HOUSE OF REPRESENTATIVES

Taxation Laws Amendment Bill (No. 2) 2002

EXPLANATORY MEMORANDUM

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

Chapter 1 - Company rate changes (franking account consequentials)

Outline of chapter

1.1 Schedule 1 to this bill amends the dividend imputation rules in the ITAA 1936 to take account of the reduction in the company tax rate from 34% to 30%.

1.2 This bill inserts Division 15 into Part IIIAA of the ITAA 1936 which deals with the conversion of the franking accounts of companies and similarly taxed entities so that the balance of their franking accounts reflects an underlying tax rate of 30%. These conversions are to occur on 1 July 2001.

1.3 This bill also introduces other necessary amendments to various provisions in Part IIIAA that rely on the prevailing company tax rate for their correct operation.

Context of amendments

1.4 The reduction in the company tax is provided for in the New Business Tax System (Income Tax Rates) Act (No. 1) 1999 . The reduction in the company tax rate is a key component of the New Business Tax System announced in Treasurers Press Release No. 58 of 21 September 1999.

1.5 The reduced company tax rate provides Australia with an internationally competitive company tax rate. The reduction of the company tax rate to 30% brings the Australian rate into line with rates in other countries in the Asia Pacific region.

Summary of new law

1.6 In broad terms, the amendments to the imputation system will:

·
convert existing class C franking account balances (which are currently based on an underlying company tax rate of 34%) so that they are based on the new company tax rate of 30% from 1 July 2001;
·
generally convert franking credits and debits arising on or after 1 July 2001 to reflect the 30% company tax rate where those credits and debits are based on another underlying company tax rate;
·
ensure that franked dividends paid on or after 1 July 2001 carry underlying imputation credits reflecting a 30% tax rate;
·
modify the operation of the required franking amount and equal franking rules to take account of the conversion process so as to ensure that these structural anti-dividend streaming provisions operate correctly; and
·
modify the operation of the estimated debit determination rules to take account of the conversion process.

Comparison of key features of new law and current law
New law Current law
Franking account entries made to a companys franking account will be calculated by reference to the 30% tax rate. Franking account entries made to a companys franking account are calculated by reference to the 34% tax rate.
Franking rebates will be calculated by reference to the 30% company tax rate. Franking rebates are calculated by reference to the 34% company tax rate.
The balance of the class C franking accounts of companies and similarly taxed entities will be converted so that their balances reflect an underlying company tax rate of 30%. The balance of the class C franking accounts of companies and similarly taxed entities are based on an underlying company tax rate of 34%.
Franking account entries based on an underlying rate other than the 30% rate are to be converted to equivalent entries based on the 30% rate. Franking account entries based on an underlying rate other than the 34% rate are converted to equivalent entries based on the 34% rate.

Detailed explanation of new law

Conversion of the class C franking account balance on 1 July 2001

1.7 Companies are required to convert their class C franking account balances (including venture capital sub-account balances) on 1 July 2001 to take account of the new tax rate of 30%. The purpose of the conversion is to ensure that the value of any existing franking credits and debits that accumulated at a higher rate of tax are preserved.

1.8 For a company with a franking year that commences on 1 July 2001, the conversion of the class C franking account (or venture capital sub-account) occurs immediately after any franking credit arises which carries forward a surplus from the previous franking year. [Schedule 1, item 10, subsection 160AUA(2)]

1.9 Companies with a standard franking year, that is, one which commences on 1 July 2001, can only have a surplus or a nil franking account balance on 1 July 2001. Companies that have a non-standard franking year may, however, have a surplus or deficit balance on 1 July 2001.

1.10 The conversion process involves cancelling any existing surplus or deficit in the franking account and reinstating the cancelled deficit or surplus with an equivalent surplus or deficit based on the 30% rate. [Schedule 1, item 10, section 160AUB]

1.11 The following 2 steps are necessary to carry out the conversion (a similar process applies for venture capital sub-accounts):

Step 1: Cancel the existing class C franking surplus or deficit.

·
In the case of a surplus , an offsetting franking debit is posted to the franking account equal to the surplus.
·
In the case of a deficit , an offsetting franking credit is posted to the franking account equal to the deficit.

