Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 4 - Dividend imputation and tax exempt entities
Overview
4.1 Part 1 of Schedule 4 of the Bill will amend Schedule 2D, Division 57 of the Income Tax Assessment Act 1936 (the Act) and will insert section 160AQCO into the Act. The provisions will:
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- cancel the franking surpluses of taxable wholly owned subsidiaries of a tax exempt entity when that tax exempt entity becomes subject to tax on any part of its income [item 2] ; and
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- cancel the franking surplus when a taxable subsidiary company ceases to be wholly owned by a tax exempt entity [item 1] .
Summary of the amendments
4.2 The purpose of the amendments is to ensure that franking credits which have accumulated in companies and which are related to a period during which they were wholly owned by tax exempt entities, are not able to be passed to third parties.
4.3 The amendments will apply to entities which cease to be wholly owned by tax exempt entities on or after 3 July 1995.
Background to the legislation
4.4 The imputation system aims to ensure that only one layer of tax is paid by a shareholder on company profits. Where a taxable company is, directly or through other entities, wholly owned by a tax exempt entity there will only be one layer of tax borne by that shareholder on the company profits. Franking credits are not required in these cases to relieve against double taxation.
4.5 In the 1996-97 Budget the Government announced its intention to introduce provisions to deal with transition issues of tax exempt entities which become taxable. Those amendments were introduced in Taxation Laws Amendment Bill (No. 3) 1996. These amendments were foreshadowed when those provisions were introduced.
Explanation of the amendments
Exempt entity which becomes taxable
4.6 Item 2 inserts new Subdivision 57-M into Schedule 2D, Division 57 of the Act. Division 57 deals with the transition issues of tax exempt entities which become, to any extent, subject to income tax.
4.7 The point of transition from exempt to taxable status is referred to as the 'transition time' and an entity is known as the 'transition taxpayer' (see paragraphs 57-5(c) and (d) of the Act).
4.8 The amendments will ensure that, where the transition taxpayer, or a subsidiary of the transition taxpayer, has a franking surplus immediately before the transition time, that surplus will be reduced to nil at the transition time. [New subsection 57-120(1)]
4.9 New section 57-125 defines what a subsidiary is for the purposes of the Subdivision.
4.10 New subsection 57-120(2) will ensure that only those franking credits that relate to the period after the transition time can be used by a company after its transition time. As a result, any franking credits that arise after the transition time that are attributable to any extent to the period before the transition time are taken not to have arisen.
4.11 New subsections 57-120(2), (3) and (4) will have the effect of cancelling a franking debit that arises after a company's transition time where:
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- that debit is attributable to the period before the transition time; and
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- the company's franking surplus at the transition time is more than the amount of the franking debit.
4.12 Conversely, if a franking surplus of a transition taxpayer or its subsidiary at transition time is less than the amount of a franking debit that arises after transition time and is attributable to the period before transition time, the franking surplus is not reduced to nil at the transition time. Rather, it is used to offset the amount of the franking debit. [New subsections 57-120(3) and (4)]
4.13 These provisions recognise that, had the franking debit arisen immediately before the transition time, the company would have been able to use its available franking surplus to absorb the effect of the franking debit.
4.14 New subsections 57-120(3) and (4) will not, however, cancel franking debits that are attributable to the period before the transition time where a company did not have a franking surplus immediately before its transition time (ie. the company's franking account balance was nil or in deficit). This means that a company cannot avoid liability to fra nking deficit tax by ensuring that a franking debit attributable to the period before its transition time does not arise until after its transition time.
4.15 New subsection 57-120(5) ensures that certain terms used in new section 57-120 have the same meaning as in Part IIIAA of the Act.
Disposal of a subsidiary by an exempt company
4.16 Item 1 inserts new Subdivision D into Division 2 of Part IIIAA of the Act. New section 160AQCO applies to a situation where a company which is wholly exempt from income tax (the 'exempt company' [new paragraph 160AQCO(1)(a)] ) disposes of a taxable subsidiary company (the 'former subsidiary' [new paragraph 160AQCO(1)(b)] ).
4.17 In that situation, any franking surplus of the former subsidiary is reduced to nil at the time it ceases to be a subsidiary [new subsection 160AQCO(2)] . The time at which the company ceases to be a subsidiary of the exempt company is the 'transition time' [new paragraphs 160AQCO(1)(a) and (b)] .
4.18 The term 'exempt company' is defined to include a State or Territory [new subsection 160AQCO(5)] . This ensures the application of the provisions to situations where, for example, a State Government sells any of the shares in a taxable company which it directly (wholly) owns.
4.19 An exempt company (A) may have a wholly owned taxable subsidiary (B) which itself has a wholly owned taxable subsidiary (C) and C has a franking surplus. If the shares in C are disposed of to a third (taxable) party, the franking surplus of C will not be reduced to nil. This is because immediately before the transition time, all of the shares in C were not beneficially owned by companies which were wholly exempt from income tax as required in new paragraph 160AQCO(1)(d) .
4.20 Apart from those aspects mentioned above, new section 160AQCO operates in the same way as new section 57-120 . For instance, new subsection 160AQCO(2) operates in the same way as new subsection 57-120(1), new subsection 160AQCO(3) operates in the same way as new subsection 57-120(2) and new subsection 160AQCO(4) operates in the same way as new subsections 57-120(3) and (4) .