House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer,the Hon Ralph Willis, M.P.)

Chapter 6 Tax File Number (TFN) Amendments

Clauses: 2,52,53,54,55 and 65

Overview

Streamlines the application of the TFN arrangements to securities lending arrangements and unregistered "cum-dividend" and "cum-interest" sales of securities.

Requires investors in securities having a "books closing time" to quote their TFN before that time.

Prevents certain nominee companies (entrepot nominee companies) used by securities dealers from being treated as investment bodies for TFN purposes.

Corrects a technical deficiency in the law which prevented the proper application of the TFN application of the TFN arrangements to unit trusts.

Tax File Number (TFN) Amendments

Tax File Number (TFN) Amendments

Summary of proposed amendments

6.1 This Bill will amend the Income Tax Assessment Act 1936 (the Act) to streamline and simplify the administration of the tax file number (TFN) arrangements. The Bill will also correct a technical deficiency in the law which prevents the proper application of the TFN arrangements to unit trusts.

6.2 The proposed amendments will ensure:

I. Cum-Dividend and Cum-Interest Security Sales and Securities Lending Arrangements

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The seller of an unregistered cum-dividend or cum-interest security, or the investor in a security that is the subject of a securities lending arrangement will:

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either retain the credit for any amounts deducted because a TFN was not quoted; or

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be able to claim a refund of the amounts withheld from income on the security from the Commissioner of Taxation.

II. TFNs to be Quoted by Books Closing Time

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Investors in investments having a "books closing time" will be required to quote their TFN before that time if they do not want 48.25% deducted from income payments made by the investment body.

III. Securities Dealers' Entrepot Nominee Companies will be Excluded from the TFN Arrangements

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Certain nominee companies (entrepot nominee companies) owned by securities dealers which make investments to facilitate securities transactions will not be treated as investment bodies for the purposes of the TFN arrangements.

IV. Trustees of Unit Trusts are to be Investment Bodies for the Purposes of Making TFN Deductions

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The correction of a technical deficiency in the existing TFN legislation which excludes most unit trusts from the requirement to deduct 48.25% from income paid when a TFN is not quoted. This deficiency is to be rectified, with effect from 1 July 1991 (the commencement of the TFN arrangements).

Background to the legislation

6.3. In 1988, the Government expanded the first phase of the tax file number (TFN) arrangements. Phase 2 of those arrangements (which became effective from 1 July 1991) provided for the quotation of TFNs by investors on certain investments.

6.4. The TFN arrangements apply to certain investments, including shares in a public company, units in a unit trust, and loans to a Government body or body corporate (for example, a bond or debenture).

6.5. If a TFN is not quoted on an investment, the investment body must deduct an amount from any income earned on the investment equal to the top marginal rate of tax plus medicare levy (currently 48.25%). The deducted amount is then paid to the Commissioner and can be applied as a credit against any tax which the investor must pay. Investment bodies must also report, annually, to the Commissioner details of income paid to investors (Income Tax Regulation 56).

6.6. In most cases, these arrangements allow the Commissioner to obtain information to assist him in ensuring that all income earned by investors is declared in their income tax returns.

Explanation of the proposed amendments

I. Cum-Dividend or Cum-Interest Security Sales and Securities Lending Arrangements

Why change the law?

6.7. Some investment bodies, nominee companies, and the Australian Stock Exchange are having difficulties applying the TFN arrangements to investments such as shares in public companies, units in a unit trust, or loans to bodies corporate or government bodies. These investments are transferable, and may be sold on a "cum-dividend" or "cum-interest" basis.

6.8. In a small number of cases, it is possible that a cum-dividend or cum-interest contract will not have the sale recorded by the investment body by the books closing time. These transactions are referred to as unregistered cum-dividend or cum-interest sales.

6.9. In these cases, arrangements are in place which provide that the income paid to the registered owner of the security (the seller) is passed on to the buyer. The buyer of the security is required to declare the income in their income tax return.

6.10. Similarly, when a security has been lent to a person (the borrower) under a securities lending arrangement the borrower becomes the registered owner of the security. If the books closing time was reached during the period of the securities lending arrangement, the borrowing arrangement will provide that the lender is entitled to any dividends or interest on the lent security. The borrower will pass on that income to the lender.

6.11. In both cases the investment body will report to the Commissioner income paid to the registered owner of the security (ie., the seller or, in the case of a securities lending arrangement, the borrower of the security). The income that is ultimately passed on to the buyer or the lender of the security, will not be included in any reports to the Commissioner of Taxation.

6.12. In addition, depending on the type of investment, the credit for an amount deducted because a TFN was not quoted may pass on to the buyer of the security or the lender of the security (see subsection 221YHZK(5)).

