House of Representatives

Explanatory Memorandum

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

Glossary

The following abbreviations and acronyms are used throughout this explanatory memorandum.

General outline and financial impact

Franking of non-share dividends

Schedule 1 to this bill amends the imputation rules contained in the income tax law that deal with the franking of non-share dividends. The changes will rectify an anomaly that prevents the franking of non-share dividends as was intended.

Date of effect: These amendments apply to non-share dividends paid on or after 1 July 2001, the date when the debt/equity rules first applied.

Proposal announced: These amendments were announced in Minister for Revenue and Assistant Treasurer's Press Release No. C134/02 of 20 December 2002.

Financial impact: Nil.

Compliance cost impact: Nil.

Consolidation: franking deficit tax offsets, MEC groups and enhancements to the cost setting rules

Schedule 2 to this bill enhances the consolidation regime by:

•

making minor adjustments to clarify the cost setting rules;

•

ensuring that MEC groups are given the same treatment as consolidated groups; and

•

enabling the transfer of unapplied excess FDT offsets in a consolidated environment.

Date of effect: The amendments have retrospective effect to 1 July 2002, which is the date of commencement of the consolidation regime. The amendments are either beneficial to taxpayers or correct unintended outcomes. All of the amendments to address unintended outcomes are consistent with the original policy intent for the consolidation regime and therefore have the same commencement date as the consolidation regime.

Proposal announced: A number of these measures were foreshadowed in Minister for Revenue and Assistant Treasurer's Press Release No. C67/03 of 30 June 2003. There are two measures that were not foreshadowed in this press release. The first is in relation to the introduction of CGT event L8. This measure has been foreshadowed in the law itself. The second is in relation to the introduction of the FDT offset provisions and is a corollary of the incorporation of the FDT offset provisions into the SIS (which are also included in this bill).

Financial impact: Nil.

Compliance cost impact: These measures are not expected to impact compliance costs because they relate to specific issues that will not affect all taxpayers.

Conservation covenants

Schedule 4 to this bill amends the ITAA 1997 to provide an income tax deduction for taxpayers entering into certain types of conservation covenants on or after 1 July 2002 with the Commonwealth, a State, a Territory or a local governing body, or an authority of the Commonwealth, a State or a Territory.

Date of effect: The amendments apply to conservation covenants entered into on or after 1 July 2002. The retrospective application is advantageous to taxpayers.

Proposal announced: The measure was announced on 20 February 2003 in a joint press release by the Minister for Revenue and Assistant Treasurer and the Minister for the Environment and Heritage.

Financial impact: The measure will have an insignificant cost to revenue.

Compliance cost impact: Compliance costs will be negligible.

Fringe benefits tax - deemed depreciation rate for cars

Schedule 5 to this bill amends the Fringe Benefits Tax Assessment Act 1986 to ensure that alignment between the FBT deemed depreciation rate used under the operating cost method for valuing a car fringe benefit and the Commissioner's determination for the effective life of the car is maintained.

Date of effect: The amendment applies in respect of cars acquired after 30 June 2002.

Proposal announced: This measure was announced in Minister for Revenue and Assistant Treasurer's Press Release No. C21/03 of 31 March 2003.

Financial impact: The estimated cost to revenue is $8 million in 2003-2004, $9 million in 2004-2005, $10 million in 2005-2006 and $10 million in 2006-2007.

Compliance cost impact: The amendment will not impose any additional compliance costs.

Endorsement of perpetual bodies as deductible gift recipients

Schedule 6 to this bill amends the ITAA 1997 to remove the requirement to have a winding up clause as part of the endorsement provisions for statutory bodies established by the Commonwealth Parliament in perpetuity.

Date of effect: The reduced requirements for endorsement as a deductible gift recipient apply from the 2003-2004 year of income and later years of income.

Proposal announced: The measure was announced in Treasurer's Press Release No. 49 of 29 August 2002.

Financial impact: The measure will have an insignificant cost to the revenue.

Compliance cost impact: Compliance costs will be negligible.

Eligibility rules for farm management deposits scheme

Schedule 7 to this bill will clarify the eligibility rules for the FMD scheme in Schedule 2G to the ITAA 1936.

First, the amendments will clarify the definition of the term 'financial institution' for the purposes of the FMD scheme. This will make it easier for primary producers to determine if the institution they are dealing with is able to issue FMD.

Second, the amendments will deem certain entities to be financial institutions in relation to pre-1 July 2003 deposits or transfers. This will protect primary producers who have made deposits with non-complying entities offering products described as FMD. Eligible deposits with non-complying entities will be included in the definition of FMD, and will retain that tax treatment into future years provided they are transferred to an authorised deposit-taking institution or institution with a State or Territory guarantee within a specified transfer period.

Date of effect: Clarification of the term 'financial institution' will take effect from 1 July 2003.

Primary producers that made deposits with, or transferred a deposit to, a non-complying entity before 1 July 2003 will have the tax status of their deposits protected.

Proposal announced: The amendments were announced in Minister for Revenue and Assistant Treasurer's Press Release No. C56/03 of 17 June 2002.

Financial impact: Nil.

Compliance cost impact: There will be no additional compliance costs for persons.

Simplified imputation system - offsetting franking deficit tax

Schedule 8 to this bill will amend Part 3-6 of the ITAA 1997 to insert rules in the SIS for offsetting of FDT against company tax. Rules are provided for both ordinary companies and life insurance companies and are based on the former provisions in Part IIIAA of the ITAA 1936.

The rules will reflect that franking additional tax penalty provisions have been replaced with a simplified penalty for an excessive franking deficit.

Date of effect: The amendments to insert rules into the SIS for offsetting of FDT apply to events arising on or after 1 July 2002, when the SIS rules commenced.

The rules which apply to reduce the company's FDT offset against future company tax liabilities by 30% where there is an excessive franking deficit will generally apply to FDT liabilities arising at the end of 2002-2003 and later income years.

Proposal announced: These rules are part of the SIS, which was announced as part of the Government's business tax reform package. The proposal was announced in Treasurer's Press Release No. 58 of 21 September 1999 as a component of the unified entity regime. On 14 May 2002, the Minister for Revenue and Assistant Treasurer announced in Press Release No. C57/02, the Government's program for delivering the next stage of business tax reform measures.

The amendment to replace the former franking additional tax penalty with a simplified penalty for an excessive franking deficit was announced in Minister for Revenue and Assistant Treasurer's Media Release No. 134 of 20 December 2002.

Financial impact: Unquantifiable but expected to be insignificant.

Compliance cost impact: These amendments are part of the SIS which will reduce compliance costs incurred by business by providing simpler processes and increased flexibility.

Chapter 1 - Franking of non-share dividends

Outline of chapter

1.1 Schedule 1 to this bill amends the imputation rules contained in the income tax law that deal with the franking of non-share dividends. The changes will rectify an anomaly that prevents the franking of non-share dividends as was intended.

Context of amendments

1.2 Non-share dividends are returns made on interests, characterised under the debt/equity rules contained in Division 974 of the ITAA 1997 as equity interests, that are not in the form of shares. These interests are intended to be frankable in the same way that dividends on shares are frankable.

1.3 Under the existing income tax law, dividends on shares have to be paid out of realised profits to be frankable. To ensure that non-share dividends are treated in a similar way, the imputation rules contained in Subdivision 215-B of the ITAA 1997 and section 160APAAAB of the ITAA 1936 align a company's ability to frank non-share dividends with the amount of its profits. This is achieved by calculating a company's 'available frankable profits'.

1.4 It was intended that 'available frankable profits' were to be calculated by adding future profits to profits on hand and subtracting committed share dividends. The anomaly is that expected profits are not recognised in the calculation of available frankable profits.

Summary of new law

1.5 These amendments rectify an anomaly that exists in Division 215 of the ITAA 1997 and section 160APAAAB of the ITAA 1936 which are imputation rules that deal with non-share dividends. The anomaly is that expected profits are not recognised when calculating if sufficient profits are available to fund a non-share dividend.

1.6 As the amendments rectify an anomaly in the law they will apply from 1 July 2001, the date when the existing provisions first applied. [Schedule 1, item 9]

Detailed explanation of new law

1.7 This bill amends subsection 215-25(1) of the ITAA 1997 by inserting subparagraph 215-25(1)(e) that is a further condition to allow an entity to anticipate available frankable profits for the purpose of franking non-share dividends. In taking into account the available profits referred to in paragraph 215-25(1)(d), this condition requires that the amount of adjusted available franking profits after each committed distribution has been paid will be greater than nil. The smallest adjusted available frankable profit figure is the entity's available frankable profits used to determine if sufficient profits are available to frank the proposed non-share dividend. [Schedule 1, item 1]

1.8 This bill repeals subsection 215-25(2) and introduces the new concept of adjusted available frankable profits. This sets out the extent to which a company can frank a non-share dividend by anticipating future profits. It is calculated at the time each committed distribution is made and is the available frankable profits that would arise when each committed distribution is made if all committed distributions paid after that time were ignored. Also, to avoid double counting, the non-share dividend is not included in the calculation of adjusted available frankable profits. [Schedule 1, item 2]

1.9 Items 1 to 4 that amend the ITAA 1997 apply to non-share dividends paid after 30 June 2001. Items 5 to 8 replicate these provisions in the ITAA 1936 and they apply to non-share dividends paid after 30 June 2001 and before 1 July 2002. [Schedule 1, item 9]

Example 1.1

Bob's Panel Beating Co. (Bob Co.) plans to pay a non-share dividend of $100 to its only non-share equity holder. It had paid an undebited non-share dividend of $40 and is committed to pay committed share dividends of $100, $100 and $150 in years 1 to 3 respectively. It has $50 of profits on hand, and expects to generate profits of $150, $200 and $150 in years 1 to 3 respectively.

