Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Ralph Willis, MP)Chapter 3 - Dividend imputation
Overview
3.1 Schedule 2 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) as a result of the increase in the company tax rate from 33% to 36%.
3.2 The amendments will require companies to establish a class C franking account and to record franking credits and debits and distribute imputation credits to shareholders by reference to tax paid at 36%. The value of existing class A and class B franking account balances will be preserved by converting them to the equivalent class C franking account balance.
3.3 The amendments will also correct certain existing defects in the dividend imputation provisions. As a result:
- •
- mutual life insurance companies will be entitled to a franking rebate for franked dividends received through a trust or partnership; and
- •
- non-mutual life insurance companies will not be entitled to a deduction for the imputation credit attached to a franked dividend received through a trust or partnership if a franking rebate is available.
3.4 The Income Tax (Franking Deficit) Amendment Bill 1995 and the Income Tax (Deficit Deferral) Amendment Bill 1995 will amend the Income Tax (Franking Deficit) Act 1987 and the Income Tax (Deficit Deferral) Act 1994 respectively to impose class C franking deficit tax and class C deficit deferral tax.
Summary of the amendments
3.5 The purpose of the amendments is to:
- •
- allow companies to record class C franking credits and debits and to distribute imputation credits to shareholders by reference to tax paid at 36%; and
- •
- correct certain existing defects in the dividend imputation provisions relating to life assurance companies.
3.6 The class C franking account amendments will apply from 1 July 1995.
3.7 The amendments to correct the defects in the current provisions relating to life assurance companies will apply from the time the defects first arose. This means that the mutual life assurance company amendment will apply from 22 August 1990, and the non-mutual life assurance company amendment will apply from 7 December 1990.
Background to the legislation
3.8 The dividend imputation system contained in Part IIIAA of the Income Tax Assessment Act 1936 (the Act) operates to attribute (or impute) company tax to resident shareholders when dividends are paid to them out of profits. Resident individual shareholders are effectively subject to tax on the before-tax profit (consisting of the dividend and the imputed company tax component) but are entitled to a rebate of tax (the 'franking rebate') for the imputed company tax.
3.9 A dividend with an imputation credit attached to it is known as a 'franked dividend'. A resident company can pay a franked dividend by declaring a dividend to be franked to a specified percentage before paying it. 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. Non-resident shareholders are exempt from dividend withholding tax to the extent of the franked amount of a dividend.
3.10 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% and 49% 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.
3.11 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 resident 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.
3.12 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. Franking deficit tax is due and payable on the last day of the month after the end of the franking year. A penalty tax, the franking additional tax, may also be imposed if the company has over-franked dividends and its franking deficit at the end of the franking year is more than 10 per cent of the franking credits arising during the year.
3.13 If an instalment of tax paid in a franking 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, the company is liable to deficit deferral tax.
Calculation of franking credits and franking debits
3.14 The amount of a franking credit or franking debit that arises from the payment or refund of company tax is calculated by adjusting the tax amount by a factor based on the relevant company tax rate.
3.15 For a class A franking credit or debit, the relevant company tax rate is generally 39%. Applying the factor 61/39 to a tax amount of, say, $390 results in a class A franking credit of $610. This represents an amount that could be distributed as a fully franked class A franked dividend. However, in relation to tax paid for the 1986-87 and 1987-88 income years, the tax rate was 49% and the relevant factor is 51/49.
3.16 For class B franking credits and debits, 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 of $670. This represents an amount that could be distributed as a fully franked class B franked dividend.
3.17 Companies also receive franking credits from the receipt of franked dividends, and franking debits from the payment of franked dividends. The amount of the credit or debit is the franked amount of the dividend. For example, if a company declares a dividend to be franked to 100 per cent, that is, the dividend is fully franked, there arises 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.
3.18 If that dividend is a class B dividend of, say, $670, a resident individual shareholder must include in assessable income the amount of the imputation credit, $330, as shown on the dividend statement provided by the company, in addition to the amount of the dividend. Thus the $1,000 is included in assessable income and the shareholder is entitled to a franking rebate of $330.
3.19 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.
3.20 Mutual life assurance companies do not receive franking credits or franking debits.
3.21 Non-mutual life assurance companies are limited in the amount of income they can distribute to shareholders rather than to policyholders. Broadly speaking, subject to solvency and capital adequacy standards, they can distribute as dividends to shareholders all their 'non-fund income' (i.e. income other than their statutory fund income), but only 20 per cent of their statutory fund income (income derived from assets included in their life, superannuation, roll-over or accident and disability insurance business). 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 (80 per cent) are excluded in franking account calculations. For these companies, franking credits and debits relating to the payment and refund of tax on their statutory fund income, and dividends received from their statutory fund, are reduced by adjusting franking debits and credits.
3.22 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.
3.23 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 per cent of the statutory fund component of company tax and are recorded in the class A franking account. This is because the special life assurance company tax rate, currently 39 per cent, applies to this income.
