Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 5 Trans-Tasman (triangular) imputation
Outline of chapter
5.1 Schedule 10 to this bill will amend the imputation rules in Part 3-6 of the ITAA 1997 so that NZ companies may choose to enter the Australian imputation system. The Australian imputation rules will generally apply to a NZ company in the same way as they apply to an Australian company. This means that a NZ company will be able to maintain an Australian franking account and attach Australian franking credits to dividends.
5.2 Where a NZ company receives a franked dividend from an Australian company or pays income tax or withholding tax, the NZ company will receive a franking credit and be able to frank dividends to its shareholders. Accordingly, Australian shareholders of NZ companies with Australian operations may receive franking credits and therefore be eligible for a tax offset reflecting Australian tax paid on Australian-sourced income (see Diagram 5.1).
Diagram 5.1
5.3 A NZ company may choose to operate an Australian franking account from 1 April 2003. However, a NZ company will not be able to make distributions with Australian franking credits until 1 October 2003.
Context of reform
5.4 Australian shareholders of NZ companies that earn Australian income are currently unable to access Australian franking credits arising from company tax paid on that income. The same problem exists with NZ shareholders of Australian companies that earn NZ income. In effect, both groups of shareholders are taxed twice on such income. This is known as 'triangular taxation'. The problem arises because Australia and NZ allow only resident companies to maintain imputation accounts.
5.5 'Triangular taxation' has been a subject of consultation between the Australian and NZ Governments. In a joint announcement on 19 February 2003 by the Australian Commonwealth Treasurer and NZ's Minister for Finance and Revenue, both Governments announced measures to resolve the 'triangular tax' problem (Treasurer's Press Release No. 7 of 19 February 2003). Australia and NZ will extend their imputation systems to include companies resident in the other country. Australian and NZ companies will be able to attach both Australian franking credits and NZ imputation credits to dividends.
Summary of new law
5.6 The Australian imputation rules will generally apply to a NZ company that chooses to enter the imputation system in the same way as they apply to an Australian company. This is achieved by providing that a NZ company will be treated as though it is resident in Australia.
5.7 However, some special rules are required to ensure that the imputation rules operate appropriately and to preserve the integrity of the imputation system. These rules, set out in new Division 220 in Part 3-6, will:
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- require a NZ company that wishes to enter the imputation system to notify the Commissioner accordingly;
- •
- enable the Commissioner to cancel a NZ company's choice to enter the Australian imputation system if the company does not pay its franking deficit tax or over-franking tax liability by the due date or fails to provide a franking return to the Commissioner;
- •
- allow franking credits to arise in the franking account held by NZ companies for dividend, interest and royalty withholding taxes deducted in Australia;
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- change the 'look-through' provisions in the exempting entity rules so Australian ownership can be traced through NZ companies and, in limited circumstances, companies that are not resident in Australia or NZ;
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- provide that a NZ listed company or a 100% subsidiary of a NZ listed company will not be an exempting entity even if it does not have more than 5% effective Australian ownership;
- •
- transfer franking credits and debits from the Australian subsidiary of a company not resident in Australia or NZ to the NZ company holding the non-resident company in the case of a wholly-owned group with a NZ parent company;
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- treat supplementary dividends or conduit tax relief additional dividends arising under NZ law as unfrankable dividends for Australian tax purposes;
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- reduce the tax offset that would otherwise arise in respect of a franked dividend paid by a NZ company to the extent of any supplementary dividend paid by the NZ company in relation to the dividend; and
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- impose joint and several liability on Australian and NZ companies in a wholly-owned trans-Tasman group for the payment of franking deficit tax, over-franking tax, related GIC and related administrative penalties where a NZ company defaults on its franking deficit tax or over-franking tax liability.
5.8 Under a transitional rule, an Australian subsidiary of a NZ company that becomes a former exempting entity will be allowed to retain franking credits accumulated before commencement, provided certain conditions are met.
Detailed explanation of new law
5.9 The main rules for NZ companies are set out in new Division 220. These rules relate to:
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- how a NZ company may enter the Australian imputation system;
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- franking distributions of NZ companies;
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- franking accounts of NZ companies;
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- transfer of franking credits and debits where a group includes a non-Tasman company;
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- effects of a supplementary dividend from a NZ franking company;
- •
- rules about exempting entities; and
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- joint and several liability for NZ company's unpaid franking liabilities.
