Senate

Revised Explanatory Memorandum

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

Chapter 6 - Imputation PAYG instalments

Outline of Chapter

6.1 This Chapter explains the consequential amendments made to the dividend imputation provisions resulting from the introduction of the PAYG system.

6.2 The amendments, which are contained in Part 1 of Schedule 3 to this Bill, provide for the generation of franking credits and debits from the payment and refund of tax and PAYG rate variation credits under the PAYG system.

Context of Reform

6.3 Under the current dividend imputation system companies receive franking credits and debits for the payment and refund respectively of tax under Division 1C of Part VI of the ITAA 1936 (the company tax instalment system).

6.4 With the introduction of the PAYG system from the 2000-2001 income year, consequential amendments are needed to the dividend imputation provisions so that franking credits and debits also arise from the payment and refund of tax and PAYG rate variation credits under PAYG.

Summary of new law

6.5 The new law will provide for the generation of franking credits and debits from the payment and refund of tax and PAYG rate variation credits under the PAYG system.

Comparison of key features of new law and current law

Detailed explanation of new law

When do franking credits arise from paying an income tax liability under the new PAYG system?

6.6 Under the new PAYG system, which applies from the 2000-2001 income year, companies will generate class C ^[F10] franking credits from paying an income tax liability in 2 different circumstances.

6.7 First, a company, other than a life insurance company ^[F11] , will generate class C franking credits when it pays a PAYG instalment. The franking credit arises on the day the instalment is paid and is equal to the adjusted amount ^[F12] of the amount paid. [Schedule 3, Part 1, item 17, section 160APME]

6.8 Second, a company will generate class C franking credits when it makes a payment in respect of an income tax assessment liability (referred to in the provisions as 'company tax'). The franking credit arises on the day the payment is made and is equal to the adjusted amount of the amount paid. [Schedule 3, Part 1, item 17, section 160APMG]

6.9 For the purposes of these provisions, a person 'pays' a PAYG instalment or company tax only if:

•

the person has a current liability to pay the instalment or company tax; and

•

either:

-

the person makes a payment to satisfy the liability (in whole or in part);

-

a credit (other than the particular credits explained below) is applied to discharge or reduce the liability; or

-

an RBA surplus is applied to discharge or reduce the liability.

The total amount of payments that may be made under these provisions in respect of a liability is limited to the full amount of that liability. [Schedule 3, Part 1, item 12, subsection 160APBB(1)]

6.10 Consistent with the current tax laws, certain credits do not generate franking credits where they are applied to discharge or reduce an income tax liability. These are foreign tax credits arising under:

•

Division 18, 18A, or 18B of Part III of the ITAA 1936; or

•

the International Tax Agreements Act 1953 .

[Schedule 3, Part 1, item 12, paragraphs 160APBB(2)(a) and (b)]

6.11 In addition, credits which arise under sections 45-30 and 45-215 in Schedule 1 to the TAA 1953 are not payments for the purposes of generating franking credits where they are applied to discharge or reduce an income tax liability. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

6.12 Each instalment payable under the PAYG instalment system represents a liability of the taxpayer in relation to a particular income year. When the Commissioner makes an assessment of the company tax payable (or determines there is no company tax payable) for that income year, the taxpayer is entitled to a credit under section 45-30 in Schedule 1 to the TAA 1953 for 'PAYG instalments payable' against the assessment. The credit is to ensure that the taxpayer's aggregate income tax liability for the income year is not overstated. The amount of the credit is equal to the amount of any instalment liabilities for the income year reduced by any PAYG rate variation credits for that income year. The credit arises whether or not the PAYG instalments have been paid.

6.13 As this credit for PAYG instalments payable effectively operates to adjust the net income tax liability of the taxpayer for the income year rather than to discharge any income tax liability, no franking credits arise (or should arise) from its application to an income tax liability. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

6.14 Section 45-215 in Schedule 1 to the TAA 1953 allows a taxpayer to claim a PAYG rate variation credit in certain circumstances. For the purposes of these measures the application of a PAYG rate variation credit to discharge a PAYG instalment or company tax liability is not a payment of that liability. Again this is a credit which adjusts rather than discharges a liability and therefore no franking credits should arise. [Schedule 3, Part 1, item 12, paragraph 160APBB(2)(c)]

What is the amount of a payment of a PAYG liability or company tax?

