House of Representatives

Explanatory Memorandum

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

General outline and financial impact

Fringe benefits tax: exemption for certain free travel on public transport by police officers

Part 1 of Schedule 1 to this Bill will amend the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to exempt from fringe benefits tax (FBT) certain free public transport provided to police officers.

Date of effect: This amendment will apply from the FBT year commencing 1 April 2000 and later years.

Proposal announced: Mid-Year Economic and Fiscal Outlook 2000-2001.

Financial impact: $5 million per annum.

Compliance cost impact: Nil.

Application of fringe benefits tax to nominated State and Territory bodies

Part 2 of Schedule 1 to this Bill will amend the FBTAA 1986 to provide the States and Territories with FBT treatment that is consistent with the treatment given to the Commonwealth. From the FBT year commencing 1 April 2001 and all later years of tax, the States and Territories will be able to devolve the administration and payment of FBT to nominated State or Territory bodies.

Date of effect: These measures will apply from the FBT year commencing 1 April 2001 and all later years.

Proposal announced: Not previously announced.

Financial impact: Nil.

Compliance cost impact: Nil.

Special rules about the tainting of share capital accounts

Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to allow all resident companies, not only those falling within the scope of Schedule 5 to the Company Law Review Act 1998, to transfer genuine share premiums and capital redemption reserves to their share capital account without tainting that account provided certain criteria are satisfied.

Date of effect: The amendments will apply to transfers from 1 July 1998.

Proposal announced: Assistant Treasurers Press Release No. 47 of 15 September 2000.

Financial impact: Due to the nature of the amendments a reliable estimate 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 their legal status. Therefore, the amendments only prevent an unintended gain to revenue.

Compliance cost impact: The proposed amendments are concessional and will not increase compliance costs for taxpayers.

Life assurance companies

Schedule 3 to this Bill amends the ITAA 1936 to correct certain anomalies in the dividend imputation provisions that apply to life assurance companies by limiting the extent to which life assurance companies can apply a payment of franking deficit tax (FDT) or deficit deferral tax (DDT) to offset their income tax assessment liability.

The amendments also provide a transitional rule that will provide an alternative treatment in certain circumstances where a liability for FDT or DDT arose before 4 May 1999.

Date of effect: The amendments apply in respect of assessments and amended assessments served on or after 4 May 1999.

Proposal announced: Assistant Treasurers Press Release No. 22 of 4 May 1999.

Financial impact: This is a revenue protection measure. That is, it will prevent a loss to revenue that would otherwise arise if life assurance companies exploited the loophole in the law.

Compliance cost impact: Negligible.

Charitable institutions

Schedule 4 to this Bill will amend the FBTAA 1986, the Income Tax Assessment Act 1997 (ITAA 1997), the ITAA 1936 and the Sales Tax (Exemptions and Classifications) Act 1992 to extend the taxation treatment currently given to public benevolent institutions to certain charitable institutions.

Charitable institutions whose principal activity is promoting the prevention or control of disease in humans will be entitled to:

•

concessional FBT treatment;

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status as tax deductible gift recipients; and

•

exemption from sales tax on goods for use by the charitable institution (prior to the introduction of the goods and services tax (GST)).

Date of effect:

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FBT - benefits provided from the FBT year commencing 1 April 1998, and all later years, by certain charitable institutions are exempt benefits;

•

deductions for gifts or contributions - gifts made to certain charitable institutions are tax deductible under the ITAA 1997 from the 1997-1998 income year and later years and under the ITAA 1936 from the 1996-1997 income year and earlier years; and

•

sales tax - goods for use by certain charitable institutions are exempt from sales tax from 28 October 1992.

Proposal announced: Treasurers Press Release No. 55 of 22 June 2000.

Financial impact: No significant impact on revenue.

Compliance cost impact: Nil.

Technical corrections to the franking rebate provisions for superannuation funds and other entities

Schedule 5 to this Bill amends the ITAA 1936 to make technical corrections to the franking rebate rules so that complying superannuation funds, pooled superannuation trusts and life assurance companies continue to be entitled to the franking rebate, and refunds of excess imputation credits for dividends and distributions that are exempt current pension income or certain other exempt income.

A further correction will ensure that registered charities and gift-deductible organisations are eligible for refunds of imputation credits in respect of indirect distributions through a trust.

Date of effect: The amendments are to apply to income derived on or after 1 July 2000.

Proposal announced: Not previously announced.

Financial impact: Nil.

Compliance cost impact: The proposed amendments are corrections and will not have any impact on compliance costs for taxpayers.

Miscellaneous amendments

Schedule 6 to this Bill will amend the Income Tax Rates Act 1986 (ITRA 1986) and the ITAA 1936. It will:

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decrease the upper limit of the shading-in range for trustees of certain resident deceased estates;

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increase the existing monthly allowance of tax-free threshold; and

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replace a superseded term in the definition of separate net income in respect of dependant rebates.

Date of effect: The decrease in the upper limit of the shading-in range and the increased monthly allowance of tax-free threshold will apply from the 2000-2001 year of income and later years of income. The definition of separate net income will apply from the 1999-2000 year of income and later years of income.

Proposal announced: Tax Reform: not a new tax, a new tax system: the Howard Governments Plan for a New Tax Systempolicy document.

Financial impact: The measure will result in no cost to the revenue as the cost was included in the A New Tax System (Personal Income Tax Cuts) Act 1999.

Compliance cost impact: Negligible.

Chapter 1 - Fringe benefits tax: exemption for certain free travel on public transport by police officers

Outline of chapter

1.1 Part 1 of Schedule 1 to this Bill will amend the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to exempt from fringe benefits tax (FBT) certain free public transport provided to police officers.

Context of reform

1.2 Under arrangements with State and Territory Governments, police officers are provided free public transport for travel to and from duty. Irrespective of their oath of office, which requires that police officers respond to any incidents they observe on or off duty, a residual fringe benefit currently arises under section 45 in respect of this free travel.

1.3 Under section 45 of the FBTAA 1986, a benefit is a residual fringe benefit if it is not a benefit under any other provisions of the FBTAA 1986, for example, free or discounted services such as travel. However, section 47 provides that certain residual benefits are exempt benefits, for example, free travel provided to an employee by an employer who carries on a business of providing transport.

Detailed explanation of new law

1.4 Section 47 is amended to exempt from FBT a benefit that is provided in the following circumstances:

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a person is provided with a residual benefit arising from the provision of travel on public transport between the persons place of residence and primary place of employment;

•

the person is an employee of a government body; and

•

the persons duties of employment are performed in a police service.

[Schedule 1, Part 1, item 1, subsection 47(1A)]

1.5 The terms place of residence, primary place of employment and government body are defined in subsection 136(1) to mean, respectively:

•

a place at which a person resides or a place at which the person has sleeping accommodation whether on a permanent or temporary basis and whether or not on a shared basis;

•

the employers business premises, or associated premises, on which the employee would normally carry out his or her employment duties; and

•

the Commonwealth, a State, a Territory or an authority of the Commonwealth or of a State or Territory.

Application and transitional provisions

1.6 This measure will apply from the FBT year commencing 1 April 2000 and all later years. [Schedule 1, Part 1, item 2]

Chapter 2 - Application of fringe benefits tax to nominated State or Territory bodies

Outline of chapter

2.1 Part 2 of Schedule 1 to this Bill will amend the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986) to provide the States and Territories with fringe benefits tax (FBT) treatment that is consistent with the treatment given to the Commonwealth. From the FBT year commencing 1 April 2001 and all later years of tax, the States and Territories will be able to devolve the administration and payment of FBT to nominated State or Territory bodies.

Context of reform

2.2 The States and Territories have sought consistent treatment with the Commonwealth for the payment of FBT. Each department or agency of the Commonwealth pays FBT, whereas each State or Territory pays FBT for the whole of its government.

2.3 Employer is defined in subsection 136(1) as a current employer, a future employer or a former employer, but does not include the Commonwealth and certain Commonwealth authorities. Current employer is defined as a person, including a government body, who pays, or is liable to pay, salary or wages. Government body is defined as the Commonwealth, a State, a Territory or an authority of the Commonwealth or of a State or Territory (subsection 136(1)). Each State and Territory is, therefore, an employer and subject to the rights, benefits and obligations that are imposed on employers by the FBTAA 1986.

2.4 Paragraph 4(1)(a) of the Fringe Benefits Tax (Application to the Commonwealth) Act 1986 provides that the FBTAA 1986 applies as if a Commonwealth employee were an employee of a Commonwealth department and not of the Commonwealth. Paragraph 4(1)(c) effectively treats a Commonwealth department as a government body and therefore as an employer. Accordingly, FBT is imposed at the departmental level in relation to the employees of each department and not at the Commonwealth level.

2.5 Therefore, to provide consistent treatment between the Commonwealth and the States and Territories, each State and Territory government department, or its equivalent, must be able to be treated as an employer for FBT.

Summary of new law

2.6 Part 2 of Schedule 1 to this Bill will amend the FBTAA 1986 to:

•

treat nominated State or Territory bodies as employers for FBT;

•

treat nominated State or Territory bodies as associates of:

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each other;

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authorities of the State or Territory; and

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the State or Territory;

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enable the calculation of FBT instalments for the nominated bodies; and

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allow the continuation of certain FBT treatment that would otherwise be lost because of the change in employer for FBT.