Bob Co.'s adjusted available frankable profits calculations

Year	0	1	2	3
Expected profits		150	200	150
Current profits	50
Committed distribution		100	100	150
Undebited NSD[F1]	40
AAFP[F2]		60	160	160

The company satisfies all of the conditions in paragraphs 215-25(1)(a) to (e) and therefore it can anticipate profits under section 215-25.

Bob Co.'s adjusted available frankable profits calculations show that the smallest of the adjusted available frankable profits, which happens to be immediately after the payment of the first committed distribution, is $60 [($50 + $150) - ($100 ? 40)] . It's other adjusted available frankable profits calculations immediately after committed distributions 2 and 3 are paid were $160 [($100 + $200) - ($100 + $40)] and $160 [($200 + $150) - ($150 + $40)] respectively. Bob Co.'s available frankable profits is therefore $60 because the smallest of the adjusted available franking profits is $60. The company can frank $60 of the proposed $100 non-share dividend.

Without being able to anticipate profits under section 215-25, Bob Co. would not have been able to frank the non-share dividend.

1.10 A minor change is needed in relation to wording to subparagraph 215-25(3)(b)(i) of the ITAA 1997 and subsection 160APAAAB(7) of the ITAA 1936 so that references to 'when' are replaced with 'immediately after' to clarify the meaning of the provisions. [Schedule 1, items 3 and 7]

Consequential amendments

1.11 Subsection 995-1(1) of the ITAA 1997 is amended to include a definition of 'adjusted available frankable profits'. [Schedule 1, item 4]

Chapter 2 - Consolidation: franking deficit tax offsets, MEC groups and enhancements to the cost setting rules

Outline of chapter

2.1 Schedule 2 to this bill enhances the consolidation regime by:

•

making minor adjustments to clarify the cost setting rules;

•

ensuring that MEC groups are given the same treatment as consolidated groups; and

•

enabling the transfer of unapplied excess FDT offsets in a consolidated environment.

Context of amendments

2.2 With the introduction of the consolidation regime, a number of enhancements, mentioned in paragraph 2.1, are being made to further clarify the consolidation cost setting rules and to ensure that the income tax law that applies to head companies of consolidated groups also applies to the head companies of MEC groups. In addition, this bill introduces rules to permit the transfer of any unapplied excess FDT offset from joining entities to the head company.

Summary of new law

Cost setting rules

2.3 Parts 1 to 6 of Schedule 2 to this bill amend the cost setting rules to clarify that:

•

the head company is required to choose an effective life for certain depreciating assets brought into a consolidated group where the prime cost method was used to determine the decline in value just before the joining time;

•

the cost base for a pre-CGT asset that is rolled over is the same as the cost applicable to the originator of the roll-over for the purposes of the cost setting rules;

•

new CGT event L8 will apply where there is excess allocable cost amount on joining that cannot be allocated to reset cost base assets;

•

in certain cases an asset's entitlement to accelerated depreciation is preserved;

•

the requirement that unfranked dividends have been paid (in working out the adjustment to the cost for certain 'over-depreciated assets') is met where unfranked profits are included in working out the allocable cost amount during the transitional period; and

•

an anomaly that incorrectly imposes a penalty on the amount of the particular tax cost setting error instead of on the amount of tax associated with the tax cost setting error is removed.

MEC groups

2.4 Part 7 of Schedule 2 to this bill amends the measures to address unintended tax benefits that were introduced into the income tax law in New Business Tax System (Consolidation and Other Measures) Act (No. 1) 2002 and the CGT provisions that were introduced in New Business Tax System (Consolidation and Other Measures) Act 2003 so that they apply to head companies of MEC groups. Currently, they only apply to head companies of consolidated groups.

Franking deficit tax offsets and consolidated groups

2.5 Part 8 of Schedule 2 to this bill contains rules to:

•

transfer to the head company any joining entity's excess (unapplied) FDT offset;

•

allow the head company to apply that FDT offset in accordance with the FDT offset provisions in the SIS contained in this bill;

•

prevent the joining entity (now subsidiary) from applying any FDT offset whilst a member of a consolidated group; and

•

ensure that any FDT offsets remain with the head company upon the departure of any subsidiary from the group.

Detailed explanation of new law

The cost setting rules

Where the prime cost method was used to determine the decline in value of an asset just before the joining time

2.6 Part 1 of Schedule 2 to this bill amends paragraph 701-55(2)(d) of the ITAA 1997 to ensure that where:

•

a joining entity brings a depreciating asset into a consolidated group;

•

the cost of the asset is increased pursuant to the consolidation cost setting rules; and

•

just before the joining time the prime cost method applied for working out the asset's decline in value; then

the head company must choose an effective life for the asset as at the joining time.

2.7 The head company is effectively required to 're-choose' an effective life for the asset in these circumstances because the effective life previously used by the joining entity is no longer be appropriate where the cost of the asset has been increased under the cost setting rules.

2.8 Prior to this amendment the head company was required to choose an effective life for the asset in accordance with section 40-95 of the ITAA 1997 (other than subsections 40-95(2) and (5)). However, subsection 40-95(4) provides that where an asset is acquired from an associate, and the associate was using the prime cost method, an effective life must be used that is equal to any period of the asset's effective life the associate was using that had not yet elapsed at the time the acquirer began to hold the asset. In the consolidation context, it is arguable, given the deemed acquisition of assets by the head company at the joining time (paragraph 701-55(2)(a)), that subsection 40-95(4) could apply when an entity that is an associate of the head company, joins a consolidated group.

2.9 Similarly, subsections 40-95(4A) to (4C) and 40-95(5A) to (5C) may also give the same unintended outcome but with respect to assets eligible for an effective life subject to a statutory cap under section 40-102.

2.10 The amendments will remove these unintended outcomes by ensuring that only subsections 40-95(1) and (3) are taken into account for the purposes of paragraph 701-55(2)(d). [Schedule 2, item 1, paragraph 701-55(2)(d)]

Maintaining a pre-capital gains tax asset's cost base following a roll-over

2.11 Part 2 of Schedule 2 to this bill ensures that, for the purposes of the consolidation cost setting rules, the recipient of a pre-CGT asset (i.e. an asset acquired before 20 September 1985) that was rolled over inherits the originator's cost base for that asset where the asset was subject to roll-over relief under either Subdivision 126-B of the ITAA 1997 or section 160ZZO of the ITAA 1936. This clarification ensures that the consolidation provisions operate in respect of pre-CGT assets in the same way that they apply to post-CGT assets.

2.12 Where there is a roll-over of a post-CGT asset under Subdivision 126-B or section 160ZZO, the recipient company is deemed to have a cost base or reduced cost base for that asset equal to the originating company's cost base or reduced cost base.

2.13 However, in relation to pre-CGT assets, Subdivision 126-B and section 160ZZO do not require that the cost base of the pre-CGT asset is the same for the recipient as it is for the originator of the roll-over. Instead it just states that the recipient is taken to have acquired the pre-CGT rolled over asset before 20 September 1985. This is because the CGT regime disregards capital gains or losses made on pre-CGT assets.

2.14 Therefore, the CGT provisions may operate to give the recipient of a rolled over pre-CGT asset a cost base of either the consideration paid for the asset or the market value of the asset received.

2.15 This outcome is inappropriate because, in a consolidation environment the cost may be used to work out the allocable cost amount that is used in resetting the cost base for assets of a joining entity or the cost of membership interests in an entity that leaves a consolidated group.

2.16 Section 716-855 of the ITAA 1997 ensures that, where pre-CGT membership interests in a joining entity are rolled over and the receiving entity becomes a subsidiary member of a consolidated group, the post-roll-over cost base (or reduced cost base) used in resetting the cost of assets is the same as the originator's cost base (or reduced cost base).

