Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 6 - Regulation impact statement
Policy objective
6.1 The imputation measure in these bills, which deals with the system to allow corporate tax entities to pass on to their members credits for income tax paid by the entities, is part of the Governments broad ranging reforms which will give Australia a New Business Tax System. The reforms are based on the recommendations of the Review of Business Taxation, instituted by the Government to consider the reform of Australias business tax system. In addition, the measure in these bills reflects feedback and submissions from the business community on the imputation rules previously exposed as part of the New Business Tax System (Entity Taxation) Bill 2000 exposure draft.
6.2 The Government instituted the Review of Business Taxation to consult on its plan to comprehensively reform the business tax system as outlined in the Governments tax reform document: Tax Reform: not a new tax, a new tax system . The Review of Business Taxation made recommendations to the Government designed to achieve a more simple, stable and durable business tax system.
6.3 The Review of Business Taxation recommended the redesigning of the company tax and imputation system to achieve:
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- integrity through the entity chain;
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- simplification of the franking account;
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- refunding excess imputation credits; and
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- the reduction of the company tax rate.
6.4 These bills are part of the legislative program implementing the New Business Tax System. Measures such as refunding excess imputation credits and the reduction of the company tax rate have already been enacted.
6.5 The new imputation provisions will broadly change the mechanics of the current imputation system to achieve:
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- a simplification of the rules and consequent reduction in compliance costs;
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- increased flexibility in franking distributions; and
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- consistency of treatment across entities receiving franked dividends.
6.6 Whilst the new imputation system changes the mechanics of the current imputation system, the new imputation provisions will generally, provide the same outcome as the current imputation system.
6.7 The new imputation provisions are redrafted using a clearer and a more accessible style, incorporating many of the presentation techniques such as examples, notes and guides developed as part of the tax law improvement project.
6.8 The object of the new imputation system is to integrate the Australian corporate tax system and its members by allowing corporate tax entities to pass on credits for income tax paid to their members and to allow the Australian members to claim a tax offset for that credit and, in some circumstances, claim a refund if they are unable to fully utilise the tax offset.
6.9 The objects of the new imputation system are also to ensure that:
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- the imputation system is not used to give the benefit of income tax paid by a corporate tax entity to members who do not have a sufficient economic interest in the entity;
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- the imputation system is not used to prefer some members over others when passing on the benefits of having paid income tax; and
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- the membership of the corporate tax entity is not manipulated to create either of the outcomes above.
Implementation options
6.10 This measure arises directly from recommendations of the Review of Business Taxation. Those recommendations were the subject of extensive consultation. The implementation options for the measure can be found in A Platform for Consultation and A Tax System Redesigned . Table 6.1 shows where the sub-measures (or the principles underlying them) are discussed in those publications.
| Measure | A Platform for Consultation | A Tax System Redesigned |
|---|---|---|
| Replacing the intercorporate dividend rebate with the gross up and credit approach. | Chapter 17, pp. 390-398 | Recommendation 11.4, pp. 416-418 |
| Franking account will record franking credits expressed on a tax-paid basis. | Chapter 17, pp. 380-381 | Recommendation 11.6(i), pp. 419-420 |
| Aligning the franking year with the income year. | Chapter 17, pp. 382-383 | Recommendation 11.6(ii), p. 420 |
| Adopting a standard rate of franking. | Chapter 17, p. 389 | Recommendation 11.6(iii), pp. 420-421 |
| Allowing widely-held entities with a single class of membership to vary their franking rate within a half year. | (Not discussed) | Recommendation 11.6(iv), pp. 420-421 |
6.11 These implementation options discussed in A Platform for Consultation and A Tax System Redesigned were included in the New Business Tax System (Entity Taxation) Bill 2000 exposure draft. As a result of feedback and submissions from the community some rules were modified. Table 6.2 lists variations from the rules as recommended in A Platform for Consultation, A Tax System Redesigned and the rules in the exposure draft legislation.
