Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Dividend imputation
Overview
4.1 Schedule 2 of the Bill will amend Taxation Laws Amendment Act (No. 4) 1995 to allow companies the option to defer conversion to the class C franking account after they are paid a class C franked dividend or a trust or partnership amount with class C franking credits attached.
4.2 Where a company exercises the option to defer conversion the amendments will allow the company to treat the dividend as either:
- (a)
- not having been franked for the purposes of determining whether a class C franking credit arose to the company; or
- (b)
- having been paid up to fourteen days after actual payment for the purpose of determining when a class C franking credit arose to the company (the Commissioner of Taxation will be given a discretion to extend the fourteen day period in appropriate circumstances).
4.3 The amendments will also eliminate an unintended dual liability to class A franking deficit tax or franking additional tax which may arise in certain situations.
Summary of the amendments
4.4 The purpose of the amendments is to:
- •
- assist companies by providing them with greater flexibility in converting to the class C franking account; and
- •
- correct an unintended dual liability to class A franking deficit tax or franking additional tax which may arise in certain circumstances.
4.5 The amendments will apply from 1 July 1995.
Background to the legislation
Conversion to class C franking account
4.6 As a result of the increase in the company tax rate from 33 per cent to 36 per cent from the 1995-96 income year, Taxation Laws Amendment Act (No. 4) 1995 introduced provisions that require companies to establish a class C franking account and to convert their existing class A and B franking account balances to that account.
4.7 Under that Act companies are required to convert to the class C franking account at the time the first of the following events occurs:
- •
- when the first class C franking credit of the company arises (e.g. from the payment of a company tax instalment in respect of the 1995-96 income year, or upon being paid a class C franked dividend); or
- •
- at the end of their 1995-96 franking year.
Companies also have the option to convert to the class C franking account before either of these events.
4.8 Once a company has converted to the class C franking account it should not pay class A or B franked dividends. To do so attracts penalties.
4.9 Some companies have unwittingly exposed themselves to these penalties because of the requirement to convert to the class C franking account upon being paid a class C franked dividend. For example, some companies were unaware that, immediately before they paid a class A or B franked dividend to their shareholders, they were paid a class C franked dividend themselves (that triggered conversion).
4.10 Further difficulties have arisen for companies that were effectively committed to paying a class A or B franked dividend and were then unexpectedly paid a class C franked dividend, however small.
Dual liability to class A franking deficit tax
4.11 Taxation Laws Amendment Act (No. 4) 1995 also contains transitional franking deficit tax provisions to ensure that, where a liability to class A franking deficit would have arisen but for the conversion to a class C franking account, that liability will remain. Similarly, where a liability to class A franking additional tax would have arisen but for the conversion to a class C franking account, that liability will also remain.
4.12 In the absence of such provisions the conversion to the class C franking account would provide companies with an opportunity to offset a class A franking deficit with a class B franking surplus. This would have enabled companies to over-distribute class A franking credits to their shareholders prior to conversion.
4.13 In determining the liability of a company to the class A franking deficit tax imposed by the transitional provisions, any further class A franking debits that the company generates after conversion (e.g. from the payment of a class A franked dividend) are taken into account.
4.14 However, if a company pays a class A franked dividend after conversion, in addition to the resulting class A franking debit being taken into account under the transitional provisions, a class A franking debit also arises under the ordinary provisions of the Income Assessment Act 1936 (which are preserved by Taxation Laws Amendment Act (No. 4) 1995). Because the franking debit arising under the ordinary provisions cannot be offset by subsequent franking credits, it will give rise to class A franking deficit tax at the end of a company's franking year.
4.15 Therefore where a company's franking account is in deficit at the time it converts to the class C franking account and it pays a class A franked dividend after that time, the class A franking debit associated with that dividend will be used in determining the company's liability to class A franking deficit tax under both the transitional and the ordinary provisions. Similarly, the class A franking debit associated with that dividend will be used in determining the company's liability to class A franking additional tax under both provisions. The potential dual liability to class A franking deficit tax or class A franking additional tax is an unintended outcome.
Explanation of the amendments
What is the effect for a company deferring conversion?
4.16 The proposed amendments will provide companies with the option to defer conversion to the class C franking account during their 1995-96 franking year. [Item 3; new section 159A]
4.17 For the purposes of deferring conversion companies may elect that the class C franking credit attached to a franked dividend or trust or partnership amount either:
- •
- does not arise; or
- •
- arises fourteen days later (or within such longer period as the Commissioner allows).
