Senate

Taxation Laws Amendment Bill (No. 4) 1994

Income Tax (Former Complying Superannuation Funds) Bill 1994

Income Tax (Former Complying Superannuation Funds) Act 1994

Income Tax (Former Non-Resident Superannuation Funds) Bill 1994

Income Tax (Former Non-resident Superannuation Funds) Act 1994

Income Tax Rates Amendment Bill 1994

Income Tax (Deficit Deferral) Bill 1994

Income Tax (Deficit Deferral) Act 1994

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)
THIS MEMORANDUM TAKES ACCOUNT OF AMENDMENTS MADE BY THE HOUSE OF REPRESENTATIVES TO THE BILL AS INTRODUCED

Dividend imputation

Overview

3.1 Part 3 of Schedule 1 to this Bill will:

·
amend the imputation system to introduce new provisions to account for payments and refunds of company tax under the new instalment arrangements;
·
introduce a liability to deficit deferral tax so that the new provisions cannot be used to defer franking deficit tax;
·
modify the operation of the imputation provisions in those exceptional situations where a company makes, during its 1993-94 franking year, a company tax payment (other than an 'initial payment') that relates to its 1993-94 year of income.

[Item 22 of Schedule 1]

The first two dot points are explained in section 1 of this chapter and the third dot point is explained in section 2.

Outline of the imputation system

3.2 The imputation system operates to attribute (or 'impute') company tax to resident shareholders when dividends are paid to them out of taxed profits. Resident individual shareholders are effectively subject to tax on the before-tax profit that consists of the dividend and the company tax component, but are entitled to a tax rebate (sometimes referred to as an imputation credit) for the imputed company tax.

3.3 A dividend with an imputation credit attached to it is known as a franked dividend. The company paying the dividend declares it to be franked to a specified percentage before it pays the dividend. The extent to which a dividend is franked depends, in broad terms, on the amount of taxed profits available for distribution by the company as reflected in its franking accounts.

Franking accounts

3.4 From the beginning of its 1994-95 franking year a company must maintain two franking accounts; a class A franking account which represents profits taxed at the 39% company tax rate, and a class B franking account which represents profits taxed at the 33% company tax rate. Each franking account consists of franking credits that add to the amount of taxed profits that can be distributed as franked dividends, and of franking debits which reduce that amount.

3.5 Franking credits arise mainly at the time of payment of company tax instalments or company tax assessed, or when franked dividends are received from other companies. Franking debits arise mainly when the company franks the dividends it pays to its own shareholders. A franking debit also arises when company tax is refunded.

3.6 Franking accounts are balanced annually at the end of a company's franking year. For companies, other than early balancing companies, the franking year coincides with the financial year - 1 July to 30 June. Early balancing companies, that is, companies with a year of income that ends before 1 June in lieu of the year ending the following 30 June, have a franking year that also ends before 1 June.

3.7 If, at the end of the franking year, there is a deficit in a franking account, that is, total franking debits of a particular class exceed total franking credits of the same class, the company becomes liable for Franking Deficit Tax ["FDT"]. The FDT is due and payable on the last day of the month after the end of the franking year. A company can either apply the 'initial payment' of company tax (under the existing collection arrangement) against its FDT liability, or it can offset FDT paid against company tax later assessed.

Franking credit and franking debit calculations

3.8 Because a franking surplus, that is, the excess of franking credits over franking debits, represents an amount of profits able to be distributed as franked dividends, the amount of a franking credit or a franking debit that arises from the payment or refund of company tax is adjusted by a factor based on the relevant company tax rate.

3.9 For a class A franking credit or debit, the relevant company tax rate is 39%. Applying the factor 61/39 to a tax amount of, say, $390 results in a class A franking credit or debit of $610. This represents an amount that could be distributed as a fully franked class A franked dividend.

3.10 Similarly, for a class B franking credit or debit, the relevant company tax rate is 33%. Applying the factor 67/33 to a tax amount of, say, $330 results in a class B franking credit or debit of $670. This represents an amount that could be distributed as a fully franked class B franked dividend.

Franked dividends

3.11 If a company declares a dividend to be franked to 100%, that is, the dividend is fully franked, there will arise in the company's franking account, at the time the dividend is paid, a franking debit of an amount equal to the amount of the dividend.

