Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 3 - Anti-streaming rules
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.
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 entitys benchmark franking percentage differs significantly between franking periods.
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.
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).
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 members entity will incur a franking debit (assuming that that entitys 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 members 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 entitys 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)]
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.
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.
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)]
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)] .
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)]
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 entitys 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.
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.
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 members 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)]
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.
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)] .
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.
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)]
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:
number of franking periods starting immediately after the last relevant franking period and ending at the end of the current franking period * 20 percentage points
[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 entitys 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 entitys 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 entitys 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)] .