House of Representatives

Explanatory Memorandum

(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)

Chapter 2 - Refunding excess imputation credits

Outline of Chapter

2.1 This Chapter explains the changes to the treatment of excess imputation credits (franking rebates). Taxpayers who receive franking rebates will be entitled to a refund if their franking rebates exceed tax payable.

2.2 These changes apply to taxpayers who are entitled to franking rebates, except trustees liable to be assessed under section 99A of the ITAA 1936. The changes apply to imputation credits in relation to dividends paid by companies on or after 1 July 2000.

Context of Reform

What is the current treatment of excess imputation credits?

2.3 Current subsection 4-10(3A) of the ITAA 1997 provides that imputation credits that exceed a taxpayers income tax liability are disregarded. That is, they cannot be refunded.

Why is the law being changed?

2.4 The current treatment means that low-income earners and certain other taxpayers may pay tax on dividend income at a rate higher than their marginal tax rate. This is because the company distributing the dividends may have already paid tax (at the company tax rate) on profits before distributing them as dividends.

2.5 The Review considered that resident individuals and superannuation funds and like entities should be taxed at their appropriate tax rates, rather than at the company tax rate. Therefore, it recommended that excess imputation credits be refunded to these taxpayers.

Summary of new law

2.6 The new law ensures that resident individuals and other taxpayers eligible for this measure will be taxed on dividends at their appropriate tax rates. Once imputation credits have been used to offset any income tax liability, any excess credits will be refunded to these taxpayers. This is the same as the current treatment for the private health insurance tax offset.

2.7 The new law applies to imputation credits relating to dividends paid on or after 1 July 2000. For most taxpayers, this means that it applies from the start of their 2000-2001 income year.

Detailed explanation of new law

What are excess imputation credits?

2.8 Certain taxpayers, such as individuals and superannuation funds, who receive partly or fully franked dividends are entitled to a franking rebate for imputation credits attached to the dividends. The imputation credit is equal to the amount of company tax paid relating to the dividends. The franking rebate is a tax offset that is available to reduce the taxpayers income tax liability. The term imputation credits is used in this Chapter to refer to franking rebate .

2.9 A taxpayer has excess imputation credits if their total imputation credits from dividends paid on or after 1 July 2000 are greater than their income tax liability, once they have used any other tax offsets to which they are entitled. Examples 2.1 and 2.2 illustrate excess imputation credits.

2.10 A taxpayer calculates any excess imputation credits in the same way as they currently calculate any excess private health insurance tax offset. [Schedule 2, item 1, subsection 4-10(3A), items 2 and 3]

2.11 Imputation credits subject to these rules are certain franking rebates found in Part IIIAA of the ITAA 1936 [Schedule 2, item 6, subsection 67-25(1)] . If the taxpayer is not entitled to a franking rebate because, for example, it is an exempt taxpayer, there are no excess imputation credits to refund.

Who is entitled to refunds of excess imputation credits?

2.12 The new law, found in Division 67 of the ITAA 1997, provides that once the income tax liability of taxpayers entitled to the refund has been offset, excess imputation credits will be refunded. The taxpayers entitled to the refund are resident:

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individuals;

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trustees assessed on a resident beneficiarys share of trust income;

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superannuation funds;

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approved deposit funds;

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life assurance companies;

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registered organisations (e.g. friendly societies); and

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pooled superannuation trusts.

2.13 Previously, the only tax offset that was refundable was the private health insurance tax offset. The new law creates an expanded class of tax offsets that are subject to the refundable tax offset rules [Schedule 2, items 4 and 5, section 61-335; item 6, subsection 67-20] . These tax offsets are imputation credits and the private health insurance tax offset [section 67-25] .

2.14 Imputation credits that are refundable are franking rebates available under the following provisions of the ITAA 1936:

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section 160AQU (applicable to dividends paid directly to a shareholder eligible to receive a franking rebate);

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section 160AQX (beneficiaries of a trust);

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section 160AQY (trustees);

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section 160AQYA (superannuation fund, approved deposit fund and pooled superannuation trust beneficiaries and partners);

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section 160AQZA (life assurance company beneficiaries and partners);

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section 160AQZ (other partners); and

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section 160ASEP (venture capital franking rebates available to certain shareholders of pooled development funds).

