House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 7 - Imputation - Life assurance companies

Outline of Chapter

7.1 This Chapter explains the measures contained in Part 2 of Schedule 3 to this Bill which amend the dividend imputation regime and the intercorporate dividend rebate provisions applying to life assurance companies.

7.2 In broad terms, the amendments set out for life assurance companies the circumstances for when franking credits and debits arise from:

•

the payment and refund of tax under the new PAYG system;

•

PAYG rate variation credits; and

•

the receipt of franked dividends.

7.3 The amendments also set out the circumstances when a life assurance company will be entitled to an intercorporate dividend rebate.

Context of Reform

7.4 Treasurer's Press Release No. 58 of 21 September 1999, released details of the New Business Tax System package including the broadening of the tax base applying to life insurers so that all profit from funds management, underwriting and other life assurance and immediate annuity business is taxed (see Chapter 5 for details of these changes).

7.5 The Treasurer also announced in the same press release that the imputation system relating to life insurers will be modified to reflect these changed taxation arrangements. In addition, consequential amendments are needed to the imputation system relating to life insurers so that the payment and refund of tax and PAYG rate variation credits under the new PAYG system give rise to franking credits and debits.

Summary of new law

7.6 In summary the amendments will:

•

provide franking credits for the payment of tax on income derived after 1 July 2000 if the income is attributable to:

-

insurance business income allocated to shareholders; or

-

non-insurance business income;

•

consistent with the current tax laws:

-

reduce by 80% the amount of franking credits and debits arising from the payment and refund of tax on income derived before 1 July 2000 if the income is attributable to the insurance funds of the company; and

-

provide franking credits and debits for the payment and refund of tax on income derived before 1 July 2000 if the income is attributable to the non-insurance funds of the company;

•

in respect of dividends paid on, or after, 1 July 2000:

-

allow an entitlement to the intercorporate dividend rebate where the assets of the company from which the dividend was derived is allocated to shareholders;

-

allow franking credits to arise in respect of the receipt of franked dividends where the assets of the company from which the dividend was derived is allocated to shareholders; and

-

allow an entitlement to the franking rebate where the assets of the company from which the dividend was derived is allocated to anything other than shareholders; and

•

make consequential amendments so that franking credits and debits arise in respect of the payment and refund of tax and PAYG rate variation credits under the new PAYG regime.

Detailed explanation of new law

Franking credits and debits for the payment and refund of tax

Background

7.7 Under the current tax laws life assurance companies other than mutual life assurance companies ^[F15] , receive franking credits and debits for the payment and refund of income tax on the same basis as other companies. Franking credits and debits that are attributable to statutory fund income of a life assurance company (i.e. insurance business income) are reduced by 80% to reflect prudential requirements that limit the portion of statutory fund income that can be distributed to shareholders. To the extent that the franking credits are not attributable to statutory fund income (i.e. non-insurance business income), no reduction takes place.

7.8 Until an assessment of tax payable for an income year is made, the life assurance company will not know the actual tax payable on its statutory fund and other components of taxable income. Therefore, the reducing franking credits and debits that arise before this time are interim ones that are based on the previous year's income tax assessment. Upon assessment, the interim franking credits are reversed out of the life companies franking account and reinstated in accordance with the current years income tax assessment.

7.9 The current imputation measures for life companies are amended to provide different treatment for tax paid on income derived on or after 1 July 2000. The explanation of these amendments is divided into the following sections:

•

standard balancing life assurance companies;

•

early balancing life assurance companies 2000-2001 income year; and

•

late balancing life assurance companies 1999-2000 income year.

Standard balancing life assurance companies

7.10 The new PAYG system for company instalments commences for taxpayers from their 2000-2001 income year. The 2000-2001 income year of a standard balancing life assurance company commences 1 July 2000 and ends on 30 June 2001. Therefore, all PAYG instalments paid by a standard balancing company for the 2000-2001 and subsequent income years will be referable to income derived on or after 1 July 2000.

7.11 Franking credits and debits arise for these life assurance companies for the payment or refund of tax or PAYG rate variation credits under the PAYG system to the extent that the payment, refund or credit is attributable to 'shareholders' funds income'.

7.12 Shareholders' funds income of a year of income is defined in these provisions as:

•

insurance business income allocated to shareholders; and

•

non-insurance business income;

derived in the relevant year of income and included in shareholders' funds before assessment for the income year. [Schedule 3, Part 2, item 54, section 160APA]

When do franking credits and debits arise for the payment of a PAYG instalment or company tax?

7.13 Standard balancing life assurance companies receive franking credits for the payment ^[F16] of income tax, which includes PAYG instalments and company tax, equal to the adjusted amount ^[F17] to which the payment of tax is attributable to income included in shareholders' funds income.

Before assessment

7.14 When a life assurance company pays a PAYG instalment for an income year, before assessment for that year, it may not be aware of the amount of the payment that will be finally attributable to tax on income that will be included in shareholders' funds income.

7.15 To enable franking credits to arise at the time of making the payment the life assurance company must undertake a 2 step process. Firstly, the company must estimate the amount of income derived upon which the PAYG instalment is calculated that will be included in shareholders' funds income. The company must then attribute none, some, or all of the tax paid to that income. The amount of the tax paid that is attributable to income that the company estimates will be included in shareholders' funds for that year of income is called the 'provisional franking component'. [Schedule 3, Part 2, item 67, section 160APVJ]

7.16 Franking credits of the life assurance company arise upon the payment of the PAYG instalment equal to the adjusted amount of the provisional franking component. The resulting franking credits are 'provisional franking credits'.