3.12 If that dividend is a class A dividend of $610, a resident individual shareholder must include in assessable income the amount of the imputation credit, $390, as shown on the dividend statement provided by the company, in addition to the amount of the dividend. Although the $1000 is included in assessable income, the shareholder is entitled to a franking rebate of $390.

3.13 The rebate is used to offset income tax on the $1000 (for a taxpayer whose marginal rate exceeds the relevant company tax rate) or income tax on the $1000 and on any other income (for a taxpayer whose marginal rate is less than the relevant company tax rate). The rebate cannot, however, be refunded or carried forward to a later year if it exceeds the gross tax on the shareholder's taxable income.

3.14 If the dividend is paid to a non-resident shareholder, the non resident is exempt from dividend withholding tax to the extent of the franked amount of the dividend. For example, if the $610 dividend is declared to be franked to 60%, that is, it is a partly franked dividend, the franked amount of the dividend is $366. Only the remaining part of the dividend, $244, would be subject to withholding tax.

Non-mutual life assurance companies

3.15 Non-mutual life assurance companies have a limitation on the amount of income that can be distributed to shareholders rather than to policyholders. Because of this limitation, franking credits for tax on the part of the statutory fund component of income that is not available for distribution to shareholders are effectively excluded in franking account calculations. For these companies, franking credits and debits relating to the payment and refund of tax are reduced by adjusting franking debits and credits.

3.16 An adjusting franking debit or credit reverses the effect on the franking account of the part of the ordinary franking credit or debit that is attributable to tax on the statutory fund component of the company's taxable income. The net effect of the adjusting franking debits and credits is that the franking account excludes amounts that are not available for distribution to shareholders.

3.17 Profits represented by the non-fund component of the company's taxable income are available for distribution to shareholders. The non fund component broadly relates to income derived from assets that are not included in the company's life assurance, superannuation, rollover annuity and accident and disability insurance business.

3.18 Ordinary and adjusting franking credits and debits for tax amounts relating to the 1993-94 and later years of income are generally recorded in the company's class B franking account. The exceptions are the franking credits and debits that represent the portion of the statutory fund component of the company's income that is available for distribution to shareholders. They are calculated by reference to 20% of the statutory fund component of company tax and are recorded in the class A franking account because the special life assurance company tax rate, currently 39%, generally applies to this income.

Section 1 - Company tax instalment system changes

Summary of the amendments

Purpose of the amendments

3.19 The amendments will align the imputation provisions with the arrangements for the collection of company tax contained in Division 1C of Part VI of the Income Tax Assessment Act 1936.

3.20 Franking credits for the payment of company tax instalments will now always arise at the time payment is made [item 31 of Schedule 1; new section 160APM]. As some instalments will be paid during the year of income to which the tax liability relates, companies will be able to frank dividends paid in that year on the basis of the franking credits corresponding to those instalments.

3.21 Refunds of company tax instalments will give rise to franking debits at the time they are received [item 36 of Schedule 1; new section 160APY]. A refund of an instalment may occur after the end of the year of income to which the instalment relates. For many companies the franking credit on payment of an instalment and the franking debit on refund will arise in different franking years.

Deficit deferral tax

3.22 The Bill contains a measure to prevent the deferral of tax when instalment payments and refunds occur in different franking years. A liability to deficit deferral tax will arise when an instalment paid in the income year is refunded in the following franking year and a franking deficit would have arisen if the refund had occurred at the end of the previous franking year. This situation is most likely to occur when dividends franked on the basis of the instalment were paid to shareholders in the earlier franking year.

3.23 Deficit deferral tax will be imposed by the Income Tax (Deficit Deferral) Bill 1994.

Date of effect

3.24 The new provisions will apply to payments of company tax instalments relating to income derived during:

·
the 1994-95 year of income for small and medium instalment taxpayers; and
·
the 1995-96 year of income for large instalment taxpayers.

3.25 Because some early balancing medium instalment taxpayers (that is, companies with accounting periods ending before 30 June 1995 in lieu of the 1994-95 financial year) are likely to make payments under the new instalment arrangements before the Bill is enacted, these provisions will commence from the date of introduction of the Bill into Parliament. [Subclause 2(2)]

3.26 Deficit deferral tax will apply to companies that become liable for the tax from the date the Income Tax (Deficit Deferral) Bill 1994 receives Royal Assent. [Clauses 2 and 3 of the Income Tax (Deficit Deferral) Bill 1994]

Background to the legislation

The existing provisions

3.27 The provisions dealing with the imputation system are contained in Part IIIAA of the Income Tax Assessment Act 1936.