Elections by a NZ company to enter the Australian imputation system
5.10 The imputation rules contained in Part 3-6 of the ITAA 1997 will apply to a NZ company that has chosen to enter the Australian imputation system in the same way as the rules apply to a company that is an Australian resident. This rule applies subject to certain modifications. This means, for example, that:
- •
- franking credits and debits will arise in the NZ company's franking account in accordance with the rules in Division 205;
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- the benchmark rule in Division 203 will apply so that franking credits can only be allocated in proportion to the shareholder's ownership in the company;
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- a NZ company must give shareholders a distribution statement on the payment of a franked dividend setting out information about the dividend; and
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- the exempting entity and former exempting entity rules in Division 208 will generally apply to a NZ company.
[Schedule 10, item 1, section 220-25]
5.11 A NZ company will enter the Australian imputation system if it is a 'NZ franking company'. The concept of 'NZ franking company' is central to these amendments. A company will be a NZ franking company if, at a particular time, the company:
- •
- is a NZ resident; and
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- has a NZ franking choice in force.
[Schedule 10, item 1, section 220-30]
5.12 'NZ resident' is defined in a similar manner as resident for Australian income tax purposes (see subsection 6(1) of the ITAA 1936) [Schedule 10, item 1, section 220-20] . The definition for both a company and an individual is summarised in Table 5.1.
| Entity | Residency test |
|---|---|
| Company |
The company:
|
| Natural person |
The person:
|
5.13 A person is not a NZ resident if the person is an Australian resident. This means that a company that is resident in both Australia and NZ will not be treated as a NZ resident for the purpose of these rules, avoiding any overlap between the general imputation rules and the specific rules applying to NZ companies. [Schedule 10, item 1, subsection 220-20(5)]
5.14 A NZ company that chooses to enter the Australian imputation system must make an election (called a 'NZ franking choice') by notifying the Commissioner in the approved form. [Schedule 10, item 1, section 220-35]
5.15 A NZ franking choice will generally be in force from the start of the income year in which the notice was given to the Commissioner. If a later income year is specified by a company, the company's NZ franking choice will be in force from the start of the specified income year. A NZ franking choice will continue in force until it is revoked by the company or cancelled by the Commissioner. [Schedule 10, item 1, section 220-40] .
5.16 A company can revoke a franking choice by notifying the Commissioner in the approved form. [Schedule 10, item 1, section 220-45]
5.17 Because of the potential difficulties involved in recovering a tax liability from a non-resident company, the Commissioner will be able to cancel a company's franking choice by written notice if the company does not:
- •
- pay its franking deficit tax or over-franking tax liability by the due date; or
- •
- provide a franking return to the Commissioner as required.
[Schedule 10, item 1, subsection 220-50(1)]
5.18 A company which has had its franking choice cancelled will only be able to make another franking choice if the Commissioner consents. [Schedule 10, item 1, subsection 220-50(4)]
5.19 A company will be able to object against the cancellation of its NZ franking choice under Part IVC of the TAA 1953. [Schedule 10, item 1, subsection 220-50(3)]
Franking distributions of NZ companies
5.20 An entity must generally satisfy the residency requirement in section 202-20 to make a franked distribution. This requirement also applies for an entity franking a distribution with exempting credits. A NZ company will satisfy this requirement because of the application of new section 220-25. The general residency requirement will be modified for NZ companies. The residency requirement will only be satisfied if a distribution is made at least one month after a NZ franking choice is made. [Schedule 10, item 1, section 220-100]
5.21 A NZ company will be able to attach both Australian franking credits and NZ imputation credits to the same dividend. This means that, for example, a dividend paid by a NZ company may be both fully franked and fully imputed.
5.22 A payment by a NZ company that is a 'conduit tax relief additional dividend' or a 'supplementary dividend' under section OB1 of the Income Tax Act 1994 (NZ) will be treated as an unfrankable distribution, consistent with the NZ tax treatment of these payments. These 'dividends' are, in general terms, payments by a NZ company to a non-resident shareholder (i.e. a shareholder not resident in NZ) that represent either a refund or an exemption from NZ company tax. [Schedule 10, item 1, section 220-105]
5.23 The maximum franking credit that can be attached to a distribution is generally the maximum amount of corporate tax that can be paid on the amount of the distribution grossed up by the maximum amount of corporate tax. This amount is calculated using the formula set out in subsection 202-60(2).
5.24 A NZ company might inadvertently breach this rule because of a fluctuation in the exchange rate between the time a company decides the amount of the franking credit to be attached to a distribution and the time the distribution is made.
