Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello MP)
Chapter 3 - Franking of dividends
3.1 Schedule 3 to this Bill will amend Part IIIAA of Income Tax Assessment Act 1936 (ITAA 1936) to make a number of changes to the franking credit trading and dividend streaming rules. Changes to the 45 day rule will:
- make a correction to section 45ZB;
- allow a deduction where franking rebates exceed the ceiling imposed under the benchmark portfolio ceiling method; and
- treat shares and interests in shares held by a bare trust as if they were held by the beneficiaries of the trust.
3.2 A change to the limiting the source rule will remove the restrictions on exempting credits for dividends paid by former exempting companies for natural persons where all the shares are owned by natural persons and there has been no change in ownership of the company.
3.3 Schedule 3 will also amend the Taxation Laws Amendment Act (No.3) 1998 to extend the scope of a transitional concession for the general anti-avoidance rule in section 177EA of the ITAA 1936 and the specific anti-streaming rule in section 160AQCBA of the ITAA 1936 .
3.4 The purpose of these changes is to make corrections to the franking credit trading and dividend streaming rules to ensure that they operate as intended.
3.5 These changes will apply from the commencement of the relevant measures.
3.6 The franking credit trading and dividend streaming rules restrict the benefits of franking credits and the franking rebate (franking benefits) or the intercorporate dividend rebate to taxpayers who are the economic owners of shares. These changes affect the following rules:
- the 45 day rule, which applies to shares acquired from 1 July 1997, requires a shareholder to hold shares for at least 45 days at risk to be eligible for franking benefits or the intercorporate dividend rebate for dividends paid on the shares;
- the related payments rule, which applies to arrangements entered into from 13May 1997, denies franking benefits and the intercorporate dividend rebate to a shareholder who is under an obligation to make related payments on substantially similar property;
- the limiting the source rule, which applies from 13 May 1997, restricts the use of franking credits of companies effectively wholly owned by non-resident or tax-exempt persons;
- a general anti-avoidance rule set out in section 177EA of the ITAA 1936, which applies to schemes entered into from 13 May 1997 for the disposition of shares with a non-incidental purpose of conferring a franking advantage; and
- an anti-streaming rule set out in section 160AQCBA of the ITAA 1936, which applies from 13 May 1997, prevents companies streaming franking credits to shareholders most able to benefit from franking.
3.7 A trust, or a partnership if prescribed by regulations, may make an election under 160APHR of the ITAA 1936 to have a franking credit or rebate ceiling applied against shares or interests in shares managed in a discrete fund. Section 45ZB caps the intercorporate dividend rebate available to corporate beneficiaries or partners that receive dividends indirectly through one or more interposed trusts or partnerships.
3.8 Item 1 makes a correction to paragraph 45ZB(6)(d) , which sets out the formula for calculating the amount of the rebate where a companies average rate of tax is not the general rate of tax. [Item 1]
3.9 Under new subsection 160APHH(6) , bare trustees and nominees holding shares (but not interests in shares) for a single beneficiary are to be ignored for the purposes of Division 1A ; instead, the shares are to be treated as if they are held by the beneficiary. [Item 2, new subsection 160APHH(6)]
3.10 This will be an exception to the rule in subsection 160APHU(1), which otherwise requires trustees to be qualified persons before beneficiaries may be qualified persons. The object of this change is to reduce compliance costs for nominees and custodians. Item 4 amends subsection 160APHU(1) accordingly. [Item 4]
3.11 This exception will apply to a trust where there is a single beneficiary under the trust and that beneficiary is absolutely entitled to the shares held by the trustee. A person is absolutely entitled to trust property if he or she is able to direct the trustee how to deal with trust property and to give the trustee a good receipt for anything with which the trustee has parted; that is, the beneficiary must be sui juris, and have a vested, indefeasible, and absolute interest in the trust property so that the trustee may be compelled to convey the trust property to the beneficiary if so requested. In such a case, there is an identity of interest between the trust and the beneficiary; indeed, the trustee is effectively an agent of the beneficiary; and it is therefore unnecessary to apply the provisions in the new Division to the trustee.
