Explanatory Memorandum(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)
General outline and financial impact
Amends the definition of provisional tax uplift factor in the income tax law so that the factor is 6 per cent for the 1996-97 year of income and, until the Parliament otherwise provides, 10 per cent for subsequent years of income.
Date of effect: The amendment applies to the calculation of provisional tax (including instalments) for the 1996-97 year of income.
Proposal announced: 'A New Deal for Small Business' policy document released on 18 February 1996.
Financial impact: A reduction in the uplift factor from 8 per cent to 6 per cent will result in a cost to the revenue of $180 million in the 1996-97 year of income.
Compliance cost impact: The compliance cost impact is negligible.
Amends the income tax law so that in an off-market share buy-back the full buy-back price is treated as consideration for capital gain or ordinary income purposes. Relief from double taxation is provided by reducing the amount of the capital gain or income by the amount of the buy-back price that is a dividend included in assessable income or paid out of profits. If the dividend is rebatable it will not create or increase a capital loss or allowable deduction.
A market value rule is also to apply to off-market share buy-backs. Any excess over the market value of a share that is a dividend will not be frankable.
Date of effect: The amendments will apply to share buy-backs that take place after 7.30pm EST on 9 May 1995, subject to certain transitional arrangements.
Proposal announced: 1995-96 Budget, 9 May 1995.
Financial impact: There is insufficient data available on which a reliable estimate of the revenue impact of this measure can be made. However, the proposed amendments have the potential to prevent a future loss to the revenue.
Compliance cost impact: The proposed amendments are not likely to result in a significant increase in compliance costs. Companies will be required to ascertain the market value of the shares bought back. For listed shares, the market value is readily ascertainable. For unlisted shares, a valuation is required. However, it could be expected that a company would ordinarily make such a valuation prior to a buy-back of the shares.
Amends the income tax law to allow income tax deductions for gifts made to certain funds and organisations.
Dates of effect: Various
Proposals announced: At various times during 1995.
Financial impact: No significant impact on revenue.
Compliance cost impact: There are no compliance cost impacts.
Chapter 1 Provisional tax uplift factor
1.1 Part 1 of Schedule 1 of the Bill proposes to amend subsection 221YA(1) of the Income Tax Assessment Act 1936 (the Act) so that a provisional tax uplift factor of 6 per cent will be used in ascertaining provisional tax payable (including instalments) for the 1996-97 year of income, and 10 per cent for later years of income, until the Parliament otherwise provides.
1.2 The purpose of the amendments is to reduce the provisional tax uplift factor to 6 per cent for the 1996-97 year of income.
1.3 The amendment will apply in relation to the calculation of provisional tax (including instalments) payable for the 1996-97 year of income. [Item 2]
1.4 The amount of income subject to provisional tax for a year is obtained by uplifting the preceding year's taxable income by the provisional tax uplift factor. Provisional tax is then calculated by applying the tax rates and Medicare levy to the uplifted income, and allowing for rebates and credit entitlements (such as tax instalments deducted) which are expected to be claimed or allowed in the provisional year of income (section 221YCAA).
1.5 The level of the uplift factor is intended to be a reasonable reflection of the growth in income of provisional taxpayers. This growth cannot be predicted with accuracy so it is preferable not to place undue emphasis on a specific forecast or estimate in setting the factor. Matters such as inflation effects are taken into account. The factor is intended, on average, over time and across taxpayers, to reflect the expected increase in provisional income.
1.6 The uplift factor for the calculation of 1995-96 provisional income currently stands at 8 per cent (definition of 'provisional tax uplift factor' in subsection 221YA(1)), and for subsequent years of income, 10 per cent. The policy document 'A New Deal for Small Business' announced that the uplift factor of 8 per cent will be reduced to 6 per cent for the purpose of calculating 1996-97 provisional tax.
1.7 This amendment to the definition of provisional tax uplift factor is to provide for the existing definition of 'provisional tax uplift factor' contained in the Act to be repealed and replaced so that the factor of 6 per cent is applicable for the 1996-97 year of income and, until the Parliament otherwise provides, 10 per cent for later years of income. [Item 1]
Chapter 2 Share buy-backs
2.1 Part 2 of Schedule 1 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to ensure that the full purchase price of a share in an off-market share buy-back is treated as disposal consideration for capital gain and ordinary income purposes. Relief from double taxation will be provided by reducing the disposal consideration by the amount of any dividends included in assessable income or paid out of profits. However, a rebatable dividend will not create or increase a capital or revenue loss.
2.2 The amendments will also provide a market value rule for off-market share buy-backs to increase the disposal consideration to market value. If the purchase price exceeds market value, the part of the excess that is a dividend will not be frankable.