Assessment

7.17 Assessment occurs for a life assurance company in respect of a year of income on the day on which a notice of original company tax assessment for that income year is served, or taken to have been served, on the company. On or after this day the life assurance company's 'company tax is assessed' for the purposes of these measures. [Schedule 3, Part 2, item 56, section 160APBE]

7.18 Upon assessment, any provisional franking credits that have arisen for the payment, or application of a PAYG variation credit (see paragraphs 7.37 to 7.45) to discharge a PAYG instalment for that income year are reversed out of the life assurance company's franking account. A franking debit equal to the provisional franking credits obtained under section 160AQVJ reverses the credits. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.19 The provisional franking credits are replaced with final franking credits based on the reassessment of both the extent to which the original payment was attributable to shareholders' funds income and the amount of shareholders' funds income. [Schedule 3, Part 2, item 67, section 160APVK] As assessment has occurred, this amount is known with certainty and is referred to in these measures as the final franking component of the payment. The resulting franking credits are final franking credits . These credits are relevant to the application of the over estimation penalty explained at paragraphs 7.24 to 7.29.

After assessment

7.20 If a life assurance company makes a payment of a PAYG instalment for a particular year on or after assessment for that year, franking credits arise equal to the adjusted amount of the 'franking component' of the payment.

7.21 The franking component of the payment is that part of the payment that is attributable to income that has been allocated to shareholders' funds income for that year [Schedule 3, Part 2, item 67, section 160APVL] . As the payment has occurred after assessment, the franking component of the payment is known with certainty, and therefore no provisional franking credits are required.

7.22 Equivalent provisions also apply when a life assurance company makes a payment of company tax ^[F18] (i.e. franking credits arise to the extent to which the payment is attributable to income included in shareholders' funds). [Schedule 3, Part 2, item 67, section 160APVM]

Payment of excess foreign tax credits

7.23 Under section 160APQB, a life assurance company receives class C franking credits for the payment of excess foreign tax credits. However, franking credits should only arise for the payment of excess foreign tax credits for the 2000-2001 or subsequent income years to the extent to which the payment is attributable to income included in shareholders' funds income. Therefore, if a life assurance company receives a franking credit under section 160APQB, the full amount of the franking credit is reversed out of the life assurance company's franking account by a corresponding franking debit. The amount of the credit is then replaced by a franking credit equal to the adjusted amount of payment that is attributable to shareholders' funds income for the income year. [Schedule 3, Part 2, item 67, section 160APVO]

Over estimation penalty

7.24 Life assurance companies will be subject to an over estimation penalty if they over estimate the provisional franking component in respect of payments of PAYG instalments for the income year. If a life assurance company over estimates the amount of the provisional franking component in respect of payments by more than 10%, they will incur an additional franking debit. [Schedule 3, Part 2, item 75, section 160AQCNCC]

7.25 The franking debit is designed to discourage life assurance companies from over estimating the provisional franking component in respect of payments to artificially increase the balance in its franking account.

7.26 The over estimation penalty compares the amount of provisional franking credits that arise from the payment of a PAYG instalment based on the provisional franking component with the amount of final franking credits that arise for those payments on assessment.

7.27 If the sum of the provisional franking credits that arose from payments of PAYG instalments for the income year exceed, by more than 10%, the final franking credits that arise upon assessment for the income year in relation to those payments, the life assurance company will incur the additional franking debit.

7.28 The franking debit that arises is the difference between the provisional franking credits generated by payments and 110% of the final franking credits. [Schedule 3, Part 2, item 75, subsections 160AQCNCC(1) and (2)]

7.29 The Commissioner has discretion to determine that the franking debit does not arise or reduce the amount of the penalty. [Schedule 3, Part 2, item 75, subsections 160AQCNCC(4) and (5)]

When do franking debits and credits arise from the refund of tax under the new PAYG system and amended assessments?

Refunds of tax

7.30 For the purposes of these provisions, a life assurance company receives a 'refund' of company tax if:

•

either:

-

the company receives an amount as a refund; or

-

the Commissioner applies a credit, or a RBA surplus, against a liability or liabilities of the company; and

•

the amount refunded or applied represents in whole or in part a return to the company of an amount paid or applied to satisfy the company's liability to pay the company tax instalment or company tax.

[Schedule 3, Part 1, item 12, section 160APBD]

7.31 An amount refunded or applied will not be a refund for the purposes of these provisions to the extent to which it is attributable to a PAYG rate variation credit (see paragraph 7.42). [Schedule 3, Part 1, item 12, subsection 160APBD(3)]

7.32 Under the new PAYG system, a life assurance company, will generate a class C franking debit when:

•

a class C franking credit arises from:

-

the payment of a PAYG instalment or company tax; or

-

the application of a PAYG rate variation credit to discharge a PAYG liability or company tax; and

•

the company receives a refund of the amount paid or applied; and

•

the refund is not referable to a reduction of company tax which produced a franking debit under section 160APZ.

[Schedule 3, Part 2, item 75, subsection 160AQCNCD(1)]

7.33 The franking debit arises on the day the refund is received and is equal to the adjusted amount of the refund that is attributable to shareholders' funds income. [Schedule 3, Part 2, item 75, subsection 160AQCNCD(2)]

Amended assessments

7.34 Companies, including life assurance companies, receive a class C franking debit under section 160APZ when they receive an amended assessment that reduces their income tax liability. The amount of the debit under this section is the same for both ordinary companies and life assurance companies.

7.35 The amount of the debit for life assurance companies in relation to their 2000-2001 and subsequent income years should be reduced to reflect only that portion of the reduction in the income tax liability of the company that is referable to shareholders' funds income.

7.36 This is achieved by ensuring that when the 160APZ franking debit arises a corresponding franking credit is created to reverse out the full amount of the 160APZ franking debit [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(a)] . A replacement class C franking debit then arises equal to the amount by which the reduction in income tax liability produced by the amended assessment represents a return to the company of an amount previously paid to satisfy a company tax instalment or company tax in respect of shareholders' funds income [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(b)] .

