Supplementary Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)General outline and financial impact
Australia as a regional financial centre
Amends certain provisions in Schedule 1 to the Taxation Laws Amendment Bill (No. 4) 1998 (TLAB 4) that give effect to the package of measures entitled Australia A Regional Financial Centre.
The proposed amendments in Schedule 1 to the Supplementary Bill relate to the thin capitalisation amendments and the foreign investment fund (FIF) amendments in TLAB 4. The proposed amendments in Schedule 1 also relate to the controlled foreign company (CFC) measures of the Income Tax Assessment Act 1936 (ITAA 1936).
Amends TLAB 4 to extend the measures that remove an impediment from the thin capitalisation provisions that prevents some Australian financing subsidiaries from raising offshore debenture funds on behalf of related Australian branches of foreign banks.
Amends TLAB 4 to clarify the wording of the proposed exemption from the FIF measures for interests in certain United States (US) FIFs. This technical amendment will clarify the wording of the limited exemption for certain US conduit entities in proposed paragraph 513(4)(b) of the ITAA 1936 contained in TLAB 4.
Amends TLAB 4 to provide an exemption from the CFC measures for interests in US real estate investment trusts (REITs) that derive income or hold assets principally in the US. The exemption is similar to the proposed exemption for FIF interests in REITs in Part 2 of Schedule 1 to TLAB 4.
Date of effect: The amendments to the thin capitalisation and FIF provisions do not affect the application date of these measures contained in TLAB 4. The exemption from the CFC measures will apply for statutory accounting periods of CFCs ending on or after 2 July 1998.
Proposal announced: The amendments have not been previously announced.
Financial impact: There are no revenue implications for extending the thin capitalisation measures or for the technical amendments to the FIF measures. The cost to the revenue of the CFC exemption is expected to be minor.
Compliance cost impact: There will not be any effect on compliance costs as a result of the amendments to the thin capitalisation measures or the FIF measures. The exemption from the CFC measures may result in a small decrease in compliance costs for affected taxpayers.
Summary of Regulation Impact Statement
The amendment does not change the regulation impact statement (RIS) contained in the explanatory memorandum (EM) to TLAB 4.
The amendment does not change the RIS contained in the EM to TLAB 4.
Impact: Low
Main points:
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- The exemption will allow Australian collective investment funds to compete on an equal footing with US real estate investment trusts in attracting Australian investment.
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- The exemption is likely to result in an initial and recurrent reduction in compliance costs because the CFC measures will not apply to investments that qualify for the exemption.
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- The cost to the revenue of providing the exemption is expected to be minor.
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- An Australian collective investment fund was consulted on the proposed exemption.
Franking credits, franking debits and the intercorporate dividend rebate
Amends Schedule 4 to the Bill by making a number of changes to the 45 day rule and related payments rule, which are measures targeting franking credit trading announced in the 1997-98 Budget. The amendments to the 45 day rule will:
- •
- clarify the nature of the interest in shares held by beneficiaries of widely held trusts;
- •
- improve the operation of the benchmark portfolio ceiling method;
- •
- extend the concessions in the transitional provisions; and
- •
- make other minor changes.
The amendments to the related payments rule will provide an exception from the related payments rule for dividends paid within 6 months of the sale of a group company.
Date of effect: The changes will apply from the commencement of the measures.
Proposal announced: The changes have not been announced previously.
Financial impact: The amendments will have an insignificant impact on revenue.
Compliance cost impact: Compliance costs will be reduced for taxpayers affected by these changes.
Summary of Regulation Impact Statement
The Office of Regulation Review has advised that no changes are required to the Regulation Impact Statement for these measures contained in the explanatory memorandum to TLAB 4.
Franking of dividends by exempting companies and former exempting companies
Amends Schedule 5 to the Bill to make several changes to limiting the source rule, which is one of the franking credit trading measures announced in the 1997-98 Budget.
The amendments to the limiting the source rule will:
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- clarify the rules for determining the effective ownership of companies to prevent arrangements to avoid the measure; and
- •
- make corrections to mechanical aspects of the provisions.
Date of effect: The changes will apply from the commencement of the measure.
Proposal announced: The changes have not been previously announced.
Financial impact: The amendments will have an insignificant impact on revenue.
Compliance cost impact: Compliance costs will be reduced for taxpayers affected by these changes.
Summary of Regulation Impact Statement
The Office of Regulation Review has advised that no changes are required to the Regulation Impact Statement for this measure contained in the explanatory memorandum to TLAB 4.
