House of Representatives

Explanatory Memorandum

(Circulated by the authority of the Treasurer,the Hon. J. Kerin, M.P.)

Chapter 11 Timing of franking credits

[Clause: 45, 46, 48, 49, 50, 51, 54, 55, 56, 57, 59, 60, 61, 62, 63, 66, 86, 89, 90, 91, 92, 94, 95, 96, 97]

Overview

Changes the basis on which companies receive franking credits from the assessment of company tax to the payment of company tax.

Summary of proposed amendments

11.1. The Bill will amend the Income Tax Assessment Act 1936 (the Act) to change the basis on which companies receive franking credits. The basis will change from the assessment of company tax to the payment of company tax.

11.2. The new payment basis of receiving franking credits will apply to payments of tax that relate to:

•

notices of assessments and amended assessments increasing tax;

•

notices of determination of foreign tax credit allowed; and

•

notices of determination of offsets allowed for franking deficit tax paid;

that are served or are deemed to be served after 20 August 1991.

Background to the legislation

11.3. Under the present law a company's capacity to pay franked dividends is determined on the basis of its company tax liability. The company tax assessed is the primary source of all franking credits under the present imputation system. Although franking credits arise for initial and any subsequent payments of tax made before the notice of assessment is served or deemed to be served, these entries in the franking account are reversed when the assessment is made.

11.4. The purpose of franking credits is to remove the second tier of tax on company income. They do this by allowing a rebate to shareholders who receive dividends paid from income that has already been taxed. Shareholders are entitled to a franking rebate for the franked dividends they receive even if the company paying the dividends has not paid, or will never pay, the company tax owing under the assessments that generated the franking credits. This last situation can happen if a company that has paid franked dividends becomes insolvent.

11.5. The imputation system was introduced before the change to self-assessment, when the Commissioner assessed company tax and served notices of assessment in all cases. Under self-assessment most companies self-assess their tax liabilities by lodging a return setting out the taxable income and the amount of any income tax payable. A notice of assessment is not served. The link between the assessment of company tax and the payment of that tax is greater under self-assessment.

11.6. The proposed change to the basis on which companies derive franking credits from assessment to payment is consistent with the closer relationship between the assessment and collection of company tax under self-assessment.

Explanation of the proposed amendments

Present law

11.7. Under the present law franking credits arise when a company makes an initial payment of tax (section 160APMA) or a subsequent payment of tax before the final payment is due (section 160APMB). When the company tax assessment is made the initial and any subsequent payments are credited against the amount of company tax assessed. The company then pays the difference as a final payment of tax. A franking credit arises (under section 160APN or 160APNA) when the assessment is served or deemed to be served and, at the same time, franking debits arise (under sections 160APYA and 160APYAA) for the application of the initial and subsequent payments.

Treatment of life assurance companies

11.8. Non-mutual life assurance companies receive franking credits and use franking debits on the same basis as other companies with shareholders. However, these franking credits and franking debits are reduced to take into account the tax liability on income that cannot be distributed to shareholders. Reducing franking debits and credits are determined by a formula that calculates the reduction on the basis that 80 per cent of the company tax liability is attributable to statutory fund income and cannot be distributed to shareholders. The tax on statutory fund income is the difference between tax on taxable income and tax on the non-fund component of taxable income.

11.9. The same principles will be applied in reducing the franking credits and franking debits that arise to life assurance companies on the basis of tax payments as were applied in an assessment based system. New formulae will therefore be provided to calculate the reducing franking debits and franking credits that relate to the new provisions. The implications for life assurance companies of new franking credits and franking debits because of the change to a payment based imputation system will be addressed under the particular franking credit or debit.

Changing to a payment basis for franking credits

11.10. The change to a tax payment based imputation system requires the repeal of sections under which franking credits and franking debits that are unrelated to a payment of company tax arise. Existing provisions that provide for franking credits to arise on the payment of company tax and those providing for franking debits to arise on the refund of certain payments will be supplemented by new sections to provide franking credits for final and other payments of company tax.

