Senate

Revised Explanatory Memorandum

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

Chapter 4 Simplified imputation system (share capital tainting rules)

Outline of chapter

4.1 Schedule 4 to this Bill amends the Income Tax Assessment Act 1997 (ITAA 1997) to ensure that a company's share capital account will become tainted if it transfers certain amounts to that account. If a company taints its share capital account, a franking debit arises in the company's franking account. If the company chooses to untaint its share capital account, an additional franking debit may arise and untainting tax may be payable.

4.2 These rules replace the share capital tainting rules in the Income Tax Assessment Act 1936 (ITAA 1936) with modifications to ensure that they interact with the simplified imputation system and to overcome some technical deficiencies.

Context of amendments

4.3 The simplified imputation system was part of the Government's business tax reform package and applies from 1 July 2002. The share capital tainting rules are an integral part of the imputation system. In Press Release No. C104/02 of 27 September 2002, the then Minister for Revenue and Assistant Treasurer announced that the share capital tainting rules would be inserted into the ITAA 1997 as part of the further implementation of the simplified imputation system.

4.4 Shareholders are taxed preferentially on distributions of share capital. In contrast, shareholders are generally taxed at their marginal tax rate on distributions of profits. The share capital tainting rules are integrity rules designed to prevent a company from disguising a distribution of profits as a tax-preferred capital distribution by transferring profits into its share capital account and subsequently making distributions from that account.

Summary of new law

4.5 A company's share capital account will become tainted if it transfers an amount to its share capital account from any other account, other than:

•

an amount that can be identified as share capital;

•

certain amounts that are transferred under debt/equity swaps;

•

an amount that is transferred by a non-Corporations Act company to remove shares with a par value;

•

certain amounts that are transferred from an option premium reserve;

•

certain amounts that are transferred in connection with the demutualisation of a non-insurance company;

•

certain amounts that are transferred in connection with the demutualisation of an insurance company at the time of the demutualisation; and

•

certain amounts that are transferred in connection with the demutualisation of a life insurance company but after the demutualisation.

4.6 If a company's share capital account becomes tainted, a franking debit arises in the company's franking account at the end of the franking period in which the transfer occurs. A tainted share capital account is treated as a profit account and any subsequent distributions from that account are unfrankable distributions (rather than returns of capital).

4.7 A company can make an irrevocable choice to untaint its share capital account. If the company chooses to untaint its share capital account, an additional franking debit may arise at the end of the franking period in which the choice to untaint is made. Untainting tax may also be payable at that time.

Comparison of key features of new law and current law

Detailed explanation of new law

What is a share capital account?

4.8 A share capital account is:

•

any account that the company keeps of its share capital; or

•

any other account (whether or not it is called a share capital account) that was created after 1 July 1998 where the first amount credited to the account was an amount of share capital.

[Schedule 4, item 20, subsection 975-300(1)]

4.9 If a company has more than one share capital account, those accounts are taken to be a single account for the purposes of the ITAA 1936 and the ITAA 1997. [Schedule 4, item 20, subsection 975-300(2)]

4.10 The concept of share capital is not defined in the ITAA 1997. Under its ordinary meaning, share capital includes amounts received by a company in consideration for the issue of shares.

A company's share capital becomes tainted when an amount is transferred to the account

4.11 A company's share capital account becomes tainted if:

•

the company transfers any amount (other than an excluded amount) to its share capital account from any of its other accounts; and

•

the company was an Australian resident immediately before the time of the transfer.

[Schedule 4, item 1, section 197-5 and subsection 197-50(1)]

When is an amount transferred from one account to another account?

4.12 An amount is transferred from one account to another where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance of the second account is increased by the same amount.

4.13 An amount is not transferred from one account to another where the particular accounting entries result in the balances of both accounts increasing in size. Accordingly, an accounting entry of the form 'debit asset, credit share capital account' does not represent a transfer in the relevant sense. Furthermore, a transfer to the share capital account will not arise if an expense account is debited at the same time that the share capital account is credited.