3.12 New paragraph 160APHH(6)(c) will therefore require the Division to be administered as if the shares or interests held by the trustee were held directly by the beneficiary, including, of course, the act of deriving income from the shares. This will effectively exempt bare trustees from the Division and render it unnecessary for them to be qualified persons in relation to a dividend. (However, the beneficiary must still satisfy the relevant requirements.)
3.13 Properly, a trustee is not a bare trustee if there are duties to be performed under the trust. However, it is not uncommon for nominees and custodians to be authorised or required by their beneficiaries to perform duties on their behalf, which may include hedging. Accordingly, the exception does not exclude a trustee merely because the trustee has duties to perform. Anything done in the performance of those duties by the trustee, such as entering into hedges, is automatically attributed to the beneficiary under new subparagraph 160APHH(6)(c)(ii) .
3.14 Since the shares held by the trustee are treated as being held by the beneficiary, transfers of the shares between trustee and beneficiary are disregarded under new paragraphs 160APHH(6)(d) and (e) . This means, for example, that if shares are transferred from one to the other, any days during which either of them held shares at risk are counted in determining whether the beneficiary has satisfied the holding period rule.
3.15 If new subsection 160APHH(6) ceases to apply to a trust, new section 160APHH(7) specifies what occurs. Subject to some special rules for trusts which become widely-held trusts, new subsection 160APHH(6) is treated, from that time on, as never having applied: the ordinary rules in new Division 1A regarding trusts will therefore apply. Consequently, from that time on, the trustee must be a qualified person in relation to a dividend if franking benefits are to be passed to the beneficiaries of the trust, and in determining whether, from that time on, the trustee is a qualified person, regard is to be had to the acts previously imputed to the beneficiary by new paragraph 160APHH(6)(c) . Except for trusts which become widely-held trusts, that means the trustee will be treated as having held its shares from the times they were acquired, or would have been taken to have been acquired, but for new subsection 160APHH(6) ; likewise, the beneficiary will be treated as having held its interest or interests in shares from the time which would, but for new subsection 160APHH(6) , have been treated as the acquisition dates. [Item 2, new subsection 160APHH(7)]
3.16 For widely-held trusts the situation is different: when a bare trust to which new subsection 160APHH(6) formerly applied becomes a widely-held trust, the beneficiary is deemed to dispose of the shares to the trustee at the time of conversion, and then acquire an interest in the shares; and the trustee is taken to acquire the shares at that time. Widely-held trusts receive special treatment under new subsection 160APHH(7), because, unlike other trusts, the new rules do not look through the trust to see if the beneficiary has a continuing interest in particular shares; it only requires a continuing interest in the trust property as a whole.
3.17 The respective positions of the trustee and beneficiary in relation to the shares or interest in shares are determined accordingly. Thus in deciding whether the trustee or beneficiary of a non widely-held trust has held a share or interest at risk for the requisite number of days, regard is had to their positions after conversion, because the trust is only taken to acquire its shares, and the beneficiary its interest in shares, after conversion. (The positions of the trustee may, of course, result from acts done before conversion and previously imputed to the beneficiary.)
3.18 For example, if the trust has actually held shares for 20 days before new subsection 160APHH(6) ceased to apply, its positions in that period would be examined to see if risk was materially diminished; if it held the shares without materially diminishing risk, and did not become a widely-held trust, that holding would count with any subsequent holding. Thus if the trust held the shares for a further 25 days during the primary qualification period, the first 20 days would count with the later 25days for the purposes of determining whether the trustee is a qualified person. But if the trust becomes a widely-held trust, the first 20 days would not count because the trustee would be taken to acquire the shares only on conversion.
3.19 When a trust to which new subsection 160APHH(6) ceases to apply does not become a widely-held trust, there is no deemed disposal of shares by the beneficiary; instead the beneficiary is treated as always having had an interest in shares. However, generally there will be an actual disposal of an interest in shares by the beneficiary to a third party. That is because the entitlement of the beneficiary in the shares held by the trust could not cease to be absolute unless the beneficiary has alienated an interest in the shares, or consented to a resettlement; nor, generally speaking, could a beneficiary be added to the trust with the alienation of an interest in the shares held on trust. If there is an actual disposal by the beneficiary of an interest in shares it will be relevant to the question of whether the beneficiary is a qualified person.