Step 2: Reinstate the class C franking surplus or deficit.

·
Where a surplus is to be reinstated, a franking credit is posted equal to the amount of the offsetting debit in step 1 multiplied by the conversion factor:

(34 / 66) * (70 / 30)

·
Where a deficit is to be reinstated, a franking debit is posted equal to the amount of the offsetting credit in step 1 multiplied by the conversion factor:

(34 / 66) * (70 / 30)

Example 1.1 Leongs Landscape Supplies Ltd maintains a class C franking account and has a standard franking year of 1 July to 30 June. On 1 July 2001, the company has a carry forward franking surplus from the previous franking year of $10,000. The company converts its franking account balance to reflect the new company tax rate as follows:class C franking account balance $10,000offsetting class C franking debit -$10,000reinstating class C franking credit $12,020

[$10,000 * (34 / 66) * (70 / 30)]

Example 1.2 Hoas Haberdashery Ltd is an early balancing company. It maintains a class C franking account and has a franking year of 1 April to 31 March. On 1 July 2001, the companys franking account has a deficit balance of $5,000. The company converts its franking account balance to reflect the new company tax rate as follows:class C franking account balance -$5,000offsetting class C franking credit $5,000reinstating class C franking debit -$6,010

[$5,000 * (34 / 66) * (70 / 30)]

Franked dividends paid on or after 1 July 2001 will reflect the 30% company tax rate

1.12 All franked dividends paid on or after 1 July 2001 will carry imputation credits reflecting the 30% company tax rate. Accordingly, franking rebates claimed by shareholders in respect of class C franked dividends paid on or after 1 July 2001 will be based on the 30% company tax rate. This change also applies to franking rebates claimed by beneficiaries and partners because a class C franked dividend is paid to a trust or partnership on or after 1 July 2001.

1.13 This result is achieved by omitting the reference to 34% in paragraph (cb) of the definition of applicable general company tax rate in section 160APA of the ITAA 1936 and replacing it with 30%. [Schedule 1, item 2, section 160APA]

Example 1.3 Sandra is a shareholder in XYZ Ltd. On 15 July 2001, XYZ pays a $100 class C fully franked dividend to Sandra.The applicable general company tax rate for the purposes of the payment of the franked dividend is 30%. This means the additional amount included in Sandras assessable income under subsection 160AQT(1AB) is equal to $42.86 (i.e. $100 30 / 70). Sandra is also entitled to a franking rebate (i.e. a tax offset) of the same amount under section 160AQU.

1.14 The amendments will also ensure that shareholders receive clear information from companies in relation to franked dividends that they receive. The shareholder statement in relation to a dividend paid on or after 1 July 2001 must include the gross up amount for the dividend (calculated under subsection 160AQT(1AB)) and specify that the applicable company tax rate used to calculate the gross up amount is 30%. [Schedule 1, item 4, subparagraph 160AQH(1)(b)(iva)]

Converting franking credits and debits arising on or after 1 July 2001 which do not reflect the 30% company tax rate

1.15 Once franking account balances are converted to reflect the 30% company tax rate, it is necessary to ensure that franking credits and debits arsing on or after 1 July 2001 reflect the 30% rate. Accordingly, special rules are required to ensure that where franking credits and debits arise based on an underlying rate other than the 30% rate, those credits and debits are converted to equivalent credits and debits based on the new rate. [Schedule 1, item 10, section 160AUC]

1.16 The process for converting franking credits and debits is a 2 step process. Firstly, where a franking credit or debit arises based on a rate other than the 30% rate, the credit or debit is cancelled by an offsetting credit or debit of the same amount and, secondly, an equivalent credit or debit is then posted based on the 30% rate.

1.17 The table in subsection 160AUC(1) sets out the conversion processes to be followed in cases where:

·
class A franking account entries arise based on a 39% rate;
·
class B franking account entries arise based on a 33% rate;
·
class C franking account entries arise based on either a 34% or 36% rate; and
·
venture capital sub-account entries arise based on either a 36% or 34% rate (note this only applies to pooled development funds).

