Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 1 - Intercorporate dividend rebate
1.1 This Chapter explains changes to the taxation of dividends that are paid by one company to another. There are 2 elements to the changes:
- where the dividend is unfranked, no section 46 rebate will be allowed unless the dividend is paid within a wholly owned company group;
- where a resident company receives an unfranked non-portfolio dividend and on-pays it to its non-resident parent, the denial of the section 46 rebate will effectively be negated by allowing a deduction for the on-payment.
1.2 The first change affects only certain dividends. The law does not change for private companies, dual residents, dividends paid by certain exempting companies, or dividends subject to certain determinations made by the Commissioner.
1.3 The second change affects only resident companies that receive and on-pay certain unfranked dividends to a non-resident parent.
1.4 The changes apply to dividends paid on or after 1 July 2000. They are in Schedule 1 to this Bill and alter section 46F of the ITAA 1936.
1.5 Sections 46 and 46A of the ITAA 1936 provide that resident company shareholders are generally entitled to a rebate for dividends received from other resident companies.
1.6 However, this is limited by certain provisions. For example, among other things, section 46F denies the rebate to private companies that receive unfranked dividends, and for unfranked dividends paid or received by dual residents.
1.7 The current law treats different resident companies in an inconsistent manner. It has resulted in loopholes because most unfranked dividends between companies are freed from tax. This has led to a wide range of complex anti-avoidance provisions dealing with the availability of the section 46 rebate.
1.8 The Review considered the advantages of the current treatment to be unwarranted where the distribution is not between companies within a wholly owned group. Therefore, it recommended that the law be altered.
1.9 The proposed changes to unfranked dividends may impede investment in Australia by non-residents by treating different forms of investment differently.
1.10 Non-residents who invest in Australia by setting up an Australian resident subsidiary may be adversely affected by these changes. However, non-residents who invest directly in an incorporated joint venture, or through an Australian partnership or trust will not be affected by this measure. This is because, in these cases, a distribution to the non-resident will usually be subject to dividend withholding tax (generally at a 15% rate) rather than being taxed at the company tax rate. To ensure that this does not occur, the effect of removing the section 46 rebate will be offset by a deduction in certain circumstances.
1.11 The Review considered that the tax system should not discriminate against commercially viable projects depending on whether investment is made through an incorporated or unincorporated joint venture. Therefore, it recommended that all non-residents who invest in Australia be treated in the same manner.
1.12 The new law will ensure consistent treatment of all resident companies that receive unfranked dividends. Section 46F will apply to deny a rebate on unfranked dividends that are received by all resident companies, unless the distribution is paid between resident companies within a wholly owned company group.
1.13 Broadly, the new law will also ensure consistent treatment of non-residents who invest in Australia. Sections 46FA and 46FB will operate to negate the denial of the section 46 rebate in certain cases by allowing a deduction for on-payments of unfranked non-portfolio dividends by a resident company to its non-resident parent.
1.14 The new law applies to dividends paid on or after 1 July 2000.
|New Law||Current Law|
|No company will be entitled to a rebate for unfranked dividends unless the distribution is paid between companies within a wholly owned group.||Most unfranked dividends received by a resident company are entitled to a rebate under section 46 unless:
|The new law will operate to negate the denial of the section 46 rebate in certain cases above by allowing a deduction for on-payments of unfranked non-portfolio dividends by a resident company to its non-resident parent.||The current law is explained above. The new law is necessary to ensure that the current treatment effectively continues in these cases.|
1.15 Most resident public companies that receive unfranked dividends will no longer be entitled to a rebate on those dividends [Schedule 1, item 1, subsection 46F(2)] . However, this does not apply if the dividend is paid within a wholly owned company group. This ensures consistent treatment of unfranked dividends received by public and private resident companies.
Example 1.1 Curtains Ltd and Blinds Ltd are resident public companies that are not members of a wholly owned company group. Curtains pays an unfranked dividend to Blinds. Blinds will not be entitled to a rebate under section 46 of the ITAA 1936 for this dividend.
1.16 The new law will also ensure that a company that receives an unfranked dividend through a trust or partnership will generally not be entitled to a section 46 rebate. This is because in most situations a company would not be entitled to a rebate if it had received the dividend directly (rather than indirectly through the trust or partnership). Because entitlement to the rebate for corporate beneficiaries and partners is determined through section 45Z, which adopts a look-through approach, a company is only entitled to a rebate if it would have been entitled to a rebate had it received the dividend directly, rather than indirectly through the trust or partnership.
1.17 The law does not change for dividends where the company receiving them is not currently entitled to a section 46 rebate. These dividends include unfranked dividends:
- paid to private companies (other than those within a wholly owned group);
- paid to dual resident companies;
- paid by dual resident companies or certain exempting companies; or
- subject to a determination by the Commissioner under paragraph 160AQCBA(3)(b) or 177EA(5)(b) that no franking credit benefit is available (because the dividend is paid under a dividend streaming or other avoidance arrangement).
