Senate

Explanatory Memorandum

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

Chapter 5 - Franking of dividends by exempting companies and former exempting companies

Overview

5.1 Schedule 5 to the Bill will amend Part IIIAA of the Income Tax Assessment Act 1936 (ITAA 1936) to prevent franking credit trading. The amendments will limit the source of franking credits available for trading by:

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prescribing that franked dividends paid by companies which are effectively wholly-owned by non-residents or tax exempt entities will provide franking benefits to resident shareholders in limited circumstances only; and

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quarantining the franking surpluses of companies which were formerly effectively wholly-owned by non-residents or tax exempt entities.

5.2 The measures will also ensure that non-resident shareholders in receipt of franked dividends from affected companies will continue to be exempt from dividend withholding tax.

Summary of the amendments

Purpose of the amendments

5.3 The purpose of the amendments is to protect the revenue by introducing a measure which limits the source of franking credits available for trading to curb the unintended usage of franking credits through franking credit trading schemes.

Date of effect

5.4 Subject to transitional measures explained below, the measure will apply to:

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companies that are effectively wholly-owned by non-residents or tax exempt entities at 7.30 pm AEST on 13 May 1997 ( exempting companies );

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companies that are effectively wholly-owned by non-residents or tax exempt entities after 7.30 pm AEST on 13 May 1997 and subsequently cease to be so owned ( former exempting companies ); and

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companies which become wholly-owned by non-residents or tax exempt entities at a time after 7.30 pm AEST on 13 May 1997 (these companies will be subject to the measure from that time).

5.5 New subsection 160AQCNI(1) applies where, before 7.30 pm AEST on 13May1997, a taxable resident has become contractually obliged to acquire shares of an exempting company so that the acquisition would result in the company ceasing to be an exempting company. This provision operates so that, although the company will be an exempting company before the acquisition and a former exempting company after the acquisition, the franking surplus or franking deficit of the company will be unchanged by the acquisition. Similarly, franking credits and debits attributable to the period or an event occurring while the company was an exempting company will not be quarantined. [Item 51, new subsection 160AQCNI(1)]

5.6 The above transitional provision will not apply if acquiring the franking credits of the company was a purpose (other than an incidental purpose) of the acquisition of the shares. [Item 51, new subsection 160AQCNI(2)]

5.7 In addition, the measures do not apply to dividends declared, but not paid, by publicly listed companies before 7.30 pm on 13May 1997, and dividends paid after that time that relate to such dividends. An example of where a dividend would relate to another dividend would be where, under a stapled stock arrangement, the declaration of a dividend in one company provides a shareholder in the company with the right to a dividend from another company. [Item 81]

5.8 Companies paying such dividends are to treat the measure as not applying to the extent necessary to allow for the exemption.

Background to the legislation

5.9 One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves.

5.10 In substance, the true economic owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or who are only very briefly exposed, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. They therefore undermine an underlying principle of imputation.

5.11 A significant source of credits for trading is to be found in companies which have controlling shareholders for whom franking credits have limited or no value, principally non-residents and tax exempt entities.

5.12 The Bill introduces a measure limiting the source of franking credits available for trading to restore these underlying principles of the imputation system.

Explanation of the amendments

Outline of the amendments

5.13 The ordinary imputation provisions in Part IIIAA of the ITAA 1936 are to apply to companies that are not effectively wholly-owned by non-residents or tax exempt entities and have never been so owned, and to exempting companies (ie. companies that are effectively wholly-owned by non-residents or tax exempt entities) in the same way as they currently apply. However, subject to certain exceptions, franked dividends paid by exempting companies will not provide an entitlement to franking rebates or credits. These dividends will, however, be exempt from dividend withholding tax in the same way as ordinary franked dividends.

5.14 Exempting companies will, therefore, continue to generate franking credits and debits, and be subject to the ordinary provisions in Part IIIAA. However, in most circumstances, dividends paid by exempting companies will only be exempt from dividend withholding tax.