Effect on assessment of tax liability

11.11. The effect of the amendments proposed by the Bill is that for assessments are served or deemed to be served and amendments served after 20 August 1991 no franking credit will arise when:

•

the Commissioner serves or is deemed to have served a notice of assessment after 20 August 1991 (sections 160APN or 160APNA); [Clause 51 and subclause 86(5)]

•

the Commissioner serves a notice of amended assessment increasing tax liability after 20 August 1991 (section 160APR); [Clause 55 and subclause 86(5)]

•

an offset to which a company is entitled is reduced and the notice is served after 20 August 1991 (section 160APS); [Clause 55 and subclause 86(9)] and

•

the amount of foreign tax credit is reduced and the notice is served after 20 August 1991 (section 160APT). [Clause 55 and subclause 86(9)]

11.12. Similarly, franking debits will no longer arise when:

•

an initial or subsequent payment of tax is applied in an assessment that is served or deemed to be served after 20 August 1991 (sections 160APYA and 160APYAA); [Clause 59 and subclause 86(6)]

•

an offset determination notice for franking deficit tax paid is served or deemed to be served after 20 August 1991 (section 160AQ); [Clause 61 and subclause 86(12)] and

•

a notice of determination of foreign tax credit allowable, or of an increase in the amount allowable, that is served or deemed to be served after 20 August 1991 (section 160AQA). [Clause 61]

11.13 . Consistent with the repeal of the above provisions, reducing franking credits and franking debits that arise to life assurance companies in respect of those provisions will also be repealed. Where the notice of assessment, amended assessment or determination of foreign tax credit was served or deemed to be served after 20 August 1991:

•

franking debits will not arise when the notice is served (or deemed to be served) to a life assurance company (sections 160AQCF, 160AQCG and 160AQCH); [Clause 62 and subclauses 86(5) and (9)] ; and

•

franking credits will not arise when an initial or subsequent payment of tax is applied in an assessment of a life assurance company (sections 160APVA and 160APVB). [Clause 56 and subclause 86(6)]

11.14. Where a notice of determination allowing a foreign tax credit (or increasing the amount allowed) was served before 21 August 1991, a transitional provision will extend the application of sections 160AQA (and 160APVE in the case of life assurance companies) to ensure that a franking debit (and reducing franking credit for life assurance companies) arises. The franking debit (and, if required, the reducing franking credit) will also arise where the determination notice issues after 20 August 1991 but the assessment for the relevant year of income issued before 21 August 1991. [Clause 92]

11.15. The proposed amendments to subparagraphs (a)(ii) and (aa)(i) and (ii) of the definition of "applicable general company tax rate" (section 160APA) relate to the proposed repeal of provisions generating franking credits or franking debits on the determination or variation of a company's tax liability. [Paragraphs 46(e), (f) and (g)]

Final payment of tax

11.16. Where a company makes a final payment of tax under section 221AZD after 20 August 1991 and the assessment for the relevant year of income is made after that date, a franking credit will arise. [Clause 50 - new section 160APMC and subclause 86(3)]

11.17. Where the final payment of tax (section 221AZD) was made before 21 August 1991 but the assessment to which the payment relates was served or deemed to be served after 20 August 1991, the final payment will be deemed to have been made on the day the assessment was served or deemed to be served, and a franking credit will arise under section 160APMC. [Clause 94]

11.18. Where the company making the final payment of tax that entitles it to a franking credit under section 160APMC is a life assurance company, a franking debit will also arise. The amount of the franking debit will be calculated using the formula provided. [Clause 62 - new section 160AQCJ]

11.19. The applicable general company tax rate to be used to calculate the franking credit under section 160APMC (and the reducing franking debit under section 160AQCJ for a life assurance company) on making a final payment of tax is set out in proposed new subparagraph (a)(iba) and amended subparagraph (aa)(ii) of the definition in section 160APA. [Paragraphs 46((c) and (g)]

Other payments of tax

11.20. A franking credit will arise when a company pays a tax liability that was notified in a notice of assessment or amended assessment increasing tax served by the Commissioner after 20 August 1991. [Clause 50 - new section 160APMD]

11.21. Where the company making the payment of tax that entitles it to a franking credit under section 160APMD is a life assurance company, a franking debit will also arise. The amount of the franking debit will be calculated using the formula provided. [Clause 62 - new section 160AQCK]

11.22. Certain provisions in the Principal Act deem a payment of tax to have been made when the Commissioner deducts an amount of a credit to which the taxpayer is entitled from the tax owing. Payments in this category include those deemed to be made by subsection 221YHG(5) (prescribed payments) and subsection 221YHZL(6) (amount deducted for failure to quote a tax file number). When a company is deemed to have made a payment of tax under one of these provisions the payments comes within the definition of "paid" for imputation purposes (section 160APA) and a franking credit will arise under new section 160APMD.

