Explanatory Memorandum
(Circulated by authority of the Treasurer, the Hon Peter Costello, MP)Chapter 10 - Franking accounts in consolidated groups
Outline of chapter
10.1 Part 1 of Schedule 1 to this bill provides for the treatment of franking accounts in consolidated groups. Briefly, this Part deals with the treatment of the existing balance of franking accounts of subsidiary members upon entry into a consolidated group, and also with the operation of the head companys franking account during the period of consolidation.
10.2 The anti-avoidance measures in section 177EA of the ITAA 1936 are complemented by new provisions in section 177EB to accommodate consolidated groups. These measures are necessary to counter potential abuse of the consolidations imputation rules. At a later stage, further franking rules will be introduced which will deal with exempting companies and former exempting companies in the context of consolidation.
Context of reform
10.3 As part of the introduction of the consolidation regime, A Tax System Redesigned recommended that a consolidated group operate a single franking account at the head company level and that all the existing franking credits of members of the group be pooled.
10.4 The proposed franking account rules for consolidated groups provide for the pooling of franking credits. The provisions also set out special rules for the operation of the franking accounts of both the head company and of subsidiary members of a consolidated group during the period of consolidation.
Summary of new law
10.5 In essence, the franking account of a subsidiary member will be inoperative during the period in which it is a member of a consolidated group. At the time at which it joins a consolidated group, any surplus in its franking account is transferred to the head companys franking account. Conversely, if the subsidiarys franking account is in deficit immediately before this time, the subsidiary is liable to pay franking deficit tax.
10.6 Any franking credits or debits that would otherwise have arisen in the franking account of the subsidiary member (i.e. were it not a member of a consolidated group with an inoperative franking account) are attributed to the franking account of the head company.
10.7 The rules also deal with the franking of distributions made by a subsidiary member to entities because those entities hold certain shares known as disregarded ESAS shares (as discussed in Chapter 3) or non-share equity interests.
| New law | Current law |
|---|---|
| The franking accounts of subsidiary members of a consolidated group do not operate during the period of consolidation. | Subsidiary members of wholly-owned groups operate an active franking account in their own right. |
| Franking credits and debits, which would otherwise arise in a subsidiary members franking account, are attributed to the head companys franking account. | Franking credits and debits arise in the subsidiarys own franking account in accordance with its treatment as a separate taxpaying entity. |
| Franking deficit tax is payable by the entity at the end of the income year and upon entry, as a subsidiary member, to a consolidated group if its franking account is in deficit at that time. No franking deficit tax is payable by the entity during the period in which it is a subsidiary member of a consolidated group. | Franking deficit tax is payable at the end of a franking year if the franking account is in deficit at that time. |
| A subsidiary member cannot frank distributions. Distributions made by subsidiary members in respect of ESAS shares or non-share equity interests are taken to be distributions by the head company. | A subsidiary may frank frankable distributions to its members in accordance with the current imputation rules. |
| Anti-avoidance rules will apply to schemes involving, broadly speaking, the acquisition of a subsidiary entity for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a franking credit to arise in the head companys franking account. | Existing anti-avoidance rules apply to schemes involving, broadly speaking, the disposition of shares for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a relevant taxpayer to obtain a franking credit benefit. |
Detailed explanation of new law
10.8 The franking account rules in consolidation can be divided into 5 distinct issues:
- •
- treatment of any surplus or deficit in a subsidiarys franking account upon joining a consolidated group;
- •
- treatment of a subsidiarys franking account during consolidation;
- •
- treatment of the head companys franking account during consolidation;
- •
- treatment of distributions by a subsidiary member during consolidation; and
- •
- anti-avoidance rules for consolidated groups.
Treatment of franking surplus or deficit on entry into consolidation
10.9 When an entity becomes a subsidiary member of a consolidated group, it must determine its franking account balance at the time of entry. The joining entity must transfer any surplus in its franking account at the joining time (the time at which the joining entity becomes a member of a consolidated group) to the franking account of the head company. In this manner, franking credits are pooled in the franking account of the head company. The application of this rule is subject to the operation of section 177EB, which gives the Commissioner the power to deny, in certain circumstances, franking credits to the head company. [Schedule 1, item 2, section 709-60]
10.10 When any surplus is transferred to the head companys franking account, an equivalent debit arises in the joining entitys franking account. This creates a nil balance in the account of the joining entity. A corresponding credit arises in the head companys franking account. [Schedule 1, item 2, subsection 709-60(2)]
10.11 If the subsidiary has a deficit in its franking account just prior to entry into a consolidated group, it is liable to pay franking deficit tax. [Schedule 1, item 2, paragraph 709-60(3)(b)]
10.12 Furthermore, a credit equal to the franking deficit arises at the joining time in the joining entitys franking account. However, to prevent the inappropriate duplication of franking credits, no franking credit arises under section 160-115 because of the crystallisation of the franking deficit tax liability. [Schedule 1, item 2, subsection 709-60(3)]
Treatment of subsidiarys franking account during consolidation
10.13 During the period in which a subsidiary entity is a member of a consolidated group, its franking account is inoperative. This means that, in general, neither credits nor debits can arise in that account. [Schedule 1, item 2, section 709-65]
10.14 Initially, however, where a subsidiary member has a franking account surplus immediately before the joining time, a debit will arise at the joining time to create a nil balance in the franking account of the subsidiary member.