2.17 Section 716-855 ensures that the post-roll-over cost base (or reduced cost base) of a pre-CGT asset that is used in resetting the cost of assets will be the same as the originator's cost base (or reduced cost base). This will be relevant, for example, in working out the cost base or reduced cost base of membership interests under step 1 of working out the allocable cost amount. In addition, the cost base will also be relevant where assets of an entity retain their existing tax values as a result of an election to be a 'chosen transitional entity' (under section 701-5 of the IT(TP) Act 1997). [Schedule 2, item 5, section 716-855; item 6, section 701-7]

2.18 A note is added to subsection 126-60(3) of the ITAA 1997 to alert readers to the amended operation of the CGT roll-over provisions for the consolidation regime [Schedule 2, item 2, subsection 126-60(3); item 3, subsection 126-60(3) (note)]. A note is also added to subsection 705-65(1) of the ITAA 1997 to refer to the operation of section 716-855 [Schedule 2, item 4, subsection 705-65(1)].

Excess of allocable cost amount on joining that cannot be allocated to reset cost base assets held on revenue account: CGT event L8

2.19 Part 3 of Schedule 2 to this bill modifies the ITAA 1997 to introduce CGT event L8. This event applies where there is an excess of allocable cost amount on joining that cannot be allocated to reset cost base assets after the operation (or successive operation) of section 705-40 of the ITAA 1997. Section 705-40 restricts the cost that can be allocated to reset cost base assets that are held on revenue account. If an amount of allocable cost amount remains, after the section 705-40 restriction operates, CGT event L8 will result in a capital loss equal to that amount. [Schedule 2, item 8, subsections 104-535(1) and (3)]

2.20 A 'reset cost base asset' is any asset that is not a retained cost base asset. The allocable cost amount remaining after deducting an amount equal to a head company's set costs, for the retained cost base assets of a joining entity, is allocated among the reset cost base assets other than 'excluded assets'. There is a proportionate allocation of the remaining allocable cost amount to each of the joining entity's reset cost base assets in accordance with their relative market value.

2.21 The amount of allocable cost amount that can be allocated to reset cost base assets that are held on revenue account is limited to the greater of the asset's market value or terminating value. It should be noted that for this amendment to apply, the joining entity must not have any reset cost base assets held on capital account, because there are no restrictions on the amount of allocable cost amount that can be allocated to reset cost base assets held on capital account.

2.22 The time CGT event L8 applies is just after the entity joins the consolidated group. This is to ensure that the capital loss that arises may be included in the head company's tax return. [Schedule 2, item 8, subsection 104-535(2)]

2.23 Certain tables in Divisions 104 and 110 are updated as a result of this amendment. Also the note to subsection 705-40(2) is updated. [Schedule 2, item 7, section 104-5 (at the end of the table); item 9, section 110-10 (at the end of the table); item 10, subsection 705-40(2) (at the end of the note)]

Preserving an asset's entitlement to accelerated depreciation

2.24 Part 4 of Schedule 2 to this bill amends sections 701-80 and 705-45 of the ITAA 1997 to ensure that the scope of a head company's entitlement to accelerated depreciation in relation to an asset that becomes an asset of the head company is retained in situations where:

•

an asset (that was entitled to accelerated depreciation) was rolled over to a joining entity after 21 September 1999 and before the joining time; or

•

an asset of a leaving entity that was entitled to accelerated depreciation through a previous application of section 701-80 or 705-45 becomes an asset of the head company of a consolidated group.

2.25 A head company's entitlement to accelerated depreciation in relation to an asset, post-consolidation, is maintained where certain conditions are satisfied under sections 701-80 and 705-45. One of those conditions is that the entity must have acquired the asset at or before 11.45am by legal time in the Australian Capital Territory on 21 September 1999 and held it continuously until the entity became a subsidiary member of the group.

2.26 Prior to these amendments certain depreciating assets would have lost their entitlement to accelerated depreciation because they have not been held continuously by one entity for the period up to the joining time. This requirement is a problem where roll-over relief has been utilised and the recipient has maintained access to accelerated depreciation because the recipient will not be taken to have acquired the asset at or before 11.45am by legal time in the Australian Capital Territory on 21 September 1999.

2.27 The amendments operate by identifying whether the joining entity was entitled, under transitional provisions, to use accelerated rates of depreciation immediately before the joining time. [Schedule 2, item 11, subsection 701-80(3); item 12, paragraphs 705-45(a) and (aa)]

2.28 Sections 40-10(3) and 40-12(3) of the IT(TP) Act 1997 preserved the entitlement to accelerated depreciation in circumstances where plant being taxed under former Division 42 of the ITAA 1997 moved to being taxed under the uniform capital allowances regime in Division 40 of the ITAA 1997. In addition, where there was a roll-over under section 40-340 of the ITAA 1997, section 40-340 of the IT(TP) Act 1997 allows the recipient of the asset in certain cases to work out its decline in value of the asset using the accelerated rates of depreciation.

2.29 By referring to subsections 40-10(3) and 40-12(3) the amendments ensure that access to accelerated depreciation is available, in appropriate circumstances, where:

•

plant was acquired at or before 11.45am on 21 September 1999 where there has been no roll-over;

•

plant acquired at or before 11.45am on 21 September 1999 where there has been roll-over relief under former Division 42; and

•

plant acquired at or before 11.45am on 21 September 1999 where there has been roll-over relief under Division 40.

Ensuring that an over-depreciation adjustment is made during the transitional period where unfranked or partly franked dividends are not paid out

2.30 Part 5 of Schedule 2 to this bill modifies the IT(TP) Act 1997 to remove an anomaly with the interaction of section 705-50 of the ITAA 1997 which restricts the cost allocated to certain assets that are 'over-depreciated' and section 701-30 of the IT(TP) Act 1997 which allows unfranked profits to be included in working out the allocable cost amount during the transitional period.

2.31 Section 701-30 of the IT(TP) Act 1997 requires that there be unfranked or partly franked dividends that could be paid to recipients entitled to the inter-corporate dividend rebate, it does not require that those dividends actually be paid. However, subsection 705-50(2) of the ITAA 1997 requires that the joining entity has actually paid one or more unfranked or partly franked dividends to recipients entitled to an inter-corporate dividend rebate. As such, in circumstances where section 701-30 applies, but no dividends were actually paid as required under subsection 705-50(2), the tax cost setting amount of the over-depreciated asset is not reduced.

2.32 The amendments remove the anomaly by treating the dividends as having been paid resulting in the unfranked profits being taken into account in working out the 'tax deferral amount' under section 705-50. [Schedule 2, item 13, subsection 701-30(3); item 14, subsection 701-30(4)]

Ensuring that an appropriate amount is used in working out penalties to be imposed as a result of certain errors made in the cost setting process

2.33 Part 6 of Schedule 2 to this bill removes an anomaly in subsection 8W(1C) of the TAA 1953 that incorrectly imposes a penalty on the amount of certain cost setting errors instead of on the amount of tax associated with the cost setting error.

2.34 Errors made in making tax cost setting amount calculations are reversed by means of an immediate capital gain or loss if it would be unreasonable to require the calculations to be re-done. However, if the errors reduce the amount of the tax payable because the taxpayer either made a false or misleading statement or entered into a scheme, a penalty should be imposed that is based on the reduction in tax resulting from this error.

2.35 These technical amendments remove an anomaly that incorrectly imposes a penalty on the amount of the cost setting error instead of on the amount of tax associated with the amount of the cost setting error. [Schedule 2, item 16, subsection 8W(1C) (formula); item 17, subsection 8W(1C) (definition of capital gain); item 18, subsection 8W(1C); item 20, subsection 284-80(2) (formula); item 21, subsection 284-80(2) (definition of capital gain); item 22, subsection 284-80(2); item 24, subsection 284-150(3) (formula); item 25, subsection 284-150(3) (definition of capital gain); item 26, subsection 284-150(3)]

2.36 Other minor technical corrections relating to cross-references and wording are also made:

•

subsections 8W(1C), 284-80(2) and 284-150(3) of Schedule 1 to the TAA 1953 had incorrect references to 'subsection 705-230(2)' instead of 'subsection 705-320(2)'; and

•

in paragraph 284-80(2)(b) and subsection 284-150(3) references to 'income tax return' are replaced with 'in a statement' to be consistent with the approach in subsection 8W(1C) of Schedule 1 to the TAA 1953.

[Schedule 2, item 15, subsection 8W(1C); item 19, paragraph 284-80(2)(b); item 23, subsection 284-150(3)]

Ensuring that the head companies of MEC groups are taxed in the same way as head companies of consolidated groups

2.37 Part 7 of Schedule 2 to this bill amends the measures to address unintended tax benefits that were introduced into the income tax law in New Business Tax System (Consolidation and Other Measures) Act (No. 1) 2002 and the CGT provisions that were introduced in New Business Tax System (Consolidation and Other Measures) Act 2003 so that they apply to head companies of MEC groups. Currently they only apply to head companies of consolidated groups.

2.38 The amendments maintain the underlying principle of consolidation that the income tax law that applies to head companies of consolidated groups should also apply to the head companies of MEC groups (see Minister for Revenue and Assistant Treasurer's Press Release No. C67/03 of 30 June 2003).

