Senate

New Business Tax System (Miscellaneous) Bill (No. 2) 2000

Revised Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
This Memorandum takes account of amendments made by the House of Representatives to this Bill as introduced.

Chapter 8 - Imputation - conversion of franking account balances

Outline of Chapter

8.1 This Chapter explains amendments that, broadly speaking, ensure the dividend imputation system in the ITAA 1936 properly takes account the new 34% company tax rate. The amendments are contained in items 85 to 97 of Schedule 3 to this Bill.

8.2 Some of the provisions being amended in this Bill were recently introduced to convert, on 1 July 2000, those parts of the imputation system reflecting a 36% rate to instead reflect the 34% rate.

8.3 The amendments arise from:

the life insurance company measures to be introduced in this Bill, the broad effect of which will be that the 39% tax rate, currently applying to some parts of taxable income, will be reduced to the company tax rate;
the possibility of franking credits and debits arising before the conversion date of 1 July 2000 that reflect a 34% rate, particularly in relation to the payment of PAYG instalments by early balancing companies; and
changes to the way estimated debit determinations are treated for the purposes of converting the imputation system to reflect the 34% rate.

Context of Reform

8.4 The reductions in the company tax rate, provided for in the Income Tax Rates Act No. 1, are a key component of the New Business Tax System announced in Treasurer's Press Release No. 58 of 21 September 1999 (refer to Attachment A).

8.5 The reduced company tax rate will provide Australia with an internationally competitive company tax rate. The eventual reduction of the company tax rate to 30% will bring the Australian rate into line with rates in other countries in the Asia Pacific region and will boost investment in Australia.

8.6 As a result of the reduction in the company tax rate for the 2000-2001 income year, amendments to the dividend imputation system were introduced in the NBTS Miscellaneous Bill 1999. That Bill amends the imputation system to:

convert class C franking account balances from 1 July 2000, from being based on a tax rate of 36%, to instead reflect the new company tax rate of 34%;
convert most franking credits and franking debits arising on or after 1 July 2000 that reflect a tax rate other than 34% to instead reflect the new company tax rate of 34%; and
provide that most franked dividends paid on or after 1 July 2000 carry imputation credits reflecting a 34% rate.

8.7 The 2 key tax reform measures giving rise to most of the amendments explained in this Chapter are:

the measures broadening the tax base, and changing the tax rates, for life insurance companies from 1 July 2000; and
the application of the PAYG system from the 2000-2001 income year for tax instalments payable by companies.

Summary of new law

Life insurance company measures

8.8 The new law will convert class A franking surpluses and deficits of life insurance companies to corresponding class C franking credits and debits on 1 July 2000. This will effectively close-off class A franking accounts for life insurance companies.

8.9 The balance of class A franking accounts represent tax paid at a 39% rate. Closing-off these accounts for life insurance companies recognises that these companies will, from 1 July 2000, no longer pay tax at a 39% rate.

8.10 Class A franking credits and debits of life insurance companies arising on or after 1 July 2000 will generally be converted to equivalent class C franking credits and debits reflecting a 34% rate.

34% credits and debits arising before 1 July 2000

8.11 The new law will also convert class C franking credits or franking debits arising before 1 July 2000 that reflect a company tax rate of 34% into equivalent class C franking credits or debits reflecting a 36% rate. This change is necessary because class C franking account balances will reflect a company tax rate of 36% before 1 July 2000, and will only reflect a 34% rate after that date.

Amendments related to estimated debit determinations

8.12 Finally, the new law will amend the conversion of franking account provisions to simplify, and correct potential anomalies in the treatment of franking credits and debits arising from estimated debit determinations.

Comparison of key features of new law and current law
New law Current law [F30]
Class A franking accounts of life insurance companies will be closed off on 1 July 2000, with class A franking surpluses and deficits being converted to equivalent class C franking credits and debits. Class A franking credits and debits arising on or after 1 July 2000 will generally be converted to equivalent class C franking credits and debits.

As a result, life insurance companies will, for practical purposes, only keep a class C franking account, reflecting a 34% rate, from 1 July 2000.