3.20 New subsection 160APHH(7) cannot apply, it should be observed, to the divestment of an interest owing to the happening of any contingency, or the failure of a condition, because contingent and defeasible interests are incapable of constituting an absolute entitlement to the trust property.
3.21 Where a taxpayer has elected under section 160APHR of the ITAA 1936 to use the benchmark portfolio ceiling method instead of the 45 day rule to determine the entitlement to franking benefits, section 160AQZF of the ITAA 1936 places a ceiling on the franking rebates or intercorporate dividend rebates to which the taxpayer is entitled. Under the current benchmark ceiling method rules, the assessable income of a taxpayer who is denied franking rebates in excess of the ceiling amount will be increased inappropriately under the grossing up rules. As a result, a taxpayer would be required to pay tax on the grossed up amount but would not receive a corresponding franking rebate.
3.22 New subsection 160AQZF(6) provides that, where the sum of the rebates of tax to which the electing taxpayer is entitled under Part IIIAA of the ITAA 1936 (ie. the franking rebates) exceeds the ceiling amount calculated under subsection 160AQZF(2) of the ITAA 1936, the excess will be allowable as deduction from the taxpayers assessable income of the year of income. [Item 6 ; new subsection 160AQZF(6)]
3.23 Item 3 amends subsection 160APHR(8) to clarify that a taxpayer who makes an election to use the benchmark portfolio ceiling method will be a qualified person in relation to dividends paid on shares held by the taxpayer to which the election applies . [Item 3]
3.24 The general anti-avoidance rule in section 177EA of the ITAA 1936 and the specific anti-streaming rule in section 160AQCBA of the ITAA 1936 generally apply to dividends paid, or distributions made in respect of dividends, after 7.30 pm on 13 May 1997 when they were announced. However, as a concession, the measures do not apply to dividends paid by a listed public company after this time if the dividends were declared before this time, or to distributions related to such dividends made after this time. This concession is set out in subitem 26(3) of Schedule 8 to the Taxation Laws Amendment Act (No. 3) 1998 .
3.25 However, this concession does not extend to distributions made after this time related to dividends declared and paid before this time. To remove this anomaly, item7 amends paragraph 26(3)(b) in Schedule 7 to the Taxation Laws Amendment Act (No. 3) 1998 to extend the concession to all distributions made after 7.30 pm on 13 May 1997 if the related dividends were declared before this time. [Item 7, new paragraph 26(3)(b) in Schedule 7 to Taxation Laws Amendment Act (No. 3) 1998]
3.26 New subsection 160AQTB(4) is intended to deal with the rare case where a company becomes an exempting company because the individuals who own it leave Australia and cease to be residents, and then becomes a former exempting company because the owners return to Australia. If this change was not made, individuals in this position would be unable to claim a franking rebate for their own franking credits. To prevent unnecessary complexity, new subsection 160AQTB(4) addresses only the simplest scenario; other cases would be very rare indeed. [Item 5, new subsection 160AQTB(4)]
3.27 For new subsection 160AQTB(4) to apply to an exempted dividend distributed by a former exempting company, each of the following conditions must be satisfied:
- all the shares in the company must be owned, directly or indirectly, by natural persons who are residents. Indirect ownership includes ownership through fixed trusts and partnerships, but not discretionary trusts since discretionary objects of a trust do not have an ownership interest in the trust property;
- the company must become an exempting company because some or all of the individual owners cease to be residents (and not, for example, by reason of a sale of shares to non-residents);
- the company must become a former exempting company because all and not merely some of the original owners are once more residents; and
- all the shares in the company must continue to be owned by the original owners (though not necessarily in the same proportions) from the day the company became an exempting company to the day the relevant distribution is received.
3.28 Where these conditions are satisfied, the exempting credit attached to the distribution is treated as if it were a franking credit, and the individual receiving the distribution accordingly receives a franking rebate. New subsection 160AQTB(4) does not include anti-avoidance provisions but section 177EA of the ITAA 1936 will apply to arrangements which amount to a disposal of shares for a purpose of conferring a franking benefit.