX SYSTEM (IMPUTATION) BILL 2002

new business tax system (over-franking tax) bill 2002

new business tax system (franking deficit tax) bill 2002

 

 

 

 

 

EXPLANATORY MEMORANDUM

 

 

 

 

 

(Circulated by authority of the
Treasurer, the Hon Peter Costello, MP)


Table of contents

Glossary                                                                                             1

General outline and financial impact.............................................. 3

Chapter 1      Overview of the imputation system.......................... 5

Chapter 2      Franking a distribution............................................. 15

Chapter 3      Anti-streaming rules................................................. 31

Chapter 4      Franking accounts................................................... 45

Chapter 5      Effect of receiving a franked distribution............... 51

Chapter 6      Regulation impact statement.................................. 67

Index                                                                                                 75

 


Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

Abbreviation

Definition

A Platform for Consultation

Review of Business Taxation: A Platform for Consultation

A Tax System Redesigned

Review of Business Taxation: A Tax System Redesigned

ADI

authorised deposit-taking institution

ATO

Australian Taxation Office

Commissioner

Commissioner of Taxation

ITAA 1936

Income Tax Assessment Act 1936

ITAA 1997

Income Tax Assessment Act 1997

PAYG

pay as you go

PST

pooled superannuation trust

TAA 1953

Taxation Administration Act 1953

 


General outline and financial impact

Imputation system

These bills introduce a new simplified imputation system into the taxation law. Like the current imputation system, the new imputation system allows Australian corporate tax entities to pass on to their members credit for income tax that they have paid.

The benefits of the new system include:

·         the simplification of the current rules which will result in compliance cost savings;

·         increased flexibility in the method in which companies frank distributions;

·         consistency of treatment across entities receiving franked dividends; and

·         improved clarity of the law using clearer and more accessible drafting techniques developed in the tax law improvement project.

Date of effect:  Broadly speaking, the measure applies from 1 July 2002.

Proposal announced:  The proposal was announced in Treasurer’s Press Release No. 58 of 21 September 1999 as a component of the unified entity regime. On 14 May 2002, the Minister for Revenue and Assistant Treasurer announced in Press Release No. C57/02, the Government’s program for delivering the next stage of business tax reform measures.  In that press release, the Minister confirmed that the simplified imputation system will commence on 1 July 2002.

Financial impact:  The new imputation system will have no revenue impact.

Compliance cost impact:  The new imputation system is designed to reduce compliance costs incurred by business by providing for simpler processes and increased flexibility.

Summary of regulation impact statement

Regulation impact on business

Impact:  Low.

Main points:

·         The changes will simplify the imputation system resulting in both reduced taxpayer compliance costs and ATO administration costs.

·         The new imputation system will, broadly speaking, provide the same outcome as that provided under the current system.

·         The changes will also address efficiency and integrity problems in the current imputation system.

 


Chapter 1   
Overview of the imputation system

Outline of chapter

1.1         This chapter provides an overview of Part 3‑6. Part 3‑6 introduces the new imputation system rules applying to companies, corporate unit trusts, public trading trusts and limited partnerships, operative from 1 July 2002.

1.2         The changes made to the imputation system are broadly consistent with the recommendations made by the Review of Business Taxation in its report, A Tax System Redesigned.

1.3         This chapter focuses on explaining the features of the new imputation system that differ from the current imputation system in Part IIIAA of the ITAA 1936. It also outlines the key features of the new system.

1.4         Some other rules dealing with the new imputation system are not included in these bills. These other rules will be included in a later bill and deal, largely, with the consequential amendments arising from the new imputation system. These other rules include provisions relating to:

·         venture capital franking;

·         life insurance and exempting companies;

·         share capital tainting;

·         holding period and related payment rules; and

·         certain transitional and machinery provisions (including the existing offset of franking deficit tax against income tax).

Context of reform

Terminology

1.5         This section explains the terminology commonly used in relation to franking and imputation. Many of these terms are defined in the bill which contains amendments made to the dictionary and core concepts in the ITAA 1997. [Schedule 2, items 1 to 45, section 995-1 of the ITAA 1997]

1.6         The income tax law taxes companies, corporate unit trusts, public trading trusts and corporate limited partnerships as taxpayers separate from their members. Members of these entities include shareholders, beneficiaries and partners.

1.7         Entities that are taxed separately from their members are called corporate tax entities, and they are taxed at the company tax rate, which is currently 30%.

1.8         To prevent double taxation of the distributed income of corporate tax entities (i.e. once when it is received by the entity and again in the hands of the members on distribution), the income tax paid by the entity will generally be imputed (i.e. passed on) to the members. Providing the means for imputing the tax paid by the corporate tax entity is the function served by both the current imputation system and the new provisions explained in this explanatory memorandum.

1.9         The imputation system is the taxation law governing how and when income tax paid by a corporate tax entity is imputed to the entity’s members. It may also be referred to as the franking system, because the tax is imputed to members by means of franking (in the sense of stamping or marking) distributions of the entity when made to members.

1.10       In essence, a franked distribution is one that is marked as carrying tax credits that can be imputed to members. Those tax credits reflect the tax already paid by the entity on the entity’s profits that are distributed to the member.

1.11       The tax credits that can be imputed to members are recorded in the entity’s franking account as franking credits. Franking credits reflect income tax paid directly by the entity, or underlying tax paid through other corporate tax entities that is imputed to the entity.

1.12       When a franked distribution is made to a member of an entity, the franking credit is referred to as an imputation credit in the member’s hands. Imputation credits usually reduce income tax by giving rise to a tax offset known as the franking rebate. In addition, if the recipient is a corporate tax entity itself, an imputation credit is also allowed as a franking credit in the entity’s own franking account, which may in turn be distributed to the entity’s members.

1.13       Subject to anti‑avoidance rules, resident individuals, superannuation entities, registered charities and deductible gift organisations, are eligible for refunds of excess imputation credits to the extent to which the imputation credits exceed tax payable by these entities.

Why is the current law being changed?

1.14       The Government instituted the Review of Business Taxation to consult on its plan to comprehensively reform the business income tax system as outlined in its release of Tax Reform: not a new tax, a new tax system. The Review of Business Taxation made recommendations to the Government designed to achieve a more simple, stable and durable business tax system.

1.15       The Review of Business Taxation recommended the redesigning of the company tax and imputation system to achieve:

·         integrity through the entity chain;

·         simplification of the franking account;

·         refunding excess imputation credits; and

·         the reduction of the company tax rate.

1.16       These bills are part of the legislative program implementing the New Business Tax System. Measures such as refunding excess imputation credits and the reduction of the company tax rate have already been introduced and passed.

1.17       The new imputation provisions will broadly change the mechanics of the current imputation system to achieve:

·         simpler rules and consequent reduction in compliance costs;

·         increased flexibility in franking distributions; and

·         consistency of treatment across entities receiving franked dividends.

1.18       Whilst the new imputation system changes the mechanics of the current imputation system, the new imputation provisions will generally provide the same outcome as the current imputation system.

1.19       The object of the new imputation system, as with the existing system, is to integrate the Australian corporate tax system and the taxation of its members by allowing corporate tax entities to pass on credits for income tax paid to their members and to allow the Australian members to claim a tax offset for that credit and in some circumstances claim a refund if they are unable to fully utilise the tax offset.

1.20       The objects of the new imputation system are also to ensure that:

·         the imputation system is not used to give the benefit of income tax paid by a corporate tax entity to members who do not have a sufficient economic interest in the entity;

·         the imputation system is not used to prefer some members over others when passing on the benefits of having paid income tax; and

·         the membership of the corporate tax entity is not manipulated to create either of the above outcomes.

Summary of new law

Simplification

1.21       The simplification of the franking account rules means that a corporate tax entity will:

·         maintain its franking account on a tax‑paid basis; and

·         align its franking year with its income year.

The franking account

1.22       The current system operates on a qualified dividend account basis (or taxed income basis) under which the company’s franking account operates on an after‑tax basis. For example, if a company derives $100 taxable profit and pays tax of $30 (at a 30% rate), it would credit its qualified dividend account by $70 – the after‑tax profit available for distribution.

1.23       Operating the franking account on this qualified dividend account basis has required companies to maintain a number of different classes of franking account and to carry out a number of complex conversions to accommodate changes in the company tax rate.

1.24       To avoid this, the new imputation provisions provide that a corporate tax entity’s franking account will record franking credits on a tax‑paid basis. On this basis, if a company paid income tax of $30 the relevant franking credit would be $30. This will also mean that corporate tax entities will not have to convert entries to the franking account to reflect taxed income.

1.25       The mechanics of the franking account and what constitutes a franking debit or franking credit are discussed in Chapter 4 of this explanatory memorandum.

The franking year

1.26       Under the current imputation rules a company’s franking year is dependent upon whether it determines its taxable income and lodges its income tax return:

·         in lieu of the next succeeding 30 June – the company has an early balance date;

·         in lieu of the preceding 30 June – the company has a late balance date; or

·         on a 30 June basis.

1.27       Broadly, under the current imputation rules a company that has an early balance date has a franking year that is aligned to its income year whilst companies that have a late balance date or a 30 June balance date have a franking year that ends on 30 June. This disparate treatment of companies that have a late balance date has led to unnecessary complexity.

1.28       The introduction of franking period rules (discussed in paragraphs 2.58 to 2.64) will result in all corporate tax entities having a franking year that is aligned with its income year. Certain transitional rules will apply to late balancing companies to reduce the initial impact of the alignment (discussed in paragraph 1.53).

Flexibility in franking distributions

1.29       To impute tax it has paid to its members a corporate tax entity must frank a distribution. This is done by allocating franking credits to the distribution. Only frankable distributions may be franked.

1.30       The current imputation system contains complex required franking amount rules that require companies to frank dividends to the maximum extent possible. This led to some criticism from businesses who were unable to provide certainty for shareholders about the extent to which dividends will be franked in the future. This lack of flexibility is addressed under the new provisions.

1.31       Under the new imputation system a corporate tax entity will be allowed to determine the extent to which it will frank a frankable distribution, having regard to the existing and expected surplus in its franking account and the rate at which earlier distributions have been franked. Generally the only restriction on a corporate tax entity’s ability to frank a distribution will be the requirement to frank all frankable distributions within the franking period to the same extent – known as the benchmark rule.

Benchmark rule

1.32       The franking percentage is a measure of the extent to which a corporate tax entity chooses to frank a frankable distribution. The level to which a corporate tax entity may frank a distribution is capped by a maximum franking credit, which is broadly the maximum amount of income tax that may be paid by the entity on the profits distributed.

1.33       The amount of franking credit allocated to a frankable distribution is taken to be the amount disclosed in the distribution statement accompanying the recipient’s distribution.

1.34       The benchmark franking percentage will be the franking percentage in relation to the first frankable distribution made during the franking period. If a corporate tax entity does not make any frankable distributions during the franking period it will not have a benchmark franking percentage.

1.35       A corporate tax entity will be required to frank all frankable distributions made within the franking period to the same extent. This is called the benchmark rule and it is designed to prevent a corporate tax entity streaming distributions within a franking period. Certain entities are excluded from the benchmark rule (see discussion in paragraph 2.54).

1.36       If the benchmark rule is breached the corporate tax entity will be subject to either:

·         underfranking penalty debits; or

·         overfranking tax.

1.37       Chapter 2 provides further discussion on how a corporate tax entity franks a distribution.

Consistent treatment of franked dividends received by entities

1.38       The current tax system has 2 different mechanisms that are designed to prevent the double taxation of company profits, namely:

·         an intercorporate dividend rebate for companies and entities taxed like companies; and

·         a ‘gross‑up and credit’ approach for all other entities.

1.39       Greater integrity and consistency is provided by bringing corporate tax entities receiving franked distributions wholly within the imputation system instead of relying on the intercorporate dividend rebate in section 46 of the ITAA 1936.

1.40       The new imputation system will provide a single rebate/tax offset mechanism, to prevent double taxation of company profits, which is consistent across all entities. It will achieve this by using a ‘gross‑up and credit’ approach that is consistent with that currently used by individuals, superannuation funds and trustees assessed under Division 6 of the ITAA 1936.

1.41       Under this approach a resident recipient of a franked distribution will generally:

·         ‘gross‑up’ the amount of the distribution to reflect the before‑tax profit of the corporate tax entity – that is, the amount of the distribution plus the attached franking credit (called an imputation credit in the hands of the recipient); and

·         receive a tax offset (also referred to as a franking rebate) for the imputation credit. In certain circumstances, this tax offset is refundable.

1.42       In effect, the same treatment applies to taxpayers who receive franked distributions indirectly through a trust (other than a corporate unit trust or a public trading trust) or a partnership.

1.43       Chapter 5 provides further discussion on the effect of receiving a franked distribution.

Anti‑streaming rules

1.44       The benchmark rule lays down the framework for ensuring that, over time, the benefit of franking credits is spread more or less evenly across members in proportion to their ownership interest in the entity. To prevent the undermining of this framework, 4 specific rules are required, namely:

·         rules applying to streaming arrangements involving linked distributions;

·         rules applying to streaming arrangements involving tax‑exempt bonus shares;

·         rules applying to arrangements where an entity streams distributions to provide imputation benefits to members who benefit more from imputation credits than other members; and

·         a disclosure rule that forms part of the anti‑streaming rules.

1.45       These rules ensure that franking credits representing tax paid on behalf of all members of an entity are not allocated to only some of them. These rules are referred to as anti‑streaming rules, because they prevent the streaming, or disproportionate allocation, of franking credits to certain members. The first three rules are consistent with the anti-streaming rules contained in the current law.

1.46       Further discussion of these rules may be found in Chapter 3.

Comparison of key features of new law and current law

1.47       This table sets out the key differences between the former imputation system and the new imputation system.

New law

Current law

Franking credits arising from income tax paid are expressed on a tax‑paid basis (e.g. a $30 income tax payment results in a franking credit of $30). As a result, the tax offset received by a member equals the face value of the franking credit allocated to that member.

Franking credits arising from income tax paid are expressed on an after‑tax distributable profits basis (e.g. a $30 income tax payment would result in a franking credit of $70, assuming a 30% tax rate). As a result, the tax offset received by a member equals the adjusted amount of the franking credit allocated to that member. The adjusted amount reconverts the after‑tax distributable profits to the amount of the underlying tax paid.

Corporate tax entities may select their preferred level of franking having regard to their existing and expected franking account surplus and the rate at which they franked earlier distributions.  However, generally, all distributions made within a franking period must be franked to the same extent.  This is referred to as the ‘benchmark rule’.

In cases where there is excessive variation of the benchmark franking percentage between franking periods, there may be a requirement for the corporate tax entity to disclose this variation to the Commissioner.

Complex ‘required franking rules’ complemented by ‘estimated debit determination’ rules provide that a company must frank a dividend to the maximum extent possible on the basis of the surplus in its franking account at the time of payment of the dividend.

There are no complex franking rules that prescribe the method in which companies are required to allocate franking credits to a distribution that it makes.  The distribution statement provides evidence of the extent to which a distribution is franked.

Companies are required to follow complex franking rules when franking a dividend including the requirement of making a declaration stipulating the extent to which a dividend is franked.

