House of Representatives

Financial Sector Legislation Amendment (Restructures) Bill 2007

Explanatory Memorandum

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

Schedule 2 - Restructure relief: taxation aspects

5.1 Schedule 2 to this Bill amends the consolidation membership rules, the imputation provisions and the capital gains tax (CGT) provisions in the Income Tax Assessment Act 1997 (ITAA 1997) to remove tax impediments that prevent financial groups containing authorised deposit-taking institutions (ADIs) from restructuring for prudential reasons.

Context of amendments

5.2 The tax consolidation rules treat wholly-owned groups as a single entity for tax purposes. A consolidated group consists of a head company and all of its wholly-owned subsidiaries. An entity is a 'wholly-owned subsidiary' of the head company for the purposes of Part 3-90 of the ITAA 1997 if the head company beneficially owns, directly or indirectly, all the 'membership interests' in the subsidiary. In the case of a company, membership interests are any interests held by a member or stockholder of the company.

5.3 Currently, if a consolidated group contains an ADI, the head company tends to be the ADI. The membership interests in the ADI contribute to the ADI's capital holdings for prudential purposes. Part of the ADI's required capital holdings is Tier 1 capital (the highest form of capital), which includes certain preference shares issued by the ADI.

5.4 For prudential reasons, ADI groups may restructure and impose a non-operating holding company as the head company of the group, making the ADI a wholly-owned subsidiary (an ADI restructure). However, this prevents the ADI from issuing certain preference shares as part of the consolidated group, despite these shares lacking key ownership characteristics.

5.5 Therefore, to ensure that an ADI can be a wholly-owned subsidiary of a non-operating holding company for tax consolidation purposes following an ADI restructure and continue to issue certain preference shares to meet its capital adequacy requirements, those shares will be disregarded for consolidation membership purposes.

5.6 The amendments will also ensure that shareholders who exchange their shares in the ADI or extended licensed entity for shares in the non-operating holding company can obtain a CGT roll-over.

Summary of new law

5.7 The amendments remove tax impediments that prevent financial groups containing ADIs from restructuring for prudential reasons by:

·
disregarding certain preference shares issued by an ADI or an extended licensed entity member, for the purposes of determining whether the ADI or extended licensed entity member is a wholly-owned subsidiary of a consolidated group headed by a non-operating holding company;
·
ensuring that certain dividends paid by the non-operating holding company are frankable if those dividends would have been frankable had they been paid by the ADI prior to the ADI restructure; and
·
ensuring that shareholders in the original company (either an ADI or an extended licensed entity member) who exchange their shares for shares in the non-operating holding company can obtain a CGT roll-over if certain preference shares remain issued by the ADI and some foreign holders of shares do not receive shares in the non-operating holding company.

Comparison of key features of new law and current law

New law Current law
Certain preference shares are disregarded for the purpose of determining whether an entity is a wholly-owned subsidiary of a consolidated group. Therefore, in certain circumstances, an ADI can be a subsidiary member of a consolidated group even though it issues preference shares to non-group members. Preference shares are membership interests for consolidation purposes. Therefore, an ADI that issues preference shares to non-group members cannot be a subsidiary member of a consolidated group.
Distributions made by a non-operating holding company of an ADI from the company's share capital account or from certain other accounts will be frankable distributions if:

·
the distributions are sourced from the profits of the ADI; and
·
the distributions would have been frankable distributions had they been paid by the ADI prior to the restructure.

Distributions made by a non-operating holding company of an ADI from the company's share capital account or from certain other accounts will be unfrankable distributions.
Shareholders of an original company (either an ADI or an extended licensed entity) who exchange their shares for shares in an interposed non-operating holding company may obtain a CGT roll-over even if:

·
certain preference shares are not exchanged; and
·
some foreign holders of shares do not participate in the exchange.

A CGT roll-over is available when a company is interposed between an existing company and its shareholders only if all the shares in the original company are exchanged for shares in the interposed company.

Detailed explanation of new law

Modification to the consolidation membership rules to disregard certain shares

5.8 Section 703-37 ensures that certain preference shares are disregarded for the purpose of applying the consolidation membership rules following an ADI restructure. The object of the section is to ensure that an ADI restructure does not prevent an ADI, or a member of an extended licensed entity including the ADI, from being a subsidiary member of a consolidated group because it issues certain preference shares. [ Schedule 2, item 3, subsection 703-37(1 )]

5.9 This is an exception to the general consolidation membership rule in section 703-15 that requires a subsidiary member of a consolidated group (in this case, the ADI or extended licensed entity member) to be wholly-owned, directly or indirectly, by the head company of the group (in this case, the non-operating holding company).