5.15 Former exempting companies (ie. companies that were effectively wholly-owned by non-residents or tax exempt entities but have ceased to be so owned) will need to maintain two franking accounts: a franking account to record franking credits and debits attributable to the period after it ceases to be an exempting company, and an exempting account to record credits and debits attributable to the period during which it was an exempting company. A surplus in the exempting account will be able to be used to pay exempted dividends to certain shareholders. Generally, exempted dividends will only be exempt from dividend withholding tax. Subject to the exceptions explained below, they will not provide an entitlement to franking rebates or credits.

5.16 The legislation, broadly speaking, works as follows:

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first, it defines the types of taxpayer who have no or a very limited use for franking; these are called prescribed persons. Prescribed persons are defined in a way which includes the entities through which persons who ultimately have no or little use for franking benefits hold their interests in the companies as well those persons themselves;

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next, the legislation defines what types of shares or interests in shares count in working out who owns a true equity interest in a company; these are called accountable shares or interests; and

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finally, it defines when a company is effectively owned by prescribed persons by testing whether prescribed persons own 95% or more of the accountable shares or interests in the company, or alternatively, substantially bear the risks and opportunities of owning the accountable shares or interests in the company.

Exempting companies

5.17 New section 160APHBA provides that a company is taken to be an exempting company if the company is effectively wholly-owned by prescribed persons. [Item 42, new section 160APHBA]

Direct ownership by prescribed persons

5.18 For the purposes of new section 160APHBB a company is effectively wholly-owned by prescribed persons if:

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95% or more of the accountable shares in the company or interests in the accountable shares are held directly or indirectly by prescribed persons; [Item 42, new paragraph 160APHBB(1)(a)] or

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it would be reasonable to conclude that, having regard to, among other things, any arrangement of which the company is aware with respect to the accountable shares or interests, the risks and opportunities resulting from holding the shares or interests substantially accrue to prescribed persons. [Item 42, new paragraph 160APHBB(1)(b)]

5.19 The purpose of the second of these tests is to ensure that arrangements which in economic substance amount to ownership of a company are also embraced by the rule. This is to deal with the use of derivatives and the like to provide synthetic ownership of equity in companies.

5.20 Where for example, a non-resident owns 70% of an Australian company and an Australian resident owns the remaining 30%, if the Australian resident has transferred the risks and opportunities of ownership of the shares to the non-resident (eg. the resident has forward sold the 30% interest to the non-resident) the Australian company will still be an exempting company notwithstanding that nominally only 70% of the company is held by prescribed persons.

5.21 This test also has regard to unissued shares. This is to prevent the test being avoided by flooding allotments of shares, under which existing shareholdings are diluted to an insignificant proportion by the issue of new shares. For example, if a resident owns two shares, which are the only issued shares, but under an arrangement (eg. an option over unissued shares) a prescribed person or persons will acquire 100 new shares to be issued in the future (which will be accountable shares) the effect may be to place effectively all the risks and opportunities of holding accountable shares into the hands of prescribed persons even though they currently hold no shares.

5.22 New section 160APHBF defines a prescribed person to be a company or natural person who is exempt from tax or a non-resident for the purposes of the ITAA 1936, or a partnership or trust where all the partners or beneficiaries are exempt from tax or non-resident for the purposes of the ITAA 1936. The Commonwealth, States and Territories will also be treated as prescribed persons. [Item 42, new section 160APHBF]

Indirect ownership by prescribed persons

5.23 New section 160APHBG provides that a company, partnership or trust that is not a prescribed person for the purposes of new section 160APHBF , which holds shares in another company, will be taken to be a prescribed person if by applying a look through approach it is determined that a non-resident or tax-exempt holds substantially all of the risks and opportunities of ownership of the shares in the other company. For example, if all the shares of a resident company are held by a trustee of a fixed trust whose beneficiaries are, apart from an inconsequential holding, all non-residents, the company is held by non-residents for the purposes of the measures. Similarly, if there is chain of wholly-owned companies, the measures will apply to each company in the chain if the holding company is within the measure. For example, if foreign company A owns 100% of Australian company B which owns 100% of Australian company C, the measures would apply to both company B and company C. [Item 42, new section 160APHBG]