[Item 3; new subsection 159A(2)]
4.18 If a company elects the deferral option, the company's fourteen day deferment period commences when the company receives its first class C franking credit from a franked dividend or a trust or partnership amount and the franking credit will arise at the end of the deferral period. For example, if a company is paid a class C franked dividend on a Monday and it elects to defer the franking credit attached to that dividend, the company will derive the franking credit (and therefore convert to the class C franking account) on the Monday fortnight. If a company elects the forfeiture option, the franking credit will never arise. Neither option will, however, permit companies to defer conversion beyond the time a class C franking credit arises from either the payment of tax or the end of their 1995-96 franking year. [Item 3; new subsections 159A(2) and (3)]
4.19 Companies will be allowed to elect to forfeit the franking credit attaching to a particular dividend or trust or partnership amount and then elect to defer the franking credit attaching to a subsequent dividend or trust or partnership amount. For example, if a company is paid a class C franked dividend on one day and is paid another class C franked dividend on the following day, the company may forfeit the franking credit attaching to the first franked dividend and elect to defer the franking credit attaching to the second franked dividend. The company's fourteen day deferment period would, therefore, commence on the day the second franked dividend was paid.
4.20 Companies may forfeit the franking credits attaching to different class C franked dividends or trust or partnership amounts as many times as they chose. However, in relation to a particular dividend or amount, the franking credit can be deferred once only. [Item 3; new subsection 159A(5)]
4.21 The proposed amendment will not affect the timing of conversion by a company due to an event other than being paid:
- •
- a class C franked dividend;
- •
- a trust amount giving rise to a class C franking credit; or
- •
- a partnership amount giving rise to a class C franking credit.
4.22 Therefore, if a company is paid a class C franked dividend and then, one week later, pays an instalment of tax for its 1995-96 income year (at 36 per cent), the company will have to convert by the time of the payment of the tax instalment. [Item 3; new subsection 159A(1)]
When will extensions of time to the 14 day deferment period be granted?
4.23 Where companies elect the deferral option, the Commissioner will have the power to extend the fourteen day period in appropriate circumstances. Relevant factors in determining whether an extension will be allowed include:
- (a)
- the reason the company has not recognised that it has converted to the class C franking account at the prescribed time and has paid a class A or B franked dividend after that time (e.g. the company may have been paid a large number of dividends during the relevant period and failed to recognise that it was paid a class C franked dividend because the amount of the dividend was relatively small and the shareholding representing the dividend was not an important component of the company's portfolio);
- (b)
- the extent to which the company was committed to paying a class A or B franked dividend more than fourteen days after being paid a class C franked dividend (e.g. the company may have declared a class A or B franked final dividend which is due to be paid more than fourteen days after the class C franked dividend was paid and it would be impractical to change the class A or B franked dividend to a class C franked dividend); and
- (c)
- whether any undue tax advantage was obtained by the company or shareholders due to the delay in conversion.
4.24 Companies may apply for an extension of the fourteen day period at any time.
How do companies elect to defer conversion?
4.25 The election made by companies to defer or forfeit the class C franking credit attaching to a particular class C franked dividend or trust or partnership amount must be in writing and is irrevocable. However, companies need not notify the Australian Taxation Office of their election unless requested. Companies will be allowed to make the election at any time. [Item 3; new subsection 159A(4)]
What is the effect of deferment on other areas of the tax law?
4.26 The election to defer conversion does not affect the timing of when a company will be assessed on the dividend or trust or partnership amount. Similarly, the election to defer or forfeit the class C franking credit attaching to a class C franked dividend or trust or partnership amount comprising class C franked dividend income will not prevent the dividend or the amount being franked for other purposes: for example, in determining whether a dividend paid to a private company is rebatable or not (see section 46F of the Income Tax Assessment Act 1936 ).
How is the potential dual liability to class A franking deficit tax removed?
4.27 To remove the potential dual liability to class A franking deficit tax the amendments provide that where, after conversion to the class C franking account, a franking debit arises from the payment of a class A franked dividend under subsection 160AQB(1) of the Income Tax Assessment Act 1936 , the debit is to be ignored for the purpose of identifying the class A franking deficit tax liability under the transitional provisions (i.e. subsection 159(1) of Taxation Laws Amendment Act (No.4) 1995 ). Equivalent amendments are made to remove the potential dual liability to class A franking additional tax. [Items 1 and 2; amend paragraphs 159(1)(c) and 159(3)(c)]