[Subsection 67-25(1)]

2.15 Trustees entitled to a franking rebate under section 160AQY can receive a refund of any excess imputation credits only if they are liable to be assessed under section 98 or 99 of the ITAA 1936. If they are liable to be assessed under any other provision, for example section 99A, then they cannot receive a refund of any excess imputation credits. This is because the measure is aimed at ensuring that taxpayers are taxed at their marginal tax rate on dividend income. Under section 99A, the trustee is assessed at a tax rate that is not linked to a beneficiary. [Subsection 67-25(1)]

2.16 Individuals entitled to imputation credits calculate their refund under this measure as follows [Schedule 2, item 6, section 67-30] :

Step 1.

Calculate tax payable on taxable income.

Step 2.

Reduce tax payable by tax offsets to which they are entitled (except the private health insurance tax offset and imputation credits).

Step 3.

Add other tax liabilities (e.g. Medicare levy and HECS repayments).

Step 4.

Deduct any refundable tax offset amount (i.e. private health insurance tax offset and imputation credit amount).

Step 5.

Deduct any tax instalment (PAYE) deductions or similar payments of tax relating to the income year.

If the result from step 4 or step 5 (if applicable) is negative, the taxpayer is entitled to a refund equal to that amount [Schedule 2, item 6, section 67-35] .

Example 2.1

Peter is resident in Australia for tax purposes. His tax on taxable income is $406. He is entitled to the full low-income rebate (of $150) and a $100 private health insurance rebate. He also is entitled to a $250 franking rebate for dividends paid on or after 1 July 2000. He is under the Medicare levy threshold.

His refund is calculated as follows:

tax on taxable income	$406
less amount of low income rebate	-$150
less amount of private health insurance rebate	-$100
less amount of imputation credits	-$250
Refund	$94

Therefore, Peter is entitled to a refund of $94, which is the amount of his excess imputation credits. (The private health insurance rebate and imputation credits are separated in this example for ease of recognition.)

Example 2.2

Deborah is resident in Australia and employed by a law firm. She is a late balancing taxpayer. Her tax on taxable income is $11,500. Her Medicare levy and HECS repayments are $1,000. Her employer deducted $11,000 PAYE from her salary and wages. She is entitled to foreign tax credits of $100 and a dependant spouse rebate of $1,300. She is also entitled to a $200 franking rebate for dividends received on or after 1 July 2000, and a $200 franking rebate for dividends received before 1 July 2000.

She works out her refund or tax payable as follows:

tax on taxable income	$11,500
less dependant spouse rebate	-$1,300
less foreign tax credits	-$100
less franking rebate (dividends paid before 1/7/2000)	-$200
add Medicare levy and HECS repayments	$1,000
less franking rebate (dividends paid on or after 1/7/2000)	-$200
less PAYE credits	-$11,000
Refund	$300

Therefore, Deborah is entitled to a refund of $300. (Because Deborah's total tax payable exceeds the amount of her imputation credits in relation to dividends paid on or after 1 July 2000, the measures do not change the amount of the refund she is entitled to receive.)

Application and transitional provisions

2.17 This measure applies to imputation credits that relate to dividends paid on or after 1 July 2000. For most taxpayers, this means that it applies from the start of their 2000-2001 income year. [Schedule 2, item 7]

2.18 If the imputation credit is obtained by a beneficiary of a trust or a partner in a partnership because the trust or partnership is paid a franked dividend, the measure applies only if the original dividend is paid on or after 1 July 2000.

2.19 This means that where, for example, a trustee distributes an amount to a beneficiary on or after 1 July 2000 and the distribution represents a franked dividend paid before that date, the beneficiary will not be entitled to a refund of imputation credits relating to the trust distribution.

Consequential amendments

2.20 There are no consequential amendments relating to this measure.