Explanatory Memorandum
CHAPTER 2 - Rebatable and frankable dividends
Overview
2.1 Part 2 of Schedule 1 of the Bill will amend the Income Tax Assessment Act 1936 (the Act) to disqualify from being rebatable or frankable those dividends that are debited to, or paid out of amounts transferred from, share capital or share premium accounts or asset revaluation reserves of a company.
Summary of the amendments
2.2 The proposed amendments are to prevent companies taking advantage of the section 46 inter-corporate dividend rebate to ensure tax free distributions to corporate shareholders, or transferring franking credits to shareholders by inappropriate means.
2.3 The proposed amendments are to take effect for dividends declared and paid after 7.30 p.m. Eastern Standard Time on 9 May 1995. Dividends declared before that time but paid afterwards are not subject to these amendments. [Item 33]
2.4 However, dividends paid from amounts transferred from a share capital or share premium account or asset revaluation reserve where the transfer occurred before that time are not subject to the amendments. Nor are dividends paid under certain transitional arrangements (see paragraphs 2.53 to 2.55 below). [Items 33-34]
Background to the legislation
2.5 The inter-corporate dividend rebate, available under sections 46 and 46A of the Act, effectively frees from tax all dividends received by resident public companies from resident companies, and franked or group company dividends received by resident private companies from resident companies.
2.6 Existing provisions of the Act are being exploited by schemes that rely on the section 46 inter-corporate dividend rebate to ensure tax-free distributions to corporate shareholders. These schemes rest on the characterisation as a dividend of certain distributions debited to a company's share capital or share premium account or asset revaluation reserve. Moreover, the characterisation of these distributions as a dividend enables a company to pass on franking credits to shareholders ordinarily unable to access them.
Explanation of the amendments
What dividends do the amendments apply to?
2.7 The amendments prevent a dividend (other than certain in specie distributions explained below in paragraphs 2.23 to 2.25) being rebatable under section 46 or 46A of the Act or frankable to the extent that it is debited to a disqualifying account, or the notional disqualifying account. These accounts are explained below. [Item 21 - new section 46G; item 26 - new paragraph (g) in the definition of 'frankable dividend in subsection 160APA(1)]
2.8 A disqualifying account is a share capital account, a share premium account (including a 'tainted' share premium account - explained below in paragraphs 2.11 to 2.13), an asset revaluation reserve (as defined below in paragraph 2.14) or a shareholders' capital account held by a life assurance company (explained below in paragraph 2.15). All other accounts and reserves of a company are non-disqualifying accounts. [Item 21 - new subsections 46H(1)-(3)]
2.9 A share capital account comprises amounts paid by shareholders as consideration for shares in the company (other than share premiums). [Item 21 - new paragraph 46H(1)(a)]
2.10 A share premium account, defined in subsection 6(1) of the Act, comprises premiums received by a company on shares issued by it. Company distributions debited to share premium accounts are usually excluded from the definition of a dividend (see, for example, paragraph (d) of the definition of a dividend in subsection 6(1)). However, such distributions can be dividends if subsection 6(4) of the Act applies (where, under an arrangement, shares are issued at a premium and the premiums are distributed as part of the arrangement).
2.11 If amounts other than share premiums received by the company are credited to a share premium account, that account is 'tainted' and ceases to be a share premium account for tax purposes. This follows from paragraph (a) of the definition of share premium account in subsection 6(1). For example, a share premium account may be tainted by the inclusion of an amount of profits.
2.12 Similarly, in terms of paragraph (b) of the definition of share premium account, if a share premium account is credited with an amount in respect of a share premium and that amount cannot be identified in the books of the company as a share premium, that account will also cease to be a share premium account for tax purposes.