Life insurance companies keep both a class C franking account (for tax paid at the general company tax rate) and a class A franking account (for tax paid at 39% on some components of their taxable income).
Franking credits and debits based on a 34% tax rate arising before the conversion date of 1 July 2000 will be converted to reflect a 36% tax rate. Franking credits and debits based on a 34% tax rate arising before the conversion date of 1 July 2000 would not have been converted at the time they arise. The conversion of class C franking accounts on 1 July 2000 would then inappropriately inflate these credits and debits.
Only one test will apply to work out whether franking credits or debits arising from estimated debit determinations reflect a 34% rate under the conversion of franking account provisions.

Under this test, all applications for estimated debits made on or after 9 June 2000 will be taken to reflect a 34% rate.

Two tests would have applied to work out whether franking credits or debits arising from estimated debit determinations reflect a 36% or a 34% rate under the conversion of franking account provisions.

Under one of these tests, companies applying for estimated debit determinations between 9 June 2000 and 30 June 2000 (inclusive) could have chosen either a 36% or a 34% rate as a basis for the debit they apply for.

Detailed explanation of new law

Closing-off class A franking accounts

8.13 Life insurance companies will effectively close-off their class A franking accounts on 1 July 2000.

Converting class A account balances into class C franking credits and debits on 1 July 2000

8.14 On 1 July 2000, the class A franking account of a life insurance company will be closed-off by:

cancelling any class A franking surplus or deficit with:

-
in the case of a surplus, an offsetting class A franking debit equal to the surplus; or
-
in the case of a deficit, an offsetting class A franking credit equal to the deficit; and

having a class C franking credit or debit arise equal to the offsetting debit or credit adjusted by this conversion factor:

(39 / 61) * (66 / 34)

[Schedule 3, item 86, section 160ATC]

8.15 The class C franking credits or debits arising from the closure of the class A franking account will reflect a 34% tax rate. This is consistent with changes made in the NBTS Miscellaneous Bill 1999, under which class C franking accounts of all companies are to be converted to reflect the new 34% company tax rate, also on 1 July 2000.

8.16 The class A franking account of a life insurance company will be closed-off after the company converts its class C franking account to reflect the new 34% company tax rate. [Schedule 3, item 85, paragraph 160ATA(1)(aa)]

Example 8.1 Meningov Ltd is a life insurance company. It maintains a class A franking account and has a franking year of 1 June to 31 May. On 1 July 2000 it has a class A franking deficit of $500. Meningov Ltd closes-off its class A franking account as follows:

* class A franking account balance ($500.00)
* offsetting class A franking credit $500.00
* class C franking debit $620.54
($500.00 * 39/61 * 66/34)

8.17 Subsection 160ATA(2) of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999) deals with a life insurance company's 2000-2001 franking year commencing on 1 July 2000. In this case, a class A franking credit under section 160APL, carrying forward a class A franking surplus from the end of the 1999-2000 franking year, will arise before the franking account is converted.

Converting class A franking credits and debits of a life insurance company arising on or after 1 July 2000

8.18 Once class A franking accounts for life insurance companies are closed-off, it is necessary to ensure that most class A franking credits and debits of life insurance companies arising on or after 1 July 2000 are converted. Those credits and debits are converted to equivalent class C franking credits and debits that reflect the 34% company tax rate.

8.19 This is done by multiplying the class A credit or debit by the conversion factor applied to close-off the class A franking account:

(39 / 61) * (66 / 34)

8.20 There is already a provision in section 160ATD of the ITAA 1936 which applies this factor to convert class A franking credits and debits arising on or after 1 July 2000 for a company other than a life insurance company. Amendments in this Bill ensure that these rules also apply to life insurance companies. [Schedule 3, items 88 and 89]

8.21 Not all class A franking credits or debits of a life insurance company arising on or after 1 July 2000 will be converted. Subsection 160ATD(1) of the ITAA 1936 ensures that the following class A credits and debits are not converted:

a class A franking credit or a class A franking debit arising under Division 14 of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999):

-
These credits and debits arise as part of the conversion process. To convert them again would frustrate the conversion;

a class A franking credit arising under subsection 160APL(1), which carries forward a class A franking surplus from the end of one franking year into a new franking year:

-
This credit is not converted because, if it arises on 1 July 2000, it is already taken into account before the class A franking account is closed-off (see paragraph 8.17). Such a credit will not arise after 1 July 2000 because the class A franking account is closed-off on 1 July 2000;

franking debits arising under sections 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA or 160AQCNB (dividend streaming or franking credit trading arrangements):

-
These debits are not converted because all of them are based on actual franked amounts. There should not be any class A franked amounts arising on or after 1 July 2000 as the class A franking account of life insurance companies will be closed-off; and

franking debits arising under sections 160APX (under-franking), 160AQCC (on-market share buy back arrangements) or 160AQCNC (private company distributions treated as dividends):

-
These debits are not converted because all of them are based on required franking amounts. There needs to be a class A franking surplus to have a class A required franking amount. This will not be possible on or after 1 July 2000 as class A franking accounts of life insurance companies will be closed-off.