3.24 Following the increase in the company tax rate from 33% to 36% with effect from the 1995-96 income year, it is necessary to amend the dividend imputation provisions so that companies can record franking credits and debits by reference to tax paid at 36%. Shareholders receiving franked dividends from profits taxed at 36% will also need to be able to calculate imputation credits and a franking rebate by reference to the 36% company tax rate.
Explanation of the amendments
3.25 During their 1995-96 franking year companies will establish a class C franking account and post class C franking credits and debits to that account. The class C franking account will represent company tax paid at the rate of 36%.
3.26 To allow companies to maintain and operate a class C franking account, the Act will be amended by extending definitions of class A and B franking account terms to class C franking account terms. [Items 3 to 14; amended section 160APA]
3.27 Most of the provisions relevant to the operation of class A and class B franking accounts are extended by simply incorporating references to class C franking account terms and restricting the application of class B franking account credits and debits to years prior to the 1995-96 income year. However, not all references to class A or B franking account terms are relevant to the class C franking account. For instance, they may relate to the company tax payment system that operated prior to the 1995-96 income year. These references are not extended.
3.28 The table below shows the class A and class B franking credit provisions that are extended to provide for class C franking credits. These amendments will allow companies to calculate franking credits by reference to the new company tax rate of 36%.
| Transaction giving rise to class C franking credit | Item |
|---|---|
| Carry forward of class C franking surplus | Item 19; new subsection 160APL(3) |
| Payment of company tax instalment for 1995-96 and later income years | Item 20; new section 160APM |
| Payment of amount on upwards estimate of 1995-96 and later year instalments | Item 21; new section 160APMAA |
| Refund of instalment giving rise to a class C deficit deferral amount | Item 22; new subsection 160APMAB(3) |
| Payments of tax for the 1995-96 and later income years after the final payment of tax | Items 23 and 24; amended section 160APMD |
| Receipt of class C franked dividend | Items 25, 26, 27 and 28; amended section 160APP |
| Receipt of class C franked dividends through trusts and partnerships | Items 29 and 30; amended section 160APQ |
| Payment of excess franking deficit tax and deficit deferral tax offset in relation to 1995-96 and later income years | Items 31 and 32; amended section 160APQA |
| Payment of excess foreign tax credit in relation to 1995-96 and later income years | Items 33 and 34; amended section 160APQB |
| Lapsing of estimated class C debit | Item 35; new subsection 160APU(3) |
| Substituted estimated class C debit determination | Item 36; new subsection 160APV(3) |
| Life assurance companies - credit reducing section 160APY or 160APYA class C franking debit | Items 37 and 38; new subsections 160APVA(1A) and 160APVA(3A) |
| Life assurance companies - credit reversing new subsection 160AQCCA(1A) class C franking debit | Item 39; new subsection 160APVB(2) |
| Life assurance companies - credit reducing section 160APYBA class C franking debit | Items 40, 41 and 42; amended section 160APVBA |
| Life assurance companies - credit reducing section 160APYBB class C franking debit | Items 43, 44 and 45; amended section 160APVBB |
| Life assurance companies - credit reducing section 160APZ class C franking debit | Item 46; new subsection 160APVD(3) |
| Life assurance companies - replacement of class C franking credit for statutory fund tax with class A franking credit | Items 47 and 48; amended section 160APVH |
3.29 The table below shows the class A and class B franking debit provisions that are extended to provide for class C franking debits. These amendments will allow companies to calculate franking debits by reference to the new company tax rate of 36%.
| Transaction giving rise to class C franking debit | Item |
|---|---|
| Class C under-franking debit | Item 49; new subsection 160APX(1B) |
| Refunds of company tax instalment for 1995-96 and later income years | Item 50; new section 160APY |
| Other refunds of company tax instalment for 1995-96 and later income years | Item 51; new section 160APYA |
| Refunds of company tax for 1995-96 and later income years | Items 52 and 53; amended section 160APYBA |
| Payment or application of foreign tax credits for 1995-96 and later income years | Items 54 and 55; amended section 160APYBB |
| Amended company tax assessment reducing tax for 1995-96 and later income years | Items 56 and 57; amended section 160APZ |
| Payment of class C franked dividends | Item 58; new subsection 160AQB(3) |
| Estimated class C debit determination | Items 59 and 79; new subsection 160AQC(3) and section 160AQDAA |
| Transfer of asset to insurance funds after class C franking credit arose | Item 60; new subsection 160AQCA(3) |
| Dividend streaming arrangements involving class C franked dividends | Items 61, 62, 63, 64 and 65; amended section 160AQCB |
| On-market share buy-backs by companies that have a class C franking account | Items 66 and 67; amended subsection 160AQCC |
| Life assurance companies - debit reducing section 160APM or 160APMAA class C franking credit | Items 68 and 69; new subsections 160AQCCA(1A) and 160AQCCA(3A) |
| Life assurance companies - debit reversing subsection 160APVA(1A) class C franking credit | Item 70; new subsection 160AQCCB(2) |
| Life assurance companies - debit reducing section 160APMD class C franking credit | Items 71, 72 and 73; amended section 160AQCK |
| Life assurance companies - debit reducing section 160APQB class C franking credit | Items 74, 75 and 76; amended section 160AQCL |
| Life assurance companies - replacement of class C franking debit for statutory fund tax refunds with class A franking debit | Items 77 and 78; amended section 160AQCN |
Class C franking account balance
3.30 In addition to the extension of the class A and B franking credit and debit terms to equivalent class C franking credits and debits, the amendments will allow the ascertainment of a class C franking account surplus or deficit at any particular time during the franking year. This is achieved by providing for the calculation of the surplus and deficit in the same way as the class A and B franking account surpluses and deficits are calculated. [Items 17 and 18; new subsections 160APJ(1B) and 160APJ(4)]
What happens to the class A and B franking accounts?
