Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
Chapter 3 - Company rate change (franking account and infrastructure borrowings rebate consequentials)
3.1 This Chapter explains the amendments made in Schedules 3 and4 to this Bill to the dividend imputation and infrastructure borrowings rebate provisions as a consequence of the changes to the company tax rate made by the Income Tax Rates Bill No. 1.
3.2 In particular, this Bill inserts Division 14 into Part IIIAA of the ITAA 1936 which generally deals with the conversion of those aspects of the imputation system that reflect an underlying company tax rate of 36% so that they reflect an underlying rate of 34% instead. This rate is proposed to be the company tax rate in the 2000-2001 income year.
3.3 This Bill also amends section 159GZZZZG of the ITAA 1936 to ensure that the infrastructure borrowings rebate is calculated by reference to the new company tax rates.
3.4 The changes generally apply to the imputation system from 1July 2000 and to dividends paid on or after that date. The changes to the infrastructure borrowings rebate apply to the 2000-2001 income year for the 34% rate and from the 2001-2002 income year for the 30% rate.
3.5 The reductions in the company tax rate provided for in the Income Tax Rates Bill No. 1 are a key component of the New Business Tax System announced in Treasurers Press Release No. 58 of 21 September 1999 (refer to Attachment A).
3.6 The reduced company tax rate will provide Australia with an internationally competitive company tax rate. The eventual reduction of the company tax rate to 30% will bring the Australian rate into line with rates in other countries in the Asia Pacific region and will boost investment in Australia.
3.7 As a result of the reduction in the company tax rate for the 2000-2001 and later income years, consequential amendments are needed to the dividend imputation and infrastructure borrowings rebate provisions.
3.8 The amendments made to the imputation system in this Bill are generally limited to the class C franking account and transactions affecting that account. The class C franking account currently reflects the 36% company tax rate.
3.9 Amendments affecting the class A franking account to reflect proposed changes to the taxation of life insurance companies will be addressed in a future Bill. The class A franking account reflects the 39% rate. A life insurance company will no longer pay tax on any part of its taxable income at the 39% rate as a result of the proposed changes to the taxation of life insurance companies.
3.10 In broad terms, the amendments to the imputation system will:
- convert existing class C franking account balances (which are based on an underlying tax rate of 36%) so that they are based on the new company tax rate of 34% from 1 July 2000;
- generally convert franking credits and franking debits arising on or after 1 July 2000 to reflect the new company tax rate of 34% (if the credits and debits are based on another underlying company tax rate); and
- provide that most franked dividends paid on or after 1 July 2000 carry underlying imputation credits reflecting a 34% rate.
|New Law||Current Law|
|Most franking credit and debit entries made to a company's franking account will be calculated by reference to the 34% company tax rate.||Most franking credit and debit entries made to a company's franking account are calculated by reference to the 36% company tax rate.|
|Most franking rebates will be calculated by reference to the 34% company tax rate.||Most franking rebates are calculated by reference to the 36% company tax rate.|
3.11 Companies will be required to convert their class C franking account on 1 July 2000 to take account of the new 34% company tax rate.
3.12 A company converts its class C franking account at the start of 1 July 2000 by:
- cancelling any class C franking surplus or deficit existing at that time with:
- in the case of a surplus, an offsetting franking debit equal to the surplus; or
- in the case of a deficit, an offsetting franking credit equal to the deficit; and
- reinstating any class C franking surplus or deficit with a class C franking credit or debit equal to the offsetting franking debit or credit adjusted by the factor:
(36/64) * (66/34)
[Schedule 3, item 13, sections 160ATA and 160ATB]
3.13 For a company with a franking year that starts on 1 July 2000, the conversion of the class C franking account occurs after any franking credit arises which carries forward a franking surplus from the previous franking year. [Item 13, subsection 160ATA(2)]
3.14 Despite this conversion, the account will be retained and have the same name the class C franking account. This avoids the need for extensive amendments to the imputation system to reflect an account with a new name.
Street Smart Ltd maintains a class C franking account and has a franking year of 1 June to 31 May. On 1 July 2000 its class C franking account has a deficit balance of $500. It converts its account to reflect the changed company tax rate as follows:
* class C franking account balance
* offsetting class C franking credit
* reinstating class C franking debit
[$500 * (36/64 * 66/34)]
* class C franking account balance
* offsetting class C franking debit
* reinstating class C franking credit
[$630 * (36/64 * 66/34)]
3.15 A further consequence of the change in the company tax rate is that all franked dividends paid on or after 1 July 2000 will carry imputation credits reflecting the 34% company tax rate. This means that franking rebates claimed by shareholders on a class C franked dividend paid on or after 1 July 2000 will be based on the 34% company tax rate. This change also applies to franking rebates claimed by beneficiaries and partners because a class C franked dividend is paid to a trust or a partnership on or after 1 July 2000.
