House of Representatives

Taxation Laws Amendment Bill 1993

Explanatory Memorandum

(Circulated by the authority of the Treasurer, the Hon John Dawkins, M.P.)

Dividend Streaming Amendments

Summary of proposed amendments

·
Purpose of amendment: The dividend streaming provisions will be amended so as to include dividend streaming arrangements that would otherwise be included but for the interposing of an entity between a shareholder and a company paying a substitute dividend.

Date of effect: The amendments will apply to dividends paid by resident companies on or after the date the Bill receives Royal Assent.

Background to the legislation

The dividend streaming provisions were introduced with effect from 1 July 1990 and are designed to remove Australian tax benefits associated with dividend selection schemes.

The basic concept of a dividend selection scheme is to allow shareholders a choice as to the manner in which their dividend entitlements are to be satisfied. The schemes can offer a shareholder a number of options. For example, a shareholder can elect to forego the right to receive a cash dividend that would otherwise be paid and, instead, receive tax-exempt bonus shares.

Other schemes involve the use of 'stapled stock'. Broadly, stapled stock are shares held in two associated companies that cannot be traded separately, one of the shares being an income rights only share. Holders of stapled stock may choose to receive either a franked or unfranked dividend as determined by the company paying the dividend. Stapled stock arrangements can be used to stream franked dividends to Australian resident shareholders and unfranked dividends to non-residents.

Allowing shareholders the choice provides the means by which a company can stream franked dividends to those shareholders able to benefit most from the imputation credits attached to those dividends (generally resident taxpayers paying tax at the top marginal rate).

A general rule of the imputation system is that companies should frank to the same extent, all dividends paid under a single distribution, on a particular class of shares. Therefore, the dividend streaming provisions treat an Australian resident company as having franked to the same extent all dividends paid on a single class of shares under a dividend streaming arrangement. This includes dividends paid by another company.

The provisions do this by, first, defining what is a 'dividend streaming arrangement'. The definition is contained in section 160APA. Central to the definition is that a company carries out or is a party to the dividend streaming arrangement. Further, a shareholder in the company must be empowered to exercise a choice or selection in relation to his or her dividend entitlements. The definition contemplates four outcomes on the exercise of that choice or selection:

·
the company pays dividends franked at different levels on the same class of share;
·
the company issues tax-exempt bonus shares to a shareholder instead of paying a franked dividend;
·
another company pays an unfranked dividend to a shareholder who receives that dividend instead of a franked dividend from the company; or
·
the company pays a franked dividend to a shareholder who receives that dividend instead of an unfranked dividend from an another company.

Secondly, section 160AQCB operates so that franking debits arise to the company in respect of the dividends substituted by, or for, the franked dividends under the arrangement. This includes the dividends satisfied by the issue of tax-exempt bonus shares and dividends paid by another company. In section 160AQCB there is a matching operative provision for each of the four types of arrangement contemplated by the definition in section 160APA.

Explanation of proposed amendments

The amendments proposed by this Bill will insert into the definition three additional types of dividend streaming arrangement. These new types are almost exactly the same as three of the four types already contemplated by the definition.

However, the difference - and this difference is common in all three new types of streaming arrangement - is the use of an interposed entity. The entity is interposed between the shareholder and the company that is paying the dividend (including a dividend satisfied by the issue of tax-exempt bonus shares) that is being substituted by, or for, the payment of the franked dividend.

It should be noted that the entity is interposed only for the purpose of paying the substitute dividend. A shareholder would still hold his or her original shares.

How is an interposed entity defined?

An interposed entity is referred to as an 'upstream entity' in the new types of dividend streaming arrangement and is defined in relation to a shareholder who is empowered to exercise the choice or selection under the arrangement.

First, an upstream entity can be a trustee of a trust estate in which the shareholder holds or is capable of holding a beneficial interest. Secondly, it can be a partnership in which the shareholder is a partner. [Paragraph 15(f), subparagraphs (a)(i) and (b)(i) of new definition 'upstream entity' in section 160 APA]

Where there is a chain of trusts and/or partnerships between the shareholder and the abovementioned trust or partnership, that trust or partnership will still be an upstream entity in relation to the shareholder. For example, a shareholder may be a partner in X Partnership which has a beneficial interest in the A Trust which in turn has a beneficial interest in the B Trust. In this case the B Trust is an upstream entity in relation to the shareholder. [Paragraph 15(f), subparagraphs (a)(ii) and (b)(ii) of new definition 'upstream entity' in section 160APA]

The use of an upstream entity and the three new types of dividend streaming arrangement are set out below.

Stapled stock enabling the payment of franked dividends in substitution for unfranked dividends

An example of this type of arrangement is where an Australian subsidiary of a foreign company pays a franked dividend to an Australian resident shareholder of the foreign parent. The shareholder would have elected to receive the franked dividend instead of receiving an unfranked dividend from the foreign parent. This type of arrangement is covered by existing sub-subparagraph (b)(ii)(D) of the definition of dividend streaming arrangement.

A variation of this arrangement is where the Australian subsidiary pays a franked dividend to a trustee of a trust estate and the trust then makes a distribution to the shareholder in the foreign parent. The trustee holds shares in the company and the shareholder holds a beneficial interest in the trust.