What is a "cum-dividend or cum-interest" sale?

6.13. Broadly, a security is sold under a cum-dividend or cum-interest contract if it is sold before the date on which the investment body closes its books (this date is known as the "ex-date"). In these cases, the buyer is entitled to any impending dividend or interest on the security.

What is a securities lending arrangement?

6.14. A securities lending arrangement arises when a person (lender) lends securities to another person (borrower) under an agreement which requires the borrower to return either the borrowed securities or identical securities to the lender at the end of the borrowing period. The borrower becomes the registered owner of the securities.

6.15. The new TFN arrangements will only apply to securities lending arrangements which satisfy the requirements of subsection 26BC(3) of the Act. [Clause 55 - new subsection 221YHZLA(1)]

6.16. Broadly, the main conditions that must be satisfied to be a securities lending arrangement within subsection 26BC(3) are that:

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the agreement is in writing;

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the agreement was entered into after 9 May 1990; and

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the security is returned to the lender no later than 12 months after it was borrowed.

What is the "books closing time"?

6.17. The books closing time is defined as the time a person must be the registered owner of an investment to be entitled to receive a payment of income from the investment. Accordingly, if income is paid on shares in a public company, units in a unit trust or debentures, to investors who were the registered owners at a particular time, that time is the books closing time for that income. [Clause 53 - new subsection 221YHZA(5)]

Example:

6.18. Mary Smith is the registered owner of shares in Woddy Limited. She owns those shares for the period 1 July 1992 to 30 June 1993.

6.19. On 1 September 1992 Woddy Limited announced a dividend that would be payable to all shareholders registered in the company's records at 4.00pm on 22 September 1992.

6.20. Because the dividend is payable to shareholders registered at 4.00pm on 22 September 1992, that time is the "books closing time".

When will the new rules apply?

6.21. The new rules will apply when a person has received income on a relevant Part VA investment which:

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has been sold under an unregistered cum-dividend or cum-interest contract, or [Clause 55 - new paragraph 221YHZLA(2)(a) & subparagraph 221YHZLA(2)(c)(i)]

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at the books closing time, the investment was subject to a securities lending arrangement which obliges the registered owner of the security (the borrower) to pass the income on to the lender. [Clause 55 - new paragraph 221YHZLA(2)(a) & subparagraph 221YHZLA(2)(c)(ii)]

What is a "relevant Part VA investment"?

6.22. A "relevant Part VA investment" is defined as one of the following investments within the table contained in subsection 202D(1) of the Act:

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loans to companies and government bodies under item 3;

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investments in units in a unit trust under item 5; or

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investments in shares in public companies under item 6. [Clause 55 - new subsection 221YHZLA(1)]

What happens under the current law?

6.23. When a security has been sold under an unregistered cum-dividend or cum-interest contract or at the books closing time, the investment was subject to a securities lending arrangement which obliges the registered owner of the security (the borrower) to pass the income on to lender, the current law will operate as follows:

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If the dividend on the investment is a partially franked dividend to which section 160AQUA applies, subsection 221YHZC(1D) provides that 48.25% of the unfranked part of the dividend will be deducted. Subsection 221YHZK(5) will then apply to transfer the credit for the amount deducted to the buyer of the cum-dividend security.

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If the income on the security is not a franked dividend (eg., an unfranked dividend, or interest from a company debenture or Government security) subsection 221YHZK(5) will not apply because the income paid on the security is not subject to section 160AQUA of the Act.

•

If a TFN has been quoted for the investment, no TFN amount will be deducted from payments of income. However, the investment body will report to the Commissioner that the seller of the security or, in the case of a securities lending arrangement, the borrower of the security has received the income, where in fact, the income has passed on to the buyer or, in the case of a securities lending arrangement, the lender of the security.

How will the new arrangements operate?

6.24. Under the new arrangements, where the conditions of new subsection 221YHZLA(2) are satisfied, the seller of the security or, in the case of a securities lending arrangement, the borrower of the investment will keep the entitlement to the credit for any TFN amounts deducted by the investment body. This result is achieved by repealing subsection 221YHZK(5) of the Act. [Clause 54]

Can the seller or borrower obtain a refund of the credit?

6.25. Yes. The seller of an unregistered cum-dividend or cum-interest security, or the borrower of a security under a securities lending arrangement, may apply to the Commissioner of Taxation for a refund of the amounts withheld from income on the security. The Commissioner will be authorised to refund amounts deducted from income paid on an investment if he is satisfied that the security was sold cum-dividend or cum-interest (and the transfer was not registered before the books closing time), or that the security was, at the books closing time, subject to a securities lending arrangement requiring the income received by the borrower to be passed on to the lender of the security. [Clause 55 - new subsection 221YHZLA(2)]

How is a request for refund to be made?