Example 4.1

A company has a retained profits reserve balance of $1,000 at the beginning of the 2006-07 income year. The company issues $100 in shares on 1 September 2006 to an individual as consideration for services rendered. The share issue is accounted for by debiting the expense account by $100 and crediting the share capital account by $100.

The company does not derive any income nor does it incur any other expenses during the income year. At the end of the income year, the balance of the expense account ($100 debit) will be transferred to the profit and loss account. On closure of its profit and loss account a $100 debit will be made to the company's retained profits reserve. The company's retained profits reserve is reduced by the net loss ($100) incurred over the income year, not directly by the expense itself. Therefore, no amount has been transferred from the company's retained profits reserve to its share capital account.

Transfers to a share capital account that do not cause the account to become tainted

Amounts that can be identified as share capital

4.14 A company's share capital account does not become tainted if an amount is transferred to its share capital account that, at all times before the transfer, can be identified in the company's books as share capital. [Schedule 4, item 1, section 197-10]

Amounts transferred under debt/equity swaps

4.15 A company's share capital account does not become tainted if the amount is transferred under a debt for equity swap. A debt for equity swap is an arrangement under which a person discharges, releases or otherwise extinguishes the whole or part of a debt that the company owes to the person in return for shares (other than redeemable preference shares) in the company. [Schedule 4, item 1, subsection 197-15(1)]

4.16 This exclusion will only apply to so much of the transferred amount that does not exceed the lesser of:

•

the market value of the shares issued by the company; and

•

the amount of the debt that is discharged, released or extinguished in return for the shares.

[Schedule 4, item 1, subsection 197-15(2)]

4.17 Amendments are made to the ITAA 1936 to ensure a consistent outcome arises under the old share capital tainting rules with effect from 1 July 1998. [Schedule 4, items 15 and 16, subsection 160ARDM(2B) of the ITAA 1936]

Amounts transferred by non-Corporations Act companies in removing shares with a par value

4.18 A company's share capital account does not become tainted if the company is not incorporated under the Corporations Act 2001 and transfers an amount from its share premium account or its capital redemption reserve to its share capital account where:

•

the transfer is made under, or in accordance with, a law of the Commonwealth, or of a State or Territory, that requires or allows either or both of the company's share premium account and capital redemption reserve to become part of the company's share capital account; and

•

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 4, item 1, section 197-20]

Amounts transferred from option premium reserves

4.19 A company's share capital account does not become tainted if an amount is transferred from an option premium reserve to its share capital account where:

•

the transfer is made because of the exercise of options to acquire shares in the company; and

•

the amount transferred represents option premiums that were received by the company in consideration for the issue of the options that have been exercised.

[Schedule 4, item 1, section 197-25]

4.20 Amendments are made to the ITAA 1936 to ensure a consistent outcome arises under the old share capital tainting rules with effect from 1 July 1998. [Schedule 4, item 16, subsection 160ARDM(2C) of the ITAA 1936]

Amounts transferred in connection with the demutualisation of non-insurance companies

4.21 A company's share capital account does not become tainted if an amount is transferred to its share capital account where:

•

the company is a non-insurance company that demutualises and Division 326 in Schedule 2H to the ITAA 1936 applies to the demutualisation; and

•

the amount is transferred to the company's share capital account in connection with the demutualisation within the limitation period in relation to the demutualisation - the limitation period is defined in subsection 326-20(3) of Schedule 2H to the ITAA 1936 to mean the period ending two years after the demutualisation resolution day or such later time as the Commissioner of Taxation (Commissioner) allows.

[Schedule 4, item 1, subsection 197-30(1)]

4.22 This exclusion will only apply to so much of the transferred amount that, together with any amounts that were previously transferred in connection with the demutualisation, do not exceed the total capital contributions amount. [Schedule 4, item 1, subsection 197-30(2)]

4.23 Where the company is not formed by the merger of two or more mutual entities, the total capital contributions amount is the sum of all the capital amounts that were contributed by the company's members before demutualisation that were not allowed as an income tax deduction and were not payments for goods or services provided by the company. [Schedule 4, item 1, subsection 197-30(3)]

4.24 Where the company is formed by the merger of two or more mutual entities, the total capital contributions amount is the sum of:

•

all the capital amounts that were contributed before demutualisation by persons that become members at or after the time when the merger took place and were not allowed as an income tax deduction or were not payments for goods or services provided by the company; and

•

the market values, at the time of the merger, of the entities that merged to form the company, as determined by a qualified valuer.