Public companies will continue to be required to provide distribution statements at the time the distribution  is made. However, private companies will be permitted to provide distribution statements up to 4 months after the end of the income year in which the distribution is made. This facility will also allow private companies to retrospectively frank distributions.

Companies are required to provide dividend statements to members at the time, or before, the dividend is made.

Resident corporate tax entities that receive a franked distribution from another corporate tax entity must ‘gross‑up’ the distribution by the amount of the attached franking credit and are entitled to a tax offset in the same way as resident individuals and superannuation entities.

Resident companies that receive a franked dividend from another company must include the net amount of the dividend in assessable income and may receive the intercorporate dividend rebate under section 46 of the ITAA 1936.

An entity’s franking account will always be based on the entity’s income year.

The franking year of a late balancing company may differ from its income year.

The franking account is a rolling balance account: the balance of the account at the end of the last day of an income year is brought forward to the beginning of the first day of the next income year. However, if the account is in deficit on the last day of an income year, the entity will be liable to pay franking deficit tax.

If the franking account is in surplus at year‑end, the amount of that surplus will be carried forward and registered in the account as a credit on the first day of the following year. If the account is in deficit, that deficit will not be carried forward. However, the company will be liable to pay franking deficit tax.

An over‑payment of corporate tax that eliminates a franking deficit at the end of an income year and is refunded shortly afterwards is addressed by a simple re-calculation of franking deficit tax for that year.

Refunds of over‑paid tax may result in a deficit deferral amount that triggers a liability to a separate tax (deficit deferral tax).

Application and transitional provisions

1.48       The new imputation system applies in respect of events occurring (e.g. franked distributions) on or after 1 July 2002. [Schedule 1, item 1, section 201-5]

1.49       Conversely, the existing imputation system ceases to apply in respect of events occurring on or after that date. [Schedule 3, item 1, section 160AOAA]

1.50       Consistent with the rules contained in the consolidations regime, the intercorporate dividend rebate will continue to apply in respect of unfranked dividends paid within wholly-owned groups until 30 June 2003. The intercorporate dividend rebate does not apply to franked dividends paid on or after 1 July 2002, instead a tax offset provided under the new imputation system applies instead. Rules to give effect to this outcome will be contained in a later bill.

1.51       Special transitional rules apply to convert franking account balances that exist at the end of 30 June 2002 into equivalent tax-paid franking account balances. If a taxpayer’s franking year ends on 30 June 2002 and its franking account is in deficit at that time, the taxpayer will continue to be liable to franking deficit tax (and possibly deficit deferral and franking additional tax) under the existing provisions contained in the ITAA 1936. These special transitional rules apply to taxpayers that have an income year ending on 30 June (i.e. ordinary balancers). Equivalent provisions will be introduced in a later bill for taxpayers that are not ordinary balancers. [Schedule 4, item 2, section 205-10]

1.52       Further transitional rules apply to ensure that inappropriate estimated debit determination consequences do not arise after 1 July 2002. [Schedule 3, item 2, section 201-1; Schedule 4, item 2, sections 205-1 and 205-5]

1.53       To reduce the initial impact of the alignment of franking and income years, special transitional provisions will be introduced at a later time. The effect of these rules will be to allow late balancing companies an extended transitional franking year (13 to 17 months) starting on 1 July 2002 and ending on the last day of their 2002-2003 income year. In effect, the extended year would enable these companies to ‘borrow’ franking credits from their 2002-2003 franking year to reduce or eliminate a franking deficit attributable to dividends paid during the period from 1 July 2002 to the end of the company’s 2001-2002 income year. This will give these companies more time to adjust to the new imputation system and avoid the imposition of franking deficit tax.

 


Chapter 2  
Franking a distribution

Outline of chapter

2.1         Franking a distribution is the means by which an entity imputes to a member tax it has paid. Therefore, to impute tax paid to its members, the entity must be capable of franking a distribution. This chapter explains how an entity may frank a distribution. In summary, an entity franks a distribution if:

·         the entity is a franking entity that is a resident when the distribution is made;

·         the distribution is a frankable distribution; and

·         the entity allocates a franking credit to the distribution.

2.2         This chapter also explains what rules the entity should have regard to when franking a distribution including the amount of franking credits that should be attached to the distribution, and the obligations the entity has in respect of providing information statements to members when making a distribution to them.

Detailed explanation of new law

Who can frank a distribution?

2.3         To impute tax paid to its members, an entity must be capable of franking a distribution.

2.4         An entity franks a distribution if:

·         it is a franking entity that is a resident of Australia when the distribution is made;

·         the distribution is a frankable distribution; and

·         it allocates a franking credit to the distribution.

[Schedule 1, item 1, section 202-5]

2.5         For these purposes a distribution made by an entity is a:

·         dividend, or something taken to be a dividend, made by a company;

·         distribution made by a corporate limited partnership, other than a distribution from profits or gains arising during a year of income in which the partnership was not a corporate limited partnership;

·         something taken to be a dividend, made by a corporate limited partnership; or

·         unit trust dividend made by a corporate unit trust or public trading trust.

2.6         A member of a corporate tax entity includes:

·         a member (including a shareholder) of a company;

·         a partner of a corporate limited partnership; or

·         a unit holder in a corporate unit trust or public trading trust.

What is a franking entity?

2.7         A franking entity is a corporate tax entity that is not a mutual life insurance company. Where the entity is a company that is a trustee of a trust it will be a franking entity at a particular time if it is not acting in its capacity as  trustee of the trust at that time. [Schedule 1, item 1, section 202-15]

What is a corporate tax entity?

2.8         A corporate tax entity is:

·         a company (a body corporate or any other unincorporated association or body of persons other than a partnership);

·         a corporate limited partnership (see Division 5A of Part III of the ITAA 1936);

·         a corporate unit trust (see Division 6B of Part III of the ITAA 1936); or

·         a public trading trust (see Division 6C of Part III of the ITAA 1936).

2.9         The following entities are not corporate tax entities:

·         a non-fixed trust;

·         a fixed trust (other than a corporate unit trust or a public trading trust);

·         a complying superannuation fund;

·         a complying approved deposit fund; and

·         a pooled superannuation trust.

How does an entity satisfy the residency requirement when making a distribution?

2.10       An entity that is a company or a corporate limited partnership satisfies the residency requirements when making a distribution if, at that time, it is an Australian resident. [Schedule 1, item 1, paragraphs 202-20(a) and (b)]

2.11       A company is an Australian resident if, either:

·         it is incorporated in Australia; or

·         if it is not incorporated in Australia – it carries on a business in Australia and either has its central management and control in Australia, or its voting power is controlled by shareholders who are themselves residents of Australia.

2.12       A corporate limited partnership is an Australian resident if and only if:

·         it was formed in Australia; or

·         either it carries on a business in Australia, or its central management and control is in Australia.

2.13       A corporate unit trust or a public trading trust will satisfy the residency requirement when making a distribution if, at that time, they were a resident unit trust for the income year in which distribution occurs. [Schedule 1, item 1, paragraphs 202-20(c) and (d)]

2.14       A corporate unit trust or a public trading trust is a resident unit trust if at any time during the income year:

·         either of the following was satisfied:

-          the unit trust has property situated in Australia; or

-          the trustee of the trust carried on a business in Australia; and

·         either of the following was satisfied:

-          the central management and control of the unit trust was situated in Australia; or

-          Australian residents hold more than 50% of the beneficial interests in the income or property of the trust.

Which corporate tax entities are excluded from franking distributions?

2.15       Consistent with the imputation provisions contained in Part IIIAA of the ITAA 1936, non-resident corporate tax entities and mutual life insurance companies are excluded from franking distributions.

Which distributions can be franked?

2.16       Not all distributions made by a corporate tax entity can be franked. Generally, only distributions attributable to a corporate tax entity’s realised taxed profits can be franked.

2.17       A distribution is frankable unless it is specifically made unfrankable [Schedule 1, item 1, subsection 202-40(1)]. Unfrankable distributions are explained in paragraphs 2.24 and 2.25. These rules, although expressed differently, are intended to replicate the same outcome as the provisions contained in section 160APA of the ITAA 1936.

2.18       The imputation rules specifically provide that a non-share dividend is frankable [Schedule 1, item 1, subsection 202-40(2)]. A non-share dividend has the meaning given by section 974-120 of the ITAA 1997.

What are non-share dividends?

2.19       In essence, a payment to a non‑share equity interest holder that corresponds to a dividend paid to a shareholder is treated in the same way as a dividend. This is effected by the definitions of non‑share distribution and non‑share dividend, which are based on the definition of a dividend in the ITAA 1936.

2.20       The starting point is the definition of a non‑share distribution. This is the distribution of money or property, or the crediting thereof, by the company to a non‑share equity holder. In this context ‘distribution’ has a very broad meaning that would encompass, for example, the repayment of a profit‑participating loan.

2.21       A non‑share distribution will usually constitute a non‑share dividend (which corresponds to a dividend on a share). However, this is qualified by a capital distribution exception, which corresponds to the exception (subject to certain anti‑avoidance rules) for distributions to a shareholder that are debited to the share capital account. In the case of the holder of a non‑share equity interest, the exception relates to distributions debited to the non‑share capital account of the company, or, where company law permits it, to the (untainted) share capital account. As a general rule, a share capital account is tainted if an amount other than share capital is credited to it.

2.22       These capital distributions are called ‘non‑share capital returns’ and are taxed as returns of capital rather than as dividends.

2.23       Non‑share dividends are generally frankable in the same circumstances that dividends on shares (share dividends) are frankable.

What are unfrankable distributions?

2.24       Unfrankable distributions are distributions that are:

·         made by a cooperative company for which a deduction is allowable under section 120 of the ITAA 1936;[1]

·         paid by a company resident in the Norfolk Islands and out of profits sourced there;

·         in respect of non-equity shares;

·         debited against certain disqualifying accounts;

·         non-share dividends paid by an Australian ADI and non-share dividends that exceed available frankable profits;

·         taken to be dividends under Division 7A (private company distributions) of the ITAA 1936;

·         taken to be dividends under section 47A of the ITAA 1936;

·         taken to be dividends under section 108 (loans to shareholders and associates) or section 109 (excessive remuneration) of the ITAA 1936; and

·         taken to be dividends under sections 45 and 45C of the ITAA 1936 (capital streaming and dividend substitution arrangements).

[Schedule 1, item 1, section 202-45]

2.25       In certain cases the amount, or part of the amount, taken to be a dividend in an off-market share buy-back will also be unfrankable. This will be the case where the purchase price exceeds the market value of the share. Where this occurs, the amount of the dividend reduced by any excess of the purchase price over the market value (as normally understood) of the share is taken to be unfrankable. The remainder of the dividend, however, is taken to be frankable. These rules that describe which distributions are unfrankable, although expressed differently, are intended to replicate the same outcome as the provisions contained in section 160APA of the ITAA 1936. [Schedule 1, item 1, paragraph 202-45(c)]

What is the amount of franking credit on a distribution?

2.26       To impute tax it has paid to its members, a corporate tax entity must frank a distribution. A corporate tax entity franks a distribution by allocating a franking credit to the distribution. Franking credits can only be allocated to frankable distributions.

2.27       The franking credit allocated to a frankable distribution is taken to be the amount stipulated on the distribution statement unless that amount exceeds the maximum franking credit for that distribution. This is unlike the existing law which requires a separate declaration by the company of the extent to which the dividend is franked. [Schedule 1, item 1, subsection 202-60(1)]

 
2.28       The maximum franking credit for a distribution is equivalent to the maximum amount of income tax that could have been paid, by the corporate tax entity, on profits underlying the distribution. It is calculated using the following formula:

The corporate tax rate is currently 30%. [Schedule 1, item 1, subsection 202‑60(2)]

Example 2.1:  Maximum franking percentage

Bertone Pty Ltd has after-tax profits of $7,000 available for distribution. On 1 September 2002 Bertone Pty Ltd decides to pay $3,500 of this after-tax profit (i.e. a frankable distribution) to its shareholders. The maximum franking credit that Bertone Pty Ltd can attach to this distribution is calculated as follows:

$3,500  ´  (30%  ¸  70%)  =  $1,500

2.29       Should the franking credit stated in the distribution statement exceed the maximum franking credit for the distribution, the franking credit on the distribution is taken to be the maximum franking credit.

What information must a corporate tax entity give to its members when it makes a franked distribution?

2.30       An entity that makes a frankable distribution must provide the recipient with a distribution statement that contains certain information about the entity and the distribution. [Schedule 1, item 1, section 202-75]

2.31       The time at which a distribution statement must be given will depend upon whether, for the income year in which the distribution is made, the entity is a private company or not.

2.32       A private company is one that is not a public company, as defined in section 103A of the ITAA 1936, for the income year. Broadly, this means that a company will be a private company if:

·         it does not have its shares listed on an official stock exchange; or

·         20 or fewer persons control 75% or more of:

-           the paid up capital of the company;

-          the voting rights in the company; or

-          the rights to the income of the company.

For the purposes of this ‘control test’ an individual, their nominees, their relatives and their relatives’ nominees are taken to be one person.

When is a private company required to provide a distribution statement?

2.33       An entity that is a private company for the income year in which a distribution was made is required to give a distribution statement to the recipient before the end of 4 months after the end of the income year in which the distribution was made [Schedule 1, item 1, subparagraph 202‑75(2)(b)(i)]. The Commissioner also has the power to extend this time if it is appropriate to do so [Schedule 1, item 1, subparagraph 202-75(2)(b)(ii)]. As the distribution statement is evidence of the franking credit attached to a distribution, these rules mean that a private company can retrospectively frank its distributions [Schedule 1, item 1, paragraph 202-75(2)(b)].

When is a company that is not a private company required to provide a distribution statement?

2.34       An entity that is not a private company (i.e. a public company) for the income year in which a distribution is made is required to give a distribution statement to the recipient on or before the day on which the distribution is made. [Schedule 1, item 1, paragraph 202-75(2)(a)]

Form of the distribution statement

2.35       The distribution statement must be in the approved form and must contain the following information:

·         the identity of the entity making the distribution;

·         the date on which the distribution is made;

·         the total amount of the distribution;

·         the amount of franking credit allocated to the distribution;

·         the franking percentage of the distribution;

·         the amount of any dividend withholding tax that has been deducted from the distribution; and

·         any other information required by the approved form.

[Schedule 1, item 1, subsections 202-80(2) and (3)]

Amending the distribution statement

2.36       The legislation provides that the amount of franking credit on a distribution is the amount stated on the distribution statement. In the event that the franking credit stated on the distribution statement was not intended, steps may be taken by the entity to amend the distribution statement.

2.37       An entity may, with the Commissioner’s written approval, amend its distribution statement to reflect a change made to the franking credit on either:

·         a specified distribution; or

·         a specified class of distributions.

[Schedule 1, item 1, section 202-85]

2.38       An entity seeking the Commissioner’s approval to change the amount of franking credit on a distribution must:

·         apply to the Commissioner in writing; and

·         include in its application all information relevant to the matters that must be considered by the Commissioner.