5.25 To avoid this outcome, the general rule will be modified so that, for distributions made in another currency (e.g. NZ$), the maximum franking credit for a distribution will be calculated using the exchange rate applicable at the time of the decision to make the distribution. [Schedule 10, item 1, section 220-110]
Example 5.1
NZ Co decides to pay a dividend in NZ$ to an Australian shareholder. Under the exchange rate applicable on that day, the distribution converts to A$70. The NZ company decides to fully frank the distribution, so a A$30 franking credit is attached. Under subsection 202-60(2) of the ITAA 1997 this is the maximum franking credit that can be allocated to the distribution.
On the day the dividend is paid, the exchange rate is such that the dividend is worth A$65. However, the distribution will not be over-franked because of new section 220-110.
Franking account of a NZ company
Franking account to be in Australian currency
5.26 A NZ company is required to maintain its franking account in Australian currency. [Schedule 10, item 1, section 220-200]
Franking credits for withholding taxes
5.27 A NZ franking company will receive a franking credit for the payment of Australian dividend, interest or royalty withholding tax which is imposed by section 128B of the ITAA 1936 [Schedule 10, item 1, section 220-205] . The amount of the franking credit will be equivalent to the amount of withholding tax paid. The franking credit will arise at the time the withholding tax is paid. This franking credit recognises that withholding taxes, like company tax, represent an additional layer of Australian tax on Australian income received by Australian shareholders.
Effect of franked distributions made to a NZ franking company
5.28 A non-resident entity is not entitled to a tax offset in respect of a franked dividend. Such dividends are exempt from withholding tax, which represents a final tax liability. The operation of new section 220-25 would result in a NZ franking company being treated as a resident for the purpose of the residency requirement in section 207-75, and therefore cause a tax offset to arise. A specific rule is required to cancel the tax offset that would otherwise arise. This rule is set out in new section 220-210. [Schedule 10, item 1, section 220-210]
Effect on franking account if NZ franking choice ceases to be in force
5.29 If a NZ franking choice is revoked or cancelled, the following consequences, which are equivalent to the consequences of a company ceasing to be a franking entity, will arise:
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- if a company's franking account balance is in surplus, the balance will be cancelled by a franking debit equal to the amount of the surplus; and
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- if a company's franking account balance is in deficit, a franking deficit liability will arise under section 205-45. [Schedule 10, item 1, subsections 220-215(1) to (3)]
5.30 In working out whether the company's franking account is in surplus or deficit it will be necessary to take into account any franking debits that arise under new section 220-605. This section provides that a franking debit arises in a NZ company's franking account that is a former exempting entity where the franking choice ceases to be in force and the company's exempting account is in deficit. [Schedule 10, item 1, subsection 220-220(5)]
Transfer of franking credits and debits where a group includes a non-Tasman company
5.31 Where a company that is not resident in Australia or NZ is interposed between an Australian or NZ subsidiary company, the Australian subsidiary or another NZ company would generally not be able to pass on franking credits to the NZ holding company.
5.32 However, a special rule will apply in the case of wholly-owned groups with a NZ parent company if all NZ companies in the group have made a NZ franking choice. In general terms, franking credits and debits that would otherwise arise in the franking account of the subsidiary (the 'franking donor company') will be transferred to the franking account of the NZ company (the 'recipient company') that holds the shares in the interposed company. [Schedule 10, item 1, subsection 220-300(1)]
5.33 This rule will only apply from the time that all NZ companies in the group have made a NZ franking choice, that is, it will not apply from the start of the income year to which a NZ franking choice applies. A NZ company that has made a NZ franking choice is referred to as a 'post-choice NZ franking company' to reflect this timing requirement. [Schedule 10, item 1, subsection 220-300(2)]
5.34 If the franking account of the franking donor company is in surplus when these conditions are satisfied:
- •
- a franking debit will arise in the franking account of the franking donor company equal to the surplus in the franking account; and
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- a franking credit equal to the surplus will arise in the franking account of the NZ recipient company. [Schedule 10, item 1, subsection 220-300(3)]
5.35 If the franking account of the franking donor company is in deficit when these conditions are satisfied, the company will incur a franking deficit tax liability in the same way as if the company had ceased to be a franking entity. [Schedule 10, item 1, subsection 220-300(4)]
5.36 If franking credits or debits arise in the franking account of the franking donor company after the time the above conditions are first met, the credits or debits arise in the franking account of the NZ recipient company. [Schedule 10, item 1, subsection 220-300(5)]
5.37 The Australian subsidiary will continue to be able to frank distributions but the franking debit will arise in the NZ company's franking account. The benchmark franking percentage of the company transferring the franking credits will not be affected because of franking debits or credits arising instead in the NZ companies' account. [Schedule 10, item 1, subsection 220-300(7)]
5.38 Diagram 5.2 illustrates how franking credits and debits will be transferred from the franking account of the franking donor company to the franking account of the NZ recipient company.