[Schedule 4, item 1, subsection 197-30(4)]

Amounts transferred in connection with the demutualisation of insurance companies

4.25 A company's share capital account does not become tainted if an amount is transferred to its share capital account where:

•

the company is an insurance company that demutualises in accordance with a demutualisation method specified in Division 9AA of Part III of the ITAA 1936; and

•

the amount was transferred in connection with the demutualisation within the listing period in relation to the demutualisation - the listing period is defined in subsection 121AE(6) of the ITAA 1936 to mean the period ending two years after the demutualisation resolution day or such later time as the Commissioner allows.

[Schedule 4, item 1, paragraphs 197-35(1)(a) to (c)]

4.26 This exclusion applies only to amounts transferred to the share capital account of the issuing company. The issuing company is:

•

if demutualisation method 1 (section 121AF) or method 2 (section 121AG) applies to the demutualisation, the demutualising company; or

•

if demutualisation method 3 (section 121AH), method 4 (section 121AI), method 5 (section 121AJ), method 6 (section 121AK) or method 7 (section 121AL) applies to the demutualisation, the company that issues the ordinary shares under the demutualisation.

[Schedule 4, item 1, paragraph 197-35(1)(d)]

4.27 This exclusion will only apply to the extent that the sum of:

•

the transferred amount;

•

all amounts that were previously transferred to the issuing company's share capital account from another account of the company in connection with the demutualisation; and

•

all amounts that were previously transferred to the issuing company's retained profit account in connection with the demutualisation,

do not exceed the listing day company valuation amount. [Schedule 4, item 1, subsection 197-35(2)]

4.28 The 'listing day valuation amount' is defined in note 3 to table 1 in section 121AS of the ITAA 1936. [Schedule 4, item 1, subsection 197-35(3)]

4.29 In most cases the listing day valuation amount will be:

•

if the demutualising company is a life insurance company, the embedded value of the company; or

•

if the demutualising company is a general insurance company, the net tangible asset value of the company.

4.30 Amendments are made to the ITAA 1936 to ensure a consistent outcome arises under the old share capital tainting rules with effect from 1 July 1998. [Schedule 4, items 17 and 18, subsections 160ARDM(4A) and (6) of the ITAA 1936]

Amounts transferred in connection with post-demutualisation transfers relating to life insurance companies

4.31 A company's share capital account does not become tainted if an amount is transferred to its share capital account where:

•

the company is a life insurance company that has demutualised in accordance with a demutualisation method specified in Division 9AA of Part III of the ITAA 1936; and

•

the amount was transferred after the end of the listing period in relation to the demutualisation - the listing period is defined in subsection 121AE(6) of the ITAA 1936 to mean the period ending two years after the demutualisation resolution day or such later time as the Commissioner allows.

[Schedule 4, item 1, paragraphs 197-40(1)(a) to (c)]

4.32 This exclusion applies to amounts transferred to the share capital account of either:

•

the demutualising company; or

•

if demutualisation method 3 (section 121AH), method 4 (section 121AI), method 5 (section 121AJ), method 6 (section 121AK) or method 7 (section 121AL) applied to the demutualisation, the company that issued the ordinary shares under the demutualisation.

[Schedule 4, item 1, paragraph 197-40(1)(d)]

4.33 In the case of the demutualising company, the amount must be transferred to the share capital account from an account of the company consisting of shareholders' capital (within the meaning of the Life Insurance Act 1995 ) in relation to a statutory fund (within the meaning of that Act) and must have been part of such an account at the time of the demutualisation. [Schedule 4, item 1, paragraph 197-40(1)(e)]

4.34 Paragraph 63(3)(a) of the Life Insurance Act 1995 applies to determine whether an amount is transferred from an account of the company consisting of shareholders' capital in relation to a statutory fund under paragraph 197-40(1)(e). For these purposes, it is not relevant that the transfer under the Corporation Act 2001 is from an account of a different description.