6.15 Generally speaking, the amount of a payment of a PAYG instalment liability or company tax liability will be the amount by which the liability has been reduced. If the liability has been discharged in full, the amount of the payment will be the amount of the liability. However, for the purpose of calculating franking credits, the amount of the payment taken to have arisen from the application of an RBA surplus will be reduced when the surplus being applied has the character of a section 45-30 credit for PAYG instalments payable. [Schedule 3, Part 1, item 12, subsections 160APBB(3) and (4)]

6.16 As discussed at paragraph 6.12 and 6.13, section 45-30 credits are designed to ensure that the taxpayer's aggregate income tax liability for the income year is not overstated. The credit achieves this effect by reducing the amount of a company tax assessment for an income year by the amount of PAYG instalment liabilities for that income year.

6.17 In circumstances where the amount of PAYG liabilities arising for the income year exceed the company tax, the application of the section 45-30 credit produces an excess. As the company tax is currently recorded in a separate RBA to the PAYG liabilities, the excess of the section 45-30 credit over the assessment may create a RBA surplus even though the PAYG liabilities may not have been satisfied and remain outstanding. This surplus may be refunded to the taxpayer (if there are no outstanding liabilities) or it may be applied to a liability of the taxpayer to pay, for example, PAYG instalments outstanding for that income year.

6.18 If the taxpayer has made full payment of PAYG instalment liabilities for the income year, the amount of the RBA surplus described above represents an amount previously paid. The application of this surplus to discharge a subsequent PAYG instalment liability or company tax represents a payment of the full amount discharged. Franking credits will arise for the full amount of the payment ^[F13] .

6.19 However, if the taxpayer has not paid the PAYG instalment liabilities for the income year, the RBA surplus merely represents a section 45-30 credit and is not the product of the overpayment of tax. In this case, the surplus would be applied against the outstanding liability to pay the unpaid PAYG instalments, and because the surplus does not represent an amount paid, no franking credits should arise from its application.

6.20 It is in this circumstance, where an RBA surplus is generated by a section 45-30 credit for an income year and applied to reduce a PAYG instalment for the same income year, that the amount of the payment taken to have arisen for the purposes of calculating franking credits will be reduced.

6.21 Therefore, if:

•

an RBA surplus is applied to a PAYG instalment for a particular year of income;

•

a section 45-30 variation credit has arisen in relation to the same year of income as the PAYG instalment and is credited to the account which generated the RBA surplus;

•

PAYG instalment liabilities are not recorded in the RBA in which the surplus arises; and

•

the amount of the section 45-30 credit is greater than the amount of the company tax for that year of income;

the amount of the payment taken to have arisen from the application of the RBA surplus will be reduced. [Schedule 3, Part 1, item 12, subsection 160APBB(4)]

6.22 The payment is reduced by the amount by which the section 45-30 credit exceeds company tax for the income year. If the amount by which the payment is to be reduced is greater than the amount of the payment, the payment is taken to be zero. [Schedule 3, Part 1, item 12, subsection 160APBB(4)]

6.23 Reducing the payment by the identified amount ensures that the payment is only reduced to the extent to which the RBA surplus has the character merely of a section 45-30 credit.

When do franking debits arise from the refund of tax under the new PAYG system?

6.24 Under the new PAYG system, a company, other than a life insurance company ^[F14] , will generate a class C franking debit when:

•

a class C franking credit arises from:

-

the payment of a PAYG instalment or company tax; or

-

the application of a PAYG rate variation credit to discharge a PAYG liability or company tax (see paragraph 6.30);

•

the company receives a refund (as defined below) of that payment or credit applied; and

•

the refund is not referable to a reduction in company tax which produced a franking debit under section 160APZ of the ITAA 1936.

[Schedule 3, Part 1, item 18, section 160APYBAA]

6.25 The franking debit arises on the day the refund is received and is equal to the adjusted amount of the amount of the refund. [Schedule 3, Part 1, item 18, section 160APYBAA]

6.26 For the purposes of these provisions, a company receives a 'refund' of a company tax instalment (including a PAYG instalment) or company tax if:

•

either:

-

the company receives an amount as a refund; or

-

the Commissioner applies a credit, or an RBA surplus, against a liability or liabilities of the company; and

•

the amount refunded or applied represents in whole or in part a return to the company of an amount paid or applied to satisfy the company's liability to pay the company tax instalment or company tax.

[Schedule 3, Part 1, item 12, section 160APBD]

6.27 The 'refund' or application of an amount to a liability of the taxpayer will not be a refund for the propose of these provisions to the extent to which it is referable to a PAYG rate variation credit. [Schedule 3, Part 1, item 12, section 160APBD(3)]

Example 6.1: Payments and refunds

Instalment 1

Marko Co's PAYG instalment liability for the first quarter of its 2000-2001 income year is $1,000. Marko Co pays the full amount of the instalment generating $1,941 franking credits (i.e. $1,000 66/34 - based on a 34% company tax rate). The balance in its franking account is $1,941.