Diagram 5.2
5.39 If the franking donor company becomes a former exempting entity when the conditions are satisfied, adjustments will be made so the franking account of the company has a nil balance. This will ensure that franking credits or debits that arise in relation to the company's transition from an exempting entity to a former exempting entity will not be inappropriately transferred to the NZ company. [Schedule 10, item 1, subsection 220-300(8)]
Effects of supplementary dividend from a NZ franking company
5.40 If a NZ company pays a supplementary dividend in relation to a franked dividend, the tax offset that a taxpayer would otherwise receive because of the franking credit attached to the dividend will be reduced by the amount of the supplementary dividend if the taxpayer also receives a foreign tax credit. [Schedule 10, item 1, section 220-400]
5.41 A supplementary dividend is a payment paid by a NZ company to a non-resident shareholder as part of NZ's foreign investor tax credit regime. A supplementary dividend, in effect, represents a refund of the NZ company tax paid in respect of the underlying income to ensure that the effective tax rate for a non-resident investor does not exceed the NZ company tax rate.
5.42 When combined with an imputation tax offset, a supplementary dividend could result in a taxpayer gaining an undue tax advantage by investing in Australia indirectly through a NZ company rather than directly through an Australian company. The tax offset will be reduced by the amount of the supplementary dividend to prevent this outcome.
5.43 Where this rule applies, the 'gross-up amount' to be included in the taxpayer's assessable income under subsection 207-20(1) because of the franking credit will be reduced by the amount of the supplementary dividend. The tax offset will be reduced by the same amount. [Schedule 10, item 1, subsections 220-400(2) and (3)]
5.44 If a taxpayer's entitlement to a tax offset is to be reduced under paragraph 207-150(2)(b) because of manipulation of the imputation system, the amount by which the offset is to be reduced because of the manipulation is to be calculated using the reduced tax offset reflecting the supplementary dividend. [Schedule 10, item 1, subsection 220-400(4)]
Example 5.2
Kiwi Co pays a franked dividend to Bob, an Australian shareholder, with a value of A$70. The dividend is fully franked, that is, a A$30 franking credit is attached. Kiwi Co also pays a supplementary dividend with a value of A$5 to Bob. NZ non-resident withholding tax is applied at the rate of 15%. Bob receives a cash dividend of A$63.75 net of NZ non-resident withholding tax.
The consequences for Bob receiving a franked dividend from Kiwi Co which includes a supplementary dividend are set out below:
Income Distribution A$63.75 Foreign tax paid A$11.25 Franking credit A$30.00 Less supplementary dividend ( A$5.00 ) Assessable income A$100.00 Tax payable (assume rate of 48.5%) A$48.50 Less Foreign tax credit (A$11.25) Tax offset reduced by supplementary dividend ( A$25.00 ) Tax payable by Bob A$12.25
5.45 An equivalent rule will apply in relation to indirect distributions, that is through a trust or partnership. In this case, a deduction will be required rather than a reduction in the 'gross-up amount'. [Schedule 10, item 1, section 220-405]
Franking credit reduced if tax offset reduced
5.46 If a corporate tax entity's tax offset in relation to a dividend is reduced because a supplementary dividend is paid in connection with the dividend, the franking credit arising in that entity's franking account because of the distribution will be equal to the reduced tax offset. [Schedule 10, item 1, section 220-410]
Distributions franked with an exempting credit
5.47 If a NZ franking company that is a former exempting entity franks a dividend with an exempting credit, and a supplementary dividend is paid in relation to the dividend, the tax effects of the exempting credit that arise under Subdivision 208-H will be adjusted in the same way. [Schedule 10, item 1, section 220-700]
Rules about exempting entities
5.48 Some changes to the exempting entity rules are required to accommodate trans-Tasman (triangular) imputation reform. Under the exempting entity rules set out in Division 208 of the ITAA 1997, franked dividends paid by a company that is not more than 5% effectively owned by prescribed persons (broadly, non-exempt Australian residents) generally do not convey franking benefits to resident shareholders. Such companies are called exempting entities.
5.49 Effective Australian ownership of an Australian company cannot be traced through a non-resident company. Unless changes were made to the exempting entity rules, an Australian or NZ subsidiary of a NZ company would be an exempting entity regardless of the extent of Australian ownership of its NZ parent company.