4.35 In the case of the issuing company, the amount must be transferred to the share capital account from a capital reserve created at the time of or in connection with the demutualisation. [Schedule 4, item 1, paragraph 197-40(1)(f)]

4.36 This exclusion will only apply to the extent that the sum of:

•

the transferred amount;

•

all amounts that were previously transferred to the demutualising company's share capital account, or to the issuing company's share capital account, as described in subsection 197-40(1); and

•

all amounts that were previously transferred, in connection with the demutualisation, to the issuing company's share capital account or retained profit account, as described in section 197-35,

do not exceed the listing day company valuation amount. [Schedule 4, item 1, subsection 197-40(2)]

4.37 The 'listing day valuation amount' is defined in note 3 to table 1 in section 121AS of the ITAA 1936. [Schedule 4, item 1, subsection 197-40(3)]

4.38 In most cases the listing day valuation amount will be:

•

if the demutualising company is a life insurance company, the embedded value of the company; or

•

if the demutualising company is a general insurance company, the net tangible asset value of the company.

4.39 Amendments are made to the ITAA 1936 to ensure a consistent outcome arises under the old share capital tainting rules with effect from 1 July 1998. [Schedule 4, items 17 and 18, subsections 160ARDM(4B) and (6) of the ITAA 1936]

Example 4.2

Life Co demutualises on 1 January 2007. The demutualisation is in accordance with demutualisation method 3 (section 121AH) in Division 9AA of Part III of the ITAA 1936. Life Co's listing day valuation amount (or embedded value) at the time of demutualisation is $200 million.

At the time of the demutualisation:

•

$110 million is transferred to Head Co's (the issuing company) share capital account before the end of the 'listing period' in relation to the demutualisation;

•

$30 million is transferred to Head Co's retained profit account before the end of the 'listing period' in relation to the demutualisation;

•

$25 million is transferred to a capital reserve created by Head Co in connection with the demutualisation; and

•

$35 million is retained in the shareholders' capital of the statutory fund of Life Co.

Section 197-35 applies to ensure that Head Co's share capital account does not become tainted by the $110 million transferred to that account before the end of the 'listing period' in relation to the demutualisation. The cap in subsection 197-35(2) is not breached because the sum of the amount transferred ($110 million) and the amount transferred to Head Co's retained profit account in connection with the demutualisation ($30 million) - that is, $140 million in total - does not exceed the listing day valuation amount at the time of demutualisation ($200 million).

In 2009 (ie, after the end of the 'listing period' in relation to the demutualisation), Head Co transfers the $25 million that was held in the capital reserve created in connection with the demutualisation to its share capital account. Section 197-40 applies to ensure that Head Co's share capital account does not become tainted by the amount transferred. The cap in subsection 197-40(2) is not breached because the sum of the amount transferred ($25 million), the amount transferred within the 'listing period' to Head Co's share capital account ($110 million) and the amount transferred to Head Co's retained profit account in connection with the demutualisation ($30 million) - that is, $165 million in total - does not exceed the listing day valuation amount at the time of demutualisation ($200 million).

In 2010, Life Co transfers the $35 million that was part of the shareholders' capital of the statutory fund at the time of the demutualisation to its share capital account. Section 197-40 applies to ensure that Life Co's share capital account does not become tainted by the amount transferred. The cap in subsection 197-40(2) is not breached because the sum of the amount transferred ($35 million), the amount transferred after the end of the 'listing period' to Head Co's share capital account from the capital reserve created in connection with the demutualisation ($25 million), the amount transferred within the 'listing period' to Head Co's share capital account ($110 million) and the amount transferred to Head Co's retained profit account in connection with the demutualisation ($30 million) - that is, $200 million in total - does not exceed the listing day valuation amount at the time of demutualisation ($200 million).

What happens when the share capital account becomes tainted?