8.22 Parts of subsection 160ATD(1) have been replaced under an amendment in this Bill. The new version of this subsection contains information about what particular provisions referred to in the subsection do. This improves the subsection from a user's perspective. [Schedule 3, item 87, subparagraphs 160ATD(1)(b)(ii) and (iii)]

Repealing the provision dealing with companies ceasing to be life insurance companies

8.23 Section 160ATE of the ITAA 1936 (inserted by the NBTS Miscellaneous Bill 1999) deals with the case where a company ceases to be a life insurance company on or after 1 July 2000. In these circumstances, section 160ATE would have converted the class A franking surplus or deficit into a class C franking credit or debit.

8.24 The amendments in this Bill mean that life insurance companies will not have operating class A franking accounts on or after 1 July 2000 (see paragraphs 8.14 to 8.17). Because of these changes, section 160ATE is no longer necessary. Therefore, the section is repealed. [Schedule 3, item 92]

Changes to the required franking amount and dividend declaration rules

8.25 The NBTS Miscellaneous Bill 1999 introduced provisions into the ITAA 1936 to address potential anomalies in working out required franking amounts and the effect of franking declarations. These anomalies may arise because of the conversion of franking accounts on 1 July 2000. These provisions:

provide for the splitting of resolutions under which dividends are paid both before and after 1 July 2000 (section 160ATF);
allow variations to certain dividend declarations (sections 160ATF and 160ATG); and
provide for changes to the required franking amount rules relating to over-franked earlier dividends (section 160ATH).

Resolution splitting

8.26 Subsection 160ATF(1) and paragraph 160ATF(2)(a) deal with the case where a company (including a life insurance company):

pays a number of class C franked dividends under a resolution made before 1 July 2000; and
some of the dividends ('first series dividends') are paid before that date, while other dividends ('second series dividends') are paid after that date.

8.27 The effect of these provisions is that the first series dividends and the second series dividends will be taken to have been made under separate resolutions.

8.28 Amendments in this Bill extend the operation of this rule to cases where a life insurance company pays:

only class A franked dividends before 1 July 2000; or
both class A and class C franked dividends before 1 July 2000;

under a resolution made before that date, under which dividends are paid both before and after 1 July 2000. [Schedule 3, item 93, paragraphs 160ATF(1)(a) and (aa)]

8.29 Because of this amendment, the second series dividends of life insurance companies (i.e. those dividends paid on or after 1 July 2000) will be taken to be paid under a separate resolution. These dividends will have a 'reckoning day' occurring on or after 1 July 2000 as a result. There will be no class A required franking amount for the second series dividends because life insurance companies will not have a class A franking surplus from 1 July 2000 (see paragraphs 8.14 to 8.17). Instead, there will only be class C required franking amounts in relation to these dividends.

Declaration variations

8.30 The effect of paragraph 160ATF(2)(b) is to allow a company to make a new declaration in relation to the second series dividends. The amendment that was just explained ensures that a life insurance company will also be able to make a new declaration where it pays a class A franked dividend in the first series.

8.31 Paragraph 160ATF(2)(c) only applies if the company does not take the opportunity provided by paragraph 160ATF(2)(b) and makes no declaration in respect of the second series dividends. It provides that the second series dividends will be taken to be franked to the same percentage as specified under the original declaration for the first series dividends.

8.32 Amendments in this Bill will ensure that paragraph 160ATF(2)(c) also extends to cases where life insurance companies have paid a class A franked dividend in the first series dividends.

8.33 Two additional rules have been added to paragraph 160ATF(2)(c):

A life insurance company paying only class A franked dividends under the original declaration will be taken to have made a declaration that any second series dividends are class C franked dividends.