3.28 At present, the imputation provisions which account for payments and refunds of company tax refer to the types of payments and refunds that can be made under the existing company tax collection arrangements. These arrangements are contained in Division 1B of Part VI of the Income Tax Assessment Act 1936 and they provide, among other things, for the making of initial, further and final payments of tax.

3.29 As tax payments under those arrangements generally occur after the year of income to which they relate, franking credits for those payments also occur in the franking year following that year of income. This means that dividends franked on the basis of the tax payments will be paid in that later franking year or subsequent franking years.

3.30 A franking credit generally arises at the time the tax payment is made. The exception is when an initial payment is made during the year of income to which the payment relates. In this instance, the franking credit is deferred until the beginning of the next franking year. This is consistent with the accounting for franking credits in the franking year linked to the year of tax which, for companies, is the year following the year of income.

The new company tax instalment arrangements

3.31 Under the new arrangements, companies are classified according to the likely amount of tax on income derived during the year of income. The three categories are:

SMALL if likely tax is less than $8 000
MEDIUM if likely tax is between $8 000 and $300 000
LARGE if likely tax is more than $300 000.

3.32 For small and medium category taxpayers the new arrangements first apply to income derived in the 1994-95 year of income. For large category taxpayers, the new arrangements first apply to income derived in the 1995-96 year of income.

3.33 The time at which tax instalments are due and payable is ascertained by reference to the start of the company's year of income according to the following schedule:

SMALL

·
100% of tax assessed on the first day of month 18

MEDIUM

·
25% of likely tax on the first day of month 12
·
25% of likely tax on the first day of month 15
·
25% of likely tax on the first day of month 18
·
tax assessed minus previous instalments on the first day of month 21

LARGE

·
25% of likely tax on the first day of month 9*
·
25% of likely tax on the first day of month 12
·
25% of likely tax on the first day of month 15
·
tax assessed minus previous instalments
·
on the first day of month 18

* For the year in which the new arrangements will first apply to large taxpayers, the 1995-96 year of income, the first instalment is not payable.

The need for revised franking account provisions

3.34 Revision of the imputation provisions is needed simply to refer to the new company tax collection provisions contained in Division 1C of Part VI of the Income Tax Assessment Act 1936.

3.35 The instalment schedule above also shows that the accounting for franking credits in the franking year linked to the year of tax is no longer appropriate. As some instalments are now required to be made during the year of income to which the tax relates, it is appropriate that franking credits be permitted to arise at the time the instalment is paid.

3.36 The bringing forward of tax payments and franking credits to an earlier franking year will permit companies to pass imputation benefits on to shareholders by franking the dividends they pay on the basis of those payments. However, if those tax payments are then refunded in the following franking year, the tax represented by the imputation credits attached to the dividends could effectively be deferred until after the end of that later franking year. Deficit deferral tax is designed to counter that deferral outcome.

Explanation of the amendments

When will franking credits arise for the payment of company tax instalments?

3.37 Under the new company tax collection arrangements a class B franking credit will always arise at the time an instalment is paid. This rule will apply both to instalments (under section 221AZK) and to additional amounts (under section 221AZR) when a company has estimated an increased amount of likely tax for the year. [Item 31 of Schedule 1; new sections 160APM, 160APMAA]

Will a franking debit also arise at the time a company tax instalment is refunded?

3.38 Yes. If an instalment (or an additional amount paid on an upwards estimate of likely tax) is refunded, for example, as a result of a downwards estimate of tax the company will be liable to pay, a franking debit will arise at the time the refund is received. [Item 36 of Schedule 1; new section 160APY]

3.39 Similarly, for company tax that is refunded (or is credited against a tax liability other than company tax payable) at the time of assessment, a franking debit will arise at the time the refund is received or the amount is credited against the other liability. [Item 36 of Schedule 1; new section 160APYA]

3.40 However, if the amount refunded or credited includes tax paid as an instalment during the franking year before the franking year in which the refund is received the company may be liable to pay deficit deferral tax.

3.41 Paragraphs 3.43 to 3.55 explain when a liability to class B deficit deferral tax will arise, and what the consequences will be for a company and its class B franking account.

3.42 Paragraphs 3.71 to 3.77 explain when a liability to deficit deferral tax will arise, and what the consequences will be for a non-mutual life assurance company and its franking accounts.