Chapter 1 - Australia as a Regional Financial Centre
Overview
1.1 Schedule 1 to the Taxation Laws Amendment Bill (No. 4) 1998 (TLAB 4) introduced amendments to provide for the implementation of the Australia A Regional Financial Centre component of the Investing for Growth Statement announced by the Government on 8 December 1997.
1.2 Schedule 1 to the Supplementary Bill contains amendments that will:
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Thin Capitalisation
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- further relax the effect of the thin capitalisation loan back provisions so that an Australian subsidiary that is indirectly owned by a foreign bank may raise section 128F interest withholding tax exempt funds and on-lend those funds to a related Australian branch without affecting the subsidiarys thin capitalisation position ( Section 1 ); Foreign Investment Funds
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- provide a technical amendment that will clarify the wording of the limited exemption for certain United States (US) conduit entities in proposed paragraph 513(4)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) contained in TLAB 4 (Section 2); Controlled Foreign Companies
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- provide an exemption from the controlled foreign company (CFC) measures for interests in US real estate investment trusts that derive income or hold assets principally in the US (Section 3).
Section 1 - Thin capitalisation
Summary of the amendments
1.3 The amendment relating to the thin capitalisation rules contained in Division 16F of Part III of the ITAA 1936 removes an impediment in those rules which prevents some Australian branches of foreign banks from gaining access to offshore debenture funds that are exempt from interest withholding tax. The amendment in TLAB 4 enables Australian finance subsidiaries of foreign banks to raise the debenture amounts and on-lend them to their related Australian bank branch without affecting the thin capitalisation position of the subsidiaries.
1.4 The proposed amendment extends the application of the measures to Australian financial subsidiaries that are indirectly beneficially owned by a foreign bank. The amendment is being proposed as a result of consultations with foreign banks following the introduction of the Australia as a regional financial centre measures contained in Taxation Laws Amendment Bill (No.5) 1998 which lapsed when Parliament was prorogued for the 1998 election.
1.5 The proposed amendment to the thin capitalisation measure does not affect the application date contained in TLAB 4.
1.6 The amendment contained in TLAB 4 removes an impediment, arising from the thin capitalisation provisions, to an Australian subsidiary of a foreign bank obtaining funds offshore free of interest withholding tax on behalf of a related Australian branch of the foreign bank. This is achieved by ensuring that the subsidiarys foreign equity calculation for thin capitalisation purposes will not be affected by the on-lending of such funds to the Australian branch of the foreign bank.
1.7 The proposed amendment extends the amendment contained in TLAB 4 to financial institutions that are indirectly beneficially owned by a foreign bank.
[Amendment 1]
Section 2 - Exemption from the foreign investment fund measures
1.8 The proposed technical amendment clarifies the wording of the proposed exemption from the FIF measures for interests in certain United States (US) FIFs. This technical amendment will clarify the wording of the limited exemption for certain US conduit entities in proposed paragraph 513(4)(b) of the ITAA 1936 contained at Item 42 of Schedule 1 to TLAB 4.
1.9 The proposed amendment to the FIF measures does not affect the application date contained in TLAB 4.
[Amendment 2]
Section 3 - Exemption from the controlled foreign company (CFC) measures for interests in US real estate investment trusts (REITs)
Overview of the CFC measures
1.10 Schedule 1 to the Supplementary Bill will amend TLAB 4 to provide an exemption from the CFC measures for interests in certain REITs and interests held through certain REITs. The exemption is being provided as the result of representations from an Australian collective investment fund following the original introduction of amendments to the FIF measures in Taxation Laws Amendment Bill (No. 5) 1998 which lapsed when Parliament was prorogued for the election.
1.11 Unless otherwise stated, references to provisions of the law in this Chapter are references to provisions of the ITAA 1936 and item references are to Schedule 1 to the Supplementary Bill.
Summary of the amendments
1.12 The proposed amendments will provide an exemption from the CFC measures for interests in REITs that derive income or hold assets principally in the US.
1.13 The proposed amendments will apply for statutory accounting periods of CFCs ending on or after 2 July 1998. [Item 48]
Background
1.14 The CFC measures (Part X of the ITAA 1936) apply to Australian residents who have an interest in a CFC at the end of a year of income. A CFC is a foreign company controlled by Australian residents. Broadly, the CFC measures operate to tax Australian residents, on a current year basis, on their share of certain undistributed amounts derived by a CFC. This treatment, referred to as accruals taxation, is directed at preventing deferral of Australian tax where profits are accumulated offshore in a CFC rather than remitted to Australian investors.
