Supplementary Explanatory Memorandum(Circulated by the authority of the Treasurer, the Hon. P.J. Keating M.P.)
General Outline and Financial Impact of the Amendments
The amendments will amend the Taxation Laws Amendment Bill (No. 2) 1991 to overcome some potential technical difficulties with amendments proposed by the Bill in relation to securities lending arrangements. The amendments will give effect to the original objectives of the Bill and will have no impact on revenue.
Summary of Proposed Changes
A number of amendments to the Bill are to be moved on behalf of the Government. These amendments relate to changes proposed by the Bill to extend the taxation relief provided for securities lending arrangements by section 26BC of the Income Tax Assessment Act 1936. The effect of the proposed amendments are:
- securities lending relief will be available where the entitlement to a distribution or rights or options in respect of borrowed securities arises during a borrowing period;
- a borrower will be able to satisfy a lender's direction to exercise a borrowed right or option by giving the lender securities identical to those that would have resulted if the borrower had exercised the right or option;
- proposed section 160AQUA will be changed to:
- provide that the basis for the transfer of franked dividends paid on shares that are the subject of a cum-dividend contract of sale or a securities lending arrangement is to be the obligation that exists at the time the company closes its books to determine dividend entitlements;
- allow persons who receive franked dividends by the operation of the section to transfer those dividends by another application of that section;
- lenders who dispose of replacement securities within 12 months will not lose indexation benefits for capital gains purposes where the borrowed securities that relate to the replacement securities were acquired at least 12 months earlier; and
- the commencement date for proposed Division 6A of Part IIIAA (Transfer of Shareholder Status for Tax Purposes) will be deferred to the later of 1 August 1991 or the first day of the month following Royal Assent
Notes on the Amendments
Clause 25 of the Bill proposes to extend the existing concession for securities lending arrangements provided by section 26BC of the Income Tax Assessment Act 1936 (the Act) by amending subsection (1) paragraphs 3(a), 3(c) and 6(b) and inserting new subsections 4(A), (4B), (9A), (9B), (9C), (9D), (9E), (9F), (9G), (11A) and (11B) into that section. The effect of this clause is that the eligible borrowing period and the range of securities that qualify for relief will be extended. Clause 25 also deals with the tax effects on borrowers and lenders of distributions made and rights or options issued or exercised during a borrowing period. Six amendments to clause 25 are proposed.
The first and second amendments in respect of clause 25 relate to borrowed securities that are rights or options. The first amendment will replace proposed subparagraph 26BC(3)(c)(iii) with a new subparagraph. The new subparagraph will continue to deal with borrowed rights and options that are exercised at the direction of a lender during a borrowing period but a borrower will not have to actually exercise the right or option. [New subparagraph 26BC(3)(c)(iii)]
The second amendment to clause 25 replaces proposed subparagraph 26BC(3)(c)(vi) with a new subparagraph. The new subparagraph will continue to specify what a lender must receive from a borrower of rights or options that are exercised during a borrowing period (ie., where subparagraph 26BC(3)(c)(iii) applies). However, a borrower will be able to replace borrowed rights or options that the lender directs are to be exercised, with securities that are the same as those that would have resulted if the borrower had exercised the borrowed or identical rights or options. [New subparagraph 26BC(3)(c)(vi)]
The effect of these two amendments is that where the lender directs a borrower to exercise borrowed rights or options during a borrowing period, the section 26BC relief will be available if the lender receives from the borrower the securities that resulted from exercising the right or option or an identical right or option securities that are identical to those that would have resulted from exercising the right or option or a compensatory payment.
The third amendment in respect of clause 25 proposes the insertion of new subsection (3A) into section 26BC. The entitlement to receive the distribution, right or option on borrowed securities might be determined during a borrowing period but not paid, made or issued until after the end of that period. Where this happens the distribution, right or option will be treated as having been made, paid or issued during the borrowing period. [New subsection 26BC(3A)]
The fourth amendment in respect of clause 25 will replace the existing subsection 26BC(7). Lenders who dispose of replacement securities within 12 months of acquiring them lose indexation benefits that would not have been lost if the securities had not been the subject of a securities lending arrangement. The reason for this is that the lender is treated under the present law as having acquired an asset (the replacement securities) for the purposes of Part IIIA of the Act (capital gains and capital losses) at the time the lender received those securities from the borrower.
For the purposes of calculating the capital gain derived by a lender on the disposal of replacement securities (other than under a securities lending arrangement) the indexed cost base the borrowed securities would have had at the time the lender received the replacement securities from the borrower is taken to be the consideration paid by a lender for the replacement securities. (Refer proposed subparagraph 26BC(6)(b)(i)) Where an asset is disposed of within 12 months of its acquisition subsection 160Z(3) of the Act provides that the indexed cost base of an asset is its cost base.
The effect of these provisions is that where a lender disposes of replacement securities within 12 months of receiving them from a borrower, even if the borrowed securities to which they relate were acquired more than 12 months earlier, a deduction is allowable only for the (deemed) cost base of the replacement securities and not the (deemed) indexed cost base.
This possible loss of indexation benefits will be overcome by excluding subsection 160Z(3) from the calculation of a lender's capital gain on the disposal of a replacement security that was acquired from a borrower within 12 months but more than 12 months after the original borrowed security was acquired. The effect of this is that the lender will be entitled to a deduction for the (deemed) indexed cost base of the replacement security. [Paragraph 26BC(7)(b)]
There will be no change to the tax treatment accorded a lender who disposes of replacement securities (other than to a borrower under a securities lending arrangement) within 12 months of acquiring the original borrowed securities. The deduction allowable to the lender in these circumstances will continue to be the cost base of the original borrowed securities. [Paragraph 26BC(7)(a)]
The fifth and sixth amendments in respect of clause 25 relate to the capital gains tax consequences for borrowers and lenders when lenders receive bonus shares, bonus units, rights, options or new securities from borrowers.