When do franking credits and debits arise from a PAYG rate variation credit?

7.37 A PAYG rate variation credit is a credit that a taxpayer may claim under section 45-215 in Schedule 1 to the TAA 1953if the taxpayer has varied down their instalment rate to a lower rate than that used to calculate the amount of a PAYG instalment for a previous quarter.

7.38 A taxpayer claims a PAYG rate variation credit to which it is entitled by lodging the claim in the approved form a BAS. The BAS also records the taxpayer's PAYG instalment liability for the period.

7.39 Broadly speaking, the credit is provided to effectively reduce the amount of the previous instalment or instalments to the amount that they would have been if calculated in accordance with the lower instalment rate. This is achieved by offsetting the credit against the PAYG instalment liability rather than directly amending the liability.

7.40 If a PAYG instalment liability is outstanding at the time the PAYG rate variation credit arises, the credit may be applied to reduce the liability to the amount it would have been if originally calculated in accordance with the varied instalment rate. This application may produce provisional franking credits (see paragraph 7.43).

7.41 If all PAYG liabilities have been paid in full at the time the PAYG rate variation credit arises, the credit may be applied to other outstanding liabilities or returned to the taxpayer. This application or return is not a refund for the purposes of this provision and will not produce a franking debit. [Schedule 3, Part 1, item 12, subsection 160APBD(3)]

Before assessment

7.42 A franking debit arises when a PAYG rate variation is claimed prior to assessment only if the credit is:

•

referable to an amount previously paid or applied; and

•

the amount paid or applied gave rise to franking credits.

[Schedule 3, Part 2, item 75, section 160AQCNCE]

7.43 A return or application of an amount referable to a PAYG rate variation credit is not a refund for the purposes of these provisions, the franking debit for a PAYG rate variation credit serves this purpose.

7.44 The application of a PAYG rate variation credit to discharge a PAYG instalment liability gives rise to provisional franking credits. The amount of the provisional franking credits is equal to the extent to which the credit is attributable to tax paid on income the company estimates will be included in shareholders' funds income. [Schedule 3, Part 2, item 67, section 160APVJ]

7.45 The franking credit arises on the day the PAYG rate variation credit is applied to reduce the company's liability for a PAYG instalment. [Schedule 3, Part 2, item 67, section 160APVJ]

Assessment

7.46 At the time of assessment, the amount of the class C franking credits that arose from the application of the PAYG rate variation credit to discharge a PAYG instalment liability are reversed out of the life assurance company's franking account by an equivalent reversing franking debit. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.47 Similarly, the amount of the franking debit that arose from claiming the PAYG rate variation credit before assessment is also cancelled. A class C franking credit equal to the amount of the franking debit arises under section 160APVN to achieve this result. [Schedule 3, Part 2, item 67, section 160APVN]

7.48 It is not necessary to reinstate a franking credit or debit upon assessment for either claiming or applying a PAYG rate variation credit. Upon assessment, franking credits and debits only arise to the extent to which they are referable to tax paid on income included in shareholders' funds income. Upon assessment, when the component of payments and credits are reassessed, the PAYG rate variation credit applies as intended to reduce the overall PAYG instalment tax liabilities. Therefore, at that time, the credit is not referable to discharging tax attributable to income included in shareholders' funds income. The temporary impact of the PAYG rate variation credit on the life assurance company's franking account before assessment is removed and it is not necessary to make any further adjustments.

After assessment

7.49 For the reasons discussed at paragraph 7.48, no franking credits or debits will arise for either claiming a PAYG rate variation credit after assessment or applying the credit to discharge a PAYG liability.

Summary of franking credits and debits

7.50 Table 7.1 provides a summary of the franking debits and credits that arise for standard balancing life assurance companies.

Example 7.1: Payments and refunds of company tax instalments and company tax

Instalment 1

Better Life is a standard balancing non-mutual life assurance company. Better Life's PAYG instalment liability for the first quarter of its 2000-2001 income year is $1,000. Better Life pays the full amount of the instalment. Better Life estimates that half of the $10,000 of income upon which the PAYG instalment liability was calculated will be included in shareholders' funds income.

The company attributes $400 of the payment of income tax to the $5,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $400.

The payment of $1,000 generates $776 franking credits (i.e. $400 * 66/34 based on a 34% company tax rate). The balance in its franking account is $776.

Instalment 2

Better Life's PAYG instalment liability for the second quarter of its 2000-2001 income year is $5,000. Better Life pays the full amount of the instalment. Better Life estimates that one quarter of the $50,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.

The company attributes $2,500 of the payment of income tax to the $12,500 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.

The payment of $5,000 generates $4,853 franking credits (i.e. $2,500 * 66/34). The balance in its franking account is $5,629.

Instalment 3

Better Life's PAYG instalment liability for the third quarter of its 2000-2001 income is $2,000. Better Life pays the full amount of the instalment. Better Life estimates that one fifth of the $20,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.

The company attributes $100 of the payment of income tax to the $4,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.

The payment of $2,000 generates $194 franking credits (i.e. $100 * 66/34). The balance in its franking account is $5,823.

Instalment 4

Better Life's PAYG instalment liability for the final quarter of its 2000-2001 income is $2,000. Better Life only pays $1,000 of the instalment. Better Life estimates that one half of the $20,000 income upon which the PAYG instalment was calculated will be included in shareholders' funds income.

The company attributes $100 of the $1,000 payment of income tax to the $10,000 estimated to be included in shareholders' funds income. The provisional franking component of the payment is $2,500.

The payment of $1,000 generates $194 franking credits (i.e. $100 * 66/34). The balance in its franking account is $6,017.