What if the refund includes some or all of an instalment paid in the previous franking year?

3.43 If an instalment paid in the income year to which it relates is refunded in the next franking year a liability to a class B deficit deferral tax will arise only if there would have been a class B franking deficit, or increased franking deficit, if the refund had occurred at the end of that earlier franking year. [Item 47 of Schedule 1; new subsection 160AQJB(1)]Z

Example

Instalment Dividend   Refund
$66000 $100500 30 June $33000
Franking credit Franking debit Franking surplus Franking debit
$134000 $100500 $33500 $67000
See hard copy.

3.44 In this example, part of an instalment paid in the earlier franking year is refunded in the following year. Imputation credits representing 75% of the tax instalment were passed on to shareholders through a fully franked dividend paid in that earlier year.

3.45 If the refund had occurred at the end of the previous franking year there would have been a franking deficit of $33 500. This is the class B deficit deferral amount in respect of the refund. [Item 47 of Schedule 1; new subsection 160AQJB(2)]

3.46 If, instead of a franking surplus, there had been a franking deficit at the end of the earlier franking year, the deficit deferral amount would be the amount of the increase in the franking deficit had the refund occurred at the end of the franking year.

3.47 In the above example, deficit deferral tax would be calculated as follows:

$33 500 x (33/67) = $16 500

[Item 47 of Schedule 1; new subsections 160AQJB(3) and (4)]

3.48 When a liability to deficit deferral tax arises, the company will be obliged to lodge a deficit deferral tax return within 14 days of receiving the refund. [Item 51 of Schedule 1; new section 160AREA]

3.49 The amount of deficit deferral tax specified on the return form will be taken, in accordance with self assessment principles, to be an assessment of the deficit deferral tax payable by the company. [Item 53 of Schedule 1; new section 160ARHA]

3.50 Deficit deferral tax will be due and payable 14 days after receipt of the refund. [Item 57 of Schedule 1; new section 160ARUA]

Successive refunds

3.51 If a further refund of, say, $16 500 were to be made in the above example, the class B deficit deferral amount would be increased by $33,500 to $67 000.

3.52 In this event, the 'gross class B deficit deferral tax amount' is calculated by the formula:

Class B defecit deferral amount x (33/67)

[Item 47 of Schedule 1; new subsection 160AQJB(4)].

In the example, the gross class B deficit deferral tax amount would be $33 000. That amount would then be reduced by any class B deficit deferral tax already payable by the company for previous refunds (in this example, $16 500) to arrive at the deficit deferral tax of $16 500 in relation to the later refund. [Item 47 of Schedule 1; new subsection 160AQJB(3)]

Franking credit when deficit deferral tax is payable

3.53 Because some or all of an amount refunded will be recovered by deficit deferral tax a franking credit equal to the adjusted amount of the deficit deferral tax payable will arise at the time of the refund. [Item 31 of Schedule 1; new subsection 160APMAB(2)]

3.54 The class B franking credit that will arise when a company is liable to pay class B deficit deferral tax is calculated as follows:

Class B deficit deferral tax x (1 - 0.33/0.33)

Example

3.55 In the example at paragraphs 3.43 to 3.47 above, where class B deficit deferral tax of $16 500 is payable, there would be a franking credit, under new subsection 160APMAB(2), of $33 500 as well as the franking debit, under new section 160APY, of $67 000 in respect of the refund.

Can Deficit Deferral Tax be offset against assessed company tax?

3.56 Yes. A company will be able to offset deficit deferral tax against company tax later assessed in the same way as franking deficit tax. [Items 48 to 50 of Schedule 1; amended subsection 160AQK(1)]

Is there an overfranking penalty if Deficit Deferral Tax is payable?

3.57 Yes. There will be a franking additional tax penalty similar to the section 160ARX overfranking penalty that can apply when there is a franking deficit at the end of the franking year. A company may become liable for a class B deficit deferral tax penalty of additional tax equal to 30% of the class B deficit deferral tax payable in relation to an instalment refund. The condition for liability to the class B deficit deferral tax penalty is that the class B deficit deferral amount that arises under new subsection 160AQJB(2) must exceed 10% of an amount calculated as follows:

Total amount of class B franking credits that arose during the first franking year - [Amount of refunds referred to in paragraph 160AQJB(1)(c) x (67/33)]

[Item 63 of Schedule 1; new subsection 160ARYB] .