1.15 It is proposed that an interest in a REIT that is subject to the CFC measures be provided with an exemption from accruals taxation similar to that proposed in TLAB 4 for FIF interests in REITs. An interest in a REIT can be subject to the CFC measures because a REIT may be a company for Australian tax purposes.
1.16 The exemption will ensure that Australian collective investment funds remain competitive with US funds in attracting Australian investment in REITs. If an exemption were not provided, direct investments in REITs could be treated more favourably than investments in Australian collective investment funds that manage REITs. In this regard, an Australian collective investment fund would be subject to the CFC measures if it were to control a company REIT. Accordingly, additional tax and compliance cost burdens associated with accruals taxation under the CFC measures would be passed on to investors in the Australian collective investment fund. These tax and compliance cost burdens would not arise, however, for investors who hold an interest directly in a non-controlled REIT because of the proposed exemption from the FIF measures.
Explanation of the amendments
Exemption from accruals taxation
1.17 The proposed amendments will provide a tightly targeted exemption from accruals taxation under the CFC measures for interests in REITs. The substantial similarity of US tax rules to those in Australia will help ensure that tax deferral opportunities do not arise because of the exemption.
1.18 New subsections 356(4A), (4B) and (4C) will give effect to the exemption for REITs by providing that a taxpayers direct attribution interest in a REIT is to be ignored where the interest satisfies the sole purpose test (refer to the discussion on new paragraphs 513(3)(a) and (4)(a) in Section 1, Part 2, Schedule 1 to TLAB 4) and:
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- the REIT does not directly or indirectly through other entities have income or investments outside the US; [New subsection 356(4B)] or
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- the REIT does not directly or indirectly through other entities have more than an incidental interest in income or investments outside the US. [New subsection 356(4C)]
[Item 47]
1.19 It should be noted, however, that interests held by a REIT indirectly through a US company, regulated investment company (RIC) or REIT are to be taken into account in determining the REITs interest in income or investments outside the US. It is necessary to have tighter rules for determining a REITs interests for the purposes of the CFC exemption because there is a greater risk of tax deferral where a taxpayer exercises significant control over an entity. [ Item 47]
1.20 The effect of ignoring a taxpayers direct attribution interests in a REIT is that these interests will not be taken into account in determining the taxpayers share of the attributable income of the REIT. Moreover, the interests would not be taken into account in determining the taxpayers share of the attributable income of a company held through the REIT (section 357).
1.21 Control interests held through a REIT will still be taken into account for the purposes of determining whether a subsidiary belonging to the REIT qualifies as a CFC. The CFC measures will continue to apply, for instance, to attribute income from a CFC that is a subsidiary of a REIT where a taxpayer has a direct interest in the subsidiary.
1.22 The application of the exemption is illustrated by the following example:
Example - Application of the exemption for CFC interests in REITs
Facts
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- Aus Co is a company resident in Australia.
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- Coy A is a US company that is a real estate investment trust for the purposes of new subsection 356(4A).
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- Coy B is a US company that conducts all its business in the US.
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- Aus Co has a direct interest in Coy A of 100% and a direct interest in Coy B of 10%.
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- Aus Cos interest in Coy A satisfies the sole purpose test.
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- Coy A has a 90% direct interest in Coy B.
The consequences of providing the exemption in determining Aus Cos share of the attributable income of Coy A and Coy B are discussed below.
No amount would be attributed to Aus Co from Coy A because Aus Cos attribution interest in Coy A would be ignored under new subsection 356(4A) . Coy A would, however, be treated as a CFC which may be relevant when determining whether deemed dividends derived by Coy A should be taxed on an accruals basis under section 459. The accruals taxation of these dividends is discussed below in the section on the attribution of deemed dividends.
Aus Co would be accruals taxed on a 10% share of Coy Bs attributable income. The indirect interest in Coy B held through Coy A would be disregarded in determining this share because of new subsection 356(4A) . The indirect interest held through Coy A would, however, still be taken into account in determining whether Coy B is a CFC.
Attribution of deemed dividends
1.23 A taxpayers direct attribution interests and indirect attribution tracing interests in a REIT will not be ignored for the purpose of section 459 which attributes to a taxpayer a share of a deemed dividend derived by a CFC. [Item 47] This will allow amounts arising under the deemed dividend rules in section 47A to be accruals taxed where profits are shifted from a CFC in an unlisted country to a REIT or one of its subsidiaries.