[Schedule 1, item 1, subsection 202-85(1)]

2.39       In considering whether to allow an entity to change the franking credit on a specified distribution the Commissioner must have regard to whether:

·         the last day for lodging the recipient’s tax return for the year of income in which the distribution was made has passed;

·         there would be any change in the recipient’s withholding tax liability as a result of changing the franking credit on the distribution;

·         amending the distribution statement will result in the entity breaching the benchmark rule or the anti-streaming rules;

·         amending the distribution statement will result in a new benchmark being set for the franking period in which the distribution was made; and

·         any other factors are considered relevant by the Commissioner.

[Schedule 1, item 1, subsections 202-85(2) and (4)]

2.40       An entity, or a member of the entity, that is dissatisfied with the Commissioner’s determination in respect of an amended distribution statement may object in the manner prescribed by Part IVC of the TAA 1953. [Schedule 1, item 1, subsection 202-85(6)]

The benchmark rule

2.41       Subject to the rules explained in the remainder of this chapter, a corporate tax entity is free to frank (i.e. allocate franking credits to) a frankable distribution to whatever extent it considers appropriate. It will be able to select the level of franking having regard to the existing and expected franking account surplus and the rate at which earlier distributions were franked.

What is the benchmark rule?

2.42       In broad terms, the benchmark rule provides that all frankable distributions made by a corporate tax entity during the franking period must be franked to the same extent – the benchmark franking percentage [Schedule 1, item 1, section 203-10]. This ensures that franking credits representing tax paid on behalf of all members of an entity are not allocated (i.e. streamed) to only some of them.

2.43       This differs from the current required franking rules, which require a company to frank a dividend to the maximum extent possible having regard to the surplus in its franking account at the time of its payment.

Franking percentage cannot exceed 100%

2.44       Consistent with the current law, however, a corporate tax entity cannot frank a distribution by more than 100% [Schedule 1, item 1, subsection 202-60(2)]. In other words, an entity cannot allocate a greater franking credit to a distribution than tax paid by the corporate tax entity on its underlying profits.

2.45       The percentage to which a distribution is franked is called the franking percentage. It is expressed as a percentage of the frankable part of a distribution, rather than of the whole of the distribution. Thus, the franking percentage of a distribution may be 100% even if it is partly unfrankable. The franking percentage of a distribution is calculated as follows:

 

 
[Schedule 1, item 1, subsection 203-35(1)]

2.46       See paragraph 2.44 on how to calculate the maximum franking credit for the distribution.

Example 2.2:  Calculating the franking percentage

A corporate tax entity derives $100 taxable profits on which it pays tax (at 30%) of $30. The maximum franking credit that can be allocated to a distribution of the $70 after-tax profit is:

$70  ´  [(30%  ¸  (100%  –  30%)]  =  $30

The entity distributes the $70 as part of a $200 distribution, $130 of which is unfrankable and $70 from available profits (i.e. the frankable distribution). It allocates $30 franking credits to the distribution. The distribution is franked to 100% (i.e. it is fully‑franked).

To whom does the benchmark rule apply?

2.47       Broadly, the benchmark rule applies to all corporate tax entities unless they are specifically excluded from the application of the rule.

2.48       It is a fundamental principle of the imputation system that corporate tax entities should not be able to direct franked and unfranked distributions to members in a way that maximises the benefits to members. Otherwise, the cost to revenue would be higher than originally intended. Instead the benchmark rule ensures that, over time, the benefit of franking credits is spread more or less evenly across members in proportion to their ownership interest in the entity.

2.49       Arrangements undermining this fundamental principle constitute ‘dividend streaming’. They include situations where unfranked distributions are streamed to members who have no need for franking credits so as to preserve the credits for those who benefit most from the credits. Dividend streaming is discussed in greater detail in Chapter 4.

2.50       Due to the limited opportunities for streaming the benchmark rule does not apply to a company in a franking period if at all times during that period either:

·         it is a listed public company that:

-          under its constituent documents, must frank all distributions made to its members under a single resolution at the same franking percentage; and

-          any distributions made during the period are made to all members of the company; or

·         it is a listed public company with a single class of membership interest.

[Schedule 1, item 1, subsections 203-20(1) and (2)]

What is the purpose of the benchmark rule?

2.51       The benchmark rule effectively prevents a corporate tax entity making distributions to its members within a particular franking period that are franked to different extents, unless the Commissioner is satisfied that there is a legitimate (non‑tax driven) reason for doing so.

2.52       The key elements of this rule are the ascertainment of the franking period and the benchmark franking percentage for that period. Once the benchmark franking percentage is established, the entity must frank all frankable distributions made within the franking period using this percentage, or face penalties. [Schedule 1, item 1, section 203-50]

Ascertaining the franking period

2.53       The franking period rules will result in an entity’s franking year being aligned with its income year. This will correct an anomaly in the current law whereby some late balancing companies have a franking year that differs from their income year. The alignment of the income year and franking year will remove the complexities that arise under the current law for these companies.

2.54       A corporate tax entity that is a private company for an income year will have a franking period that is the same as its income year.

2.55       On the other hand, a corporate tax entity that is not a private company for an income year will have its franking periods determined by reference to the length of its income year. However, that period will usually be a 6 month period.

What is the franking period for a company that is not a private company?
Income year is 12 months

2.56       Each of the following is its franking period:

·         first 6 months beginning at the start of the entity’s income year; and

·         the remainder of the income year.

[Schedule 1, item 1, subsection 203-40(2)]

Income year of 6 months or less

2.57       The franking period will be its income year.

[Schedule 1, item 1, subsection 203-40(3)]

Income year more than 6 months but less than 12 months

2.58       Each of the following is the franking period:

·         first 6 months beginning at the start of the entity’s income year; and

·         the remainder of the income year.

[Schedule 1, item 1, subsection 203-40(4)]

Income year is more than 12 months

2.59       Each of the following is the franking period:

·         first 6 months beginning at the start of the entity’s income year (first franking period);

·         next 6 months beginning immediately after the first franking period; and

·         the remainder of the income year.

[Schedule 1, item 1, subsection 203-40(5)]

What is the benchmark franking percentage for a franking period?

2.60       The benchmark franking percentage for a franking period will be the franking percentage allocated to the first frankable distribution made by the entity within that period. If no frankable distributions are made in the franking period, the entity does not have a benchmark franking percentage for the franking period. [Schedule 1, item 1, section 203-30]

Example 2.3:  Establishing the benchmark

On 31 August 2002 Wong Enterprises made a frankable distribution of $7,000 (i.e. after-tax profits) to its shareholders. The distribution statement that issued in relation to this showed that no franking credits were allocated to the distribution. As this was the first frankable distribution made in the franking period Wong Enterprises has a benchmark franking percentage of 0%.

On 21 September 2002 Wong Enterprises paid its first quarterly PAYG instalment liability. This resulted in a franking credit of $3,000 in its franking account.

On 31 October 2002 Wong Enterprises made another frankable distribution of $7,000. As the benchmark franking percentage for the franking period is 0%, Wong Enterprises cannot frank this second distribution made in the franking period.

If on the other hand, the distribution made on 31 August 2002 was an unfrankable distribution (e.g. a distribution on a non-equity share) then the frankable distribution made on 31 October 2002 will be the first frankable distribution made in the franking period. Consequently, Wong Enterprises could potentially frank this distribution to a maximum of 100%. The franking percentage of this distribution would then set the benchmark franking percentage for the franking period.

Penalty for franking distributions differently within a franking period

2.61       A breach of the benchmark rule will not invalidate the allocation made to the distribution, but it will result in a penalty to the corporate tax entity.

2.62       The penalty is calculated by reference to the difference between the franking credits actually allocated and the benchmark percentage. The penalty is either:

·         over-franking tax, if the franking percentage for the distribution exceeds the benchmark franking percentage; or

·         a franking debit (penalty debit), if the franking percentage for the distribution is less than the benchmark franking percentage.

[Schedule 1, item 1, subsection 203-50(1)]

2.63       The amount of over-franking tax is imposed by a separate bill, the proposed New Business Tax System (Over-franking Tax) Bill 2002.

2.64       The penalty debit for under-franking a distribution arises on the day on which the frankable distribution is made and is in addition to the franking debit that arises from the payment of a franked distribution [Schedule 1, item 1, paragraph 203-50(2)(b)]. It is equivalent to the extra franking credit that should have been allocated according to the benchmark rate. The additional debit effectively cancels out the unused credit. Therefore the penalty for under‑franking by the entity is that the extra franking credit that ought to have been allocated to the distribution is wasted.

 
2.65       The amount of overfranking tax or the penalty debit is worked out using the following formula:

2.66       For the purposes of the formula, the franking % differential is the difference between:

·         the franking percentage for the distribution; and

·         either:

-          the entity’s benchmark franking percentage for the franking period in which the distribution is made; or

-          the franking percentage permitted by the Commissioner in a determination made under section 160-85 of this Part (see paragraphs 2.70 to 2.76).

Example 2.4:  Over-franking a distribution

Jeneris Ltd, a corporate tax entity, has a benchmark franking percentage for the current franking period of 80%. Using this benchmark would mean that a frankable distribution of $700 would have $240 of franking credits attached.

However, Jeneris Ltd makes a fully franked distribution of $700 within that franking period. In other words, it allocates a $300 franking credit (resulting in a franking percentage of 100%). The entity has over‑franked this distribution and over-franking tax will be imposed.

The amount of the over-franking tax will be equivalent to the franking credit allocated in excess of the benchmark. It is calculated on the same basis as a penalty debit would have been if the distribution were under‑franked, that is:

(100%  –  80%)  ×  $700  ×  (30%  ÷  70%)  =  $60

Commissioner’s power to permit departure from benchmark rules

2.67       A corporate tax entity may apply to the Commissioner in writing, either before or after a distribution is made, for permission to depart from the benchmark rule. [Schedule 1, item 1, subsection 203-50(1)]

2.68       An entity seeking permission to depart from the benchmark rule should include all relevant information in support of the application. In particular, the application should address the following factors, which must be considered by the Commissioner in making a decision:

·         the entity’s reasons for wanting to depart or proposing to depart from the benchmark rule;

·         the extent of the departure or proposed departure (the greater the departure, the greater the onus on the corporate tax entity to justify it);

·         whether the entity has previously sought the exercise of the Commissioner’s powers to permit the departure in the past (assuming the previous applications resulted from circumstances within the entity’s control – if so, the onus on the entity to justify a departure will increase if the entity applies for a variation relatively frequently);

·         whether a member of the entity will be disadvantaged by the departure or proposed departure (e.g. because the member will receive a distribution with a lower franking percentage than the distribution received by another member);

·         whether a member of the entity will receive franking benefits in preference to other members of the entity as a result of the departure (in such a case the departure may be motivated by a desire to stream franking credits inappropriately); and

·         any other matters that the Commissioner considers relevant.

[Schedule 1, item 1, subsection 203-55(3)]

Power to be exercised in extraordinary circumstances only

2.69       The power to permit a departure from the benchmark rule will be exercised by the Commissioner only in extraordinary circumstances. Thus, the circumstances justifying a departure would generally need to be unforeseeable and beyond the control of the entity, its members and controllers. [Schedule 1, item 1, subsection 203-55(2)]

2.70       A change in ownership of an entity would rarely amount to extraordinary circumstances sufficient to warrant a departure from a benchmark rule.

Example 2.5:  Permitted departure from the benchmark rule

McDonald Ltd, a corporate tax entity, conducts a farming business. In the current franking period, its benchmark franking percentage is 80%. It declares a distribution, expecting a credit to arise in its franking account from a tax instalment to be paid later in the franking period.

The distribution will be made from profits arising from the sale of its crops. However, shortly before harvest heavy flooding devastates the crops. Therefore, McDonald Ltd pays less tax than it had expected and receives only a small credit to its franking account.

McDonald Ltd applies to the Commissioner for permission to depart from its benchmark franking percentage.

These would be extraordinary circumstances since they are unforeseeable and beyond the control of McDonald Ltd. The Commissioner would consider all the relevant circumstances in deciding whether to permit a departure from the benchmark rules.

Note:  If McDonald Ltd were to apply for permission to deviate from its benchmark in a later franking period, the later application would not be weakened because McDonald Ltd had made this application.

What is the consequence of allowing a departure from the benchmark rule?

2.71       A distribution that is franked in accordance with the Commissioner’s permission to depart from the relevant benchmark rules is taken to comply with the benchmark rule to which the permission relates. [Schedule 1, item 1, subsection 203-55(5)]

2.72       Where the Commissioner permits a deviation from a benchmark rule the entity is taken to comply with the rule so long as it does not deviate from the rule by more than was permitted.

Example 2.6:  Commissioner’s permission to depart from the benchmark rule

Trimble Ltd is a corporate tax entity that has a benchmark franking percentage of 0% for a particular franking period. The company wishes to set a benchmark franking percentage of 50%. The entity applies to the Commissioner for permission to do so.

The Commissioner determines, having regard to the relevant factors, that a benchmark franking percentage of 50% is appropriate. Notwithstanding this determination, Trimble Ltd makes a distribution allocating franking credits using a franking percentage of 100%.

Over-franking tax will be imposed on the entity for franking inconsistently with the benchmark franking percentage, as set by the Commissioner’s determination. That is, the over-franking tax will be based on the excess of the franking percentage applied (100%) over the benchmark franking percentage the Commissioner has permitted (50%).


Chapter 3  
Anti-streaming rules

Outline of chapter

3.1         This chapter explains the anti-streaming rules that form part of the package for these bills.

3.2         The benchmark rule lays down the framework for ensuring that, over time, the benefit of franking credits is spread more or less evenly across members in proportion to their ownership interest in the entity. To prevent the undermining of this framework, 4 specific rules are required to ensure that franking credits representing tax paid on behalf of all members of an entity are not allocated to only some of them. These rules are referred to as anti‑streaming rules, because they prevent the streaming, or disproportionate allocation, of franking credits to certain members.

Summary of new law

3.3         The first anti-streaming rule, explained in paragraphs 3.11 to 3.20, is based on subsections 160AQCB(3) and (4A) of the ITAA 1936. It applies to streaming arrangements involving linked distributions, where a member of one entity can choose to receive a distribution from another entity that is franked to a greater or lesser extent than distributions made to other members of the first entity. This rule supplements the benchmark rule, which applies where distributions franked to a different extent are made by the same entity.

3.4         The second anti-streaming rule, explained in paragraphs 3.21 to 3.25, is based on subsection 160AQCB(2) of the ITAA 1936. It applies to streaming arrangements involving tax-exempt bonus shares, where a member of an entity can choose that tax-exempt bonus shares are issued to the member, or to another member of the entity, instead of receiving a franked dividend.

3.5         The third anti-streaming rule, explained in paragraphs 3.26 to 3.57, replicates section 160AQCBA of the ITAA 1936. It applies to arrangements where an entity streams distributions to provide imputation benefits to members who benefit more from imputation credits than other members.

3.6         There is also a new disclosure rule that forms part of the anti‑streaming rules. The disclosure rule is explained in paragraphs 3.58 to 3.63 and applies where an entity’s benchmark franking percentage differs significantly between franking periods.

Detailed explanation of new law

Background

3.7         To gain a full understanding of the anti-streaming rules it is necessary to understand the underlying policy.