2.3 The proposed amendments will prevent:
- companies gaining undue tax advantages from off-market share buy-backs that take place at a price higher or lower than the market value of the shares bought back;
- certain untaxed dividends that arise from an off-market share buy-back reducing taxable gains or increasing tax losses; and
- rebatable dividends that arise from an off-market share buy-back creating or increasing tax losses.
2.4 The proposed amendments will apply to off-market share buy-backs that are executed after 7.30pm EST on 9May1995, unless they occur under an excluded transitional arrangement explained below in paragraphs 2.34 to 2.37. [Items 10-12]
2.5 In an off-market share buy-back, the amount of the purchase price that is treated as a dividend is the amount that exceeds the sum of the paid-up capital of the shares and the amount debited to a share premium account.
2.6 Subsection 159GZZZQ(1) of the Act currently provides that, in calculating any gain or loss on the buy-back of a share, the amount of disposal consideration does not include that part of the purchase price that is treated as a dividend. This is so even if the dividend is tax exempt and paid from untaxed amounts.
2.7 For example, section 23AJ of the Act exempts from income tax certain dividends received by resident company taxpayers on shares held in foreign companies. Where a resident company taxpayer receives a section23AJ dividend in an off-market share buy-back, the disposal consideration and consequently any taxable gain on the buy-back will be reduced by the amount of that dividend. This is inappropriate if the dividend was paid from share capital funds or an asset revaluation reserve because the dividend is not taxable in the shareholder's hands, and the funds from which it was paid would not have been taxed in the hands of the paying company.
2.8 Similarly, an intercorporate dividend eligible for the section 46 rebate could reduce the disposal consideration so as to create or increase a capital or revenue loss. This is also inappropriate because the rebate effectively frees the dividend from tax so there is no economic loss.
2.9 Tax advantages might also be gained if an off-market share buy-back could take place at a price lower than the market value of the share bought back. In such a case it could be argued that a taxable gain on the buy-back could be reduced or a tax loss created.
2.10 On the other hand, if the purchase price of the share is higher than the market value, any excess could be a frankable dividend and a company would be in a position to pass on franking credits to taxpayers ordinarily unable to access them.
2.11 The proposed amendments will not change the calculation of that part of the purchase price of a share in an off-market buy-back that is a dividend. However, the amount that is to be treated as disposal consideration for the purposes of calculating any ordinary income or capital gain or loss will change. Subject to the provisions explained below, the consideration will now be the purchase price of the share. [Items 5 and 6 - amended section 159GZZZQ]
2.12 If the purchase price in respect of the off-market buy-back is different from the market value of the share at the time of the buy-back, a market value rule will apply.
2.13 The market value of the share at the time of the buy-back is the amount that would have been the market value of the share at that time if the buy-back did not occur and was never proposed to occur. This will ensure that the market value of the share will not be affected in any way by any decision or action relating to the proposed share buy-back. [Item7- new paragraph 159GZZZQ(2)(b)]
2.14 If the purchase price of the share is less than the market value of the share, the difference between that price and the market value will be treated as consideration for ordinary income or capital gain purposes. It will not be treated as a dividend. This will prevent the artificial reduction of a taxable gain or the creation of a tax loss. [Item 7 - new subsection 159GZZZQ(2)]
2.15 If the purchase price is more than the market value of the share, the dividend is to be calculated in the manner described in paragraph 2.5 above. However, so much of the dividend component of the purchase price as is attributable to the excess over market value of the share will not be frankable, regardless of the source of the funds used to buy back the shares. This will prevent a company paying a higher franked dividend than would otherwise be possible. [Item 8 - new paragraph (ba) in the definition of 'frankable dividend' in section 160APA]
2.16 To prevent the dividend component of the purchase price in an off-market share buy-back being subject to double taxation, the purchase price (increased to market value if necessary) is reduced by 'the reduction amount'. The reduction amount is so much of the dividend as is included in the shareholder's assessable income, or, to the extent it is not so included, so much of the dividend that is an eligible non-capital amount. [Item 7 - new subsections 159GZZZQ(3) and (4)]
2.17 Most dividends are included in assessable income. However dividends received by non-resident shareholders which are subject to dividend withholding tax or are fully franked are not included in assessable income because of section 128D of the Act. It is appropriate to allow such dividends to reduce the buy-back consideration because they have been subject to tax (directly if unfranked, and indirectly if franked). For this reason, dividends subject to dividend withholding tax will be treated for the purposes of an off-market share buy-back as if they were included in assessable income. [Item 7 - new subparagraph 159GZZZQ(4)(b)(i)]
2.18 A dividend comprises an eligible non-capital amount to the extent that it is not debited to a share capital or share premium account or an asset revaluation reserve. Therefore, dividends not included in assessable income because of, for instance, section 23AJ, will not reduce the disposal consideration unless they are paid out of, for example, realised profits. [Item 7 - new subsection 159GZZZQ(5)]
2.19 For these purposes, a dividend will be treated as being debited to one of those accounts or reserves if it is attributable, directly or indirectly, to amounts transferred from such an account or reserve. For example, if an amount is transferred from a share premium account to retained earnings, a dividend subsequently debited to retained earnings will be treated as being debited to the share premium account to the extent that it is attributable to the transferred amount. [Item 7 - new paragraph 159GZZZQ(5)(b)]
2.20 If an exempt dividend is debited partly to a share capital or share premium account or an asset revaluation reserve, and partly to a realised profit account, the eligible non-capital amount will be only that amount debited to the realised profit account.