Detailed explanation of new law

2.7 To allow State and Territory governments to devolve the administration and payment of FBT to a departmental level, Part XIC is inserted in the FBTAA 1986. Part XIC provides for the application of the FBTAA 1986 to nominated State or Territory bodies. [Schedule 1, Part 2, item 3, Part XIC]

Nomination of eligible State or Territory bodies

2.8 If a State or Territory chooses to devolve its FBT responsibility, the State or Territory must make a nomination and provide the Commissioner of Taxation (Commissioner) with certain information to facilitate the process. [Schedule 1, Part 2, item 3, section 135S]

2.9 States and Territories may nominate only certain bodies for treatment as employers under Part XIC [Schedule 1, Part 2, item 3, subsection 135S(1)] . The bodies eligible for nomination are the State and Territory equivalents of Commonwealth departments (see paragraphs 2.14 to 2.28). A body nominated for the purposes of Part XIC is referred to as a nominated State or Territory body [Schedule 1, Part 2, item 3, subsection 135S(6)] .

2.10 The nomination must be in the approved form and must specify the first year of tax for which it will apply (the first year of tax). The nomination must be given to the Commissioner no later than 21 May of the first year of tax. [Schedule 1, Part 2, item 3, subsection 135S(2)]

2.11 The nomination has effect for the first year of tax and all subsequent years unless a variation or revocation is made [Schedule 1, Part 2, item 3, subsection 135S(3)] . A variation or revocation of a nomination must:

•

be in the approved form;

•

specify the first year of tax for which it is to have effect; and

•

be given to the Commissioner by 21 May of that first year of tax [Schedule 1, Part 2, item 3, subsection 135S(5)] .

2.12 A State or Territory may nominate more than one eligible State or Territory body for treatment as an employer. The nominations do not have to be effective from the same year of tax and do not have to be made at the same time. This allows a State or Territory to phase in the devolution of FBT if it so chooses and to make changes as the need arises. [Schedule 1, Part 2, item 3, subsection 135S(4)]

2.13 For the purposes of establishing an employer/employee relationship between a nominated State or Territory body and certain employees, the nomination may also specify that a class or classes of employees are to be considered as having a sufficient connection (see paragraphs 2.30 to 2.31) with the nominated State or Territory body. [Schedule 1, Part 2, item 3, paragraph 135S(2)(c)]

Eligible State or Territory bodies

2.14 The bodies that are eligible for nomination are listed in section 135T. Because each State and Territory has its own legislative definitions of bodies that are the equivalent of Commonwealth departments, subsection 135T(1) defines an eligible State or Territory body by reference to the State or Territory legislation.

2.15 A government body that pays, or is liable to pay, salary or wages is excluded from being an eligible State or Territory body because it is an employer in its own right. [Schedule 1, Part 2, item 3, subsection 135T(2)]

2.16 In the case of amendment or repeal of the State or Territory legislation cited in paragraphs 2.17 to 2.27, regulations may be made to make modifications, including additions, omissions and substitutions, to the list in subsection 135T(1). [Schedule 1, Part 2, item 3, subsections 135T(3) and (4)]

New South Wales

2.17 New South Wales may nominate a department as defined in section 3 of the New South Wales Public Sector Management Act 1988 [Schedule 1, Part 2, item 3, paragraph 135T(1)(a)] . Section 3 of that Act defines department as a department of the Public Service that is specified in Schedule 1 to that Act. Schedule 1 lists departments and their heads by name and title, for example, Department of Education and Training, Community Relations Commission and Cabinet Office.

Victoria

2.18 Victoria may nominate either:

•

an agency as defined in section 4 of the Victorian Public Sector Management and Employment Act 1998 [Schedule 1, Part 2, item 3, paragraph 135T(1)(b)] ; or

•

an office as referred to in subsection 16(1) of that Act [Schedule 1, Part 2, item 3, paragraph 135T(1)(c)] .

2.19 Section 4 of that Act provides that an agency is a department or an administrative office. Both terms are also defined in that section. A department is established by the Governor in Council and an administrative office is a body or group existing in relation to a department and established by the Governor in Council.

2.20 Subsection 16(1) of that Act lists the following offices:

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Victorian Auditor-Generals Office;

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the Office of Public Prosecutions;

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the Victorian Electoral Commission;

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the Chief Commissioner of Police;

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the Ombudsman;

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the Office of the Commissioner for Public Employment;

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the Office of the Regulator-General; and

•

the Legal Ombudsman.

Queensland

2.21 Queensland may nominate a department as defined in section 7 of the Queensland Public Service Act 1996 [Schedule 1, Part 2, item 3, paragraph 135T(1)(d)] . Section 7 of that Act defines a department as an entity declared under the Act to be a department of government by the Governor in Council.

Western Australia

2.22 Western Australia may nominate a department as defined in section 3 of the Western Australian Public Sector Management Act 1994 and as extended by subsection 3(2) of the Western Australian Financial Administration and Audit Act 1985 [Schedule 1, Part 2, item 3, paragraph 135T(1)(e)] . Section 3 of the Public Sector Management Act 1994 provides that a department is established under section 35 by the Governor. The definition is extended by subsection 3(2) of the Financial Administration and Audit Act 1985 to include:

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the Legislative Assembly;

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the Legislative Council;

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the Joint House Committee;

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the Joint Printing Committee;

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the Joint Library Committee;

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the Parliamentary Commissioner for Administrative Investigations; and

•

the Information Commissioner.

2.23 Western Australia may also nominate a subsidiary body as defined in paragraphs (aa) and (b) of the definition of the term in subsection 3(1) of the FAAA 1985 [Schedule 1, Part 2, item 3, paragraph 135T(1)(f)] . These bodies are declared under an act or determined by the Treasurer to be subsidiary bodies of a department.

South Australia

2.24 South Australia may nominate an administrative unit as defined in section 3 of the South Australian Public Sector Management Act 1995 [Schedule 1, Part 2, item 3, paragraph 135T(1)(g)] . Section 3 of that Act defines an administrative unit as an administrative structure in which persons are, or are to be, employed and established under the Act as an administrative unit.

Tasmania

2.25 Tasmania may nominate a government department as defined in section 3 of the Tasmanian State Service Act 1984 [Schedule 1, Part 2, item 3, paragraph 135T(1)(h)] . Section 3 of that Act provides that a government department is established under section 24 by the Governor.

Australian Capital Territory

2.26 The Australian Capital Territory may nominate a department as defined in section 3 of the Financial Management Act 1996 of the Australian Capital Territory [Schedule 1, Part 2, item 3, paragraph 135T(1)(i)] . Section 3 provides that a department is an administrative unit, part of an administrative unit or a group of 2 or more administrative units.

Northern Territory

2.27 The Northern Territory may nominate either an agency or a government business divisionas defined in section 3 of the Northern Territory Financial Management Act 1995 [Schedule 1, Part 2, item 3, paragraphs 135T(1)(j) and (k)] . An agency is broadly a unit of government administration nominated for the purposes of the Act. A government business division is an activity or group of activities of which a significant proportion of the operating costs is recovered through charges on users.

Parliament or Legislative Assembly

2.28 Each State or Territory may also nominate a department of a Parliament of a State or a department of a Legislative Assembly of a Territory. [Schedule 1, Part 2, item 3, paragraphs 135T(1)(l) and (m)]

Consequences of nomination

2.29 Under section 66 of the FBTAA 1986, tax is imposed in respect of the fringe benefits taxable amount of an employer for a year of tax and is payable by the employer. Nominated State or Territory bodies are taken to be government bodies [Schedule 1, Part 2, item 3, paragraph 135U(5)(c)] and are, therefore, employers.

2.30 By nominating an eligible State or Territory body, the State or Territory is no longer the employer of the relevant employees. Instead, the nominated body is treated as the employer of each employee who has a sufficient connection with that body. [Schedule 1, Part 2, item 3, subsection 135U(1)]

2.31 An employee has a sufficient connection with a nominated State or Territory body if:

•

the employee performs their duties of employment wholly or principally in that body [Schedule 1, Part 2, item 3, subsection 135U(2)] ; or

•

the employee is of a class of employees that the State or Territory has specified in the nomination (under paragraph 135S(2)(c)) as having a sufficient connection with the body and the employee does not perform the duties of employment wholly or principally in any other nominated State or Territory body [Schedule 1, Part 2, item 3, subsection 135U(3)] .

2.32 However, if a nominated State or Territory body ceases to exist during a year of tax, the State or Territory becomes the employer, from the time of cessation, of the employees who had a sufficient connection with the body immediately before it ceased to exist. This means that the State or Territory is responsible for any FBT liability that may arise in relation to these employees for the remainder of the FBT year. [Schedule 1, Part 2, item 3, subsection 135U(6)]

2.33 Because the nominated State or Territory bodies do not have a separate legal identity from the State or Territory, any right that would be conferred or obligation that would be imposed on that body is instead conferred or imposed on the State or Territory. For example, if a nominated body were not to comply with its obligations as an employer, the State or Territory would be ultimately responsible for those obligations. [Schedule 1, Part 2, item 3, subsection 135U(4)]

2.34 As a consequence of the nomination, each nominated State or Territory body is treated as a company for the purposes of the FBTAA 1986 [Schedule 1, Part 2, item 3, paragraph 135U(5)(a)] . Also each:

•

other nominated State or Territory body of the State or Territory concerned; and

•

State or Territory concerned; and

•

authority of the State or Territory concerned,

are treated as related companies [Schedule 1, Part 2, item 3, paragraph 135U(5)(b)] .

