Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 1 - Company law review
Overview
1.1 Schedule 1 to the Bill will amend the Income Tax Assessment Act 1936 (ITAA 1936) and the Taxation Laws Amendment (Company Law Review) Act 1998 (the Act) to ensure that:
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- a share capital account does not become tainted by the merger of tainted share premiums with share capital unless the share capital account ceases to be more than the total of the tainted share premium account immediately before the merger;
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- all debt for equity swap arrangements which should qualify for the exception to the tainting rule do so; and
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- the delayed crediting of share capital to the share capital account does not trigger the share tainting rule.
1.2 Some clarificatory amendments are also made to the Proclamation that set the commencement date for the Act.
Summary of amendments
1.3 The purpose of the amendments is to prevent the inappropriate tainting of the share capital account.
1.4 The amendments apply from 1 July 1998. [Subclause 2(1)] - Background to the legislation
1.5 The Act, which received Royal Assent on 1 July 1998, made various consequential amendments to the tax laws as a result of changes being made to the Corporations Law by the Company Law Review Act 1998 (Review Act) which abolished the concept of par value for shares and the associated terms of share premium as well as made it easier for companies to return capital to shareholders.
1.6 The tainting rule within the Act prevents companies disguising a profit distribution as a tax-preferred capital distribution from the share capital account by first transferring profits into that account and then distributing from it. A similar rule applied to share premium accounts before their abolition on 1 July 1998: in cases where the share premium account contained amounts other than share premiums (tainted share premium accounts') the share premium account was also treated as a profit account.
1.7 Since the tainting rule's inception two unintended outcomes have emerged. First, the merger of tainted share premiums with share capital on 1 July 1998 has the effect of tainting the new share capital account for tax purposes, thereby preventing the distribution of profits in the guise of share capital. This has the inappropriate flow-on effect of producing an automatic franking debit upon merger and it removes the ability of companies to defer distribution of tainted amounts already transferred to share premium accounts.
1.8 Second, under the rules formerly applicable to share premium accounts before 1 July 1998, a share premium account did not become tainted when share premiums were credited to another account and then transferred to the share premium account, provided they could be identified in the books of the company at all times as such a premium. The law in its present form does not expressly provide for this exception.
1.9 The Act also provides an exception to the tainting rule where an amount is transferred to a share capital account under a debt for equity swap. The exception reflects the fact that no undue tax advantage can arise by companies transferring amounts which only represent a liability, as distinct from a profit, to the share capital account, and then making a distribution from that account.
1.10 To achieve this, the tainting rule adopts the existing definition of debt for equity swap in section 63E of the ITAA 1936. However, for technical reasons some debt for equity swaps fail to qualify as the definition is currently expressed.
Explanation of amendments
Merger of tainted share premiums with share capital
1.11 To prevent companies from being adversely affected by the compulsory merger of tainted share premiums with share capital, the amendments provide that a share capital account does not become tainted by the merger of tainted share premiums with share capital under section 1446 of the Review Act. [Item 7 of Schedule 1]
1.12 However, to ensure that the merger of tainted share premiums does not confer an undue tax advantage by sanctioning the transfer of profits to share capital, the share capital will be treated as if it were tainted during periods when the amount standing to the credit of the share capital account is equal to the balance of the tainted share premium account merged in it (ie. nothing remains in it other than tainted share premiums). [Subitems 7(1) and 7(2) of Schedule 1]
1.13 Where the amount standing to the credit of the share capital account becomes equal to the balance of the tainted share premium account merged in it, the amendments also provide that no immediate franking debit arises in the companies franking account. [Subitem 7(3) of Schedule 1]
1.14 For this purpose the balance of the tainted share premium account will be the amount standing to the credit of the tainted share premium account when it was merged with the share capital account on 1 July 1998, less any subsequent distributions during periods when the share capital account is treated as tainted under this rule. [Subitems 7(4) and 7(5) of Schedule 1]
1.15 This will prevent the distribution of existing tainted amounts as share capital, while allowing companies to continue to distribute untainted share capital as such.