4.40 If a company's share capital account is tainted, then:

•

a franking debit arises in the company's franking account;

•

the account is generally taken not to be a share capital account for the purposes of the ITAA 1936 and the ITAA 1997; and

•

any distributions from the account are taxed as unfranked dividends in the hands of the shareholder.

A franking debit arises in the company's franking account

4.41 When an amount is transferred to a company's share capital account that causes the share capital account to become tainted, a franking debit arises in the company's franking account immediately before the end of the franking period in which the transfer occurs. [Schedule 4, item 1, subsection 197-45(1)]

4.42 The amount of the franking debit is calculated by applying the formula:

4.43 The applicable franking percentage is the company's benchmark franking percentage (determined under section 203-30 of the ITAA 1997) for the franking period in which the tainting occurs. If the company has not set a benchmark franking percentage by the end of the franking period, it is taken to be 100 per cent. [Schedule 4, item 1, subsection 197-45(2)]

Example 4.3

A company's share capital account becomes tainted when an amount of $700 is transferred to the account from another account. The company has a benchmark franking percentage for the franking period in which the tainting occurred of 80 per cent. Section 197-45 imposes a franking debit at the end of the franking period of $240,

(ie, $700 × 30/70 × 80%).

The share capital account is taken not to be a share capital account except where specified

4.44 If a company's share capital account is tainted, then the account is generally taken not to be a share capital account for the purposes of the ITAA 1936 and the ITAA 1997.

4.45 However, a tainted share capital account continues to be recognised as a share capital account for the purposes of applying:

•

subsection 118-20(6) of the ITAA 1997, which ensures that a capital gain is not reduced by the amount of a non-portfolio dividend paid by a non-resident company that is debited against the company's share capital account;

•

the share capital tainting rules (Division 197 of the ITAA 1997);

•

the definition of 'paid-up share capital' in subsection 6(1) of the ITAA 1936;

•

subsection 44(1B) of the ITAA 1936, which deems dividends debited against a share capital account to be paid out of profits for certain purposes;

•

section 46H of the ITAA 1936, which specifies a share capital account to be a disqualifying account under the dividend tainting rules; and

•

subsection 159GZZZQ(5) of the ITAA 1936, which specifies that an amount that is debited against a share capital account is not an eligible non-capital amount under the off-market share buy-back rules.

[Schedule 4, item 20, subsection 975-300(3)]

Distributions are taken to be unfrankable dividends

4.46 If a company's share capital account is tainted, then any distributions from the account are taxed as dividends in the hands of the shareholder. This is because subsection 975-300(3) applies to ensure that a tainted share capital account is not regarded as a share capital account for the purposes of paragraph (d) of the definition of a 'dividend' in subsection 6(1) of the ITAA 1936. In addition, the dividend is taken to be an unfrankable distribution (see section 202-45 of the ITAA 1997 and section 46M of the ITAA 1936).

How does the share capital account become untainted?

4.47 A company's share capital account remains tainted until the company chooses to untaint the account. [Schedule 4, item 1, subsection 197-50(2)]

4.48 A company can untaint its share capital account by making a choice in the approved form given to the Commissioner. This choice is made at the time the form is given to the Commissioner and cannot be revoked. [Schedule 4, item 1, section 197-55]

What happens when the share capital account is untainted?

4.49 If a company chooses to untaint its share capital account, the company may have:

•

a further franking debit to its franking account; and

•

a liability to pay untainting tax.

An additional franking debit may arise in the company's franking account

4.50 If a company chooses to untaint its share capital account, an additional franking debit will arise in the company's franking account if its applicable franking percentage at the end of the franking period in which the choice to untaint is made is higher than its applicable franking percentage at the end of the franking period in which the share capital account was tainted. [Schedule 4, item 1, section 197-65]

4.51 The applicable franking percentage at the end of the franking period in which the choice to untaint is made is the company's benchmark franking percentage (determined under section 203-30 of the ITAA 1997) for that franking period. If the company has not set a benchmark franking percentage by the end of the franking period, it is taken to be 100 per cent. [Schedule 4, item 1, subsection 197-65(3)]

4.52 The amount of the additional franking debit is equal to the excess of the amount worked out under the formula:

over the amount of the franking debits that arose at the time of tainting under section 197-45 in relation to the transferred amount. [Schedule 4, item 1, subsection 197-65(3)]

Example 4.4

A company's applicable franking percentage at the end of the franking period in which the share capital account was tainted was 100 per cent. Therefore, if the company chooses to untaint its share capital account, no additional franking debit will arise in its franking account.