Attribution accounts
1.24 Existing attribution surpluses held by a REIT will continue to be available to taxpayers for application against profits repatriated to Australia. This will ensure that amounts accruals taxed previously under the CFC measures will not be taxed again on distribution.
[Amendment 3]
Regulation impact statement
1.25 The proposed amendment does not change the regulation impact statement (RIS) contained in the Explanatory Memorandum (EM) to TLAB 4.
1.26 The proposed amendment does not change the RIS contained in the EM to TLAB 4.
1.27 The proposed exemption from the CFC measures is intended to ensure that Australian collective investment funds remain competitive with US funds in attracting and managing Australian investment in REITs.
1.28 If an exemption were not provided, direct investments in REITs may be treated more favourably than indirect investments in REITs managed by Australian collective investment funds. This is because the indirect investments would continue to be subject to accruals taxation under the CFC measures whereas direct investments are likely to be exempt from accruals taxation following the proposed exemption from the FIF measures for US FIFs. Indirect investments would therefore continue to be subject to additional tax and compliance cost burdens associated with accruals taxation while direct investments in REITs would no longer be accruals taxed under the FIF measures.
1.29 Less favourable treatment of REITs managed by Australian collective investment funds could have a significant impact on their ability to compete. In this regard, direct investments in REITs are a close substitute for indirect investments in REITs managed by Australian funds.
1.30 The proposed exemption from the CFC measures is more tightly targeted than the proposed FIF exemption because there is a greater risk of tax deferral where a taxpayer exercises significant control over an entity. The risk to revenue is not likely to be greatly increased by a tightly targeted exemption from the CFC measures because the US tax rules are sufficiently robust to prevent tax deferral opportunities from arising for investments that qualify for the exemption.
1.31 It is necessary to amend the ITAA 1936 to provide an exemption from the CFC measures.
1.32 There are considered to be no alternatives to the structure of the exemption outlined below that would provide interests in REITs with an exemption from the CFC measures without giving rise to significant tax deferral opportunities and increasing the risk to the revenue.
Structure of the new exemption
1.33 The exemption is being limited to interests in REITs that derive income or hold investments principally in the US where a taxpayer can demonstrate that the investment was made for the sole purpose of investing within the US.
1.34 The exemption would normally not be available if the REIT directly or indirectly has an interest in amounts derived from sources outside the US. The exemption will, however, be available where the REIT has only an incidental interest in assets that produce amounts from sources outside the US. This incidental interest must not exceed five percent of the total value of the assets of the REIT, whether these assets are held directly, or indirectly through one or more other entities. Unlike the exemption from the FIF measures, it will be necessary to look through interests held in US companies, RICs and REITs for the purposes of determining interests held in assets that produce amounts from sources outside the US.
1.35 The exemption will affect Australian collective investment funds that manage REITs and investors in those funds.
1.36 The exemption will allow Australian collective investment funds to compete on an equal footing with REITs. Resident investors may also be advantaged by having the option of investing indirectly in a REIT managed through an Australian fund.
1.37 The exemption is likely to result in an initial and recurrent reduction in compliance costs because the CFC measures will not apply to investments that qualify for the exemption.
1.38 The effect of the exemption on administrative costs is uncertain but is expected to be minor.
1.39 The cost to the revenue of providing an exemption from accruals taxation under the CFC measures is expected to be minor because the US tax rules are substantially comparable to Australias and therefore prevent most tax deferral opportunities from arising.
1.40 An Australian collective investment fund was consulted on the proposed exemption from the CFC measures. The fund made representations for an exemption following the introduction of amendments giving effect to the exemption from the FIF measures in Taxation Laws Amendment Bill (No. 5) 1998. This Bill lapsed when Parliament was prorogued for the election.
1.41 The implementation option is considered the only effective means of achieving the policy objective of ensuring that Australian collective investment funds remain competitive with US funds in attracting and managing Australian investment in REITs without giving rise to significant tax deferral opportunities. The option is expected to lead to an overall reduction in compliance costs for Australian collective funds that manage REITs.
Chapter 4 - Franking credits, franking debits and the intercorporate dividend rebate
Overview
4.1 The amendments to Schedule 4 to the Bill will make a number of changes to the 45 day rule and related payments rule. The amendments to the 45 day rule will:
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- clarify the nature of the interest in shares held by beneficiaries of widely held trusts;
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- improve the operation of the benchmark portfolio ceiling method;
- •
- extend the concessions in the transitional provisions; and
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- make other minor changes.