11.23. However, a credit to which a company is entitled because of a foreign tax credit will not be a payment of tax for imputation purposes. (See the notes below on "foreign tax credits".)

11.24. If a company has made a payment of tax before 21 August 1991 in anticipation of receiving an assessment or amended assessment, and the assessment or amended assessment in respect of which the payment was made was served after 20 August 1991, the payment will be treated as having been made on the day the assessment was served and a franking credit will arise under section 160APMD. [Clause 95]

11.25. The applicable general company tax rate to be used to calculate the franking credit under section 160APMD on making a final payment of tax is set out in proposed new subparagraph (a)(ibb) of the definition in section 160APA. [Paragraph 46((c)]

Offsets

11.26. Under the present assessment based imputation system a franking debit arises where an offset is allowed in the company tax assessment for franking deficit tax paid or the amount of offset previously allowed is increased (section 160AQ). This adjustment is necessary because tax equal to the amount of the franking deficit tax offset has already been used to frank dividends. In the same say, a franking credit arises where an offset previously allowed is reduced (section 160APS). An entitlement to an offset or variations to that entitlement will not generate a franking credit or franking debit where the notice issues after 20 August 1991. (Sections 160APS and 160AQ will be repealed.) [Clauses 55 and 61]

11.27. If an offset allowed to a company is later found to be excessive the Commissioner may recover the amount of the excess as if it was company tax due and payable (section 160AQR). When a company makes a payment of company tax that became due because the amount of the franking deficit offset to which the company was entitled has been reduced, and the notice of determination was served after 20 August 1991, a franking credit will arise. [Clause 54 - new section 160APQA and subclause 86(10)]

11.28. If a company has made a payment of tax before 21 August 1991 in anticipation of receiving a notice of determination reducing an offset entitlement, and the notice reducing the offset was served after 20 August 1991, the payment will be treated as having been made on the day the notice was served and a franking credit will arise under section 160APQA. [Clause 96]

11.29. The tax rate to be used to calculate the franking credit under section 160APQA is that specified in subparagraph 160APA(b)(ii) of the definition of "applicable general company tax rate".

Refunds of company tax

11.30. Where a company receives a refund of a payment of company tax that when made gave rise to a franking credit, or the amount is not refunded but is applied to pay other amounts owing, a franking debit will arise. [Clause 60 - new section 160APYBA]

11.31. When a refund is made of an initial payment the effect for Division 1B purposes is that the refund reduces the amount of the initial payment. However, an amendment to section 221AZA (to apply to the 1990-91 and later years of income) will prevent any such refund from having that effect for imputation purposes. This amendment will ensure that the franking credit that arises (under section 160APMA) on the making of an initial payment will not be affected if the initial payment is later refunded. The reduction in a company's franking capacity as a result of any refund of an initial payment will be reflected by the franking debit under new section 160APYBA. [Clause 66 and subclause 85(13)]

11.32. The franking debit will arise for a refund of company tax paid even if the amount is applied to pay company tax owing, either under an assessment, amended assessment, or to recover company tax owing because the amount of foreign tax credit or an offset allowed was excessive (subsection 160AN(5) or section 160AQR). The application of the amount to pay company tax will itself give rise to a franking credit.

11.33. Where company tax paid is refunded or applied to discharge a Commonwealth liability and a franking debit arises (under section 160APYBA), if the company is a life assurance company a franking credit will also arise. The amount of the franking debit will be calculated using the formula provided. [Clause 56 - new section 160APVBA]

11.34. The applicable general company tax rate to be used to calculate the franking debit under section 160APYBA (and the reducing franking credit under section 160APVBA for a life assurance company) when company tax is refunded, or applied to pay a Commonwealth liability, is set out in proposed new subparagraphs (a)(id) and (aa)(i) of the definition in section 160APA. [Paragraphs 46(d) and (f)]

Foreign tax credits

11.35. Foreign tax paid on foreign income cannot give rise to a franking credit even if the credit for the foreign tax paid has been allowed against the Australian tax payable on the income. This outcome is achieved under the present assessment based system by a franking debit arising for the amount of the foreign tax credit allowable or any increase in the amount allowable (section 160AQA). Similarly, where the amount of foreign tax credit is reduced a franking credit arises because of the increase in the company's tax liability (section 160APT).