Instalment 2

Marko Co's PAYG instalment liability for the second quarter of its 2000-2001 income year is $5,000. Marko Co pays the full amount of the instalment generating $9,706 franking credits (i.e. $5,000 66/34). The balance in their franking account is $11,647.

Instalment 3

Marko Co's PAYG instalment liability for the third quarter of its 2000-2001 income is $2,000. Marko Co pays the full amount of the instalment generating $3,882 franking credits (i.e. $2,000 66/34). The balance in their franking account is $15,529.

Instalment 4

Marko Co's PAYG instalment liability for the final quarter of its 2000-2001 income year is $2,000. Marko Co only pays $1,000 of the instalment generating $1,941 franking credits (i.e. $1,000 66/34). The balance in their franking account is $17,470.

Assessment

The company tax assessment for Marko Co's 2000-2001 income year is $8,000. Upon assessment, a section 45-30 credit for PAYG instalments payable arises of $10,000 (i.e. $1,000 + $5,000 + $2,000 $2,000).

The application of the section 45-30 credit against the company tax assessment in Marko Co's RBA produces a surplus of $2,000.

Marko Co has $1,000 outstanding PAYG liability in relation to the fourth instalment. $1,000 of the RBA surplus is applied to discharge that liability. To determine whether a franking credit arises in relation to this application it is necessary to first identify the amount of the instalment paid.

At first instance, the amount of the PAYG instalment paid is $1,000. However, this amount is reduced as the requirements in section 160APBB are satisfied. That is:

•

the surplus of an RBA account is applied to satisfy a PAYG instalment for the 2000-2001 income year;

•

a section 45-30 RBA credit has arisen for the 2000-2001 income year;

•

the RBA surplus arose in a different account of the taxpayer from the account in which the PAYG instalment discharged is recorded; and

•

the amount of the section 45-30 credit is greater than the company tax assessment for the year of income.

The amount taken to be paid of $1,000 is reduced by the amount by which the section 45-30 credit is greater than the company tax for the 2000-2001 income year. That is $2,000. The resulting amount of the payment for the purposes of these provisions is $0. Consequently, no franking credits arise.

The application of $1,000 of the RBA surplus to discharge the outstanding PAYG instalment liability is not a refund. This is because the surplus applied does not represent a return to Marko Co of an amount previously paid or applied to satisfy a liability to a PAYG instalment or company tax. Consequently, no franking debit is created.

The remaining $1,000 of the RBA surplus is returned to Marko Co. This amount is a refund as it represents the return of an amount paid to satisfy a PAYG instalment liability. The refund produces a franking debit equal to $1,941 (i.e. $1,000 66/34). The remaining balance in Marko Co's franking account is $15,529.

When do franking credits and debits arise from a PAYG rate variation credit?

6.28 A PAYG rate variation credit is a credit that a taxpayer may claim under the PAYG system if the taxpayer has varied down their instalment rate to a lower rate than that used to calculate the amount of a PAYG instalment for a previous quarter.

6.29 A company claims a PAYG rate variation credit under section 45-215 in Schedule 1 to the TAA 1953 only when the company is entitled to the credit in accordance with that section and claims the credit on the approved form - a BAS. Broadly speaking, the credit is provided to effectively reduce the amount of the previous instalment or instalments to the amount they would have been if calculated in accordance with the lower instalment rate. The effect is achieved by offsetting the credit against the PAYG instalment liability rather than directly amending it.

6.30 If a PAYG instalment liability is outstanding at the time the PAYG rate variation credit arises, the credit may be applied to reduce the liability to the amount it would have been if originally calculated in accordance with the varied instalment rate.

6.31 If all PAYG liabilities have been paid in full at the time the PAYG rate variation credit arises, the credit may be applied to other outstanding liabilities or returned to the taxpayer. This application or return is not a refund for the purposes of these provisions as it is referable to a PAYG rate variation credit and will not produce a franking debit. As discussed at paragraph 6.33, claiming a PAYG rate variation credit produces a franking debit. Any further franking debit resulting from a return or application of the credit would be inappropriate.