Assessment

Upon assessment, a class C franking debit arises. The amount of the debit is equal to the amount of the provisional franking credits that arose for the income year. Better Life accumulated $6,017 provisional franking credits for the income year. Therefore, the class C franking debit that arises upon assessment is $6,017. The balance in Better Life's franking account is nil.

At the time of assessment, both the final company tax liability and the amount of income included in shareholders' funds income is known.

At this time, Better Life uses generally accepted accounting principles to identify that the actual amount of the payments made during the income year that is referable to tax paid on shareholders' funds income (i.e. final franking component) is:

•

Instalment 1 - $500

•

Instalment 2 - $2,500

•

Instalment 3 - $150

•

Instalment 4 - $50

Franking credits arise under section 160APVK on the assessment day equal to:

•

Instalment 1 - $970 ($500 * 66/34)

•

Instalment 2 - $4,853 ($2,500 * 66/34)

•

Instalment 3 - $291 ($150 * 66/34)

•

Instalment 4 - $97 ($50 * 66/34)

The payments of PAYG instalment liabilities before assessment generate $6,211 franking credits at the time of assessment. The balance in Better Life's franking account is $6,211.

Payment after assessment

Better Life's company tax assessment for the 2000-2001 income year is $12,000. Better Life makes a payment of $3,000 on the assessment day.

Of the $3,000 payment, $1,000 is attributable to the fourth instalment. Franking credits arise for the payment of a PAYG instalment after assessment equal to the franking component of the payment. Better Life uses generally accepted accounting principles to identify that $80 of the payment is attributable to tax paid on income included in shareholders' funds income. The payment of $1,000 generates $155 franking credits ($80 * 66/34). The balance in its franking account is $6,366.

The remaining $2,000 of the payment is a payment of company tax. Franking credits arise for this payment under section 160APVL equal to the adjusted amount of the payment that is attributable to tax paid on income included in shareholders' funds. Better Life uses generally accepted accounting principles to identify that $180 of the payment is attributable to tax paid on income included in shareholders' funds income. The payment of $2,000 generates $349 franking credits ($180 * 66/34). The balance in its franking account is $6,715.

Refund amended assessment

The taxpayer obtains an amended assessment for the income year reducing its tax liability from $12,000 to $11,000 producing a $1,000 refund. On the day of the amended assessment a $1,941 class C franking debit arises under 160APZ. The balance in Better Life's franking account is $4,774.

This 160APZ debit is reversed out of Better Life's franking account by a $1,941 franking credit, returning the franking account balance to $6,715.

The amount of the $1,000 return to Better Life that represented a reassessment of tax attributable to shareholders' funds income is $200. The refund from the amended assessment generates a $388 franking debit. The balance in Better Life's franking account is $6,327.

Example 7.2: Over estimation penalty

Adopting the facts in Example 7.1, Better Life accumulated $6,017 provisional franking credits for payments of PAYG instalment liabilities under section 160APVJ.

Upon assessment, $6,211 final franking credits arise under section 160APVK to replace the provisional franking credits.

The section 160APVJ franking credits do not exceed 110% of the 160APVK franking credits. Therefore, Better Life is not subject to a penalty franking debit.

Now assume that upon assessment that final franking component of the relevant payments are as follows:

•

Instalment 1 - $200

•

Instalment 2 - $1,500

•

Instalment 3 - $100

•

Instalment 4 - $20

Franking credits arise under section 160APVK on the assessment day equal to:

•

Instalment 1 - $388 ($200 * 66/34)

•

Instalment 2 - $2,912 ($1,500 * 66/34)

•

Instalment 3 - $194 ($100 * 66/34)

•

Instalment 4 - $39 ($20 * 66/34)

Upon assessment, $3,533 final franking credits arise to replace the provisional franking credits under 160APVK.

The section 160APVJ franking credits do not exceed 110% of the 160APVK franking credits. Therefore, Better Life is not subject to a penalty franking debit.

The amount of the debit is:

$6,017 - (110% * $3,533)
= $6,017 - $3,886
= $2,131


Early balancing life assurance companies 2000-2001 income year

7.51 The 2000-2001 income year of an early balancing life assurance company commences before 1 July 2000. Therefore payments of company tax made under the new PAYG system in relation to the company's 2000-2001income year may be referable to income derived both before and after 1 July 2000.

7.52 Under the proposed amendments, tax paid and refunded on income derived:

•

before 1 July 2000 will ultimately produce:

-

class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to non-insurance business income; and

-

class A franking credits and debits equal to the adjusted amount of 20% of tax paid or refunded that is attributable to insurance business income.

•

on or after 1 July 2000 will ultimately produce class C franking credits equal to the adjusted amount of the tax paid that is attributable to income included in shareholders' funds income.

7.53 Special transitional amendments are required for the 2000-2001 income year for early balancing life assurance companies to ensure that franking credits and debits arise appropriately to reflect that their income tax liability is referable to income derived both before and after 1 July 2000.

7.54 Payments of company tax in relation to the company's 2001-2002 and subsequent income years is always referable to income derived after 1 July 2000. Therefore, franking credits and debits arise for early balancers for the 2001-2002 and subsequent income years as for standard balancing life assurance companies.

When do franking credits or debits arise for the payment of a PAYG instalment or company tax?

Before assessment

7.55 If an early balancing life assurance company pays a PAYG instalment before assessment it may be unaware of the amount of the payment that will be finally attributable to tax on income derived before and after 1 July 2000. To overcome this limitation franking credits will arise for the payment of a PAYG instalment for the 2000-2001 income year by an early balancing life assurance company in the same way as for standard balancing life assurance companies.