5.10 The exception enables the consolidation rules (except those applying specifically to multiple entry consolidated groups under Division 719) to apply as if the entity that issues the preference shares was a wholly-owned subsidiary of the holding body. That is, the preference shares issued by the ADI or extended licensed entity are effectively ignored for consolidation purposes. [ Schedule 2, item 3, subsection 703-37(2 )]

5.11 The exception is limited to preference shares issued, either prior to or after the ADI restructure, by specific bodies at a time when a restructure instrument is in force and that have certain characteristics.

Who can issue the preference shares that are disregarded?

5.12 The preference shares can be disregarded for the purpose of applying the consolidation membership rules only if the body issuing the preference shares is:

·
a body that would be a wholly-owned subsidiary of the holding body, were the shares not to exist; and
·
an ADI, or a member of an extended licensed entity (within the meaning of the prudential standards) that includes the ADI.

[ Schedule 2, item 3, subsection 703-37(3 ) and paragraph 707-37(4 )( c )]

5.13 An entity is a member of an extended licensed entity if it is a subsidiary of the ADI which is used to conduct some of the ADI's activities. The Australian Prudential Regulation Authority recognises that an ADI subsidiary operates, to all intents and purposes, as a division of an ADI. As such, an extended licensed entity member can be considered part of the ADI for tax consolidation membership purposes.

5.14 The 'prudential standards' are defined in subsection 995-1(1) to mean the prudential standards determined by the Australian Prudential Regulation Authority and in force under section 11AF of the Banking Act 1959 .

Restructure instrument must be in force when shares issued

5.15 The exception in section 703-37 applies only if:

·
a restructure instrument under Part 4A of the Financial Sector (Business Transfer and Group Restructure) Act 1999 is in force in relation to the non-operating holding company; and
·
because of the restructure to which the instrument relates, an ADI becomes a subsidiary (within the meaning of the Financial Sector (Business Transfer and Group Restructure) Act 1999 ) of the non-operating holding company.

[ Schedule 2, item 3, paragraphs 703-37(4)(a) and 703-37(4)(b) ]

Characteristics of disregarded shares

5.16 A share can be disregarded for consolidation membership purposes following an ADI restructure only if it is a preference share with certain specified characteristics. [ Schedule 2, item 3, paragraphs 703-37(4 )( d ) and(5 )( a )]

5.17 First, any returns on the share must be fixed at the time of issue by reference to the amount subscribed. For these purposes, the returns can be fixed by reference to a rate, formula or amount set out in the terms of issue for the preference share. [ Schedule 2, item 3, paragraph 703-37(5 )( b )]

5.18 Second, the share must not be a voting share. A 'voting share' is defined in subsection 995-1(1) of the ITAA 1997 to mean, so far as is relevant, a voting share as defined by section 9 of the Corporations Act 2001 . [ Schedule 2, item 3, paragraph 703-37(5 )( c )]

5.19 A voting share in a body corporate is defined by the Corporations Act 2001 as an issued share in the body that carries any voting rights beyond the following:

·
a right to vote while a dividend (or part of a dividend) in respect of the share is unpaid;
·
a right to vote on a proposal to reduce the body's share capital;
·
a right to vote on a resolution to approve the terms of a buy-back agreement;
·
a right to vote on a proposal that affects the rights attached to the share;
·
a right to vote on a proposal to wind the body up;
·
a right to vote on a proposal for the disposal of the whole of the body's property, business and undertaking; and
·
a right to vote during the body's winding up.

5.20 Third, the share must be either Tier 1 capital within the meaning of the prudential standards, or would be Tier 1 capital were it not for a limit imposed by those standards on the proportion of Tier 1 capital that can be made up of such shares. [ Schedule 2, item 3, paragraph 703-37(5 )( d )]

5.21 The share may be issued on its own or as part of a stapled instrument. A share is issued as part of a stapled instrument if it is issued in combination with one or more schemes that are related to the scheme under which the share is issued. A 'related scheme' is defined in section 974-155 of the ITAA 1997.

[ Schedule 2, item 3, subsection 703-37(6 )]

5.22 Consequently, the share will satisfy the requirements of paragraph 703-37(5)(d), for example, if the share, either on its own or as part of a stapled instrument, is Tier 1 capital or would be Tier 1 capital were it not for a limit imposed by the prudential standards on the proportion of Tier 1 capital that can be made up of such shares or instruments.

What happens if the characteristics of the share change?

5.23 If the characteristics of a share change so that it no longer complies with the requirements of subsection 703-37(5), the share will continue to be disregarded for the purpose of applying the consolidation membership rules for a period of 180 days. [ Schedule 2, item 3, subsection 703-37(7 )]

5.24 The most likely cause of a change in characteristics of a share that would result in the share failing the conditions in section 703-37 would be a change to the rights to returns or voting rights associated with the share. Subsection 703-37(7) provides consolidated groups with a transitional period in which to adjust their holdings to avoid non-compliance with the consolidation membership rules.