3.16 This result is achieved by omitting the reference to 36% in paragraph (cb) of the definition of applicable general company tax rate in section 160APA of the ITAA 1936 and replacing it with 34%. [Item 2]
Example 3.2 Sebastian is a shareholder in Big Jean Ltd. On 1 July 2000, Big Jean pays a $200 fully franked class C dividend to Sebastian.The applicable general company tax rate for the purposes of the payment of the franked dividend is 34%. This means the additional amount included in Sebastian's assessable income under subsection 160AQT(1AB) is equal to $200 * 34/66, or $103.03. Sebastian is also entitled to a franking rebate (i.e. a tax offset) of the same amount under section 160AQU.
3.17 The amendments will also ensure that shareholders receive clear information about the nature of their franked dividends, particularly given that the class C franking account name will be maintained. The shareholder statement in relation to a dividend paid on or after 1 July 2000 must include the gross up amount for the dividend (calculated under subsection 160AQT(1AB)) and specify that the applicable company tax rate used to calculate the gross up amount is 34%. [Item 4, subparagraph 160AQH(1)(b)(iva)]
3.18 Once franking accounts are converted to reflect the new 34% company tax rate, it is necessary to ensure that franking credits or debits arising on or after 1 July 2000 reflect the 34% company tax rate. This means that franking credits and franking debits that are based on a different underlying rate will generally be converted to equivalent credits and debits based on the new rate. [Item 13, section 160ATD]
3.19 In summary:
- class A franking credits and debits (other than those for life insurance companies) are converted into equivalent class C franking credits and debits using the factor:
(39/61) * (66/34)
- class B franking credits and debits are converted into equivalent class C franking credits and debits using the factor:
(33/67) * (66/34)
- class C franking credits and debits that have been calculated by reference to the 36% company tax rate are converted into equivalent 34% class C franking credits and debits using the factor:
(36/64) * (66/34)
[Item 13, table in subsection 160ATD(1)]
3.20 Class A franking credits and debits for life insurance companies are not converted [item 13, table in subsection 160ATD(1), items 1 and 2] . These credits and debits will be converted as part of proposed changes to the taxation of life insurance companies that will be addressed in a later Bill.
3.21 However, not all old class A, B, or C franking credits or debits arising on or after 1 July 2000 are necessarily converted. Those that are not converted include:
- franking credits and debits arising under Division 14. These franking credits and debits arise as part of the conversion to reflect the new company tax rate. To convert them again would frustrate the conversion;
- franking credits arising under section 160APL. These franking credits, which carry forward franking surpluses from previous franking years, are already taken into account in the conversion process (see paragraph 3.13); and
- franking debits arising under sections 160APX (underfranking debits), 160AQB (payment of franked dividends), 160AQCB, 160AQCBA, 160AQCC, 160AQCNA, 160AQCNB and 160AQCNC (all of which arise in relation to dividend streaming arrangements). It is unnecessary to convert these franking debits because they will already be calculated by reference to the 34% rate if they arise on or after 1 July 2000.
[Item 13, subsection 160ATD(1)]
3.22 A critical part of maintaining the class C franking account name is to identify those credits and debits that arise at a 36% rate. Only those credits and debits should be converted those reflecting a 34% rate should not be converted.
3.23 To achieve this, the Bill stipulates when a credit or debit reflects an applicable general company tax rate of 36% [item 13, subsection 160ATD(2)] . The most common case of where a credit or debit reflects an applicable general company tax rate of 36% is where that rate is used in working out the amount of the credit or debit (including where that rate is used in working out an adjusted amount for the purposes of working out the amount of a credit or a debit). An example is a franking credit arising from a payment of tax at the 36% rate.
3.24 A company which ceases to be a life insurance company on or after 1 July 2000 will have its class A franking surplus or deficit converted and moved to the class C franking account at the time the company ceases to be a life insurance company. In order for the conversion to take place, it is necessary that the company still exists after it ceases to be a life insurance company. [Item 13, section 160ATE]
3.25 The process for converting the accounts is similar to the conversion process explained in paragraphs 3.11 to 3.14 for the conversion of class C franking accounts.
3.26 Section 160ATE will be affected by the proposed changes to the taxation of life insurance companies to be addressed in a future Bill.
3.27 Division 13 of Part IIIAA of the ITAA 1936 contains provisions that deal with:
- the conversion of class A and B franking credits and debits into equivalent class C franking credits and debits; and
- companies ceasing to be life insurance companies,
following the increase in the company tax rate from 33% to 36% from the 1995-1996 income year. A new provision has been inserted to ensure that these provisions in Division 13 do not operate in relation to events occurring on or after 1 July 2000 [item 6, section 160ASEA] . Sections 160ATD and 160ATE (see paragraphs 3.18 to 3.26) will apply instead.