3.31 Companies, other than life assurance companies, will convert their existing class A and B franking account balances to a class C franking account at some stage during their 1995-96 franking year. A surplus will be converted to a class C franking credit; a deficit will be converted into a class C franking debit. Therefore most companies will revert to a single franking account with consequent reductions in compliance costs.
3.32 Life assurance companies will continue to pay tax at 39% on their statutory fund income. To avoid the distortions that would arise by on-going conversion of tax paid at 39% into an equivalent class C franking credit, life assurance companies will convert only their class B franking account and will continue to maintain a class A franking account. However, if they subsequently cease to be a life assurance company (but remain a company which is required to maintain franking accounts) they will convert their existing class A franking account to an equivalent class C franking account at the time the company ceases to be a life assurance company. [Item 158; new subsections 160ASJ(1) and 160ASJ(2)]
3.33 The conversion factor for a class A franking account balance is:
39/61 * 64/36
[Item 158; new subsections 160ASG(1) and 160ASG(2)]
3.34 For example, a company with a class A franking surplus of, say, $10,000 would convert that surplus into a class C franking account credit of $11,366.12 (i.e. $10,000 * 39/61 * 64/36).
3.35 The conversion factor for a class B franking account balance is:
33/67 * 64/36
[Item 158; new subsections 160ASH(1) and 160ASH(2)]
3.36 For example, a company with a class B franking deficit of, say, $20,000 would convert that deficit into a class C franking account debit of $17,512.43 (i.e. $20,000 * 33/67 * 64/36).
3.37 The conversion of the class A and B franking account to the class C franking account using these conversion factors preserves the value of the underlying imputation credits for ultimate shareholders.
3.38 Companies will be required to convert to the class C franking account at the time the first of the following events occurs:
- •
- when the first class C franking credit of the company arises (e.g. from the payment of a company tax instalment in respect of the 1995-96 income year, or upon the receipt of a class C franked dividend) [item 158; new paragraph 160ASF(a)] ;
- •
- at the end of their 1995-96 franking year [item 158; new paragraph 160ASF(b)] .
3.39 Companies will have the option of converting to the class C franking account before these times. However, companies will not have the option of converting before this Bill was introduced into Parliament. Nor will they be able to convert after the conversion times mentioned above.
3.40 To exercise the option of converting early, a company will be required to make a written declaration that it has converted to the class C franking account. Such a declaration will be irrevocable and cannot operate retrospectively. [Item 158; new subsection 160ASF(2)]
3.41 For most companies the 1995-96 franking year will be the 1995-96 financial year (i.e. the year commencing 1 July 1995). However, for early balancing companies the 1995-96 franking year will generally be the income year that is adopted in lieu of the income year that balances on 30 June 1996. For example, where a company has a substituted accounting period ending 31 December 1995 in lieu of 30 June 1996, its 1995-96 franking year will be the period 1 January 1995 to 31 December 1995. [Item 16; new section 160APBA]
How are class A and B credits and debits treated after conversion?
3.42 After a company has converted to the class C franking account it may receive a class A or class B franking credit or debit. For example, it may receive a class A or B franked dividend from a company that has not yet converted, or, following an amended assessment, it may receive a refund of tax for a year prior to the 1995-96 income year.
Equivalent class C franking credits and debits
3.43 Life assurance companies will still be able to post a class A franking credit or debit to their class A franking account. Other companies, however, will have to convert the credit or debit to an equivalent class C franking credit or debit. Similarly, all companies, including life assurance companies, will have to convert class B franking credits and debits received after conversion to the equivalent class C franking credit or debit.
