House of Representatives

Explanatory Memorandum

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

Chapter 6 Repeal of dividend tainting rules

Outline of chapter

6.1 Schedule 6 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) and the Income Tax Assessment Act 1997 (ITAA 1997) to repeal the dividend tainting rules and to make consequential amendments that will:

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ensure that distributions from a share capital account (including a tainted share capital account) continue to be unfrankable; and

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modify a general anti-avoidance rule that applies in relation to the imputation system so that, when considering whether to apply the rule, the Commissioner of Taxation (Commissioner) can take into account whether a distribution is sourced from unrealised or untaxed profits.

Context of amendments

6.2 The dividend tainting rules, which are contained in sections 46G to 46M of the ITAA 1936, were introduced in 1995 to prevent corporate taxpayers from taking advantage of the inter-corporate dividend rebate to make tax-free distributions to corporate shareholders or transferring franking credits to shareholders by inappropriate means. The rules operate by preventing distributions debited to certain accounts from being rebatable or frankable.

6.3 The rules also provide a mechanism to ensure that a return of capital from a tainted share capital account is treated as an unfranked distribution for tax purposes.

6.4 Under the simplified imputation system, the inter-corporate dividend rebate has been removed. The gross-up and credit approach now applies to all shareholders.

6.5 As a result of the removal of the inter-corporate dividend rebate and the introduction of the consolidation regime, the schemes that the dividend tainting rules were primarily directed at preventing can no longer be entered into. However, the rules may be inadvertently triggered by accounting entries required under the Australian Equivalent of the International Financial Reporting Standards .

Summary of new law

6.6 The dividend tainting rules (sections 46G to 46M of the ITAA 1936) will be repealed. Consequential amendments will:

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ensure that distributions from a share capital account (including a tainted share capital account) continue to be unfrankable; and

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modify a general anti-avoidance rule (section 177EA of the ITAA 1936) that applies in relation to the imputation system so that, when considering whether to apply the rule, the Commissioner can take into account whether a distribution is sourced directly or indirectly from unrealised or untaxed profits.

Comparison of key features of new law and current law

Detailed explanation of new law

Repeal of the dividend tainting rules

6.7 The dividend tainting rules (sections 46G to 46M of the ITAA 1936) will be repealed. [Schedule 6, item 1]

Distributions from a company's share capital account continue to be unfrankable

6.8 Currently, the dividend tainting rules operate to ensure that distributions made from share capital accounts (including tainted share capital accounts) are not frankable.

6.9 Therefore, a consequential amendment to section 202-45 of the ITAA 1997, which lists distributions that are unfrankable, will ensure that a distribution that is sourced directly or indirectly from a company's share capital account (including a tainted share capital account) is unfrankable. [Schedule 6, item 4, paragraph 202-45(e )]

6.10 A distribution will be sourced directly from a company's share capital account if an accounting debit is made to the share capital account for the making of the distribution.

6.11 A distribution will be sourced indirectly from a company's share capital account if, for example, a company transfers an amount from its share capital account into a distributable profits reserve and subsequently makes a distribution to shareholders that is debited against the distributable profits reserve in circumstances where it is reasonable to conclude that the distribution represents the amount transferred from the share capital account.

6.12 Further consequential amendments to the ITAA 1997 will:

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update section references in the note to subsection 197-50(1), which outlines the consequences of a share capital accounting becoming tainted;

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modify subsection 375-872(4) to ensure that paragraph 202-45(e) does not operate to treat the return of concessional capital by a film licensed investment company as an unfrankable distribution for the purpose of working out whether certain distributions of capital are taken to be a dividend; and

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modify section 975-300 of the ITAA 1997, which defines a 'share capital account', to:

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ensure that, for the purposes of applying paragraph 202-45(e), a tainted share capital account is treated as a share capital account; and

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remove an obsolete reference to section 46H of the ITAA 1936.

[Schedule 6, items 3, 5, 6 and 7, subsections 197-50(1), 375-872(4) and 975-300(3 )]

Extension of the general anti-avoidance rule

6.13 The general anti-avoidance rule in section 177EA of the ITAA 1936 applies where a scheme involving the disposition of membership interests in a company is entered into with a more than incidental purpose of enabling a taxpayer to obtain an imputation benefit. If the section applies, the Commissioner may make a determination that a franking debit arises in the distributing company's franking account or deny the imputation benefit to the taxpayer.

6.14 Section 177EA applies if, broadly:

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there is a scheme for the disposition of membership interests in a company;

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a frankable distribution has been paid in respect of the membership interests, or has flowed indirectly to a person in respect of the membership interests;

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the distribution was franked and, but for section 177EA, the taxpayer would receive imputation benefits as a result of the distribution; and

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having regard to the relevant circumstances of the scheme, it would be concluded that a person entered into the scheme or any part of the scheme for a purpose (whether or not a dominant purpose but not including an incidental purpose) of enabling the taxpayer to obtain an imputation benefit.

6.15 Subsection 177EA(17) contains a list of factors that are the relevant circumstances of a scheme. An amendment is being made to subsection 177EA(17) so that a relevant circumstance includes whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced directly or indirectly from unrealised or untaxed profits. [Schedule 6, item 2, paragraph 177EA(17)(ga) of the ITAA 1936]

Application and transitional provisions

6.16 These amendments apply in relation to distributions made on or after 1 July 2004. [Schedule 6, item 8]

6.17 The repeal of the dividend tainting rules with effect from 1 July 2004 will be beneficial for corporate taxpayers:

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Companies will not inadvertently trigger the dividend tainting rules by posting accounting entries required under the Australian Equivalent of the International Financial Reporting Standards .

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Compliance costs will be significantly reduced as companies will no longer be required to keep 'disqualifying accounts' and 'notional disqualifying accounts'.

6.18 Some practical consequences may arise for companies that have made distributions since 1 July 2004 that were made unfrankable by the operation of the dividend tainting rules. Some of those distributions may now be frankable. Companies that wish to attach franking credits retrospectively to such distributions (eg, to avoid a breach of the benchmark franking rule in Division 203 of the ITAA 1997) will need to approach the Commissioner for a determination that will allow them to amend the relevant distribution statements.