6.32 A company will generate class C franking credits when a PAYG rate variation credit is applied to reduce the company's liability for a PAYG instalment. In this case the amount of the franking credit is equal to the adjusted amount of the amount by which the company's liability for a PAYG instalment is reduced. The franking credit arises on the day the PAYG rate variation credit is applied to reduce company's liability for a PAYG instalment. [Schedule 3, Part 1, item 17, section 160APMF]

6.33 To ensure the correct net amount of franking credits arise from claiming a PAYG rate variation credit and its application to discharge PAYG instalment liabilities, a company will generate class C franking debits when it claims a PAYG rate variation credit to which it is entitled. The franking debit arises on the day that the company claims the variation credit and is equal to the adjusted amount in relation to the amount of the PAYG rate variation credit. [Schedule 3, Part 1, item 18, section 160APYBAB]

6.34 For the purpose of these provisions only, if a company is liable to pay a PAYG instalment and has a PAYG rate variation credit the PAYG rate variation credit must be fully applied to reduce the liability for the PAYG instalment before any other credit or payment can be applied to reduce that liability. This is to ensure that franking credits arise at the earliest opportunity in order to offset the franking debit that arises at the time the PAYG rate variation credit is claimed. [Schedule 3, Part 1, item 12, section 160APBC]

Example 6.2: PAYG variation credits and payments of PAYG instalments and company tax

Instalment 1

The Commissioner has notified Company A that its instalment rate is 15%. Company A uses that rate to calculate its first quarterly instalment for the income year. Its instalment income for that quarter is $80,000 and therefore the company is liable to pay $12,000 (i.e. 15% $80,000) as its first quarterly instalment. Company A pays $10,000 of the instalment.

At the time of making the payment, the company receives a class C franking credit equal to the adjusted amount of the payment. That is $19,411 (i.e. $10,000 66/34 - assuming a 34% company tax rate). The balance in Company A's class C franking account is $19,411.

Instalment 2

Company A's instalment income for its second instalment quarter is $10,000. It is concerned that the instalment rate notified by the Commissioner is too high. Company A varies its instalment rate to 10%. In accordance with the operation of section 45-215 in Schedule 1 to the TAA 1953, the amount of the variation credit is calculated as follows.

Step 1:

Company A's earlier instalment liabilities for the year add up to $12,000.

Step 2:

Company A has no previous credits by which to reduce the $12,000.

Step 3:

Company A's $80,000 instalment income from the first instalment quarter is multiplied by its varied instalment rate of 10%. The result is $8,000.

Step 4:

The difference between the instalment liabilities for the year and the amount they would have been if calculated by reference to the current instalment rate is $4,000 (i.e. $12,000 $8,000).

Step 5:

The amount of the variation credit that the company may claim is $4,000.

For the second quarter, the company will have an instalment liability of $1,000 (i.e. 10% $10,000) and claims a variation credit of $4,000.

At the time of claiming the PAYG rate variation credit Company A receives a class C franking debit equal to the adjusted amount of that credit. That is $7,764 (i.e. $4,000 66/34). The balance in Company A's class C franking account is now $11,647.

Company A has a $3,000 outstanding PAYG instalment liability ($2,000 for instalment 1 and $1,000 for instalment 2). The PAYG rate variation credit is applied on the day the credit is claimed to those liabilities to the extent of $3,000. Company A receives a class C franking credit equal to the adjusted amount of the extent to which the PAYG rate variation credit was applied to reduce the Company's liability. That is $5,823 (i.e. $3,000 66/34). The balance in Company A's class C franking account is now $17,470.

The remaining balance of the PAYG rate variation credit of $1,000 is returned to Company A. No franking debit arises in relation to the remaining $1,000 as it is not a refund for the purposes of these measures.

Assessment

Company A's company tax assessment for the income year is $13,000. Upon assessment credits for PAYG instalments payable arise under section 45-30 in Schedule 1 of the TAA 1953 . The amount of that credit is $9,000 (i.e. $12,000 + $1,000 - $4,000). No franking credit arises for the application of this credit to the assessment as the application of the credit is not a payment of the company tax.

Company A has an outstanding company tax liability of $4,000. The company pays this amount in full. Company A receives a class C franking credit on the day the payment is made equal to the adjusted amount of the payment. That is $7,764 (i.e. 4,000 66/34). The balance in Company A's class C franking account is now $25,234.

Application and transitional provisions

6.35 The amendments apply to the 2000-2001 and later income years. [Schedule 3, Part 1, item 28]

Consequential amendments

6.36 In order to implement the amendments described above a number of further consequential amendments have also been made. In broad terms, these amendments make appropriate definitional changes and ensure that the provisions relating to deficit deferral tax, estimated debit determinations and franking additional tax continue to operate appropriately. [Schedule 3, Part 1, items 1 to 11, 13 to 16, and 19 to 27]