Explanatory Memorandum
(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)Pooled Development Funds
Summary of proposed amendments
3.1. This Bill will amend the Income Tax Assessment Act 1936 (the Act) to provide for the taxation treatment of Pooled Development Funds (PDF) and the holders of PDF shares.
3.2. PDFs will be taxed on their taxable income, which will be calculated under the existing income tax laws in the same way as that of companies. The taxable income of a PDF will be taxed at the rate of 30 per cent. PDFs will derive franking credits on the payment of company tax and the receipt of franked dividends and will be able to frank its dividends.
3.3. Shareholders will be exempt from tax on unfranked dividends. In the case of franked dividends (including the franked amount of a dividend), the dividend will also be exempt from tax unless the shareholder makes an election that such dividends derived in a year of income are to be taxed as dividends paid by an ordinary company. PDF dividends paid to non-resident shareholders will be exempt from withholding tax. Gains on the disposal of shares in PDFs will also be exempt from income tax, but losses on disposal will not be deductable.
Background to the legislation
3.4. A PDF will be a company registered as such under the Pooled Development Funds Bill 1992, which, when enacted, provide development capital to small and medium companies.
3.5. This Bill deals with the taxation treatment of a company that has been registered as a PDF and provides special treatment for:
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- dividends paid on PDF shares; and
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- the tax consequence of disposing of PDF shares.
Explanation of proposed amendments
3.6. A PDF will be a company that is registered under the Pooled Development Funds Act 1992 (the PDF Act) throughout the whole of the year of income. A company acting in the capacity of trustee will not be taxed as a PDF.
3.7. Although the general company tax rate is 39 per cent, PDFs will be taxed on their taxable income at the concessional rate of 30 per cent. This rate will be imposed by the proposed amendment to Part III of the Income Tax Rates Act 1986 . [Clause 84 - new subsection 23(4D)] .
3.8. A company will be taxed as a PDF for a year of income if it is registered as a PDF for the whole of the last day of that year of income. The proposed PDF Act will treat a company as being registered as a PDF for the whole of the day registration is effected. Therefore, if a company is registered as a PDF for the whole of a year of income it will be registered for the whole of the last day of that year.
How a PDF is taxed in the first year
3.9. Special rules will apply to calculate the taxable income for the year of income where a company is registered as a PDF part-way through that year. (See also the notes on a company becoming a PDF.)
3.10. If a company becomes registered as a PDF part-way through a year of income, the company will be taxed as a PDF for the period from the day of its registration to the end of the year of income as if that period (the PDF period) was a year of income.
3.11. For the period from the beginning of the year of income to the day before it is registered as a PDF, the company will be taxed as an ordinary company. This period (the non-PDF period) will be treated as a separate year of income.
3.12. In the year a company becomes a PDF it will be required to lodge two returns of income - one for the non-PDF period and another for the PDF period.
3.13. The taxable income of the company for the first year it is a PDF will be calculated using the proposed definition of "PDF component" and the amended definition of "taxable income" (subsection 6(1)). If the PDF incurs a loss in the PDF period, the "PDF component" is taken to be nil. [Clause 8]
3.14. If the PDF derives a taxable income in its first year, the taxable income for the two periods of that first year are calculated in the normal way because, as the PDF component is not nil, proposed new paragraph (c) of the definition of "taxable income" is not applicable.
3.15. If a company derives a taxable income in both the non-PDF and PDF periods of the first year a separate taxable income is calculated for the non-PDF period (using the existing definition of "taxable income") and for the PDF period (using the definition of "PDF component").
How the company is taxed in its last year as a PDF
3.16. A company will cease to be a PDF on the day it is deregistered. A company that loses its PDF status during a year of income will be taxed as an ordinary company for the whole of that year of income. The test for whether a company will be taxed as a PDF is that it is a PDF for the whole of the last day of the year of income. [Paragraph 8(b)]
3.17. The dividends paid by a PDF will be frankable. Therefore, the PDF will be required to provide its shareholders with a statement setting out the franked and unfranked amounts of the dividend and the amount of any imputation credit attached.
3.18. A PDF will derive franking credits on the same basis as other companies for the payment of company tax and when it receives franked dividends.
3.19. In the same way as any other company, dividends paid by a PDF will be "frankable dividends" (section 160APA). A PDF will be required to frank the dividends it pays to the extent of the surplus in its franking account on the day the dividend is paid (section 160AQE). Similarly, a PDF that overfranks a dividend will become liable to franking deficit tax (section 160AQJ).
