House of Representatives

Explanatory Memorandum

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

Chapter 13 - Simplified imputation system

Outline of chapter

13.1 Schedules 27 to 30 to this bill will amend Part 3-6 of the ITAA 1997 to insert rules for the following aspects of the SIS:

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venture capital franking;

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cum dividend sales and securities lending arrangements; and

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machinery provisions, for example, the rules relating to franking account returns and assessments.

13.2 These rules complement the core SIS rules set out in the New Business Tax System (Imputation) Act 2002 , which apply from 1 July 2002.

13.3 In addition, consequential amendments will be made to the ITAA 1936 in relation to:

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section 177EA, the general anti-avoidance provision dealing with franking credit trading and dividend streaming; and

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certain dividend withholding tax provisions.

Summary of new law

13.4 These rules generally replicate the former provisions in Part IIIAA of the ITAA 1936, with changes to reflect the new rules and terminology of the SIS rules. The law has been rewritten using clearer and more accessible drafting techniques developed as part of the tax law improvement project.

13.5 The consequential amendments will ensure that section 177EA and the dividend withholding tax provisions operate as intended in relation to the SIS rules.

Detailed explanation of new law

Venture capital franking

Scheme of the legislation

13.6 The venture capital franking provisions are designed to encourage venture capital investment in Australia by allowing resident complying superannuation funds (and like entities) a special tax offset which enables them to receive venture capital gains free of tax through PDFs.

13.7 Eligible superannuation entities will receive a tax offset for CGT paid by PDFs on venture capital investments. To trace the CGT paid by the PDFs through to their shareholders, the concept of venture capital franked dividends applies.

13.8 For eligible superannuation funds (and like entities) that receive a venture capital franked dividend, the dividend will be exempt income. However, the shareholder will also receive a tax offset for the attached venture capital credits which effectively exempts from tax the underlying venture capital gain.

New provisions

13.9 The new venture capital franking provisions are in Division 210 of the ITAA 1997. In line with the rules that apply to ordinary companies, the franking and venture capital sub-accounts of PDFs will be maintained on a tax-paid basis.

13.10 Table 13.1 provides cross-references from the new provisions in the ITAA 1997 to the former provisions in the ITAA 1936.

Cum dividend sales and securities lending arrangements

Scheme of the legislation

13.11 Broadly speaking, these provisions provide for the flow of imputation credits when interests are sold under a cum-dividend contract on a stock exchange or a franked distribution is received by a borrower under a securities lending arrangement.

13.12 A member to whom a franked distribution is paid in respect of a particular share is able to pass that distribution on to either a transferee under a contract for the sale of the interest on the stock exchange or to a lender under a securities lending arrangement. A transferee who receives a distribution from a member has the same status as the original member and is able to pass that distribution on to another transferee or lender. The member who may transfer membership status is the actual person whose name in the interests is registered, a person who has the right to be registered as the member or a transferee or lender who has obtained membership status by a previous application of this rule.

13.13 Where the franked distribution is paid on shares that are the subject of a cum-dividend contract of sale the franked distribution paid is able to be transferred to the person to whom the member (see paragraph 13.12) was under an obligation to transfer the interests at the time the company closed its books to determine the members to whom the distribution would be paid.

13.14 A member who is a borrower under a securities lending arrangement at the time the company determined the entitlement to the distribution and under an obligation to transfer the distribution to the lender, is able to transfer the franked distribution to the lender.

New provisions

13.15 The new provisions dealing with the transfer of membership status for tax purposes are in Division 216 of the ITAA 1997. Table 13.2 provides cross-references from the new provisions to the former provisions in the ITAA 1936.

Machinery provisions

Scheme of the legislation

13.16 The proposed machinery provisions for the SIS are broadly based on the former machinery provisions in Divisions 8 to 12 of Part IIIAA of the ITAA 1936. The machinery provisions relate to:

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the lodgement of returns, assessments, and the collection and recovery of tax relevant to the imputation system;

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evidentiary requirements and objection rights as they apply to franking returns and assessments;

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imposition of the GIC;

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record keeping requirements; and

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the power of the Commissioner to obtain information from tax agents.

13.17 Part IIIAA formerly imposed a franking deficit tax and in certain circumstances, franking additional tax, where a company's franking account was in deficit at the end of the franking year. In circumstances where a deficit was deferred to the following income year, a deficit deferral tax and a deficit deferral penalty tax were imposed. Under the new rules, these 4 taxes are effectively rolled into one tax, that is, franking deficit tax.

13.18 The benchmark rules impose a new tax called over franking tax. Accordingly, the machinery provisions including items, those relating to assessment, collection and recovery, will also apply to over franking tax.

New provisions

13.19 The new machinery provisions will be in Division 214 of the ITAA 1997. Table 13.3 provides cross-references from the new provisions in the ITAA 1997 to the former provisions in the ITAA 1936.

Retrospective franking

13.20 Private companies are generally permitted to frank distributions within the period of 4 months after the end of the income year. However, a private company will not be able to frank distributions retrospectively if a franking deficit tax liability would arise or be increased as a consequence. [Schedule 28, item 1, subsection 202-75(4)]

Significant variation of benchmark percentage

13.21 An entity is required by section 204-75 to notify the Commissioner of a significant variation in the benchmark percentage from one franking period to the next. This notification must be given either with a franking return or within one month after the end of the income year in which the franking period occurs. [Schedule 28, item 2, subsection 204-75(4)]

13.22 Some new rules are required to reflect the 'rolling-in' of deficit deferral tax into franking deficit tax. An amendment to a franking assessment will arise automatically if a corporate tax entity has an franking deficit tax liability in respect of a franking account deficit at the end of the income year and then receives a refund of tax after the end of the income year that results in an increased franking deficit tax liability. [Schedule 28, item 3, section 214-65]

13.23 However, an amendment will not arise where the 14 day period for payment of a franking deficit tax liability arising in respect of a tax refund would expire on or before the end of the month following the income year. In this case, the due date is extended to the end of the month following the income year and a company would simply show a revised franking account balance and a franking deficit tax liability on the franking return, which would be assessed under section 214-50. This outcome is achieved because section 214-40, which requires a company to lodge a return within 14 days for a franking deficit tax liability arising in respect of a tax refund, does not apply where an entity has an outstanding franking return at the time a tax refund is received. [Schedule 28, item 3, sections 214-40 and 214-50]

Late balancing companies

13.24 A parallel set of machinery provisions for late balancing companies that elect to have their franking deficit tax liability determined on 30 June rather than at the end of their income year is provided in Division 214 of the IT (TP) Act 1997. [Schedule 28, item 13, Division 214 of the IT(TP) Act 1997]

Consequential amendments to ITAA 1936

13.25 Consequential amendments have been made to the following provisions of the ITAA 1936 to reflect the new SIS rules and terms:

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section 177EA, the general anti-avoidance provision dealing with franking credit trading and dividend streaming [Schedule 29, item 11] ; and

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paragraphs 128B(3)(aaa), 128B(3)(ga) and 128B(3)(gaa), which deal with the interaction between the imputation system and the dividend withholding tax regime [Schedule 29, items 8 to 10] .

Application and transitional provisions

13.26 These amendments generally apply to events arising on or after 1 July 2002, when the SIS rules commenced. [Clause 2]