3.8         Where members hold interests in the profits of a corporate tax entity, the policy is that credits for tax paid on behalf of all members should flow to all members and not to only some of them. The franking rules do not, in general, attempt either to track the source of distributed profits or the particular members who hold an interest in a corporate tax entity at any given time. However, the policy of the tax law assumes that the benefit of imputation will, over time, be spread more or less evenly across members in proportion to their holdings in a corporate tax entity, having regard to any particular rights that attach to those holdings.

3.9         A consequence of generally spreading imputation benefits evenly across members is that members who cannot use, or cannot fully use, imputation benefits will nevertheless receive franked distributions. This results in the ‘wastage’ of those benefits, which is a design feature of the imputation system. Wastage of imputation benefits also includes the failure to use franking credits attributable to profits that are never distributed.

3.10       The benchmark rule and the anti-streaming rules ensure that the intended wastage of imputation benefits is not undermined.

Streaming using linked distributions

3.11       The benchmark franking rule could be circumvented if members of a corporate tax entity (referred to in the provisions as the first entity) were able to choose to receive a distribution from another corporate tax entity in substitution for a distribution with a different benchmark percentage from the first entity.

3.12       To prevent this, a penalty franking debit will arise when a member of an entity who would otherwise receive a distribution from the entity can choose to receive a distribution with a higher or lower franking percentage from another entity. The distribution received from the other entity is called a ‘linked distribution’. The rules dealing with streaming using linked distributions are contained in Subdivision 160DA.

3.13       A penalty franking debit will also arise where a member of an entity can decide that a member of another entity will receive a distribution rather than receiving a distribution franked to a different extent. An election of this nature might be made by a member if an associate of the electing member was the recipient of the distribution from the other entity. [Schedule 1, item 1, subsection 204-15(1)]

3.14       This rule would apply, for example, where stapled stock arrangements are used for streaming. Under these arrangements, holders of stapled stock can choose to receive either a franked or an unfranked (or a lesser franked) dividend depending on the company paying the dividend. These arrangements might be used in an attempt to stream franked dividends to Australian resident shareholders of a company group and unfranked dividends to non-resident shareholders (who receive less benefit from imputation credits).

What are the consequences of streaming using linked distributions?

3.15       If the linked distribution streaming rule applies, one of the entities involved in the arrangement will incur a penalty franking debit. The franking debit imposed is equal to the debit that would have arisen if the relevant entity had made the linked distribution at its benchmark franking percentage [Schedule 1, item 1, subsection 204-15(1)]. The debit will arise on the day the linked distribution is made [Schedule 1, item 1, subsection 204-15(4)].

3.16       The penalty debit is imposed on the entity with the higher benchmark franking percentage [Schedule 1, item 1, subsection 204-15(2)]. If the electing member would, but for the election, have received a distribution with a higher franking percentage than the distribution made by the other entity, the electing member’s entity will incur a franking debit (assuming that that entity’s benchmark franking percentage is also higher). If, on the other hand, the foregone  distribution had a lower franking percentage (reflecting a lower benchmark franking percentage), the entity making the linked distribution (with a higher franking percentage) will incur the franking debit. The debit is not imposed on the electing member’s entity in all cases because that entity may be a non-resident entity, particularly where the foregone  distribution is an unfranked distribution.

3.17       The penalty debit is in addition to any other debit that arises in an entity’s franking account because of the linked distribution. [Schedule 1, item 1, subsection 204-15(5)]

3.18       It is possible that the first entity does not itself have a benchmark franking percentage for the relevant franking period. In this case, a hypothetical benchmark franking percentage is attributed to the entity for the purposes of these rules. The hypothetical benchmark franking percentage depends on the franking percentage of the linked distribution. If the linked distribution has a franking percentage of less than 50% then a hypothetical benchmark franking percentage of 100% will be attributed to the entity for that period. If the linked distribution has a franking percentage of 50% or more a hypothetical benchmark franking percentage of 0% will be attributed for that period.[Schedule 1, item 1, subsection 204‑15(6)]

Comparison with section 160AQCB

3.19       The linked distribution streaming rule covers the same circumstances as subsections 160AQCB(3) and (4A) of the ITAA 1936. However, the franking debit is calculated by reference to the new benchmark franking percentage concept.

3.20       The circumstances to which subsection 160AQCB(1) of the ITAA 1936 applies are covered by the benchmark franking percentage rules and the rule covering the streaming of benefits to members who benefit more from imputation than others.

Streaming using tax-exempt bonus shares

3.21       The tax-exempt bonus shares streaming rule covers the same circumstances as subsection 160AQCB(2) of the ITAA 1936. However, as with linked distributions, the franking debit is calculated by reference to the new benchmark franking percentage concept. These rules are contained in Subdivision 160DB.

3.22       The benchmark franking rule could be circumvented if members of an entity were able to choose to receive tax-exempt bonus shares, or for tax-exempt bonus shares to be issued to another member of the entity, in substitution for a distribution (the substituted distribution) from the entity.

What are tax-exempt bonus shares?

3.23       Tax-exempt bonus shares are shares issued to a shareholder of a company in the circumstances described in subsection 6BA(6) of the ITAA 1936 (broadly speaking, bonus shares issued by a listed public company without crediting the share capital account). For those few companies that still have par value shares, tax-exempt bonus shares are shares paid up by debiting the share premium account. [Schedule 1, item 1, subsections 204-25(4) and (5)]

What are the consequences of streaming using tax-exempt bonus shares?

3.24       To prevent this type of streaming, a penalty franking debit arises when a member of an entity who would otherwise receive a distribution from the entity can choose that the member, or another member, receives tax-exempt bonus shares. An election that another member receives the shares might be made by a member if the other member were an associate of the electing member [Schedule 1, item 1, subsection 204-25(1)]. The penalty debit arises on the day when the shares are issued [Schedule 1, item 1, subsection 204-25(3)].

3.25       If the tax-exempt bonus shares streaming rule applies, the entity involved in the arrangement will incur a penalty franking debit. The franking debit imposed is equal to the debit that would have arisen if the entity had made the substituted distribution at its benchmark franking percentage [Schedule 1, item 1, subsection 204-25(2)]. If the entity does not have a benchmark franking percentage for the franking period in which the shares are issued, the entity is taken to have a benchmark franking percentage of 100% for that period [Schedule 1, item 1, subsection 204-25(6)].

Streaming benefits to members who benefit more from imputation than others

3.26       The third of the specific anti-streaming rules, contained in Subdivision 160DC, applies where a corporate tax entity streams distributions in such a way as to give those members who benefit most from imputation credits (e.g. taxable residents) a greater imputation benefit than those who benefit less (e.g. non-residents). The rule applies regardless of whether the streaming occurs within a single franking period or between different franking periods. [Schedule 1, item 1, subsection 204-30(1)]

3.27       The streaming may occur by making franked distributions to some members of the entity and unfranked (including unfrankable) distributions to others. It may also occur, for example, by making franked distributions to some members and providing non-distribution benefits (e.g. superannuation contributions) to others. [Schedule 1, item 1, subsection 204-30(2)]

What is streaming?

3.28       Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29       The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

3.30       Thus, streaming is unlikely to occur when a corporate tax entity, in making franked distributions, distinguishes between 2 classes of members, both of which comprise members who can and who cannot benefit from imputation credits. However, where one class is predominantly able to use imputation credits, and the other is predominantly not, it may be apparent that an arrangement is streaming, notwithstanding the presence in each class of a small minority of the other type of member.

3.31       Broadly speaking, any strategy directed to defeating the policy of the law by avoiding wastage of imputation benefits through directing the flow of franked distributions to members who can most benefit from them to the exclusion of other members, may amount to streaming. While it is not possible to specify in detail every combination of circumstances which can constitute the streaming of franking credits (which in some cases may involve questions of degree), some guidance is given below.

3.32       In the simplest case of streaming, the members who can benefit from imputation credits receive a franked distribution, while members who cannot benefit to the same degree (e.g. non-residents) or who receive no benefit (e.g. tax-exempt organisations) simultaneously receive an unfranked distribution (normally adjusted in amount for the lack of franking).

3.33       However, it is not necessary for there to be 2 distributions by the corporate tax entity for streaming to occur. For example, in more complex cases of streaming, while the members who benefit most from imputation credits will receive a franked distribution from the entity, the other members may receive benefits from persons other than the entity, or they (or the entity) may defer the realisation of their share of the profits derived by the entity. Benefits may also be directed to associates of members. In some cases where the member less able to benefit from imputation is a corporate tax entity, trust or partnership, streaming may involve by‑passing the member in favour of its ultimate owners.

3.34       Members less able to benefit from imputation credits may not receive unfranked distributions at the time the other members get franked distributions, and instead realise their interest in the corporate tax entity’s profits in some other way, either at the same time or in the future. In this case, streaming will occur where it is apparent that the corporate tax entity or the members less able to benefit from imputation credits have deferred or avoided the distribution of their interest in profits as part of a strategy to avoid the wastage of imputation benefits. On the other hand, it would not be streaming if there is merely a deferred distribution of profits to one group of members which it is reasonable to expect will be franked (to a similar percentage) when it is distributed, or, if it is unfranked, will not be unfranked as the result of any strategy to direct franking to members most able to benefit from franking. In these cases it is appropriate to look to the intentions of the entity and members, and to the pattern of distributions among the members.

Example 3.1:  Single distribution streaming by a non-resident controlled company

A non-resident controlled company with resident minority shareholders adopts a strategy of distributing all its franking credits to the minority shareholders while retaining the share of profits belonging to the controlling shareholder in the company. It does this with a view to ultimately paying an unfranked dividend, or paying some other benefit to the majority shareholder, or someone else, in lieu of a dividend (which would include realising accumulated profits as a capital amount on the sale of shares).

This would constitute streaming. On the other hand, if the non-resident majority shareholder merely deferred distributions in order to provide more equity capital for its subsidiary, but ultimately takes franked distributions, that would not be streaming.

Example 3.2:  Share buy-back – limited franking surplus

A corporate tax entity has members with differing abilities to benefit from franking and a limited supply of franking credits. It makes a franked distribution by buying back off-market the shares owned by taxable residents to stream the limited franking credits available to those who can most benefit from them.

This would constitute streaming. Alternatively, where there remain sufficient franking credits to frank distributions to the remaining shareholders, streaming would not occur, absent other special features. Special features are present in Example 3.3.

Example 3.3:  Share buy-back – excess credits

A corporate tax entity has ‘excess’ franking credits – that is, more franking credits than it is reasonably likely to use to frank its ordinary distributions. It buys back shares off-market predominantly from members most able to benefit from imputation credits because the terms of the buy-back are not attractive to the other members. As a result of the buy-back it uses profits it would not normally distribute, thereby directing a large franked distribution predominantly to those who benefit most from imputation credits.

This would be streaming. In this case avoiding wastage of franking credits is not a matter of concentrating scarce credits – there may well be sufficient credits to frank distributions to other members. (This type of arrangement may result in a proportionately greater interest in the corporate tax entity being held by members less able to benefit from imputation credits, and a value shift in favour of the shares not bought back. In these cases the remarks in paragraph 3.34 concerning deferral strategies may also be applicable.)

Example 3.4:  Dividend access share

A company group contains an operating subsidiary which is owned by a loss company (i.e. a company that has tax losses). The members of the loss company can, because they are not in tax loss, derive a greater benefit from imputation credits than the loss company. The members are issued with a dividend access share (broadly speaking, a share which confers no rights, and is issued only to enable a taxpayer to get a distribution from the company – dividend access shares therefore frequently feature in streaming arrangements). The dividend access share is used to stream dividends directly to them.

 

 

 

 

 


This is another illustration of more sophisticated streaming. In cases such as these there will rarely be any distribution flowing to the member less able to benefit from the imputation credit.

3.35       It is necessary to distinguish cases where individual members have no effective interest in the profits of a corporate tax entity from the foregoing examples of ‘single distribution’ streaming.

3.36       In most cases, the members less able to benefit from imputation credits have a real interest in the undistributed profits of the corporate tax entity, although the entity may not have yet allocated those profits to the members. However, some corporate tax entities have membership interests where the rights of the members holding those interests are effectively discretionary, since the entity can make distributions to some members to the exclusion of other members at its discretion. In these entities, which are usually family companies or trusts, the members do not have anything, in a sense relevant for streaming purposes, resembling a definite interest in the profits of the corporate tax entity, they have only a possibility of being considered as a possible recipient of distributions.

3.37       In these cases, the receipt of a franked distribution by one class of members does not imply that the other classes of members who have not received a franked distribution have deferred distribution of their share in the profits. More commonly it is reasonable to assume that they have simply missed out on any share in the profits. This is not streaming; all members with an actual share of the profits have appropriately received franked distributions.

3.38       In general, therefore, the distribution of franked and unfranked distributions by a closely-held family company or trust among family members is unlikely to be streaming.

What is an imputation benefit?

3.39       For streaming to occur, a member better able to benefit from imputation credits must receive one or more imputation benefits. An imputation benefit is:

·         an entitlement to a tax offset or, if the member is a corporate tax entity, a franking credit;

·         an amount that would be included in the member’s assessable income as a result of the distribution because of the operation of section 161-285A; or

·         an exemption from withholding tax (relevant if the member is a non-resident).

[Schedule 1, item 1, subsection 204-30(6)]

When does a member derive a greater benefit from imputation credits?

3.40       For this streaming rule to apply, the recipient must:

·         receive an imputation benefit; and

·         because of the nature or status of the recipient, derive a greater benefit from imputation credits than another member who misses out on an imputation benefit.

3.41       Relevant factors in determining whether the recipient derives a greater benefit from imputation credits than another member include:

·         the residency of the members (non-residents cannot fully use imputation credits) [Schedule 1, item 1, paragraph 204-30(8)(a)];

·         whether one of the members would not gain the full benefit of the tax offset from the franking credit (e.g. corporate tax entities are not entitled to a refund of excess imputation credits) [Schedule 1, item 1, paragraphs 204-30(8)(b) and (c)];

·         if one of the members is a corporate tax entity, whether it would not be entitled to franking credits (e.g. because it is a mutual life insurance company) [Schedule 1, item 1, paragraph 204-30(8)(d)]; and

·         if one of the members is a corporate tax entity, whether it would be unable to make a franked distribution to its members (and therefore would be unable to distribute the franking credits it has received) [Schedule 1, item 1, paragraph 204-30(8)(e)].

3.42       A difference in marginal tax rates of members of a corporate tax entity does not, by itself, indicate that some members derive a greater benefit from imputation credits than others.

Commissioner’s determination

3.43       If the elements of this streaming rule are present, the Commissioner may make a determination that:

·         the streaming entity will incur an additional franking debit in respect of each distribution made or other benefit received by a member; and/or

·         no imputation benefit is to arise in respect of any streamed distributions paid to a member.

[Schedule 1, item 1, subsection 204-30(3)]

3.44       The Commissioner may specify the franking debit under the first determination above by specifying the franking percentage to be used in working out the amount of the debit. [Schedule 1, item 1, subsection 204-30(4)]

3.45       The Commissioner may also specify the distribution under either of the determinations above by specifying the date on which the distribution was made or the period during which the distribution was made, and the member or class of members to whom the distribution was made. [Schedule 1, item 1, subsection 204-30(5)]

3.46       The determination made by the Commissioner can be revoked or varied and can be made at any time after the streaming has occurred.