6.26. Applications for a refund must be made in a form approved by the Commissioner. In most cases, the application will be endorsed by the applicant's securities dealer (if applicable) to the effect that the security was transferred on a cum-dividend or cum-interest basis or that the income was passed on to the lender of the security under a securities lending arrangement.

6.27. If there is no securities dealer involved in the transfer or securities lending arrangement, other evidence, such as the share transfer or lending agreement, will be required. [Clause 55 - new subsection 221YHZLA(3)]

Can the investor claim the TFN credit in his or her income tax return?

6.28. Yes. If the seller of the security, or the borrower of the security wishes, they will be able claim the TFN credit in their income tax return. Investors will not be able to claim the credit in their income tax return, however, if they have claimed (or are seeking to claim) a refund directly from the Commissioner under proposed new subsection 221YHZLA(2). [Clause 55 - new subsection 221YHZLA(4)]

6.29. Similarly, where the TFN credit is claimed by the investor in his or her income tax return, that person cannot apply for a refund from the Commissioner under the proposed new subsection 221YHZLA(2). [Clause 55 - new subsection 221YHZLA(5)]

Will subsection 202D(3) apply?

6.30. Under the existing TFN arrangements, subsection 202D(3) may treat a body corporate as an investment body if it makes an investment in a security which is subject to the TFN arrangements, but another person is entitled to the income from that security.

6.31. It is possible that the seller of a security or, in the case of a securities lending arrangement, the borrower of a security is a body corporate. In such cases, subsection 202D(3) could apply to treat that company as an investment body and require it to obtain a TFN from the buyer or lender of the security. This would result in significant disruption to the securities market and a large compliance cost on the body corporate concerned.

6.32. Subsection 202D(3) of the Act will be amended to ensure that it will not apply to bodies corporate which have received income under a relevant Part VA investment, if the security was transferred on a cum-dividend or cum-interest basis or that the income was passed on to the lender of the security under a securities lending arrangement. [Subclause 52(b) - new subsection 202D(3A)]

What reporting will be required?

6.33. The Income Tax Regulations will be amended to require suitable information to be given to the Commissioner of Taxation so that the ultimate recipient of the income earned on these transactions can be identified. [Clause 55 - new subsection 221YHZLA(6)]

6.34. Any notice, report or copy of a notice or report, required under the proposed regulations, will be a record for the purposes of section 262A of the Act. Accordingly, the notices or reports must be kept for the same time other records are kept for income tax purposes. [Clause 55 - new subsection 221YHZLA(7)]

II. TFNs to be Quoted by Books Closing Time

What happens now?

6.35. Under the current TFN arrangements, an investment body must deduct an amount from income paid on an investment if a TFN has not been quoted (subsection 221YHZC(1A)). This income is defined as "unattributed income". Investors are currently able to quote a TFN at any time until the income is actually paid by the investment body.

6.36. Income is paid on transferable investments, such as shares, debentures, or units in a unit trust to investors who were registered as investors at a particular time. This time is called the books closing time. [Clause 53 - new subsection 221YHZA(5)]

6.37. Allowing investors to quote their TFN for investments after the books closing time is causing significant administrative difficulties to those investment bodies. When an investor quotes a TFN after the books closing time it is often impossible for the investment body to record that TFN as being quoted. Accordingly, many investment bodies are required to make time consuming adjustments after the payment of the income to the investor to refund the amount incorrectly deducted.

When should a TFN be quoted?

6.38. This Bill will amend the TFN arrangements so that investors in transferable securities, such as shares in public companies, debentures, or units in a unit trust, will have to quote their TFN to the investment body before the books closing time if they are to avoid having 48.25% deducted from the income paid. [Clause 53 - new definition of "unattributed income" in section 221YHZA and new subsection 221YHZA(5)]

III. Securities Dealers' Entrepot Nominee Companies to be Excluded from TFN Arrangements

What is an entrepot nominee company?

6.39. An entrepot nominee company is nominee company controlled and operated solely by a securities dealer (or dealers) which is only used to facilitate the settlement of security transactions. [Clause 52 - New subsection 202D(8)]

Are "Entrepot Nominee Companies" Investment Bodies?

6.40. Entrepot nominee companies are not intended to be treated as investment bodies for the purposes of the TFN arrangements. However, because entrepot nominee companies may become the registered owners of securities such as shares, debentures or units in a unit trust in the course of completing a transaction, subsections 202D(3) and (4) may apply to treat a dealer's entrepot nominee company as an investment body.

