House of Representatives

Taxation Laws Amendment (Company Distributions) Bill 1987

Taxation Laws Amendment (Company Distributions) Act 1987

Second Reading Speech

by the Hon. P.J. Keating, M.P.

This Bill will give effect to the most significant business taxation reform in this country in the post war years - the elimination of the double taxation of company dividends.

It will do this by amending the income tax law to introduce, with effect from 1 July 1987, the full imputation system of company tax announced on 10 December 1986.

It will also give effect to a number of the related measures that were also announced on that day.

Under the imputation system, dividends paid by Australian companies will be relieved from tax in the hands of resident individual shareholders by a rebate to the extent to which tax has been paid at the corporate level.

Dividends relieved from tax in this way will be known as franked dividends.

Such dividends when paid to non-residents will be exempt from withholding tax. The Australian imputation system is a world first.

It will put Australia at the forefront of business tax reform, and give us one of the most advanced and efficient tax regimes in the world.

It will restore the position of the stockmarket as the mobiliser of investment funds and reduce the previous bias in favour of corporate debt finance over equity.

It will mean that entrepreneurs trying to get new businesses off the ground should find it easier to raise equity finance.

It will make investment in these enterprises relatively more attractive for investors.

It will improve the climate for productive investment and enhance economic growth for Australia.

It will provide increased incentives for all Australians to participate in the ownership of Australian companies by significantly reducing taxes on dividend income.

In conjunction with the substantial personal income tax cuts being delivered by this government, imputation will result in a reduction of up to 40 per cent in the overall tax burden for shareholders and small businesse.d

To put this another way, imputation will substantially increase the after-tax return to shareholders.

Under the existing system and before the personal tax cuts already in place, a dividend paid to a shareholder in the top tax bracket was effectively taxed at a rate of 78.4 cents in the dollar.

The return to the shareholder was 21.6 cents in the dollar.

Under imputation and with the maximum personal tax rate and company tax rate to operate from 1 July aligned, the maximum tax that will be paid on any dividends will be 49 cents in the dollar.

The return to the shareholder will be 51 cents in the dollar - a return more than twice as much as under the old system.

And for taxpayers in the middle to lower income ranges the outcome will be just as favourable, as any excess rebate on franked dividends will be available to reduce tax on other income, including capital gains.

The direct cost of these changes, and of the associated abolition of division 7 additional tax on the undistributed profits of private companies for which legislation will be introduced shortly, will be almost $500 million in a full year.

In my announcement of 10 December 1986, I indicated that the Government would also eliminate the double taxation of company income derived by non-residents from Australian sources.

This Bill will implement that proposal by abolishing dividend withholding tax on franked dividends paid after 30 June 1987 to non-residents, and the branch profits tax on income of the 1986-87 and later income years.

This will be at a further full year cost of $280 million.

The total cost of all these changes amounting to $775 million will be offset in part by the increase of 3 percentage points in the company tax rate from 1 July that will be given effect by the accompanying income tax rates amendment Bill 1987.

The net benefit of all of these changes for taxpayers will therefore be $300 million in a full year.

This will be on top of the benefit of $4.5 Billion in personal income tax cuts delivered by this government from 1 December last year and 1 July this year - in part paid for by action that only this government was prepared to take in properly closing longstanding gaps in the income tax base relating to capital gains, fringe benefits and the substantiation of claims for income tax deductions.

As part of the package announced on 10 December 1986 the Bill will modify the scope of liquidation distributions which are brought within the income tax base.

Liquidator's distributions out of realised capital gains on taxable assets acquired after 19 September 1985 will be taxed as dividends, and be dealt with under the new imputation arrangements.

The same treatment will apply to distributions out of other profits that are assessable income, but which are not presently taxed on liquidation.

And finally, the Bill will deny the intercorporate dividend rebate on dividends paid before 1 July 1987, and on unfranked dividends paid on and after that date, being dividends that are in effect paid in substitution for payments of interest under certain finance arrangements.