3.28 In addition, amendments have been made to Division 13 to ensure that other provisions within it continue to operate appropriately and reflect the 34% company tax rate. [Items 7 to 12]
3.29 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 account at the time the dividend is paid. When a company pays a franked dividend, the franking account will be debited at least to the extent of the required franking amount.
3.30 The required franking amount of a dividend can be affected by the required franking amount or the franked amount of an earlier dividend. In particular, the required franking amount rules effectively require dividends paid under a single resolution to be franked to the same extent. This is achieved by calculating the required franking amount of a dividend by reference to the franking surplus on the reckoning day for that dividend. For a dividend paid under a resolution, the reckoning day is the day on which the first dividend in the resolution is paid.
3.31 Therefore, where dividends under a resolution are paid both before and after 1 July 2000 anomalies could arise. The required franking amount of a dividend paid on or after 1 July 2000 that will carry imputation credits at a 34% rate would be worked out by reference to a franking surplus based on the 36% rate.
3.32 To address this situation 3 specific amendments have been made:
- providing for resolution splitting for dividends straddling 1 July 2000;
- allowing variations to dividend declarations; and
- providing modifications to the rules relating to over-franked earlier dividends.
3.33 Where a company:
- pays a number of class C franked dividends under a resolution made before 1 July 2000; and
- some of the dividends (first series dividends) are paid before that date, while other dividends (second series dividends) are paid after that date;
the first series dividends and second series dividends will be taken to have been made under separate resolutions. [Item 13, subsection 160ATF(1) and paragraph 160ATF(2)(a)]
3.34 The effect of this rule is that the second series dividends will have their required franking amount worked out on the basis of a franking surplus that has been converted on 1 July 2000 to a 34% rate.
Example 3.3 Tree Surgeons Ltd makes a resolution on 10 December 1999 under which dividends are payable on 5 May 2000 (dividend 1) and 5 November 2000 (dividend 2). The reckoning day for these dividends is therefore 5 May 2000.Under subsection 160ATF(1), this resolution will be split into 2 separate resolutions one dealing with dividend 1 and the other dealing with dividend 2. The reckoning day for dividend 1 is still 5 May 2000 and the calculation of the required franking amount will remain substantially unaltered. The reckoning day for dividend 2 will now be 5 November 2000 and the required franking amount will be worked out on the basis of the franking surplus on that day. That surplus will reflect the 34% rate, just as the imputation credits underlying the franked dividend will.
3.35 If a company has already made a declaration under section 160AQF in relation to the dividends, the second series dividends may be franked to a different extent than that set out under the new required franking amounts for those dividends.
3.36 To deal with this, the original declaration made under section 160AQF will be taken to have applied to the first series dividends and the company will be permitted to make a further declaration in respect of the second series dividends. [Item 13, paragraph 160ATF(2)(b)]
3.37 However, if the company makes no declaration in respect of the second series dividends before the new reckoning day for those dividends, the dividends will be taken to be franked to the same percentage as the first series dividends. [Item 13, paragraph 160ATF(2)(c)]
Example 3.4 Continuing from Example 3.3, Tree Surgeons may make a new declaration for dividend 2 before 5 November 2000 if it had previously made a declaration in relation to dividends 1 and 2. If Tree Surgeons does not make a new declaration for dividend 2, the declaration originally made for both dividends 1 and 2 will stand for dividend 2.
3.38 Circumstances may also arise where, before 1 July 2000, a company declares dividends under a resolution to be franked based on the 36% company tax rate, but no dividend will be paid under that resolution until on or after 1 July 2000.
3.39 Ordinarily, section 160AQF declarations cannot be varied because of subsection 160AQF(2). However, an exception will be made where a resolution is made before 1 July 2000 but no dividends under the resolution are paid until on or after that date. In these cases, any declaration can be varied before the reckoning day of the dividend to take into account the new 34% company tax rate. [Item 13, section 160ATG]
3.40 Subsection 160AQE(3) provides that if a company over-franks a dividend (called the earlier franked dividend in that subsection), and there is a committed future dividend, that committed future dividend must be franked to at least the same extent.
3.41 It could be the case that the committed future dividend (called the current dividend in subsection 160AQE(3)) may have a reckoning day after 1 July 2000, but the earlier franked dividend has a reckoning day before that time. This means that the required franking amount of the current dividend may be affected by the franked amount of the earlier dividend, which will not reflect the new 34% company tax rate.
3.42 To prevent the required franking amount of the current dividend being distorted by the franked amount of the earlier dividend, the amendments will convert franked amounts of earlier dividends into amounts reflecting a 34% rate. [Item 13, section 160ATH]
3.43 Section 160AQG effectively provides that dividends that are part of a combined class of dividends must be equally franked. If this is not the case, then the dividends will all be treated as though they had been paid under the resolution relating to the first dividend of the class to ensure that those dividends are equally franked. The purpose of this section is to prevent blatant dividend streaming arrangements.