1.18 In summary:

·
class A franking credits and debits are converted into equivalent class C franking credits and debits using the factor:

(39 / 61) * (70 / 30)

·
class B franking credits and debits are converted into equivalent class C franking credits and debits using the factor:

(33 / 67) * (70 / 30)

·
class C franking credits and debits (based on a 34% rate) are converted into equivalent class C franking credits and debits using the factor:

(34 / 66) * (70 / 30)

·
class C franking credits and debits (based on a 36% rate) are converted into equivalent class C franking credits and debits using the factor:

(36 / 64) * (70 / 30)

·
venture capital sub-account franking credits and debits (based on a 34% rate) are converted into equivalent franking credits and debits using the factor:

(34 / 66) * (70 / 30)

·
venture capital sub-account franking credits and debits (based on a 36% rate) are converted into equivalent franking credits and debits using the factor:

(36 / 64) * (70 / 30)

1.19 Some franking credits and debits that arise on or after 1 July are not to be converted. Those that are not converted include:

·
franking credits and debits arising under this Division. These franking credits and debits arise as part of the conversion to reflect the new company tax rate. To convert them again would frustrate the conversion;
·
franking credits arising under sections 160APL and 160ASEE. These franking credits, which carry forward franking surpluses from previous franking years, are already taken into account in the conversion process (see paragraph 1.8); and
·
franking debits arising under sections 160APX (underfranking debits), 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA or 160AQCNB (dividend streaming or franking credit trading arrangements), 160AQCC (on-market share buyback arrangements) and 160AQCNC (private company distributions treated as dividends). It is unnecessary to convert these franking debits because they would have been calculated by reference to the 30% rate if they arise on or after 1 July 2001.

[Schedule 1, item 10, paragraph 160AUC(1)(b)]

Converting franking credits and debits arising before 1 July 2001 which originally reflected a 30% company tax rate

1.20 The new company tax rate of 30% applies to the 2001-2002 income year. For most companies, this rate applies from 1 July 2001. In the case of early balancing companies, however, franking credits and debits may arise prior to 1 July 2001 based on a 30% tax rate.

1.21 In order to ensure that the conversion of franking account balances on 1 July 2001 does not cause anomalous results, it is necessary to convert any franking credits or debits that arise prior to 1 July 2001 that are based on a 30% rate to equivalent franking credits based on a 34% rate.

1.22 Accordingly, any class C or venture capital sub-account franking credit or debit arising before 1 July 2001 that reflects an applicable company tax rate of 30% is to be converted to the equivalent 34% credit or debit. [Schedule 1, item 10, section 160AUD]

1.23 Where class C or venture capital sub-account franking credits or debits arise based on the 30% rate, the credit or debit is cancelled by an offsetting credit or debit of the same amount and an equivalent credit or debit is posted based on the 34% rate.

1.24 The table in subsection 160AUD(1) sets out the conversion processes to be followed in cases where:

·
class C franking credits and debits (based on a 30% rate) are converted into equivalent class C franking credits and debits using the factor:

(30 / 70) * (66 / 34)

·
venture capital sub-account franking credits and debits (based on a 30% rate) are converted into equivalent franking credits and debits using the factor:

(30 / 70) * (66 / 34)

1.25 The following franking credits and debits are excluded from the conversion:

·
franking credits arising under sections 160APL and 160ASEE. These franking credits, which carry forward franking surpluses from previous franking years, are already taken into account in the conversion process. A franking credit under this section will reflect a 34% company tax rate if it arises before 1 July 2001.
·
franking debits arising under sections 160APX (underfranking debits), 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCNA or 160AQCNB (dividend streaming or franking credit trading arrangements), 160AQCC (on-market share buyback arrangements) and 160AQCNC (private company distributions treated as dividends). These debits will reflect a company tax rate of 34% where they arise before 1 July 2001.

[Schedule 1, item 10, paragraph 160AUD(1)(b)]

Consequential modifications to the required franking amount rules

1.26 The operation of the required franking rules is to be modified as a consequence of the franking account conversions. This modified operation is only relevant to situations where dividends are paid both before and after 1 July 2001 under a single resolution.

1.27 The required franking amount rules are designed to prevent dividend streaming arrangements by ensuring that dividends are franked to the maximum extent possible having regard to the companys franking account balance. Further, the rules ensure that where 2 or more dividends are paid under a single resolution, those dividends are franked to the same extent.

