House of Representatives

Explanatory Memorandum

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

Chapter 9 - Consolidation: imputation rules

Outline of chapter

9.1 Schedule 9 to this bill introduces imputation rules that are relevant to consolidated groups, namely:

•

the application of the exempting entity provisions to consolidated groups;

•

the franking of distributions by a member of a consolidated group whose membership interests are held by a non-resident;

•

the transfer of franking account balances between eligible tier-1 entities in a MEC group where a new provisional head company is appointed;

•

the franking of distributions by eligible tier-1 entities in a MEC group other than by the head or provisional head company; and

•

the franking of distributions by entities in a MEC group (other than by eligible tier-1 companies) to non-resident interposed entities.

Context of reform

9.2 As part of the introduction of the consolidation regime, A Tax System Redesigned recommended that a consolidated group operate a single franking account at the head entity level and that all the existing franking credits of members of the group be pooled.

9.3 In order to fulfil the recommendations of A Tax System Redesigned , the franking account rules for consolidated groups introduced in the May Consolidation Act provide for the pooling of franking credits. The provisions also set out special rules for the operation of the franking accounts of both the head company and of a subsidiary member of a consolidated group during the period of consolidation.

9.4 Consistent with the principles relating to the pooling of franking credits and the operation of a single franking account for a consolidated group, the imputation rules introduced in Schedule 9 to this bill provide for the application of the exempting entity franking rules to a consolidated group, pooling of exempting credits where appropriate, and special rules for the operation of exempting accounts of the head company and subsidiary members during consolidation.

9.5 In addition, the rules introduced in this bill deal with special franking account issues for MEC groups to give practical effect (in relation to imputation) to the recommendations of A Tax System Redesigned to allow resident wholly-owned subsidiaries of a foreign company to consolidate for tax purposes as a MEC group.

Summary of new law

Exempting entity rules for consolidated groups

9.6 This section sets out rules to ensure that the exempting entity provisions introduced in the June Consolidation Act apply appropriately to consolidated groups.

9.7 These rules are used to determine the status of a consolidated group (i.e. whether it is an exempting entity, former exempting entity or neither of the 2) and to determine the franking account and exempting account consequences that arise when an exempting entity or a former exempting entity joins a consolidated group.

Special franking rules for MEC groups

Appointment of a new provisional head company

9.8 These rules ensure that where there is a change in the provisional head company during the life of a MEC group (i.e. a new provisional head company is appointed because a cessation event occurs under subsection 719-60(3)) that the franking account balance of the former provisional head company is transferred to the new provisional head company. Note that a cessation event occurs where a company ceases to qualify as a provisional head company of a group or the company ceases to exist.

9.9 The rules provide that where a new provisional head company is appointed as a result of subsection 719-60(3), the franking account balance of the former provisional head company is cancelled and the account becomes inoperative. The new provisional head company's franking account becomes operative and a franking surplus or deficit (as appropriate) arises in the new provisional head company's franking account equal to the surplus or deficit in the former provisional head company's franking account immediately before the new provisional head company is appointed.

Distributions by eligible tier-1 entities other than the provisional head company of the group

9.10 These rules deal with the payment of distributions by eligible tier-1 entities within the MEC group which are not the provisional head company of the group.

9.11 The rules provide that where an eligible tier-1 entity makes a frankable distribution and that entity is not the provisional head company, Part 3-6 (the imputation provisions) operates as if the distribution were a frankable distribution made by the provisional head company.

Distributions by group members not being eligible tier-1 companies whose membership interests are held by non-residents

9.12 These rules deal with the franking of distributions by group members which are not eligible tier-1 companies and whose membership interests are held by non-residents.

9.13 The rules provide that where a frankable distribution is made by a group member whose membership interests are held by non-residents and that entity is not an eligible tier-1 company, Part 3-6 operates as if the distribution were a frankable distribution made by the provisional head company.

Special franking rules for transitional foreign-held entities

9.14 These rules deal with the franking of distributions by a group member whose membership interests are held by a non-resident.

9.15 The rules provide that where a frankable distribution is made by that member, Part 3-6 operates as if the distribution were a frankable distribution made by the head company.

Detailed explanation of new law

Exempting entities and former exempting entities

9.16 Subdivision 709-B modifies the operation of Division 208, which deals with exempting entities and former exempting entities, in relation to consolidated groups. [Schedule 9, item 4, section 709-150]

9.17 Division 208 limits franking credit trading by:

•

prescribing that franked distributions paid by corporate tax entities, which are effectively owned by non-residents or tax-exempt entities, will provide franking benefits to members in limited circumstances only; and

•

quarantining the franking surpluses of corporate tax entities which were formerly effectively owned by non-residents or tax-exempt entities.