5.24 New subsection 160APHBG(9) , however, provides that the look through approach will not apply in relation to a company which is itself a prescribed person. Therefore if a resident company is wholly-owned by a non-resident company which has resident shareholders, the resident company is subject to the measures notwithstanding that a look through approach would reveal that the risks and opportunities of ownership lie with residents. [Item 42, new subsection 160APHBG(9)]

Ownership through trusts

5.25 New subsection 160APHBG(4) provides that a trustee of a trust is a prescribed person in relation to a company if one or more prescribed persons controls the trust or all of the beneficiaries actually receiving income are prescribed persons. This test applies to trusts in addition to the risks and opportunities test which applies under new subsection 160APHBG(3) . [Item 42, new subsection 160APHBG(5)]

5.26 However, new subsection 160APHBG(7) provides for the case where a prescribed person controls a trust which holds accountable shares in a company, but some beneficiaries who are not prescribed persons receive distributions comprising dividends paid on accountable shares in the company. New subsection 160APHBG(7) provides that, in this circumstance, the Commissioner may deem that the trust is not a prescribed person in relation to the company if it is reasonable to conclude that persons who are not prescribed persons effectively hold the risks and opportunities of the accountable shares in the company. [Item 42, new subsection 160APHBG(7)]

5.27 In determining whether a person is a controller of a trust, regard is to be had to whether:

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the person beneficially owns, or is able in any way, whether directly or indirectly, to control the application of the interests in the trust property or in the trust income; [Item 42, new paragraph 160APHBG(6)(a)]

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the person has the power to directly or indirectly appoint or remove the trustee or beneficiaries of the trust; or [Item 42, new paragraphs 160APHBG(6)(b) and 160APHBG(6)(c)]

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the trustee of the trust is accustomed or under a formal or informal obligation to act according to the wishes of the person or an associate of the person. [Item 42, new paragraph 160APHBG(6)(d)]

Excluded shares

5.28 In determining whether a company is effectively wholly-owned by non-resident or tax-exempt shareholders, only accountable shares and accountable interests are taken into account. The rules relating to what are accountable shares and accountable interests are concerned with the effective ownership of a company.

5.29 The owner of property, in the economic sense, is the person who bears the risks of loss and has the opportunities for profit arising from that property. In the case of a company, this would mean the person or persons exposed to the performance of the company. However, in the case of a company, the law regards each share in the company as the subject of property, rather than the company itself. It might usually be expected that all the shares in a company in totality will reflect the risks and opportunities of owning the company, but some shares involve their holders in bearing few, if any, risks or opportunities reflecting the performance of the company. For example, some shares carry only rights equivalent to those of creditors; others may have no dividend rights. Often, therefore, the whole of the equity in a company, considered as a matter of substance, is represented by only some of the shares in it. It is therefore necessary to determine which shares, and where there are indirect holdings, which interests in shares, represent the real equity in a company in order to determine who effectively owns it.

5.30 Generally speaking, the clearest case of an owner of a company is the holder of an ordinary share in that company; the standard of ownership is therefore to be found in the rights usually attached to ordinary shares and in the risks and opportunities which flow from such rights. This is the standard adopted by the tests for determining the effective ownership of a company. Shares with different rights, and indirect interests in shares held through trusts and partnerships, are to be judged as relevant or irrelevant to the question of who effectively owns the company according to the extent that they approximate the rights, and participate in the risks and opportunities, from holding such shares.

5.31 Under the rules relating to accountable shares and accountable interests regard must be had, not only to the rights attached to particular shares, but also the rights attached to other shares; both those held by the same shareholder (or associates), and those held by other shareholders. For example, instead of ordinary shares, a company might have different classes of shares carrying only voting rights, only dividend rights, or only rights to capital. Conversely, there might be cases where there are ordinary shares in a company which of themselves appear to represent an ownership interest, but which in fact do not, because there are other super shares with rights that effectively override theirs. The criteria require the relationship between the value of the share or interest and the company to be taken into account, along with the nature of any relationship or connection between holders of shares and interests in shares. The overall position must be taken into account to ensure that the test operates, as intended, as in substance test of ownership.