7.56 That is, franking credits arise equal to the adjusted amount of the extent to which the payment is attributable to tax on income that the company estimates will be included in shareholders' funds income (see 7.13 to 7.15). [Schedule 3, Part 2, item 67, section 160APVJ]

Assessment

7.57 Upon assessment, any provisional franking credits that have arisen for the payment, or application of a PAYG variation credit to discharge a PAYG instalment for that income year prior to assessment, are reversed out of the life assurance company's franking account. The credits are reversed by franking debits, equal to the sum of provisional franking credits that arose under section 160AQVJ. [Schedule 3, Part 2, item 75, section 160AQCNCB]

7.58 If any part of the early balancing life assurance company's company tax for the 2000-2001 income year is referable to income that was derived before 1 July 2000, franking credits are reinstated as follows:

•

class C franking credits equal to the adjusted amount of the payment that is attributable to non-insurance business income derived before 1 July 2000;

•

class A franking credits ^[F9] equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 that is included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCG]

After assessment

7.59 If, on or after assessment, a life assurance company makes a payment of a PAYG instalment or company tax or receives a section 160APQB franking credit from the payment of excess foreign tax credits, franking credits arise as follows:

•

class C franking credits equal to the adjusted amount of the payment that is attributable to non-insurance business income derived before 1 July 2000;

•

class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits equal to the adjusted amount of the payment that is attributable to income included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCG]

Over estimation penalty

7.60 The over estimation penalty does not apply to the 2000-2001 income year of early balancing life assurance companies as the basis upon which franking credits initially arise and are reinstated is significantly different. However, the penalty does apply to subsequent income years for early balancers (see paragraphs 7.24 to 7.29). [Schedule 3, Part 2, item 75, subsection 160AQCNCC(3)]

When do franking debits and credits arise from the refund of tax under the new PAYG system and amended assessments?

Refunds of tax

7.61 When an early balancing life assurance company receives a refund (as discussed at paragraphs 7.30 and 7.33) in relation to its 2000 income year, the following franking debits arise:

•

class C franking debits equal to the adjusted amount of the refund that is attributable to non-insurance business income derived before 1 July 2000;

•

class A franking debits equal to the adjusted amount of 20% of the amount of the refund that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking debits equal to the adjusted amount of the refund that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCI]

Amended assessments

7.62 When a franking debit that is attributable to a reduction in company tax for the company's 2000-2001 income year of an early balancing life assurance company arises under section 160APZ, the following franking credit and debits arise:

•

class C franking credit equal to the class C franking debit that arose under section 160APZ to reverse out the original debit [Schedule 3, Part 2, item 75, paragraph 160AQCNCD(3)(a)] ;

•

class C franking debit equal to the adjusted amount of the reduction that is attributable to non-insurance business income derived before 1 July 2000;

•

class A franking debit equal to the adjusted amount of 20% of the amount of the reduction that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking debit equal to the adjusted amount of the reduction that is attributable to income included in shareholders' funds income derived on or after 1 July 2000.

[Schedule 3, Part 2, item 75, section 160AQCNCI]

When do franking credits and debits arise for a PAYG rate variation credit?

7.63 Franking credits and debit arise for claiming and applying a PAYG rate variation credits to discharge PAYG instalment liabilities for early balancing life assurance companies in the same way as they do for standard balancing life assurance companies. (See paragraphs 7.48 to 7.54)

When do franking credits and debits arise for the purposes of calculating franking deficit tax, deficit deferral tax and franking additional tax?

7.64 Payments of PAYG instalments and PAYG rate variation credits produce franking debits and credits for a life assurance company.

7.65 Where the payment or credit arises before assessment, the resulting provisional franking credits and debits are generated without reference to the extent to which the payment or credit is attributable to tax on income derived before 1 July 2000. It is only upon assessment after the provisional franking credits and debits are reversed out of the life assurance company's franking account that they are reinstated in accordance with when the underlying income was derived.

7.66 Where the provisional franking credits arise in a different franking year (the 'first franking year') than assessment (the 'second franking year'), the balance of company's franking account at the end of the first franking year may be distorted. This distortion only arises to the potential disadvantage of the taxpayer for the 2000-2001 income year of early balancing life companies.

7.67 To ensure that the taxpayer is not disadvantaged by the distortion, franking credits and debits that arise upon assessment for:

•

the payment of a PAYG instalment before assessment;

•

the application of a PAYG rate variation credit to discharge a PAYG instalment liability before assessment; or

•

the claiming of a PAYG rate variation credit before assessment;

during the first franking year (the 2000-2001 income year) are deemed, for the purposes of franking deficit tax, deficit deferral tax, and franking additional tax, to have arisen on the last day of that franking year.

[Schedule 3, Part 2, item 75, section 160AQCNCJ]

Example 7.3: Franking deficit tax, deficit deferral tax and franking additional tax

Simple Life is an early balancing life assurance company.

Simple Life accrues the following franking credits and debits for payments of PAYG instalments and company tax for its 2000-2001 income year.

Assume the taxpayer makes a distribution on 1 April creating a $5,000 deficit in its franking account. On the last day of the franking year - 31 December 2000 - Simple Life's franking account has a $147 deficit.

The franking credits and debits that arise for the payment of tax during the 2000-2001 income year are deemed to have arisen on the last day of the franking year (i.e. 31 December 2000). Simple Life's franking account will have a $570 franking account surplus on this day for the purposes of franking deficit tax, deficit deferral tax and franking additional. Consequently, Better Life will not be subject to franking deficit tax for the 2000-2001 income year.

Summary of franking credits and debits

7.68 Table 7.3 provides a summary of the franking debits and credits that arise for the 2000-2001 income year for early balancing life assurance companies.