South and Daughter Ltd is a resident public company that receives dividends on 30 July 2000:
- The dividend paid by The Chocolate Shoppe is entitled to a section 46 rebate. This is because distributions paid between members of a wholly owned company group are not affected by this measure.
- The dividend paid by Clocks R Us is not entitled to the section 46 rebate. The dividend is subject to this measure.
1.18 The new law acts to ensure consistent treatment of non-residents who invest in Australia. Sections 46FA and 46FB will operate to negate the denial of the section 46 rebate in certain cases by allowing a deduction for on-payments of unfranked non-portfolio dividends by a resident company to its non-resident parent.
1.19 Diagram 1.1 shows the circumstances in which the new law operates, where the conditions for the new law are met.
1.20 A non-portfolio dividend is defined in section 317 of the ITAA 1936 [Schedule 1, item 2, subsection 46FA(11) and item 2, subsection 46FB(6)] . Broadly speaking, it is a dividend paid to a company with at least a 10% voting interest in the company paying the dividend.
1.21 The new law generally applies where:
- a resident company (Company A) pays a non-portfolio unfranked or partly franked dividend to another resident company (Company B) [paragraph 46FA(1)(a)] ;
- Company A and Company B are not members of the same wholly owned company group in the year in which the dividend is paid (where Company A and Company B are members of the same wholly owned company group, the section 46 rebate will generally apply this is discussed at paragraphs 1.15 to 1.17) [paragraph 46FA(1)(b)] ;
- Company B on-pays that amount to its sole non-resident owner as an unfranked or partly franked dividend (the flow-on amount) [paragraphs 46FA(1)(d) and (e)] ;
- the flow-on amount does not exceed the amount in Company B's unfranked non-portfolio dividend account (the account cannot be in deficit see paragraphs 1.29 to 1.36) [subsection 46FA(4)] ;
- the flow-on amount is not greater than the unfranked amount of the dividend on-paid [paragraph 46FA(1)(f)] ;
- Company B makes the relevant declaration in writing before paying the dividend. This is called the flow-on declaration and specifies the amount to be on-paid under these provisions [paragraphs 46FA(1)(f) and subsection 46FA(3)] .
1.22 Company B must be a resident company, wholly owned by the same non-resident company at all relevant times. These times are when it receives the original dividend from Company A, when it makes the flow-on declaration, and when it pays the dividend to its non-resident parent. [Paragraph 46FA(1)(g)]
1.23 Where the requirements of the new law are met, Company B may claim the on-payment as a tax deduction, effectively freeing the unfranked non-portfolio dividend from income tax [subsection 46FA(1)] . The amount eligible to be claimed as a tax deduction is the percentage of the dividend specified in the flow-on declaration multiplied by the unfranked amount of the dividend [subsection 46FA(2)] .
1.24 Provided that the distribution is made in the same income year that Company B derives the dividend, the dividend will be directly freed from tax. If the on-payment is made in a subsequent income year, the deduction is available to free other income from tax in that income year. [Subsection 46FA(1)]
1.25 As the distribution to the non-resident is unfranked, it will usually be subject to dividend withholding tax.
1.26 The operation of the new law is shown in Example 1.3.
The Natural Fertiliser Co and Quality Products Ltd are Australian resident companies. Quality Products is wholly owned by Superbe Nourriture, a French company. Natural Fertilisers and Quality Products are involved in a joint venture to produce high quality organic produce for the international market. They set up a company, Top Notch Organics, in which they each own 50% of the shares. The structure is shown by the following diagram.
Top Notch Organics pays an unfranked dividend of $100 to Quality Products on 15 November 2000. To take advantage of the new provisions, Quality Products:
Top Notch Organics pays an unfranked dividend of $100 to Quality Products on 15 November 2000. To take advantage of the new provisions, Quality Products:
1.27 A company (Company B) is wholly owned by a non-resident company if the non-resident company (Company C) directly owns all of the shares in Company B (both beneficially and legally) [subsection 46FA(6)] . However, if a third party is in a position to affect rights as between Company B and Company C, presently or in the future, then Company B is not wholly owned by a non-resident company [subsections 46FA(7) and (8)] .
1.28 The definition of wholly owned by a non-resident company is based on the definition of 100% subsidiary in section 975-505 of the ITAA 1997.
1.29 A person is in a position to affect rights of Company C in relation to Company B if, for any reason, they are able to acquire those rights, or to somehow prevent either Company B or Company C from exercising those rights as it chooses [subsections 46FA(9) and (10)] . The definition is the same as the definition of in a position to affect rights in section 975-150 of the ITAA 1997.
1.30 A company may set up an unfranked non-portfolio dividend account [subsection 46FB(1)] . However, to take advantage of the new law, a company must set up an unfranked non-portfolio dividend account [subsection 46FA(4)] .