| Approach reflected in these bills | Reason for the approach |
|---|---|
| The abolition of Benchmark Rule No. 2. Benchmark Rule No. 2 was intended to prevent streaming opportunities between franking periods by restricting the extent to which companies could vary their franking rate from one period to the next. | There are already anti-avoidance rules that can be relied upon to address streaming of franking credits. A new rule that requires companies to disclose excessive franking rate variations between franking periods to the Commissioner has also been introduced. |
| Simplifying the process of allocating franking credits to distributions by simply allowing companies to attach franking credits to a distribution. The original allocation rules, the standing and specific allocation rules , were overly prescriptive and complex. | This process avoids unnecessarily complex allocation rules. Moreover, there are not significant integrity issues needing to be addressed by having such rules. |
| Benchmark for a particular franking period is established by the franking percentage applying to the first dividend paid in the period. | This process avoids complex declaration and default rules for benchmarking. |
| Subject to certain conditions, allow private companies to retrospectively frank dividends. Although this change does not represent a departure from the original recommendations, consultation identified it as being a desirable feature. | This change enhances the original recommendation and adds to the compliance cost reductions that were the initial driver to the proposal. It also more closely aligns with ordinary commercial practices and ATO administrative practices. |
6.12 Some rules which are required to complete the imputation system are not in these bills. These measures will be included in a later bill and largely deal with consequential amendments.
Assessment of impacts
6.13 The potential compliance, administrative and economic impacts of these bills have been carefully considered, both by the Review of Business Taxation and by the business sector. The Review of Business Taxation focused on the economy as a whole in assessing the impacts of its recommendations and concluded that there would be net gains to business, government and the community generally from business tax reform.
6.14 These bills specifically impacts on those taxpayers identified in Table 6.3.
| Measure | Affected taxpayers |
|---|---|
| Franking a distribution. | Corporate tax entities that can frank distributions. Estimates based on ATO data indicate that historically, up to 76,500 corporate tax entities pay franked distributions to their members each year. |
| Benchmark rule. | Corporate tax entities other than certain listed public companies that have little opportunity for streaming. |
| Franking accounts. | All corporate tax entities. Estimates based on ATO and Australian Securities and Investments Commission data indicate that there are between 1,184,227 and 1,235,120 registered companies. |
| Effect of receiving a distribution. | Members of corporate tax entities. Members include shareholders, beneficiaries and partners. |
6.15 A major concern for businesses is the cost incurred in complying with their obligations under the various taxation and other laws. These bills are designed to reduce compliance costs incurred by business by providing simpler processes.
6.16 The new imputation system, which have adopted different mechanics to the current system, will result in lower costs of compliance for a corporate tax entity in maintaining a franking account principally as a result of simplified and more easily understood rules.
Franking account maintained on a tax paid basis
6.17 The current approach to recording amounts for tax paid in an entitys franking account on the basis of the after-tax profit available for distribution has involved complex conversion provisions when the company tax rate has changed. In the years before these conversion provisions were introduced, multiple franking accounts were generally used to accommodate changes to the company tax rate. This lead to the undesirable proliferation of franking accounts - the class A, B and C franking accounts - and with it further complexities surrounding their interaction.
6.18 To avoid this, the new imputation franking account provisions record credits on a tax-paid basis. This approach will dispense with the need for complex conversion provisions and multiple franking accounts whenever the prevailing company tax rate changes. As a result, there will be compliance cost reductions in the form of labour cost savings as taxpayers and their advisors will no longer have to put their mind to the complex conversion provisions when the company tax rate changes. The extent of the savings is not quantifiable but they are estimated as being moderate against the background of the rest of the imputation system. The change does not impact on shareholders receiving franked distributions.
Aligning franking year with income year
6.19 The new imputation rules will also align an entitys franking year with its income year. Under the current imputation rules, a companys franking year can differ from its income year, particularly in the case of late balancing companies. In some circumstances, the misalignment of these periods can cause reconciliation problems as well as providing a further unnecessary complexity to the law. The proposal to align the 2 periods will eliminate this complexity for those entities which would otherwise have 2 different periods. Although this change will simplify the law it is not expected to result in significant compliance cost savings. There may be some small labour saving cost reductions through the avoidance of the reconciliation problems associated with having disparate periods.
6.20 Under the current imputation rules, companies are required to use a very prescriptive process in order to attach franking credits to dividends that they make to their shareholders. For example, the current rules require companies to make a declaration stipulating the extent to which a dividend is to be franked.