Measures to address unintended tax benefits

2.39 In New Business Tax System (Consolidation and Other Measures) Act (No. 1) 2002 provisions were included to ensure that there were no unintended tax benefits to groups during the transition to consolidation. The application of these provisions has been expanded so that they will equally apply to head companies of MEC groups.

2.40 The measures that were included in New Business Tax System (Consolidation and Other Measures) Act (No. 1) 2002 prevent, in certain circumstances, the consolidated group receiving unintended tax benefits as a result of:

•

the combined application of the current law and the cost setting rules that reset the cost of revenue assets of an entity that becomes a member of a consolidated group;

•

tax values of trading stock receiving an uplift on consolidation; and

•

internally generated assets giving rise to periodic tax deductions for the decline in value of the assets where the cost of creating the assets have already been previously allowed as deductions.

For further information about these measures see paragraphs 1.89 to 1.114 and 1.123 to 1.174 of the explanatory memorandum to the New Business Tax System (Consolidation and Other Measures) Bill (No. 1) 2002.

2.41 In relation to the provisions concerning membership interests that were formerly pre-CGT assets, the provisions that are found in Division 705 of the ITAA 1997 apply to head companies of MEC groups. This is by application of section 719-2 of the ITAA 1997. However, an amendment is made to CGT event L1 so that it applies to MEC groups [Schedule 2, item 27, section 102-30 (item 7A in the table); item 28, section 104-5 (table row relating to event number L1); item 29, Subdivision 104-L (heading); item 30, subsection 104-500(1)]. Another amendment is made to include a reference to MEC groups in the table in section 110-10 of the ITAA 1997 where it mentions CGT event L1 [Schedule 2, item 34, section 110-10].

2.42 The transitional provisions concerning pre-CGT membership interests (see Division 701B of the IT(TP) Act 1997) are also being amended so that they apply to head companies of MEC groups. Normally, this would not be necessary because reliance could be placed on section 719-2 of the IT(TP) Act 1997 to achieve the result that transitional provisions referring to ordinary consolidated groups would apply in the same way to MEC groups. However, in the case of Division 701B, the references are different from those in the rest of the transitional consolidation provisions, in that the consolidation provisions of the ITAA 1997 to which Division 701B refers expressly apply not only to ordinary consolidated groups but also to MEC groups (see item 30 of Schedule 2 which amends section 104-500 of the ITAA 1997). In order to avoid any argument that because of this the general provision in section 719-2 of the IT(TP) Act 1997 would not apply to the references in Division 701B, it is considered prudent to amend Division 701B directly, to make it clear that MEC groups are covered [Schedule 2, item 35, paragraph 701B-1(1)(b)]. As a consequence, section 719-2 of the IT(TP) Act 1997 has also been amended since it need not have application to Division 701B [Schedule 2, item 36, subsection 719-2(1)].

2.43 In order to ensure that the rules concerning the tax values of trading stock and internally generated assets apply appropriately to head companies of MEC groups (see Division 701A of the IT(TP) Act 1997), the MEC group general modifying rule in Subdivision 719-C of the IT(TP) Act 1997 has been expanded so that it can be applied to Division 701A of the IT(TP) Act 1997 [Schedule 2, item 37, subsection 719-160(2)]. In brief, the MEC group general modifying rule operates to treat each eligible tier-1 company of a MEC group as if it were part of the head company of the group, rather than a separate entity. By expanding the application of this rule, it ensures that when a MEC group joins another MEC group the joining entity's eligible tier-1 companies become part of the head company of the acquiring group.

Other capital gains tax provisions

2.44 Included in New Business Tax System (Consolidation and Other Measures) Act 2003 were six additional CGT events (see Schedules 4 and 21). These CGT events (CGT events L2 to L7) deal with capital gains and losses that arise when applying the consolidation cost setting rules. Because these provisions are outside Part 3-90 of the ITAA 1997, amendments have been made to extend their operation to include MEC groups.

2.45 In brief, this expansion to include MEC groups has been achieved by including in the relevant CGT provisions the words 'or MEC group' after the words 'consolidated group'. [Schedule 2, item 31, paragraphs 104-505(1)(a), 104-510(1)(a), 104-515(1)(a), 104-520(1)(a) and 104-525(1)(a); item 32, subsection 104-525(6); item 33, subsection 104-530(1); item 34, section 110-10]

Franking deficit tax offsets and consolidated groups

Transfer of excess franking deficit tax offset to head company

2.46 Part 8 of Schedule 2 to this bill provides that where an entity joins a consolidated group, any unapplied FDT offset, either from a previous year or the year ending at the joining time, is transferred to the head company. [Schedule 2, item 38, subsection 701-30(10); item 39, subsection 709-185(1)]

2.47 The transferred FDT offset then becomes either the excess FDT offset balance of the head company (where it previously did not have an FDT offset balance), or is added to the head company's existing excess FDT offset balance (where one already existed).

2.48 In either case, the transferred FDT offset amount is able to be applied by the head company consistent with the FDT offset provisions in the SIS contained in this bill. [Schedule 2, item 39, subsection 709-185(2)]

Joining entity prevented from utilising franking deficit tax offset in later income years

2.49 A joining entity is prevented from utilising, in later income years, an FDT offset it may have whilst a member of the group. This rule prevents any possible double application that could arise by virtue of applying the FDT offset provisions in the SIS, contained in this bill, to the subsidiary as well as the head company. [Schedule 2, item 39, subsection 709-185(3)]

Consequences for exiting subsidiary

2.50 The exit history rule does not apply to any amount of FDT offset which a joining entity may have transferred to the head company at the joining time. This section applies irrespective of whether the exiting entity transferred an excess FDT offset to the head company at the joining time. Thus, any subsidiary member that exits a consolidated group will exit with a nil FDT offset balance. [Schedule 2, item 39, section 709-190]

No rules for MEC groups

2.51 To avoid doubt, no special rules are required where a cessation event occurs in respect of a MEC group by virtue of subsection 719-60(6) of the ITAA 1997.

2.52 Unlike the specific rules relating to the transfer of franking account balances from one provisional head company to another, no equivalent rules are required to provide for the transfer of an FDT offset balance from one provisional head company to another as the offset entitlements are only relevant to the head company itself when it determines its income tax liability - not part way through the year as is the case with franking accounts.

2.53 This outcome arises because the entitlement to an FDT offset arises at the end of an entity's income year, and a provisional head company will become the head company of a MEC group at the end of the income year by virtue of section 719-75 of the ITAA 1997.

Application and transitional provisions

2.54 The amendments discussed in this chapter have a retrospective application date of 1 July 2002 (being the commencement date of the consolidation regime). [Schedule 2, item 40]

2.55 The amendments are either beneficial to taxpayers or correct unintended outcomes. All of the amendments to address unintended outcomes are consistent with the original policy intent for the consolidation regime and therefore have the same commencement date as the consolidation regime.

2.56 The transitional provisions inserted by this bill have the same application date as the changes to the ongoing provisions of the consolidation regime (i.e. 1 July 2002). Until this bill it has always been by implication that Part 3-90 of the IT(TP) Act 1997 has application as from 1 July 2002 (being the application date of Part 3-90 of the ITAA 1997). However, this implication has not been continued in this bill. Instead, an express provision has been included that states that the amendments contained in this bill apply on and after 1 July 2002 [Schedule 2, item 40]. The reason for the difference is purely one of drafting approach and it is not intended that there be any change to the date of commencement (i.e. 1 July 2002) of any provision contained in Part 3-90 of the IT(TP) Act 1997.

Chapter 3 - Conservation covenants

Outline of chapter

3.1 Schedule 3 to this bill amends the ITAA 1997 to provide an income tax deduction for taxpayers entering into certain types of conservation covenants on or after 1 July 2002 with the Commonwealth, a State, a Territory or a local governing body, or an authority of the Commonwealth, a State or a Territory.

Context of amendments

3.2 In 2001, the ITAA 1997 was amended (Schedule 7, Taxation Laws Amendment Act (No. 2) 2001) to allow land holders a deduction when they enter into eligible conservation covenants with a fund, authority or institution that meets the requirements of section 31-10. Section 31-10 limits eligible funds, authorities or institutions to certain deductible gift recipients and prescribed private funds. The amount of the deduction is determined by the Commissioner and is generally equal to the fall in the market value of the land as a result of the conservation covenant.

3.3 This amendment will extend the deduction to taxpayers entering into certain types of conservation covenants with the Commonwealth, a State, a Territory or a local governing body, or an authority of the Commonwealth, a State or a Territory.

Summary of new law

3.4 Under the new law, the ITAA 1997 will allow an income tax deduction for land owners entering into conservation covenants (subject to conditions set out in section 31-5) with a fund, authority or institution that meets the requirements of section 31-10, or the Commonwealth, a State, a Territory or a local governing body, or an authority of the Commonwealth, a State or a Territory.