2.35 Companies and related companies are deemed to be associates of each other under section 159 of the FBTAA 1986. A fringe benefit is defined in subsection 136(1) to include benefits provided by an associate of an employer to an employee of the employer. Therefore, an FBT liability may arise where one nominated State or Territory body provides benefits to an employee of another nominated State or Territory body of the same State or Territory.

Notional tax amount

2.36 An instalment of tax is calculated by reference to an employers notional tax amount under section 111. An employers notional tax amount is generally the amount of tax assessed to the employer for the most recent year of tax. However, the notional tax amount is nil when there is no previous year of tax for which an assessment has been made (section 110).

2.37 Therefore, to ensure the uninterrupted payment of tax instalments by States and Territories, rules are required to determine the notional tax amount where a nomination has been made, varied or revoked under section 135S. [Schedule 1, Part 2, item 3, section 135V]

2.38 Where a State or Territory makes, varies or revokes a nomination for a year of tax (year of the change), the State or Territory must specify the amounts of tax that are deemed to be assessed for the immediately preceding year of tax (prior year of tax) for:

•

each nominated State or Territory body for the year of the change; and

•

the State or Territory [Schedule 1, Part 2, item 3, subsection 135V(2)] .

These amounts are used to determine the notional tax amount under subsection 110(1) [Schedule 1, Part 2, item 3, subsection 135V(5)] .

2.39 The State or Territory will determine these amounts based on each bodys share of the total FBT liability of the State or Territory and any nominated State or Territory bodies in the prior year of tax. The sum of the amounts specified under subsection 135V(2) must equal the sum of the tax that was assessed for the prior year of tax in respect of the State or Territory and the nominated State or Territory bodies, if any. [Schedule 1, Part 2, item 3, subsection 135V(3)]

2.40 The amounts determined in accordance with subsections 135V(2) and 135V(3) must be specified in the approved form and given to the Commissioner on or before 21 May of the year of change. [Schedule 1, Part 2, item 3, subsection 135V(4)]

2.41 If these requirements are not satisfied, there are no nominated State or Territory bodies for the year of tax. In this case, the amount of tax deemed to have been assessed for the prior year of tax to the State or Territory is the sum of the amounts of tax assessed to the State or Territory and any nominated State or Territory bodies. [Schedule 1, Part 2, item 3, paragraph 135V(6)]

2.42 If a nominated State or Territory body ceases to exist during a year of tax, then the notional tax amount of the State or Territory is determined as:

•

the actual amount of tax assessed in respect of the State or Territory for the immediately preceding year; plus

•

the notional tax amount of the nominated State or Territory body in respect of the year of tax as at the end of the last quarter before the body ceased to exist; less

•

the total of any tax instalments of the nominated State or Territory body for the year of tax that became due and payable before it ceased to exist; less

•

the total of any credits claimed under section 112A in relation to one or more instalments of tax of the nominated State or Territory body for the year of tax.

[Schedule 1, Part 2, item 3, subsection 135W]

2.43 This returns the responsibility for FBT to the State or Territory for the remainder of the year of tax, taking into account any tax instalments that have become due and payable during the year.

Application of certain provisions

2.44 Section 135X provides that the Commissioner may enter into a written agreement with a State or Territory regarding the application of certain provisions in certain circumstances [Schedule 1, Part 2, item 3, section 135X] . Where the agreement is inconsistent with the FBTAA 1986, the agreement prevails [Schedule 1, Part 2, item 3, subsection 135X(4)] .

2.45 Section 135X has 2 objects. The first is to ensure that the calculation of the taxable value of certain fringe benefits is not affected as a result of a break in the continuity of certain record keeping requirements solely because of a transitional event [Schedule 1, Part 2, item 3, paragraph 135X(1)(a)] . The second object is to preserve the character of certain benefits where the character would otherwise be lost solely because of a transitional event [Schedule 1, Part 2, item 3, paragraph 135X(1)(b)] .

2.46 A transitional event is defined as:

•

the making of a nomination under section 135S;

•

the variation of a nomination under section 135S;

•

the revocation of a nomination under section 135S; or

•

the cessation of the existence of a nominated State or Territory body.

[Schedule 1, Part 2, item 3, subsection 135X(2)]

2.47 Under these circumstances only, a written agreement may be entered into in relation to the application of the following provisions:

[Schedule 1, Part 2, item 3, subsection 135X(3)]

Application and transitional provisions

2.48 These measures will apply from the year of tax commencing 1 April 2001 and all later years of tax. [Schedule 1, Part 2, item 3, section 135R]

Chapter 3 - Special rules about the tainting of share capital accounts

Outline of chapter

3.1 Schedule 2 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to allow all resident companies, not only those falling within the scope of Schedule 5 to the Company Law Review Act 1998 (CLRA 1998), to transfer genuine share premiums and capital redemption reserves to their share capital account without tainting that account provided certain criteria are satisfied.

Context of reform

3.2 Taxation Laws Amendment (Company Law Review) Act 1998 (TLA(CLR)A 1998) amended the tax laws as a result of changes to the Corporations Law made by the CLRA 1998 which abolished the concept of par value for shares and required affected companies to transfer their share premiums to their share capital account.

3.3 The amendments made by the TLA(CLR)A 1998 included rules to prevent companies transferring profits and other amounts to their share capital account and distributing those profits as preferentially taxed share capital. To prevent this occurring, a tainting rule applies where any amount other than share capital is transferred into the share capital account. (Where a companys share capital is tainted it converts into a profit account and distributions from it are treated as dividends.)

3.4 However, as an exception to the foregoing rule, the TLA(CLR)A 1998 provides for a transitional rule that allowed companies to transfer their share premium account to their share capital account without tainting that account provided it was done in accordance with Schedule 5 to the CLRA 1998. Schedule 5 required companies incorporated under the Corporations Law to transfer their share premiums to their share capital account.

3.5 This exception recognises that share premiums are effectively share capital and should not result in the share capital account being tainted and treated as a profit account.

3.6 As currently drafted, the transitional rule only applies to companies that transfer their share premium account to their share capital account in accordance with Schedule 5 to the CLRA 1998. It has come to the attention of the Government that the transitional rules do not extend to companies not covered by the Corporations Law. To address this anomaly, the Government intends to amend the tainting provisions so that an equivalent rule applies to all resident companies, not only those falling within the scope of Schedule 5 to the CLRA 1998.

Summary of new law

3.7 The amendments allow certain resident companies to transfer genuine share premiums and capital redemption reserve amounts to their share capital account without tainting that account provided certain criteria are satisfied.

Detailed explanation of new law

3.8 Subsection 160ARDM(1) of the ITAA 1936 sets out the current share capital tainting rule: a companys share capital account is tainted if the company transfers an amount to its share capital from any of its other accounts.

3.9 As an exception to the foregoing rule, subsection 160ARDM(2) currently provides 2 circumstances where the share capital account does not become so tainted:

•

where all amounts transferred could be identified in the books as amounts of share capital at all times before the transferred amounts were credited to the share capital account (paragraph 160ARDM(2)(a)); and

•

where an amount is transferred to a companys share capital account under a debt for equity swap arrangement in accordance with section 63E of the ITAA 1936 (paragraph 160ARDM(2)(b)).

3.10 A further exception was provided in the transitional rules that accompanied the TLA(CLR)A 1998 (see item 9 of Schedule 2). In these circumstances a companys share capital account does not become tainted upon the transfer of share premiums or capital redemption reserves to their share capital provided the transfer is made in accordance with Schedule 5 to the CLRA 1998. Schedule 5 required companies to transfer their share premiums to its share capital as part of the Corporations Law simplification measures that abolished par value for shares together with the related concept of share premium.

3.11 To cater for the situation where a company transfers its share premium account or capital redemption reserves to its share capital account but cannot take advantage of the transitional rule because the company is not governed by the Corporations Law, an amendment is made to subsection 160ARDM(2)^[F1].

3.12 The amendment, which is cast as a third exception in subsection 160ARDM(2), provides that a companys share capital account does not become tainted through the transfer of a share premium account (within the meaning of the ITAA 1936)^[F2] or capital redemption reserve to the share capital account provided certain conditions are met. [Schedule 2, item 1, paragraph 160ARDM(2)(c) and item 2, subparagraphs 160ARDM(2A)(c)(i) and (ii)]

3.13 The conditions, which are set out in subsection 160ARDM(2A), are that:

•

the company transferring its share premiums or capital redemption reserve amounts into its share capital account is a resident of Australia^[F3] [Schedule 2, item 2, paragraph 160ARDM(2A)(a)] ;

•

at the time immediately before the transfer, the company is not incorporated under the Corporations Law [Schedule 2, item 2, paragraph 160ARDM(2A)(b)] ;

•

the transfer of either or both of the companys share capital account or capital redemption reserve to the companys share capital account is required or allowed under a law of the Commonwealth or of a State or Territory [Schedule 2, item 2, paragraph 160ARDM(2A)(c)] ;

•

the transfer is made as part of a process that leads to there being no shares in the company that have a par value [Schedule 2, item 2, paragraph 160ARDM(2A)(d)] ; and

•

the amount transferred to the share capital account is an amount standing to the credit of the companys share premium account or capital redemption reserve (as the case may be) immediately prior to the transfer [Schedule 2, item 2, paragraph 160ARDM(2A)(e)] .