The revenue savings from these two measures are unquantifiable, but are expected to be significant.

I turn now to the main features of the Bill.

Full imputation

By the measures contained in this Bill, tax paid at the company level will be imputed, or allocated, to shareholders by means of imputation credits attached to dividends they receive.

Such dividends will be known as franked dividends.

An amount equal to the imputation credits attached to franked dividends will be included in the assessable income of resident individual shareholders, who will then be entitled to a rebate of tax equal to the amount included in their income.

The extent to which a company May frank a dividend will depend on the credit or surplus balance in its franking account at the time of payment of the dividend.

Credits to this account will most commonly arise when a company pays a company tax instalment or when a company tax assessment is issued.

Credits will also arise whenever a company receives a franked dividend from another company.

In this way, credit for company tax borne by one company will be effectively transferred to the company receiving the franked dividend to allow that company in turn to frank dividends it pays to its shareholders.

Predominantly, debits to the franking account will be for the payment of franked dividends.

Special statutory rules will apply to determine, in any given situation, the minimum amount to which a dividend is to be franked.

Subject to an exception for small balances, the basic rule is that a company must frank dividends to the extent permitted by the franking account surplus at the date of payment of the dividends.

Other rules will operate to ensure that, when determining the extent to which particular dividends are to be franked - . Future dividends which the company has an obligation to pay, for example, dividends on preference shares, are taken into account; and . All dividends paid as part of the one distribution, for example, interim dividends paid to ordinary shareholders, or as part of another distribution made on the same day, are franked to the same extent.

Those rules will operate to prevent blatant channelling of imputation credits to particular shareholders in preference to others.

Subject to those rules, there will be no requirement for a company to equally frank interim and final dividends and dividends on different classes of shares.

It will be the franking account balance at relevant times that will determine the extent of franking in each case.

Apart from these rules, a company will be able, at its option, to frank dividends to an extent greater than otherwise would be the case by making a reasonable estimate of any additional franking credits it expects to receive later in the yea.

I originally announced that if a company wished to overfrank a dividend in this way it would have to make a formal estimate of its anticipated franking credits for the year, at the time of payment of the first dividend in that year.

The legislation before the House, however, dispenses with the need for a formal estimate.

This will substantially reduce the administrative burden on companies and introduce increased flexibility into the system.

Penalties will apply to prevent clear abuses of this over-franking concession.

Where, however, a company has over-franked a dividend at any time, or otherwise has a franking account deficit at the end of a year, the company will be required to make a non-refundable payment shortly after the end of the year to make good this deficit.

While this requirement will be formally imposed as a tax - to be known as a franking deficit tax - in practice, this payment will be treated as a prepayment on account of future company tax.

It will be offset against any company tax liability in respect of the 1986-87 or any later income year that is raised after the end of the year in which the deficit arose.

In order to frank a dividend, a company will have to declare the extent to which it is franked, and will be required to provide shareholders with this and other pertinent advice in relation to the dividend.

Where a dividend is fully or partially franked, the attached imputation credit will fully offset any personal income tax liability of resident individual shareholders - even those on the top marginal rate of 49 cents in the dollar on the franked part of the dividend.

Any part of a dividend that is unfranked will have no imputation credits attached, and will remain subject to tax in the hands of resident individual shareholders in the same way as dividends received by such shareholders are taxed under the present law.

For resident individual shareholders on lower rates, imputation credits attached to franked dividends will exceed the tax payable on the franked amount of the dividends.

The excess rebate will be available to offset tax on other income, including unfranked dividends and capital gains, but will not be refundable where it exceeds such tax, and will not be offset against medicare levy.

Imputation credits attached to franked dividends will not form part of separate net income for dependant rebate purposes, but will be included in the medicare levy tax base.

Special rules will apply to franked dividends paid to a partnership or to a trustee of a trust estate.

These will ensure that the attached imputation credits flow through to each partner or beneficiary (or trustee if appropriate) in proportion to their share of the net income of the trust or partnership that is attributable to franked dividends.