2.13 To prevent avoidance of these proposed amendments by deliberately tainting a share premium account prior to debiting dividends to that account, new subsection 46H(2) ensures that a tainted share premium account is treated in the same way as an untainted share premium account. If, for example, a share premium account is tainted by the inclusion of $1,000 which is covered by paragraph (a) or (b) of the definition of share premium account, the whole of the original account, plus the $1,000 tainting amount, is treated as a disqualifying account. [Item 21 - new subsection 46H(2)]
2.14 An asset revaluation reserve is a reserve (however called) comprising profits arising from the re-valuation of an asset or assets to the extent that those profits have not been realised by disposing of the asset. If a reserve contains such profits in addition to other amounts, only that part of the reserve comprising the re-valuation profits is taken to be an asset revaluation reserve. In such cases, the company will determine to what extent a debit to the reserve is a debit to that part of the reserve which is an asset revaluation reserve (i.e. the part of the reserve comprising profits arising from the revaluation of assets which have not been disposed of). [Item 21 - new paragraph 46H(1)(d)]
2.15 A shareholders' capital account comprises shareholders' capital (as defined in the Life Insurance Act 1995 ) held in a statutory fund of a life assurance company. A statutory fund contains assets included in the company's life, superannuation, roll-over or accident and disability insurance business. [Item 21 - new paragraph 46H(1)(b)]
Notional disqualifying account
2.16 Every company has a notional disqualifying account. However, the existence of the account is only relevant if there is a surplus in the account at the time a dividend is paid. [Item 21 - new subsection 46I(1)]
2.17 The notional disqualifying account of a company has a surplus if the amounts credited to the account exceed the amounts debited to the account. Credits arise if an amount is transferred from a disqualifying account to a non-disqualifying account (for example, from a share premium account to retained profits) and the transfer is not an excluded transfer (explained below at paragraphs 2.32-2.39). Debits arise if the reverse occurs, or if a dividend debited to a non-disqualifying account is paid by the company when there is a surplus in the notional disqualifying account. [Item 21 - new subsections 46I(2)-(5)]
2.18 The notional disqualifying account, therefore, comprises amounts of share capital, share premiums and profits arising from the revaluation of assets that have been transferred from their respective accounts. Dividends paid by the company after the transfer are deemed to be paid first out of the amounts transferred, irrespective of the debits made in the company's books. This treatment is necessary to prevent the purpose of the proposed amendments being thwarted by effectively paying dividends out of disqualifying accounts by first transferring amounts from those accounts to different accounts.
Apportionment of debits for same day dividends
2.19 If a number of dividends are paid on the same day, the total debits to a disqualifying or notional disqualifying account must be apportioned equally across all the dividends. For these purposes, debits arising in relation to in specie distributions covered by the exception explained below are disregarded. [Item 21 - new section 46L]
2.20 For example, if a company pays dividends to all shareholders on a particular day and 50 per cent of the total dividend paid by the company is debited to a disqualifying account, then each shareholder is deemed to receive a dividend that is 50 per cent debited to a disqualifying account. This has the effect that only half the dividend is frankable or rebatable.
2.21 Certain provisions of the Act deem dividends to have been paid as a result of a distribution, payment or crediting of some kind. For example, section 159GZZZP provides that, in an off-market share buy-back, so much of the purchase price of the share as exceeds the paid-up capital of the share and any amount debited against a share premium account is taken to be a dividend paid by the company out of profits of the company. Notwithstanding that the dividend is deemed to be paid out of profits, new section 46J will prevent these deemed dividends being rebatable or frankable to the extent that they are debited to a disqualifying account or the notional disqualifying account. [Item 21 - new section 46K]
2.22 For example, if a share paid-up to $10 is bought back off-market for $100, and the company debits $10 to the share capital account, $40 to the share premium account and $50 to an asset revaluation reserve, the $50 deemed dividend will not be rebatable or frankable, because it is debited to an asset revaluation reserve.
What dividends do the amendments not apply to?
2.23 A company may distribute an asset to shareholders instead of paying a cash dividend (for instance, on the liquidation of the company). Distributions of assets as dividends are called in specie distributions.
2.24 If an asset revaluation reserve has been created in relation to an asset and the asset is distributed by the company as a dividend to a shareholder, the company would debit the asset revaluation reserve. Unless the proviso concerning revaluation profits of assets that have been disposed of applies (see paragraph 2.14 above), these in specie distributions would not be rebatable or frankable. However, it would be inappropriate to prevent a dividend being rebatable or frankable in these circumstances because the effect of the transaction is the same as if the company disposed of the asset to a third party and paid a dividend to the shareholder from the proceeds of the disposal (i.e. a realised profit).