Testing consolidated groups

9.18 The tests in Division 208 (relating to ownership by non-residents) are applied to the head company of a consolidated group to determine whether the group is an exempting entity or a former exempting entity. [Schedule 9, item 4, subsection 709-155(1)]

9.19 However, the application of Division 208 is modified in some circumstances for consolidated groups. [Schedule 9, item 4, subsection 709-155(2)]

9.20 When Subdivision 709-B modifies the operation of Division 208 for consolidated groups, Division 208 is applied to determine the status of the head company of the group and then to determine the status of the subsidiary member. However, the status of the subsidiary member is determined on the assumption that the subsidiary was not actually a member of the group at the time. [Schedule 9, item 4, subsection 709-155(3)]

9.21 Once the status of the subsidiary member has been determined as above, Division 208 does not operate in relation to the subsidiary. [Schedule 9, item 4, subsection 709-155(4)]

9.22 Table 9.1 summarises the operation of the exempting entity rules for consolidated groups.

The subsidiary member is an exempting entity

9.23 When the head company of a consolidated group is neither an exempting entity nor a former exempting entity as determined under Division 208, and a corporate tax entity, which becomes a subsidiary member of the group at the joining time, is an exempting entity at that time, then the head company becomes a former exempting entity at the joining time. [Schedule 9, item 4, section 709-160]

9.24 In these circumstances, the head company has both a franking account and an exempting account under subsection 709-160(2) and the subsidiary member's franking account does not operate while it is a member of the group in accordance with section 709-65.

9.25 Any franking surplus in the subsidiary member's franking account at the joining time is transferred to the head company's exempting account by the following entries:

•

a debit equal to the surplus arises in the subsidiary member's franking account at the joining time; and

•

a credit equal to the surplus arises in the exempting account of the head company at the joining time.

[Schedule 9, item 4, subsection 709-160(2)]

9.26 As a result of these entries a number of existing rules relating to the treatment of franking accounts upon consolidation and former exempting entities are not required:

•

subsection 709-60(2), which transfers a franking account surplus from a subsidiary member to the head company on consolidation, does not apply to the subsidiary member;

•

item 1 in the table in section 208-115 (exempting credits) does not apply to the head company;

•

item 1 in the table in section 208-120 (exempting debits) does not apply to the head company;

•

item 1 in the table in section 208-130 (franking credits and exempting entities or former exempting entities) does not apply to the head company; and

•

item 1 in the table in section 208-145 (franking debits and exempting entities or former exempting entities) does not apply to the head company. [Schedule 9, item 4, subsection 709-160(2)]

9.27 It should be noted that if the subsidiary member has a deficit in its franking account at the joining time, it will be liable for franking deficit tax in accordance with subsection 709-60(3).

The subsidiary member is a former exempting entity

9.28 When the head company of a consolidated group is neither an exempting entity nor a former exempting entity, and a corporate tax entity, which becomes a subsidiary member of the group at the joining time, is a former exempting entity at that time, then the head company becomes a former exempting entity at the joining time. [Schedule 9, item 4, section 709-165]

9.29 In these circumstances, the head company has both a franking account and an exempting account. The subsidiary member's franking account does not operate while it is a member of the group in accordance with section 709-65 nor does its exempting account. [Schedule 9, item 4, subsection 709-165(2)]

9.30 Any exempting surplus in the subsidiary member's exempting account at the joining time is transferred to the head company's exempting account by the following entries:

•

a debit equal to the surplus arises in the subsidiary member's exempting account at the joining time; and

•

a credit equal to the surplus arises in the exempting account of the head company at the joining time.

[Schedule 9, item 4, subsection 709-165(2)]

9.31 Any exempting deficit in the subsidiary member's exempting account at the joining time is transferred to the franking account of the subsidiary member by the following entries:

•

a credit equal to the deficit arises in the subsidiary's exempting account at the joining time; and

•

a debit equal to the deficit arises in the subsidiary's franking account just before the joining time.

[Schedule 9, item 4, subsection 709-165(2)]

9.32 As a result of these entries a number of existing rules relating to the treatment of franking accounts upon consolidation and former exempting entities are not required:

•

item 1 in the table in section 208-115 (exempting credits) does not apply to the head company;

•

item 1 in the table in section 208-120 (exempting debits) does not apply to the head company;

•

item 1 in the table in section 208-130 (franking credits and exempting entities or former exempting entities) does not apply to the head company; and

•

item 1 in the table in section 208-145 (franking debits and exempting entities or former exempting entities) does not apply to the head company.

[Schedule 9, item 4, subsection 709-165(2)]

9.33 It should be noted that if the subsidiary member has a surplus in its franking account it will be transferred to the head company's franking account under subsection 709-60(2) and any deficit in its franking account - taking into consideration the transfer of any deficit from its exempting account - will result in a liability for franking deficit tax in accordance with subsection 709-60(3).