11.36. Where a notice of determination of the foreign tax credit allowable is served after 20 August 1991 no franking credit or franking debit will arise for a foreign tax credit entitlement or any variation to that entitlement. [Clauses 55 and 61]

11.37. A foreign tax credit to which a company is entitled (section 160AF) is a debt due and payable to the company by the Commissioner (subsection 160AN(1)). This credit may then be applied against any tax liability the company may have to the Commonwealth (subsection 160AN(2)). Where the foreign tax credit is applied to discharge a tax liability, the company is deemed to have paid the amount applied (subsection 160AN(3)).

11.38. However, for the purposes of franking credits and debits arising under Division 2 of Part IIIAA (dividend imputation), any foreign tax credit applied to discharge a company tax liability will not be deemed to be company tax paid. [Clause 45 - new subsection 160AN(3A)]

11.39. A similar amendment to the definition of "paid" (section 160APA) will specifically exclude the discharge of a company tax liability by an application of a foreign tax credit from being a payment of company tax for imputation purposes. [Clause 46(h)]

11.40. If the amount of foreign tax credit allowed to a company is later found to be greater than the amount to which the company was entitled, the Commissioner can recover the amount of the excess as if it was Australian tax payable (subsection 160APN(5)). When a company makes a further payment of company tax because the amount of the foreign tax credit has been reduced and the notice is served after 20 August 1991, a franking credit will arise when the further payment is made. [Clause 54 - new section 160APQB and subclause 86(11)]

11.41. Where, as a result of making a payment of tax that became due because of a reduction in amount of foreign tax credit allowable, a life assurance company receives a franking credit under section 160APQB, a franking debit will also arise. The amount of the franking debit will be calculated using the formula provided. [Clause 62 - new section 160AQCL]

11.42. If a company has made a payment of tax before 21 August 1991 in anticipation of receiving a notice of determination reducing the amount of foreign tax credit allowable, and the notice reducing the foreign tax credit was served after 20 August 1991, the payment will be treated as having been made on the day the notice was serviced and a franking credit will arise (new section 160APQB). [Clause 97]

11.43. The tax rate to be used to calculate the franking credit under section 160APQB is that specified in paragraph 160APA(a)(iii) of the definition of "applicable general company tax rate". The rate for calculating the reducing franking debit under section 160AQCL will be as set out in amended subparagraph (aa)(ii) of the definition. [Paragraph 46(g)]

Refunds of foreign tax credit

11.44. Where a company receives a refund of company tax because an amount of foreign tax credit has been allowed, or the amount is not refunded but is applied to pay other amounts owing, a franking debit arises. [Clause 60 - new section 160APYBB]

11.45. However, unlike proposed section 160APYBA, a franking debit will not arise when the foreign tax credit is applied to discharge a liability for:

•

company tax owing under an assessment or an amended assessment;

•

an initial, subsequent or final payment of tax due under Division 1B of Part VI (collection of tax on companies and trustees of certain funds);

•

company tax owing because an excess amount of foreign tax credit was allowed (subsection 160AN(5)); or

•

company tax owing because an excess amount has been allowed as an offset (section 160AQR).

11.46. The franking debit for an application of a foreign tax credit arises even if the amount is applied to pay company tax owing, either under an assessment, amended assessment, or because the amount allowed as a foreign tax credit or an offset is excessive (subsection 160AN(5) or 160AQR). Where the credit is applied against these liabilities no franking credit arises for the deemed payment.

11.47. Where the amount of foreign tax credit refundable has been applied to reduce company tax owing in the above circumstances, the application of the excess will not be a payment of company tax for imputation purposes (section 160APA). (See earlier notes under "foreign tax credits")

11.48. The effect of no franking debit arising where the refund is applied for the purposes specified in paragraphs 160APYBB(b)(i), (ii), (iii) and (iv) is the same as if the application was deemed to be a payment of company tax for imputation purposes and generated a franking credit.