3.14 For the purposes of these measures the term share premium account takes the meaning provided in subsection 6(1) of the ITAA 1936. This definition was retained for companies maintaining par value shares (see item 67 of Schedule 5 to the TLA(CLR)A 1998). It follows, therefore, that companies will only have access to the tainting rule exception for transferred amounts that represent genuine share premiums. [Schedule 2, item 2, note to section 160ARDM(2A)]

Application and transitional provisions

3.15 The amendments to section 160ARDM will apply to transfers on or after 1 July 1998, the same date the TLA(CLR)A 1998took effect. [Schedule 2, item 3]

Chapter 4 - Life assurance companies

Outline of chapter

4.1 Schedule 3 to this Bill amends the Income Tax Assessment Act 1936 to correct certain anomalies in the dividend imputation provisions as they apply to life assurance companies by limiting the extent to which life assurance companies can apply a payment of franking deficit tax (FDT) or deficit deferral tax (DDT) to offset their income tax assessment liability.

4.2 The amendments also provide a transitional rule that will provide an alternative treatment in certain circumstances where an FDT or DDT liability arose before 4 May 1999.

Context of reform

4.3 The dividend imputation provisions that apply to non-mutual life assurance companies generally limit the extent to which franking credits and debits arise in the companys franking account. Broadly speaking, the limitations are based on the extent to which dividends can be paid to shareholders of the company.

4.4 Prior to 1 July 2000, the franking credits and debits that arose were limited to those referable to the income attributable to the non-insurance funds of the company and 20% of the income attributable to the insurance funds of the company.

4.5 From 1 July 2000, the franking credits and debits that arise are limited to those attributable to insurance business income allocated to shareholders and non-insurance business income included in shareholders funds income.

4.6 Due to anomalies in the existing imputation provisions, the rules can be circumvented in circumstances where a life assurance company over-franks the payment of dividends and applies the resulting FDT to offset the companys final income tax assessment liability.

Summary of new law

4.7 In summary, the amendments will address the anomalies:

•

in respect of income arising on or after 1 July 2000 - by limiting the extent to which life assurance companies can apply FDT or DDT to offset their income tax assessment to that part of the assessment that is referable to the income of shareholders, if any;

•

in respect of pre 1 July 2000 income - by limiting the extent to which life assurance companies can apply FDT or DDT to offset their income tax assessment to that part of the assessment that is referable to non-insurance income and 20% of statutory fund income (i.e. insurance business); and

•

by providing a transitional rule that allows life assurance companies, in certain limited circumstances, to treat the payment of FDT or DDT as a payment of company tax where the company became liable for FDT or DDT before 4 May 1999.

Detailed explanation of new law

Background

4.8 The dividend imputation provisions as they apply to non-mutual life assurance companies generally limit the extent to which franking credits and debits arise in the companys franking account.

4.9 Prior to 1 July 2000, franking credits and debits arose for the payment and refund of income tax and receipt of franked dividends on the same basis as for other companies with shareholders. However, franking credits and debits that were attributable to policyholders income were intended to be reduced by 80% to reflect the prudential requirements that limited the portion of insurance income that could be distributed to shareholders. To the extent that the franking credits and debits were not attributable to insurance income, there was no reduction. In this way, franking credits and debits arose in relation to income attributable to shareholders.

4.10 As a result of measures introduced to broaden the tax base of life insurers, new rules apply from 1 July 2000 which provide that franking credits and debits arise for the payment and refund of income tax and the receipt of franked dividends attributable to shareholders funds income. Shareholders funds income comprises insurance business income allocated to shareholders and non-insurance business income included in shareholders funds income.

4.11 If, at the end of the franking year (generally a companys income year) the franking account of a life assurance company is in deficit - that is, the total franking debits of a particular class exceeds the total franking credits of the same class - the company becomes liable for FDT. The amount of the FDT is the adjusted amount of the franking deficit. Subsequent company tax assessments may be offset by the FDT liability.

4.12 The intended limitation on franking credits for payments of income tax that is not attributable to the income of shareholders is circumvented where a life assurance company overfranks the payment of dividends and applies the resulting FDT liability to offset the companys final income tax assessment liability.

4.13 In effect, by meeting its end of year tax liability by applying the payment of FDT, no reduction in franking credits occurs. By implementing such a strategy, a life assurance company could distribute a significantly higher amount of franked dividends to its shareholders than it could do by meeting its end of year tax liability by paying income tax.

Provisions to correct anomalies

4.14 The anomalies in the dividend imputation provisions will be corrected by introducing rules that limit the extent to which a liability for FDT or DDT can be applied to an original company tax assessment (or amended company tax assessment). In general terms, the application of any liability for FDT or DDT offset to reduce a company tax assessment liability will be limited to the lesser of:

•

the sum of all class A and class C FDT and DDT amounts not previously offset; and

•

the amount of the company tax assessment (or amended company tax assessment) less any foreign tax credits allowable in respect of that income year, that would have given rise to franking credits had it been paid.

4.15 Limiting the amount of the offset as described in paragraph 4.14 ensures that a life company does not generate more franking credits in any one year than would otherwise be available. This limitation recognises that the franking credits that would be generated for the payment of company tax for that year of income have in effect already been generated and distributed resulting in the original franking deficit. To provide for a greater offset would effectively allow more franking credits to arise for that income year than would otherwise arise from the payment of the company tax.

4.16 These rules apply in respect of original company tax assessments (or amended company tax assessments) arising on or after 4 May 1999. [Schedule 3, item 3, sections 160AQKAA to 160AQKAD]

4.17 The current offsetting rules provided in sections 160AQK and 160AQKA do not apply to life assurance companies in respect of liabilities for FDT or DDT that arises for franking years that end on or after 4 May 1999. [Schedule 3, item 1, subsection 160AQK(3) and item 2, subsection 160AQKA(2)]

Determination of an offset entitlement

4.18 The amendments provide that where a life assurance company has become liable to pay FDT or DDT, or both, in respect of a franking year and, after the end of the franking year, the Commissioner of Taxation (Commissioner) serves a notice of an original company tax assessment (or amended company tax assessment) on or after 4 May 1999, the Commissioner must make a determination of any offset entitlement in relation to that company tax (or amended company tax). [Schedule 3, item 3, subsections 160AQKAA(1) and (3)]

4.19 However, consistent with the self-determination rules a life assurance company can also self-determine whether an offset is allowable to the company and the amount of that offset. [Schedule 3, item 3, subsection 160AQKAA(5)]

4.20 The amount of the offset entitlement determined under an original or new determination is equal to the lesser of the following 2 amounts:

•

the sum of the class A FDT, class A DDT, class C FDT and class C DDT reduced by any part thereof that has previously been applied; and

•

the amount of the companys liability to pay company tax that would normally give rise to franking credits (determined under section 160AQKAB) reduced by allowable foreign tax credits in respect of income derived in the eligible year of income.

[Schedule 3, item 3, subsections 160AQKAA(2) and (4)]

4.21 Section 160AQKAB identifies the amount of the company tax assessment (or amended assessment) that would have given rise to franking credits for a particular year had the assessment liability been discharged by a payment.

4.22 Due to the introduction of the new franking regime for life assurance companies from 1 July 2000, the extent to which a payment of company tax produces franking credits varies according to the time the income upon which the tax is paid was derived. Subsections 160AQKAB(1) to (4) apply to different income years due to the variation in franking regimes.

4.23 Subsection 160AQKAB(1) applies in respect of company tax assessments (or amended assessments) for an income year that ends before 1 July 2000. Therefore, company tax which would normally produce franking credits for these years when paid is:

•

100% of company tax in respect of non-statutory fund income;

•

20% of company tax in respect of statutory fund income (other than retirement savings account (RSA) income); and

•

0% of company tax paid in respect of RSA income.

[Schedule 3, item 3, subsection 160AQKAB(1)]

4.24 Subsection 160AQKAB(2) applies in respect of company tax assessments (or amended assessments) for a life assurance companys 1999-2000 income year where that income year ends on or after 1 July 2000. This rule is applicable to late balancing life assurance companies. Income is derived in this income year both before and after 1 July 2000. Therefore, the tax which would normally produce franking credits when paid for this income year is:

•

100% of company tax in respect of non-statutory fund income derived before 1 July 2000;

•

20% of company tax in respect of statutory fund income (other than RSA income) derived before 1 July 2000;

•

0% of company tax in respect of RSA income derived before 1 July 2000; and

•

company tax in respect of shareholders funds income derived on or after 1 July 2000.

[Schedule 3, item 3, subsection 160AQKAB(2)]

4.25 Subsection 160AQKAB(3) applies in respect of company tax assessments (or amended assessments) for a life assurance companys 2000-2001 income year where that income year commences before 1 July 2000. This rule is applicable to early balancing life assurance companies. Income is also derived in this income year both before and after 1 July 2000. Therefore, the company tax which would normally produce franking credits when paid for this income year is:

•

100% of company tax in respect of non-statutory fund income derived before 1 July 2000;

•

20% of company tax in respect of statutory fund income (other than RSA income) derived before 1 July 2000;

•

0% of company tax in respect of RSA income derived before 1 July 2000; and

•

company tax in respect of shareholders funds income derived on or after 1 July 2000.