5.50 The law will be amended so that a NZ franking company will not be automatically treated as a prescribed person under section 208-40. This means that a NZ franking company can be looked through to find effective Australian ownership, so that an Australian or NZ subsidiary of a NZ franking company that has more than 5% effective Australian ownership will not be an exempting entity. This rule is illustrated in Diagram 5.3. [Schedule 10, item 1, section 220-505]
Diagram 5.3
5.51 It is possible that a NZ listed company would be an exempting entity notwithstanding the look-through approach, that is because it has less than 5% effective Australian ownership. A NZ listed company that is a NZ franking company, together with any Australian or NZ 100%-owned subsidiaries, will not be treated as exempting entities. [Schedule 10, item 1, subsection 220-500(2)]
5.52 This concession is intended to assist NZ companies that wish to increase their Australian shareholder base. The application of the general exempting entity rules to NZ listed companies would be inappropriate in the context of triangular reform. The concession is confined to NZ listed companies to maintain the integrity of the exempting entity rules.
5.53 The third change to the exempting entity rules is to provide that a company that is a member of a wholly-owned group with a parent company that is a NZ franking company that includes a company not resident in Australia or NZ will not be an exempting entity if the parent company is not an exempting entity. [Schedule 10, item 1, section 220-510]
5.54 This rule complements the rule in new section 220-300, which provides for the transfer of franking credits and debits from the franking account of an Australian or NZ subsidiary of a company not resident in Australia or NZ to the franking account of the NZ company that holds the non-resident company. The Australian or NZ subsidiary would otherwise be an exempting entity.
5.55 If an Australian or NZ company becomes a former exempting entity because one or more NZ companies become NZ franking companies, it will generally become a former exempting entity at the time that the NZ companies make a NZ franking choice. The company would not become a former exempting entity from the start of the income year to which the NZ franking choice relates. This outcome is achieved by the concept of 'post-choice NZ franking company', which is explained in paragraph 5.33. This is illustrated in Diagram 5.4.
Diagram 5.4
NZ companies' exempting accounts
5.56 As for franking accounts, an exempting account of a NZ franking company must be kept in Australian currency. [Schedule 10, item 1, section 220-600]
5.57 Where a NZ franking company that is a former exempting entity ceases to be a NZ franking company, the exempting account of the company will be treated in the same way as if the company had ceased to be a corporate tax entity. The following exempting credits and debits are made if a NZ company is a former exempting entity and its NZ franking choice ceases to have effect:
- •
- if the exempting account is in surplus - an exempting debit arises in the exempting account equal to the amount of the surplus; or
- •
- if the exempting account is in deficit - an exempting credit equal to the deficit arises in the exempting account at the relevant time (and an equal franking debit arises).
[Schedule 10, item 1, section 220-605]
Joint and several liability for NZ resident company's unpaid franking liabilities
5.58 Joint and several liability will be imposed on members of a trans-Tasman group to overcome the potential difficulty of recovering an Australian tax liability from a NZ company. If a NZ company that is a member of a wholly-owned group fails to meet its franking-related tax obligations on time, the Commissioner will be able to seek to recover the franking-related liability of the NZ company directly from an Australian entity or another NZ company that is a member of the same wholly-owned group. [Schedule 10, item 1, section 220-800]
5.59 There will be an exception for entities prohibited by an Australian or NZ law from entering into such an arrangement. This exception recognises prudential requirements that apply, for example, to the banking and finance industry.
5.60 Joint and several liability will be imposed on all members of a wholly-owned group that includes a NZ franking company. There will be an exception for entities prohibited by an Australian or NZ law from entering into such an arrangement.
5.61 Joint and several liability under these rules will be confined to a NZ company's franking-related liabilities:
- •
- franking deficit tax, imposed on a company that has a deficit balance in its franking account at the end of the income year;
- •
- over-franking tax, imposed on a company that attaches a franking credit to a distribution in excess of the company's benchmark franking percentage, in breach of the benchmark rule;
- •
- the GIC payable in respect of franking deficit tax and over-franking tax incurred by the NZ company; and
- •
- an administrative penalty relating to another franking-related liability.
5.62 The liability of resident entities will be determined in a similar way as for members of a consolidated group under Division 721 of the ITAA 1997:
- •
- a NZ company will be solely liable, in the first instance, for its franking deficit tax and over-franking tax liability. If the NZ company fails to meet its franking deficit tax or over-franking tax liability by the time the liability becomes due and payable, each resident or NZ entity that was a member of the group at any time during the income year for which the liability arose would become jointly and severally liable for the liability together with the NZ company;
- •
- the joint and several liability will arise immediately after the defaulting NZ company's liability became due and payable;
- •
- the joint and several liability of a particular member will become due and payable 14 days after the member is given notice of the liability by the Commissioner; and
- •
- the franking-related liability will be treated as an income tax liability for the purposes of section 254 of the ITAA 1936, which provides for the recovery of a tax liability from an agent or trustee.