2.25 An exception is therefore made to the rule that dividends debited to an asset revaluation reserve are not rebatable or frankable. The exception applies where a dividend is a distribution of property other than money (i.e. an in specie distribution) and the property is an asset that has been revalued (resulting in a revaluation profit). If the asset revaluation reserve in relation to the distributed asset is debited, or the notional disqualifying account is debited because profits in the reserve were transferred to another account, the dividend may be rebatable and frankable to the extent that the debit is attributable to the profits arising on the revaluation. [Item 21 - new subsections 46G(2) and 46M(2)]
2.26 The crediting of the notional disqualifying account because of transfers from disqualifying accounts (explained above in paragraphs 2.16-2.18) prevents a company circumventing the measures of the Bill by transferring share capital and asset revaluation reserve profits to other accounts and then paying rebatable and frankable dividends from those other accounts.
2.27 There are, however, circumstances where this treatment is inappropriate. These circumstances are where:
- (a)
- a company offsets accumulated losses against share capital, or losses in the value of an asset against an asset revaluation reserve;
- (b)
- a life assurance company transfers share premiums from its shareholders' funds to a statutory fund (i.e. a fund containing assets included in the company's life, superannuation, roll-over or accident and disability insurance business); or
- (c)
- a life assurance company revalues assets held in its statutory fund and subsequently transfers an amount from the statutory fund to the shareholders' fund.
(a) Transfers to offset losses
2.28 A company may reduce its share capital by writing off accumulated losses against paid-up capital or share premiums. This effectively involves a transfer from a share capital account (a disqualifying account) to another account (a non-disqualifying account).
2.29 Similarly, a company may reduce its asset revaluation reserve to offset a loss in the value of an asset to correctly reflect the recoverable value of that asset in the accounts of the company. This also results in a transfer from a disqualifying account to a non-disqualifying account.
2.30 However, in the ordinary course of events, neither of these transfers facilitate the payment of a dividend. The company therefore, has not put itself in a position by which it could circumvent the provisions of the Bill.
2.31 Therefore transfers to offset accumulated losses or to reflect a reduction in value of assets are 'excluded transfers'. An excluded transfer is a transfer from a disqualifying account to a non-disqualifying account that, contrary to the general rule, does not give rise to a credit in the notional disqualifying account. [Item 21 - new subsection 46I(3)]
2.32 In relation to capital reductions to offset accumulated losses, an excluded transfer is a transfer from a share capital account or share premium account which gives effect to a reduction in paid-up share capital or share premiums that have been lost or ceased to be represented by assets. This would be the case, for example, in a capital reduction scheme under paragraph 195(1)(b) of the Corporations Law. An exception is provided in relation to certain dividend payment or replacement arrangements (explained below). [Item 21 - new subsections 46J(1) and (2)]
2.33 To prevent companies obtaining the benefit of the exemption in relation to accumulated losses that are likely to be recovered, the loss or deficiency in share capital or share premiums must be permanent. In the context of capital reductions, the courts have provided guidance as to what permanent means: see for example Re Jupiter House Investments (Cambridge) Ltd [1985] 1 WLR 975 at 979. These judicial decisions will be relevant for the purposes of determining whether the permanency test in new paragraph 46J(2)(b) is satisfied.
2.34 In relation to the reduction in value of an asset, an excluded transfer is a transfer from an asset revaluation reserve to reflect a decrease in value of the asset. Once again, this is subject to the exception for certain dividend payment or replacement arrangements. [Item 21 - new subsections 46J(1) and (3)]
What is a dividend payment or replacement arrangement?
2.35 To prevent abuse of the exemptions explained above, excluded transfers do not include transfers to the extent to which they constitute dividend payment or replacement arrangements. If part of a transfer is made under a dividend payment or replacement arrangement, and the remainder is not so made, then only the remainder will be an excluded transfer. [Item 21 - new subsection 46J(5)]
2.36 A dividend payment or replacement arrangement is defined as a transfer under an arrangement in which the company will pay a dividend directly or indirectly from the transferred amount, or will use the transferred amount to replace, directly or indirectly, an amount from which a dividend was paid. [Item 21 - new subsection 46J(6)]
2.37 For example, a company with an accumulated loss may reduce the par value of its shares to offset that loss (thereby effectively transferring an amount from its share capital account to the accumulated loss account). If the amount of the reduction in par value equals the loss then, assuming the company had not undertaken the transfer as part of an arrangement involving the payment of a dividend, the transfer would be an excluded transfer.