1.28 The required franking amount of a dividend is calculated by reference to the franking surplus on the reckoning day for that dividend. For a dividend paid under a resolution, the reckoning day is the day on which the first dividend under the resolution is paid.

1.29 Anomalies could arise where dividends are paid under a single resolution both before and after 1 July 2001. This would occur because a dividend paid on or after 1 July 2001 will carry imputation credits based on a 30% rate, where as the required franking amount of the dividend is calculated by reference to the franking surplus on the reckoning day which is based on the 34% tax rate.

1.30 Three specific amendments have been made to address this situation:

·
providing for resolution splitting for dividends straddling 1 July 2001;
·
allowing variations to dividend declarations; and
·
providing modifications to the rules relating to overfranked earlier dividends.

Resolution splitting

1.31 Where a company pays a number of class C franked dividends under a resolution made before 1 July 2001 and some of the dividends (first series dividends) are paid before that date, while other dividends (second series dividends) are paid after that date, the first series and second series dividends will be taken to have been made under separate resolutions. [Schedule 1, item 10, subsection 160AUE(1) and paragraph 160AUE(2)(a)]

1.32 The effect of this rule is that the second series dividends will have their required franking amount worked out on the basis of a franking surplus that has been converted on 1 July 2001 to reflect a 30% tax rate.

Example 1.4 Julias Junkyard Ltd makes a resolution on 1 December 2000 to pay dividends on 1 May 2001 (first series dividend) and 1 November 2001 (second series dividend). Under the existing law, the reckoning day for these dividends is therefore 1 May 2001.Under the new rules, however, this resolution will be split into 2 separate resolutions - one dealing with the first series dividend and one dealing with the second series. The reckoning day for the first series is still 1 May 2001 and the calculation of the required franking amount remains substantially unaltered. The required franking amount will be calculated based on a class C franking account balance that reflects the 34% tax rate. The franked dividends received by shareholders will carry imputation credits that reflect the 34% tax rate.The reckoning day for the second series dividend will now be 1 November 2001. The required franking amount will be calculated based on a class C franking account balance that reflects the 30% tax rate just as the imputation credits underlying the franked dividend will be based on a 30% tax rate.

Declaration variations

1.33 If a company has already made a declaration under section 160AQF or 160ASEL in relation to the dividends, the second series dividends may be franked to a different extent than that set out under the new required franking amounts for those dividends.

1.34 To deal with this, the original declaration made will be taken to have applied to the first series dividends and the company will be permitted to make a further declaration in respect of the second series dividends. [Schedule 1, item 10, paragraph 160AUE(2)(b)]

1.35 However, if the company makes no declaration in respect of the second series dividends before the reckoning day for those dividends, the dividends will be taken to be franked to the same percentage as the first series dividends. [Schedule 1, item 10, paragraph 160AUE(2)(c)]

Example 1.5 Continuing from Example 1.4.Julias Junkyard Ltd may make a new resolution for the second series dividend before 1 November 2001 if it had previously made a declaration in relation to the first and second series dividends. If the company does not make a new declaration for the second series, the declaration originally made for both the first series and second series dividend will stand for the second series.

1.36 Circumstances may also arise where, before 1 July 2001, a company declares dividends under a resolution to be franked based on the 34% company tax rate, but no dividend will be paid under that resolution until on or after 1 July 2001.

1.37 Ordinarily, section 160AQF declarations cannot be varied however, an exception will be made where a resolution is made before 1 July 2001 but no dividends under the resolution are paid until on or after that date. In these cases, any declaration can be varied before the reckoning day of the dividend to take into account the 30% company tax rate. [Schedule 1, item 10, section 160AUF]

Modifications to the rules for overfranked earlier dividends

1.38 When a dividend is to be paid, the required franking amount for that dividend is calculated under section 160AQE. If the dividend is franked to a greater extent than the required franking amount for that dividend, the dividend is said to be overfranked. This means that the dividend has been franked to a greater extent than can be supported by the franking account surplus.

1.39 The required franking amount provisions in section 160AQE contains a special rule that provides that if a company overfranks an earlier franked dividend and there is a committed future dividend at the time of the earlier franked dividend, that committed future dividend must be franked at least to the same extent. This rule is set out in subsection 160AQE(3).