Detailed explanation of new law

3.5 On or after 1 July 2002, landowners who enter into conservation covenants over land they own are entitled to claim an income tax deduction if the conditions set out in section 31-5 are met. Schedule 4 amends one of the conditions of deduction in section 31-5 so that the covenant must now be entered into with:

•

a fund, authority or institution that meets the requirements of section 31-10;

•

the Commonwealth, a State, a Territory or a local governing body; or

•

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

[Schedule 3, item 1, paragraph 31-5(2)(e)]

Application and transitional provisions

3.6 The amendments apply to conservation covenants entered into on or after 1 July 2002 [Schedule 3, item 2]. The retrospective application is advantageous to taxpayers.

Chapter 4 - Fringe benefits tax - deemed depreciation rate for cars

Outline of chapter

4.1 Schedule 4 to this bill amends subsection 11(1) of the Fringe Benefits Tax Assessment Act 1986 to ensure that alignment between the FBT deemed depreciation rate used under the operating cost method for valuing a car fringe benefit and the Commissioner's determination for the effective life of the car is maintained.

Context of amendments

4.2 The Commissioner announced on 20 June 2002 that, for cars acquired after 30 June 2002, the effective life would be increased from six years and eight months to eight years for income tax depreciation purposes.

4.3 An amendment is required to realign the deemed depreciation rate used under the operating cost method for valuing car fringe benefits with the new effective life determination.

4.4 The approach taken in this amendment of setting the deemed depreciation rate by reference to the Commissioner's determination of the effective life of the car (rather than simply replacing the current figure in the legislation with a new one) is designed to ensure that further legislative amendment will not be required should the Commissioner's effective life determination change in the future.

Summary of new law

4.5 Under this amendment, the deemed depreciation rate used in calculating a deemed depreciation amount will be calculated by reference to the Commissioner's determination for the effective life of that car as applies at the most recent time the provider of the car fringe benefit becomes the owner of the car.

Detailed explanation of new law

4.6 Where the operating cost method is used by a taxpayer to calculate the taxable value of a car fringe benefit, a deemed depreciation amount is included in the valuation if the car is owned (or deemed to be owned) by the provider of the fringe benefit.

4.7 Subsection 11(1) of the Fringe Benefits Tax Assessment Act 1986 sets out the depreciation formula used to calculate the deemed depreciation amount. This formula currently includes a figure representing the deemed depreciation rate. The rate is currently set in the legislation at 22.5%.

4.8 This figure is based on an effective life of cars of six years and eight months calculated using the diminishing value method; namely:

150% / effective life of cars of 6⅔ years = 22.5%


The Commissioner is empowered to determine the effective life of depreciating assets under the capital allowance provisions by virtue of section 40-100 of the ITAA 1997.

4.9 Under this amendment, the deemed depreciation rate will be calculated as:

150% / effective life of the car


where the effective life of the car is the car's effective life as set out in the determination in force (as made by the Commissioner under the capital allowance provisions) at the most recent time the provider becomes the owner of the car. [Schedule 4, item 2, subsection 11(1AA)]

Example 4.1

Christine purchases a standard 6-cylinder family car on 1 August 2003 and provides it as a fringe benefit to her employee Nathalie. Christine chooses to calculate the taxable value of the car fringe benefit using the operating cost method. As Christine owns the car, she includes an amount of deemed depreciation in calculating the taxable value of the vehicle.

The Commissioner's determination of the effective life of this type of car in force at the time Christine becomes the car's owner is eight years. Accordingly, the deemed depreciation rate that Christine will use in calculating the deemed depreciation amount will be:

150% / 8 = 18.75%


4.10 In accordance with subsection 10(3) of the Fringe Benefits Tax Assessment Act 1986, the changes made by this amendment also apply to non-business accessories fitted to cars valued using the operating cost method.

Application and transitional provisions

4.11 The amendment applies in respect of cars acquired after 30 June 2002. The amendment only affects car fringe benefits valued using the operating cost method and does not affect cars valued using the statutory formula method.

Chapter 5 - Endorsement of perpetual bodies as deductible gift recipients

Outline of chapter

5.1 Schedule 5 to this bill will permit statutory bodies that are established in perpetuity by the Commonwealth Parliament to be endorsed by the Commissioner as deductible gift recipients despite not having a winding up clause.

Context of amendments

5.2 To receive endorsement as a deductible gift recipient the law or document constituting the fund, authority or institution must contain, inter alia, a winding up clause that states that any surplus assets must be transferred to another deductible gift recipient. A number of statutory bodies were established in perpetuity by Parliament and so do not have any winding up provisions. Accordingly, endorsement as a deductible gift recipient would be denied to such statutory bodies that would otherwise satisfy the endorsement provisions.

5.3 As part of its response to the Report of the Inquiry into the Definition of Charities and Related Organisations the Government decided to remove the requirement to have a winding up clause for entities established in perpetuity by the Commonwealth Parliament.

Summary of new law

5.4 Statutory bodies established by the Commonwealth Parliament in perpetuity that wish to be deductible gift recipients (other than those specifically named or that are prescribed private funds) will be required to satisfy the endorsement provisions other than the provision concerning the transfer of assets from the gift fund.

Detailed explanation of new law

5.5 In order to be a deductible gift recipient a fund, authority or institution that is described in Division 30 of the ITAA 1997 is required to be endorsed by the Commissioner. However, the endorsement provisions do not apply to those listed by name or to prescribed private funds. The endorsement provisions contain a requirement that the law, constitution or other governing documents of an entity that is a fund, authority or institution contain a winding up clause requiring that any surplus assets be transferred to a fund, authority or institution that is a deductible gift recipient. Similarly, an entity that operates a fund, authority or institution must contain a winding up clause as required above.

5.6 This amendment will modify the endorsement provisions for entities established by a Commonwealth Act that do not have a provision for the winding up or termination of the entity. Where such an entity is a fund, authority or institution, the amendment will remove the requirement to have a winding up clause in order to be endorsed as a deductible gift recipient [Schedule 5, item 1]. Similarly, a statutory body established by the Commonwealth Parliament in perpetuity that operates a fund, authority or institution will not be required to have a winding up clause to be endorsed as a deductible gift recipient [Schedule 5, item 2].

5.7 The amendment is retrospective to 1 July 2003. However, no taxpayer will be disadvantaged. The amendment will allow taxpayers a deduction for the making of a gift to such a fund, authority or institution.

Application provisions

5.8 The amendments to section 30-125 of the ITAA 1997 will apply from 1 July 2003. [Schedule 5, item 3]

Chapter 6 - Eligibility rules for farm management deposits scheme

Outline of chapter

6.1 Schedule 6 to this bill amends Schedule 2G to the ITAA 1936 to make it easier for primary producers to determine if an entity is eligible to issue FMD. The Schedule also protects the tax status of certain pre-1 July 2003 deposits and transfers that were made in good faith with non-complying entities offering products described as FMD.

Context of amendments

6.2 The FMD scheme allows eligible primary producers to set aside pre-tax income in profitable years to establish cash reserves to help meet costs in low-income years.

6.3 Subject to certain eligibility criteria being met, FMD are deductible from assessable income. Any withdrawals of the deposits are included in assessable income, but only to the extent that they have previously been claimed as a deduction.

6.4 One of the requirements for deposits to be FMD is that they must be made with a 'financial institution', as defined in the FMD provisions.

Summary of new law

6.5 The new law clarifies which entities are eligible to issue FMD, by replacing references to "prudential supervision or regulation under a law of the Commonwealth, a State or a Territory" with a requirement that the entity be an authorised deposit-taking institution.

6.6 The amendments will also protect primary producers who in good faith made deposits with, or transferred deposits to, non-complying entities offering products described as FMD before 1 July 2003.

6.7 To effect this protection, non-complying entities will be deemed to be 'financial institutions' in relation to certain pre-1 July 2003 deposits and transfers. Provided all other requirements of the FMD scheme are met, these deposits will be treated as FMD. The deposits will retain this tax status into future years if they are transferred to a financial institution within a specified period. If a deposit is not transferred to a financial institution within this period, the deposit will be treated as if it had been repaid immediately before the end of the period.

Detailed explanation of new law

Clarification of the definition of financial institution

6.8 For deposits to be FMD, those deposits must be made with a 'financial institution', as defined in section 393-25 of Schedule 2G to the ITAA 1936.

6.9 The definition of this term will be clarified to make it easier for primary producers to determine whether the entity they are dealing with is eligible to accept FMD. This will be achieved by replacing the requirements of "prudential supervision or regulation under a law of the Commonwealth, a State or a Territory" in the current definition of the term 'financial institution' with a requirement that the entity be an authorised deposit-taking institution for the purposes of the Banking Act 1959.

6.10 Authorised deposit-taking institutions are prudentially regulated by the Australian Prudential Regulation Authority. All banks, building societies and credit unions are authorised deposit-taking institutions.

6.11 Persons that carry on in Australia a business of banking or taking money on deposit, and which have a State or Territory guarantee in relation to deposits, will continue to meet the definition of 'financial institution'.

6.12 However, the proposed amendments will remove references to entities with a Commonwealth guarantee in relation to deposits, because there are no such entities.