1.16 Consistent with existing tainting rules distributions from a tainted share capital continue to be treated as unrebatable and unfrankable dividends in the hands of recipient shareholders. [Subitem 7(4) of Schedule 1]
1.17 Where a company's share capital account becomes tainted under the above circumstances, companies will continue to have the opportunity to untaint the account through the ordinary tainting rules contained in section 160ARDR of the ITAA 1936. Furthermore, the amendments do not override the potential application of the ordinary tainting rules contained in the ITAA 1936. Therefore, if a company transfers profits to a share capital account containing tainted share premiums, the ordinary rules will continue to treat the entire account as a tainted share capital account unless the company has taken the necessary steps to untaint it. [Subitem 7(2) of Schedule 1]
Example:
For example, if a company had a tainted share premium account totalling $200,000 on 1 July 1998, and paid-up share capital of $300,000, it would thereafter have a share capital account of $500,000 with a tainted share premium account balance of $200,000. As long as the total of the share capital account is more than $200,000 (and no fresh tainting amounts are transferred to it) distributions from it will be treated as distributions of share capital.
If the company made a distribution of $400,000 from the share capital account, leaving a total of $100,000, $300,000 will be treated as a distribution of share capital, and $100,000 will be treated as an unfranked, non-rebatable dividend because the distribution reduces the share capital account to less than the tainted share premium account balance of $200,000.
The new tainted share premium account balance in this example will be $100,000. If no fresh share capital is raised, all subsequent distributions from the share capital account would also be taken to be dividends because the share capital account is not greater than the tainted share premium account balance.
However, if the company raised fresh capital of $200,000, the share capital account total would be $300,000, which is greater than the new tainted share premium account balance of $100,000; and as long as subsequent distributions did not reduce the share capital account to less than the new balance (and there is no fresh tainting of the share capital account) they will be distributions of share capital.
1.18 Under the current tax laws an exception to the tainting rule applies where an amount is transferred to a share capital under a debt for equity swap. The exception reflects the fact that no undue tax advantage can arise by companies transferring amounts which only represent a liability, as distinct from profit, to the share capital account, and then making a distribution from that account.
1.19 To achieve this, the tainting rule adopts the existing definition of debt for equity swap provided in section 63E of the ITAA 1936. However, for technical reasons some debt for equity swaps fail to qualify as the definition is currently expressed.
1.20 To ensure that all arrangements that should qualify do so, the amendments provide that, for the purposes of the tainting rule, a debt for equity swap includes an arrangement where a taxpayer discharges, releases, or otherwise extinguishes the whole or part of a debt owed to the taxpayer in return for the issue by the debtor to the taxpayer of shares (other than redeemable preference shares) in the debtor. [Items 3 and 4 of Schedule 1; amends subsection 160ARDM(2) and new subsection 160ARDM(3)]
1.21 However, this exception only applies provided the amount of the debt transferred to the share capital account does not exceed the lesser of the value of the shares issued to the creditor and the amount of the debt. [Item 3 of Schedule 1; new subparagraph 160ARDM(2)(b)(ii)]
1.22 For the purposes of this exception to the tainting rule, the term arrangement' means any agreement, arrangement, understanding, promise, undertaking, or scheme, whether express or implied, and whether or not enforceable, or intended to be enforceable, by legal proceedings. [Item 4 of Schedule 1; new subsection 160ARDM(4)]
Delayed crediting of share capital
1.23 Under the current tainting rule, the delayed crediting of share capital to the share capital account results in tainting the account. This may occur in circumstances where share capital received on the issue of shares is not credited by the company to its share capital account, but to another account. For example, some accounting standards may require share capital received by a company on the issue of redeemable preference shares to be credited to a liability account.
1.24 In this way the current tainting rule is inconsistent with the rules that were formerly applicable to share premium accounts whereby a share premium account did not become tainted when share premiums were credited to another account and then transferred to the share premium account, provided they could be identified in the books of the company at all times as such a premium.
