Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 1 - Franking of non-share dividends
Outline of chapter
1.1 Schedule 1 to this bill amends the imputation rules contained in the income tax law that deal with the franking of non-share dividends. The changes will rectify an anomaly that prevents the franking of non-share dividends as was intended.
Context of amendments
1.2 Non-share dividends are returns made on interests, characterised under the debt/equity rules contained in Division 974 of the ITAA 1997 as equity interests, that are not in the form of shares. These interests are intended to be frankable in the same way that dividends on shares are frankable.
1.3 Under the existing income tax law, dividends on shares have to be paid out of realised profits to be frankable. To ensure that non-share dividends are treated in a similar way, the imputation rules contained in Subdivision 215-B of the ITAA 1997 and section 160APAAAB of the ITAA 1936 align a company's ability to frank non-share dividends with the amount of its profits. This is achieved by calculating a company's 'available frankable profits'.
1.4 It was intended that 'available frankable profits' were to be calculated by adding future profits to profits on hand and subtracting committed share dividends. The anomaly is that expected profits are not recognised in the calculation of available frankable profits.
Summary of new law
1.5 These amendments rectify an anomaly that exists in Division 215 of the ITAA 1997 and section 160APAAAB of the ITAA 1936 which are imputation rules that deal with non-share dividends. The anomaly is that expected profits are not recognised when calculating if sufficient profits are available to fund a non-share dividend.
1.6 As the amendments rectify an anomaly in the law they will apply from 1 July 2001, the date when the existing provisions first applied. [Schedule 1, item 9]
| New law | Current law |
|---|---|
| Subdivision 215-B of the ITAA 1997 and section 160APAAAB of the ITAA 1936 ensure that the calculation of 'available franking profits' includes expected profits. | Non-share dividends can only be franked to the extent that sufficient profits are available. Profits are calculated by subtracting committed dividends from profits on hand. The extent to which these dividends can be funded using future profits is inappropriately not taken into account. |
Detailed explanation of new law
1.7 This bill amends subsection 215-25(1) of the ITAA 1997 by inserting subparagraph 215-25(1)(e) that is a further condition to allow an entity to anticipate available frankable profits for the purpose of franking non-share dividends. In taking into account the available profits referred to in paragraph 215-25(1)(d), this condition requires that the amount of adjusted available franking profits after each committed distribution has been paid will be greater than nil. The smallest adjusted available frankable profit figure is the entity's available frankable profits used to determine if sufficient profits are available to frank the proposed non-share dividend. [Schedule 1, item 1]
1.8 This bill repeals subsection 215-25(2) and introduces the new concept of adjusted available frankable profits. This sets out the extent to which a company can frank a non-share dividend by anticipating future profits. It is calculated at the time each committed distribution is made and is the available frankable profits that would arise when each committed distribution is made if all committed distributions paid after that time were ignored. Also, to avoid double counting, the non-share dividend is not included in the calculation of adjusted available frankable profits. [Schedule 1, item 2]
1.9 Items 1 to 4 that amend the ITAA 1997 apply to non-share dividends paid after 30 June 2001. Items 5 to 8 replicate these provisions in the ITAA 1936 and they apply to non-share dividends paid after 30 June 2001 and before 1 July 2002. [Schedule 1, item 9]
Example 1.1
Bob's Panel Beating Co. (Bob Co.) plans to pay a non-share dividend of $100 to its only non-share equity holder. It had paid an undebited non-share dividend of $40 and is committed to pay committed share dividends of $100, $100 and $150 in years 1 to 3 respectively. It has $50 of profits on hand, and expects to generate profits of $150, $200 and $150 in years 1 to 3 respectively.
The company satisfies all of the conditions in paragraphs 215-25(1)(a) to (e) and therefore it can anticipate profits under section 215-25.
Bob Co.'s adjusted available frankable profits calculations show that the smallest of the adjusted available frankable profits, which happens to be immediately after the payment of the first committed distribution, is $60 [($50 + $150) - ($100 ? 40)] . It's other adjusted available frankable profits calculations immediately after committed distributions 2 and 3 are paid were $160 [($100 + $200) - ($100 + $40)] and $160 [($200 + $150) - ($150 + $40)] respectively. Bob Co.'s available frankable profits is therefore $60 because the smallest of the adjusted available franking profits is $60. The company can frank $60 of the proposed $100 non-share dividend.
Without being able to anticipate profits under section 215-25, Bob Co. would not have been able to frank the non-share dividend.
1.10 A minor change is needed in relation to wording to subparagraph 215-25(3)(b)(i) of the ITAA 1997 and subsection 160APAAAB(7) of the ITAA 1936 so that references to 'when' are replaced with 'immediately after' to clarify the meaning of the provisions. [Schedule 1, items 3 and 7]
Consequential amendments
1.11 Subsection 995-1(1) of the ITAA 1997 is amended to include a definition of 'adjusted available frankable profits'. [Schedule 1, item 4]