6.13 The amendment applies from 1 July 2003. [Schedule 6, items 1 to 3]

Entities taken to be financial institutions for pre-1 July 2003 deposits and transfers

6.14 This amendment is intended to protect primary producers who have in good faith made deposits with ineligible financial institutions offering products described as FMD. This will be achieved by treating certain entities (non-complying entities) as financial institutions, in relation to certain pre-1 July 2003 deposits and transfers (eligible deposits).

6.15 Treating these non-complying entities as financial institutions will mean that eligible deposits are within the definition of FMD, provided all other requirements of the scheme are met.

6.16 Primary producers that wish to retain the tax status of these deposits into future years will have until at least 30 June 2004 to transfer those deposits to entities that are authorised deposit-taking institutions, or entities with a State or Territory guarantee. For some fixed-term deposits, the transfer period will be extended to the date of maturity of the deposit, up to a maximum of four years.

Eligible deposits

6.17 The provision will apply in relation to certain pre-1 July 2003 deposits and transfers (eligible deposits).

6.18 Specifically, the provision will apply in relation to a deposit where:

•

the deposit was made before 1 July 2003 with an entity that was not a financial institution;

•

the deposit is made in good faith; and

•

if the deposit was made after 17 June 2003 (the date the measure was announced), the non-complying entity was offering agreements of that type on 17 June 2003.

[Schedule 6, item 4, subsection 393-52(2)]

6.19 The provision will apply in relation to a transfer of a deposit where:

•

a written request was made before 1 July 2003 to a financial institution to have a deposit transferred from a financial institution to a non-complying entity;

•

the financial institution transferred the deposit to the non-complying entity within a reasonable time after the request;

•

the request was made in good faith; and

•

if the request was made after 17 June 2003 (the date this measure was announced), the non-complying entity was offering agreements of that type on 17 June 2003.

[Schedule 6, item 4, subsection 393-52(3)]

6.20 Restricting the operation of these provisions to pre-1 July 2003 deposits and transfers recognises that the definition was clarified with effect from 1 July 2003.

6.21 The additional requirements for deposits and requests made after 17 June 2003 prevented non-complying entities commencing to offer FMD after this measure was announced.

Non-complying entity taken to be a financial institution

6.22 A non-complying entity will be treated as if it were a financial institution in relation to an eligible deposit throughout the period:

•

starting when the eligible deposit was made or transferred; and

•

ending when the eligible deposit is transferred to a financial institution, actually repaid or in any other case, immediately before the relevant deadline.

[Schedule 6, item 4, subsection 393-52(4)]

6.23 This means that pre-1 July 2003 deposits or transfers will be treated as FMD, provided they meet all the other requirements of the FMD scheme (i.e. all conditions except that they were made with or transferred to an entity that was not a financial institution).

Deposits taken to be repaid in certain circumstances

6.24 Deposits will be taken to be repaid to the depositor if:

•

the depositor, before the deadline, fails to make a written request to the non-complying entity to transfer the deposit to a financial institution; or

•

if such a request is made, the non-complying entity fails to transfer the deposit in a reasonable period of time.

[Schedule 6, item 4, subsection 393-52(5)]

6.25 This means that deposits that are retained with a non-complying entity, after the relevant deadline, will be treated as if they were FMD when made, but were then repaid immediately before the relevant deadline expired. Such amounts are included in the assessable income of the owner, except to the extent that any such amount has been previously included in the owner's assessable income.

Deadline

6.26 The deadline for eligible deposits to be transferred to a financial institution, if they are to retain their FMD status, depends on the term to maturity of the deposit as at 30 June 2003.

6.27 Specifically:

•

for those deposits with a term maturity of less than or equal to 12 months as at 30 June 2003, the deadline is 1 July 2004; and

•

for those deposits with a term maturity exceeding 12 months as at 30 June 2003, the deadline is 1 July 2007 or the date of maturity of the deposit (whichever comes first).

[Schedule 6, item 4, subsection 393-52(6)]

6.28 This transfer period means that there is no requirement for primary producers to withdraw fixed term deposits before they mature. In addition, the transfer period will allow for a managed transfer of funds to authorised deposit-taking institutions and institutions with a State or Territory guarantee.

Application and transitional provisions

6.29 The amendments will apply from the commencement of the FMD scheme.

Clarification of eligibility rules for farm management deposits

6.30 The new definition of 'financial institution' will take effect from 1 July 2003.

Transfer period

6.31 The amendments will apply from the commencement of the FMD scheme.

Chapter 7 - Simplified imputation system - franking deficit tax offset

Outline of chapter

7.1 Schedule 7 to this bill will amend Part 3-6 of the ITAA 1997 to insert rules in the SIS to allow entities which have incurred an FDT liability to offset this amount against an income tax liability. Special rules are provided for life insurance companies to ensure that an FDT liability can only be offset against that part of the company's income tax liability that is attributable to shareholders.

7.2 The new rules will also replace the franking additional tax penalty provisions which operated under the former imputation rules in Part IIIAA of the ITAA 1936 where there was an excessive franking deficit. Instead of a separate penalty, a new rule will operate to reduce an entity's FDT offset by 30%.

Context of amendments

7.3 The rules which will allow FDT to be offset against company tax generally replicate the former provisions contained in Subdivision C in Division 5 of Part IIIAA of the 1936. However, changes are made to reflect the new rules and terminology of the SIS rules. The law has been rewritten using clearer and more accessible drafting techniques of the tax law improvement project.

7.4 In Minister for Revenue and Assistant Treasurer's Media Release No. 134 of 20 December 2002 the Government announced that it will replace the former franking additional tax penalty provisions with a simplified penalty for an excessive franking deficit. Broadly, franking additional tax applied where a company had a franking deficit at the end of the year and the deficit was more than 10% of all the franking credits that arose during the year. The new rule will operate instead to reduce an entity's FDT offset by 30% where there is an excessive franking deficit.

Summary of new law

7.5 This bill amends Part 3-6 of the ITAA 1997 to allow entities that have incurred an FDT liability to offset that amount against an income tax liability. Any unapplied amounts can be carried forward and offset against future income tax liabilities. In the case of life insurance companies the amount of the offset that can be applied will be limited to the company's income tax liability for the income year that is attributable to shareholders.

7.6 The new provisions generally replicate the provisions of the former imputation system but have been greatly simplified. The main departures from the former rules are:

•

the FDT offset will be treated as a tax offset and therefore be part of a taxpayer's assessment - this removes the need for the Commissioner or taxpayer to make a determination on an offset entitlement:

-

a consequence is that machinery and administrative provisions contained in sections 160AQKB to 160AQS of Part IIIAA of the ITAA 1936 do not need to be replicated;

•

for life insurance companies a series of complicated formulae are replaced with a general rule which operates to limit the amount of FDT offset to that part of an entity's income tax liability that can be attributed to shareholders; and

•

replacing franking additional tax with a simplified rule for an excessive franking deficit.

7.7 The new FDT offsetting rules will come into operation as from 1 July 2002, the date that SIS rules came into operation. Although the rules are retrospective, they do not adversely affect taxpayers. If the rules did not apply from this date, companies would not be able to apply an FDT liability against their income tax assessment for the 2002-2003 income year.

7.8 Transitional rules are also included to ensure a proper transition for the removal of the franking additional tax for late balancers and also to allow entities with unapplied amounts of FDT and deficit deferral tax incurred in earlier years to be offset against future income tax liabilities.

7.9 The rule which replaces the franking additional tax will generally operate in respect of FDT liabilities arising at the end of the 2002-2003 income year and later years.

Detailed explanation of new law

Ordinary companies

Background

7.10 The Australian imputation system prevents the double taxation of company profits by allowing the company to impute to its shareholders (as an imputation credit attached to a franked dividend) the tax that it has paid on the income that it distributes to them.

7.11 Resident companies can frank dividends paid to shareholders even though the company may have insufficient credits to support that level of franking. Where this occurs a company's franking account may go into deficit. Where a deficit exists in the company's franking account at the end of the income year, that company would be liable to pay FDT.

7.12 The FDT is not a penalty, but merely a payment required to make good the amount imputed to shareholders which exceeds the amount of tax actually paid.

7.13 Under the former imputation rules in Part IIIAA of the ITAA 1936, the liability to FDT could be applied to reduce the company's income tax liability for the relevant income year, including an amended assessment which increases an income tax liability. Any unapplied amounts could be carried forward to be offset against an income tax liability in a later income year. The rules operated so that the Commissioner was required to determine the company's entitlement to an FDT offset or a company could self-determine their own entitlement.

7.14 FDT cannot be offset against PAYG instalments payable, but may be taken into account in any application for variation of such instalments.

Franking deficit tax offsetting rules

7.15 A corporate tax entity that meets a residency requirement is entitled to apply an FDT tax offset to reduce its income tax liability for an income year where the following conditions are met:

•

the entity has incurred a liability to pay FDT in an income year; or

•

it has an unapplied amount of FDT tax offset from a previous income year (including an unapplied amount from an income year when it did not satisfy the residency requirement).