11.49. Where the foreign tax credit is refunded or applied to discharge a Commonwealth liability and the franking debit arises (under section 160APYBB) to a life assurance company, a franking credit will also arise. The amount of the franking credit will be calculated using the formula provided. [Clause 56 - new section 160APVBB]

11.50. The applicable general company tax rate to be used to calculate the franking debit (under section 160APYBB (and the reducing franking credit under section 160APVBB for a life assurance company) on making a final payment of tax is set out in proposed new subparagraphs (a)(ie) and (aa)(i) of the definition in section 160APA. [Paragraphs 46(d) and (f)]

Estimated debit determinations

11.51. A company is required to frank a dividend to the extent of the surplus in the franking account on the day the dividend is paid. If a company has taken some action that is likely to result in a reduced tax liability, such as lodging an objection against an assessment that is expected to be allowed in full, the franking debit likely to arise can be reflected in the franking account by way of an estimated debit determination. The present law allows a company to apply for an estimated debit determination if it has taken "liability reduction action" (a term defined in section 160APA) or has made an initial payment of tax.

11.52. The ability to apply for an estimated debit determination when an initial payment of tax has been made allows companies who estimate that their tax liability will be less than the initial payment to take that into account in determining the extent to which dividend should be franked. The ability to apply for an estimated debit determination where an initial payment has been made is to be changed.

11.53. The definition of "estimated debit determination" will be amended to restrict its application in relation to initial payments to those cases in which the company is seeking a refund of an initial payment of tax under subsections 221AQ(3), 221AR(6) or 221AU(4). [Paragraph 63(c) - new subsection 160AQD(1A)]

11.54. A company is entitled to a refund under subsection 221AQ(3) where it has made its initial payment on the basis of its notional tax and the estimated tax payable is less than the notional tax. A refund is available under subsection 221AR(6) where a company makes a revised estimated of its tax payable and the revised estimate is less than the original estimate. A company that elects to make a single payment of tax after it has made its initial payment is entitled to a refund of the initial payment under 221AU(4).

Termination time

11.55. Estimated debit determinations terminate when the action giving rise to the estimated debit determination is finalised. This is also the time at which a franking credit equal to the estimated debit arises (section 160APU). In the case of action taken by the company to reduce its tax liability, such as referring the matter to a court or tribunal or lodging an objection, the termination time is the time the matter is resolved and the company's tax liability is reduced or it receives notice of the unfavourable decision.

11.56. The definition of "termination time" in relation to an estimated debit determination for an initial payment of tax will be amended by replacing existing paragraph (b). The termination time will be the time at which the company receives the refund to which it is entitled. However, if the company has not received the refund by the time the company makes its final payment of tax (section 221AZD), the estimated debit determination will terminate when the payment is made. If no final payment is required the termination time will be the time the final payment would have been due if it had been required. [Paragraph 46(i)]

Liability reduction action

11.57. Liability reduction action is action taken by a company to reduce its tax liability and allows a company to apply for an estimated debit determination. In its present form the definition of "liability reduction action" includes action taken to claim an entitlement or increased entitlement for a foreign tax credit or franking deficit tax offset. Since franking debits will no longer arise on the basis of a company's tax liability or increased entitlement to an offset or a foreign tax credit (sections 160AQ and 160AQA are to be repealed), a new definition will be provided in section 160APA for liability reduction action. The broader definition of the term will cover claims for refunds on account of an offset of franking deficit tax paid or foreign tax credit. [Paragraph 46(k)]

Instalments

11.58. The instalment system of collection company tax does not apply for the 1989-90 or any subsequent year of income. Since companies are no longer paying company tax by instalments, provisions in Part IIIAA relating to the imputation effects of paying tax by instalments are no longer operative.