Example 4.5

A company's applicable franking percentage at both the end of the franking period in which the share capital account was tainted and the end of the franking period in which the choice to untaint is made is 80 per cent. Therefore, if the company chooses to untaint its share capital account, no additional franking debit will arise in its franking account.

Example 4.6

A company's share capital account becomes tainted when an amount of $700 is transferred to the account from another account. The company's benchmark franking percentage at the end of the franking period in which the share capital account was tainted was 80 per cent. Therefore, a franking debit of $240 was made to the company's franking account at that time.

The company chooses to untaint its share capital account. Its applicable franking percentage at the end of the franking period in which the choice to untaint is made is 100 per cent. Therefore, a franking debit of $60, (ie, ($700 × 30/70 × 100%) = $300 - $240) will arise in its franking account at the end of the franking period in which the choice to untaint is made.

The company may be liable to pay untainting tax

4.53 If a company chooses to untaint its share capital account, it may be liable to pay untainting tax. Untainting tax is due and payable 21 days after the end of the franking period in which the choice to untaint is made. [Schedule 4, item 1, subsection 197-60(2) and section 197-70]

4.54 Untainting tax is imposed by section 3 of the New Business Tax System (Untainting Tax) Bill 2006.

4.55 The amount of the liability to untainting tax depends on whether the company is:

•

a company with only lower tax members in relation to the tainting period - that is, a company that is wholly-owned by other companies, complying superannuation entities or foreign residents; or

•

a company with higher tax members in relation to the tainting period - that is, a company that is not a company with only lower tax members in relation to the tainting period.

[Schedule 4, item 1, subsection 197-60(1)]

4.56 If a company that chooses to untaint its share capital account only has lower tax members in relation to the tainting period, it will be liable to untainting tax only if its applicable franking percentage at either the end of the franking period in which the share capital account was tainted or the end of the franking period in which the choice to untaint is made was less than 100 per cent.

4.57 If a company that chooses to untaint its share capital account has higher tax members in relation to the tainting period, it will always be liable to untainting tax.

4.58 The amount of untainting tax that is payable is worked out by applying the formula:

where:

•

the applicable tax amount is the grossed-up tainting amount at the time of the choice to untaint multiplied by the applicable tax rate;

•

the section 197-45 franking debits are the franking debits that arose at the end of the franking period in which the share capital account became tainted; and

•

the section 197-65 franking debits are the further franking debits that arise at the end of the franking period in which the choice to untaint the share capital account was made.

[Schedule 4, item 1, section 197-60]

4.59 The applicable tax rate is:

•

if the company only has lower tax members in relation to the tainting period, the company tax rate (currently, 30 per cent);

•

if the company has higher tax members in relation to the tainting period, the highest marginal tax rate plus Medicare levy and Medicare levy surcharge (from 1 July 2006, 47.5 per cent).

[Schedule 4, item 1, subsection 197-60(3)]

Example 4.7

A company's share capital account becomes tainted when an amount of $700 is transferred to the account from another account. The company's benchmark franking percentage at the end of the franking period in which the share capital account was tainted was 80 per cent. Therefore, a franking debit of $240 was made to the company's franking account at that time.

The company chooses to untaint its share capital account. The company only has lower tax members in relation to the tainting period.

The company's applicable franking percentage at the end of the franking period in which the choice to untaint is made is 90 per cent. Therefore, a franking debit of $30, (ie, ($700 × 30/70 × 90%) = $270 - $240) will arise in its franking account at the end of the franking period in which the choice to untaint is made under section 197-65.

The company will be liable to pay untainting tax of $30, worked out as follows:

•

the applicable tax amount is $300,

(ie, $700 + ($700 × 30/70) = $1,000 × 30%);

•

the section 197-45 franking debits are $240;

•

the section 197-65 franking debits are $30;

•

the amount of untainting tax is $30, (ie, $300 - ($240 + $30)).