Consequences of an ADI restructure

5.25 Generally a consolidated group will cease to exist where the head company of the group no longer satisfies the conditions for being a head company. However, as an exception to this rule, the consolidated group is taken to continue to exist if:

·
an entity (the original company) ceases to be the head company because, through a share exchange, another company is interposed between the original company and its shareholders; and
·
the interposed company makes an irrevocable choice that the consolidated group is to continue in existence.

5.26 In these circumstances, section 703-75 of the ITAA 1997 operates to ensure that the original company and the interposed company are treated as having exchanged identities throughout the period before the completion time. As all the tax attributes of the original company effectively become those of the interposed company, tax outcomes should be seamless and neutral.

5.27 Therefore, the interposition of the non-operating holding company as the head company does not create a new consolidated group and the single entity rule (section 701-1) continues under the new head company. The single entity rule ensures that subsidiary members of a consolidated group for head company core purposes and entity core purposes are treated as parts of the head company.

5.28 One effect of section 703-75, together with the single entity rule, is that, if a subsidiary is moved from the original company (that is, the ADI or an extended licensed entity member) to the non-operating holding company, the assets in the subsidiary are treated as moving within the head company and there are no taxation consequences. The membership interests in the subsidiary, being intra-group assets, are not recognised for taxation purposes. Consequently, the transfer of the membership interests cannot trigger a taxation event, such as CGT event J1, in the group.

5.29 A second effect of section 703-75 is that the interposed company (ie, the non-operating holding company) is taken to have the same shareholder history as the original company (that is, the ADI or an extended licensed entity member), including tracing through any interposed entities.

5.30 Therefore, for the purpose of applying the continuity of ownership test to determine whether the non-operating holding company is entitled to deductions for prior year losses and bad debts, the non-operating holding company is taken to have the same ownership as the ADI or an extended licensed entity member prior to the completion time. Consequently, if the ADI was a widely-held company before the completion time, the non-operating holding company is taken to be a widely-held company before that time.

Modifications to the imputation provisions to ensure that certain distributions from the non-operating holding company are frankable

5.31 Following an ADI restructure, distributable profits of the ADI that are transferred to the non-operating holding company in connection with the ADI restructure may be classified under the accounting standards as, for example, share capital of the non-operating holding company. This may inappropriately result in distributions that would have been frankable if made by the ADI being treated as unfrankable because they are made from the non-operating holding company.

5.32 Therefore, a distribution made by the non-operating holding company will be taken to be a dividend for the purposes of the income tax law that is not an unfrankable distribution where:

·
the distribution is sourced, directly or indirectly from the ADI's profits before the restructure instrument came into force; and
·
the distribution would have been a frankable distribution if it had been made by the ADI prior to the ADI restructure.

[ Schedule 2, item 2, section 202-47 ]

5.33 An amount sourced indirectly from the ADI's profits could include retained earnings of subsidiaries of the ADI prior to the ADI restructure.

Modifications to the CGT provisions to facilitate a CGT roll-over

5.34 Subdivision 124-G of the ITAA 1997 provides a CGT roll-over when shareholders of an original company exchange their shares in the company for shares in an interposed company. Requirements of the roll-over include:

·
all the shareholders in the original company exchange their shares for shares in the interposed company;
·
the percentage of shares that each exchanging member receives in the interposed company are equal to the percentage of the shares that each member owned in the original company; and
·
the following ratios are equal:

-
the ratio of the market value of each exchanging member's shares in the interposed company to the market value of the shares in the interposed company issued to all the exchanging members; and
-
the ratio of the market value of that member's shares in the original company that were redeemed or cancelled to the market value of all the shares in the original company that were redeemed or cancelled.

5.35 Subdivision 124-G will be modified to ensure that shareholders of an original company who exchange their shares for shares in an interposed non-operating holding company are able to roll-over any capital gain or loss that arises from the exchange, into the shares they receive in the interposed non-operating holding company. [ Schedule 2, item 1, section 124-382 ]

5.36 The modification will apply if:

·
the original company is either an ADI or part of an extended licensed entity;
·
a non-operating holding company, within the meaning of the Financial Sector (Business Transfer and Group Restructure) Act 1999 , is interposed between the original company and its shareholders;
·
a restructure instrument under Part 4A of that Act is in force in relation to the non-operating holding company; and
·
the ADI becomes a subsidiary of the non-operating holding company as a result of the restructure.

[ Schedule 2, item 1, subsection 124-382(1 )]

Certain preference shares are disregarded

5.37 If section 124-382 applies, then the preference shares that can be disregarded under subsection 703-37(4) are also disregarded in determining whether the requirements of Subdivision 124-G are satisfied. The characteristics of these preference shares are explained in paragraphs 5.16 to 5.22. [ Schedule 2, item 1, subsection 124-382(2 )]

Certain foreign-owned shares are disregarded

5.38 In some circumstances, when a non-operating holding company is interposed between an original company and its shareholders, arrangements may need to be made for foreign holders of shares to dispose of their shares in the original company (or have their shares cancelled) through a share sale facility, rather than exchange their shares for shares in the non-operating holding company.