11.59. Sections 160APM and 160APY which provide a franking credit and a franking debit, respectively, on the payment or application of a company tax instalment will be repealed. Also, amendments to section 160APA relating to subparagraph (a)(i) of the definition of "applicable company tax rate", the definition of "company tax instalments" and paragraph (b) of the definition of "termination time", will remove references to the payment of tax by instalments. [Paragraphs 46(a), (i) and (j)]

11.60. Where an instalment of company tax is refunded, and the assessment for the year of income to which the instalment relates was served after 20 August 1991, a franking debit will arise under new section 160APYBA because the application of that section will be extended to cover instalments paid. [Clause 89]

Commencement date

11.61. The provisions effecting the amendments to the Income Tax Assessment Act 1936 to change the basis on which companies receive franking credits will commence on 21 August 1991. [Subclause 2(4)]

Clauses involved in the proposed amendments

Clause 45: amends section 160AN to exclude credits applied to discharge tax liabilities from being payments of tax for imputation purposes

Clause 46: amends section 160APA which contains definitions of terms used in the dividend imputation provisions (Part IIIAA)

Clause 48: repeals section 160APM which relates to the instalment system of paying company tax

Clause 49: makes a minor amendment to section 160APMB

Clause 50: inserts new sections 160APMC and 160APMD which provide franking credits on the making of a final and later payments of tax

Clause 51: repeals sections 160APN and 160APNA which provide a franking credit when an assessment is served or deemed to be served

Clause 54: inserts new sections 160APQA and 160APQB which will provide franking credits for the payment of company tax due because the franking deficit tax offset and foreign tax credit is reduced, respectively

Clause 55: repeals sections 160APR, 160APS and 160APT which provide franking credits for an amended company tax assessment increasing tax, a reduction of an offset entitlement and a reduction of foreign tax credit allowable, respectively

Clause 56:

•

repeals sections 160APVA and 160APVB which provide franking credits to life assurance companies to reduce the franking debits when an initial or subsequent payment of tax is applied in an assessment; and

•

inserts sections 160APVBA and 160APVBB which will provide franking credits to reduce the franking debit arising to a life assurance company when company tax or foreign tax credit is refunded or applied to discharge Commonwealth liabilities

Clause 57: repeals section 160APVE which provides a franking credit to a life assurance company to reduce the franking credit for the allowance of a foreign tax credit

Clause 59: repeals section 160APY, 160APYA and 160APYAA which provide franking debits on the application of a company tax instalment, an initial and subsequent payment of tax, respectively

Clause 60: inserts new sections 160APYBA and 160APYBB which will provide franking debits when tax paid or a foreign tax credit is refunded or applied to discharge other Commonwealth liabilities

Clause 61: repeals sections 160AQ and 160AQA which provide a franking debit for an offset and foreign tax credit allowed, respectively

Clause 62:

•

repeals section 160AQCF, 160AQCG and 160AQCH which provide franking debits to life assurance companies to reduce the franking credits that arise when an assessment or an amended assessment increasing tax is made, or foreign tax credit is reduced; and

•

inserts new sections 160AQCJ, 160AQCK and 160AQCL which will provide franking debits to life assurance companies to reduce the franking credits that arise when the company makes a final payment, later payment or a payment in relation to a foreign tax credit

Clause 63: amends section 160AQD to delete references to company tax instalments and to modify the circumstances under which an estimated debit determination is available when an initial payment is made

Clause 66: amends section 221AZA to prevent its application for imputation purposes

Clause 86: contains the application provisions for the amendments that relate to changing to a payment basis for franking credits

Clause 89: is a transitional provision to extend the scope of section 160APYBA to cover refunds of company tax instalments in certain circumstances

Clause 90: is a transitional provision to provide the company tax rate to be used to calculate franking debits and credits for life assurance companies when a repealed provision is operating transitionally

Clause 91: is a transitional provision for estimated debit determinations relating to an entitlement of an offset or a foreign tax credit

Clause 92: is a transitional provision relating to franking credits and debits under sections 160APVE and 160AQA for foreign tax credits

Clause 94: is a transitional provision extending the application of section 160APMC for final payments of tax

Clause 95: is a transitional provision extending the application of section 160APMD for later payments of tax

Clause 96: is a transitional provision extending the application of section 160APQA for payments of excess offsets

Clause 97: is a transitional provision extending the application of section 160APQB for payments of excess foreign tax credit allowed

(Editorial note: *Amendment - Non-Mutual Life Assurance Companies*

* Inclusion of provisions to deal with specific matters which effect non-mutual life assurance companies only (introduced during passage through Parliament, refer pages 6-9 of Supplementary EM).*)