1.25 To ensure that the delayed crediting of share capital to the share capital account does not inappropriately taint the account the amendments insert a new definition of share capital account'. [Items 1 and 2 of Schedule 1; new section 6D]
1.26 The amendments provide that a share capital account is to include, in addition to the ordinary account which a company keeps of its share capital, an account (whether called a share capital account) where the first amount credited to the account was an amount of share capital. [Item 2 of Schedule 1; new subsection 6D(1)]
1.27 Where the company has more than one share capital account, the accounts are taken for the purposes of the tax laws to be a single account. (As a result the tainting of any of the share capital accounts will result in the tainting of all of the share capital accounts.) This means that where a company establishes a special account for share capital before transferring the share capital to the main account, the special account will be treated as always having been part of the share capital account. Any subsequent transfer of amounts between accounts will therefore amount to a transfer between sub-accounts of the share capital account, and will not taint share capital. [Item 2 of Schedule 1; new subsection 6D(2)]
1.28 Furthermore, the transfer to a company's share capital account of an amount of share capital which has been credited to an existing non-share capital account, for example, an account of amounts owed creditors, will not result in the share capital account becoming tainted if the amount could be identified in the books of the company as an amount of share capital at all times before it was credited to the share capital account. [Item 3 of Schedule 1; new paragraph 160ARDM(2)(a)]
1.29 The amendments also provide that an account that is tainted under the tainting rule is not a share capital account for the purposes of the Act other than for the purposes of:
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- the definition of paid-up share capital in subsection 6(1);
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- subsection 44(1B);
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- section 46H;
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- subsection 159GZZZQ(5);
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- Division 7B of Part IIIAA; and
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- subsection 160ZA(7A).
[Item 2 of Schedule 1; new subsection 6D(3)]
1.30 The Proclamation that set the commencement date for the Act contains a defect that arguably prevents three amendments commencing from the date intended (ie. 1 July 1998). To ensure that these amendments apply from the date intended certain clarificatory amendments have been made to the Act to make this commencement date explicit. [Items 5 and 6 of Schedule 1; amend subsection 2(2) and Item 3 of Schedule 1 of the Act] - Regulation Impact Statement
Specification of policy objective
1.31 To ensure that a company's share capital account is not inappropriately tainted as a result of the compulsory merger of tainted share premiums with the share capital account under recent company law changes.
Identification of implementation options
1.32 The Act which received Royal Assent on 1 July 1998, made various consequential amendments to the tax laws as a result of changes being made to the Corporations Law (by the Review Act) which will abolish the concept of par value for shares and the associated terms of share premium as well as make it easier for companies to return capital to shareholders.
1.33 The tainting rule within the Act prevents companies disguising a profit distribution as a tax-preferred capital distribution from the share capital account by first transferring profits into that account and then distributing from it. A similar rule applied to share premium accounts before their abolition on 1 July 1998 by the Review Act: in cases where the share premium account contained amounts other than share premiums (tainted share premium accounts') the share premium account was also treated as a profit account.
1.34 Under section 1446 of the Review Act, share premium accounts existing on 1 July 1998 were merged with share capital. Where the share premium account was tainted the merger has the effect of tainting the new share capital account for tax purposes, thereby preventing the distribution of profits in the guise of share capital. Two unintended effects with this element of the tainting rule is that it produces a franking debit on the merger of tainted share premiums and it removes retrospectively the ability of companies to defer distribution of tainted amounts already transferred to share premium accounts.
1.35 There is only one option to implement the policy objective, that is, the option announced by the Assistant Treasurer in his Press Release No. 43 on Nov 1998. A company's share capital account will not be tainted upon its merger with a tainted share premium account under section 1446 of the Review Act. However, to ensure that an undue tax advantage is not conferred, the share capital account will be treated as if it were tainted during periods when the amount standing to the credit of the share capital account is equal to the balance of the tainted share premium account merged in it (ie. nothing remains in it other than tainted share premiums).
Assessment of Impacts (Costs and Benefits) of the Implementation Option
1.36 The proposed provisions will only impact on those companies that had a tainted share premium account immediately before 1 July 1998 (the date of the compulsory merging of the accounts) and the shareholders of those companies.
Analysis of the costs and benefits associated with the implementation option
1.37 The advantage of the proposed approach is that the legislation implementing it will not be complex. The provisions will simply require companies to record the extent to which they have a tainted share premium account at the time of merging, if any.
1.38 The amendments are concessional to taxpayers and as such there are no disadvantages.
1.39 The nature of these amendments is such that a reliable estimate of the revenue effect of the proposed amendments cannot be made. However, these amendments are designed to clarify the law and preserve the taxation treatment of companies and their shareholders prior to changes in the Corporations Law and therefore prevent an unintended gain to the revenue.
1.40 Extensive discussions were held with the tax profession on this issue.
1.41 The Australian Taxation Office has consultative arrangements in place to obtain feedback from professional and small business associations and through other taxpayer consultation forums.