6.21 Under the new rules the process will be significantly streamlined. The new rules do not, for tax purposes, require companies to go through a formal process to frank a dividend. Companies are simply required to disclose the extent to which a dividend is franked by issuing a distribution statement to the member receiving the distribution.
6.22 This streamlined approach will reduce compliance costs for companies because they will be able to frank distributions by the process which best suits their needs and without regard to any tax laws which might have prescribed this process. This will result in unquantifiable labour cost savings.
6.23 Consistent with the current laws, companies making franked distributions to their members will have to provide those members with a distribution statement.
6.24 This means that for companies that are not private companies the distribution statement is required to be given on or before the day on which the distribution is made.
6.25 However, a modification has been made for distribution statements issued by private companies. The change allows private companies to provide distribution statements before the end of 4 months after the end of the income year in which the distribution is made. This change is intended to further ease compliance costs for private companies and to also reflect commercial practice and the manner in which private companies typically make dividend payments. Although this change will not result in any labour cost savings, it will provide affected companies with timing benefits and increased flexibility.
Effects of receiving a franked distribution
6.26 Under the current tax laws, 2 different rebate provisions apply to relieve tax from franked dividend income: the intercorporate dividend rebate applies in respect of corporate shareholders; and the franking rebate generally applies to shareholders that are natural persons.
6.27 Under the new imputation rules a single rebate provision will apply - the franking rebate. This will mean that resident corporate tax entities that receive a franked distribution from another corporate tax entity will no longer need to determine the amount of the intercorporate dividend rebate. Rather, they will apply the franking rebate in the same way as resident individuals and superannuation entities (using the gross-up and credit approach that applies). The adoption of a single rebate provision for all taxpayers in respect of franked dividend income significantly simplifies the law. This simplification is not expected to result in any tangible labour cost savings.
6.28 As is standard with a new measure, groups affected by it are expected to incur a small up-front cost in either familiarising themselves with the new law or having advisors familiarise themselves with the new law and, if necessary, communicating that information to affected taxpayers. These costs are not expected to be significant, however, as the new imputation system largely replicates the existing regime. This will mean that the existing systems and processes that taxpayers already have in place in complying with the existing imputation regime will continue to be relevant under the new system. However, there may be some modifications required to the systems and processes that taxpayers have in place but these are not expected to be significant and would not outweigh the benefits of the new imputation regime as a whole.
6.29 In the first year of the new imputation system, it is expected the ATO will incur additional administration costs in updating systems and tax returns and in providing advice to taxpayers on the new system. The ATO will also incur on-going costs in monitoring the system. These costs in administering the system will be funded from existing resources. In the longer term, administration costs should decrease as the need for advice on the new imputation system decreases.
6.30 These bills will have no impact on revenue.
6.31 The new imputation system as a part of the New Business Tax System will contribute towards achieving the broader aims of the New Business Tax System to provide Australia with an internationally competitive business tax system that will create the environment for achieving higher economic growth, more jobs and improved savings.
Other issues - consultation
6.32 The consultation process began with the release of the Governments tax reform document: Tax Reform: not a new tax, a new tax system in August 1998. The Government established the Review of Business Taxation in that month. Since then, the Review of Business Taxation has published 4 documents about business tax reform, including discussions on redesigning the imputation system. In particular, A Platform for Consultation and A Tax System Redesigned canvassed options, discussed issues and sought public input.
6.33 In October 2000, the Government released legislation as part of the New Business Tax System (Entity Taxation) Bill 2000 exposure draft. Although the exposure draft legislation was withdrawn, the feedback and submissions received on the imputation component of the exposure draft legislation have been reflected in these bills.
6.34 There has also been ongoing consultation with this measure since that time. The consultation has been very productive with many significant improvements made to the legislation and in the design of the various processes. The changes explained in Table 6.2 reflect some of the main areas that have changed as a result of consultation.
Conclusion and recommended option
6.35 The imputation system contained in these bills should be adopted to support a more efficient, innovative and internationally competitive Australian business sector, to reduce compliance costs and to establish a simpler and more structurally sound business tax system.