3.47       Where it is decided to make a determination, generally speaking, it could be expected that a determination will be made to impose a franking debit, rather than to remove imputation benefits, especially where there are numerous members. Where the Commissioner determines that the entity is to incur an additional franking debit, that debit is calculated as discussed in paragraphs 3.55 to 3.57.

3.48       Where, however, excess franking credits are being streamed it will usually be appropriate to remove the imputation benefit from the members, because imposing a franking debit on the corporate tax entity may not effectively counteract the streaming arrangement if the entity retains a significant surplus of franking credits. Also, these are likely to be cases where there will be no other distribution, or equivalent benefit, in respect of which a franking debit could be calculated.

3.49       To give effect to the determination, the Commissioner is required to serve notice of the determination in writing on the taxpayer to which it relates. The notice may be included in a notice of assessment or served separately. [Schedule 1, item 1, subsections 204-30(2) and (4)]

3.50       Where the Commissioner makes a determination that no imputation benefit is to arise and the determination applies in respect of a distribution made by a widely-held entity, the Commissioner will be able to satisfy the requirement of serving the notice of determination in writing on the taxpayer by publishing the notice in an Australian national newspaper. The notice is taken to have been served on the day that it is published. [Schedule 1, item 1, subsection 204-50(3)]

3.51       A taxpayer dissatisfied with a determination will have the same rights of review and appeal as if the determination were an assessment [Schedule 1, item 1, section 204-55]. However, to ensure that a determination carries its own rights of appeal a determination will not form part of an assessment [Schedule 1, item 1, subsection 204-50(1)].

Bonus shares

3.52       When the Commissioner is considering whether and how to exercise the discretion to make a determination, it is relevant to consider the effect of other provisions of both the ITAA 1936 and the ITAA 1997, as well as the differing effects of imposing a franking debit or removing a franking credit benefit.

3.53       For example, certain bonus share plans offer shareholders a choice between bonus shares or franked dividends (usually because some shareholders have pre-CGT shares and therefore a tax preference for capital). Under section 160-86A (explained in paragraphs 3.21 to 3.25) an automatic franking debit arises to the entity in these cases.

3.54       In cases where the shareholders with pre-CGT shares are also disadvantaged shareholders, section 160-87 may apply if the bonus share plan was also part of a strategy to direct franked dividends to advantaged shareholders. However, if section 160-86A already applies to give the entity a franking debit, it would only be appropriate in rare cases for the Commissioner to make a determination to remove the imputation benefit from the pre-CGT shareholders who receive bonus shares.

How is the additional franking debit calculated?

3.55       If the streaming involves the making of distributions only, the additional franking debit is equal to the difference between:

·         the amount of the franking credit (if any) allocated to the distribution paid to those members who do not derive as great a benefit from imputation credits as others; and

·         the amount of the franking credit that would have been allocated to the distribution if the distribution had been franked to the same extent as the streamed distribution made to the members who benefit most from imputation credits.

[Schedule 1, item 1, section 204-40]

3.56       If the streaming arrangement involves the streaming of more than one distribution to the members who benefit most from imputation credits, it is the extent to which the maximum franked distribution is franked (i.e. the distribution with the greatest franking percentage) that is relevant in determining the additional franking debit. For example, suppose during consecutive franking periods a company streams:

·         two franked dividends to a shareholder, one of which is franked to the extent of 60% and the other franked to the extent of 80%; and

·         one unfranked distribution to another shareholder.

The additional franking debit that could arise in relation to the unfranked distribution is the amount of the franking debit that would have arisen if it had been franked to 80%.

3.57       If the streaming involves the making of distributions and the provision of other benefits, the additional franking debit is equal to the franking debit that would have arisen if a distribution equal to the value of the benefit had been franked at the highest franking percentage at which a distribution to a favoured member is franked. [Schedule 1, item 1, subsection 204-40(1)]

Disclosure rule

3.58       To ensure corporate tax entities do not stream between periods by excessively varying the benchmark franking percentage between franking periods, the Commissioner will require entities to disclose any significant variation together with reasons for the variation. This disclosure requirement is designed to assist the Commissioner in identifying possible streaming cases.

3.59       A corporate tax entity must notify the Commissioner in writing if its benchmark franking percentage for a franking period (the current franking period) differs significantly from the benchmark franking period of its last franking period in which a frankable distribution was made (the last relevant franking period). [Schedule 1, item 1, subsection 204-75(1)]

 
3.60       The benchmark franking percentage for the current franking period varies significantly from its benchmark franking percentage for the last relevant franking period if it has increased or decreased by an amount that is greater than the amount worked out under the following formula:

[Schedule 1, item 1, subsection 204-75(2)]

3.61       For example, there would be a disclosure obligation where an entity has a benchmark franking percentage of 30% in the current franking period after it had a benchmark franking percentage of 0% in the immediately preceding franking period. However, there would be no disclosure obligation where an entity has a benchmark franking percentage of 30% in the current franking period if it had not made a frankable distribution in the previous franking period but had a benchmark franking percentage of 0% in the franking period before that.

3.62       The notice must be in the approved form. [Schedule 1, item 1, subsection 204-75(4)]

3.63       The following information must be provided in the notice:

·         the benchmark franking percentages for the current franking period; and

·         the benchmark franking percentage for the last relevant franking period

[Schedule 1, item 1, paragraphs 204-75(a) and (b)]

3.64       Where the benchmark percentage differs significantly from the previous franking period, the Commissioner has the power to request additional information surrounding the reasons for the variance. The additional information required to be furnished includes:

·         the entity’s reasons for setting the benchmark franking percentage at a rate that significantly differs from the rate that applied in the previous franking period [Schedule 1, item 1, paragraph 204-80(1)(a)];

·         the franking percentages for all frankable distributions made in the current and last relevant franking period [Schedule 1, item 1, paragraph 204-80(1)(b)];

·         details of any other benefits given to the entity’s members, either by the entity or an associate of the entity, in the period from the beginning of the last relevant franking period to the end of the current franking period [Schedule 1, item 1, paragraph 204-80(1)(c)];

·         whether any of the entity’s members has derived, or will derive, a greater benefit from the imputation credits than another member of the entity as a result of the variation in the benchmark franking percentage [Schedule 1, item 1, paragraph 204-80(1)(d)]; and

·         any other information required by the approved form [Schedule 1, item 1, paragraph 204-80(1)(e)].


Chapter 4  
Franking accounts

Outline of chapter

4.1         The rules relating to franking accounts are set out in Subdivision 160-F. These rules essentially replicate the rules relating to franking credits and debits in the current law. The most significant departures from the current law include:

·         entries are to be recorded on a tax paid basis rather than an after-tax distributable profits basis; and

·         the franking account will operate on a rolling balance account rather than a yearly account with an annual balance transfer.

Summary of new law

4.2         In summary, franking credits will arise upon payment of income tax and PAYG instalments, and receipt of franked distributions. Franking debits will arise upon payment of franked distributions, and refunds of income tax. Franking deficit tax will be imposed if a franking account is in deficit at the end of the income year (i.e. if the sum of the franking debits in the franking account exceeds the sum of the franking credits).

Detailed explanation of new law

General rules

4.3         The franking account rules apply to all corporate tax entities rather than only to franking entities. A corporate tax entity that is not a franking entity will incur a liability for franking deficit tax if it purports to make a franked distribution (this is explained in more detail in paragraph 4.15). However, franking credits or debits will not otherwise arise for corporate tax entities that are not franking entities and, unless they purport to make a franked distribution, for practical purposes, these entities can disregard the franking account rules. [Schedule 1, item 1, section 205-10]

4.4         Franking credits for payment of PAYG instalments and corporate income tax, and franking debits for refunds of corporate income tax, arise only for resident entities. The residency criteria are contained in the ‘sufficiently resident’ test, which is carried over from the current law.

4.5         The franking account will be a rolling balance account rather than a yearly account with an annual balance transfer. This is a simplification measure that removes the need for franking entries to effect the transfer of a credit balance to the following income year.

Franking credits

4.6         The circumstances in which a franking credit will arise are set out in the table in section 160-115. These circumstances are discussed in paragraphs 4.7 to 4.12.

Payment of a PAYG instalment or income tax

4.7         Payment of a PAYG instalment or income tax will give rise to a franking credit. The amount of the franking credit is reduced on an attribution basis if an entity is not a franking entity for the whole of the relevant instalment period in the case of PAYG instalments, or for the whole of the relevant income year in the case of corporate tax. The entity must also satisfy the residency requirementfor the income year in relation to which the PAYG instalment or income tax is paid. [Schedule 1, item 1, section 205-15, items 1 and 2 in the table]

4.8         Section 160-126 explains the residency requirement. For an entity that is a company or corporate limited partnership the entity must either be resident for more than one half of the year, or be resident at all times during the year when the company exists. If an entity is a corporate unit trust or public trading trust the entity must be a corporate unit trust or public trading trust for the income year. [Schedule 1, item 1, section 205-25]

4.9         Section 160-120 explains when a corporate tax entity is taken to have paid a PAYG instalment or income tax for the purpose of the imputation rules. Broadly speaking, an entity pays a PAYG instalment if:

·         the entity has a liability to pay the instalment; and

·         either:

-          the entity makes a payment to satisfy the liability; or

-          a credit is applied to discharge or reduce the liability.

This replicates section 160APBB of the ITAA 1936. [Schedule 1, item 1, section 205-20]

4.10       Under the new law, franking credits arising from income tax paid will be expressed on a tax paid basis. As a result, the tax offset received by a member will equal the face value of the franking credit allocated to that member. This is a departure from the current law where franking credits are expressed on an after-tax distributable profits basis.

Receipt of a franked distribution

4.11       Receipt of a franked distribution will also generally give rise to a franking credit. The franking credit equals the franking credit on the distribution [Schedule 1, item 1, section 205-15, item 3 in the table]. Receipt of a franked distribution can also flow indirectly through a partnership or trust. [Schedule 1, item 1, section 205-15, item 4 in the table]

Liability for franking deficit tax

4.12       A franking credit will arise if an entity incurs a liability for franking deficit tax. Section 160-135 explains when an entity’s franking account is in deficit. The credit is triggered by liability for, rather than payment of, franking deficit tax to avoid the possibility of franking deficit tax being imposed in respect of outstanding franking deficit tax incurred for an earlier income year. Although a franking credit does not arise under the current law for a liability to pay franking deficit tax, in effect the same outcome is achieved because a franking deficit is not carried over to the following year. The effect of this provision is that the franking account will operate as a rolling balance account compared to the current imputation rules that essentially require companies to establish new franking accounts from one franking year to the next. [Schedule 1, item 1, section 205-15, item 5 in the table]

Franking debits

4.13       The circumstances in which a franking debit will arise are set out in the table in section 160-130. These circumstances are discussed below.

Making a franked distribution

4.14       A franking debit arises if a franking entity makes a franked distribution.

4.15       A franking debit also arises if a corporate tax entity that is not a franking entity purports to frank a distribution. This debit would result in the entity becoming liable to pay franking deficit tax because, not being a franking entity, it would not be able to obtain franking credits to offset the debit. However, no imputation credits would arise for the recipient of the distribution in this case because it would not be a franked distribution (only franking entities can make franked distributions). [Schedule 1, item 1, section 205-30, item 1 in the table]

4.16       The debit for making a distribution arises at the time the distribution is made.

Refund of income tax

4.17       A franking debit will arise if an entity receives a refund of income tax. The amount of the franking debit is reduced on an attribution basis if an entity is not a franking entity for the whole of the relevant income year. [Schedule 1, item 1, section 205-30, item 2 in the table]

4.18       The relevant parts of section 160APBD of the ITAA 1936 are replicated to provide when a refund of income tax is received. Broadly speaking, an entity receives a refund of income tax if:

·         either:

-          the entity receives an amount as a refund; or

-          the Commissioner applies a credit, or a running balance account surplus, against a liability or liabilities of the entity; and

·         the refund of the amount, or the application of the credit, represents in whole or in part a return to the entity of an amount paid or applied to satisfy the entity’s liability to pay income tax.

[Schedule 1, item 1, section 205-35]

Underfranked distributions

4.19       A franking debit will arise if an entity makes an underfranked distribution, that is, a distribution with a franking percentage that is less than the entity’s benchmark franking percentage for the franking period. This debit is explained in more detail in paragraphs 2.69 to 2.71 in the context of the benchmark rules. [Schedule 1, item 1, section 205-30, item 3 in the table]

Ceasing to be a franking entity

4.20       If an entity ceases to be a franking entity, a franking debit will arise to eliminate any franking surplus. The debit will ordinarily arise at the time the entity ceases to be a franking entity. [Schedule 1, item 1, section 205-30, item 4 in the table]

Linked distribution

4.21       A franking debit will arise if an entity makes a linked distribution. This debit is explained in more detail in the context of the anti-streaming rules in paragraphs 3.11 to 3.20. [Schedule 1 , item 1, section 205‑30, item 5 in the table]

Tax-exempt bonus shares

4.22       A franking debit will arise if an entity issues tax-exempt bonus shares instead of making a distribution. This debit is explained in more detail in the context of the anti-streaming rules in paragraphs 3.21 to 3.25. [Schedule 1, item 1, section 205-30, item 6 in the table]

Streaming determination

4.23       A franking debit will also arise if the Commissioner makes a determination that a franking debit should arise because the entity is streaming imputation benefits to members most able to benefit from them. This debit is explained in more detail in the context of the anti-streaming rules in paragraphs 3.26 to 3.57. [Schedule 1, item 1, section 205-30, item 7 in the table]

Division 7A distributions

4.24       Consistent with the current law, a franking debit arises if an entity is taken to have paid a distribution under Division 7A of Part III of the ITAA 1936. The debit is equal to the debit that would have arisen had the amount of the distribution been a frankable distribution franked to the entity’s benchmark franking percentage for the franking period in which the distribution is taken to have been made (or franked at 100% if there is no benchmark). This ensures that no benefits are available by streaming unfrankable distributions to certain members. [Schedule 1, item 1, section 205‑30, item 8 in the table]

On-market buy-backs

4.25       Also consistent with the existing law, a franking debit arises if a company buys back a share on-market. The debit is equal to the debit that would have arisen had the buy-back been off-market. Again, this prevents streaming by companies buying back some shares off-market (giving rise to a frankable dividend) and other shares on-market (which results in no dividend). [Schedule 1, item 1, section 205-30, item 9 in the table]

Franking deficit tax

4.26       If a corporate tax entity has a deficit in its franking account at the end of an income year, it has imputed to its members more tax than it has paid. In these circumstances it needs to pay franking deficit tax to account for the over-imputation of tax.

4.27       An entity will be liable to pay franking deficit tax if its franking account is in deficit at the end of an income year or, if it ceases to be a franking entity, when it ceases to be a franking entity [Schedule 1, item 1, section 205-45]. An entity’s franking account is in deficit at a particular time when the sum of the franking debits in the account exceeds the sum of the franking credits. The franking deficit is the amount of the excess.