Example 4.8

A company's share capital account becomes tainted when an amount of $700 is transferred to the account from another account. The company's benchmark franking percentage at the end of the franking period in which the share capital account was tainted was 80 per cent. Therefore, a franking debit of $240 was made to the company's franking account at that time.

The company chooses to untaint its share capital account. The company has higher tax members in relation to the tainting period.

The company's applicable franking percentage at the end of the franking period in which the choice to untaint is made is 90 per cent. Therefore, a franking debit of $30, (ie, ($700 × 30/70 × 90%) = $270 - $240) will arise in its franking account at the end of the franking period in which the choice to untaint is made under section 197-65.

The company will be liable to pay untainting tax of $205, worked out as follows:

•

the applicable tax amount is $475,

(ie, $700 + ($700 × 30/70) = $1,000 × 47.5%);

•

the section 197-45 franking debits are $240;

•

the section 197-65 franking debits are $30;

•

the amount of untainting tax is $205,

(ie, $475 - ($240 + $30)).

Example 4.9

A company's share capital account becomes tainted when an amount of $700 is transferred to the account from another account. The company's benchmark franking percentage at the end of the franking period in which the share capital account was tainted was 100 per cent. Therefore, a franking debit of $300 was made to the company's franking account at that time.

The company chooses to untaint its share capital account. The company has higher tax members in relation to the tainting period.

As the company's applicable franking percentage at the end of the franking period in which the share capital account was tainted was 100 per cent, no further franking debit will arise under section 197-65.

The company will be liable to pay untainting tax of $175, worked out as follows:

•

the applicable tax amount is $475,

(ie, $700 + ($700 × 30/70) = $1,000 × 47.5%);

•

the section 197-45 franking debits are $300;

•

the section 197-65 franking debits are nil;

•

the amount of untainting tax is $175,

(ie, $475 - ($300 + 0)).

How do the share capital tainting rules apply to consolidated groups?

4.60 If a subsidiary member of a consolidated group or multiple entry consolidated (MEC) group transfers an amount to its share capital account that causes the share capital account to become tainted, only the subsidiary member's share capital account is tainted - that is, the single entity rule does not apply to cause the head company's account to become tainted.

4.61 Franking debits that arise at the time of tainting (section 197-45) or untainting (section 197-65) will arise in the franking account of the head company because the consolidated group or MEC group has a single franking account (see section 709-75). The applicable franking percentage, which applies to determine the amount of the franking debits that arise under sections 197-45 and 197-65, will be the head company's benchmark franking percentage for the relevant franking period. If the head company has not determined a benchmark franking percentage for the relevant franking period, the applicable franking percentage will default to 100 per cent.

4.62 Where a subsidiary chooses to untaint its share capital account, any untainting tax liability is calculated on the basis of its position as a company with either higher tax or lower tax shareholders.

4.63 If a subsidiary member joins a consolidated group or MEC group with a tainted share capital account, no further franking debit will arise under section 197-45. Any liability to untainting tax liability will be determined on the basis of the subsidiary member's position as a company with higher or lower tax shareholders.

4.64 If a subsidiary member leaves a consolidated group or MEC group with a tainted share capital account, its share capital account will remain tainted.

Machinery provisions

4.65 Machinery provisions are included that:

•

impose the general interest charge on unpaid amounts of untainting tax;

•

allow the Commissioner to give a company a notice of its liability to pay untainting tax; and

•

specify the evidentiary effect of such a notice.

[Schedule 4, item 1, sections 197-75, 197-80 and 197-85]

4.66 These machinery provisions are consistent with the machinery provisions that applied under the old share capital tainting rules.

Application and transitional provisions

Application of the amendments

4.67 The new share capital tainting rules in Division 197 apply to transfers made to a company's share capital account after the day this Bill is introduced into Parliament. The changes to the definition of share capital account apply from the date of Royal Assent. [Schedule 4, items 2, 14 and 30, section 197-5 of the Income Tax (Transitional Provisions) Act 1997]

4.68 The old share capital tainting rules effectively ceased to apply from 1 July 2002. Therefore, amounts transferred to a company's share capital account between 1 July 2002 and the day that this Bill is introduced into Parliament will not cause the share capital account to be tainted.