[Schedule 3, item 3, subsection 160AQKAB(3)]

4.26 Subsection 160AQKAB(4) applies in respect of company tax assessments (or amended assessments) for an income year that commences on or after 1 July 2000. Therefore, the relevant amount of company tax that normally produces franking credits is all company tax in respect of shareholders funds income. [Schedule 3, item 3, subsection 160AQKAB(4)]

Consequences of determining an offset entitlement - reduction of company tax liability

4.27 Where a life assurance company is entitled to an offset under section 160AQKAA, the companys liability to pay company tax (or amended company tax in the case of an amended assessment) is reduced by that amount. This means that the company is liable to pay the difference between the assessed tax and the offset applied to reduce the assessment liability - the reduced liability. [Schedule 3, item 3, section 160AQKAC]

Consequences of determining an offset entitlement - franking credits and debits

4.28 Special rules are required to calculate any franking credits and debits that arise where a life assurance company discharges its company tax assessment (or amended assessment) and is entitled to an offset under section 160AQKAA. [Schedule 3, item 3, section 160AQKAD]

4.29 During an income year, a life assurance company will pay company tax instalments or pay as you go (PAYG) instalments. Payment of these instalments gives rise to franking credits (or franking debits) under the ordinary life assurance company imputation rules. Where a life assurance company becomes entitled to an offset entitlement, those franking credits and debits are reversed out and the appropriate franking credits are calculated under the special rules.

4.30 Even though the franking account entries that arose during the year are reversed out at the time the offset entitlement occurs, they are taken to have occurred during the year. Accordingly, the reversal does not affect any required franking amount calculations that may have been made if dividends were paid during the year.

4.31 The franking credits and debits relating to the companys company tax for the eligible income year are reversed out under subsections 160AQKAD(4) and (6). Those subsections operate to reverse out:

•

franking credits and debits relating to the companys company tax for the eligible income year; and

•

in the case where an amended offset determination is made under section 160AQKAA, those franking credits and debits that have previously arisen under section 160AQKAD in relation to the eligible income year.

[Schedule 3, item 3, subsections 160AQKAD(4) and (6)]

4.32 To ensure that the special rules in section 160AQKAD that give rise to franking credits and debits apply exclusively, subsection 160AQKAD(3) operates to ensure that no franking credits or debits arise on or after the day on which an original company tax assessment for the eligible year of income is served except those that arise under section 160AQKAD. [Schedule 3, item 3, subsection 160AQKAD(3)]

4.33 Where an original company tax assessment is served on a life assurance company and an offset entitlement under section 160AQKAA arises, the class C franking credits that arise equal to the adjusted amount of the amount calculated by applying the formula in subsection 160AQKAD(5). [Schedule 3, item 3, subsection 160AQKAD(5)]

4.34 The formula effectively provides that franking credits arise upon assessment based on the extent to which the companys company tax liability for the year, reduced by the offset entitlement, has been paid. Further, the formula reduces the amount of the company tax assessment that would produce franking credits to an amount representing tax that would normally give rise to franking credits less the amount by which the company tax assessment has been reduced by an offset entitlement.

4.35 Where an amended company tax assessment is served on the company in respect of an eligible income year, a class C franking credit arises equal to the adjusted amount of the amount calculated by applying the formula in subsection 160AQKAD(7). [Schedule 3, item 3, subsection 160AQKAD(7)]

4.36 Where a payment of tax is made after assessment, a class C franking credit arises equal to the adjusted amount of the amount calculated by applying the formula in subsection 160AQKAD(9). [Schedule 3, item 3, subsection 160AQKAD(8) and (9)]

4.37 Where a life assurance company receives a refund of tax on or after assessment, a class C franking debit arises equal to the adjusted amount of the amount calculated according to the formula in subsection 160AQKAD(11). [Schedule 3, item 3, subsection 160AQKAD(10) and (11)]

Amended assessments

4.38 Where an offset entitlement arises in relation to a company tax assessment and that assessment is amended, the original offset determination is revoked and a new determination is made under subsection 160AQKAA(3). The consequence of this is that the original determination is taken not to have arisen. [Schedule 3, item 3, paragraph 160AQKAA(3)(d)]

4.39 The franking credits and debits that previously arose under section 160AQKAD are reversed out of the companys franking account by the posting of a reversing debits and credits. [Schedule 3, item 3, paragraphs 160AQKAD(6)(a) and (b)]

4.40 Where an amended assessment is served in respect of a year in which an offset determination was made under section 160AQKAA, a new offset determination is to be made in respect of that year. [Schedule 3, item 3, paragraph 160AQKAA(3)(e]

Example 4.1: Determination of an offset entitlement in respect of an original company tax assessment

Wonderful Life Limited is a standard balancing non-mutual life assurance company. During the income year ended 30 June 2001, Wonderful Life paid $150,000 in franked dividends causing a franking deficit of $132,000 in its class C franking account at year end. Accordingly, at the end of its 2001 franking year, the company became liable for class C FDT under subsection 160AQJ(1B). The amount calculated was $68,000 (i.e. $132,000 34 / 66).

On 31 December 2001, Wonderful Lifes original company income tax liability for the 2000-2001 income year was assessed as $400,000. Of that liability, $80,000 was attributable to the shareholders funds income.

Offset determination - original assessment

Subsection 160AQKAA(2) provides that the companys offset entitlement is the lesser of:

•

the paragraph 160AQKAA(2)(a) amount, that is, the class C FDT amount of $68,000; and

•

the paragraph 160AQKAA(2)(b) amount, that is, the amount calculated under subsection 160AQKAB(4).

The amount calculated under subsection 160AQKAB(4) equals the amount of the companys liability to pay company tax that is attributable to shareholders funds income, that is, $80,000. This is the amount of the companys liability to pay company tax that would normally give rise to franking credits.

As the FDT liability of $68,000 is less than the amount calculated under subsection 160AQKAB(4), the offset entitlement that can be applied against the 2000-2001 company tax assessment liability is $68,000 (i.e. the paragraph 160AQKAA(2)(a) amount).

Consequences of an offset determination - original assessment

The first consequence of the claiming of the offset determination is that the companys liability to pay company tax is reduced by the amount of the offset. Accordingly, that liability is reduced to $332,000 (i.e. $400,000 - $68,000).

The second consequence is that the franking credits and debits that arose during the year are reversed out. Assume that during the year the company paid $300,000 in PAYG instalments. At the time of paying the PAYG instalments, the company estimated that 15% of each instalment was referable to shareholders funds income. During the year provisional franking credits arose under section 160APVJ equal to $87,353 (i.e. $300,000 15% 66 / 34).

Ordinarily, these provisional franking credits would be reversed out upon assessment under section 160AQCNCB and final franking credits would be posted under section 160APVK. However, as there has been an offset determination under section 160AQKAA, the provisional franking credits that arose during the year are reversed out under paragraph 160AQKAD(4)(a). Sections 160AQCNCB and 160APVK are effectively switched off.

A franking debit arises at assessment time equal to the franking credits that arose during the year in respect of the payment of PAYG instalments, that is, $87,353.

As the company has paid $300,000 in PAYG instalments during the year and its company tax assessment has been reduced to $332,000, the company must pay $32,000 upon assessment. Assume that the company does pay this amount at assessment time.

Calculation of franking credits upon assessment

The franking credits that arise upon assessment are calculated under subsection 160AQKAD(5).

The company has a reduced liability for company tax of $332,000. The company has paid $332,000 in PAYG instalments and company tax for the eligible income year.

The amount of the companys liability to pay company tax that would normally give rise to franking credits was calculated earlier under subsection 160AQKAB(4) to be $80,000. The offset entitlement for the relevant income year was calculated earlier as $68,000. Therefore, the amount by which the liability to pay company tax has been reduced under section 160AQKAC is $68,000.

The franking credits that arise upon assessment are equal to the adjusted amount of the amount worked out using the formula in subsection 160AQKAD(5).

That is:

Substituting the information into the equation:

The resulting amount calculated by applying the formula is $12,000. The class C franking credits that arise upon assessment is equal to the adjusted amount of $12,000 - that is, $23,294 (i.e. $12,000 66 / 34).

Example 4.2: Determination of an offset entitlement in respect of an amended company tax assessment

Assume that Wonderful Life Limited receives an amended assessment on 31 March 2002 which reduces the companys company tax assessment to $300,000 before taking into account any offset entitlement. The original offset determination is revoked under paragraph 160AQKAA(3)(c) and a new determination is to be made under subsections 160AQKAA(3) and (4).

Offset determination - original assessment

Subsection 160AQKAA(4) provides that the companys offset entitlement is the lesser of:

•

the paragraph 160AQKAA(4)(a) amount, that is, the class C FDT amount of $68,000; and

•

the paragraph 160AQKAA(4)(b) amount, that is, the amount calculated under subsection 160AQKAB(4).

As the original offset determination has been revoked, the amount of the FDT offset previously applied in respect of the original assessment is taken to not have been applied. Accordingly, the company has an amount of $68,000 that may potentially be applied against its amended assessment.

The company determines that the extent to which the amount of the amended assessment is attributable to shareholders funds is $60,000. Therefore, the amount calculated under subsection 160AQKAB(4) equals $60,000. This is the amount of the companys liability to pay company tax that would normally give rise to franking credits.