3.20. The company tax rate to be used in calculating the franking credit that arises on the payment of tax will be the general company tax rate of 39%. The definition of "general company tax rate" will be amended to exclude the tax rate applicable to PDFs. [Clause 13]
3.21. A PDF will be a company within the meaning of the definition of the term for the purposes of the Act. It will therefore be entitled to a rebate under section 46 or 46A on the dividends it receives.
3.22. A loss incurred by a PDF in a year of income that it is taxed as a PDF will only be deductible against income derived in a year of income in which it is taxed as a PDF. Except for the year of income during which a company is first registered as a PDF (when special rules apply - see notes below) and subject to the quarantining rules, losses incurred by PDFs will be deductible on the same basis as losses incurred by other taxpayers.
3.23. A PDF will incur a loss in a year of income if its allowable deductions, excluding any deductions allowable for losses of earlier years, exceed the sum of its assessable income and net exempt income for that year.
3.24. The deduction allowable to a PDF for losses incurred in an earlier year of income will be:
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- if the PDF has not derived exempt income in the particular year of income, the amount of losses of earlier years that have not been allowed as a deduction; or
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- if the PDF has derived exempt income in the particular year of income, the amount of losses of earlier years that have not been allowed as a deduction less the amount of the net exempt income derived by the PDF in that year.
3.25. The net exempt income of a PDF will be the amount by which the PDF's exempt income for the year exceeds the sum of the expenses (not being expenses of a capital nature) incurred in deriving that income.
3.26. If a company is registered as a PDF during a year of income, the company will be treated as having two years of income. These deemed years of income are:
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- the period from the beginning of the year of income to the day before the company is registered as a PDF (the non-PDF period); and
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- the period from the day the PDF is registered as such and the end of the year of income (the PDF period).
3.27. If a PDF incurs a loss in the PDF period , new paragraph (c) of the definition of "taxable income" will apply because the "PDF component" for that (actual) year of income will be taken to be nil. If a company has a taxable income in the non-PDF period and a loss in the PDF period, the amount of the PDF loss will be the amount by which the loss for the PDF period exceeds the taxable income for the non-PDF period. This overall loss is calculated under section 79E. [Clause 9 - new section 79EA]
3.28. If a PDF has a taxable income in the PDF period of the year of income in which it was registered, but in the period before the company became a PDF it incurred a loss, the amount of the loss will be allowable against the taxable income of the PDF period.
3.29. A loss incurred by a PDF in a year of income that it is taxed as a PDF will only be deductible in any year of income in which it is taxed as a PDF. [Clause 9 - new subsection 79EB(1)]
3.30. However, if a company incurred a loss in the non-PDF period of the year in which it became a PDF, deductions for that loss will not be restricted to PDF income. If any such losses have not been recouped by the time the company ceases to be a PDF, such unrecouped losses will continue to be allowable (section 79E) after the company ceases to be a PDF. So that companies are not disadvantaged PDF losses will be recouped ahead of non-PDF losses. [Clause 9-new section 79EB(2)]
Group companies - section 80G losses
3.31. Losses incurred by a PDF that is a "group company" (section 80G) will not be able to be transferred to other companies, including those that are PDFs, in the group. However, losses incurred by the company in any year it is not a PDF and that have not been deducted from PDF income, will be transferable. [Clause 10 - new subsections 80G(9A) and (9B)]
3.32. Capital losses incurred in a year of income or in a preceding year of income can be deducted from capital gains accruing to a taxpayer in a year of income (section 160ZC). However, capital losses incurred by a company in a year of income in which it is taxed as a PDF will not be deductible from capital gains accruing to the company after it has ceased to be a PDF. [Clause 17 - new subsection 160ZC(6)]
3.33. However, capital losses incurred in the non-PDF period of the year of income in which the company was registered as a PDF and the immediately preceding year of income (provided the company was not a PDF in that year), will be able to be deducted from any capital gains derived in the non-PDF period. [Clause 17 - new subsection 160ZC(7)]
Group companies - capital losses
3.34. Capital losses incurred by a group company that is a PDF will not be able to be transferred to other companies in the group. However, capital losses incurred by the company in any year that it was not a PDF will be able to be transferred to other companies in the group, unless the loss was offset against capital gains derived by the company while it was a PDF. [Clause 19 - new subsections 160ZP(9B) and(9C)]
How the holders of PDF shares will be taxed
3.35. The Bill will insert new Division 10E into the Act to provide for the taxing of shares in PDFs. [Clause 11]
3.36. Dividends paid by a PDF will be exempt if they are unfranked. If the dividends are franked, taxpayers will have the option of including the PDF income in their assessable income in the normal manner.