2.38 However, if in the above example the reduction in par value exceeded the loss to be offset, there may be a dividend payment arrangement which would preclude the amount of the excess transferred being an excluded transfer. This would depend on whether, on the facts of the case, the transfer could be described as part of an arrangement involving the payment of a dividend. The company could show that there was no such arrangement by, for instance, demonstrating a reason for the excess transfer which did not involve the payment of a dividend, and by conclusively showing that the excess will not be distributed as a dividend. An undertaking to a court that, as part of a capital reduction scheme, the excess will be held in a special reserve and not distributed to shareholders would be sufficient for these purposes.
2.39 A dividend payment or replacement arrangement requires a link, other than a merely temporal link, between the transfer and the payment of the dividend. This link may, for example, be a preconceived plan under which the company makes a transfer intending to subsequently pay a dividend from all or part of the amount transferred.
(b) Transfers of share premiums by life assurance companies
2.40 As part of its ordinary business, a life assurance company may transfer share premiums from its shareholders' funds to a statutory fund it maintains to eliminate a deficit in the statutory fund or to provide capital for investment.
2.41 Life assurance companies can transfer share premiums to their statutory funds without triggering the rebatable and frankable dividend measures. This is made possible because the Bill provides for a shareholders' capital account as a disqualifying account, comprising shareholders' capital (as defined in the Life Assurance Act 1995 ) held in a statutory fund. [Item 21 - new paragraph 46H(1)(b)]
2.42 A transfer from a share premium account to a shareholders' capital account will be a transfer between disqualifying accounts. Therefore the transfer will not create a credit in the notional disqualifying account. Similarly, a life assurance company will be able to transfer amounts from a shareholders' capital account held in one statutory fund to a shareholders' capital account in another statutory fund without causing a credit to the notional disqualifying account.
2.43 A transfer from a shareholders' capital account held in a statutory fund to a non-disqualifying account will generally give rise to a credit in the notional disqualifying account because of new subsection 46I(3). However, one type of transfer from a shareholders' capital account that does not facilitate the payment of a dividend is a transfer to enable a distribution to participating policy-holders pursuant to paragraph 63(3)(c) of the Life Insurance Act 1995 . Therefore, to prevent a credit arising in the notional disqualifying account, this type of transfer is defined as an 'excluded transfer'. Excluded transfers are explained above in paragraphs 2.32 to 2.39. [Item 21 - new subsection 46J(4)]
(c) Revaluation of statutory fund assets
2.44 It is also an ordinary part of a life assurance company's business to revalue assets to determine the surplus held in the statutory fund that can be allocated to policyholders or shareholders. This surplus can be transferred to shareholders' funds to pay dividends.
2.45 Notwithstanding that the value of assets is a factor in determining any surplus in the statutory fund, the surplus could also be attributable to the taxed profits of the statutory fund. The amount of the surplus attributable to the asset revaluation reserve cannot be determined. Therefore profits from the revaluation of assets of a statutory fund are excluded from the definition of the asset revaluation reserve disqualifying account. This means that a transfer of profits, including from the revaluation of assets, from the statutory fund of a life assurance company to its shareholders' fund will not affect the company's ability to pay frankable and rebatable dividends. [Item 21 - new subparagraph 46H(1)(d)(ii)]
How much of the rebate is denied?
2.46 The inter-corporate dividend rebate is not allowed to the extent the dividend is debited to a disqualifying account or the notional disqualifying account. If, for example, $40 of a $100 dividend is debited to a disqualifying or notional disqualifying account, with the remainder debited to profits, 40 per cent of the rebate otherwise arising will be denied to the shareholder. [Item 21 - new subsection 46G(1)]
2.47 If the dividend is a frankable dividend, new section 46L will, as explained below, apply to treat the original dividend as two separate dividends. In these cases the dividend that is not a frankable dividend (i.e. the $40 of the original dividend debited to a disqualifying or notional disqualifying account) will be denied the rebate, while the rebate for the dividend which is frankable (i.e. the remaining $60 of the original dividend) will still be available. [Item 21 - new subsection 46G(1) and new section 46M]
What part of the dividend is not frankable?