The head company and subsidiary are exempting entities

9.34 The status of a head company of a consolidated group does not change if:

•

the head company is an exempting entity; and

•

the corporate tax entity becoming a subsidiary member at the joining time is also an exempting entity.

[Schedule 9, item 4, section 709-170]

9.35 The franking account of the subsidiary member does not operate while it is a member of the group in accordance with section 709-65. Any surplus in the subsidiary member's franking account will be transferred to the franking account of the head company (subsection 709-60(2)) and any deficit in the subsidiary's franking account will result in a liability for franking deficit tax under subsection 709-60(3).

The head company is a former exempting entity

9.36 When the head company of a consolidated group is a former exempting entity under Division 208, and a corporate tax entity, which becomes a subsidiary member of the group at the joining time, is an exempting entity at that time, then the status of the head company does not change. [Schedule 9, item 4, subsections 709-175(1) and (2)]

9.37 Any franking surplus in the subsidiary member's franking account at the joining time is transferred to the head company's exempting account by the following entries:

•

a debit equal to the surplus arises in the subsidiary member's franking account at the joining time; and

•

a credit equal to the surplus arises in the exempting account of the head company at the joining time.

[Schedule 9, item 4, subsection 709-175(2)]

9.38 As a result of these entries subsection 709-60(2), which transfers a franking account surplus from a subsidiary member to the head company on consolidation, does not apply to the subsidiary member. [Schedule 9, item 4, subsection 709-175(2)]

9.39 However, subsection 709-60(3) applies to impose a liability for franking deficit tax if the subsidiary's franking account is in deficit. The subsidiary member's franking account does not operate while it is a member of the group under section 709-65.

9.40 When the head company of a consolidated group is a former exempting entity, and a corporate tax entity, which becomes a subsidiary member of the group at the joining time, is a former exempting entity at that time, then the status of the head company does not change. [Schedule 9, item 4, subsections 709-175(3) and (4)]

9.41 Any exempting surplus in the subsidiary member's exempting account at the joining time is transferred to the head company's exempting account by the following entries:

•

a debit equal to the surplus arises in the subsidiary member's exempting account at the joining time; and

•

a credit equal to the surplus arises in the exempting account of the head company at the joining time.

[Schedule 9, item 4, subsection 709-175(4)]

9.42 Any exempting deficit in the subsidiary member's exempting account at the joining time is transferred to the franking account of the subsidiary member by the following entries:

•

a credit equal to the deficit arises in the subsidiary's exempting account at the joining time; and

•

a debit equal to the deficit arises in the subsidiary's franking account just before the joining time.

[Schedule 9, item 4, subsection 709-175(4)]

9.43 Section 709-60 operates in relation to the subsidiary member's franking account. Neither the subsidiary's franking account (section 709-65) nor the subsidiary's exempting account operates while the subsidiary is a member of the group. [Schedule 9, item 4, subsection 709-175(4)]

9.44 When the head company of a consolidated group is a former exempting entity in accordance with Division 208, and a corporate tax entity, which becomes a subsidiary member of the group at the joining time, is neither an exempting entity nor a former exempting entity at that time, then the status of the head company does not change. [Schedule 9, item 4, subsection 709-175(5)]

9.45 Section 709-60 operates in relation to the subsidiary member's franking account and the subsidiary's franking account does not operate while the subsidiary is a member of the group under section 709-65.

The subsidiary member's distributions to a foreign resident are taken to be distributions by the head company

9.46 To ensure that frankable distributions made by subsidiary members of a consolidated group receive the benefits of the imputation system contained in Part 3-6, special rules are required.

9.47 Part 3-6 operates as if a frankable distribution made by a subsidiary member of a consolidated group (the foreign-owned subsidiary) had been made by the head company of the group if the foreign-owned subsidiary meets certain requirements in section 703-45, section 701C-10 of the IT(TP) Act 1997 or section 701C-15 of that Act and the distribution is made to a foreign resident. [Schedule 9, item 5, section 709-90]

MEC groups

9.48 Subdivision 719-H contains imputation rules relevant only to MEC groups. [Schedule 9, item 5, section 719-425]

Transfer of the franking account balance on a cessation event

9.49 When a cessation event happens to a provisional head company of a MEC group (the former head company) and another company (the new head company) is appointed as the provisional head company under subsection 719-60(3), rules are required to transfer franking account balances. [Schedule 9, item 5, subsection 719-430(1)]

9.50 When the new head company is appointed, the following rules apply:

•

the franking account of the former head company ceases to operate [Schedule 9, item 5, paragraph 719-430(2)(a)] ;

•

the new head company has a franking account [Schedule 9, item 5, paragraph 719-430(2)(b)] ; and

•

any franking surplus or franking deficit in the former head company's franking account just before the cessation event occurred is transferred to the franking account of the new head company [Schedule 9, item 5, paragraph 719-430(2)(c)] .