[Schedule 7, item 5, subsection 205-70(1)]

7.16 A method statement is provided which sets out how the amount of the tax offset is worked out. The six steps involved are as follows:

Step 1: calculate the entity's liability to FDT as required under section 205-45.

Step 2: if the amount in step 1 is more than 10% of the total franking credits that arose in the entity's franking account in the income year, reduce the amount calculated in step 1 by 30%.

Step 3: calculate the entity's liability to FDT for an income year in which the entity did not satisfy the residency requirement where the entity has not previously claimed the amount as a tax offset.

Step 4: if the amount in step 3 is more than 10% of the total franking credits that arose in the entity's franking account in the income year, reduce the amount calculated in step 3 by 30%.

Step 5: add the amounts calculated under step 2 and step 4.

Step 6: if there is any unapplied FDT offset from a previous year add this amount to the amount calculated under step 5. This step allows any unapplied FDT tax offsets from previous years to be applied against an entity's income tax liability for the current income year.

[Schedule 7, item 5, subsection 205-70(2)]

7.17 Steps 2 and 4 of the method statement replaces the former franking additional tax penalty provisions with a 30% reduction in the amount of the tax offset.

Example 7.1

In the 2003-2004 income year a company's franking account has a $3,000 franking deficit at the end of the income year and the company will incur a liability to FDT for this amount. During the year the company's franking account had $10,000 of franking credits. As the franking deficit exceeds the total franking credits by more than 10%, the company's offset entitlement is reduced under step 2 to $2,100. The remaining $900 FDT liability (being 30% of the deficit) produces no offset entitlement.

7.18 The tax offset can be applied not only against an income tax liability arising from an original assessment but also against an increased income tax liability resulting from an amended assessment for the current income year.

7.19 The tax offset is deducted from the entity's income tax liability after all other tax offsets (including foreign tax credits) have been deducted. [Schedule 7, item 5, subsection 205-70(3)]

Example 7.2

For the 2002-2003 income year X Co has a franking deficit of $60,000. Accordingly, at the end of the income year, the company became liable to FDT of $60,000. X Co also has an unapplied FDT offset from the previous year of $40,000.

X Co lodges its income tax return on 21 February 2004 and is assessed on that day. Before tax offsets are applied its income tax liability is $540,000. It is entitled to a foreign tax credit of $50,000. After subtracting this tax offset its income tax liability is $490,000. It can further subtract an FDT offset of $100,000. Its final income tax liability for 2002-2003 is $390,000.

7.20 The residency requirement for a corporate tax entity claiming the FDT offset is contained in subsection 205-25(1) of the ITAA 1997 [Schedule 7, item 4, subsection 205-70(4)]. As a result of an amendment to be made by Taxation Laws Amendment Bill (No. 7) 2003, a company will satisfy the residency requirement for the purpose of applying an FDT offset where either of the following are satisfied:

•

if the liability to FDT arises before the end of an income year - the entity is an Australian resident for more than one half of the immediately preceding 12 months;

•

if the liability to FDT arises on or after the end of an income year - the entity is an Australian resident at all times during the income year; or

•

the entity is an Australian resident for more than one half of an income year.

Life insurance companies

Background

7.21 Taxation Laws Amendment Bill (No. 7) 2003 contains amendments to include imputation rules for life insurance companies in the SIS. These rules provide that franking credits and debits only arise in the franking account of life companies to the extent that the payment or refund of tax or the receipt of franked dividend income is attributable to the shareholders of the company.

7.22 This bill will amend the rules included in Taxation Laws Amendment Bill (No. 7) 2003 to provide FDT tax offset rules for life insurance companies. The amendments seek to ensure that an FDT offset can only be applied to that part of the company's income tax liability that is referable to shareholders. If this rule was not included a life company could over-frank the payment of dividend and apply the resulting FDT liability to offset the company's final income tax assessment liability including that part that is not attributable to shareholders.

Franking deficit tax offsetting rules

7.23 The tax offset rules set out in section 205-70 apply to life insurance companies but modified on the basis that references to an amount of income tax liability in that section were a reference to that part of the income tax liability that is attributable to shareholders [Schedule 7, item 5, subsection 219-70(1)]. This rule has the effect that the amount of FDT tax offset that can be applied by a life company is limited to the amount of the entity's income tax liability that is attributable to its shareholders after all other tax offsets have been deducted.

7.24 In working out the amount of income tax liability that is attributable to a company's shareholders, regard must be had to the company's accounting records. [Schedule 7, item 5, subsection 219-70(2)]

7.25 Sections 219-15 and 219-30 in Taxation Laws Amendment Bill (No. 7) 2003 set out events that give rise to franking credits and debits for life insurance companies. In working out franking credits or franking debits that arise where there is an FDT tax offset a modification is made to the shareholders' ratio as referred to in the method statement in section 219-50. This is referred to as the 'revised shareholders' ratio' which is worked out as follows:

Step 1: work out the amount that remains after the amount of FDT tax offset has been subtracted from the amount of income tax that is attributed to shareholders for the income year.

Step 2: divide the amount worked out under step 1 by the life insurance company's income tax liability for the income tax year after the tax offset has been applied in relation to the year.

[Schedule 7, item 5, subsections 219-75(1) and (2)]

7.26 A further rule is required to ensure the correct amount of franking credits or debits arise in the case of an amended assessment where either:

•

a tax offset was applied in the earlier assessment; or

•

a tax offset is applied in making the amendment of the previous assessment.

[Schedule 7, item 5, subsection 219-75(3)]

7.27 The rule operates to treat the reference to shareholders' ratio in section 219-55 of Taxation Laws Amendment Bill (No. 7) 2003 as if it were a reference to a revised shareholders' ratio. [Schedule 7, item 5, subsection 219-75(4)]

Example 7.3: Offset entitlement in respect of an original company tax assessment

X Co is a life insurance company. During the income year 2002-2003 X Co imputed to its shareholders more tax than it paid and as a result it has incurred an FDT liability of $68,000.

On 21 February 2004 X Co's income tax liability for the income year 2002-2003 is assessed as $400,000. Of that liability $80,000 is attributable to the shareholders' share of the income tax liability as calculated under the method statement in section 219-50 (i.e. shareholders' ratio of 20%). This is the amount of the company's income tax liability that would normally give rise to franking credits.

The company's FDT offset entitlement that can be applied against the 2002-2003 income tax liability is $68,000. The company's liability is reduced by the amount of the offset. Accordingly, that liability is reduced to $332,000. The company has paid $300,000 in PAYG instalments in the income year and it pays a further $32,000 on assessment.

The franking credits that will arise under item 2 in the table in section 219-15 is calculated by first determining the revised shareholders' ratio using the method statement in subsection 219-75(2):

Step 1: the difference between that part of the company's income tax liability that is attributable to its shareholders and the amount of the tax offset that has been applied (i.e. $12,000).

Step 2: divide the amount arrived at in step 1 by the company's income tax liability for the income year reduced by the tax offset (i.e. $12,000/$332,000). The revised shareholders' ratio is 3/83.

Using this ratio the amount of franking credits arising on the payment of PAYG instalments is $300,000 ? 3/83 (i.e. $10,843) and the payment of company tax is $32,000 ? 3/83 (i.e. $1,156).

On assessment the amount of franking credits that arise are $10,843 + $1,156 = $12,000.

Example 7.4: Tax paid after assessment

The same as Example 7.3 except the outstanding tax of $32,000 is paid after assessment.

The franking credits that arise are as follows:

•

under item 3 in the table in subsection 219-15(2)

$10,843 * ((3 / 83) * 300,000)


•

under item 4 in the table in subsection 219-15(2)

$1,156 * ((3 / 83) * 32,000)


The total amount of franking credits on and after assessment is $12,000.

Example 7.5: Amended company assessment

Following from Example 7.3, assume that X Co receives an amended assessment on 31 March 2004 which reduces the company's income tax assessment from $400,000 to $300,000 before taking into account any tax offset entitlement.

The amount of the amended assessment attributable to shareholder's funds is $60,000 (i.e. 20% shareholders' ratio). This is the amount of the company's liability to pay income tax that would normally give rise to franking credits.

The reduced offset entitlement will be $60,000. The balance of $8,000 can be carried forward to a subsequent year.

The company's liability to pay income tax is reduced by the amount of the tax offset. Accordingly, that liability is reduced to $240,000 (i.e. $300,000 - $60,000). The company receives a refund of $92,000. That is, the difference between the amount previously paid of $332,000 and the new income tax liability for the year.

Determine the revised shareholders' ratio using the method statement in subsection 219-75(2):

Step 1: the difference between that part of the company's income tax liability that is attributable to its shareholders and the amount of the tax offset that has been applied (i.e. $60,000 - $60,0000) which equals zero.

Step 2: divide the amount arrived at in step 1 by the company's income tax liability for the income year reduced by the tax offset (i.e. 0/240,000). The revised shareholders' ratio is zero.