Late balancing life assurance companies 1999-2000 income year

7.69 The COIN system under Division 1C of Part IV of the ITAA 1936 is to be replaced by the PAYG system from the 2000-2001 income year.

7.70 The current law provides for franking credits and debits to arise for the payment and refund of tax under the COIN system to produce the following net result:

•

class A franking credits and debits equal to the adjusted amount of 20% of the extent to which the payment or refund is attributable to insurance business income of the company; and

•

class C franking credits or debits equal to adjusted amount of the extent to which the payment or refund is attributable to non-insurance business income of the company.

7.71 However as payments and refunds under the COIN system for the 1999-2000 income year of a late balancing life assurance company may be referable to income derived both before and after 1 July 2000 transitional amendments are necessary.

7.72 The effect of these amendments is to provide that franking debits and credits ultimately arise in respect of the 1999-2000 income year of late balancing life assurance companies as follows:

•

class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to non-insurance business income derived before 1 July 2000;

•

class A franking credits and debits equal to the adjusted amount of 20% of the amount of tax paid or refunded that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits and debits equal to the adjusted amount of the tax paid or refunded that is attributable to income derived on or after 1 July 2000 that is included in shareholders' funds income.

7.73 Payments of company tax in relation to the company's 2000-2001 and subsequent income years will always be referable to income derived after 1 July 2000. Therefore, franking credits and debits arise for late balancing life assurance companies for the 2000-2001 and subsequent income years as for standard balancing life assurance companies.

When do franking credits and debits arise for the payment of a COIN instalment or company tax?

Before assessment

7.74 Late balancing life assurance companies receive franking credits for the payment of income tax (COIN instalments) for the 1999-2000 income year before assessment, in accordance with the current imputation system.

7.75 Broadly speaking, under the current law a life assurance company receives class C franking credits equal to the adjusted amount of a payment of a company instalment made before assessment under sections 160APM and 160APMAA.

7.76 The class C franking credit is then reduced by a class C franking debit equal to the adjusted amount of the extent to which the payment is referable tax paid in relation to insurance business income. The extent to which the payment is referable to tax paid in relation to insurance business income is based on the proportions of income tax on insurance business income to non-insurance business income for the previous income year. These debits arise under section 160AQCCA.

7.77 When the reducing class C franking debits arise, they trigger a class A franking credit. The amount of the class A franking credit is equal to the adjusted amount of 20% of the extent to which the payment is attributable to tax paid in relation to insurance business income. The credit arises under section 160APVH. Again the amount of the class A franking credit arising from the payment is determined by reference to the previous year's proportions of tax paid on insurance and non-insurance income.

Assessment

7.78 Upon assessment, the reducing class C franking debits are reversed out of the life assurance company's franking account by corresponding class C franking credits arising under section 160APVB. The class A franking credits are similarly reversed by class A franking debits under section 160AQCN.

7.79 By reversing out the reducing class C franking credits, the life assurance company is left with class C franking credits equal to the adjusted amount of the original payment.

7.80 Under the current law, the class C reducing franking debits and class A franking credits would ordinarily be reinstated upon assessment in accordance with the current years proportion of tax paid on insurance business income and non-insurance business income. However, the proposed amendments prevent reducing class C franking debits, and consequently class A franking credits, from being reinstated after assessment for the 1999-2000 income year for late balancing life assurance companies. [Schedule 3, Part 2, item 71, paragraph 160AQCCA(3A)(b)]

7.81 Instead the proposed amendments reinstate franking credits and debits to take account of income derived before and after 1 July 2000 as follows:

•

class C franking debits arise equal to the adjusted amount of the payment that is attributable to:

-

income derived before 1 July 2000 other than non-insurance business; or

-

income derived on or after 1 July 2000;

•

class A franking credits arise equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits arise equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCF]

After assessment

7.82 If, on or after assessment, the life assurance company makes a payment of a COIN instalment or company tax or receives a section 160APQB franking credit for the payment of excess foreign franking credits, franking credits and debits arise as follows:

•

class C franking credits equal to the adjusted amount of the payment (see sections 160APM, 160APMA, 160APMD of the ITAA 1936);

•

class C franking debits equal to the adjusted amount of the payment that is attributable to:

-

income derived before 1 July 2000 other than non-insurance business; or

-

income derived on or after 1 July 2000;

•

class A franking credits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCF]

7.83 Consequential amendments to the current law ensure that no other franking credits and debits arise for late balancing life assurance companies from these payments. [Schedule 3, Part 2, items 71 to 74.]

Over estimation penalty

7.84 The over estimation penalty does not apply to the 1999-2000 income year for any life assurance companies. However, the penalty can apply to subsequent income years for late balancers under the provisions described for standard balancing life assurance companies at paragraphs 7.27 to 7.29. [Schedule 3, Part 2, item 75, section 160AQCNCC]

When do franking debits and credits arise from the refund of tax under Division 1C of Part VI and amended assessments?

Before assessment

7.85 Late balancing life assurance companies receive franking debits for refunds of income tax for the 1999-2000 income year before assessment in accordance with the current imputation system.

7.86 Broadly speaking, under the current law, a life assurance company receives a class C franking debit equal to the adjusted amount of the refund received before assessment under sections 160APY and 160APYA.

7.87 The class C franking debit is then reduced by a class C franking credit equal to the adjusted amount of the extent to which the refund is referable to tax paid on insurance business income based on the proportions of income tax on insurance business income to non-insurance business income for the previous income year. These credits arise under section 160APVA.

7.88 When the reducing class C franking credits arise, they trigger a class A franking debit. The amount of the class A franking debit is equal to the adjusted amount of 20% of the extent to which the refund is attributable to tax paid in relation to insurance business income (see section 160AQCN).