5.32 The rules which treat holders of accountable shares and interests as prescribed persons if the risks and opportunities of holding those shares lie with prescribed persons (ie. if the real owners of the shares or interests are prescribed persons) extend also to holders of excluded shares and interests. This is because whether some shares or interests are excluded shares or interests may depend on whether they are held by prescribed persons. This will prevent prescribed persons from deliberately structuring their shareholdings so that they are excluded from the definitions of accountable shares and accountable interests.

5.33 New subsection 160APHBC(2) provides that accountable shares are shares which are not excluded shares . New subsection 160APHBC(3) provides that a share is an excluded share if, having regard to the criteria outlined in new paragraphs 160APHBC(3)(a) to 160APHBC(3)(f) , it would be reasonable to conclude that the share should not be taken into account when determining whether the company is effectively wholly-owned by prescribed persons because the share does not involve the holder having to bear any of the risks or opportunities normally associated with share ownership. For example, if resident company A which is wholly-owned by a non-resident issues a negligible amount of Z class non-voting, non-dividend shares to a resident, resident company A will still be an exempting company even though it has a resident shareholder because the type of shareholding indicates that substantially all of the risks and opportunities of ownership of resident company A still lie with the non-resident. [Item 42, new subsection 160APHBC(3)]

5.34 New subsection 160APHBC(5) also provides that finance shares (defined in new subsections 160APHBC(6) and (7) ), dividend access shares (defined in new subsection 160APHBC(8) ), shares without dividend rights and shares issued for the non-incidental purpose of avoiding the application of the measures are to be treated as excluded shares where the shares are held by a person who is not a prescribed person. For example, if all the ordinary shares in resident company A are owned by a non-resident and all the redeemable preference shares are owned by a resident, resident company A will be an exempting company notwithstanding the resident redeemable preference shareholder because the redeemable preference shares are excluded shares. Similarly, if resident company B had two classes of shares, class X which had full voting, dividend and capital rights, and class Y which had only dividend rights, and non-residents held class X shares and residents held class Y shares, resident company B would be an exempting company because the class Y shares would be dividend access shares and therefore excluded. [Item 42, new subsections 160APHBC(5) - 160APHBC(8)]

5.35 New section 160APHBD provides that an accountable interest is an interest in accountable shares which is not an excluded interest . New subsection 160APHBD(3) provides that an interest is an excluded interest if having regard to the criteria outlined in new paragraphs 160APHBD(3)(a) to 160APHBD(3)(g) it would be reasonable to conclude that the interest should not be taken into account when determining whether the company is effectively wholly-owned by prescribed persons because the interest does not involve the holder having to bear any of the risks or opportunities normally associated with ownership of interests in shares. [Item 42, new subsections 160APHBD(2) and 160APHBD(3)]

5.36 In addition, interests issued for the non-incidental purpose of avoiding the application of the measures are also excluded interests. [Item 42, new subsection 160APHBD(5)]

5.37 Therefore, if a trust which holds all the accountable shares in a company and which has non-resident beneficiaries only appoints a resident as a discretionary object, for the purposes of determining whether the trust is a prescribed person in relation to the company, the interest held by the resident may be disregarded if the interest does not involve the holder having to bear any of the risks or opportunities normally associated with ownership of interests in shares.

Effectively wholly-owned group companies

5.38 New section 160APHBI provides that two or more companies are members of the same effectively wholly-owned group if:

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95% or more of the accountable shares or interests in each of the companies are directly or indirectly held by the same persons; or [Item 42, new paragraph 160APHBI(1)(a)]

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it would be reasonable to conclude that, having regard to the matters referred to in new subsection 160APHBI(2) , the risks and opportunities resulting from holding accountable shares or interests in each of the companies are borne by or substantially accrue to the same persons. [Item 42, new paragraph 160APHBI(1)(b)]

5.39 Therefore, if companies B and C each hold 50% of company D and company A owns 96% of company B and 96% of company C, for the purposes of new section 160APHI , companies A, B, C and D will form an effectively wholly-owned group notwithstanding that company A only holds 96% of companies B and C.