The amount of franking credits that arise under the item at the time of the amended assessment is zero. Because of the operation of subsections 219-75(3) and (4) the franking credits that arose on the original assessment will be cancelled. The adjustment is a franking debit of $12,000 that arises on the day of the amendment of the assessment.

Example 7.6: Amended company assessment resulting from a change in shareholder ratio

Following on from Example 7.3, assume that X Co receives an amended assessment on 31 March 2004 because there has been a change in the shareholder's ratio from 20% to 15%. That is, of the assessed amount of $400,000, $60,000 is attributable to the shareholder's share of the income tax liability as calculated under the method statement in section 219-50.

The amount of FDT offset that can be applied against X Co's income tax liability is $60,000. The balance of $8,000 can be carried forward to a subsequent year.

The company's liability to pay income tax is reduced by the amount of the offset. Accordingly, that liability is reduced to $340,000 (i.e. $400,000 - $60,000).

The company has paid $300,000 in PAYG instalments and $32,000 on assessment. The company has an increased tax liability of $8,000 which it pays on receiving the amended assessment.

The amount of franking credits that can arise at the time of the amended assessment is zero. Because of the operation of subsections 219-75(3) and (4) the franking credits that arose on the original assessment will be cancelled. The adjustment is a franking debit of $12,000 that arises on the day of the amendment of the assessment.

Application and transitional provisions

Application of offset rules

7.28 Subject to rules inserted into the IT(TP) Act 1997, the amendments in items 1 to 8 will apply to events that occur on or after 1 July 2002, the start date for the SIS rules. [Schedule 7, item 9]

Income Tax (Transitional Provisions) Act 1997

Application of section 205-70

7.29 Apart from an exception that deals with late balancers, section 205-70 of the ITAA 1997 which deals with the FDT tax offset will apply in relation to an entity's assessment for the 2002-2003 and later income years. [Schedule 7, item 10, subsection 205-70(1)]

Late balancers - 2001-2002 income year

7.30 A transitional rule is required for late balancers for the 2001-2002 income year to ensure that the FDT offset rules apply properly for that year in relation to the removal of the franking additional tax penalty provisions.

7.31 The method statement in subsection 205-70(2) of the ITAA 1997 used to calculate an entity's tax offset entitlement is modified by the removal of step 2 (i.e. the rule that replaces franking additional tax where there is an excessive franking deficit). [Schedule 7, item 10, subsection 205-70(2)]

7.32 Under the modified method statement an amount of FDT will only arise under step 1 where an entity ceases to be a franking entity before the end of the income year. This is because an FDT liability will not arise at the end of the income year because of section 205-35 of the IT(TP) Act 1997. This provision operates so that an entity is not liable to pay FDT at the end of the 2001-2002 income year. Instead, the deficit is carried forward to the start of the 2002-2003 income year.

Late balancers - 2002-2003 income year

7.33 A transitional rule is also required for late balancers for the 2002-2003 income year to ensure that the removal of the franking additional tax penalty provisions apply properly in relation to late balancers who make an election referred to in section 205-20 of the IT(TP) Act 1997. The effect of an entity making this election is that their liability to pay FDT is determined under transitional provisions in sections 205-25 to 205-30 of the IT(TP) Act 1997. These provisions provide that the entity's FDT liability, if any, is determined at 30 June rather than the end of their income year.

7.34 The modified method statement provides that FDT incurred before 30 June 2003 is not subject to step 2 of the method statement in subsection 205-70(2) of the ITAA 1997 (i.e. the rule that replaces franking additional tax which reduces the offset by 30%) but step 2 is applied in relation to FDT liabilities incurred on or after that date. Step 2 also does not apply in relation to an FDT liability incurred in the 2001-2002 income year where the entity did not meet the residency requirement in that year [Schedule 7, item 10, subsection 205-70(3)]. Step 3 of the method statement will only apply where an entity ceases to be a franking entity before 30 June 2003.

Late balancers - later income years

7.35 A modified method statement will apply to late balancing entities that make an election under section 205-20 of the IT(TP) Act 1997 to have its FDT liability determined at 30 June. The method statement takes into account that in relation to the rule which reduces the offset by 30%, it is the franking credits that arose in the entity's franking account during the 12 months prior to 30 June that are relevant. The method statement also ensures that the 30% reduction to the FDT offset amount works appropriately for entities ceasing to be franking entities after 30 June in an income year [Schedule 7, item 10, subsection 205-70(4)]. This rule will have application for each income year that the entity makes an election to have its FDT liability determined at this date.

Tax offset for the first income year

7.36 A transitional rule applies to ensure any unapplied amounts of deficit deferral tax or FDT incurred in a previous income year are taken into account in determining the amount of an entity's entitlement to a tax offset in the first income year the new rules apply. These amounts, to be taken into account in step 6 of the method statement in subsection 205-70(2) of the ITAA 1997, are:

•

for ordinary companies these are liabilities referred to in paragraph 160AQK(1)(a) of the ITAA 1936; and

•

for life insurance companies these are liabilities referred to in paragraph 160AQKAA(1)(a) of the ITAA 1936.

[Schedule 7, item 10, section 205-75]

Determinations for income years ending before 1 July 2002

7.37 A transitional provision is included to ensure that determinations referred to in the former FDT offset rules in Subdivision C of Division 5 of the ITAA 1936 can be made in relation to income years ending before 1 July 2002 after 1 July 2002 even though the determination is made after 1 July 2002. [Schedule 7, item 10, section 205-80]

Consequential and related amendments

Income Tax Assessment Act 1936

7.38 An amendment is made to subsection 160AO(2) to change the meaning of 'the amount of Australian tax' so that it reflects that the FDT offset is not taken into account in calculating the amount of Australian tax. [Schedule 7, item 11]

Application

7.39 The amendment made by item 11 applies to an entity's assessment for the 2002-2003 income year and later income years. However, for late balancers the relevant assessment is for the 2001-2002 income year and a later income year. [Schedule 7, item 11]

Income Tax Assessment Act 1997

7.40 Notes are inserted at the end of subsections 219-50(1) and 219-55(1) to provide cross references to the FDT offsetting rules. [Schedule 7, items 6 and 7]

7.41 The Guide Material to Division 205 and section 205-5 is amended to reflect the new tax offset rules. [Schedule 7, items 1 to 4]

7.42 Section 13-1 of the ITAA 1997 is amended to reflect the FDT offset. [Schedule 7, items 13 and 14]

7.43 The rules contained in Taxation Laws Amendment Bill (No. 5) 2003 allow corporate tax entities to convert excess franking credits into a tax loss. The amendment will ensure proper interaction of those rules with the FDT offset rules. [Schedule 7, item 15]

7.44 An amendment is made to section 67-30 of the ITAA 1997 to ensure that the priority rule for refundable tax offsets interacts properly with the FDT offset rules. [Schedule 7, item 16]

7.45 The definition of 'residency requirement' in subsection 995-1(1) of the ITAA 1997 is amended to include a reference to the residency requirement in the new FDT offset rules. [Schedule 7, item 17]

Application

7.46 The amendments made by items 13 to 17 apply to an entity's assessment for the 2002-2003 income year and a later income year. However, for late balancers the relevant assessment is for the 2001-2002 income year and a later income year. [Schedule 7, item 18]

Taxation Administration Act 1953

7.47 An amendment is made to the method statements in sections 45-340 and 45-375 in Part 2-10 of Division 45 of the TAA 1953 to ensure that the FDT offset is not taken into account in formulating the rate of PAYG instalments. The FDT offset will be ignored because it is allowed only on assessment like other offsets that are already excluded and it is not necessarily reasonable to assume that an entity will again be liable to pay FDT in the subsequent income year. [Schedule 7, items 19 and 21]

Application

7.48 The amendment made to section 45-340 of Schedule 8 to the TAA 1953 applies in relation to the calculation of an entity's adjusted tax as follows:

•

for a base year that is the 2002-2003 income (or for late balancers, the 2001-2002 income year); and

•

in relation to a PAYG instalment period that includes or starts on the date of Royal Assent of this bill.

This ensures that the Commissioner is not required to recalculate an instalment rate given to an entity prior to the commencement of the amendments in this bill. [Schedule 7, item 20]

7.49 The amendment made to section 45-375 in Schedule 8 to the TAA 1953 generally applies in relation to the calculation of an entity's benchmark instalment rate, or benchmark tax for an income year in relation to an entity's assessment for the 2002-2003 income year or a later income year. However, for late balancers the amendment applies where the relevant assessment is that for the 2001-2002 income year or a later income year. [Schedule 7, item 20]

Index

Schedule 1: Franking of non-share dividends

Schedule 2: Various amendments relating to consolidated groups

Schedule 3: Conservation covenants

Schedule 4: Depreciation of cars for FBT

Schedule 5: Endorsement of perpetual bodies as deductible gift recipients

Schedule 6: Farm management deposits

Schedule 7: Simplified imputation system - franking deficit tax offset