4.2 The change to the related payments rule will provide an exception from the related payments rule for dividends paid within 6 months of the sale of a group company.
4.3 The 45 day rule and the related payments rule are measures targeting franking credit trading announced in the 1997-98 Budget. In broad terms, the 45 day rule requires taxpayers to hold shares at risk for at least 45 days to be eligible for franking benefits (ie, franking credits and the intercorporate dividend rebate and the franking rebate).
4.4 The related payments rule requires taxpayers who are under an obligation to make a related payment in respect to a dividend to hold shares for at least 45 days to be eligible for franking benefits.
4.5 These changes will apply from the commencement of these measures.
Explanation of the amendments
Amendments 4, 12 and 13: exception to related payments rule for sales of subsidiary companies
4.6 Amendment 13 inserts new section 160APHNA to provide an exception to the related payments rule for dividends paid within 6 months of the sale of a group company out of profits it is reasonable to regard as attributable to the period of ownership of the selling company.
4.7 The related payments rule requires taxpayers who are under an obligation to make a related payment with respect to a dividend to hold shares at risk for at least 45 days to be eligible for franking benefits.
4.8 If a parent company, whether resident or non-resident, sells a resident subsidiary company, the risks of ownership and opportunities for gain will generally pass to the buyer because a contract of sale is in place. If the seller is entitled under the contract to cause the subsidiary to distribute dividends to it, and to reduce the sale price accordingly, the reduction in the sale price would be a related payment under the current provisions, and consequently the inter-corporate dividend rebate would be denied. However, this would prevent holding companies from extracting the franking credits attributable to what are, in substance, their own taxed profits from their subsidiaries once a contract of sale was agreed. By deeming such reductions not to be related payments (provided the dividend is paid within six months of the contract to sell), the selling shareholder is afforded a reasonable opportunity to extract its own taxed profits from the company along with the franking credits applicable to them.
4.9 Amendments 4 and 12 make consequential amendments to new sections 160APHD and 160APHN .
Amendments 5, 6, 10, 11, 14 and 15: acquisition of interests in shares by beneficiaries of widely held trusts
4.10 Amendments 5 and 6 amend new subsections 160APHG(6) and (8) to make it clear that a beneficiary of a widely held trust will be treated as holding, while a beneficiary, an interest in any shares or interests in shares held from time to time by the trustee, whether or not the shares are held by the trustee during the same period as the period in which the taxpayer is a beneficiary. Thus a beneficiary of a widely held trust who receives dividends from shares previously included in the trust estate will be treated as holding an interest in those shares while he or she continues to hold his or her interest as beneficiary of the trust, even though the shares were disposed of by the trustee before or soon after the beneficiary acquired the interest in the trust.
4.11 These changes will ensure that beneficiaries of a widely held trust will not be precluded from franking benefits where a distribution includes dividends paid on shares or interests in shares disposed of by the trustee before or soon after they acquired their interests in the trust, provided that the beneficiary has held its interest in the trust as a whole for the required period of 45 days.
4.12 Under the holding period rule, a beneficiary of a widely held trust is treated as holding an interest in all the shares, or interests, held by the trust as an undissected aggregate, and is only required to satisfy the 45 day rule in relation to his or her interest in the trust as a whole, rather than in relation to each share in which he or she has an interest under the trust. The provisions do not look through the widely held trust to see whether the beneficiary has had an interest for 45 days in each of the underlying shares in the trust estate. This stands in contrast with the position of a beneficiary of an ordinary trust, where such a look through approach is required.
4.13 Amendments 10, 11, 14 and 15 make consequential amendments to new subsections 160APHL(2) and (4) and 160APHP(1) .
Amendment 7: bonus shares
4.14 Amendment 7 will amend new subsection 160APHH(2) to provide that bonus shares taken to have been acquired at the same time as the original shares will be taken to have been held at risk prior to their issue only on the days on which the original shares were held at risk.
4.15 This rule is consistent with the rules for shares, or interests in shares, distributed to taxpayers in satisfaction of an interest in shares under a trust or as a partner in a partnership. New subsection 160APHH(2) currently is silent on the issue of how to calculate the number of days that the shares have been held at risk for the period between the acquisition of the original shares and the acquisition of the bonus shares.