4.69 Consequently, any transfers to a company's share capital account that occurred as an immediate result of the adoption of the Australian Equivalent of the International Financial Reporting Standards will not cause the share capital account to be tainted. Companies were required to adopt those Standards on the first day of the first accounting period beginning on or after 1 January 2005.

4.70 Some amendments are made to the old share capital tainting rules in the ITAA 1936 with effect from 1 July 1998. These amendments are beneficial to taxpayers as they reduce the circumstances in which a company's share capital account becomes tainted. [Schedule 4, item 19]

Transitional provisions

4.71 Schedule 4 to this Bill inserts transitional rules into the Income Tax (Transitional Provisions) Act 1997 to facilitate the untainting of accounts that became tainted under the old share capital tainting rules and had not been untainted before 1 July 2002. [Schedule 4, item 2, section 197-10 of the Income Tax (Transitional Provisions) Act 1997]

4.72 Under the transitional rules, if a company had a tainted share capital account as at 30 June 2002:

•

the share capital account will be taken to be untainted from 1 July 2002 - therefore any distribution from the account between 1 July 2002 and the day after the introduction of this Bill will be treated as a capital distribution;

•

no franking debit or liability to untainting tax will arise at that time;

•

immediately after the day that this Bill is introduced into Parliament, the share capital account will be taken to be tainted to the same extent under Division 197 of the ITAA 1997; and

•

no franking debit will arise under section 197-45 of the ITAA 1997 as a result of the share capital account becoming tainted.

[Schedule 4, item 2, sections 197-15 and 197-20 of the Income Tax (Transitional Provisions) Act 1997]

4.73 The company will be able to choose to untaint its share capital account under section 197-55 of the ITAA 1997.

4.74 If the company chooses to untaint its share capital account, the operation of sections 197-60 and 197-65 of the ITAA 1997 will be modified as follows:

•

the tainting amount is taken to include the amount that was tainted under the old share capital tainting provisions;

•

references to franking debits arising under section 197-45 of the ITAA 1997 are taken to be references to franking debits that arose under the former sections 160ARDQ and 160ARDV of the ITAA 1936;

•

the amount of the franking debits that arose under the former section 160ARDQ or 160ARDV of the ITAA 1936 will be converted into a tax paid basis - this is achieved by multiplying the amount of any Class A franking debits by 39/61 and any Class C franking debits by 30/70; and

•

no untainting tax will be payable if the company has only lower tax members.

[Schedule 4, item 2, section 197-25 of the Income Tax (Transitional Provisions) Act 1997]

Consequential amendments

ITAA 1936

4.75 Consequential amendments to the ITAA 1936:

•

modify the definition of 'share capital account' in subsection 6(1);

•

insert a definition of 'tainted';

•

modify the definition of 'tainting amount'; and

•

repeal the former definition of 'share capital account' in section 6D.

[Schedule 4, items 3, 4, 21 and 22]

ITAA 1997

4.76 Consequential amendments to the ITAA 1997:

•

modify the table of franking debits in section 205-30 so that it includes references to the franking debits arising under sections 197-45 and 197-65;

•

modify the table of tax-related liabilities of the head company of a consolidated group in subsection 721-10(2) to update the reference to untainting tax; and

•

insert definitions of 'share capital account', 'tainted', 'tainting amount'; and 'untainting tax' into subsection 995-1(1); and

•

insert asterisks before various references to the term 'share capital account'.

[Schedule 4, items 5 to 9 and 23 to 29]

Taxation Administration Act 1953

4.77 Consequential amendments to the Taxation Administration Act 1953 :

•

modify the tables in section 8AAB that list provisions that make persons liable to the general interest charge to include section 197-60 of the ITAA 1997; and

•

modify the table of tax-related liabilities in section 250-10 to update the reference to untainting tax.

[Schedule 4, items 10 to 13]