In effect, what is stapled together and held by the shareholder under this arrangement is the share in the foreign company and the beneficial interest in the trust.

Under the imputation system a taxpayer who receives franked dividends via a trust (or partnership) is treated in the same way as if the taxpayer had received the dividend directly.

This type of arrangement will now fall within the definition of dividend streaming arrangement.

It is described like this: the Australian subsidiary (the 'first company') carries out part of the arrangement and under the arrangement two things happen. First, the Australian resident shareholder in the foreign parent (the 'target shareholder') exercises some form of choice. Secondly, as a result of exercising that choice the Australian subsidiary pays a franked dividend to the trust (the upstream entity) instead of the foreign parent paying an unfranked dividend to the Australian resident shareholder. [Paragraphs 15(a) and (b), inserting new paragraph (a) into definition of 'dividend streaming arrangement' in section 160APA]

The amended definition is not limited to the foreign parent/Australian subsidiary situation. Any arrangement where the payment by one company to a shareholder of an unfranked dividend was substituted by the payment to an upstream entity of a franked dividend would fall within the definition.

It follows that, under subsection 160AQCB(4) - the matching operative provision - a franking debit arises to the company paying the franked dividend to the upstream entity. Broadly, the franking debit is the total amount of dividends paid by the company that would otherwise pay the unfranked dividends. In the example above, the debit arises to the Australian subsidiary calculated by reference to the total dividends paid by the foreign subsidiary.

This change applies to franked dividends paid on or after the date the Bill receives Royal Assent [Subclause 17(3)].

Unfranked Dividends paid in lieu of franked dividends

Dividend selection schemes will often allow shareholders to elect to receive a franked or an unfranked (or partly franked) dividend. Sub-subparagraph (b)(ii)(A) of the definition of dividend streaming arrangement covers this type of arrangement. What is contemplated by the sub-subparagraph is the payment by the company directly to the shareholder of either the franked or unfranked dividend.

The proposed amendments will insert a second additional type of arrangement into the definition of dividend streaming arrangement. This will cover the situation where, rather than paying the unfranked or partly franked dividend directly to the shareholder, the dividend is first paid to an interposed entity (an upstream entity). The interposed entity is a shareholder in the company.

In practice the interposed entity, be it a trust or a partnership, distributes the dividend income to the shareholder. This additional type of arrangement is otherwise described in the same terms as sub-subparagraph (b)(ii)(A) of the definition. [Paragraph 15(d), inserting sub-subparagraph (b)(ii)(AA) into the definition of 'dividend streaming arrangement' in section 160APA]

A minor amendment to subsection 160AQCB(1), the matching operative provision, will ensure the provision operates as intended when the unfranked or partly franked dividend is paid to the interposed entity. The provision will now refer to the payment of the unfranked or partly franked dividend to the relevant shareholder or to another shareholder. [Clause 16]

Broadly, under 160AQCB(1) a franking debit arises to the company paying the unfranked or partly franked dividend to the upstream entity. The debit is the amount of the franking debit that would have arisen if the company had franked those dividends at the same rate as the franked dividends that otherwise would have been paid to the shareholder.

This change will apply to substitute unfranked or partly franked shares paid on or after the date the Bill receives Royal Assent. [Subclause 17(1)]

Tax-exempt bonus shares issued instead of paying franked dividend

A third additional type of arrangement will be inserted into the definition of dividend streaming arrangement. It is proposed to insert a provision that mirrors sub-subparagraph (b)(ii)(B) of the definition but with the necessary modification to reflect the use of an interposed entity.

Thus, an arrangement where a shareholder exercises a choice resulting in tax-exempt bonus shares being issued to an upstream entity in relation to the shareholder in substitution for the payment of franked dividends to that shareholder will be a dividend streaming arrangement. [Paragraph 15(e), inserting sub-subparagraph (b)(ii)(BA) into the definition of 'dividend streaming arrangement' in section 160APA]

Again, the matching operative provision, in this case subsection 160AQCB(2), will be amended to cover the situation of the tax-exempt bonus shares being issued to another shareholder - the upstream entity - rather than directly to the shareholder making the choice. [Clause 16]

Broadly a franking debit arises under subsection 160AQCB(2) where the company issues tax-exempt bonus shares to the upstream entity. The debit that arises is the amount that would have arisen if the company had paid the franked dividends to the shareholder instead of issuing the bonus shares to the upstream entity.

This change will apply to tax-exempt bonus shares issued on or after the date the Bill receives Royal Assent. [Sub clause 17(2)]

Interposed entities and the fourth type of dividend streaming arrangement

Under the current definition, a fourth type of dividend streaming arrangement is contemplated. This is set out in sub-subparagraph (b)(ii)(C).

An example of this type of arrangement is one that allows non-resident shareholders in an Australian company to receive unfranked dividends paid by a foreign subsidiary of the Australian company.

The definition already covers the situation where the unfranked dividend is paid to an interposed entity. The definition refers to the a company paying an unfranked dividend or partly franked dividend to a shareholder in that other company. This can be any shareholder, including the interposed entity, and not only the shareholder making the choice.


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