2.48 If a dividend is debited wholly against a disqualifying or notional disqualifying account then the whole of the dividend is an unfrankable dividend. [Item 21 - new subsection 46L(3)]
2.49 If only part of the dividend is debited against a disqualifying or notional disqualifying account, the dividend is treated as comprising two separate dividends, an unfrankable dividend (representing the part of the dividend debited to a disqualifying or notional disqualifying account) and a frankable dividend (representing the remaining part). This dual dividend treatment applies for the purposes of provisions of the Act relevant to calculating the inter-corporate dividend rebate or the extent to which a dividend is franked or frankable (for example section 46F, which denies the rebate for unfranked dividends paid to non-group private companies). Beyond this, it does not affect the amount of a dividend included in assessable income, or the tax payable on that dividend. [Item 21 - new subsection 46M(4)]
2.50 Section 160AQF of the Act effectively provides that two or more dividends paid under the same resolution have to be franked to the same extent (for these purposes, dividends paid under different resolutions but paid on the same class of shares may be deemed to be paid under the same resolution by section 160AQG). This requirement could not be satisfied if one of the dividends is an unfrankable dividend because of the application of new subsection 46M(3) , or is a dividend which is treated as two dividends by new subsection 46M(4) , one of which is unfrankable. Therefore, a dividend that is treated as unfrankable because of those new subsections is deemed not to be a dividend to which section 160AQF or section 160AQG applies. As a result, if for example, two $100 frankable dividends are debited half to a disqualifying account and half to profits (thereby deeming each dividend to be two $50 dividends, one frankable and one not), only the $50 frankable dividends need to be franked to the same extent under section 160AQF. [Item 21 - new subsection 46M(4); items 27 and 28]
2.51 The proposed amendments apply to dividends paid, or deemed to be paid (for example, a liquidator's distribution or off-market share buy-back), after 7.30 p.m. Eastern Standard Time on 9 May 1995 (the starting time) unless the dividend:
- •
- is not a deemed dividend and was declared before that time; or
- •
- was a dividend paid under an excluded transitional arrangement (explained below in paragraphs 2.53 to 2.55). [Subitem 33(1)]
2.52 Credits to the notional disqualifying account do not arise in relation to transfers from disqualifying accounts that occurred before the starting time or transfers under an excluded transitional arrangement (see below). Therefore if an amount is transferred to a non-disqualifying account from a disqualifying account before the starting time, subsequent dividends debited to a non-disqualifying account will not be prevented from being rebatable or frankable by reason of the transfer. Transfers after the starting time would result in a credit to the notional disqualifying account and therefore would prevent subsequent dividends being frankable or rebatable. [Subitem 33(2)]
Excluded transitional arrangement
2.53 Some companies may, prior to the announcement of these proposed amendments, have already embarked on a particular arrangement with a legitimate expectation that dividends paid under the arrangement will be rebatable and frankable. To avoid unnecessary disruption to commercial arrangements, the proposed amendments will not apply to excluded transitional arrangements.
2.54 An excluded transitional arrangement is an arrangement, plan or proposal that began to be implemented and was announced to shareholders before the starting time and under which there is a court-approved capital reduction. If a dividend is paid under the arrangement within six months of the starting time, the proposed amendments do not apply. Similarly, credits to the notional disqualifying account do not arise in relation to transfers from disqualifying accounts under an excluded transitional arrangement within that period. [Item 34]
2.55 The requirement that the arrangement begins to be implemented prior to the starting time means that something integral to the arrangement must be done before that time. The announcement of the arrangement to shareholders needs to be in writing (for example, a Stock Exchange Announcement), or at a general meeting of the company. Provided the arrangement begins to be implemented and is announced before the starting time, the court approval and capital reduction may occur after that time. [Item 34]
2.56 The proposed amendments explained above achieve the aim of the rebatable dividend adjustment (RDA) provisions in the Act more comprehensively and simply. These provisions and their related provisions are therefore redundant and are repealed with effect from the date of effect of the proposed amendments. However, the pre-acquisition profits RDA defined in subsections 160ZK(5)-(7) is not affected by these amendments. [Item 22 - repealed section 159GZZZMA; item 23 - omitted subsection 159GZZZP(3); item 24 - amended subsection 159GZZZQ(1); item 25 - omitted subsection 159GZZZQ(2); item 29 - substituted subsection 160ZA(4A); item 30 - substituted subsection 160ZA(5A); item 31 - omitted subsection 160ZL(5); item 32 - repealed section 160ZLA]