2.21 A share capital account comprises amounts paid by shareholders as consideration for shares in the company (other than share premiums).
2.22 A share premium account is defined in subsection 6(1) of the Act. Because of that definition, it is possible to 'taint' a share premium account by, for instance, crediting to it amounts other than share premiums received by the company. Such a tainted account generally ceases to be a share premium account for tax purposes.
2.23 To prevent a company avoiding these proposed amendments by deliberately tainting a share premium account, new subsection 159GZZZQ(6) ensures that a tainted share premium account is treated in the same way as an untainted share premium account. For example, an amount of profits credited to a share premium account would not taint the account for the purposes of new subsection 159GZZZQ(5) , and the profits would also form part of the share premium account for those purposes. [Item 7 - new subsection 159GZZZQ(6)]
2.24 An asset revaluation reserve is a reserve (however called) comprising profits arising from the revaluation of an asset or assets to the extent that those profits have not been realised by disposing of the asset. If a reserve contains such profits in addition to other amounts, only that part of the reserve comprising the revaluation profits is taken to be an asset revaluation reserve. In such a case, the company will determine to what extent a debit to the reserve is a debit to that part of the reserve which is an asset revaluation reserve (i.e. the part of the reserve comprising profits arising from the revaluation of assets which have not been disposed of).
2.25 Section 159GZZZP of the Act provides that the dividend component of the purchase price in an off-market share buy-back is deemed to be paid out of profits of the company. Notwithstanding that the dividend is deemed to be paid out of profits, new subsection 159GZZZQ(7) will ensure that, if the dividend is in fact sourced from a share capital or share premium account or an asset revaluation reserve, it will be deemed to have been debited to those accounts for the purposes of determining whether it comprises an eligible non-capital amount. [Item 7 - new subsection 159GZZZQ(7)]
2.26 A dividend arising on a share buy-back may create or increase a tax loss because it reduces the disposal consideration for the share. This compensates a shareholder who receives a return of capital from a share buy-back as an assessable dividend because the purchase price exceeds the paid-up capital on the share and the amount debited to a share premium account.
2.27 However, this treatment is not appropriate for intercorporate dividends that are rebatable under section 46 or 46A of the Act. These dividends, to the extent that they are rebatable, will not be able to create or increase a tax loss, because they are effectively free from tax. However, they will be able to reduce an ordinary income or capital gain. For these purposes, the rebatable amount of a dividend is calculated by dividing the amount of the dividend rebate by the general company tax rate as defined in section 160APA of the Act. [Item 7 - new subsection 159GZZZQ(9)]
2.28 A rebatable amount will create or increase a tax loss if, as a result of the reduction of the purchase price by the reduction amount (see paragraph 2.16 above), the shareholder whose shares are bought back incurs a 'loss amount'. A loss amount is defined as:
- a capital loss or increased capital loss [item 7 - new subparagraph 159GZZZQ(8)(c)(i)] ;
- a loss or increased loss arising under the Act other than Part IIIA [item 7 - new subparagraph 159GZZZQ(8)(c)(ii)] ; or
- the amount by which the deduction obtained at the time of acquisition of the share exceeds, or exceeds by a greater amount, the consideration obtained on its buy-back [item 7 - new subparagraph 159GZZZQ(8)(c)(iii)] .
The third dot point applies in the case where the shares are acquired as trading stock and a deduction is obtained for their acquisition.
2.29 If a rebatable amount creates or increases a tax loss, the reduction amount is reduced by so much of the rebatable amount as does not exceed the loss amount. [Item 7 - new subsection 159GZZZQ(8)]
2.30 Assume a share has a reduced cost base of $120. The market value and purchase price in an off-market buy-back of that share is $100. Of this amount, $30 represents the paid-up value of the share and $70 represents a dividend included in assessable income. Therefore, before the application of new subsection 159GZZZQ(8) , the consideration for the purposes of calculating the capital gain or loss is $100 less the reduction amount ($70), i.e. $30.