5.40 The question of whether companies are members of the same effectively wholly-owned group is relevant for the purposes of determining whether certain dividends paid by a former exempting company or exempting company can provide the shareholder with a franking credit benefit.

Eligible continuing substantial shareholders

5.41 New section 160APHBJ provides a definition of eligible continuing substantial shareholder . This is also relevant for the purposes of determining whether certain dividends paid by a former exempting company can provide the shareholder with a franking credit benefit (including an exemption from dividend withholding tax). A shareholder is an eligible continuing shareholder in relation to a dividend paid by a former exempting company if:

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the shareholder is a non-resident, life company, exempting company or former exempting company, or a partnership or trust having the aforementioned groups as beneficiaries or partners; and

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the shareholder directly or indirectly holds the prescribed percentage of shares ( prescribed percentage is the same percentage as that provided under subsection 708(5) of the Corporations Law dealing with substantial shareholdings); and

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if the assumptions set out in new subsection 160APHBJ(4) are made the shareholder, beneficiary or partner (if a non-resident) would be exempt from dividend withholding tax or (if a resident) would be entitled to a franking credit or franking rebate in respect of the dividend.

[Item 42, new subsections 160APHBJ(2) and 160APHBJ(3)]

5.42 New section 160APHBJ effectively provides that a shareholder who is a company (first company) who holds a prescribed percentage of accountable shares in a former exempting company (second company) is an eligible continuing substantial shareholder if, when the second company was an exempting company , the first company was able to benefit from franked dividends paid by the second company. For example, if a resident company formerly wholly-owned by non-residents and now owned by taxable residents has a wholly-owned resident subsidiary, both the company and its subsidiary will be former exempting companies and the parent company will be an eligible continuing shareholder of the subsidiary, even if the parent company sells some of its shares in the subsidiary to a third party.

Former exempting companies

5.43 As outlined above, to comply with the measure, exempting companies will not need to modify their franking procedures. However, if a company ceases to be an exempting company so that it becomes a former exempting company, subject to the transitional and short-term ownership provisions explained below, franking surpluses or deficits existing at that time will be quarantined in an exempting account. The exempting account will be used to record franking credits and debits attributable to the period, or to an event taking place, when the relevant company was an exempting company. [Item 42, new section 160APHBE]

5.44 New sections 160AQCNG and 160AQCNH provide that when a company ceases to be an exempting company and becomes a former exempting company the class A or C franking surplus or deficit of the company at that time is to be converted into an equivalent exempting surplus or deficit. For example, if, just before a company became a former exempting company, it had a class A franking surplus (because it is a life company) of $1 million and a class C franking deficit of $2 million, the class A and class C exempting account balances would be, respectively, $1 million surplus and $2 million deficit, and the franking account balances would become zero. The conversion is implemented by:

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cancelling a franking surplus or deficit by posting an equivalent franking debit or credit (respectively); and

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posting an exempting credit equal to the amount of the franking surplus, or an exempting debit equal to the amount of the deficit. [Item 51, new sections 160AQCNG and 160AQCNH]

5.45 However, if an exempting company becomes a former exempting company, and franking credits and debits had arisen before that time which are attributable to the period that the company is a former exempting company, the franking surplus or deficit of the company at the time it becomes a former exempting company will be reduced or increased accordingly. The proportion of the franking credits or debits attributable to the period that the company is a former exempting company will not be quarantined: it will continue to be treated as franking credits or debits by the company. [Item 51, new subsections 160AQCNG(3), 160AQCNG(4), 160AQCNH(3) and 160AQCNH(4)]