1.40 The rule in subsection 160AQE(3) effectively provides a formula in paragraph 160AQE(3)(c) that ensures that the franked amount of the earlier dividend is factored into the calculation of the required franking amount of the current dividend.

1.41 It may arise that the committed future dividend (called the current dividend in subsection 160AQE(3)) may have a reckoning day on or after 1 July 2001, but the earlier franked dividend has a reckoning day before that time. This means that the required franking amount of the current dividend may be affected by the franked amount of the earlier dividend.

1.42 The franked amount of the earlier dividend would have been determined on the basis of a franking account balance based on the 34% tax rate. The required franking amount of the current dividend with a reckoning day on or after 1 July 2001 must be determined having regard to franking account balance that reflects a 30% tax rate.

1.43 As the earlier franked amount is to be used in the calculation of the required franking amount for the current dividend, a modification to subsection 160AQE(3) is necessary to convert the earlier franked amount into an amount that reflects a 30% tax rate. This will prevent any unintended distortions in the calculation of the required franking amount of the current dividend. [Schedule 1, item 10, section 160AUG]

Example 1.6 Jaimies Jet Propelled Cycles Ltd pays a franked dividend (the earlier dividend) of $20,000 on 1 May 2001. At the time, the required franking amount of the dividend was determined to be $10,000 but the company decided the franked amount of the dividend would be $15,000 (i.e. the dividend was overfranked). At that time the company had a committed future dividend to be paid on 1 October 2001.On 1 October 2001, the company pays a dividend of $12,000 and at that time the company has a franking surplus of $6,000. In determining the required franking amount of the current dividend (i.e. what was a committed future dividend on 1 May 2001), the company must have regard to the earlier franked amount of the dividend paid on 1 May 2001.In applying the rules in section 160AQE, the company must make 2 calculations of the provisional required franking amount. A calculation is made under subsection 160AQE(2) and another is made under subsection 160AQE(3).The required franking amount for the current dividend will be the greater of the 2 provisional required franking amounts calculated below:Amount calculated under subsection 160AQE(2):current dividend * (amount of the franking surplus / current dividend)$12,000 * [$6,000 / $12,000] = $6,000Amount calculated under subsection 160AQE(3):current dividend * (earlier franked amount / earlier franked dividend)$12,000 * [$18,030 / $20,000] = $10,818where the earlier franked amount is calculated as:franked amount of the earlier dividend * ( 34 / 66 * 70 / 30)$15,000 * (34 / 66 * 70 / 30 ) = $18,030Therefore, the required franking amount of the current dividend is $10,818.

Modifications to the equal franking rule in section 160AQG

1.44 Section 160AQG effectively provides that dividends that are part of a combined class of dividends must be equally franked. If this is not the case, then the dividends will all be treated as though they had been paid under the resolution relating to the first dividend of the class to ensure that those dividends are equally franked. The purpose of this section is to prevent blatant dividend streaming arrangements.

1.45 A new subsection has been inserted into section 160AQG to ensure that companies are not inappropriately caught by section 160AQG where a combined class of dividends paid during the year straddles 1 July 2001. The provision splits the franking year (other than one starting on 1 July 2001) into 2 separate franking years - the first ending on 30 June 2001 and the second starting on 1 July 2001. [Schedule 1, item 3, subsection 160AQG(5)]

1.46 The effect of this amendment is that section 160AQG will apply separately in respect of the two split franking years. This rule means that companies will not be subject to section 160AQG if dividends are not equally franked only because of the rules relating to the conversion of franking accounts to reflect the new company tax rate.

1.47 Notwithstanding these amendments, companies that enter into a strategy to stream franking credits can still expect to attract the operation of the various anti-streaming rules in Part IIIAA.

Estimated debit determinations

1.48 A company can request an estimated debit determination if it can foresee a refund of company tax in certain circumstances. An estimated debit determination will give rise to a franking debit. This means that dividends can be franked to take account of the estimated debit.

1.49 Under the current law, a taxpayer may apply to the Commissioner for a class C estimated debit determination under section 160AQDAA. However, if the Commissioner does not make a declaration within 21 days, the Commissioner is deemed to have made a determination of the amount requested in the application.