3.44 The conversion factor for class A franking credits and debits is:
39/61 * 64/36
[Item 158; new subsections 160ASI(1) and 160ASI(2)]
For class B franking credits and debits it is:
33/67 * 64/36
[Item 158; new subsections 160ASI(3) and 160ASI(4)]
3.45 For example, if after conversion a company receives a fully franked class A dividend of $100 and a fully franked class B dividend of $200, the following calculation would be performed to convert the attached imputation credits into the company's class C franking account:
| $100 * 39/61 * 64/36 = | $113.66 |
| $200 * 33/67 * 64/36 = | $175.12 |
| $288.78 class C franking credit |
3.46 In this example, the class A franking credit of $100 has been increased to reflect the fact that the imputation credits which the franking credits represent are now worth 36% rather than 39%. By increasing the franking credits (and therefore the amount that can be distributed as a fully franked dividend) the value of the 39% imputation credits is preserved. Conversely, the class B franking credits are reduced because the imputation credits they represent are now more valuable (calculated by reference to 36% rather than 33%).
Neutralisation of original class A or B franking credit or debit
3.47 The conversion of class A and B franking credits and debits into equivalent class C franking credits and debits does not prevent those class A or B credits and debits arising. However, the effect of a class A or B franking credit which is converted to a class C franking credit is neutralised by means of an offsetting franking debit equal to the amount of the credit. Similarly class A or B franking debits are neutralised by means of an offsetting franking credit. [Item 158; new section 160ASI]
3.48 It is necessary for the original class A or B franking credit or debit to arise even though it is converted to the class C equivalent because some franking credit and debit provisions dealing with life assurance companies depend on a previous franking debit or credit arising. For example if, after its class C conversion time, a life assurance company pays its final payment of tax under section 221AZD of the Act for its 1994-95 income year, a class B franking credit will arise under paragraph 160APMC(b). This franking credit will give rise to a class B franking debit under paragraph 160AQCJ(1)(b), which in turn will give rise to a class A franking credit because of subsection 160APVH(1)(e).
3.49 The amendments will ensure that the above result is still achieved, but they will effectively eliminate the relevant class B franking credits and debits by means of the neutralising franking debits and credits.
Can a company pay a class A or B franked dividend after conversion?
3.50 Class A and B franking debits arising from the payment of class A and B franked dividends by a company which has converted to the class C franking account before the dividends' reckoning day are specifically excluded from the provisions explained above which convert class A and class B franking debits to equivalent class C franking debits. [Item 158; new paragraph 160ASI(2)(b) and subsection 160ASI(4)]
3.51 Therefore, a company could pay a class A or B franked dividend even if it no longer has a class A or class B franking account on the dividend's reckoning day. However, the amendments ensure that no advantage can arise from doing this, either for the paying company or its shareholders.
3.52 To prevent any advantage arising from the payment of a class A franked dividend with a reckoning day after a company has converted its class A franking account, the payment will give rise to a class A franking debit. Because all future franking credits will be class C franking credits (any class A franking credit that does arise will be neutralised by a corresponding franking debit), a company that pays a class A franked dividend in these circumstances will be unable to eliminate the resulting class A franking account deficit. Therefore, at the end of the franking year, the company will be liable to pay class A franking deficit tax and franking additional tax for over-franking its dividends. [Item 158; new paragraph 160ASI(2)(b)]
3.53 If, however, a company pays a class B franked dividend with a reckoning day after it has converted to the class C franking account, a class C franking debit will arise equal to the amount that would have been the class B franking debit from the payment of the dividend (i.e. the class B franked amount of the dividend). This results in a greater debit to the class C franking account than is represented by the imputation credits distributed to the shareholders. [Item 158; new subsection 160ASI(5)]
What if the dividend had a reckoning day before conversion?
3.54 If the reckoning day for a dividend occurs before the class C conversion time, the dividend would have a class A or class B required franking amount. Therefore the company will pay the dividend as class A or B franked even if, at the time of payment, it has converted to the class C franking account.
3.55 The amendments will ensure that no adverse consequences flow to the company or the shareholder in relation to these dividends. This is achieved by converting the class A or B franking debit to an equivalent class C franking debit and neutralising the class A or B franking debit by an equivalent credit. [Item 158; new section 160ASK]
Class C franking account returns and assessments
3.56 Consistent with the obligation imposed on companies in relation to their class A and B franking accounts, the amendments will:
- •
- require companies to lodge class C franking account returns;
- •
- provide for the issuing of assessments for remitting class C franking deficit tax and class C deficit deferral tax;
- •
- provide for the imposition of additional tax by way of penalty on companies which fail to meet their dividend imputation obligations; and
- •
- require companies to maintain relevant class C franking account records.
3.57 The table below lists these amendments.
| Amendment | Item |
|---|---|
| Class C deficit deferral returns | Item 137; amended 160AREA |
| First class C franking return deemed to be an assessment | Item 138; new subsection 160ARH(3) |
| Class C franking account balance part-year assessment | Items 139 and 140; amended section 160ARJ |
| Default of class C franking account assessment | Item 141; new subsection 160ARK(2A) |
| Amended class C franking account assessment | Items 142 and 143; amended section 160ARN |
| Definition of class C franking account terms used in Division 11 | Items 144 to 150; amended subsection 160ARXA(1) |
| Penalty for over-franking class C franked dividends | Item 151; new subsection 160ARX(3) |
| Class C deficit deferral tax penalty | Item 152; new section 160ARYC |
| Penalty for failure to lodge class C franking account return | Item 153; new paragraph 160ARZ(1)(c) |
| Penalty tax because of position taken on class C franking tax shortfall | Items 154, 155 and 156; amended subparagraph 160ARZD(1)(c)(ii) |
| Company to keep records of class C franking account | Item 157; amended paragraph 160ASC(b) |
What is the class C required franking amount for a dividend?