5.39 This is likely to occur because:

·
the foreign holders of shares in the original company would not be permitted to own shares in the non-operating holding company; or
·
the foreign holders of shares in the original company would only be permitted to own shares in the non-operating holding company after certain regulatory conditions are satisfied.

5.40 A foreign holder, as defined by section 9 of the Corporations Act 2001 , is a holder of securities (including shares) whose address, as shown in the register which records the details of their holding, is a place outside Australia and the external Territories.

5.41 Under a share sale facility, the foreign holders would dispose of their shares in the original company to the non-operating holding company (or the shares would be cancelled) and an agent or nominee would acquire shares, on their behalf, in the non-operating holding company. The agent or nominee would then dispose of the shares in the non-operating holding company and give the capital proceeds (less expenses) from that disposal to the former foreign holders of shares in the original company.

5.42 To ensure that shareholders in the original company who exchange their shares for shares in the non-operating holding company can obtain the CGT roll-over when a foreign share sale facility is used, certain foreign-owned shares are disregarded when determining whether certain requirements of Subdivision 124-G are satisfied.

5.43 Shares in the ADI will be disregarded for the purposes of applying Subdivision 124-G if:

·
the shares are owned by a foreign holder;
·
the shares are either disposed of to the non-operating holding company or cancelled;
·
an agent or nominee, appointed on behalf of the foreign holder, acquires shares in the non-operating holding company; and
·
the agent or nominee subsequently:

-
disposes of the shares; and
-
gives the foreign holder an amount equal to the capital proceeds of the disposal less expenses.

[ Schedule 2, item 1, paragraph 124-382(3 )( a ) and subsection 124-382(4 )]

5.44 In some circumstances the agent or nominee may dispose of the shares in the non-operating holding company on a pooled basis. That is, the agent or nominee may dispose of the shares together with other shares that the agent or nominee acquired under the share sale facility.

5.45 In these circumstances the agent or nominee will be required to give the foreign holder of shares in the original company an amount equal to their proportion of the capital proceeds (less expenses). [ Schedule 2, item 1, subparagraph 124-382(4 )( f )( ii )]

5.46 A foreign holder's proportion of the capital proceeds would be determined by reference to their shareholding in the original company relative to the total shareholdings of all the foreign holders in the original company who receive capital proceeds from the agent or nominee.

Example 5.1 Brilliant Banking Ltd (Brilliant Banking) is an ADI. It has three foreign holders of shares; Peter, Gary and Philip. Of the shares in Brilliant Banking, Peter holds 10 per cent, Gary holds 15 per cent and Philip holds 5 per cent. Together they hold 30 per cent of the shares in Brilliant Banking.Brilliant Banking proposes to interpose a non-operating holding company, Gold Holding Ltd (Gold Holding), between itself and its shareholders under an arrangement where its ordinary shareholders exchange their shares in Brilliant Banking for shares in Gold Holding. However, Peter, Gary and Philip are unable to receive shares in Gold Holding and so set up a share sale facility with Paul as their agent.Gold Holding is interposed between Brilliant Banking and its shareholders, and Brilliant Banking's shareholders (including Peter, Gary and Philip) dispose of their shares to Gold Holding. Paul then acquires shares in Gold Holding on behalf of Peter, Gary and Philip and subsequently disposes of them on a pooled basis.Peter's proportion of the capital proceeds would be determined by reference to his shareholding in Brilliant Banking relative to the total shareholdings of Gary, Philip and himself (that is, the foreign holders who will receive capital proceeds from Paul).As the total shareholdings of Peter, Gary and Philip totalled 30 per cent of Brilliant Banking, and Peter held 10 per cent, he would be entitled to receive 33.33 per cent of the capital proceeds (less expenses) from Paul (that is, 10/30).Similarly, Gary would receive 50 per cent and Philip would receive 16.67 per cent of the capital proceeds (less expenses).

5.47 Shares in the non-operating holding company will be disregarded for the purposes of applying Subdivision 124-G if the agent or nominee acquires shares in the non-operating holding company. [ Schedule 2, item 1, paragraph 124-382(3)(b) and 124-382(4)(d) ]

Application and transitional provisions

5.48 The amendments to the consolidation membership rules and the imputation provisions apply to restructure instruments that come into force under the Financial Sector (Business Transfer and Group Restructure) Act 1999 on or after 1 July 2007. [ Schedule 2, subitem 4(2 )]

5.49 The amendments to the CGT rules apply to CGT events happening on or after 1 July 2007. [ Schedule 2, subitem 4(1 )]


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