3.58 The penalty is payable when the Commissioner makes an assessment of the franking additional tax [section 160ARL]. The Commissioner also has a remission power under which franking additional tax may be reduced [section 160ASB].

3.59 A non-mutual life assurance company may also become liable to a franking additional tax penalty if a class A deficit deferral tax arises. The class A deficit deferral tax penalty may consist of additional tax equal to 30% of the class A deficit deferral tax payable in relation to an instalment refund. The condition for liability to a class A deficit deferral tax penalty is that the class A deficit deferral amount that arises under new subsection 160AQJA(2) must exceed 10% of an amount calculated as follows:

Total amount of class A franking credits that arose during the first franking year - [(0.2 x 61/39) x Amount of refunds referred to in paragraph 160AQJA(1)(c)

[Item 63 of Schedule 1; new subsection 160ARYA].

Can an estimated debit determination be obtained for the expected refund of an instalment?

3.60 Yes. If a company intends to pay a dividend, but expects to receive a refund of an instalment that will result in a franking surplus less than that required to fully frank the dividend, the refund can be taken into account for 'required franking rule' purposes.

3.61 A company will be able to apply for the determination of an estimated class B debit so that the franking surplus before the dividend is paid will be reduced by a franking debit equal to the franking debit that will arise when the refund is received. [Items 44 to 46 of Schedule 1; amended section 160AQDA]

Example
Instalment Estimated debit Dividend   Refund
$66000 $134000 30 June $3300
Franking credit Franking debit Franking debit Franking surplus Franking debit
$134000 $67000 $67000 Nil $67000

3.62 In this example, the company initially has a class B franking surplus of $134 000 that relates to the instalment paid. The company expects to pay dividends of $134 000 before the end of the year but has lodged a downwards estimate of tax payable for the year which will result in a refund, in part, of the instalment. The refund is expected to be received in the following year.

3.63 If the company did not apply for an estimated debit determination, a class B franking debit of $134 000 would arise in relation to the dividend as a result of the required franking rules. Although there would be no franking deficit at the end of the year, there would be a class B deficit deferral amount in relation to the refund. This could expose the company to a liability for deficit deferral tax penalty (see paragraph 3.57 above).

3.64 By obtaining an estimated class B debit determination, the company's franking surplus would be reduced so that the dividends, franked to the extent of 50%, would give rise to a franking debit of $67 000.

3.65 In this case, there would be no franking deficit at the end of the year and no class B deficit deferral amount in relation to the refund. This is because the class B franking debit that would arise, under new subsection 160APY, on receipt of the refund would be matched by an equal franking credit that would arise, under subsection 160APU(2), on the lapsing of the estimated debit.

3.66 A non-mutual life assurance company will also be able to apply for the determination of an estimated class A debit in the same way. [Items 41 to 43 of Schedule 1; amended section 160AQD]

What are the consequences if a deficit deferral tax return is not lodged?

3.67 The Commissioner will be empowered to make an assessment of deficit deferral tax payable by a company [item 54 of Schedule 1; new subsection 160ARK(3)] and the company will become liable for a franking additional tax penalty for the failure to lodge the return as required [item 64 of Schedule 1; new subsection 160ARZ(2)].

3.68 An additional tax penalty for late payment will also accrue from the time deficit deferral tax was taken to have become due and payable, that is, 14 days after the refund was received. [Item 58 of Schedule 1; amended subsection 160ARW(1)]

What are the consequences if deficit deferral tax is underpaid?

3.69 If there is a shortfall in the amount of deficit deferral tax paid the company will become liable for franking additional tax in the same way as if a shortfall had occurred in the payment of franking deficit tax. [Items 59 to 62 and 65 to 85 of Schedule 1]

What about the adjusting and class A franking debits and credits for non-mutual life assurance companies?