3.58 The required franking amount represents the minimum extent to which a dividend should be franked having regard to the balance in the company's franking accounts at the time it is paid.
3.59 Section 160AQE of the Act currently provides the general formula for determining the required franking amount of a dividend. Subsection 160AQDB(1) applies this formula to calculate the class A required franking amount for the dividend. Subsection 160AQDB(2) then provides that any of the required franking amount that is not a class A required franking amount is the class B required franking amount.
3.60 For companies that have not converted to the class C franking account before the reckoning day for a dividend, the calculation of the class A and class B required franking amounts of the dividend will remain unchanged. [Items 80 and 81; amended subsection 160AQDB(2)]
3.61 Companies that have converted will not have a class B franking surplus. Therefore the class B required franking amount for a dividend with a reckoning day after conversion will be nil. [Item 82; new subsection 160AQDB(3)]
3.62 The class C required franking amount for a dividend with a reckoning day after the class C conversion time will be worked out using the formula:
Gross required franking amount - Class A required franking amount
[Item 82; new subsection 160AQDB(4)]
The class C franking surplus will be taken into account when applying the general formula in section 160AQE to calculate the gross required franking amount. [Item 84; new paragraph 160AQE(6)(c)]
3.63 This formula will apply to both general companies and to life assurance companies. However, companies, other than life assurance companies, that have converted to the class C franking account will not have a class A franking account surplus and therefore the class A required franking amount for the dividend will be nil.
3.64 Consistent with the current rules, the class C required franking amount specifies only the minimum extent to which a dividend must be class C franked. A company will be able to frank a dividend in excess of the class C required franking amount. However, if a company does so, and there is a class C franking deficit at the end of the franking year, the company will be liable to pay class C franking deficit tax and may be liable to pay franking additional tax. [Items 92 and 151; new subsections 160AQJ(1B) and 160ARX(3)]
3.65 The under-franking rules will also apply in relation to the class C franking account. Thus, where the class C required franking amount is not less than 10% of the dividend and the dividend is not franked to that amount, a class C franking debit arises equal to the amount by which the class C required franking amount exceeds the franked amount of the dividend. [Item 49; new subsection 160APX(1B)]
What is the effect of earlier franked dividends on the class C required franking amount?
3.66 In certain situations, the required franking amount of a dividend will be affected by the required franking amount or the franked amount of an earlier dividend. Anomalies could arise if the class C required franking amount of a dividend is affected by class A or class B franked dividends. Therefore the amendments explained below have been made in relation to the formulas in subsections 160AQE (2) and (3).
3.67 In the formula in subsection 160AQE(2), the RFS component is the franking surplus of the company on the reckoning day for the current dividend reduced by the franked amount or required franking amount of unpaid dividends with an earlier reckoning day than the current dividend. It is possible for the company's class C conversion time to occur after the reckoning day of the earlier dividend but before the reckoning day of the current dividend. In these cases there may be a class C franking surplus of the company for the purposes of the current dividend, but the franked amount or required franking amount to reduce that surplus may be a class A or class B amount.
3.68 To prevent class C franking surpluses being reduced by class A or class B franking amounts in these cases, the amendments provide for the conversion of the class A or class B franking amounts to an equivalent class C franking amount. [Item 158; new section 160ASL]
Over-franked earlier dividends
3.69 Subsection 160AQE(3) provides that if a company over-franks a dividend (the 'earlier franked dividend') in relation to which there is a committed future dividend, that committed future dividend has to be franked at least to the same extent.
3.70 The committed future dividend (i.e. the current dividend referred to in subsection 160AQE(3)) may have a reckoning day after the class C conversion time, but the earlier franked dividend may have a reckoning day before conversion. Therefore the class C required franking amount of the current dividend may be affected by the class A or class B franked amounts of earlier dividends. To prevent the class C required franking amount of a dividend being distorted by the class A or class B franked amount of earlier dividends, the amendments will convert the class A or class B franked amounts to equivalent class C franked amounts. [Item 158; new section 160ASM]
Correction of error in subsection 160AQE(2)
3.71 The amendments also correct a small error that currently exists in subsection 160AQE(2). Under the definition of 'SD' (i.e. substituted dividends) in subsection 160AQE(2) the current reference to subsection 160ACQB(4) is corrected to section 160AQCB(4). A reference to the equivalent class C franking debit provision, new subsection 160AQCB(4A), is also inserted. [Item 83; amended subsection 160AQE(2)]
How does a company pay a class C franked dividend?