Related amendments
5.63 A number of minor consequential amendments will be made to the ITAA 1997:
- •
- section 200-45 will be amended to include a reference to the new imputation rules for NZ companies [Schedule 10, item 2] .
- •
- section 202-45, which lists unfrankable distributions, will be amended to also include distributions which section 220-105 lists as unfrankable [Schedule 10, item 3] .
- •
- amendments will be made to subsection 995-1(1) to include new dictionary terms and also to update existing definitions to take account of the new measures [Schedule 10, items 4 to 11] .
5.64 A consequential amendment will also be made to the TAA 1953 to insert a note to subsection 250-10(2) of Schedule 1. [Schedule 10, item 12]
Amendments contingent on imputation for co-operative companies
5.65 A number of technical contingent amendments relating to the imputation rules for co-operative companies contained in Taxation Laws Amendment Bill (No. 8) 2002 [F6] may be required if that bill receives Royal Assent after this bill. [Schedule 10, items 13 to 16]
Amendments contingent on taxation of financial arrangements
5.66 A number of technical amendments will be made which are contingent on the proposed reform of the income tax law concerning foreign exchange gains and losses [F7] . These amendments will be required to ensure consistency with those rules. [Schedule 10, items 17 to 23]
Income Tax (Transitional Provisions) Act 1997
5.67 Division 220 of the ITAA 1997 and the related amendments will apply on and after 1 April 2003. [Schedule 10, item 24, section 220-1]
5.68 In determining whether a NZ franking company meets the residency requirement for the income year including 1 April 2003 things that happen before that time can be taken into account. This means that the residency test will generally apply in relation to the whole of the income year including 1 April 2003, not merely to the period from 1 April 2003 until the end of the income year. [Schedule 10, item 24, section 220-5]
A NZ company cannot frank before 1 October 2003
5.69 A NZ franking company will not be able to frank a distribution (including with an exempting credit) made before 1 October 2003. [Schedule 10, item 24, section 220-10]
Extended time to make a NZ franking choice
5.70 A company that is a NZ resident may make a NZ franking choice that comes into force at the start of the company's income year including 1 April 2003 by giving notice in the approved form to the Commissioner before the end of the next income year. This rule will enable a NZ resident company to make the choice at any time before 1 July 2004 and that choice will apply from 1 April 2003. [Schedule 10, item 24, section 220-35]
Franking and exempting accounts of former exempting entities
5.71 As a transitional measure, an Australian subsidiary of a NZ franking company will be allowed to retain franking credits accumulated before the subsidiary becomes a former exempting entity. This rule will apply if the subsidiary becomes a former exempting entity as a result of the NZ company making a NZ franking choice that comes into force at the start of the NZ company's income year that includes 1 April 2003. [Schedule 10, item 24, subsection 220-501(1)]
5.72 The subsidiary will become a former exempting entity at the time that the NZ company makes a NZ franking choice. This time is called the 'switch time'.
5.73 A subsidiary will be entitled to retain franking credits accumulated before the switch time provided that the subsidiary would have not been an exempting entity if the changes to the exempting entity rules had applied retrospectively. In other words, the subsidiary will retain credits accumulated before the switch time if, during the period starting on 13 May 1997 (when the exempting entity rules commenced) and ending on the switch time, either:
- •
- effective Australian ownership of the company, determined using the look-through approach, was always greater than 5%; or
- •
- the company was a 100% subsidiary of a NZ listed company. [Schedule 10, item 24, subsections 220-501(2) and (3)]
5.74 If the subsidiary satisfies one of these conditions for a shorter period ending on the switch time, it will retain franking credits accumulated during that period. Credits accumulated during the period will be determined by subtracting the franking account balance at the start of that period from the franking account balance at the switch time. [Schedule 10, item 24, subsections 220-501(2) and (3)]
5.75 Under the general exempting entity rules, the franking account balance of a company is transferred to the company's exempting account when it becomes a former exempting entity. To ensure that a subsidiary will retain the relevant franking credits, an exempting debit and a franking credit will arise to reverse the transfer. [Schedule 10, item 24, subsection 220-501(7)]
Example 5.3
Ausco is sold on 1 January 1998 to NZ Co, a NZ listed company. Ausco consequently becomes an exempting entity because it is 100% owned by a prescribed person as described in section 208-40 of the ITAA 1997. There are no further changes in ownership between the time of acquisition and 1 April 2003.