4.28       Consistent with the current rules, franking deficit tax will continue to be offsetable against income tax.

4.29       If a franking deficit would have arisen but does not because of a payment of tax that is refunded in the following year (within 3 months of the end of the previous year), the refund that arises in the following year will be treated for the purpose of franking deficit tax as though it had been paid at the end of the preceding income year. This will result in a recalculation of franking deficit tax. The franking deficit tax, or additional amount of franking deficit tax, is payable within 14 days of the day the refund is paid or such later day as set by the ITAA 1997. [Schedule 1, item 1, section 205-45]

4.30       This rule is a disincentive for an entity that might overpay tax to avoid franking deficit tax. The rule achieves the same outcome as the deficit deferral tax that is imposed under the current law, but removes the need for a separate tax.

4.31       Additional franking deficit tax of 30% will be imposed where an entity’s franking deficit is more than 10% greater than the total of the franking credits arising during the relevant income year. This additional tax will be imposed under subsection 5(2) of the New Business Tax System (Franking Deficit Tax) Bill 2000. [Schedule 1, item 1, section 205-45]

 


Chapter
Effect of receiving a franked distribution

Outline of chapter

5.1         Division 207 of the ITAA 1997 sets out the tax effects for an entity that receives a franked distribution, whether the distribution is received directly from a corporate tax entity or indirectly through a partnership or trust.

Summary of new law

Tax offset for direct distributions

5.2         If an entity receives a franked distribution directly, and the distribution is not passed on to another entity, the amount of the franking credit on the distribution will be included in the assessable income of the entity (i.e. the entity’s assessable income will be ‘grossed-up’) and the entity will be entitled to a tax offset equal to the amount of the franking credit. This will generally be the case where the entity is:

·         an individual;

·         a corporate tax entity;

·         an eligible superannuation fund, approved deposit fund or PST; or

·         an eligible income tax exempt charity or a deductible gift recipient.

Tax offset for indirect distributions

5.3         If a franked distribution is received by a partnership or a trust, the assessable income of the partnership or trust will be grossed-up by the amount of the franking credit. A partner, beneficiary or trustee who is assessed in respect of a share of the franked distribution will be entitled to a tax offset equal to a proportionate share of the franking credit. Where a franked distribution flows through more than one partnership or trust, the ultimate recipients of the distribution will be entitled to a tax offset equal to their share of the franking credit.

Residency requirements for tax offset

5.4         An individual or a corporate tax entity that receives a franked distribution directly must be resident at the time the distribution is paid to be eligible for a franking offset. If the taxpayer was not a resident, the distribution would be exempt from withholding tax because it is franked and therefore exempt from income tax, removing the need for a tax offset. The taxpayer’s assessable income is not grossed-up in this case. In the case of indirect distributions, adjustments are made to the taxpayer’s assessable income to ensure that the entity’s share of the franking credit is not included in the entity’s assessable income.

No tax offset if distribution is exempt income

5.5         An entity will generally not be entitled to a tax offset if the franked distribution or share of a franked distribution is exempt income. In this case, the entity’s assessable income will not be grossed-up where the entity receives the distribution directly. If the entity has received a share of the distribution indirectly, a deduction (or reduction) will be allowed to remove the entity’s share of the franking credit from the entity’s assessable income.

5.6         There are 2 exceptions to the rule that an offset does not arise in respect of a franked distribution that is exempt income:

·         complying superannuation funds, approved deposit funds and PSTs (eligible superannuation entities) and life insurance companies will be entitled to a tax offset in respect of certain exempt income, for example, income derived by a complying superannuation fund from segregated pension assets; and

·         eligible income tax exempt charities and deductible gift recipients will be entitled to a tax offset. Although these bodies are exempt from income tax, they are given an entitlement to an offset to make them eligible for a refund of their share of the franking credit under Division 67 of the ITAA 1997.

No offset if the imputation system has been manipulated

5.7         An entity that directly or indirectly receives a franked distribution will be denied a tax offset in the following circumstances because the imputation system has been ‘manipulated’:

·         the entity does not satisfy the holding period rule;

·         the Commissioner has made a determination under paragraph 204-30(3)(b) that no imputation benefit is to arise because a corporate tax entity has streamed distributions in a certain way;

·         the distribution is made as part of a dividend stripping operation;

·         the Commissioner has made a determination under paragraph 177EA(5)(b) that no imputation benefit is to arise because the distribution was paid as part of a scheme to obtain a franking credit benefit; or

·         the entity’s share of the distribution is equivalent to the payment of interest on a loan.

5.8         In these cases, the assessable income of an entity that receives the distribution directly will not be grossed-up. An entity that receives the distribution indirectly will be allowed a deduction (or reduction) to ensure that the entity’s share of the franking credit is not included in the entity’s assessable income.

Detailed explanation of new law

Structure of Division 207

5.9         Subdivision 207-A sets out the consequences for an entity other than a trust or partnership that receives a franked distribution directly.

5.10       Subdivision 207-B sets out the consequences for a trust or partnership that receives a franked distribution directly, and for an entity that receives a share of a franked distribution indirectly.

5.11       Subdivision 207-C sets out rules concerning the residency requirements for individuals and corporate tax entities to receive a tax offset for a direct distribution.

5.12       Subdivision 207-D provides for adjustments to the assessable income of an entity that receives a distribution indirectly that is exempt from income tax because the distribution is exempt from withholding tax.

5.13       Subdivision 207-E sets out the consequences of receiving a franked distribution that is exempt income, including the tax offset for eligible superannuation entities and life insurance companies for certain exempt income and the tax offset for eligible income tax exempt charities and deductible gift recipients.

5.14       Subdivision 207-F sets out the consequences of receiving a franked distribution where the imputation system has been manipulated.

5.15       Subdivision 207-J, which will be inserted by a later bill, will provide rules for calculating the amount of the adjustment to an entity’s assessable income that need to be made where an entity is not entitled to a tax offset.

Direct distribution to an entity (other than a partnership or trust)

5.16       The consequences for an entity other than a trust or partnership of receiving a franked distribution directly are set out in Subdivision 207-A.

5.17       If an entity other than a trust or partnership receives a franked distribution directly:

·         an amount equal to the franking credit on the distribution is included in the assessable income of the entity [Schedule 1, item 1, subsection 207-20(1)]; and

·         the entity is entitled to a tax offset equal to the franking credit on the distribution [Schedule 1, item 1, subsection 207-20(2)].

5.18       Section 207-20 will apply to the following entities:

·         an individual;

·         a corporate tax entity; and

·         an eligible superannuation fund, an approved deposit fund and a PST.

5.19       The gross-up and tax offset rules under section 207-20 do not apply to a partnership or trust that receives a franked distribution directly. Nor do these rules apply to a partner or beneficiary that receives a share of a franked distribution, or to a trustee that is assessed on a share of a franked distribution, because the distribution ‘flows indirectly’ to the taxpayer in these cases. This term is defined in section 207-20 and is explained in the commentary on Subdivision 207-B. [Schedule 1, item 1, section 207-15]

5.20       The general gross-up and offset rules are also subject to rules relating to:

·         residency requirements which must be satisfied by individuals and corporate tax entities, set out in Subdivision 207-C (explained in paragraphs 5.38 to 5.41);

·         the treatment of franked distributions which are exempt income or received by certain exempt institutions, set out in Subdivision 207-E (explained in paragraph 5.45); and

·         cases where the imputation system has been manipulated, set out in Subdivision 207-F (explained in paragraphs 5.51 to 5.53).

Example 5.1:  Direct distribution to an entity other than a partnership or trust

Company X makes a franked distribution of $7 million to one of its members, Company Y, which is an Australian resident at the time the distribution is made. Company Y also has net income from other sources of $12 million in the same income year.

The consequences for Company Y of receiving a franked distribution directly from Company X are set out below:

Company Y

Other income                                       $12.0 million

Franked distribution                             $ 7.0 million

Franking credit (‘gross up’)                  $ 3.0 million

Taxable income                                  $22.0 million

Tax at company rate (30%)                 $ 6.6 million

Less tax offset                                     $ 3.0 million

Tax payable by Company Y              $ 3.6 million

Direct distribution to a partnership or trust, or an indirect distribution to any entity

5.21       The consequences for a trust or partnership of receiving a franked distribution directly, and for an entity of receiving a share of a franked distribution indirectly, are set out in Subdivision 207-B.

When does a distribution flow indirectly to an entity?

5.22       The key concept in this Subdivision, and in Division 207, is that a franked distribution flows indirectly to an entity. In general terms, a distribution flows indirectly to an entity if the distribution is received indirectly by the entity. A franked distribution may flow indirectly from a partnership to a partner of the partnership. Similarly, it may flow from a trust to a beneficiary of the trust, or to the trustee of the trust where the trustee is assessed on a share of the net income of the trust. [Schedule 1, item 1, section 207-35]

5.23       A franked distribution will be taken to flow indirectly to the partner from a partnership, or to a beneficiary or trustee from a trust, only if:

·         the distribution was made directly to the partnership or the trustee of the trust, or the distribution flowed indirectly to the partnership or the trustee (i.e. from another partnership or trust) [Schedule 1, item 1, paragraphs 207-35(2)(c), (3)(c) and (4)(c)];

·         an amount is included in the assessable income of the partnership, or an amount is included in, or allowed as a deduction from, the assessable income of the trust, because the distribution was made directly to, or flowed indirectly to, the partnership or trust [Schedule 1, item 1, paragraphs 207-35(2)(c), (3)(c) and (4)(c)];

·         a share of the net income or partnership loss of the partnership is included in, or allowed as a deduction from, the partner’s assessable income under section 92 of the ITAA 1936, or a share of the net income of the trust is included in the beneficiary’s assessable income under section 97, 98A or 100 of the ITAA 1936, or the trustee is assessed on a share of the net income of the trust under section 98, 99 or 99A of the ITAA 1936 [Schedule 1, item 1, paragraphs 207-35(2)(b), (3)(b) and (4)(b)]; and

·         the whole or part of that share is attributable to an amount included in, or allowed as a deduction from, the assessable income of the partnership or trust because the distribution was made directly to it or flowed indirectly to it [Schedule 1, item 1, paragraphs 207-35(2)(c), (3)(c) and (4)(c)].

5.24       A distribution can only flow indirectly to an entity through a partnership or trust if an amount attributable to the distribution is included in the assessable income of the partnership or trust. This means, for example, that a distribution cannot flow indirectly to the beneficiary of a trust that is exempt from income tax.

5.25       A distribution can only flow indirectly to an entity if under Division 5 or 6 of Part III of the ITAA 1936 a share of the net income of a partnership or trust is included in the assessable income of the entity, or a share of a partnership loss is allowable as a deduction to the entity, or the entity is assessed on a share of the net income of the trust. This means, for example, that a distribution cannot flow to an individual from an eligible superannuation fund, approved deposit funds or PST.

5.26       Where a number of partnerships and/or trusts are interposed between the corporate tax entity making the franked distribution and the ultimate recipient of the distribution, the distribution will be received directly by the first interposed entity and must then flow indirectly to each of the other interposed entities in order for the distribution to flow indirectly to the ultimate recipient of the distribution.

Example 5.2:  How a franked distribution flows indirectly to an entity.

A partnership receives a franked distribution from a corporate tax entity. The partnership has 2 partners with equal individual interests in the partnership, one of which is a resident trust. The trust has one beneficiary, Stephanie, who is a resident individual and presently entitled to the net income of the trust.

Whether the franked distribution flows indirectly to Stephanie is determined as follows:

 

 

 

 

 

 

 

 

 

 

 

 


Step 1:  Does the distribution flow indirectly to the beneficiary?

To determine whether the distribution flows indirectly to Stephanie, it is necessary to ask:

·         Is Stephanie a beneficiary of the trust? Yes.

·         Is a share of the net income of the trust included in Stephanie’s assessable income? Yes, under subsection 97(1) of the ITAA 1936.

·         Is Stephanie’s share of the net income of the trust attributable to the distribution being included in the assessable income of the trust (i.e. does the distribution flow directly to the trustee of the trust)? No.

·         Is Stephanie’s share of the net income of the trust attributable to an amount that has flowed indirectly into the assessable income of the trust because of a previous application of section 207-35? See step 2.

Step 2:  Does the distribution flow indirectly to the trust?

To determine whether the distribution flows indirectly to the trust, it is necessary to ask:

·         Is the trust a partner in the partnership? Yes.

·         Is a share of the net income of the partnership included in the trust’s assessable income under subsection 92(1) of the ITAA 1936? Yes.

·         Is that share of the net income of the partnership attributable to the distribution being included in the assessable income of the partnership (i.e. does the distribution flow directly to the partnership)? Yes.

Conclusion

The distribution flows indirectly to the trust (see step 2). The distribution therefore flows indirectly to Stephanie under subsection 207-35(3).

Gross-up for a partnership or trust that receives a distribution directly

5.27       Where a frankable distribution is made directly to a partnership or a trust, the assessable income of the partnership or the trustee of the trust will be grossed-up by the amount of the franking credit under section 207-40. [Schedule 1, item 1, section 207-40]

5.28       The assessable income of a partnership will be grossed-up only if Division 5 of Part III of the ITAA 1936 (the general partnership provisions) applies to the partnership. This is because of the requirement that the distribution must flow indirectly to a partner. [Schedule 1, item 1, paragraph 207-40(1)(b)]

5.29       The assessable income of a trust will be grossed-up only if Division 6 of Part III of the ITAA 1936 (the general trust provisions) applies to the trust. This is because of the requirement that the distribution must flow indirectly to a beneficiary or the trustee of the trust. [Schedule 1, item 1, paragraph 207-40(2)(b)]

Tax offset for partners, beneficiaries and trustees

5.30       Where a franked distribution flows indirectly to a partner or a beneficiary, or a trustee who is assessed on a share of the net income of the trust, that entity will be entitled to a tax offset under subsection 207‑50(1) equal to the entity’s share of the franking credit. [Schedule 1, item 1, section 207-50]

5.31       A partner or beneficiary will be entitled to a tax offset in respect of a franked distribution only if the distribution does not flow indirectly to another entity, that is, if the partner or beneficiary is the ultimate recipient of the distribution. The following entities are entitled to a tax offset under subsection 207‑50(1):

·         an individual;

·         a corporate tax entity;

·         a trustee who is assessed on a share of the net income of the trust; or

·         an eligible superannuation fund, approved deposit fund or PST.

[Schedule 1, item 1, paragraph 207-50(1)(b)]

What is an entity’s share of the franking credit on a franked distribution?

5.32       Where a franked distribution is made to a partnership or a trust and flows indirectly to an entity, that entity’s share of the franking credit on the distribution is calculated, in broad terms, by apportioning the franking credit according to the entity’s share of the cash amount of the distribution in relation to the total cash amount of the distribution. [Schedule 1, item 1, subsection 207-55(1)]

5.33       If, on the other hand, the distribution flows through more than one partnership or trust, and the distribution flows indirectly from a partnership or trust that received the distribution indirectly (the flow‑through entity) to the ultimate recipient of the distribution, the ultimate recipient’s share of the franking credit is calculated, in broad terms, by apportioning the flow-through entity’s share of the franking credit according to the ultimate recipient’s share of the cash amount of the distribution in relation to the flow-through entity’s share of the cash amount of the distribution. [Schedule 1, item 1, subsection 207-55(2)]

Example 5.3:  How to calculate an entity’s share of the franking credit on a franked distribution

A partnership receives a franked distribution from a corporate tax entity of $140,000. In that income year, the partnership also earns other income of $560,000 and has allowable deductions of $100,000. The partnership has 2 partners, Company A and Company B (both residents), who have equal individual interests in the net income of the partnership.