Treatment of head companys franking account during consolidation
10.15 The rules for franking accounts are intended to facilitate the operation of imputation rules in accordance with the single entity principle. That is, once a subsidiary entity has become a member of a consolidated group, the provisions of the tax law which concern imputation and franking accounts will operate as if the consolidated group is a single entity.
10.16 To this end, the imputation rules ensure that the head company is responsible for operating the single franking account and that events which would affect a subsidiary are instead attributed to the head company. Therefore, activities which would otherwise have caused a franking credit or debit to arise in the franking account of a subsidiary member will instead give rise to a franking credit or franking debit in the franking account of the head company (other than the special credit explained in paragraph 10.12). [Schedule 1, item 2, sections 709-70 and 709-75]
Example 10.1
While it is a member of a consolidated group, a subsidiary member receives a refund of income tax in relation to an assessment of income tax relating to a period prior to when the member joined the consolidated group. In the ordinary course and outside of consolidation, this would lead to a debit arising in the franking account of the subsidiary.
However, given that the subsidiarys franking account does not operate during the period of consolidation, the debit will arise in the head companys franking account. This is the case even though the assessment relates to a pre-consolidation period.
10.17 Other credits and debits will arise in the head companys franking account in the ordinary course of its usual activities as a taxpayer and a franking entity. For example, the payment of income tax will generate franking credits in the head companys franking account and similarly, the franking of dividends will generate franking debits.
Other credits or debits as a result of consolidation
10.18 As mentioned in paragraph 10.10, any franking surplus in the subsidiary members franking account immediately before joining time will give rise to a franking credit in the head companys franking account at the time of consolidation.
Treatment of distributions made by a subsidiary during consolidation
10.19 The general rule in consolidated groups is that a subsidiary member cannot frank distributions to entities outside the group because its franking account is inoperative [Schedule 1, item 2, section 709-65] . Only the head company of the group may allocate franking credits to frankable distributions by a subsidiary member while it is a member of that group.
Distributions made to entities in respect of ESAS shares and non-share equity interests
10.20 Certain shares held in a subsidiary member are able to be disregarded when determining whether that subsidiary member is a 100% Australian subsidiary of the head company and therefore eligible to be a member of a consolidated group. These are ESAS shares.
10.21 For the purpose of distributions made by a subsidiary in relation to disregarded ESAS shares, a frankable distribution made by a subsidiary member will be treated as a frankable distribution by the head company to a shareholder of the head company for the purposes of the imputation rules. This means that the imputation and franking consequences flowing from those rules will apply in respect of the distributions made by the subsidiary. [Schedule 1, item 2, section 709-80]
10.22 Distributions made by a subsidiary member in relation to non-share equity interests will be treated as a frankable distribution by the head company for the purposes of the imputation rules. Consistent with the treatment of distributions made in respect of ESAS shares, the imputation and franking consequences flowing from the operation of the imputation rules will apply in respect of such distributions. [Schedule 1, item 2, section 709-85]
Anti-avoidance rules for consolidated groups
10.23 The anti-avoidance rules provided in section 177EA of the ITAA 1936 are complemented by special rules dealing with consolidated groups. These rules are necessary to counter potential abuse of the consolidation imputation rules. [Schedule 3, item 40, section 177EB]
10.24 Section 177EB allows the Commissioner to deny the transfer of franking credits from a subsidiary entity to a head company upon consolidation in circumstances where a scheme exists which results in a subsidiary entity becoming a member of a consolidated group and having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into or carried out for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a franking credit to arise in the head companys franking account. [Schedule 3, item 40, subsection 177EB(3) and (5)]
10.25 The expressions used in section 177EB have the same meanings as those in section 177EA (unless the contrary intention is specified). [Schedule 3, item 40, subsection 177EB(1)]
10.26 The relevant circumstances set out in subsection 177EB(10) have been modelled on the relevant circumstances contained in subsection 177EA(19). [Schedule 3, item 40, subsection 177EB(10)]
10.27 In a manner similar to section 177EA, section 177EB allows the Commissioner to make a determination that where section 177EB applies, no franking credit is to arise in the head entitys franking account because of the joining entity becoming a subsidiary member of a consolidated group. [Schedule 3, item 40, subsection 177EB(5)]
10.28 Taxpayers dissatisfied with such a determination are entitled to object against the determination in a manner set out in Part IVC of the TAA 1953. [Schedule 3, item 40, subsection 177EB(9)]
Application and transitional provisions
10.29 These provisions will come into effect on 1 July 2002, along with the other aspects of the consolidation measures.
Consequential amendments
10.30 Amendments consequential to the measures in this chapter will be included in subsequent legislation.
Copyright notice
© Australian Taxation Office for the Commonwealth of Australia
You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).