As the amount determined under subsection 160AQKAB(4) is less than the paragraph 160AQKAA(4)(a) amount, the offset entitlement that can be applied against the companys amended assessment liability is $60,000 (i.e. the paragraph 160AQKAA(4)(b) amount). Accordingly, the balance of the FDT liability, $8,000, may be carried forward to a subsequent year.

Consequences of an offset determination - amended assessment

The first consequence of the claiming of the offset determination is that the companys liability to pay company tax is reduced by the amount of the offset. Accordingly, that liability is reduced to $240,000 (i.e. $300,000 - $60,000).

The second consequence is that the franking credits that arose at the time of the original assessment are reversed out. That is, a class C debit of $23,294 is posted to the companys franking account.

The companys amended liability to pay company tax is $240,000. Therefore, the company receives a refund of $92,000. That is, the difference between the amount previously paid of $332,000 and the new company tax liability for the year.

Calculation of franking credits at the time of amendment

The franking credits that arise are calculated under subsection 160AQKAD(7).

The company has an amended liability for company tax reduced by an offset entitlement. The liability is equal to $240,000. The company has paid $332,000 in PAYG instalments and company tax for the eligible income year and has received a refund of $92,000.

The amount of the companys liability to pay company tax that would normally give rise to franking credits was calculated under subsection 160AQKAB(4) to be $60,000. The offset entitlement for the relevant income year was calculated earlier as $60,000. Therefore, the amount by which the liability to pay company tax has been reduced under section 160AQKAC is $60,000.

The franking credits that arise upon assessment are equal to the adjusted amount of the amount worked out using the formula in subsection 160AQKAD(7).

That is:

Substituting the information into the equation:

The result of this calculation is zero. Therefore, no class C franking credits arise at the time of the amended assessment.

Transitional rule where franking year ends before 4 May 1999

4.41 Transitional provisions are provided to ensure that the ongoing provisions to close the loophole do not have retrospective application.

4.42 The provisions effectively allow arrangements to exploit the existing anomaly to be unravelled in situations where a wholly-owned life assurance company (the subsidiary company) paid an overfranked dividend to its parent company and the resulting FDT/DDT liability has not yet been fully applied to reduce the subsidiarys company tax liability.

4.43 The transitional provisions restore the franking accounts of both the subsidiary and the parent company to their equivalent positions had the arrangement to exploit the existing anomaly not been executed.

4.44 The inappropriately generated franking credits passed on by the subsidiary to the parent are clawed back. The payment of FDT and DDT made by the subsidiary is treated as a payment of company tax for the purposes of the imputation provisions.

4.45 The transitional provisions apply where the following conditions are met:

•

a life assurance company (the subsidiary company) becomes liable for FDT or DDT before 4 May 1999;

•

some or all of the FDT/DDT liability (i.e. the available deficit/ deferral tax liability) has not been offset before 4 May 1999; and

•

the company (the subsidiary company) is a wholly-owned resident subsidiary of another resident company (the holding company).

[Schedule 3, item 3, subsection 160AQKAE(1)]

Consequences for the subsidiary company where the transitional rule applies

4.46 Where the conditions of subsection 160AQKAE(1) are satisfied, the subsidiary company is not entitled to an offset under section 160AQK but may be entitled to an offset under the transitional rule. [Schedule 3, item 3, subsection 160AQKAE(2)]

4.47 Where the subsidiary satisfies in whole or part its FDT or DDT liability (i.e. the deficit/deferral tax amount) that arose before 4 May 1999, and the Commissioner serves on the company a notice of original company tax assessment (or an amended company tax assessment) for an income year in which the company was sufficiently resident, an offset entitlement arises under the transitional rule. The Commissioner, in such cases, must determine that the subsidiary company is entitled to an offset in relation to the company tax or increased company tax. [Schedule 3, item 3, subsection 160AQKAE(3)]

4.48 Consistent with sections 160AQK and 160AQKAA, the subsidiary company may determine an offset entitlement under the transitional rule. [Schedule 3, item 3, subsection 160AQKAE(5)]

4.49 The amount of the offset entitlement that is determined under this rule is equal to the lesser of the following 2 amounts:

•

the deficit/deferral tax amount worked out under subsection 160AQKAE(3) reduced by any part thereof that has previously been applied; and

•

the amount of the company tax or increased company tax reduced by allowable foreign tax credits in respect of income derived in the eligible year of income.

[Schedule 3, item 3, subsection 160AQKAE(4)]

4.50 Where an offset entitlement arises under the transitional rule, the payment of FDT and/or DDT is treated for the purposes of the imputation provisions of Division 2 of Part IIIAA as a payment of company tax. Accordingly, franking credits and debits arise in the subsidiarys franking account as if the offset that is applied were a payment of the company tax liability. This treatment is necessary to ensure that the subsidiary is returned to the equivalent position it would have been in if it had not entered into the arrangement to exploit the anomaly. The franking credits or debits arise at the later of 7 June 2001 or the date when the offset entitlement arose. [Schedule 3, item 3, subsection 160AQKAE(7)]

Consequences for the holding company where the transitional rule applies

4.51 In order to restore the holding (parent) company to the equivalent position it would have been in if the subsidiary had not entered the arrangement, it is necessary to ensure that the inappropriate franking credits that arose under the arrangement are clawed back from the parent entity. This is done by causing a debit to arise in the parent companys franking account according to the rule in subsection 160AQKAE(8). It therefore follows that the original overfranked dividend that was paid by the subsidiary to the parent is effectively unfranked. [Schedule 3, item 3, subsection 160AQKAE(8)]

4.52 A class C franking debit arises in the holding companys franking account on the later of 7 June 2001 or the date the subsidiary company offsets the relevant FDT/DDT liability. The amount of the franking debit is calculated as follows:

(available deficit and deferral tax liability) 64 / 36

Example 4.3: Application of transitional rule

Lucky Life Limited is an early balancing non-mutual life assurance company. The company is wholly-owned by Lucky Life Holdings Limited. Its 1998-1999 income year and franking commenced on 1 January 1998 and concluded on 31 December 1998.

At the end of its 1998-1999 franking year, Lucky Life Limited had a deficit in its class C franking account of $240,000.

As a result of this deficit, the company incurred a liability on 31 December 1998 to FDT under subsection 160AQJ(1B) equal to $135,000 (i.e. $240,000 36 / 64). The liability was discharged on 31 January 1999.

The resulting franking debit and credit entries are recorded as follows:

Holding company (class C franking debit)

Class C franking debit = total class C liability 64 / 36

= $135,000 64 / 36

= $240,000

Subsidiary company (class A and/or C franking credit)

On 1 June 1999, the subsidiarys final income tax assessment liability was determined to be $250,000. The components of the company tax assessment liability were as follows:

•

statutory fund component (excluding the RSA component) $200,000; and

•

general fund component:

-

RSA component $20,000; and

-

standard component $30,000.

The following franking credits arise in the subsidiary companys franking account on 7 June 2001:

•

class A credit: $200,000 20% 61 / 39 = $62,564

•

class C credit: $30,000 64 / 36 = $53,333

Note that the class A credit and class C credit would be converted to the equivalent credits based on the 34% tax rate because they arose after 1 July 2000.

Application and transitional provisions

4.53 The provisions apply in respect of company tax assessments (or amended assessments) arising on or after 4 May 1999. The transitional rule applies in limited circumstances where FDT has been paid before this date.

Chapter 5 - Charitable institutions

Outline of chapter

5.1 Schedule 4 to this Bill will amend the Fringe Benefits Tax Assessment Act 1986 (FBTAA 1986), the Income Tax Assessment Act 1997 (ITAA 1997), the Income Tax Assessment Act 1936 (ITAA 1936) and the Sales Tax (Exemptions and Classifications) Act 1992 (ST(E&C)A 1992) to extend the taxation treatment currently given to public benevolent institutions (PBIs) to certain charitable institutions.

5.2 Charitable institutions whose principal activity is promoting the prevention or control of disease in human beings will be entitled to:

•

concessional fringe benefits tax (FBT) treatment;

•

status as tax deductible gift recipients; and

•

exemption from sales tax on goods for use by the charitable institution (prior to the introduction of the goods and services tax (GST)).

Context of reform

5.3 The Treasurer announced on 22 June 2000 (Treasurers Press Release No. 55) that the Government would ensure that organisations whose main activity is promoting the prevention or control of disease in humans would continue to access the tax benefits available to PBIs. These charitable institutions may have been PBIs in the past but, over time, their activities have changed such that they may no longer be PBIs and therefore, no longer eligible for taxation concessions such as exemption from FBT and sales tax. However, these institutions continue to be exempt from income tax and entitled to GST concessions under the current law.

Public benevolent institutions

5.4 Generally, a PBI:

•

has as its main or principal object, the relief of poverty, sickness, suffering, distress, misfortune, destitution or helplessness;

•

is carried on without purpose of private gain for particular persons;

•

is established for the benefit of the public or a section or class of the public;

•

the relief is available without discrimination to every member of that section of the public which the organisation aims to benefit; and

•

the aid is given directly to those in need.

Charitable institutions

5.5 A charitable institution is an organisation established for:

•

the relief of poverty;

•

the advancement of education;

•

the advancement of religion; or

•

other purposes that are beneficial to the community.

Fringe benefits tax

5.6 Section 57A of the FBTAA 1986 provides that benefits provided by certain employers, including PBIs, are exempt benefits. An exempt benefit is not a fringe benefit. However, from the FBT year commencing 1 April 2000, an employers fringe benefits taxable amount may be increased when benefits provided in respect of an employees employment are exempt under section 57A (subsection 5B(1D)).