The net income of the partnership is calculated as follows:

Other income                                       $560,000

Franked distribution                             $140,000

Franking credit (gross up)                 $  60,000

Assessable income                               $760,000

Less allowable deductions                   $100,000

Net income                                          $660,000

As both partners have equal individual interests in the net income of the partnership, both Company A and Company B will include an amount of $330,000 in their respective assessable incomes, being an amount which represents so much of their shares of the net income of the partnership.

The partners’ shares of the franking credit on the franked distribution is calculated using the formula in item 1 of the table in subsection 207-55(1) in this case because the distribution has flowed through only one entity. As both partners have equal individual interests in the net income of the partnership, the calculation will be the same for each partner.

Step 1:  Calculate the numerator.

So much of the individual interest of Company A in the net income or partnership loss of the partnership as is attributable to the distribution:

    Share of cash amount of distribution:

    $140,000  ¸  2  =  $70,000

Step 2:  Calculate the denominator.

So much of the net income or partnership loss of the partnership as is attributable to the distribution:

    $140,000 (total cash amount of the franked distribution)

Step 3:  Calculate the franking credit on the distribution.

    $60,000

Step 4:  Apply the formula in item 1 of the table in subsection 207‑55(1) to calculate Company A’s share of the franking credit.

    Share of franking credit:

    $60,000  ´  ($70,000  ¸  $140,000)  =  $30,000

Therefore, Company A’s share of the franking credit on the franked distribution is $30, 000. Company B’s share is also $30,000.

Adjustment of the amount included in the assessable income of an entity to whom a distribution flows indirectly

5.34       The amount included in a beneficiary’s assessable income that is attributable to the franking credit on a franked distribution received by the trust will always be proportionate to the beneficiary’s share of the franked distribution. This outcome is ensured by section 207-45. This rule applies similarly where a franked distribution flows indirectly to a partner or to the trustee of a trust. [Schedule 1, item 1, section 207-45]

5.35       A beneficiary’s share of the net income of a trust, for example, would generally include an amount attributable to the franking credit on a franked distribution received by the trust, which would be included in the beneficiary’s assessable income under section 97, 98A or 100 of the ITAA 1936. The amount included in the beneficiary’s assessable income that is attributable to the franking credit on the franked distribution received by the trust should be, and often would be, proportionate to the beneficiary’s share of the cash amount of the franked distribution.

5.36       It is possible, however, that the amount attributable to the franking credit is not proportionate. For example, a discrepancy between the beneficiary’s share of the distribution and the amount of the franking credit included in the beneficiary’s assessable income may occur where the beneficiaries of a trust do not all have an interest in the dividend income of the trust. A share of the franking credit on a franked distribution would generally be included in the share of the net income of the trust of all the beneficiaries, including those beneficiaries who do not have an interest in the dividend.

5.37       In this case, the assessable income of the beneficiaries will be adjusted. The assessable income of the beneficiaries with an interest in the dividend income will include an amount equal to their proportionate share of the franking credit based on their interest in the dividend. The assessable income of the other beneficiaries will not include any amount attributable to the franking credit on the distribution. [Schedule 1, item 1, subsection 207‑45(1)]

Residency requirements for tax offsets

5.38       The rules concerning the residency requirements for individuals and corporate tax entities to receive a tax offset for a direct distribution are set out in Subdivision 207-C.

5.39       An individual or a corporate tax entity that receives a franked distribution directly must be a resident at the time the distribution is made to be eligible for a tax offset. [Schedule 1, item 1, section 207-70]

5.40       If the taxpayer was not a resident, the distribution would be exempt from withholding tax because it is franked and therefore exempt from income tax, removing the need for a tax offset. The taxpayer’s assessable income is not grossed-up in this case because the distribution is exempt income.

5.41       The residency tests for individuals and corporate tax entities are as follows:

·         for individuals, companies and corporate limited partnerships – must be a resident at the time the distribution is made;

·         for a corporate unit trust or public trading trust – must be a resident unit trust for the year of income in which the distribution is made.

[Schedule 1, item 1, section 207-75]

Adjustments for non-residents

5.42       The rules for adjustments to the assessable income of an entity that receives a distribution indirectly that is exempt from income tax because the distribution is exempt from withholding tax are set out in Subdivision 207-D.

5.43       Where an individual or a corporate tax entity receives a franked distribution indirectly, and the individual or corporate tax entity was a non-resident at the time the distribution was made (so that the distribution would be exempt from withholding tax because it is franked and therefore exempt from income tax), the assessable income of the entity will be adjusted to remove the entity’s share of the franking credit from the entity’s assessable income. This adjustment is necessary because, while the distribution would be exempt from income tax, the entity’s share of the franking credit would otherwise be included in the entity’s assessable income. The rules for determining the amount of the adjustment will be set out in Subdivision 207-J. [Schedule 1, item 1, section 207-90]

Consequences for gross up and offset if distribution not taxed

5.44       The consequences for an entity of receiving a franked distribution that is exempt income are set out in Subdivision 207-E. An entity will generally not be entitled to a tax offset if the franked distribution is exempt income of the entity. There are 2 exceptions to this rule:

·         eligible superannuation entities and life insurance companies will be eligible for a tax offset for certain exempt income; and

·         eligible income tax exempt charities and deductible gift recipients, which are exempt from income tax, will also be entitled to a tax offset.

5.45       An entity will not be entitled to a tax offset if the franked distribution or share of a franked distribution is exempt income. In this case, the entity’s assessable income will not be grossed-up where the entity receives the distribution directly. If the entity has received a share of the distribution indirectly, a deduction (or reduction) will be allowed to remove the entity’s share of the franking credit from the entity’s assessable income. [Schedule 1, item 1, section 207-110]

Tax offsets for exempt distributions and exempt institutions

5.46       Complying superannuation funds, approved deposit funds and PSTs (eligible superannuation entities) and life insurance companies will be entitled to a tax offset for franked distributions that are covered by certain exemptions, namely:

·         the exemption under sections 282B, 283 and 297B of the ITAA 1936 and paragraph 320-35(1)(b) for income relating to current pensions; and

·         the exemption under subparagraph 320-35(1)(f)(ii) for income of a life insurance company that is a friendly society relating to income bonds, funeral policies and scholarship plans.

[Schedule 1, item 1, section 207-120]

5.47       Eligible income tax exempt charities and deductible gift recipients will be entitled to a tax offset. Although these bodies are exempt from income tax, they are given an entitlement to an offset to make them eligible for a refund of their share of the franking credit under Division 67. [Schedule 1, item 1, section 207-125]

5.48       The eligible income tax exempt charities and deductible gift recipients that are entitled to a tax offset are, in broad terms:

·         charitable institutions that are endorsed as exempt from income tax under Subdivision 50-B, that satisfy the residency requirement set out in section 207-135;

·         deductible gift recipients that are endorsed under paragraph 30-120(a), that satisfy the residency requirement set out in section 207-135;

·         deductible gift recipients that are specified in Subdivision 30‑B and have an Australian Business Number and satisfy the residency requirement set out in section 207-135;

·         a public fund declared by the Treasurer to be a relief fund in accordance with subsection 30-85(2) (other than a fund prescribed in the regulations as not being eligible); and

·         any income tax exempt entities prescribed in the regulations as being eligible for the offset.

[Schedule 1, item 1, section 207-130]

5.49       The residency requirements for exempt institutions mentioned in paragraph 5.48 are that the institution has a physical presence in Australia and, to that extent, incurs its expenditure and pursues its objectives in Australia for the whole of the year of income for which the tax offset is being claimed. [Schedule 1, item 1, section 207-135]

Manipulation of imputation system

5.50       The consequences of receiving a franked distribution where the imputation system has been manipulated are set out in Subdivision 207-F.

Direct distributions

5.51       The assessable income of an entity that receives a franked distribution directly will not be grossed-up and the entity will be denied a tax offset in the following circumstances:

·         the entity is not a qualified person because the holding period rule is not satisfied;

·         the Commissioner has made a determination under paragraph 204-30(3)(b) that no imputation benefit is to arise because a corporate tax entity has streamed distributions in a certain way;

·         the distribution is made as part of a dividend stripping operation; or

·         the Commissioner has made a determination under paragraph 177EA(5)(b) that no imputation benefit is to arise because the distribution was paid as part of a scheme to obtain a franking credit benefit.

[Schedule 1, item 1, subsection 207-145(1)]

5.52       If the Commissioner has made a determination under paragraph 177EA(5)(b) that an imputation benefit is not to arise in respect of part of a franked distribution, an entity’s entitlement to a tax offset will be reduced proportionately. [Schedule 1, item 1, subsection 207-145(2)]

Indirect distributions

5.53       Where a franked distribution flows indirectly to an entity, a tax offset will be denied in the same circumstances that a tax offset is denied to an entity that receives a franked distribution directly. In addition to these circumstances, an entity that receives a franked distribution indirectly will also be denied a tax offset if the entity’s share of the distribution is equivalent to the payment of interest on a loan. The purpose of this rule is to ensure that trust or partnership distributions that consist of dividends, but are effectively in the nature of interest, do not give rise to an entitlement to a tax offset. This rule will apply to taxpayers that hold a debt-like interest in shares indirectly through a trust or partnership; that is, to taxpayers who, under a trust or partnership, are effectively creditors rather than share owners. This rule is intended to replicate the existing law (see, for example, subsections 160AQX(4) to (6) of the ITAA 1936). [Schedule 1, item 1, section 207-160]

5.54       A deduction (or reduction) will be allowed to ensure that the entity’s share of the franking credit is not included in the entity’s assessable income if the tax offset is denied. The amount of the adjustment will be calculated under Subdivision 207-J. [Schedule 1, item 1, section 207-150]

5.55       If the Commissioner has made a determination under paragraph 177EA(5)(b) that an imputation benefit is not to arise in respect of part of a franked distribution, an entity’s entitlement to a tax offset will be reduced proportionately. [Schedule 1, item 1, subsection 207‑150(5)]

Distributions made as part of a dividend stripping operation

5.56       A distribution will be regarded as one that is made as part of a dividend stripping operation if the making of the distribution arose out of, or was made in the course of, a scheme that was by way of, or in the nature of, dividend stripping or a scheme that had substantially the effect of such a scheme. This rule is intended to replicate the existing law (see section 160APHA of the ITAA 1936). [Schedule 1, item 1, section 207-155]

5.57       Schemes by way of, or in the nature of, dividend stripping schemes include those where a person purchases for a capital sum the shares in a target company that has accumulated profits, and then draws off the profits by effecting the payment of a dividend by the target company.

5.58       Schemes having substantially the same effect as dividend stripping schemes include those in which the profits of the target company are not stripped from it by a formal dividend payment, but where irrecoverable loans are made to entities that are associates of the dividend stripper or where the profits are used to purchase assets from such entities at greatly inflated prices.

5.59       A scheme would come within the scope of these rules where, with a view to gaining a tax offset in respect of a franked distribution, persons pay amounts to companies in consideration for the issue of shares carrying dividend rights that are substantial in relation to the consideration given. A simple example is where a person enters into an arrangement with a company under which that company issues shares to the person of, for example $1.20, and those shares carry a one-off dividend right of, for example $1.00. Thereafter, the shares effectively carry no further right to participate in profits or capital, or the value of any rights is insignificant in relation to the consideration given.

 


Chapter
Regulation impact statement

Policy objective

Background

6.1         The imputation measure in these bills, which deals with the system to allow corporate tax entities to pass on to their members credits for income tax paid by the entities, is part of the Government’s broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the recommendations of the Review of Business Taxation, instituted by the Government to consider the reform of Australia’s business tax system. In addition, the measure in these bills reflects feedback and submissions from the business community on the imputation rules previously exposed as part of the New Business Tax System (Entity Taxation) Bill 2000 exposure draft.

6.2         The Government instituted the Review of Business Taxation to consult on its plan to comprehensively reform the business tax system as outlined in the Government’s tax reform document: Tax Reform: not a new tax, a new tax system. The Review of Business Taxation made recommendations to the Government designed to achieve a more simple, stable and durable business tax system.

6.3         The Review of Business Taxation recommended the redesigning of the company tax and imputation system to achieve:

·         integrity through the entity chain;

·         simplification of the franking account;

·         refunding excess imputation credits; and

·         the reduction of the company tax rate.

6.4         These bills are part of the legislative program implementing the New Business Tax System. Measures such as refunding excess imputation credits and the reduction of the company tax rate have already been enacted.

6.5         The new imputation provisions will broadly change the mechanics of the current imputation system to achieve:

·         a simplification of the rules and consequent reduction in compliance costs;

·         increased flexibility in franking distributions; and

·         consistency of treatment across entities receiving franked dividends.

6.6         Whilst the new imputation system changes the mechanics of the current imputation system, the new imputation provisions will generally, provide the same outcome as the current imputation system.

6.7         The new imputation provisions are redrafted using a clearer and a more accessible style, incorporating many of the presentation techniques such as examples, notes and guides developed as part of the tax law improvement project.

The objectives of the measure

6.8         The object of the new imputation system is to integrate the Australian corporate tax system and its members by allowing corporate tax entities to pass on credits for income tax paid to their members and to allow the Australian members to claim a tax offset for that credit and, in some circumstances, claim a refund if they are unable to fully utilise the tax offset.

6.9         The objects of the new imputation system are also to ensure that:

·         the imputation system is not used to give the benefit of income tax paid by a corporate tax entity to members who do not have a sufficient economic interest in the entity;

·         the imputation system is not used to prefer some members over others when passing on the benefits of having paid income tax; and

·         the membership of the corporate tax entity is not manipulated to create either of the outcomes above.

Implementation options

6.10       This measure arises directly from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for the measure can be found in A Platform for Consultation and A Tax System Redesigned. Table 6.1 shows where the sub-measures (or the principles underlying them) are discussed in those publications.

Table 6.1:  Options for implementing sub-measures in these bills arising directly from recommendations of the Review of Business Taxation

Measure

A Platform for Consultation

A Tax System Redesigned

Replacing the intercorporate dividend rebate with the ‘gross up and credit’ approach.

Chapter 17, pp. 390-398

Recommendation 11.4,
pp. 416-418

Franking account will record franking credits expressed on a tax-paid basis.

Chapter 17, pp. 380‑381

Recommendation 11.6(i), pp. 419‑420

Aligning the franking year with the income year.

Chapter 17, pp. 382-383

Recommendation 11.6(ii),
p. 420

Adopting a standard rate of franking.

Chapter 17,
p. 389

Recommendation 11.6(iii), pp. 420‑421

Allowing widely-held entities with a single class of membership to vary their franking rate within a half year.

