House of Representatives

Explanatory Memorandum

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

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

Outline of chapter

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

Context of reform

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

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

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

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

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

Summary of new law

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

Detailed explanation of new law

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Application and transitional provisions

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