Amendments 8 and 9: disposals of shares within wholly owned groups of companies
4.16 Amendment 9 inserts new subsections 160APHI(4A) and (4B) so that a disposal of securities within a wholly-owned company group is not treated as a disposal of identical securities held by a company within the group under new section 160APHI . New section 160APHI requires disposals of shares to be accounted for on a Last-in First-out base for the purpose of the holding period rule.
4.17 In certain circumstances, as new section 160APHI stands, a disposal of shares within a company group could lead to a company holding identical securities being precluded from obtaining franking benefits in respect of dividends paid in respect of the securities because it acquired those shares within 45 days of the deemed disposal. This outcome would not be appropriate because there has been no real change in the underlying ownership of the shares.
4.18 Amendment 8 makes a consequential amendment to new subsection 160APHI(4) .
Amendments 16 and 17: franking debit where ceiling exceeded
4.19 Amendment 17 will amend new subsection 160AQZE(1) to provide that, where a company has elected to use the benchmark portfolio ceiling method and the ceiling has been exceeded, a franking debit will arise to reduce a companys total franking credit claim for an income year.
4.20 Although new subsection 160AQZE(1) currently imposes a franking credit ceiling, it does not provide a mechanism to reduce a companys total franking credit claim for the year if, at the end of the year, it is determined that the ceiling has been exceeded.
4.21 Amendment 16 makes a consequential amendment to new paragraph 160AQZE(1)(d) .
Amendments 18, 20 and 22: calculation of benchmark ceiling amounts
4.22 Amendments 18, 20 & 22 amend new paragraphs 160AQZE(4)(a), 160AQZF(3)(a) and 160AQZG(3)(a) so that the ceiling amounts for franking credits and franking rebates and intercorporate dividend rebates will be calculated in respect of dividends which become ex-dividend during the year of income on shares in the benchmark portfolio.
4.23 These amendments will remove the practical difficulties that would otherwise arise for taxpayers in determining their franking credit ceiling. Under the current rules, the ceiling amounts are calculated by reference to dividends paid on shares in the benchmark portfolio during the year of income. However, the franking yields for the All Ordinaries Index published by the Australian Stock Exchange, which taxpayers use in determining the ceiling amounts, are based on shares which become ex dividend during the year.
Amendments 19, 21 and 23: calculation of benchmark ceiling amounts for part of a year
4.24 Amendments 19, 21 and 23 amend new sections 160AQZE, 160AQZF and 160AQZG to provide for the calculation of a franking credit or rebate ceiling where a fund exists for only part of an income year. There is no provision in the current rules for the calculation of the relevant ceiling where a fund is in existence for part of a year rather than a full year of income.
4.25 Where a fund exists for only part of a year of income, the ceiling amounts for franking credits and franking rebates and intercorporate dividend rebates will be calculated on the basis of the shares in the benchmark portfolio which become ex-dividend during that part of the year during which the fund exists. This rule is set out in new subsections 160AQZE(4A) and (4B), 160AQZF(4A) and (4B) and 160AQZG(4A) and (4B) .
Amendments 24 - 27: benchmark portfolio of shares
4.26 Amendments 24 - 27 amend new subsections 160AQZH(2) and (4) to make corrections to the method for determining the benchmark portfolio of shares so that it is based on the average weekly net equity exposure of a fund. The definition of relevant week set out in new subsection 160AQZH(5) facilitates the calculation of ceiling amounts where a fund exists for only part of an income year.
Amendments 28 - 30: changes to application provisions
Distribution of shares or interest in shares in satisfaction of a previous interest
4.27 Amendments 28 - 30 make changes to the application provisions. Subitem 25(2A) , inserted by amendment 28 , provides that for the purpose of the general application rule set out in subitem 25(1) , where a taxpayer has held an interest in shares under a trust or as a partner in a partnership, and shares, or an interest in shares, are subsequently distributed in specie to the taxpayer in satisfaction of the original interest, the taxpayer will be taken to have acquired the shares or interest in shares from the time when the taxpayer acquired the original interest in the trust or partnership. This means, for example, that where a taxpayer acquires shares or an interest in shares on or after 1 July 1997 in satisfaction of an interest in shares under a trust or as a partner acquired before that day, the 45 day and related payments rules will not apply.
4.28 Amendment 30 makes parallel changes in respect of the application of new section 160APHL by inserting subitem 25(4A). New section 160APHL sets out the rules for determining a beneficiarys interest in shares or interests in shares held by a trust.