3.72 Section 160AQF of the Act specifies the circumstances in which a dividend may be franked and how it is franked. Broadly, a frankable dividend is franked if a resident company makes a declaration before the reckoning day that the current dividend is a franked dividend to the extent of a certain percentage (not exceeding 100 per cent).
3.73 The franking rules set out in section 160AQF for class A and B franked dividends will be extended to class C franked dividends. To determine the class C franked amount of a dividend a company needs to make a declaration that a dividend is class C franked to the percentage specified in the declaration. [Items 85 and 87; new subsections 160AQF(1AAA) and 160AQF(1AC)]
3.74 Dividend statements provided to shareholders will be required to set out how much of the dividend has been class C franked and the amount of class C imputation credits that are attached. This is the same information currently required for class A and B franked dividends. [Items 88, 89, 90 and 91; amended section 160AQH, and new subparagraph 160AQH(b)(iva)]
What happens if a company has already declared a dividend to be class A or B franked?
3.75 Circumstances may arise where, before it converts to the class C franking account, a company declares a dividend to be class A or class B franked under section 160AQF of the Act, but, because the reckoning day of the dividend is after conversion, the dividend should have been class C franked.
3.76 Ordinarily, section 160AQF declarations cannot be varied: subsection 160AQF(2). However, an exception will be made where the declaration was made before the class C conversion time but the dividend to which the declaration relates (or at least one of the dividends if there is more than one) has a reckoning day after conversion. In these cases, the declaration can be varied to take into account the fact that the dividend should be class C franked. [Item 158; new subsection 160ASN(1)]
How can a company frank a class A or B franked dividend to the same extent as a class C franked dividend?
3.77 Section 160AQF requires a company to frank all dividends to which a particular resolution relates to the same extent. If some of those dividends have a reckoning day before conversion, and some have a reckoning day after conversion, it would not be possible to frank all the dividends to the same extent.
3.78 However, it is possible to pay a class C franked dividend which is substantially similar to a class A or class B franked dividend. For example, a $100 fully-franked class B franked dividend is substantially similar to a $100 dividend which is class C franked to $88. This is because the value of the imputation credits attached to each dividend is the same.
3.79 Provided the franked amount of all the dividends with reckoning days after conversion is substantially similar to the franked amount of dividends with reckoning days before conversion, the requirements of section 160AQF will have been met. For these purposes, a fully-franked class C franked dividend will be substantially similar to a fully-franked class A franked dividend even though the imputation credits attached to the class A franked dividend will have a greater value than those attached to the class C franked dividends. In this case, the company would have franked the class C franked dividend to the maximum extent possible to ensure equivalence with the class A franked dividend. [Item 158; new subsection 160ASN(2)]
3.80 Section 160AQJ of the Act imposes a liability to franking deficit tax on a company where the class A or class B franking account balance of that company is in deficit at the end of its franking year.
3.81 Similarly, where a company has a class C franking account balance in deficit at the end of its franking year a class C franking deficit tax liability will arise. The amount of the class C franking deficit tax is calculated using the formula:
franking deficit * company tax rate / [1-company tax rate]
[Item 92; new subsection 160AQJ(1B)]
3.82 Where a company incurs a liability to class C franking deficit tax, that amount will be able to be offset against assessed tax of the company in the same way as class A and B franking deficit tax can currently be offset. [Items 95 and 97; amended subsection 160AQK(1)]
3.83 The Income Tax (Franking Deficit) Amendment Bill 1995 amends the Income Tax (Franking Deficit) Act 1987 to allow class C franking deficit tax to be imposed.
What transitional franking deficit tax provisions will operate?
3.84 Under the current dual-franking account system, companies are not permitted at the end of the franking year to offset a franking deficit that arises in one franking account against a franking surplus that arises in the other franking account. This prevents a company paying class A franked dividends (which are more valuable for resident shareholders) when it does not have any (or sufficient) class A franking credits.
3.85 Without amendment the conversion to a class C franking account would provide companies with an opportunity to effectively offset a class A deficit with a class B surplus. This would enable a company to over-distribute class A franking credits prior to conversion. To prevent this the Act will be amended to ensure that, where a liability to class A franking deficit tax would have arisen but for the conversion to a class C franking account, that liability will remain. [Subitem 159(1)]
3.86 The amendments will also ensure that where a liability to class A franking additional tax would have arisen but for the conversion to a class C franking account, the liability will also remain. [Subitem 159(3)]
3.87 The amendment will only apply to companies whose class A franking account is in deficit at the time of conversion. If this condition is met it is necessary to determine whether, had the conversion not taken place, the company would have been liable to class A franking deficit tax or franking additional tax at the end of that franking year. To determine this, it is necessary to make the following assumptions:
- •
- the class A franking account balance was not converted to a class C account balance but remained as it was; and
- •
- any class C franking credit or debit arising after conversion that would have given rise to a class A franking credit or debit if the amendments were not made did give rise to such a credit or debit (for example, receipt of a class A franked dividend or payment or refund of company tax for an income year prior to 1993-94). [Subitem 159(1)]
3.88 The following example illustrates how the class A franking deficit tax will be preserved in these circumstances.
On 30 May 1996 a company has a class A franking deficit of $100,000 and a class B franking surplus of $20,000. On 1 June 1996 the company pays a company tax instalment of $10,000 (at 36%) giving rise to a class C franking credit of $17,778. The payment of company tax triggers conversion of the class A and B franking account balances into the class C franking account.