Deductions for gifts or contributions

5.7 Section 30-15 of the ITAA 1997 allows a deduction for certain types of gifts made to particular recipients. Item 1 in the table to subsection 30-15(1) provides that certain gifts made to a fund, authority or institution listed in Subdivision 30-B are deductible. PBIs are listed in Subdivision 30-B in the general category of welfare and rights recipients (subsection 30-45(1)).

5.8 For the 1996-1997 income year and earlier income years, section 78 of the ITAA 1936 allows a deduction for, amongst other things, certain gifts or contributions. Subsection 78(4) provides that a deduction is allowable for gifts made to listed funds, authorities and institutions. PBIs are listed in the general category of welfare and rights recipients in Table 4.

Sales tax

5.9 Chapter 14 of Schedule 1 to the ST(E&C)A 1992 allowed an exemption from sales tax for goods for use by certain organisations. Goods for use by PBIs are exempt from sales tax under item 140(c) of Subchapter 14.3.

Detailed explanation of new law

Fringe benefits tax

5.10 Subsection 57A(5) is inserted in the FBTAA 1986 to provide that a benefit is an exempt benefit if:

•

the benefit is provided in respect of the employment of an employee;

•

the employer is a charitable institution; and

•

the principal activity of the charitable institution is promoting the prevention or control of diseases in humans.

[Schedule 4, item 1, subsection 57A(5)]

5.11 Disease is defined in subsection 136(1) to include any physical or mental ailment, disorder, defect or morbid condition whether of sudden onset or gradual development and whether of genetic or other origin.

5.12 The charitable institutions to be covered by this amendment are medical or health organisations whose principal focus is preventative in nature, rather than providing direct relief of sickness or suffering. These organisations typically focus on particular types of ailments or health issues, for example, asthma, cancer, acquired immune deficiency syndrome (AIDS), arthritis, heart conditions, brain conditions, paraplegia and kidney conditions.

5.13 Benefits satisfying these criteria are exempt for the FBT year commencing 1 April 1998 and later years of tax [Schedule 4, subitem 4(1)] . This date has been chosen because section 74 allows the amendment of assessments within a period of 3 years after the date of the original assessment. However, from the FBT year commencing 1 April 2000, exempt benefits provided under section 57A may result in an employers fringe benefits taxable amount being increased by subsection 5B(1D).

Consequential amendments

5.14 Section 135Q explains how certain employers, including those described in section 57A, work out whether an employee has a reportable fringe benefits amount for a year of income. Because section 57A is extended to charitable institutions whose principal activity is the prevention or control of disease in humans, the note to subsection 135Q(1) is amended to refer to these charitable institutions. [Schedule 4, item 3]

5.15 This amendment applies from the FBT year commencing 1 April 1999 and later years, consistent with the application of section 135Q. [Schedule 4, subitem 4(3)]

5.16 From the FBT year commencing 1 April 2000, PBIs are excluded from being rebatable employers and therefore ineligible for the rebate available under section 65J. For consistent treatment, subsection 65J(1) is amended to exclude those charitable institutions described in subsection 57A(5) from being rebatable employers. This means that these charitable institutions do not qualify for both an FBT exemption and a rebate of tax. [Schedule 4, item 2]

5.17 This amendment applies from the FBT year commencing 1 April 2000. [Schedule 4, subitem 4(2)]

Deductions for gifts or contributions

Income Tax Assessment Act 1997

5.18 Section 30-15 of the ITAA 1997 allows a deduction for, amongst other things, gifts made to funds, authorities or institutions listed in Subdivision 30-B. Subdivision 30-B is amended to include charitable institutions whose principal activity is promoting the prevention or control of diseases in humans. These charitable institutions are inserted in the table of general categories of health recipients at item 1.1.6 in subsection 30-20(1). [Schedule 4, item 8]

5.19 Disease is defined in subsection 995-1(1) to include any physical or mental ailment, disorder, defect or morbid condition whether of sudden onset or gradual development and whether of genetic or other origin.

5.20 The charitable institutions to be covered by this amendment are medical or health organisations whose principal activity is preventative in nature, rather than providing direct relief of sickness or suffering. These organisations typically focus on particular types of ailments or health issues, for example, asthma, cancer, AIDS, arthritis, heart conditions, brain conditions, paraplegia and kidney conditions.

5.21 The amendment applies to gifts made in the 1997-1998 income year and later years. [Schedule 4, item 10]

Consequential amendments

5.22 Section 30-315 of Subdivision 30-G contains an index to Division 30, gifts or contributions. Amendment is made to the table in subsection 30-315(2) as a result of the listing of these particular charitable institutions in Subdivision 30-B. [Schedule 4, item 9]

5.23 This amendment applies to gifts made in the 1997-1998 income year and later years. [Schedule 4, item 10]

Income Tax Assessment Act 1936

5.24 Section 78 of the ITAA 1936 is also amended to allow deductions for gifts made to charitable institutions whose principal activity is promoting the prevention or control of diseases in humans. Table 1 in subsection 78(4) is amended to include these charitable institutions in the general category of health recipients. [Schedule 4, item 6]

5.25 Disease is not defined for the purposes of section 78, therefore, it has its ordinary meaning. Disease is defined in the Macquarie Dictionary, third edition, as a morbid condition of the body, or of some organ or part; illness; sickness; ailment.

5.26 The charitable institutions to be covered by this amendment are medical or health organisations whose principal activity is preventative in nature, rather than providing direct relief of sickness or suffering. These organisations typically focus on particular types of ailments or health issues, for example, asthma, cancer, AIDS, arthritis, heart conditions, brain conditions, paraplegia and kidney conditions.

5.27 The amendment applies to gifts made in the 1996-1997 income year and earlier income years. [Schedule 4, item 7]

Consequential amendments

5.28 Subsection 78(3) contains an index to section 78. Amendment is made to update the index in subsection 78(3) as a result of the amendment to subsection 78(4). [Schedule 4, item 5]

5.29 This amendment applies to gifts made in the 1996-1997 income year and earlier years. [Schedule 4, item 7]

Sales tax

5.30 Goods for use by PBIs and certain other organisations were exempt from sales tax under Subchapter 14.3 of Schedule 1 to the ST(E&C)A 1992. Item 140A is inserted in Subchapter 14.3 to provide that goods for use by charitable institutions whose principal activity is promoting the prevention or control of diseases in humans are exempt from sales tax. [Schedule 4, item 11]

5.31 Disease is not defined for the purposes of sales tax therefore, it has its ordinary meaning (see paragraph 5.25).

5.32 The charitable institutions to be covered by this amendment are medical or health organisations whose principal activity is preventative in nature, rather than providing direct relief of sickness or suffering. These organisations typically focus on particular types of ailments or health issues, for example, asthma, cancer, AIDS, arthritis, heart conditions, brain conditions, paraplegia and kidney conditions.

5.33 This amendment applies to dealings with goods on or after 28 October 1992, which is the date of commencement of the ST(E&C)A 1992. [Schedule 4, item 12]

Application and transitional provisions

5.34 The amendments will apply as follows to ensure the continuity of concessional tax treatment given to certain charitable institutions:

•

FBT - benefits provided from the FBT year commencing 1 April 1998, and all later years, by certain charitable institutions are exempt benefits;

•

deductions for gifts or contributions - gifts made to certain charitable institutions are tax deductible under the ITAA 1997 from the 1997-1998 income year and later years and under the ITAA 1936 from the 1996-1997 income year and earlier years; and

•

sales tax - goods for use by certain charitable institutions are exempt from sales tax from 28 October 1992.

Chapter 6 - Technical corrections to the franking rebate provisions for superannuation funds and other entities

Outline of chapter

6.1 Schedule 5 to this Bill amends the Income Tax Assessment Act 1936 (ITAA 1936) to make technical corrections to the franking rebate rules so that complying superannuation funds, pooled superannuation trusts and life assurance companies continue to be entitled to the franking rebate and refunds of excess imputation credits for dividends and distributions covered by certain exemptions.

6.2 A further correction will ensure that registered charities and gift-deductible organisations are not denied refunds of imputation credits in respect of indirect distributions received through a trust.

Context of reform

6.3 Amendments to implement changes to the tax treatment of life companies inadvertently removed the entitlement of complying superannuation funds, pooled superannuation trusts and life assurance companies to the franking rebate, and consequently to refunds of excess imputation credits, in respect of dividends and distributions covered by certain exemptions. These are the exemptions for current pension income under sections 282B, 283 and 297B of the ITAA 1936 or paragraph 320-35(1)(b) of the Income Tax Assessment Act 1997 (ITAA 1997) and for payments received by friendly societies attributable to friendly society income bonds, funeral bonds and scholarship plans which are exempt under subparagraph 320-35(1)(f)(ii) of the ITAA 1996.

6.4 The same amendments also unintentionally repealed a provision necessary to provide refunds of imputation credits to registered charities and gift-deductible organisations in respect of indirect distributions received through a trust.

Summary of new law

6.5 The amendments restore the entitlement of complying superannuation funds, pooled superannuation trusts and life assurance companies to the franking rebate in respect of dividends and distributions paid from 1 July 2000 that are exempt current pension income or certain other exempt income.

6.6 The amendments also ensure that registered charities and gift-deductible organisations are not denied refunds of imputation credits in respect of indirect distributions through a trust.