4.29 Subitem 25(2B) , also inserted by amendment 28 , provides that for the purpose of the general application rule set out in subitem 25(1) , bonus shares other than bonus shares treated as dividends will be excluded from these measures if the original shares were acquired before 1 July 1997. This change is consistent with the general tax treatment of bonus shares under which bonus shares that are not treated as dividends are generally taken to have been acquired when the original shares were acquired.
4.30 Amendment 30 makes parallel changes in respect of the application of new section 160APHL by inserting subitem 25(4B) .
Application of new section 160APHL
4.31 Amendment 29 amends subitem 25(4) so that shares, or interests in shares, which a trust was obliged to acquire under a contract made before 3.00 pm on 31 December 1997 will be excluded from the operation of new section 160APHL . Beneficiaries would otherwise not be entitled to franking benefits in respect of dividends paid on such shares unless they held their interests in shares at risk.
4.32 This change ensures that the general application rule under subitem 25(1) and the application rule for new section 160APHL under subitem 25(4) are consistent in respect of shares and interests in shares acquired under contracts before the commencement of the respective rules.
Chapter 5 - Franking of dividends by exempting companies and former exempting companies
Overview
5.1 Schedule 5 to the Bill sets out the limiting the source rule, one of the franking credit trading measures announced in the 1997-98 Budget. The amendments to Schedule 5 will:
- •
- clarify the rules for determining the effective ownership of companies to prevent arrangements to avoid the measure; and
- •
- make corrections to mechanical aspects of the provisions.
5.2 The limiting the source rule is one of the measures targeting franking credit trading announced in the 1997-98 Budget. The limiting the source rule reduces the source of franking credits available for trading by restricting the franking benefits that flow from the payment of franked dividends by companies effectively owned by non-resident or tax-exempt persons.
5.3 The changes will apply from the commencement of the measure.
Explanation of the amendments
Amendment 31: correction to Item 39
5.4 Amendment 31 corrects a reference in item 39 , which inserts a definition of interest in section 160APA.
Amendments 32 - 44: rules concerning effective ownership of company by prescribed persons
5.5 The limiting the source rule reduces the source of franking credits available for trading by restricting the franking benefits that flow from the payment of franked dividends by companies effectively wholly-owned by non-resident or tax-exempt entities. In determining whether a company is effectively wholly-owned by non-resident or tax-exempt shareholders, only accountable shares and accountable interests are taken into account.
5.6 Amendments 32 - 44 clarify the rules for determining the effective ownership of shares. These changes will prevent certain arrangements under which shares in a company, or interests in shares in a company, would not be accountable shares or accountable interests under the current rules even though all the shares or interests in the company were held by non-resident or tax-exempt persons. They also clarify the test of effective ownership.
5.7 The owner of property, in the economic sense, is the person who bears the risks of loss and has the opportunities for profit arising from that property. In the case of a company, this would mean the person or persons exposed to the performance of the company. However, in the case of a company, the law regards each share in the company as the subject of property, rather than the company itself. It might usually be expected that all the shares in a company in totality will reflect the risks and opportunities of owning the company, but some shares involve their holders in bearing few, if any, risks or opportunities reflecting the performance of the company. For example, some shares carry only rights equivalent to those of creditors; others may have no dividend rights. Often, therefore, the whole of the equity in a company, considered as a matter of substance, is represented by only some of the shares in it. It is therefore necessary to determine which shares, and where there are indirect holdings, which interests in shares, represent the real equity in a company in order to determine who effectively owns it.
5.8 Generally speaking, the clearest case of an owner of a company is the holder of an ordinary share in that company; the standard of ownership is therefore to be found in the rights usually attached to ordinary shares and in the risks and opportunities which flow from such rights. The amendments make it clear that this is the standard to be adopted by the legislation. Shares with different rights, and indirect interests in shares held through trusts and partnerships, are to be judged as relevant or irrelevant to the question of who effectively owns the company according to the extent that they approximate the rights, and participate in the risks and opportunities, from holding such shares.
5.9 The amendments also make it clear that regard must be had, not only to the rights attached to particular shares, but also the rights attached to other shares; both those held by the same shareholder (or associates), and those held by other shareholders. For example, instead of ordinary shares, a company might have different classes of shares carrying only voting rights, only dividend rights, or only rights to capital. As the proposed legislation stands, it would be possible to split an ordinary shareholding into shares of types each of which would consist of excluded shares, although together they represented all the real equity in the company. Conversely, there might be cases where there are ordinary shares in a company which of themselves appear to represent an ownership interest, but which in fact do not, because there are other super shares with rights that effectively override theirs. The criteria now specifically require the relationship between the value of the share or interest and the company to be taken into account, along with the nature of any relationship or connection between holders of shares and interests in shares. Thus, the proposed amendments require the overall position to be taken into account to ensure that the test operates, as intended, as in substance test of ownership.