-
That dividend or those dividends will be franked to the extent of the class A percentage in the original declaration; and

A life insurance company paying both class A and class C franked dividends under the original declaration will be taken to have made a declaration that any second series dividends are class C franked dividends.

-
That dividend or those dividends will be franked to the extent of the sum of the class C percentage and the class A percentage in the original declaration.

[Schedule 3, item 94, paragraph 160ATF(2)(c), items 2 and 3 in the table]

8.34 Section 160ATG also allows companies to vary declarations or make new declarations in relation to franked dividends paid on or after 1 July 2000. However, unlike paragraph 160ATF(2)(b), section 160ATG will apply only where dividends are paid on or after 1 July 2000 under the original resolution.

8.35 Amendments in this Bill ensure that declarations of class A franked dividends made by life insurance companies before 1 July 2000 can be varied or revoked but only where those dividends are paid on or after 1 July 2000 under the original resolution. [Schedule 3, item 95, subsection 160ATG(1)]

Modifications to rules for over-franked earlier dividends

8.36 Subsection 160AQE(3) of the ITAA 1936 provides that any committed future dividend must be franked to at least the same extent as an earlier over-franked dividend.

8.37 This rule is modified by section 160ATH. This section prevents the required franking amount of a committed future dividend with a reckoning day on or after 1 July 2000 being distorted by the franked amount of the earlier franked dividend paid before 1 July 2000. This distortion would arise because the earlier dividend would have been paid out of a franking account not reflecting a 34% rate, whereas the committed future dividend will be paid out of a franking account reflecting a 34% rate.

8.38 Amendments in this Bill convert class A franked amounts paid by a life insurance company before 1 July 2000 into amounts reflecting a 34% rate for the purposes of working out the required franking amount of committed future dividends with a reckoning day on or after 1 July 2000. [Schedule 3, item 96, subsection 160ATH(3)]

Converting franking credits and debits that reflect 34% company rate that arise before 1 July 2000

8.39 Although the company tax rate of 34% will not take effect until the 2000-2001 income year, it is still possible that franking credits and debits will arise prior to 1 July 2000 reflecting a 34% rate.

8.40 This possibility arises because of substituted accounting periods. Early balancing companies will commence their 2000-2001 income year before 1 July 2000. Therefore, the 34% tax rate will apply to these companies for a period of time before 1 July 2000.

8.41 The introduction of PAYG instalments from the 2000-2001 income year will lead to the payment of those instalments before 1 July 2000 for some early balancing companies. Those instalments will be based on the 34% tax rate.

8.42 Other amendments to the imputation system in this Bill will ensure that a payment of a PAYG instalment, or a refund related to such an instalment, gives rise to a class C franking credit or debit respectively (see Chapter 6) . These will be the major cases of class C franking credits and debits arising before 1 July 2000 based on a 34% rate.

8.43 These credits and debits will arise at a time when the class C franking account reflects a 36% rate. That account will only reflect the 34% rate when the conversion of franking account provisions, introduced in the NBTS Miscellaneous Bill 1999, convert on 1 July 2000.

8.44 Left untreated, the true value of these credits and debits will be distorted by the proposed conversion of class C franking account balances on 1 July 2000. Therefore, it is necessary to convert any franking credits or debits arising before 1 July 2000 that reflect a 34% rate into an equivalent credit or debit reflecting a 36% rate.

The conversion process

8.45 The conversion process for these franking credits and debits mirrors the conversion process for franking credits and debits arising at a 36% rate after the class C franking account has been converted on 1 July 2000 (see section 160ATD of the ITAA 1936).

8.46 A company converts a 34% class C franking credit or debit arising before 1 July 2000 by:

cancelling any 34% class C franking credit or debit arising at that time with:

-
in the case of a credit, an offsetting class C franking debit; or
-
in the case of a debit, an offsetting class C franking credit; and

reinstating a class C franking credit or debit equal to the offsetting debit or credit adjusted by this conversion factor:

(34 / 66) * (64 / 36)

[Schedule 3, item 91, section 160ATDA]

Example 8.2 Wires Ltd maintains a class C franking account and has a franking year of 1 January to 31 December. It makes its first PAYG instalment payment for the 2000-2001 income year on 21 April 2000. The amount of the instalment is $500. A franking credit arises in relation to this instalment based on the general applicable company tax rate of 34% for the 2000-2001 income year. The company converts this credit to reflect the 36% company tax rate as follows:

* class C franking credit $970.59
* offsetting class C franking debit $970.59
* reinstating class C franking credit $888.89
($970.59 * 34/66 * 64/36)

8.47 A number of credits and debits are excluded from the conversion. Those that are not converted include:

a franking credit arising under section 160APL, which carries forward a class C franking surplus from the end of one franking year into a new franking year:

-
This credit is not converted because it will reflect a tax rate of 36% if it arises before 1 July 2000; and

franking debits arising under sections 160APX (under-franking), 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA, 160AQCNB (all of which deal with dividend streaming or franking credit trading arrangements), 160AQCC (on-market share buy back arrangements), or 160AQCNC (private company distributions treated as dividends):

-
These debits are not converted because they are based on class C franked amounts or class C required franking amounts. Any class C franked amount or class C required franking amount arising before 1 July 2000 will reflect a 36% rate.

[Schedule 3, item 91, paragraph 160ATDA(1)(b)]

What 'reflects an applicable general company tax rate of 34%'?

8.48 The proposed conversion is limited to those class C franking credits and debits arising before 1 July 2000 that reflect an applicable general company tax rate of 34% . [Schedule 3, item 91, subsection 160ATDA(2)]

8.49 The most common case of where a credit or debit reflects an applicable general company tax rate of 34% is where that rate is used in working out the amount of the credit or debit. This includes where that rate is used in working out an 'adjusted amount' when calculating the amount of a credit or debit (e.g. a franking credit arising from a PAYG instalment made in the 2000-2001 income year).

Treating estimated debit determinations under the conversion of franking account provisions

8.50 A company can request an estimated debit determination if it can foresee a reduction in company tax in certain circumstances.

8.51 Under section 160ATI of the ITAA 1936 (introduced in the NBTS Miscellaneous Bill 1999) applications for class C estimated debit determinations made between 9 June 2000 and 30 June 2000 (inclusive) could be made on the basis of either a 36% or a 34% rate. This period is critical because the amount of the estimated debit specified in the application automatically takes effect if the Commissioner does not make a determination within 21 days of the application being lodged. Any estimated debit from an application lodged in this period could therefore arise either before or after the conversion of class C franking accounts on 1 July 2000, depending on whether the Commissioner makes a determination.

8.52 There are 2 tests in paragraphs 160ATD(2)(b) and (c) (introduced in the NBTS Miscellaneous Bill 1999) for working out whether a credit or debit arising from an estimated debit determination reflects a 36% tax rate. These tests are for the purposes of converting such a credit or debit if it arises on or after 1 July 2000. The first test, in paragraph 160ATD(2)(b), relies on the company tax rate for the income year in which the company tax payment, potentially subject to reduction, is made. The second test, in paragraph 160ATD(2)(c), relies on any choice made under section 160ATI.

8.53 There is a possibility that these 2 tests could conflict, leading to uncertainty and potential anomalies. The 2 tests in paragraphs 160ATD(2)(b) and (c), and section 160ATI, have all therefore been removed from the law. [Schedule 3, items 90 and 97]

8.54 Instead, the law will proceed on the assumption that any applications for estimated debits made on or after 9 June 2000 (the start of the critical period identified in paragraph 8.51 above) will be class C estimated debit applications. The law will also assume that the debit applied for will be based on the 34% rate. This will be the case even if the application would have otherwise led to a class A or a class B debit. A company will be able to factor in the conversion of franking accounts to reflect a 34% rate when working out the debit specified in its application.

8.55 Section 160ATDA (explained in paragraphs 8.45 to 8.49 above) will apply if the Commissioner makes a determination in relation to such an application before 1 July 2000. Franking debits arising in these cases will be based on a 34% rate, and will therefore need to be converted to reflect a 36% rate at the time they arise. [Schedule 3, item 91, paragraph 160ATDA(2)(b)]

Application and transitional provisions

8.56 The amendments made in Part 3 of Schedule 3 to this Bill commence immediately after item 13 of Schedule 3 of the NBTS Miscellaneous Bill 1999. That item inserts the original conversion of franking account provisions, which commence on 1 July 2000. Therefore, these amendments will also take effect on 1 July 2000. [Subclause 2(9) of this Bill]

Consequential amendments

8.57 There are no other consequential amendments.


View full documentView full documentBack to top