3.70 Adjusting and class A franking debits and credits for non-mutual life assurance companies will be calculated for company tax payments and refunds under the new instalment arrangements in the same way as under the existing arrangements. The following table lists the new or modified provisions:

New or modified provision Description
160AQCCA(1)[Item 38] Provisional class B franking debit when a franking credit for payment of company tax instalment arises under section 160APM or 160APMAA before assessment of company tax.
160AQCCA(3)[Item 38] Class B franking debit in relation to a franking credit for payment of company tax instalment that arises, or has arisen, under section 160APM or 160APMAA.
160APVA(1)[Item 33] Provisional class B franking credit when a franking debit for refund of company tax instalment arises under section 160APY.
160APVA(3)[Item 33] Class B franking credit in relation to a franking debit for the refund or crediting of a company tax instalment that arises, or has arisen, under section 160APY or 160APYA.
160APVB[Item 33] Class B franking credit [contra to subsection 160AQCCA(1) class B franking debit] when class B franking debit arises under subsection 160AQCCA(3).
160AQCCB[Item 38] Class B franking debit [contra to subsection 160APVA(1) class B franking credit] when class B franking credit arises under subsection 160APVA(3).
160APVH(1)(aa)[Item 34] Provisional class A franking credit equal to 20% of the subsection 160AQCCA(1) class B franking debit calculated by reference to the 39% rate instead of 33%.
160APVH(1)(ab)[Item 34] Class A franking credit equal to 20% of the subsection 160AQCCA(3) class B franking debit calculated by reference to the 39% rate instead of 33%.
160APVH(3)[Item 35] Class A franking credit [contra to paragraph 160AQCN(1)(aa) class A franking debit] when class B franking credit arises under subsection 160APVA(3).
160AQCN(1)(aa)[Item 39] Provisional class A franking debit equal to 20% of the subsection 160APVA(1) class B franking credit calculated by reference to the 39% rate instead of 33%.
160AQCN(1)(ab)[Item 39] Class A franking debit equal to 20% of the subsection 160APVA(3) class B franking credit calculated by reference to the 39% rate instead of 33%.
160AQCN(2A)[Item 40] Class A franking debit [contra to paragraph 160APVH(1)(aa) class A franking credit] when class B franking credit arises under subsection 160AQCCA(3).

Can a non-mutual life assurance company be liable for both class A deficit deferral tax and class B deficit deferral tax?

3.71 Yes. It will be possible for a non-mutual life assurance company to be liable for both class A deficit deferral tax and class B deficit deferral tax in relation to a particular refund. This will depend, of course, on whether the conditions for liability to deficit deferral tax are satisfied in each case when an instalment is refunded.

Example
Instalment Dividend   Refund
Full component - $19.5 m S10m Full component $9.75m
Non-Fund component $3.3m $10m 30 June Non-fund component - $1.65m
Franking accounts Franking debits Franking accounts Franking accounts
Class Bcr. - $46.29m Class A - $6.1m Class A - zero balance Class B dr. - $23.145m
Adjusting Class B dr. - $39.59m Class B - $3.9m Class B - $2.8m surplus Adjusting Class B cr. $19.795m
Class A cr. - $6.1m Class A dr. - $3.05m

3.72 In this example, the payment of the instalment gives rise to:

·
a class B franking credit under new section 160APM;
·
an adjusting class B franking debit under new subsection 160AQCCA(1) which reduces the franking credit by an amount corresponding to the statutory fund component of the company's tax liability; and
·
a class A franking credit under new paragraph 160APVH(1)(aa) which corresponds to the portion of the company's tax on profits represented by the statutory fund component that are available for distribution to shareholders.

3.73 Before the end of the first franking year, the company pays franked dividends which, in accordance with the required franking rules of sections 160AQDB and 160AQE, first exhausts the class A franking surplus.

3.74 In the following franking year, part of the instalment is refunded giving rise to:

·
a class B franking debit under new section 160APY;
·
an adjusting class B franking credit under new subsection 160APVA(1) which reduces the franking debit by an amount corresponding to reduction in the statutory fund component of the company's tax liability; and
·
a class A franking debit under new paragraph 160AQCN(1)(aa) which corresponds to the reduction in the portion of the company's tax on profits represented by the statutory fund component that are available for distribution to shareholders.

3.75 Both a class A deficit deferral amount [item 47 of Schedule 1; new subsection 160AQJA(2)] and a class B deficit deferral amount [item 47 of Schedule 1; new subsection 160AQJB(2)] will arise in respect of the refund. This is because there would have been both a class A franking deficit of $3.05 million [item 47 of Schedule 1; new paragraph 160AQJA(1)(c)] and a class B franking deficit of $0.55 million [item 47 of Schedule 1; new paragraph 160AQJB(1)(c)] if the refund had occurred on the last day of the first franking year.