3.37. Distributions made by a liquidator on the winding up of a company that are not a return of paid-up capital are deemed to be dividends (subsection 47(1)). These deemed dividends will be taxed in the same way as dividends.
3.38. An unfranked dividend, or the unfranked part of a franked dividend, paid by a PDF will be exempt from income tax. [New subsection 124ZM(1)]
Franked dividends / flow-on franking amount
3.39. If a taxpayer is a beneficiary in a trust or a partner in a partnership that derives a franked dividend, and the share of the net income of the trust or partnership distributed to the taxpayer includes an amount attributable to the franked dividend, the share of the net income that is attributable to the franked dividend is the "flow-on franking amount". [New subsection 124ZM(9)]
Elections for franked PDF dividends
3.40. A shareholder, or a taxpayer receiving income through a partnership or trust, will be able to elect to have the franked PDF dividend (or the flow-on franking amount attributable to franked PDF dividends) taxed as if they were not PDF dividends.
3.41. The election will be made simply by disclosing the dividends as assessable income in the return of income of the year of income in which the dividends were derived by the taxpayer. The election will apply to the franked amount of all PDF dividends paid during the particular year of income.
3.42. Franked PDF dividends received by a taxpayer, or a taxpayer's share of trust or partnership income that is attributable to franked PDF dividends, will be exempt from tax. [New subsection 124ZM(2)]
3.43. However, if a taxpayer who would be assessed on the franked dividends if the income was assessable, includes the dividends in his, her or its assessable income the PDF dividends or the flow-on franking amount attributable to the PDF dividends will constitute assessable income of the taxpayer . [New subsection 124ZM(3)]
3.44. If a taxpayer is a partner in a partnership that incurs a loss, the flow-on franking amount will not be an allowable deduction unless the taxpayer chooses to be assessed on the franked PDF dividends. [New subsections 124ZM(4) and (5)]
3.45. The trustee of a trust estate is assessable on income derived by the trust as if the trust were an individual where:
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- the beneficiary is under a legal disability (eg. a minor) (section 98);
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- no person is presently entitled to the income of the trust and the trust income is not to be taxed at a special rate (section 99); and
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- no person is presently entitled to the income of the trust and the trust income is taxed at a special rate (section 99A).
3.46. Franked PDF dividends derived by trustees liable to be taxed as an individual on the net income of the trust will be exempt from tax. The exemption will apply whether the trustee receives the dividends directly as a shareholder or indirectly through a partnership or trust. [New subsection 124ZM(6)]
3.47. However, the trustee may elect to include the franked PDF dividends or the flow-on franking amount in the assessable income. [New subsection 124ZM(7)]
3.48. The trustee will make an election to include the PDF income derived in a particular year of income in the assessable income of that year by including the amount in its assessable income for the relevant year of income. [New subsection 124ZM(8)]
3.49. The franked dividends that a company receives from a PDF will give rise to a franking credit because the dividends will not be treated as being as exempt. [Clause 14 - new subsection 160APP(3A)]
3.50. If a taxpayer (that is not a company) elects to treat PDF dividends received directly or indirectly through a partnership or trust as assessable income, the taxpayer will be entitled to the imputation credits attached to those dividends. The income will not be taken to be exempt. [Clause 15 - new subsection 160AQT(5)]
3.51. The imputation credits attached to PDF shares sold cum-dividend will be able to be transferred to the purchaser of the shares. Also, franked PDF dividends will be able to be passed on to a lender under a securities lending arrangement (section 26BC). [Clause 16]
Dividends paid after PDF status lost
3.52. When a company ceases to be a PDF on a particular day in a year of income, dividends paid by the PDF up to the date of deregistration will be PDF dividends and exempt from tax, unless the dividend is franked and the shareholder elects to be taxed on the dividend in the same way as if it had been paid by an ordinary company. (See later notes) [New section 124ZM]
3.53. PDF shares will not be trading stock of a share trader for the purposes of the existing section 28. Therefore, profits from the disposal of PDF shares as trading stock will not be assessable and losses will not be deductible. [New section 124ZO]
Gains and losses on disposal of shares
3.54. Capital gains derived on the disposal of PDF shares will not be subject to tax. Similarly, capital losses incurred on the disposal of PDF shares will not be deductible. [New section 124ZP]
3.55. A company that comes into existence on or after 1 July 1992, and whose activities since coming into existence, or since it was acquired if it was a shelf company, have all been directed towards obtaining registration as a PDF will be able to be registered as a PDF under the PDF Act.