6.41. This Bill amends the Act to ensure that entrepot nominee companies are excluded from the operation from the TFN arrangements. [Subclause 52(a)]

6.42. Investments made by nominee companies operated by securities dealers which are not made solely for the purpose of facilitating securities transactions will remain subject to the ordinary TFN arrangements. In such cases, the nominee company will have all the obligations of an investment body. [Subclause 52(c) - new subsection 202D(8)]

When will this apply?

6.43. Entrepot nominee companies were not intended to be investment bodies. Accordingly, the amendment excluding them from the TFN arrangements will apply to a persons right to receive income from an entrepot nominee company which arises on or after 1 July 1991. [Subclause 65(3)]

IV. Trustees of unit trusts will be investment bodies for the purposes of making TFN deductions

What is the current law?

6.44. Distributions from unit trusts are subject to the existing TFN provisions which require, if a TFN has not been quoted by the investor, that 48.25% be deducted from any payments of income from the investment.

6.45. The table in subsection 202D(1) defines the investment body for an investment in a unit trust as "the manager of the unit trust" . The obligation to deduct TFN amounts from unit trust income distributions falls on the investment body when the investment body is liable to pay income, in respect of the investment (paragraph 221YHZC(1A)(a)).

Why change the current law?

6.46. In most unit trusts the trustee is liable to pay the income for an investment, not the manager. The investment body in relation to a unit trust (the manager) is currently not required to make deductions if a TFN is not quoted because he or she is not the person liable to pay the income to the investor.

How will the new rules operate?

6.47. The proposed amendments rectify the technical deficiency in the current law by treating the person liable to pay income in respect of the unit trust investment (usually the trustee) as the investment body for the purposes of deducting amounts from income paid to investors who have not quoted a TFN. [Clause 53 - New subsection 221YHZA(4)]

6.48. The manager of the unit trust, who has day to day management responsibility for the unit trust, will remain the person to whom the TFN must be quoted.

When will the amendment apply from?

6.49. The proposed amendment will generally apply from 1 July 1991 (the commencement of the TFN arrangements).

6.50. However, any actions of the person liable to pay income for a unit trust (the trustee) on or after that date will be treated as if that person was an investment body [subclause 65(2)]. As a result, if a trustee had deducted an amount, because a TFN was not quoted (technically in breach of the current law) the proposed amendment will ratify the trustee's actions by treating him or her as an investment body. [Subclause 65(4)]

What happens if a TFN amount was not deducted?

6.51. If the person liable to pay the income for the unit trust has not deducted a TFN amount from payments of income, where no TFN has been quoted, (in observance of the current law), he or she will not be disadvantaged by the new law.

6.52. The new arrangements will not apply to a person liable to pay income for the unit trust if the application of the new rules would result in an offence arising under subsection 221YHZC(1A) in respect of a payment of income made before the date of the Royal Assent to the new law. [Subclause 65(5)]

Commencement date

6.53. The amendments affecting the TFN arrangements will, with the exception of proposed subsection 202D(8) and subsection 221YHZA(4), apply from the date of the Royal Assent to this Bill.

6.54. Proposed subsection 221YHZA(4) will apply to income to which an investor becomes presently entitled on or after 1 July 1991. However, where, the application of that subsection would result in the person liable to pay the income for a unit trust becoming liable for an offence under subsection 221YHZC(1A), the new rules will only apply to income paid on or after the date of the Royal Assent to the Bill.

6.55. Proposed section 202D(8) will apply to a persons right to receive income from an entrepot nominee company which arises on or after 1 July 1991.

Clauses involved in the proposed amendments

Clause 2: provides that the Act proposed by the Bill will commence on the date it is given the Royal Assent.

Clause 52: amends section 202D of the Act by preventing the application of subsection 202D(3) to entrepot nominee companies. The clause also prevents subsection 202D(3) applying to companies which receive income from investments which have either been sold under an unregistered cum-dividend or cum-interest contract , or where at the books closing time, the investment was subject to a securities lending arrangement.

Clause 53: makes it clear what is meant by the terms, unattributed income, investment body (in relation to unit trusts) and books closing time.

Clause 54: repeals subsection 221YHZK(5).

Clause 55: provides for the refund of TFN amounts deducted from income paid on an investment which has either been sold under an unregistered cum-dividend or cum-interest contract , or where at the books closing time, the investment was subject to a securities lending arrangement. This clause also provides for the making of regulations concerning the reporting of income from such investments.

Clause 65: provides for the application of the amendments affecting the TFN arrangements which do not apply from the date the Act proposed by the Bill is given the Royal Assent to the new provisions.