Distributions by subsidiary members of a MEC group are taken to be distributions by the head company

9.51 To ensure that certain subsidiary members of MEC groups are able to frank distributions under Part 3-6, rules are required.

9.52 Part 3-6 operates as if a frankable distribution made by an eligible tier-1 company - that is a member of a MEC group and is not the provisional head company of the group - had been made by the provisional head company of the group to a member of the provisional head company. [Schedule 9, item 5, subsection 719-435(1)]

9.53 Part 3-6 also operates as if a frankable distribution made by a subsidiary member of a MEC group (the foreign-owned subsidiary) that is not an eligible tier-1 company was a frankable distribution made by the head company of the group to a member of the head company where the foreign-held subsidiary meets certain requirements in sections 703-45 and 701C-10 of the IT(TP) Act 1997 or section 701C-15 of that Act and the distribution is made to a foreign resident. [Schedule 9, item 5, subsection 719-435(2)]

Special franking rules for transitional foreign-held entities

9.54 Part 3-6 also operates as if a frankable distribution made by a transitional foreign-held entity was a frankable distribution made by the head company of the group to a member of the head company where the foreign-held subsidiary meets certain requirements in sections 703-45 and 701C-10 of the IT(TP) Act 1997 or section 701C-15 of that Act and the distribution is made to a foreign resident. [Schedule 9, item 2, section 709-90]

Example 9.1

Assume B Co and C Co are Australian resident wholly-owned subsidiaries of a foreign holding parent, A Co, and that D Co is a wholly-owned resident subsidiary of C Co. Both B Co and C Co are eligible tier-1 companies of a potential MEC group.

Under Division 208, B Co, C Co and D Co are all exempting entities.

On 1 July 2003, B Co and C Co decide to form a MEC group. B Co is appointed the provisional head company of the MEC group with C Co and D Co comprising the other eligible members. The effect of the imputation rules is that a MEC group will, by definition, always be an exempting entity. Therefore, distributions made by the provisional head company will be subject to Division 208 of the ITAA 1997.

In addition, assume that after the MEC group is formed, E Co, an Australian owned and resident company, is acquired by C Co and therefore becomes a subsidiary member of the MEC group. Once acquired by C Co, E Co (neither an exempting or former exempting entity prior to acquisition) becomes an exempting entity as it is now wholly-owned by an exempting entity (the MEC group).

As a consequence of joining the consolidated group, E Co's franking account balance is transferred to B Co.

The status of the head company as an exempting entity is not affected by E Co becoming a member of the MEC group.

Example 9.2

Assume the facts are as presented in Example 9.1 except that in the present example, E Co is an Australian owned and resident company which was formerly 100% owned by a foreign company at the time of joining the MEC group (i.e. it is a former exempting company immediately before acquisiton).

In addition, assume that F Co is also purchased by C Co. F Co is neither an exempting entity nor a former exempting entity prior to acquisition.

Upon being acquired by C Co, E Co becomes an exempting entity as it is now wholly-owned by an exempting entity (the MEC group).

Under Division 208, E Co's exempting account balance is merged with their franking account balance under sections 208-120 and 208-130.

When E Co joins the group, its franking account balance is transferred to B Co in accordance with the ordinary franking account balance transfer rules in Division 709.

The status of the head company as an exempting entity is not affected by E Co becoming a member of the MEC group.

Upon joining the group, F Co also becomes an exempting entity, as it is now wholly-owned by an exempting entity. F Co's franking account is pooled with that of the head company's in accordance with the ordinary franking account balance transfer rules in Division 709.

The status of the head company as an exempting entity is not affected by F Co becoming a member of the MEC group.

Example 9.3

Assume that on 1 July 2003, A Co makes an election to consolidate and becomes the head company of a consolidated group which comprises D Co and C Co as the eligible subsidiary members.

Immediately prior to consolidating, C Co is an exempting entity as it is wholly-owned by an interposed non-resident entity (B Co).

In the above example, the act of consolidating will result in A Co becoming a former exempting entity.

Immediately after consolidating, A Co will have both a franking account balance and an exempting account balance. Its franking account balance will comprise any franking credits it had in its account prior to consolidating, in addition to those franking credits which may have been transferred to it from D Co in accordance with Division 709.

The balance in A Co's exempting account will comprise the transfer of C Co's franking account upon becoming a member of the group.

Consequential amendments

9.55 Section 177EB of the ITAA 1936 is amended to extend its application to exempting credits arising in the exempting account of a head company of a consolidated group. [Schedule 9, item 1, subsection 177EB(11)]