Assessment

7.89 Upon assessment, the reducing class C franking credits are reversed out of the life assurance company's franking account by a corresponding class C franking debit arising under section 160AQCCB. The class A franking debits are similarly reversed by class A franking credits under section 160APVH.

7.90 By reversing out the reducing class C franking credits, the life assurance company is left with class C franking debits equal to the adjusted amount of the original refund.

7.91 Under the current law, the class C reducing franking credits and class A franking debits would ordinarily be reinstated upon assessment in accordance with the current year's proportion of tax paid on insurance business income and non-insurance business income. Amendments have been made to ensure that these credits and debits do not arise for the 1999-2000 income year for late balancing life assurance companies. [Schedule 3, Part 2, items 64 and 74]

7.92 Rather, the following franking debits and credits arise reflecting the extent to which the refund was referable to tax paid on income derived before and after 1 July 2000:

•

class C franking credits equal to the adjusted amount of the refund that is attributable to:

-

income derived before 1 July 2000 other than non-insurance business; or

-

income derived on or after 1 July 2000;

•

class A franking debits equal to the adjusted amount of 20% of the amount of the payment that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking debits equal to the adjusted amount of the payment that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCH]

After assessment

7.93 If the life assurance company receives a refund after assessment or a reduction in company tax that produces a section 160APZ franking debit in relation to its 1999-2000 income year, franking credits and debits arise as follows:

•

class C franking debits equal to the adjusted amount of the refund (see sections 160APY, 160APYA and 160APYBA of the ITAA 1936);

•

class C franking credits equal to the adjusted amount of the refund or reduction that is attributable to:

-

income derived before 1 July 2000 other than non-insurance business; or

-

income derived on or after 1 July 2000;

•

class A franking debits equal to the adjusted amount of 20% of the amount of the refund or reduction that is attributable to insurance business income derived before 1 July 2000; and

•

class C franking credits equal to the adjusted amount of the refund or reduction that is attributable to income derived on or after 1 July 2000 and included in shareholders' funds income.

[Schedule 3, Part 2, item 75, section 160AQCNCH]

7.94 The current law is also amended to ensure franking credits and debits do not arise in relation to these payments for late balancing life assurance companies. [Schedule 3, Part 2, items 64 to 66 and 74]

Summary of franking credits and debits

7.95 Table 7.4 provides a summary of the franking debits and credits that arise for the 1999-2000 income year for late balancing life assurance companies.

Intercorporate dividend rebate, franking credits arising from the receipt of franked dividends, and the franking rebate

7.96 As a result of the proposal to broaden the tax base of life assurance companies, modifications have also been made to the provisions in the ITAA 1936 that provide for the intercorporate dividend rebate (under sections 46 and 46A), franking credits arising from the receipt of franked dividends (under sections 160APP and 160APQ) and the franking rebate (under sections 160AQU and 160AQZA).

7.97 In summary, these amendments, which apply in respect of franked dividends paid on or after 1 July 2000, will entitle a life assurance company to:

•

an intercorporate dividend rebate in respect of franked dividends received provided the assets of the company from which the dividend was derived is, at all relevant times, allocated to shareholders;

•

a franking credit in respect of franked dividends received provided the assets of the company from which the dividend was derived is, at all relevant times, allocated to shareholders; and

•

a franking rebate in respect of franked dividends received where the assets of the company from which the dividend was derived is not at any relevant time allocated to shareholders.

When is a life assurance company entitled to an intercorporate dividend rebate?

7.98 Subsections 46(2) and 46A(5) of the ITAA 1936 set out the general provisions for determining a company's entitlement to the intercorporate dividend rebate. In broad terms, a resident company is entitled to a rebate in its assessment for an income year by applying the average rate of tax payable by the company to the part of any dividends that are included in its taxable income for that year.

7.99 However, the entitlement to the rebate for life assurance companies is limited to those dividends forming part of the standard component of the life assurance company's taxable income (see subsections 46(1A) and 46(10)).

7.100 As a result of the wider proposal to broaden the tax base of life assurance companies, amendments have been made so that a life assurance company will only be entitled to the intercorporate dividend rebate in respect of dividends included in its taxable income that are included in the shareholders' funds of the life assurance company. ^[F26] This is achieved by deeming the taxable income of a life assurance company to be that part of the company's taxable income that is attributable to shareholders' funds income of the company for that income year for the purposes of the rebate. [Schedule 3, Part 2, items 37 and 43, subsections 46(1A) and 46A(6A)]

7.101 However, no entitlement to the rebate arises in respect of a particular dividend if:

•

the assets of the life assurance company from which the dividend was derived were included in the insurance funds of the life assurance company at any time during the period that:

-

starts at the beginning of the income year of the life assurance company in which the dividend was paid; and

-

ends at the time when the dividend was paid,

unless at all times when those assets were included in the insurance funds during that period they were held on behalf of the life assurance company's shareholders. [Schedule 3, Part 2, items 39 and 45, subsections 46(10) and 46A(17)]

7.102 For the purpose of these provisions the term:

•

'shareholders' funds' has the same meaning as in the Life Insurance Act; and

•

'insurance funds' has the same meaning of that term provided in Division 8 of Part III immediately before 1 July 2000.

[Schedule 3, Part 2, items 30 and 33, subsection 6(1)]

7.103 As a result of the proposed tax rate changes applying to the various components of a life assurance company's taxable income, a consequential amendment is also necessary to the term 'average rate of tax payable' in subsections 46(6AA) and 46A(8AA) of the ITAA 1936. The 'average rate of tax payable' for a year of tax will now be the rate of tax applicable under sections 23A and 23B of the ITRA 1986. [Schedule 3, Part 2, items 38 and 44, subsections 46(6AA) and 46A(8AA)]

7.104 To ensure that these amendments operate as intended a number of definitional amendments have also been made to subsections 6(1) and 46(1). [Schedule 3, Part 2, items 30 to 36, subsections 6(1) and 46(1)]

When does a life assurance company receive franking credits from the receipt of franked dividends?