1.50 The period of 21 days means that applications made by companies between 9 June 2001 and 30 June 2001 may have been based on a 34% tax rate. If that were the case, the actual debit that arises as a result of the determination may be inappropriate where the 21 day period ends on or after 1 July 2001.

1.51 A special rule has been introduced to provide for this situation. Essentially, the rule provides that if a debit arises on or after 1 July 2001 under section 160AQC(3) or section 160ASEI as a result of an estimated debit determination, and the amount of the debit is based on a 34% tax rate, that debit will be reversed out and an equivalent debit based on the 30% tax rate will arise in the companys franking account. [Schedule 1, item 10, paragraph 160AUC(2)(b)]

Division 14 not to apply after 30 June 2001

1.52 Sections 160ATA and 160ATD which deal with franking account conversions to the 34% company tax rate will no longer apply after 30 June 2001. Where franking credits or debits arise after 1 July 2000 but before 1 July 2001, however, these provisions still have effect. [Schedule 1, items 6 to 9, subsections 160ATA(3) and 160ATD(1), paragraphs 160ATD(1)(a) and 160ATDA(2)(b)]

Changing other references to a 34% rate in the imputation provisions

1.53 The following references in the imputation provisions that rely on a company tax rate of 34% will be replaced by references relying on the new rate of 30%:

·
in paragraph (baa) of the definition of applicable general company tax rate (which applies in relation to a companys liability to pay class C FDT) in section 160APA [Schedule 1, item 1, section 160APA] ; and
·
in the formula in subsection 160AQJC(4) which calculates the gross class C deficit deferral amount for the purposes of working out liabilities to class C DDT [Schedule 1, item 5, subsection 160AQJC(4)] .

Application and transitional provisions

1.54 The following amendments apply to relevant dividends paid on or after 1 July 2001:

·
item 2 of Schedule 1, which provides for the change in the applicable company tax rate for a payment of class C franked dividends and for trust amounts and partnership amounts related to the payment of class C franked dividends [Schedule 1, subitem 11(2)] ; and
·
item 4 of Schedule 1, which modifies the requirements for dividend statements [Schedule 1, subitem 11(3)] .

1.55 The amendments in items 1 and 5 of Schedule 1 that reflect the new company tax rate of 30% for the purposes of FDT and DDT apply to:

·
FDT for franking years ending on or after 1 July 2001 [Schedule 1, subitem 11(1)] ; and
·
DDT in relation to company tax instalments paid during a franking year ending on or after 1 July 2001 [Schedule 1, subitems 11(1) and (4)] .

REGULATION IMPACT STATEMENT

Policy objective

1.56 Companies (and similar taxpayers) will convert their franking account balances on 1 July 2001 to reflect the reduction of the company tax rate from 34% to 30%.

1.57 The policy objective is to convert the franking account balances of companies. This will ensure that the value of franking credits accumulated prior to the rate change is preserved whilst minimising compliance costs for corporate taxpayers.

Implementation options

1.58 This measure is substantially similar to the conversion process that was implemented last year when the company tax rate was reduced from 36% to 34%.

Assessment of impacts

1.59 The franking account conversion legislation will impose a small, generally once only, compliance burden on those taxpayers affected. The conversion process that a taxpayer will be required to follow will be substantially similar to that required when the tax rate was reduced last year, so companies are familiar with the conversion process.

Impact group identification

1.60 The taxpayers affected by these rules are those resident taxpayers that are required to maintain franking accounts. They are:

·
all resident companies (including non-mutual life assurance companies);
·
all resident public trading trusts;
·
all resident corporate unit trusts; and
·
all limited partnerships.

Analysis of costs/benefits

1.61 The rules are generally beneficial to taxpayers in that they preserve the value of franking credits that accumulated at a higher tax rate. The measure imposes a small compliance burden on affected taxpayers, generally involving a simple calculation and simple accounting entries.

Other issues - consultation

1.62 There is no need for consultation in relation to this measure because it is consistent with previous conversions and therefore with taxpayers expectations.

Conclusion and recommended option

1.63 There are no other options for implementing this policy objective.


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