In addition the company enters into the following transactions before the completion of its 1995-96 franking year:
- •
- 10 June 1996 - payment of a fully franked class C dividend of $20,000 giving rise to a class C franking debit of $20,000.
- •
- 15 June 1996 - receipt of a fully franked class A dividend of $60,000 giving rise to a class C franking credit of $68,197.
3.89 The franking account entries for the company are shown in the following table:
| Date | Transaction | Class C franking credit/debit | Class A franking a/c balance (notional) | Class C franking a/c balance |
|---|---|---|---|---|
| 1 June | Conversion of class A and B franking accounts | $113,661 Dr $17,512 Cr | ($100,000) | ($96,149) |
| 1 June | Payment of $10,000 company tax (36%) | $17,778 Cr | ($78,371) | |
| 10 June | Payment of fully franked class C dividend of $20,000 | $20,000 Dr | ($98,371) | |
| 15 June | Receipt of fully franked class A dividend of $60,000 | $68,197 Cr | ($40,000) | ($30,174) |
| 30 June | Balance | ($40,000) | ($30,174) |
3.90 At the end of the franking year the company has a class C franking account deficit of $30,174 and a notional class A franking account deficit of $40,000. The amendment will apply here to preserve the class A franking deficit tax of $25,574 (i.e. $40,000 * 39/61) (see section 160AQJ). Class A franking additional tax may also apply if the requirements of section 160ARX are satisfied.
Compensatory class C franking credit
3.91 If a company pays franking deficit tax because of the above amendment, it is appropriate to exclude from the class C franking account balance the amount attributable to the class A franking deficit. This is because the payment of franking deficit tax has offset the amount of that deficit. This result is achieved by giving rise to a class C franking credit at the end of the franking year equal to the class A franking deficit converted to the equivalent class C amount. [Subitem 159(2)]
3.92 In the above example this amount is:
$25,574 * 64/36 = $45,464
Posting this class C franking credit to the class C franking account will result in a carry forward surplus of $15,291. If the class C franking account was already in surplus, the amount of that surplus would have been increased by $45,464.
3.93 Sections 160AQJA and 160AQJB impose a liability to class A or B deficit deferral tax where an instalment of tax 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.
3.94 Where an instalment of tax paid in respect of the 1995-96 or later income year is refunded in the following franking year, and a class C franking deficit would have arisen if the refund had occurred at the end of the previous franking year, a class C deficit deferral tax liability will also arise. Equivalent to the class A and B deficit deferral tax, the amount of the class C deficit deferral tax is calculated using the formula:
class C deficit deferral amount * 36/64
[Item 94, new section 160AQJC]
3.95 Class B deficit deferral tax will now only apply in relation to refunds of company tax instalments for years prior to 1995-96. Class A deficit deferral tax will continue to apply to life assurance companies. [Item 93; amended subsection 160AQJB(1)]
3.96 Where a company incurs a liability to class C deficit deferral tax, that amount will be able to be offset against assessed tax of the company in the same way as class A and B deficit deferral tax can currently be offset. [Items 96 and 98; amended subsection 160AQK(1)]
3.97 The Income Tax (Deficit Deferral) Amendment Bill 1995 amends the Income Tax (Deficit Deferral) Act 1994 to allow class C deficit deferral tax to be imposed.
What are the tax effects of the class C franking account for shareholders?
3.98 Under section 160AQT of the Act, non-corporate resident shareholders who receive class A or B franked dividends are required to include in their assessable income the amount of the imputation credit together with the amount of the dividend (the grossed-up amount of the dividend). The shareholder is then entitled to a franking rebate equal to the amount of the imputation credit under section 160AQU of the Act.
3.99 Non-corporate resident shareholders who receive a class C franked dividend will be required to include in their assessable income the class C imputation credits attached to the dividend using the formula:
class C franked amount * (company tax rate/ [1 - company tax rate])
[Items 99 and 100; new subsections 160AQT(1AB) and 160AQT(1C)]
3.100 As with class A and B franked dividends, the shareholder will be entitled to a franking rebate equal to the amount of the imputation credit under section 160AQU of the Act.
Dividends paid to trusts and partnerships
3.101 Under Division 7 of Part IIIAA of the Act, class A and class B franked dividends received indirectly through partnerships and trusts are, broadly speaking, treated in the hands of partners and beneficiaries in the way that such dividends would have been dealt with if received directly. In other words where a partnership or trust derives franked dividends, that income retains its character when it is distributed to a partner or beneficiary.