7.105 Sections 160APP and 160APQ of the ITAA 1936 set out the circumstances for determining when a company records a franking credit from the receipt of franked dividends (section 160APP for dividends received directly from other companies and section 160APQ for dividends received indirectly through trusts or partnerships). These provisions provide that a franking credit arises to the recipient company equal to the franked amount of the dividend at the time the dividend is paid, in the case of direct dividends, or at the end of the relevant income year, in the case of indirect dividends.

7.106 However, for life assurance companies the provisions are modified in circumstances where the assets from which the dividend was derived were included in the insurance funds of the company at any time commencing at the start of the relevant income year and ending at the time the dividend is paid. In these circumstances the franking credit is reduced by 80% to take into account that there is a 20% limit on the amount of profits that can be distributed to shareholders because of various prudential rules contained in the Life Insurance Act. ^[F27]

7.107 There are further rules contained in section 160AQCA to claw back franking credits arising under either section 160APP or 160APQ where the assets from which the dividend was derived are included in the insurance funds of the company after the dividend has been received and before the end of the relevant income year.

7.108 In keeping with the proposal to broaden the tax base of life assurance companies, amendments have been made to sections 160APP and 160APQ by preventing franking credits arising from the receipt of a franked dividend if the assets from which the dividend was derived were included in the insurance funds of the company at any time from the beginning of the relevant income year to the time the dividend was paid unless those assets were held on behalf of the company's shareholders during that time. [Schedule 3, Part 2, item 60, subsection 160APP(5)]

7.109 An equivalent amendment has also been made in respect of indirect distributions provided under section 160APQ and exempting distributions provided under section 160APPA. [Schedule 3, Part 2, items 61 and 62, subsections 160APPA(9) and 160APQ(3)]

7.110 The rules in section 160AQCA have also been amended so that where the assets from which a dividend was derived cease to be held on behalf of shareholders after the dividend has been received and before the end of the relevant income year, the franking credits that arose in respect of the receipt of the original dividend under section 160APP or 160APQ are cancelled (with an offsetting franking debit). [Schedule 3, Part 2, item 69, subsection 160AQCA(3)]

When is a life assurance company entitled to a franking rebate or venture capital franking rebate?

7.111 Under the current dividend imputation provisions, where a franked dividend is paid to a shareholder who is a resident individual, or a partnership or trustee of a trust estate, the shareholder is required to include the imputed company tax attached to the dividend as assessable income, and is entitled to a rebate, or to pass on the rebate in the case of a partnership or trust, of the amount so included under sections 160AQT and 160AQU of the ITAA 1936.

7.112 These provisions also apply to life assurance companies to the extent that the assets of the shareholder from which the dividend was derived are included in the insurance funds of the company at any time during the period starting at the beginning of the relevant income year and ending at the time the dividend was paid (see example in subsection 160AQT(1C)). ^[F28]

7.113 As a result of the proposals to broaden the tax base of life assurance companies, a life assurance company will be required to include the imputed company tax attached to the dividend as assessable income if:

•

at any time during the period that:

-

starts at the beginning of the income year of the life assurance company in which the dividend was paid; and

-

ends at the time when the dividend was paid; and

•

the assets of the life assurance company from which the dividend was derived were both:

-

included in the insurance funds of the life assurance company; and

-

not held on behalf of the life assurance company's shareholders.

[Schedule 3, Part 2, item 77, subsection 160AQT(1C)]

7.114 Where the amount is so included in the life assurance company's assessable income, the company is entitled to franking rebate equal to the amount provided under section 160AQU.

7.115 An equivalent rebate is available to life assurance companies under section 160AQZA in respect of distributions received indirectly through a trust or partnership provided subsection 160APQ(3) applies in respect of the distribution. Subsection 160APQ(3) applies where the assets from which the distribution is attributable are included in the insurance funds of the life assurance company in the relevant income year.

7.116 Certain life assurance companies who engage in superannuation business may be eligible for the venture capital franking rebate. The operation of this rebate has also been amended to ensure it will only be available if the relevant assets of the life assurance company from which the eligible dividend was derived were both:

•

included in the insurance funds of the life assurance company; and

•

not held on behalf of the life assurance company's shareholders.

[Schedule 3, Part 2, item 83, paragraph 160ASEP(1)(i)]

Application and transitional provisions

7.117 The amendments governing franking credits and debits for the payment and refund of tax under the new PAYG system and PAYG rate variation credits apply to the 2000-2001 income year.

7.118 The amendments governing franking credits and debits for the 1999-2000 income year for late balancing life assurance companies apply from the 1999-2000 income year.

7.119 The amendments to the intercorporate dividend rebate, franking credits arising from the receipt of franked dividends, and the franking rebate apply to dividends paid on or after 1 July 2000.

7.120 Consequential amendments are required to reflect the changes to life assurance company taxation base made under items 78 to 82 apply to income derived on or after 1 July 2000.

Consequential amendments

7.121 To facilitate the amendments described at paragraphs 7.117 to 7.120 a number of further consequential amendments have also been made. In broad terms, these amendments make appropriate definitional and interpretation changes and ensure that the provisions relating to calculating the 'adjusted amount' and applying rebates continue to operate appropriately. [Schedule 3, Part 2, items 30 to 36, 40 to 42, 46 to 55, 57 to 59, 63, 68 and 70]

7.122 Further consequential amendments have been made to take account of amendments to the ITAA 1936 from the broadening of the tax base applying to life insurance companies. ^[F29] [Schedule 3, Part 2, items 78 to 82]