- If the dividend is non-rebatable, the capital loss will be:
$30 - $120 = ($90)
- If the dividend is fully rebatable,
new subsection 159GZZZQ(8)
will apply to reduce the reduction amount by $70 (being so much of the rebatable amount that does not exceed the loss of $90). Therefore the disposal consideration will be $100 and the capital loss will be:
$100 - $120 = ($20)
- If only half of the dividend is rebatable,
new subsection 159GZZZQ(8)
will apply to reduce the reduction amount by $35 (i.e. the rebatable amount). Therefore the consideration will be $65 and the capital loss will be:
$65 - $120 = ($55)
2.31 Subsection 160ZA(4) operates to reduce a capital gain by the amount of disposal consideration included in assessable income under the Act apart from Part IIIA. In the case of an off-market share buy-back, the amount of the dividend may reduce the disposal consideration of the share because of the operation of section 159GZZZQ. New subsection 159GZZZP(1A) provides specifically that subsection 160ZA(4) will not apply to reduce a capital gain arising from an off-market share buy-back by the amount of the dividend. [Items 3 and 4 - amended section 159GZZZP]
2.32 This amendment is not to be taken into account in interpreting the law as it operated prior to these proposed amendments. [Item 13]
2.33 The proposed amendments apply to off-market share buy-backs that take place after 7.30pm EST on 9 May 1995, unless the buy-back takes place under an excluded transitional arrangement. [Items 10-12]
2.34 Some companies may, prior to the announcement of these proposed amendments, have already embarked on a particular share buy-back arrangement. To avoid unnecessary disruption to commercial arrangements, the proposed amendments will not apply to buy-backs occurring under an excluded transitional arrangement.
2.35 An excluded transitional arrangement is an arrangement, plan or proposal that was announced and began to be implemented before 7.30pmEST on 9 May 1995. The arrangement need not be the actual buy-back itself, rather it can be a series of related transactions, one of which is an off-market share buy-back. [Subitem 12(2)]
2.36 The requirement that the arrangement began to be implemented prior to 7.30pm EST on 9 May 1995 means that something integral to the arrangement (not necessarily the buy-back itself) must have been done before that time. The announcement of the arrangement needed to be:
- made at a general meeting of the company;
- in writing and available to all shareholders in the company; or
- in writing to the Commissioner of Taxation or one of his officers acting in his or her official capacity.
2.37 However, taxpayers who have sought to gain undue tax advantages by relying on the buy-back provisions as they existed prior to these amendments should not be able to take advantage of these transitional arrangements. Therefore, if it was the purpose, or one of the purposes, of the arrangement, or of any party to the arrangement, to enter into the arrangement to create or increase a tax loss, this transitional measure will not apply to the arrangement. [Paragraph (c) of subitem 12(2)]
2.38 In certain circumstances the share value shifting provisions in Division 19B of Part IIIA of the Act could apply to the off-market buy-back of a share at less than market value. This would occur, for example, if the shares to be bought back are shares of the controller of the company, and the decrease in value of those shares as a result of the proposed buy-back at less than market value causes an increase in value of an associate's shares.
2.39 However, the market value rule discussed above at paragraph 2.14 would increase the purchase price to the market value of the share for the purposes of the buy-back provisions. This would ensure that any gain reflected in the value shifted to the associate's share would be realised under the ordinary capital gains tax provisions. Therefore, it would be unnecessary for Division 19B to apply.
2.40 To prevent double taxation if the market value rule applies to a share buy-back which resulted in a decrease in value of the shares to be bought back, that decrease in value is to be ignored for the purposes of the value shifting provisions. [Item 9 - new subsection 160ZZRM(2A)]
Chapter 3 Deductions for gifts
3.1 The amendments in Part 3 of Schedule 1 will allow income tax deductions for gifts of $2 or more to the funds/organisations listed in paragraph 3.3. This will be done by listing them in tables 2, 5 or 10 of the gift provisions in subsection 78(4) or extending the period in which tax deductible gifts may be made. The index to the gift provisions in subsection 78(3) will also be updated. [Items 14 to 17 and 19 to 21]
3.2 The commencement date of 24 November 1992 of tax deductibility for gifts made to the Shrine of Remembrance Restoration and Development Trust will also be inserted in the law by the amendments. This date was inadvertently omitted when the gift provisions were restructured in 1993. [Item 18]
3.3 The amendments will result in gifts being tax deductible as follows:
|Item||Fund/organisation||Gifts made after||Gifts made before|
|2.2.16||The Polly Farmer Foundation (Inc)||6 September 1995||No limit|
|5.2.7||Cobram and District War Memorial Incorporated Fund||18 October 1995||19 October 1997|
|10.2.6||Australian Games Uniform Company Limited||6 September 1995||No limit|
|Extensions of existing tax deductibility|
|5.2.1||Shrine of Remembrance Restoration and Development Trust||24 November 1992||1 July 1999*|
|5.2.2||The Sandakan Memorials Trust Fund||29 July 1993||30 July 1997#|
|* extended from 1 July 1995|
|# extended from 30 July 1995|