On 1 March 2004, NZ Co makes a franking choice which is in force for the NZ income year commencing 1 April 2003. Ausco consequently becomes a former exempting entity on 1 March 2004.
If new section 220-500 had been in operation between 1 January 1998 and 1 March 2004, Ausco would not have been an exempting entity as it is a subsidiary of a NZ listed company.
Ausco has a franking surplus of $2 million at 1 January 1998 and a franking surplus of $5 million on 1 March 2004. A franking credit will arise in Ausco's franking account and an exempting debit will arise in its exempting account immediately after it becomes a former exempting entity. The amount of the franking credit and exempting debit will be $3 million, the difference between Ausco's franking surplus on 1 January 1998 and its franking surplus on 1 March 2004.
REGULATION IMPACT STATEMENT
5.76 Trans-Tasman (triangular) imputation reform is designed to improve the ease of trans-Tasman capital flows by reducing an additional layer of tax on those flows by providing relief to Australian (or NZ) investors from the residence taxation imposed on income that has already been taxed at source through company and withholding taxes by Australia (or NZ).
5.77 The proposal is also designed to further strengthen the important bilateral relationship between Australia and NZ, which is formalised under the Closer Economic Relations agreement.
5.78 The problem of triangular taxation arises because Australian shareholders of a NZ company earning Australian income are unable to access Australian franking credits arising from the payment of Australian tax on that income because the credits are unable to flow through the NZ company. (A similar problem applies for NZ shareholders of Australian companies earning NZ income).
5.79 The triangular reform proposal arose directly from a recommendation of the Review of Business Taxation. The implementation option that forms the basis of this reform proposal can be found in Recommendation 20.6 of A Tax System Redesigned.
"That the Australian Government propose to the NZ Government that discussions be held with a view to introducing a mechanism to allow franking credits to flow through trans-Tasman companies on a pro-rata basis to Australian and NZ investors."
5.80 On 6 March 2002, the Australian and NZ governments jointly released a discussion paper on triangular taxation to serve as a basis for business consultation on the feasibility of implementing a pro-rata solution to triangular taxation.
5.81 Although the discussion paper focused primarily on issues concerning the possible implementation of a pro-rata solution to triangular taxation, there are a number of other options (noted in the paper) that could be used to achieve the policy objective identified above including:
- •
- mutual recognition of franking credits;
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- triangular (dividend) streaming; and
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- apportionment.
5.82 Mutual recognition involves the provision of franking credits for company taxes paid in another country. In the case of Australia and NZ, it would mean allowing a franking credit generated in NZ (by the payment of NZ company tax) to accompany a dividend distributed to an Australian resident shareholder and vice versa. The credit would remain attached to the dividend and could be used as a rebate against the Australian resident's tax liability.
5.83 Triangular (dividend streaming) involves distributing dividends with franking credits attached to those shareholders for whom the credits are of maximum value. Australian franking credits are of no value to a NZ parent's NZ shareholders, and the converse applies for NZ imputation credits. As such, the NZ parent would direct all its Australian franking credits to its Australian shareholders and all its NZ imputation credits to its NZ shareholders. Australian shareholders therefore receive more than their pro-rata entitlement of franking credits.
5.84 Apportionment involves attaching credits to dividends split into Australian and NZ franking credit components according to the ratio of income earned in either country and in equal proportions for all shareholders. This method is similar to pro-rata allocation except that the credits are allocated not only in proportion to the residence of the shareholder, but also in proportion to the country in which the income is earned. It would give the same result as pro-rata allocation when a company had no previous balances of credits and fully distributed all tax-paid income.
5.85 These other options were briefly discussed in the discussion paper, which clearly stated that the pro-rata option was the only one being considered for implementation. Although business have indicated in submissions and in consultation that they would prefer the more generous options of mutual recognition or triangular (dividend) streaming, these options exceed what is required to solve triangular taxation. The apportionment approach was strongly rejected by business because of its high compliance costs and because the outcome under apportionment was not as generous as under the pro-rata proposal.
5.86 The underlying principle used in developing a mechanism to facilitate the pro-rata reform proposal is that Australian shareholders who invest in a NZ company that earns Australian income should be neither better off nor worse off in taxation terms than if they had earned that income directly from an Australian company. This implies that NZ companies maintaining an Australian franking account should be subject to the same imputation rules as Australian companies.