3.76 In this example, class A deficit deferral tax will be calculated under new subsection 160AQJA(3) [item 47 of Schedule 1] as follows:

$3.05m * (39/61) = $1.95m

and class B deficit deferral tax will be calculated under new subsection 160AQJB(3) [item 47 of Schedule 1] as follows:

$550 000 * (33/67) = $270 896

3.77 A class A franking credit, under new subsection 160APMAB(1) [item 31 of Schedule 1] of $3.05 million and a class B franking credit, under new subsection 160APMAB(2) [item 31 of Schedule 1], of $0.55 million will arise at the time the refund is received.

Section 2 - Early payment of company tax for 1993-94

Purpose of the amendments

3.78 These amendments will ensure that the imputation credits attached to dividends franked on the basis of an early payment, other than an initial payment, of company tax relating to taxable income of the 1993 94 year of income will be equal to the amount of company tax paid.

3.79 This will be achieved by requiring franking credits arising from early payments and franking debits arising from the refund of such payments to be calculated by reference to the 39% rate instead of the 33% rate that ordinarily applies to tax amounts relating to taxable income of the 1993-94 year of income.

Date of effect

3.80 The amendment will apply to payments and refunds of company tax for the 1993-94 year of income made after 17 February 1994. It is a transitional measure that will apply only to payments made during a company's 1993-94 franking year and to the refund of such amounts. [Item 86 of Schedule 1]

Background to the legislation

3.81 The general company tax rate was reduced from 39% to 33% by Part 5 of the Taxation Laws Amendment Act (No.2) 1993. The reduced rate applies to income derived in the 1993-94 year of income and later years. To accommodate this change, the imputation provisions were amended by Division 9 of Part 4 of the Taxation Laws Amendment Act (No.3) 1993. Those amendments introduced dual franking accounts; class A for franking credits and debits calculated by reference to the 39% rate and class B for franking credits and debits calculated by reference to the 33% rate. The class B franking account is created at the beginning of a company's 1994-95 franking year.

3.82 A company with a notional or estimated tax liability of more than $300 000, and with its year of income from 1 July to 30 June, was obliged to make its 'initial payment' of tax on income derived in the 1993-94 year of income by 28 July 1994. If it made its initial payment during July 1994, a class B franking credit will have arisen at the time the payment was made. The franking credit enables the company to distribute as fully franked dividends the after-tax profits calculated at 67/33 of the tax paid.

3.83 If the company had made its initial payment in June 1994, a class B franking credit would have again arisen, but would have been deferred until 1 July, the beginning of its 1994-95 franking year. The effect of the deferral is to prevent dividends, paid on the basis of the initial payment, being franked at the 39% rate when the tax has been paid at the 33% rate. In the absence of the deferral the imputation credits attached to dividends paid on the basis of the initial payment would be overstated by approximately 30%.

3.84 The amendment contained in this Bill will modify the imputation provisions in situations other than the making of an initial payment. It will address the situation where a company had ceased its business operations and a final payment of tax was made before the end of its 1993-94 franking year.

Explanation of the amendments

3.85 The payment of company tax on income derived in the 1993-94 year of income ordinarily gives rise to a class B franking credit. The class B franking credit represents profits taxed at the 33% company tax rate that can be distributed to shareholders as fully franked dividends. It is calculated by applying the factor 67/33 to the amount of company tax paid.

3.86 If a company makes its initial payment of tax in relation to the 1993-94 year of income during that year, an existing provision ensures that the class B franking credit arises at the beginning of the company's next franking year [paragraph 160APMA(a)].

3.87 Deferral of the time at which the franking credit arises would be impractical for a company that has satisfied its income tax liability for the 1993-94 income year and is being wound up. Shareholders would desire that the final distribution be promptly made and that it would absorb the franking surplus generated by the final tax payment.

3.88 Because the imputation credit attached to a dividend paid by a company during its 1993-94 franking year is calculated by reference to the 39% rate, there would be a disparity between the imputation credit and the amount of company tax paid if the franking credit that represents taxed profits were to be calculated by reference to the 33% rate.

3.89 The amendment will overcome this anomaly by calculating the franking credit by reference to the 39% rate. By applying the factor 61/39 to the amount paid to calculate the franking credit arising at the time an early payment of tax is made, the imputation credit on the dividends will equate with the company tax paid.