3.56. A company that came into existence before 1 July 1992 and whose only activities prior to that day related to raising funds for investing in development funds, may also be registered as a PDF.
3.57. A shareholder who continues to hold shares in a company after it becomes registered as a PDF will be taken to have held PDF shares from the time the shareholder acquired the shares.
3.58. As the shares will be treated as having been PDF shares since they were acquired by the shareholder:
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- no deductions will be allowable for the costs of acquiring or holding the shares before they became PDF shares;
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- the shares will never have been trading stock; and
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- no amounts will be assessable or deductible as a result of the company being registered as a PDF. [New section 124ZQ]
When shares cease to be PDF shares
3.59. On the day a company ceases to be a PDF the shares will cease to be PDF shares and the holders of such shares will be deemed to have disposed of the PDF shares and to have immediately reacquired non-PDF shares for their market value on that day. This will apply where the shares would have been trading stock of a share trader or held on revenue account. It will also apply where the capital or gain arising on disposal would have been taxed under Part IIIA (capital gains and capital losses). [New section 124ZR]
3.60. Where PDF shares are acquired on revenue account, any income (or loss) derived (or incurred) on the disposal of the shares will not be assessable income (or an allowable deduction). [New section 124ZN]
3.61. Where exempt income is generated by a unit trust and is distributed to investors, the cost base of the units is reduced for capital gains tax purposes. Unitholders of a unit trust that derive exempt dividends from PDF shares will be exempt from any notional capital gains derived under the present section 160ZM when the trust distributes an amount that is not assessable. [Clause 18 - new subsection 160ZM(3A)]
3.62. Unless a PDF shareholder elects that the franked amount of a PDF dividend is to be treated as assessable income PDF dividends will be tax exempt. Expenditure incurred in a year of income will not be tax deductible to the extent that it is incurred in deriving exempt income (subsection 51(1)).
3.63. However, where the shareholder has elected that the franked amount of PDF dividends paid during a particular year of income are to be assessable, the income will not be exempt and borrowing costs incurred in the particular year of income will be an allowable deduction.
3.64. PDF dividends paid to non-residents of Australia, whether franked or unfranked, will be exempt from withholding tax. [Clause 12 - new paragraph 128B(3)(ba)]
Commencement date
3.65. The amendments will commence from the day the Bill receives Royal Assent. They will also apply in respect of losses incurred, dividends paid or profits derived before that time, if needed for the purposes of determining the taxable income of a PDF.
Clauses involved in proposed amendments
Income Tax Assessment Act 1936
Clause 8: amends the definition of "taxable income" and inserts the definitions of "PDF" and "PDF component" in subsection 6(1).
Clause 9: inserts new sections 79EA and 79EB which deal with losses incurred by a company in the year it becomes a PDF and prevents deductions for losses that were incurred by a PDF that has since ceased to be a PDF.
Clause 10: amends section 80G by inserting new sections (9A) and (9B) to deny the transfer of PDF losses within a company group.
Clause 11: inserts new Division 10E (which contains new sections 124ZM to 124ZR) to deal with shares in a PDF.
Clause 12: amends subsection 128B(3) to exempt PDF income from withholding tax.
Clause 13: amends the definition of "general company tax rate" in section 160APA to exclude the PDF tax rate.
Clause 14: inserts new subsection 160APP(3A) to provide that franked PDF dividends received by companies will not be treated as exempt income for imputation purposes.
Clause 15: inserts new subsection 160AQT(5) to provide that franked PDF dividends included in assessable income will not be treated as exempt income for imputation purposes.
Clause 16: amends section 160AQUA to allow the transfer of franked PDF dividends paid on PDF shares sold cum-dividend or transferred to lenders under securities lending arrangements.
Clause 17: amends section 160ZC to deal with net capital losses incurred while a company is a PDF.
Clause 18: amends section 160ZM to prevent the exempt income arising from PDF shares affecting the cost base of units in a unit trust.
Clause 19: amends section 160ZP to prevent the transfer of net capital losses of a PDF to other companies in the group.
Clause 20: provides for the application of the amendments to deal with PDFs.
Clause 82: facilitates reference to the Income Tax Rates Act 1986.
Clause 83: amends subsection 3(1) to insert a definition of PDF.
Clause 84: amends section 23 to impose tax at the rate of 30 per cent on PDFs.
Clause 85: provides for the application of the amendments to deal with PDFs.