The fifth amendment is a technical change to proposed subsection 26BC(9B) and will have no effect on its operation.
The sixth amendment replaces proposed subsections 26BC(9C), (9D) and (9E).
The capital gain or loss arising when a lender disposes of new securities received from a borrower will be calculated as if the lender had actually exercised the right or option. This will be the case even if the borrower did not exercise the borrowed (or an identical) right or option but have the lender securities identical to those that would have resulted if the borrower had exercised the right or option. [New subsection 26BC(9C)]
For Part IIIA purposes (capital gains and capital losses) bonus shares and bonus units issued on borrowed (or identical) securities, or shares or units that a lender receives from a borrower instead of the bonus shares or bonus units issued, will have the same cost base and date of acquisition as if the lender had been the registered shareholder or unitholder when the company or trustee determined the entitlement to the bonus shares or units. [New subsections 26BC(9D) and (9E)]
The seventh amendment will amend clause 52 of the Bill to include the definition of "borrowing period" in section 160APA. This term will be used in revised section 160AQUA as a consequence of the eighth amendment.
The eighth amendment relates to clause 53 and will replace proposed section 160AQUA with a new section 160AQUA. Section 160AQUA is in new Division 6A of Part IIIAA which provides for the flow of imputation credits when shares are sold under a cum-dividend contract on a stock exchange or a franked dividend is received by borrower under a securities lending arrangement.
A shareholder to whom a franked dividend is paid in respect of a particular share will be able to pass that dividend on to either a transferee under a contract for the sale of the share on the stock exchange or to a lender under a securities lending arrangement. A transferee who receives a dividend from a shareholder under an application of section 160AQUA will have the same status under that section as the original shareholder and will be able to pass that dividend on to another transferee or lender. The shareholder who will be able to transfer shareholder status is the actual person in whose name the shares are registered, the person who has the right to be registered as the shareholder or a transferee or lender who has obtained shareholder status by a previous application of this section. [Paragraph 160AQUA(1)(a)]
Where the franked dividend is paid on shares that are the subject of a cum-dividend contract of sale the franked dividend paid will be able to be transferred to the person to whom the shareholder (see previous paragraph) was under an obligation to transfer the shares at the time the company closed its books to determine the shareholders to whom the dividend would be paid. [Paragraph 160AQUA(1)(b)(i)]
A shareholder (see earlier notes) who is a borrower under a securities lending arrangement at the time the company determined the entitlement to the dividend and under an obligation to transfer the dividend to the lender, will be able to transfer the franked dividend to the lender. [Paragraph 160AQUA(1)(b)(ii)]
The operation of the new section can be illustrated by considering the position of a broker acting for a vendor who borrows shares under a securities lending arrangement and uses those borrowed shares to satisfy the vendor's obligation to the purchaser. At the time the company determines dividend entitlements both the vendor and purchaser are registered shareholders The vendor then has an obligation, under a (cum-dividend) contract for the sale of the shares, to transfer the shares to the broker. The franked dividend paid by the company to the vendor will be able to be transferred to the broker, who is the transferee under the sale contract that exists between the vendor and the broker, under paragraph 160AQUA(1)(b)(i).
The broker, who is also a borrower under a securities lending arrangement, has received shareholder status in respect of the dividend from the vendor. The broker was under an obligation, as the borrower under the securities lending arrangement, to transfer the dividend to the lender at the time the company determined dividend entitlements. The broker (borrower) can transfer the franked dividend received from the vendor to the lender under paragraph 160AQUA(1)(b)(ii).
Both subparagraphs 160AQUA(1)(b)(i) and (ii) cannot apply to the same dividend on the same application. For example, a "vendor" who has sold shares "short" will not receive a dividend in respect of the shares "sold short" if shares have not been acquired in time for the "vendor" to be registered as a shareholder when the company determines dividend entitlements.
If the "vendor" has borrowed shares to complete the sale and is the registered shareholder for those shares the "vendor" will receive a dividend. The "vendor" will then have two obligations - one under a cum-dividend contract of sale and the other under a securities lending arrangement - but only one franked dividend. The section can only be applied to transfer the one dividend paid to the "vendor". It cannot be used to "create" dividends to satisfy all the "vendor's obligations in relation to the dividend. It would be for the "vendor" to determine which obligation the dividend would be used to satisfy.
The ninth, tenth and eleventh amendments will amend proposed paragraphs 160AQUB(a), 160AQUC(a) and 160AQUD(a) respectively. Sections 160AQUB, 160AQUC and 160AQUD together with section 160AQUA comprise new Division 6A of Part IIIAA of the Act (Transfer of Shareholder Status for Tax Purposes).
These are consequential amendments to deal with the change to section 160AQUA to allow the transfer of shareholder status acquired by another application of that section. The obligations imposed by those sections on securities dealers acting as agents, other parties and borrowers transferring franked dividends under section 160AQUA to furnish dividend statements will be extended to dividends transferred because of another application of that section.
The twelfth amendment proposes the replacement of subclause 83(13) of the Bill. This subclause provides that new Division 6A of Part IIIAA (Transfer of Shareholder Status for Tax Purposes) is to come into effect seven days after the Bill receives Royal Assent. The effect of new subclause 83(13) is that the commencement of the new Division will be deferred until the later of 1 August 1991 or the first day of the month after the Bill receives Royal Assent. [New subclause 83(13)]