3.90 The 61/39 factor will be applied to calculate the franking credit that arises when a company makes an early payment of tax, other than an initial payment, during the transitional period, that is, after 17 February 1994 but during its 1993-94 franking year. [Paragraph (a) of subitem 86(1) of Schedule 1]

Example

3.91 A company has a taxable income of $200 000 for the 1993-94 year of income. Its business operations ceased, and winding-up commenced, during the 1993-94 financial year.

3.92 On 1 March 1994, an income tax return was lodged and company tax of $66 000 paid for the 1993-94 year of income.

3.93 The franking credit that arises on payment of company tax is the 'adjusted amount' in relation to the payment, and as a result of this amendment will be calculated as follows:

$66 000 * (1 - 0.39/0.39) = $103 231

3.94 The 61/39 factor will also be applied to calculate the franking debit that arises if an early payment made during the transitional period, other than an initial payment, is refunded or credited against another liability. [Paragraphs (b) to (d) of subitem 86(1) of Schedule 1]

3.95 It will also apply if a notice of amended assessment reducing the company's income tax liability for the 1993-94 year of income is served on the company, providing the original assessment was made after 17 February 1994 but before the end of the company's 1993-94 franking year. [Paragraph (e) of subitem 86(1) of Schedule 1]

Modification of the transitional rule if it would result in a franking deficit

3.96 The transitional rule will be modified if a company has made tax payments to which the amendment applies and, at the end of its 1993-94 franking year, there would be a franking deficit, or an increase in the franking deficit, that resulted only because of the amendment.

3.97 In this event, the company will not become liable for the franking deficit tax, or the increased franking deficit tax, for the 1993-94 franking year. Instead, there will be a class A franking debit equal to the amount of the franking deficit, or increased franking deficit, that would have resulted from the transitional rule. The class A franking debit will arise on the day on which these transitional provisions commence. [Subitem 86(2) of Schedule 1]

Example

3.98 Assuming, in the example at paragraphs 3.91 to 3.93 above, the company had not been wound up by 30 June 1994 (the end of its 1993-94 franking year) and it had paid fully franked dividends of $134 000 during the year (that is, on the basis of the company tax paid but without allowing for the adjustment required by this amendment). In this case, the imputation credits attached to the dividends, calculated by reference to the 39% rate, would amount to $85 672.

3.99 The result of the calculation of the franking credit for company tax paid according to the transitional rule, i.e., $103 231, together with the franking debit of $134 000 arising from the payment of the franked dividends, would be a franking deficit of $30 769 for the 1993-94 franking year.

3.100 In this instance, the transitional rule will be modified so that, instead of a franking deficit for the 1993-94 franking year, there will be a class A franking debit of $30 769 that will arise on commencement of this amendment.

3.101 If there are no other franking account entries during the company's 1994-95 franking year, the class A franking debit will result in a class A franking deficit at the end of that franking year. The franking deficit tax on that class A franking deficit will then be calculated as follows:

$30 769 * (0.39/1 - 0.39) = $19 672

3.102 The class A franking deficit tax of $19 672, together with the company tax paid of $66 000 for the 1993-94 year of income, will then equal the total amount of imputation credits attached to the $134 000 dividends paid in the 1993-94 franking year.

Non-mutual life assurance companies

3.103 The transitional measure will in the same way modify the franking credit and franking debit provisions that apply exclusively to non-mutual life assurance companies. As for other companies, a franking credit arises at the time a payment of tax is made. However, for these companies, a franking debit also arises at the same time to reduce the value of the franking credit by the part corresponding to the income tax attributable to the statutory fund component of the company's taxable income. For the 1993-94 income year, these franking credits and debits would ordinarily be calculated by reference to the 33% company tax rate.

3.104 The amendment will therefore apply the 61/39 factor to calculate the franking credits and franking debits corresponding to any early payment, other than an initial payment, of tax by a non-mutual life assurance company. [Paragraph (f) of subitem 86(1) of Schedule 1]

3.105 For a non-mutual life assurance company, another franking credit arises at the time a tax payment is made. This franking credit corresponds to the tax on a statutory percentage of the income on assets held in statutory funds that is available for distribution to shareholders. As this franking credit is already calculated by reference to the 39% company tax rate, there is no need to modify the calculation of this franking credit.

3.106 The modification of the transitional rule (by subitem 86(2) - see paragraphs 3.96 to 3.97 above), will apply equally to a non-mutual life assurance company if a franking deficit, or increased franking deficit, for the 1993-94 franking year would result from application of the rule to any early payments of company tax by such a company.


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