5.10 Finally, the existing provisions which treat holders of accountable shares and interests as prescribed persons if the risks and opportunities of holding those shares lie with prescribed persons (ie. if the real owners of the shares or interests are prescribed persons) have been extended to holders of excluded shares and interests. This is because whether some shares or interests are excluded shares or interests may depend on whether they are held by prescribed persons. The change prevents prescribed persons from deliberately structuring their shareholdings so that they are excluded from the definitions of accountable shares and accountable interests .
5.11 Amendment 32 amends new paragraph 160APHBB(1)(b) , which is part of the rule for determining whether a company is taken to be effectively owned by prescribed persons.
5.12 Amendment 33 amends new section 160APHBC , which defines accountable share. It amends new subsection 160APHBC(3) and inserts new subsection 160APHBC(3A) .
5.13 Amendment 35 makes parallel changes to new section 160APHBD , which defines accountable interest .
5.14 Amendments 37-44 make consequential amendments.
5.15 Amendment 34 amends new paragraph 160APHBC(4)(d) to clarify that it applies to shares issued, transferred or acquired for the relevant purpose, rather than merely shares issues for the relevant purpose.
5.16 Amendment 36 amends new paragraph 160APHBC(6)(a) , which relates to finance shares, to make it consistent with a corresponding provision in paragraph 177EA(19)(g).
Amendments 45 and 46: conversion of franking surplus or franking deficit
5.17 If an exempting company becomes a former exempting company, and franking credits and debits had arisen before that time which are attributable to the period that the company is a former exempting company, the franking surplus or deficit of the company at the time it becomes a former exempting company will be reduced or increased accordingly.
5.18 Amendments 45 and 46 amend new sections 160AQCNG and 160AQCNH to change the treatment of the franking surplus or deficit of an exempting company at the time it becomes a former exempting company. Where an exempting company becomes a former exempting company and franking credits or debits had arisen before that time which are attributable to the period that the company is a former exempting company, those franking credits or debits are apportioned in the same way as franking credits or debits arising after that time.
5.19 These changes will ensure that the treatment of franking credits or debits arising in an income year during which an exempting company becomes a former exempting company is consistent irrespective of whether they arose before or after the change.
5.20 Amendment 45 inserts new subsections 160AQCNG(3) and (4). Amendment 46 inserts new subsections 160AQCNH(3) and (4) .
5.21 These amendments prevent an anomaly that would otherwise arise in respect of franking credits and debits that arise before a company became a former exempting company that are attributable to the period that the company is a former exempting company for example, franking credits from tax instalments paid for the year in which the exempting company became a former exempting company.
5.22 Currently, these franking credits or debits would be reflected in any franking surplus or deficit at the time an exempting company becomes a former exempting company, which is converted to an exempting credit or debit. On the other hand, franking credits and debits that arise after an exempting company becomes a former exempting company are apportioned according to the period of time that the company is a former exempting company.
5.23 For example, say a company pays a tax instalment on 1 March. If the company becomes a former exempting company on 2 March, the company would not be entitled to franking credits in respect of the payment of tax under the current provisions. If, however, the company became a former exempting company on 28 February, the company would be entitled to franking credits on an apportionment basis.
Amendment 47: transitional rules franking credits and franking debits
5.24 Amendment 47 extends the operation of new subsection 160AQCNI(1) so that franking credits and debits attributable to the period or an event occurring while the company was an exempting company are not converted to exempting credits and debits.
5.25 When an exempting company becomes a former exempting company, any franking surplus generally becomes an exempting credit and any franking deficit becomes an exempting debit. Similarly, franking credits and debits of a former exempting company attributable to the period that a company was an exempting company are converted to exempting credits and debits.
5.26 As a transitional measure, however, new subsection 160AQCNI(1) provides an exception to the general rule if an exempting company becomes a former exempting company after 13 May 1997 but the contract for the sale of shares was made before this time. In this case, a company is not required to quarantine the franking surplus or deficit attributable to the period that the company was an exempting company. Instead, the company can use franking credits attributable to this period to pay franked dividends that will provide franking benefits to shareholders in the normal way. However, an exception is not currently provided for payments of instalments of company tax, or receipt of refunds, after the company became a former exempting company in respect of the period before the company becomes a former exempting company.