5.87 This was the starting point in developing the mechanism but some changes to Australia's imputation rules were required to make triangular workable for NZ companies.
5.88 Although the direct cost to revenue of the triangular reform can be estimated, the dynamic gains to revenue from the reform proposal cannot be reliably quantified. This is because there is no reliable information on the extent to which the reform will ease trans-Tasman capital flows and free up the dividend distribution policies of trans-Tasman companies. Estimating these effects accurately would require information on the behavioural responses of trans-Tasman companies and shareholders to the reform. Behavioural responses are intrinsically difficult to model and they are made more so when the effects have to be considered in more than one country.
5.89 The reform proposal will have an impact on NZ companies that earn income in Australia, have Australian shareholders and have made a NZ franking choice. NZ companies that wish to pass franking credits to their Australian shareholders will make a choice to maintain Australian franking accounts and these changes will have an impact on these companies. The changes will have no impact on those NZ companies that do not make the choice.
5.90 Data on the number of NZ companies that earn Australian income and have Australian shareholders is not generally available. However, it is anticipated that between 500 to 1,000 NZ companies may elect into triangular reform. There are between 50 to 100 large Australian companies that pay tax in NZ and have NZ shareholders who may benefit from triangular reform albeit from changes to NZ's imputation system. It is not known how many smaller Australian enterprises pay tax in NZ and have NZ shareholders.
5.91 NZ companies that make a choice to enter the Australian imputation system will incur a minor increase in compliance costs in complying with Australia's imputation rules. Australian companies that elect into triangular reform will incur a similar increase in costs in having to comply with NZ's imputation rules.
5.92 NZ companies will have to maintain an Australian franking account in addition to a NZ imputation account. This will involve an up-front cost in setting up a system to monitor the Australian franking credit balance and amending distribution statements to include information about Australian franking credits attached to a dividend. There will also be an ongoing cost that would be similar to the cost of maintaining a NZ imputation account. Data is not available to make an accurate assessment of the quantum of these costs but it is expected that they would be minimal.
5.93 There will be an increase in administrative costs for the ATO. Forms and systems changes will be required to support the election mechanism and also the collection of tax from NZ companies. Information booklets and promotional material will be prepared to advise NZ companies and Australian shareholders about the new rules.
5.94 There will also be a need for the ATO to undertake specific compliance activities in relation to NZ companies. These activities will include the exchange of information with NZ's Department of Inland Revenue.
5.95 The recommendations are estimated to have a revenue cost of $5 million in 2003-2004, $20 million in 2004-2005, $20 million in 2005-2006 and $25 million in 2006-2007.
5.96 Although the Closer Economic Relations agreement has made significant inroads towards creating a single market between Australia and NZ, the capital market remains the least integrated part of the trans-Tasman market and taxation disincentives may be impeding the flow of capital. Reform of triangular taxation will improve the ease of trans-Tasman capital flows by reducing an additional layer of tax on those flows.
5.97 Triangular reform will reduce the incentive for trans-Tasman companies to establish a separate structure in the other jurisdiction and seek shareholders in the other jurisdiction. This option is costly and is only effectively open to large companies with significant operations in both countries.
5.98 The reform will further strengthen the important bilateral relationship between the 2 countries.
5.99 The discussion paper released in March 2002 called for submissions on the pro-rata reform proposal. Submissions were generally supportive of the more generous options of mutual recognition or triangular (dividend) streaming to solve the triangular problem.
5.100 A consultation workshop was held in June 2002 to discuss issues raised in submissions to the discussion paper. As a result of the consultation process, changes were made to aspects of the reform proposal as outlined in the discussion document. There was also further consultation in March/April 2003 on a detailed description of the proposed triangular rules.
5.101 A number of concessions sought by taxpayers in consultations were accepted:
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- franking credits accumulated by the Australian subsidiaries of NZ companies before commencement of the measure will not be 'quarantined' as exempting credits, so that the franking credits may be passed to NZ parent companies;
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- NZ companies within a wholly-owned group will be able to access franking credits accumulated by an Australian subsidiary of a company that is not an Australian or NZ resident; and
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- joint and several liability for franking deficit tax and other imputation-related taxes that a NZ company fails to pay will be imposed on related companies only in the case of a wholly-owned group.
5.102 Triangular reform will result in a minor increase in compliance costs for those Australian and NZ companies that choose to enter into the Australian imputation system.
5.103 The triangular reform proposal is expected to improve the ease of trans-Tasman capital flows and further strengthen the bilateral relationship between Australia and NZ. The benefits of the reform are expected in the longer term to outweigh the revenue costs.