The amount flowing through will be dealt with on the bases outlined earlier depending on whether the partner or beneficiary is a resident individual or company, or is a non-resident.

Related measures

Dividend withholding tax

Imputation credits will not be allowed to non-resident shareholders.

However, where a franked dividend is paid to a non-resident after 30 June 1987 - whether an individual or company - the franked amount of the dividend will be exempt from dividend withholding tax.

Dividend withholding tax will continue to apply to the unfranked amount of any dividends paid to a non-resident after that date.

Branch profits tax

In association with the introduction of imputation, the additional tax imposed on the reduced taxable income of non-resident companies - the branch profits tax - is being abolished.

This tax will last apply to income derived during the 1985-86 income year.

Dividends derived after 30 June 1987 by non-resident companies with a branch in Australia will be subject to the revised withholding tax rules outlined, and will no longer be subject to tax by assessment in Australia.

Distributions by liquidation

By this Bill the provisions of the income tax law that deem liquidation distributions to be dividends will be extended to include distributions made out of amounts, other than indexed capital gains, assessable under any provision of the income tax law, and out of realised capital gains on assets acquired after 19 September 1985.

The changes will apply to distributions made in the course of a winding up of a company that commenced after 1.00pm Australian eastern summer time on 10 December 1986.

This will mean that the new measures will not apply where an application for the winding up of a company was lodged with the court, or a special resolution for voluntary winding up was passed by the company in general meeting, before that time.

Dividends paid instead of interest

Amendments to the income tax law announced on 7 April 1986 and contained in the Taxation Laws Amendment Bill (No. 5) 1986 effectively treat certain finance arrangements for periods of two years or less as loan arrangements for income tax purposes although formally they are structured as issues of shares.

The amendments will do this by denying the intercorporate dividend rebate in relation to the dividends paid on the relevant shares, but allowing a deduction to the issuer of the shares as if the dividends were interest payments.

The amendments proposed by this Bill will extend this treatment so as to also deny the intercorporate dividend rebate to dividends paid on shares used in finance arrangements of any term where the dividends are equivalent to the payment of interest on a loan.

In the case of such a dividend paid on or after 1 July 1987, only so much of the dividend as has not been franked under the new imputation system will be denied the dividend rebate under this new measure.

Unlike the measures in the Taxation Laws Amendment Bill (No. 5), the payment of dividends subject to the provisions of this Bill will not entitle the issuer to a deduction.

Dividends subject to this new measure will be those paid on relevant shares either issued, or used in finance arrangements entered into or extended, after 1.00pm Australian eastern summer time on 10 December 1986.

Other matters relating to imputation

Madam Speaker, the legislation before the House today contains the essential elements of the imputation system.

I mentioned earlier that legislation to abolish the division 7 tax on private companies that I also announced on 10 December 1986 would be included in a later Bill.

Some other measures I announced on that day as part of the imputation package will also be included in that Bill.

These are the measures required - to apply the intercorporate dividend rebate on a grcss, rather than net, basis; - to remove the present exemption from tax for bonus shares issued after 30 June 1987 and alter the capital gains treatment of such shares, and give parallel treatment to issues of bonus units in unit trusts; - to extend by a series of technical provisions the imputation measures to corporate unit trusts and public trading trusts that are taxed as companies; - to enable franking rebate entitlements to be taken into account in the calculation of provisional tax payable by individual shareholders; and To enact some measures of an anti-avoidance nature as a consequence of the introduction of imputation.

These additional matters are peripheral to the working of the imputation system and the Government has expedited the introduction of the measures contained in this Bill so as to enable companies and shareholders to plan for imputation with the certainty of legislation before them.

A memorandum explaining the main features and operation of the Bill and two other Bills I shall introduce shortly has been circulated to Honourable Members.

I will be circulating to Honourable Members within the next week a further memorandum containing an explanation of each clause of the Bills.

I commend the Bill to the House.