1.31 The account effectively records the unfranked non-portfolio dividends that are available for on-distribution to the non-resident parent company. An on-distribution is taken to be made if a declaration is made to that effect. The on-paid dividend is a flow-on dividend . [Paragraphs 46FA(1)(d) and (f)]
1.32 If the amount in the declaration is more than the surplus in the unfranked non-portfolio dividend account (the account) at the time the declaration is made, a deduction is only allowed for the amount that is actually in the account [subsection 46FA(4)]. This is because the account cannot be in deficit. In other words, a company cannot on-distribute more unfranked non-portfolio dividends than it receives.
1.33 If the total unfranked non-portfolio dividend credits is greater than the total unfranked non-portfolio dividend debits at a particular time, then the account has a surplus. The amount of the surplus is the difference between the credits and debits. [Subsections 46FB(2) and (3)]
1.34 A credit to an unfranked non-portfolio dividend account only arises if Company B receives an unfranked non-portfolio dividend from a resident company (Company A) on or after 1 July 2000. Company A and Company B cannot be part of the same wholly owned company group.
1.35 Also, Company B must be entitled to a rebate under section 46 for the unfranked part of the dividend if it were not for the fact the rebate is denied for unfranked dividends [subsection 46FB(4) and paragraph 46FA(1)(c)] . The effect of this requirement is that no credit will arise if, for example, the dividend is paid under a dividend stripping or franking credit trading arrangement.
1.36 The amount of the credit is the unfranked amount of the dividend. It is credited to the account when it is paid to Company B. [Subsection 46FB(4)]
1.37 Once the declaration has been made, the amount in the declaration is debited to the unfranked non-portfolio dividend account. [Subsection 46FB(5)]
Example 1.4 Using the information in Example 1.3, if Quality Products does not establish an unfranked non-portfolio dividend account, then it cannot claim an income tax deduction for the amount of the on-payment.If Quality Products establishes an unfranked non-portfolio dividend account, then the $100 dividend from Top Notch Organics may be credited to that account.If Top Notch also distributes a $50 franked dividend, this amount cannot be credited to the unfranked non-portfolio dividend account.The unfranked non-portfolio dividend account now has a surplus of $100. On 16 November 2000, Quality Products makes a flow-on declaration. Although it does not on-pay the $100 dividend until 30 May 2001, the account is debited by $100 on 16 November 2000. This is because the amount is debited to the account when the declaration is made.If Quality Products pays $150 to Superbe Nourriture and makes the declaration in relation to $150, then Quality Products is only entitled to an income tax deduction of $100. This is because the unfranked non-portfolio dividend account cannot be in deficit.
1.38 There will be circumstances where the on-payment has a class A or class C required franking amount (under section 160AQE). Because a flow-on declaration can only be made in relation to the unfranked part of a dividend, a company may expose itself to under-franking penalties under section 160APX if it fails to frank the dividend to take advantage of this measure. To prevent this, the flow-on amount of the on-payment is treated as though it were a class A or class C franked amount for the purposes of section 160APX. [Paragraphs 46FA(5)(a) and (b)
1.39 If the dividend has both a class A and a class C required franking amount, then the treatment for the purposes of section 160APX is ordered.
- First, the flow-on amount is treated as though it is a class A franked amount.
- Then, if there is a remaining flow-on amount, it is treated as though it is a class C franked amount.
1.40 This treatment ensures that Company B does not suffer any penalty for under-franking the dividend [subsection 46FA(5)] . This is illustrated by Example 1.5.
Example 1.5 Using the facts from Example 1.3, Quality Products declares a dividend of $200 to Superbe Nourriture, $100 of which is class C franked and $100 of which is unfranked and represents the dividend referred to in Example 1.3. The company has made a flow-on declaration that results in $100 of the dividend being a flow-on amount. The class C required franking amount for the dividend paid to Superbe Nourriture is $160. The on-payment is taken to be franked to $200 for the purposes of section 160APX. Therefore, no under-franking occurs for section 160APX purposes.
Using the facts from Example 1.5, Quality Products is a life insurance company and pays the same dividend, but with the following required franking amounts:
- $80 class A franked amount; and
- $20 class C franked amount
1.41 The denial of the section 46 rebate for unfranked dividends applies to dividends paid on or after 1 July 2000. [Schedule 1, item 4]
1.42 The changes applying to non-resident owned companies apply in relation to unfranked non-portfolio dividends paid on or after 1 July 2000. That is, only those dividends can provide a credit to the unfranked non-portfolio dividend account and so be on-paid to the non-resident owner in a deductible form. For most companies, this will be the start of their 2000-2001 income year. [Item 4]
1.43 Section 12-5 of the ITAA 1997 is a non-operative provision that contains a list of available tax deductions. Deductions that relate to unfranked non-portfolio dividends on-paid to a non-resident parent company under this measure are added to this list. [Schedule 1, item 3, section12-5]