Detailed explanation of new law

6.7 These amendments make 3 corrections to the franking rebate provisions. The first 2 corrections restore the entitlement of superannuation funds, pooled superannuation trusts and life assurance companies to the franking rebate in respect of dividends and distributions that are exempt current pension income or certain other exempt income. The other correction will ensure that registered charities and gift-deductible organisations are eligible for refunds of excess imputation credits.

Franking rebate for superannuation funds, pooled superannuation trusts and life assurance companies

6.8 For a taxpayer to be entitled to the franking rebate in respect of a distribution attributable to a franked dividend received indirectly through a trust or partnership, the distribution (i.e. the trust amount or partnership amount) must be included in the assessable income of the taxpayer. Subsection 160AQWA(1) provides that, for the purpose of working out the rebate, certain exempt income is to be assumed to be not exempt. Otherwise taxpayers would not be entitled to the franking rebate in respect of exempt income.

6.9 Subsection 160AQWA(1) is amended so that it will apply in calculating rebates under section 160AQYA, which is the relevant provision for complying superannuation funds and pooled superannuation trusts, or section 160AQZA, which is the relevant provision for life assurance companies. [Schedule 5, item 3, subsection 160AQWA(1)]

6.10 Note that amended subsection 160AQWA(1) will not apply in respect of sections 160AQX or 160AQZ. These sections formerly provided the franking rebate for registered organisations, among other taxpayers, in respect of distributions from trusts or partnerships that were exempt current pension income.

6.11 The concept of registered organisation was removed with effect from 1 July 2000 as part of the amendments to implement changes to the tax treatment of life assurance companies. Friendly societies were the only category of registered organisation which carried on life assurance business. Following amendments to the Life Insurance Act 1995 (Cth), friendly societies carrying on life assurance business are now required to register under the Act and, once registered, become life insurance companies. Consequently, friendly societies that were previously allowed the rebate under sections 160AQX or 160AQZ would now be entitled to the rebate under section 160AQZA.

6.12 The second correction inserts references to section 283 in paragraphs 160AQT(4)(a), 160AQU(2)(a) and 160AQWA(1)(a). Section 283 exempts current pension income of complying superannuation funds that is calculated on an apportionment basis. These amendments ensure that complying superannuation funds will be entitled to the franking rebate in respect of dividends received directly and distributions received indirectly that are exempt income under section 283. [Schedule 5, item 1, paragraph 160AQT(4)(a); item 2, paragraph 160AQU(2)(a) and item 3, paragraph 160AQWA(1)(a)]

Refunds of excess imputation credits for registered charities and gift-deductible organisations

6.13 Subsection 160AQWA(2) has been reinserted so that exempt institutions (i.e. registered charities and gift-deductible organisations) are not denied refunds of imputation credits [Schedule 5, item 3, subsection 160AQWA(2)] . These tax-exempt entities are made eligible for refunds by giving them a hypothetical entitlement to the franking rebate. To overcome the technical problem of providing a franking rebate to a tax-exempt entity, subsection 160AQWA(2) provides that the income tax exempt status of these entities is ignored for the purposes of determining entitlement to a franking rebate.

6.14 Subsection 160AQWA(2) was possibly repealed by item 80 in Schedule 3 to the New Business Tax System (Miscellaneous) Act (No. 2) 2000, which amended section 160AQWA to reflect changes to the tax treatment of life assurance companies. Subsection 160AQWA(2) was originally inserted by item 6H in Schedule 2 tothe New Business Tax System (Miscellaneous) Act (No. 1) 2000. Both amendments commenced on 30 June 2000, when the Bills received Royal Assent, and both amendments applied in respect of income derived on or after 1 July 2000. This amendment clarifies the previously uncertain status of subsection 160AQWA(2).

Application and transitional provisions

6.15 The amendments are to apply to income derived on or after 1 July 2000, the income to which the unintended changes would otherwise apply.

Chapter 7 - Miscellaneous amendments

Outline of chapter

7.1 Schedule 5 to this Bill amends the Income Tax Rates Act 1986 (ITRA 1986) and the Income Tax Assessment Act 1936 (ITAA 1936) to correct some minor technical errors.

Context of reform

Resident deceased estates

7.2 The Government in its Tax Reform: not a new tax, a new tax system:the Howard Governments Plan for a New Tax Systempolicy document, stated its intention to reduce personal income tax rates and thresholds with effect from 1 July 2000. The amendments to reduce personal income tax rates were contained in A New Tax System (Personal Income Tax Cuts) Act 1999 (PITCA 1999). PITCA 1999 inadvertently omitted consequential amendments to section 14 of the ITRA 1986.

7.3 Section 14 provides limitations on the amount of tax payable by trustees of resident deceased estates where the deceased person died not less than 3 years before the end of the year of income. Where the net income of the estate is $416 or less no tax is payable. A shading-in range ensures that trustees of such estates do not have a large liability where the net income is just over $417.

7.4 When the lowest marginal tax rate was 20% the upper limit of the 50% shading-in range was $693. Where the net income was $694 or more trustees paid 20% on the whole net income of the trust up to the $20,700 limit. PITCA 1999 included consequential amendments to the ITRA 1986 to substitute references to $20,700 (the previous upper limit of the lowest marginal tax rate) with references to $20,000 (the new upper limit of the lowest marginal tax rate). However, with the change to the 17% rate the upper limit of the shading-in range for trustees should also have been changed to $630.

Pro-rating of the tax-free threshold

7.5 Section 20 of the ITRA 1986 provides for pro-rating of the tax-free threshold. Taxpayers are subject to pro-rating of the tax-free threshold for a year of income where they are either a resident for only part of that income year or they cease full-time education for the first time during that income year. PITCA 1999 included consequential amendments to the ITRA 1986 to substitute references to $5,400 (the then existing annual tax-free threshold) with references to $6,000 (the new annual tax-free threshold). However, section 20 was not amended to change the monthly amount of tax-free threshold from $450 to $500.

Separate net income

7.6 Subsection 159J(6) of the ITAA 1936 contains a definition of separate net income which makes specific inclusions and exclusions from that term for the purpose of calculating the amount of dependant rebates.

7.7 Prior to 1 July 1999, child disability allowance was a payment that was excluded from the calculation of separate net income. The Assistance for Carers Legislation Amendment Act 1999 amended the Social Security Act 1991 to replace the term child disability allowance with the term carer allowance. As a consequence the definition of separate net income in the ITAA 1936 was amended to replace the reference to child disability allowance with the term carer allowance.

7.8 However, as a result of the introduction of the new family tax benefit, the A New Tax System (Family Assistance) (Consequential and Related Measures) Act (No. 2) 1999 amended the definition of separate net income. The amendment removed a paragraph which contained the previous forms of family assistance as well as other payments including the carer allowance. Three new paragraphs were inserted. In the process the term child disability allowance (which no longer existed) was inserted which had the effect of replacing the term carer allowance.

Detailed explanation of new law

Resident deceased estates

7.9 Schedule 5 to this Bill proposes to amend paragraph 14(2)(c) of the ITRA 1986 to change from $693 to $630, the upper limit of the 50% shading-in range which applies to resident deceased estates where the deceased person died not less than 3 years before the end of the year of income. [Schedule 6, item 3]

7.10 The shading-in range provides a smooth flow of tax increases up to the point where the trustee pays 17% on the whole net income of the trust. If this range did not exist affected trustees would pay the full 17% on the whole of the trusts net income once the net income exceeded $417.

7.11 The upper limit should be $1 less than the amount of net income where the trustee would first pay more tax using the 50% shading-in method than the trustee would by applying the lowest marginal tax rate to the whole net income of the trust. The $693 upper limit of the shading-in area was calculated on the basis of a tax rate of 20% of the net income of the trust. The lowest marginal tax rate from 1 July 2000 is 17%. Without the change such trusts with net income between $630 and $20,001 would pay more than 17% on the net income of the trust.

Pro-rating of the tax-free threshold

7.12 Schedule 5 to this Bill also proposes to amend subsection 20(1) of the ITRA 1986 to change from $450 to $500, the amount of tax-free threshold available to a taxpayer for each month that the taxpayer is eligible to receive a partial tax-free threshold. [Schedule 6, item 4]

7.13 Subsection 20(2) of the ITRA 1986 will also be amended to provide the same treatment to trustees of trust estates assessed under section 98 of the ITAA 1936 in respect of a beneficiaries share of the net income of a trust estate.

7.14 The amendments to section 20 of the ITRA 1986 will mean that each month of tax-free threshold will be worth the full one-twelfth of the annual tax-free threshold.

Separate net income

7.15 Paragraph 159J(6)(ad) of the definition of separate net income contained in subsection 159J(6) of the ITAA 1936 will be amended to refer to the term carer allowance rather than the previously existing term child disability allowance. [Schedule 6, item 1]

7.16 The amendment will mean that a taxpayers dependant in receipt of carer allowance will not have the amount of the payment included in the dependants separate net income. This is consistent with the treatment of the former child disability allowance.

Application and transitional provisions

7.17 The amendments to the ITRA 1986 made by Schedule 5 apply to assessments for the 2000-2001 income year and all later income years. [Schedule 6, item 5]

7.18 The amendment to the ITAA 1936 made by Schedule 5 applies to assessments for the 1999-2000 income year and all later income years. [Schedule 6, item 2]