3.102 The same treatment will apply to class C franked dividends. The following table details the amendments made to extend this treatment to class C franked dividends.
| Amendment | Item |
|---|---|
| Class C flow-on franking amount and class C potential rebate amount (beneficiaries) | Items 101, 102, 103, 104 and 105; amended section 160AQX |
| Class C flow-on franking amount and class C potential rebate amount (trustee's assessment) | Items 106, 107, 108, 109 and 110; amended section 160AQY |
| Class C flow-on franking amount and class C potential rebate amount (trustees of superannuation funds, ADFs and PSTs) | Items 111, 112, 113, 114, 115, 116, 117, 118, 119 and 120; amended section 160AQYA |
| Class C flow-on franking amount and class C potential rebate amount (partnerships) | Items 121, 122, 123, 124 and 125; amended section 160AQZ |
| Class C franking credit and class C potential rebate amount (life assurance companies) | Item 126; new section 160AQZA |
| Adjustments in relation to section 160AQT amounts for companies and non-residents where a class C franking credit arises | Items 129 and 132; amended section 160AR |
| Adjustment for non-resident beneficiary | Item 133; amended section 160ARA |
| Adjustment where trustee assessed for non-resident beneficiary | Item 134; amended section 160ARB |
| Adjustment where trustee assessed for company | Item 135; new subsection 160ARC(3) |
| Adjustment for non-resident partner | Item 136; amended section 160ARD |
3.103 The last four amendments listed in the above table relate to the potential rebate amount in relation to a trust or partnership amount. Because of the definition of 'potential rebate amount' in section 160APA, if there is a combination of class A, class B and class C potential rebate amounts in relation to the trust or partnership amount, then the potential rebate amount is the sum of those amounts.
Correction of defective provisions
3.104 Section 160AQZA of the Act allows a franking rebate for dividends paid to the statutory funds of a life assurance companies where those dividends are received through a trust or partnership. These dividends are treated in the same way as dividends received by individuals (the life assurance company includes the grossed-up amount of the dividend in its assessable income and receives a rebate of the imputation credit).
3.105 When section 160AQZA was first introduced into the Act, subsection 160APQ(3) prevented any franking credit arising for dividends paid to the statutory funds of a life assurance company. Therefore, the proviso in the section 'apart from subsection 160APQ(3)' was appropriate. However, subsection 160APQ(3) now allows a franking credit to arise, although reduced by 80 per cent. The proviso in subsection 160APQ(3) is therefore no longer appropriate and has been amended by making section 160AQZA operative where subsection 160APQ(3) applies to reduce a franking credit arising under 160APQ(1). [Item 126, new section 160AQZA]
3.106 An additional defect in section 160AQZA that applies to mutual life assurance companies has also been corrected. Under section 160APKA, no franking credits arise to mutual life assurance companies. However, because section 160AQZA is based on the premise that franking credits will arise, mutual life assurance companies were effectively denied a franking rebate. To overcome this defect section 160AQZA will apply as if section 160APKA did not exist. [Item 126, new section 160AQZA]
3.107 Because the defect in section 160AQZA produces a result that is clearly unintended and inconsistent with policy, the amendments will apply from the time the defect came into existence. This means that the amendments to section 160AQZA will affect dividends received through a trust or partnership after 21 August 1990 (the date from when section 160APKA denies franking credits for mutual life assurance companies). [Subitem 160(2)]
3.108 Ordinary companies receive a franking credit for franked dividends received but do not 'gross up' the dividend or receive a franking rebate. However, section 160AQT, in conjunction with section 160AQW, requires all companies to include in their assessable income the gross-up of their share of franked dividends received by a trust or partnership. To ensure they are not taxed on amounts which they do not receive (and do not get a rebate for), section 160AR allows shareholders who receive a franking credit for the dividend (i.e. companies) a deduction for the gross-up.
3.109 At the time section 160AR was enacted, life assurance companies received a rebate but did not receive franking credits for statutory fund dividends because of the former subsection 160APQ(3). Therefore section 160AR would not apply. However, now they do receive franking credits (but reduced by 80 per cent). Therefore, it is arguable that section 160AR applies to allow a deduction for the gross-up of dividends paid to the statutory fund of the company, even though section 160AQZA also allows a rebate for that amount. This is inappropriate since the deduction is intended to apply only where the franking rebate is not available.
3.110 Section 160AR has therefore been amended so that it only applies when a franking credit arises under section 160APQ which is not reduced by subsection 160APQ(3) [Items 127, 128, 130 and 131; amended section 160AR]
3.111 The defect in section 160AR also produces a result that is clearly unintended and inconsistent with policy. Therefore it is appropriate for the amendments to apply from the time the defect came into existence. This means that the amendments to section 160AR will apply to deny a deduction in relation to dividends received through a trust or partnership during a company's first franking year that commences after 6 December 1990, and subsequent franking years. [Subitems 160(3) and (4)]