(Not discussed)

Recommendation 11.6(iv), pp. 420‑421

6.11       These implementation options discussed in A Platform for Consultation and A Tax System Redesigned were included in the New Business Tax System (Entity Taxation) Bill 2000 exposure draft. As a result of feedback and submissions from the community some rules were modified. Table 6.2 lists variations from the rules as recommended in A Platform for Consultation, A Tax System Redesigned and the rules in the exposure draft legislation.

Table 6.2:  Other options following from the original recommendations and the exposure draft legislation

Approach reflected in these bills

Reason for the approach

The abolition of Benchmark Rule No. 2. Benchmark Rule No. 2 was intended to prevent streaming opportunities between franking periods by restricting the extent to which companies could vary their franking rate from one period to the next.

There are already anti-avoidance rules that can be relied upon to address streaming of franking credits. A new rule that requires companies to disclose excessive franking rate variations between franking periods to the Commissioner has also been introduced.

Simplifying the process of allocating franking credits to distributions by simply allowing companies to attach franking credits to a distribution. The original allocation rules, the standing and specific allocation rules, were overly prescriptive and complex.

This process avoids unnecessarily complex allocation rules. Moreover, there are not significant integrity issues needing to be addressed by having such rules.

Benchmark for a particular franking period is established by the franking percentage applying to the first dividend paid in the period.

This process avoids complex declaration and default rules for benchmarking.

Subject to certain conditions, allow private companies to retrospectively frank dividends. Although this change does not represent a departure from the original recommendations, consultation identified it as being a desirable feature.

This change enhances the original recommendation and adds to the compliance cost reductions that were the initial driver to the proposal. It also more closely aligns with ordinary commercial practices and ATO administrative practices.

6.12       Some rules which are required to complete the imputation system are not in these bills. These measures will be included in a later bill and largely deal with consequential amendments.

Assessment of impacts

6.13       The potential compliance, administrative and economic impacts of these bills have been carefully considered, both by the Review of Business Taxation and by the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform.

Impact group identification

6.14       These bills specifically impacts on those taxpayers identified in Table 6.3.

Table 6.3:  Taxpayers affected by these bills

Measure

Affected taxpayers

Franking a distribution.

Corporate tax entities that can frank distributions. Estimates based on ATO data indicate that historically, up to 76,500 corporate tax entities pay franked distributions to their members each year.

Benchmark rule.

Corporate tax entities other than certain listed public companies that have little opportunity for streaming.

Franking accounts.

All corporate tax entities. Estimates based on ATO and Australian Securities and Investments Commission data indicate that there are between 1,184,227 and 1,235,120 registered companies.

Effect of receiving a distribution.

Members of corporate tax entities. Members include shareholders, beneficiaries and partners.

Analysis of costs/benefits

Compliance costs

6.15       A major concern for businesses is the cost incurred in complying with their obligations under the various taxation and other laws. These bills are designed to reduce compliance costs incurred by business by providing simpler processes.

6.16       The new imputation system, which have adopted different mechanics to the current system, will result in lower costs of compliance for a corporate tax entity in maintaining a franking account principally as a result of simplified and more easily understood rules.

Franking account maintained on a tax paid basis

6.17       The current approach to recording amounts for tax paid in an entity’s franking account on the basis of the after-tax profit available for distribution has involved complex conversion provisions when the company tax rate has changed. In the years before these conversion provisions were introduced, multiple franking accounts were generally used to accommodate changes to the company tax rate. This lead to the undesirable proliferation of franking accounts – the class A, B and C franking accounts – and with it further complexities surrounding their interaction.

6.18       To avoid this, the new imputation franking account provisions record credits on a tax-paid basis. This approach will dispense with the need for complex conversion provisions and multiple franking accounts whenever the prevailing company tax rate changes. As a result, there will be compliance cost reductions in the form of labour cost savings as taxpayers and their advisors will no longer have to put their mind to the complex conversion provisions when the company tax rate changes. The extent of the savings is not quantifiable but they are estimated as being moderate against the background of the rest of the imputation system. The change does not impact on shareholders receiving franked distributions.

Aligning franking year with income year

6.19       The new imputation rules will also align an entity’s franking year with its income year. Under the current imputation rules, a company’s franking year can differ from its income year, particularly in the case of late balancing companies. In some circumstances, the misalignment of these periods can cause reconciliation problems as well as providing a further unnecessary complexity to the law. The proposal to align the 2 periods will eliminate this complexity for those entities which would otherwise have 2 different periods. Although this change will simplify the law it is not expected to result in significant compliance cost savings. There may be some small labour saving cost reductions through the avoidance of the reconciliation problems associated with having disparate periods.

Franking a distribution

6.20       Under the current imputation rules, companies are required to use a very prescriptive process in order to attach franking credits to dividends that they make to their shareholders. For example, the current rules require companies to make a declaration stipulating the extent to which a dividend is to be franked.

6.21       Under the new rules the process will be significantly streamlined. The new rules do not, for tax purposes, require companies to go through a formal process to frank a dividend. Companies are simply required to disclose the extent to which a dividend is franked by issuing a distribution statement to the member receiving the distribution.

6.22       This streamlined approach will reduce compliance costs for companies because they will be able to frank distributions by the process which best suits their needs and without regard to any tax laws which might have prescribed this process. This will result in unquantifiable labour cost savings.

Distribution statement

6.23       Consistent with the current laws, companies making franked distributions to their members will have to provide those members with a distribution statement.

6.24       This means that for companies that are not private companies the distribution statement is required to be given on or before the day on which the distribution is made.

6.25       However, a modification has been made for distribution statements issued by private companies. The change allows private companies to provide distribution statements before the end of 4 months after the end of the income year in which the distribution is made. This change is intended to further ease compliance costs for private companies and to also reflect commercial practice and the manner in which private companies typically make dividend payments. Although this change will not result in any labour cost savings, it will provide affected companies with timing benefits and increased flexibility.

Effects of receiving a franked distribution

6.26       Under the current tax laws, 2 different rebate provisions apply to relieve tax from franked dividend income:  the intercorporate dividend rebate applies in respect of corporate shareholders; and the franking rebate generally applies to shareholders that are natural persons.

6.27       Under the new imputation rules a single rebate provision will apply – the franking rebate. This will mean that resident corporate tax entities that receive a franked distribution from another corporate tax entity will no longer need to determine the amount of the intercorporate dividend rebate. Rather, they will apply the franking rebate in the same way as resident individuals and superannuation entities (using the gross-up and credit approach that applies). The adoption of a single rebate provision for all taxpayers in respect of franked dividend income significantly simplifies the law. This simplification is not expected to result in any tangible labour cost savings.

Initial costs

6.28       As is standard with a new measure, groups affected by it are expected to incur a small up-front cost in either familiarising themselves with the new law or having advisors familiarise themselves with the new law and, if necessary, communicating that information to affected taxpayers. These costs are not expected to be significant, however, as the new imputation system largely replicates the existing regime. This will mean that the existing systems and processes that taxpayers already have in place in complying with the existing imputation regime will continue to be relevant under the new system. However, there may be some modifications required to the systems and processes that taxpayers have in place but these are not expected to be significant and would not outweigh the benefits of the new imputation regime as a whole.

Administration costs

6.29       In the first year of the new imputation system, it is expected the ATO will incur additional administration costs in updating systems and tax returns and in providing advice to taxpayers on the new system. The ATO will also incur on-going costs in monitoring the system. These costs in administering the system will be funded from existing resources. In the longer term, administration costs should decrease as the need for advice on the new imputation system decreases.

Government revenue

6.30       These bills will have no impact on revenue.

Economic benefits

6.31       The new imputation system as a part of the New Business Tax System will contribute towards achieving the broader aims of the New Business Tax System to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings.

Other issues – consultation

6.32       The consultation process began with the release of the Government’s tax reform document: Tax Reform: not a new tax, a new tax system in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform, including discussions on redesigning the imputation system. In particular, A Platform for Consultation and A Tax System Redesigned canvassed options, discussed issues and sought public input.

6.33       In October 2000, the Government released legislation as part of the New Business Tax System (Entity Taxation) Bill 2000 exposure draft. Although the exposure draft legislation was withdrawn, the feedback and submissions received on the imputation component of the exposure draft legislation have been reflected in these bills.

6.34       There has also been ongoing consultation with this measure since that time. The consultation has been very productive with many significant improvements made to the legislation and in the design of the various processes. The changes explained in Table 6.2 reflect some of the main areas that have changed as a result of consultation.

Conclusion and recommended option

6.35       The imputation system contained in these bills should be adopted to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.


Index       

Schedule 1:  The simplified imputation system

Bill reference

Paragraph number

Item 1, section 201-5

1.48

Item 1, section 202-5

2.4

Item 1, section 202-15

2.7

Item 1, paragraphs 202-20(a) and (b)

2.10

Item 1, paragraphs 202-20(c) and (d)

2.13

Item 1, subsection 202-40(1)

2.17

Item 1, subsection 202-40(2)

2.18

Item 1, section 202-45

2.24

Item 1, paragraph 202-45(c)

2.25

Item 1, subsection 202-60(1)

2.27

Item 1, subsection 202‑60(2)

2.28, 2.44

Item 1, section 202-75

2.30

Item 1, paragraph 202-75(2)(a)

2.34

Item 1, paragraph 202-75(2)(b)

2.33

Item 1, subparagraph 202‑75(2)(b)(i)

2.33

Item 1, subparagraph 202-75(2)(b)(ii)

2.33

Item 1, subsections 202-80(2) and (3)

2.35

Item 1, section 202-85

2.37

Item 1, subsection 202-85(1)

2.38

Item 1, subsection 202-85(2) and (4)

2.39

Item 1, subsection 202-85(6)

2.40

Item 1, section 203-10

2.42

Item 1, subsections 203-20(1) and (2)

2.50

Item 1, section 203-30

2.60

Item 1, subsection 203-35(1)

2.45

Item 1, subsection 203-40(2)

2.56

Item 1, subsection 203-40(3)

2.57

Item 1, subsection 203-40(4)

2.58

Item 1, subsection 203-40(5)

2.59

Item 1, section 203-50

2.52

Item 1, subsection 203-50(1)

2.62, 2.67

Item 1, paragraph 203-50(2)(b)

2.64

Item 1, subsection 203-55(2)

2.69

Item 1, subsection 203-55(3)

2.68

Item 1, subsection 203-55(5)

2.71

Item 1, subsection 204-15(1)

3.13, 3.15

Item 1, subsection 204-15(2)

3.16

Item 1, subsection 204-15(4)

3.15

Item 1, subsection 204-15(5)

3.17

Item 1, subsection 204‑15(6)

3.18

Item 1, subsection 204-25(1)

3.24

Item 1, subsection 204-25(2)

3.25

Item 1, subsection 204-25(3)

3.24

Item 1, subsections 204-25(4) and (5)

3.23

Item 1, subsection 204-25(6)

3.25

Item 1, subsection 204-30(1)

3.26

Item 1, subsection 204-30(2)

3.27, 3.49

Item 1, subsection 204-30(3)

3.43

Item 1, subsection 204-30(4)

3.44, 3.49

Item 1, subsection 204-30(5)

3.45

Item 1, subsection 204-30(6)

3.39

Item 1, paragraph 204-30(8)(a)

3.41

Item 1, paragraphs 204-30(8)(b) and (c)

3.41

Item 1, paragraph 204-30(8)(d)

3.41

Item 1, paragraph 204-30(8)(e)

3.41

Item 1, section 204-40

3.55

Item 1, subsection 204-40(1)

3.57

Item 1, subsection 204-50(1)

3.51

Item 1, subsection 204-50(3)

3.50

Item 1, section 204-55

3.51

Item 1, paragraphs 204-75(a) and (b)

3.63

Item 1, subsection 204-75(1)

3.59

Item 1, subsection 204-75(2)

3.60

Item 1, subsection 204-75(4)

3.62

Item 1, paragraph 204-80(1)(a)

3.64

Item 1, paragraph 204-80(1)(b)

3.64

Item 1, paragraph 204-80(1)(c)

3.64

Item 1, paragraph 204-80(1)(d)

3.64

Item 1, paragraph 204-80(1)(e)

3.64

Item 1, section 205-10

4.3

Item 1, section 205-15, items 1 and 2 in the table

4.7

Item 1, section 205-15, item 3 in the table

4.11

Item 1, section 205-15, item 4 in the table

4.11

Item 1, section 205-15, item 5 in the table

4.12

Item 1, section 205-20

4.9

Item 1, section 205-25

4.8

Item 1, section 205-30, item 1 in the table

4.15

Item 1, section 205-30, item 2 in the table

4.17

Item 1, section 205-30, item 3 in the table

4.19

Item 1, section 205‑30, item 5 in the table

4.21

Item 1, section 205-30, item 6 in the table

4.22

Item 1, section 205-30, item 7 in the table

4.23

Item 1, section 205‑30, item 8 in the table

4.24

Item 1, section 205-30, item 9 in the table

4.25

Item 1, section 205-35

4.18

Item 1, section 205-45

4.27, 4.29, 4.31

Item 1, section 207-15

5.19

Item 1, subsection 207-20(1)

5.17

Item 1, subsection 207-20(2)

5.17

Item 1, section 207-35

5.22

Item 1, paragraphs 207-35(2)(b), (3)(b) and (4)(b)

5.23

Item 1, paragraphs 207-35(2)(c), (3)(c) and (4)(c)

5.23

Item 1, section 207-40

5.27

Item 1, paragraph 207-40(1)(b)

5.28

Item 1, paragraph 207-40(2)(b)

5.29

Item 1, section 207-45

5.34

Item 1, subsection 207‑45(1)

5.37

Item 1, section 207-50

5.30

Item 1, paragraph 207-50(1)(b)

5.31

Item 1, subsection 207-55(1)

5.32

Item 1, subsection 207-55(2)

5.33

Item 1, section 207-70

5.39

Item 1, section 207-75

5.41

Item 1, section 207-90

5.43

Item 1, section 207-110

5.45

Item 1, section 207-120

5.46

Item 1, section 207-125

5.47

Item 1, section 207-130

5.48

Item 1, section 207-135

5.49

Item 1, subsection 207-145(1)

5.51

Item 1, subsection 207-145(2)

5.52

Item 1, subsection 207-150

5.54

Item 1, subsection 207‑150(5)

5.55

Item 1, section 207-155

5.56

Item 1, section 207-160

5.53

Schedule 2:  Consequential amendments of Chapter 6 (the Dictionary) of the ITAA 1997

Bill reference

Paragraph number

Items 1 to 45, section 995-1 of the ITAA 1997

1.5

Schedule 3:  Transitional provisions dealing with the application of Part IIIAA of the ITAA 1936

Bill reference

Paragraph number

Item 1, section 160AOAA

1.49

Item 2, section 201-1

1.52

Schedule 4:  Transitional provisions dealing with the conversion of the franking account

Bill reference

Paragraph number

Item 2, sections 205-1 and 205-5

1.52

Item 2, section 205-10

1.51

 

 



 


 



[1]     The Government has announced a review of the imputation system to make it easier for cooperative companies to frank distributions (see former Assistant Treasurer’s Press Release No. 41 of 21 August 2001). As a result, the identification of what distributions made by cooperatives are frankable may change.