3.44 A new provision has been inserted to ensure that companies are not inappropriately caught by section 160AQG where a combined class of dividends paid during a franking year straddles 1 July 2000. The provision splits the franking year (other than one starting on 1 July 2000) into 2separate franking years the first ending on 30 June 2000 and the second starting on 1 July 2000. [Item 3, subsection 160AQG(4)]
3.45 The effect of this amendment is that section 160AQG will apply separately in respect of the 2 split franking years. This rule means that companies will not be subject to section 160AQG if dividends are not equally franked only because of the rules relating to the conversion of franking accounts to reflect the new company tax rate.
3.46 Notwithstanding these amendments, companies that enter into a strategy to stream franking credits can still expect to attract the operation of the various anti-streaming rules elsewhere in Part IIIAA.
3.47 A company can request an estimated debit determination if it can foresee a refund of company tax in certain circumstances. An estimated debit determination will give rise to a franking debit. This means that dividends can be franked to take account of the estimated debit.
3.48 Under the current law, a taxpayer may apply to the Commissioner for a class C estimated debit determination under section 160AQDAA. However, if the Commissioner does not make a declaration within 21 days, the Commissioner is deemed to have made a determination of the amount requested in the application.
3.49 The period of 21 days means that applications made between 9 June 2000 and 1 July 2000 may be based on a 36% or a 34% rate of company tax. To accommodate this situation, the amendments allow a company to specify in its application whether the application is based on the 34% or 36% tax rate. However, if the company does not specify a tax rate, the application will be treated as though it were based on the 36% tax rate. [Item 13, section 160ATI]
3.50 Companies should ensure any application made on or after 1 July 2000 is based on the 34% company tax rate.
3.51 This Bill makes changes to venture capital sub-accounts, which basically reflect the general changes outlined in relation to class C franking accounts above. Venture capital sub-accounts are being introduced in this Bill and are explained in greater detail in Chapter 4.
3.52 The following references in the imputation provisions that rely on a company tax rate of 36% will be replaced by references relying on the new rate of 34%:
- in paragraph (baa) of the definition of applicable general company tax rate (which applies in relation to a company's liability to pay class C franking deficit tax or class C deficit deferral tax) in section 160APA [item 1] ; and
- in the formula in subsection 160AQJC(4) which calculates the gross class C deficit deferral amount for the purposes of working out liabilities to class C deficit deferral tax [item 5] .
3.53 Division 16L of the ITAA 1936 is designed to encourage private investment in the construction of certain public infrastructure projects. The Division effectively transfers the benefit of interest deductions from borrowers to lenders in these projects. Under that Division, taxpayers may currently elect to benefit from a tax rebate in relation to the interest under a loan at a rate of 36% that is, the current company tax rate.
3.54 The references to the 36% rate in section 159GZZZZG are amended by this Bill to account for the change in the company tax rate to 34% for the 2000-2001 income year. [Schedule 4, items 1 to 4]
3.55 The references to the 34% rate will then be amended to take account of the change in the company tax rate to 30% for the 2001-2002 and later income years. [Schedule 4, items 6 to 9]
3.56 The following amendments apply to relevant dividends paid on or after 1 July 2000:
- item 2 of Schedule 3, which provides for the change in the applicable general company tax rate for the payment of class C franked dividends and for trust amounts and partnership amounts related to the payment of class C franked dividends (see paragraphs 3.15 and 3.16) [Schedule 3, subitem 14(2)] ;
- item 4 of Schedule 3, which modifies the requirements for dividend statements (see paragraph 3.17) [subitem 14(3)] ; and
- items 7 to 12 of Schedule 3, which modify the operation of Division 13 of Part IIIAA to reflect the new company tax rate of 34% (see paragraph 3.28) [subitems 14(5) and 14(6)] .
3.57 The amendments in items 1 and 5 of Schedule 3 that reflect the new company tax rate of 34% for the purposes of franking deficit tax and deficit deferral tax (see paragraph 3.52) apply to:
- franking deficit tax for franking years ending on or after 1 July 2000; and
- deficit deferral tax in relation to company tax instalments paid during a franking year ending on or after 1 July 2000.
[Subitems 14(1) and 14(4)]
3.58 The amendments to the infrastructure borrowings rebate provisions to reflect the new company tax rate of 34% in items 1 to 4 of Schedule 4 (see paragraph 3.54) apply to assessments for the 2000-2001 income year. [Schedule 4, item5]
3.59 The amendments to the infrastructure borrowings rebate provisions to reflect the new company tax rate of 30% in items 6 to 9 of Schedule 4 (see paragraph 3.55) apply to assessments for the 2001-2002 and later income years. [Item 10]
3.60 There are no other consequential amendments.