5.46 To allow former exempting companies to maintain and operate exempting accounts the definitions of franking account terms in the ITAA have been extended to include exempting account terms. Amended section 160APA provides for class A or C exempting deficits, surpluses, debits, credits, account balances and class A or C exempted dividends. [Items 16 to 35, amended section 160APA]

5.47 In addition to the extension of the franking credit and debit terms to equivalent exempting account terms, the amendments will allow the ascertainment of a class A or C exempting surplus or deficit at any particular time during the franking year. This is achieved by providing for the calculation of the surplus and deficit in the same way as the class A and C franking account surpluses and deficits are calculated. [Item 51, new section 160AQCND]

5.48 Because only former exempting companies retain exempting accounts, if a former exempting company reverts to being an exempting company (eg. if a company originally held by non-residents is sold to taxable residents and then sold back to non-residents), the exempting account once again becomes a franking account. Therefore, new sections 160AQCNK and 160AQCNL convert the exempting surplus or deficit of such companies into a franking surplus or deficit. These provisions operate so that, upon becoming an exempting company, the company will receive an exempting debit or credit to cancel an exempting surplus or deficit, and receive an equivalent franking credit or debit. However, franking credits of exempting companies are generally not able to provide franking credit benefits to residents. [Item 51, new sections 160AQCNK and 160AQCNL]

Allocation of credits and debits to the exempting account

5.49 As explained above, exempting companies are to maintain franking accounts which are governed by the current provisions in Part IIIAA, including the provisions of Division 2 providing for the generation of franking credits and franking debits.

5.50 Former exempting companies are also to maintain an exempting account. New sections 160AQCNM and 160AQCNN provide that former exempting companies are to convert franking credits and debits (generated from the payment of company tax or the receipt of a refund of company tax) which are attributable to the period, or to an event taking place, when they were exempting companies into equivalent exempting credits or debits. New subsections 160AQCNM(2) and 160AQCNN(2) provide that the franking credit or debit does not arise if it is attributable to a period when the company was an exempting company and instead an equivalent exempting credit or debit arises to the company. [Item 51, new sections 160AQCNM and 160AQCNN]

5.51 For example, suppose an exempting company paid $360,000 tax at 36%, was sold to a taxable Australian resident and, after the change in ownership, received a full refund of the tax paid. Instead of posting a franking debit under section 160APYBA, the company, now a former exempting company, would post a class C exempting debit of $640,000 ($360,000 64/36).

5.52 As a result of this amendment, if a company becomes a former exempting company during an income year, credits arising from tax instalments paid for that year (see Division 1C of Part VI of the ITAA) will be partly franking credits and partly exempting credits. The pro-rating is to be made on the basis of the proportion of the period during the year that the company was an exempting company (exempting credits) to the remaining period (franking credits). For example, where a June balancing company becomes a former exempting company on 1January in a particular income year, 50% of the credits that arise from company tax instalments relating to that year will be franking credits and 50% will be exempting credits. Similarly, if the above company were to receive a refund in respect of those instalments, 50% of the debits arising from the refund would be franking debits and 50% would be exempting debits.

5.53 Therefore, in the example below of a 30 June balancing large taxpayer (as defined in section 221AZH) which was an exempting company until being sold to residents on 1 October 1997 (when it became a former exempting company), the credits accruing on the 1 December 1997 tax instalment would be exempting credits (because it is the final instalment for the previous income year, during the whole of which it was an exempting company), while the credit accruing on the instalments for the 1997-98 income year (ie. 1 March, 1 June, 1 September and 1December in 1998) would be in the proportions of 25% exempting credits and 75% franking credits. This is because the company is an exempting company for a quarter of the income year.

Payment of dividends by former exempting companies

5.54 Former exempting companies can pay either exempted dividends or franked dividends.

5.55 Former exempting companies will generally pay ordinary franked dividends according to the prevailing balance in their franking account: they will be subject to the required franking rules in Division 4 of Part IIIAA. They will also be able, at their option, to pay exempted dividends to certain shareholders (provided they have the required surplus), including employees under eligible employee share schemes. However, only the unfranked portion of a dividend can be exempted by a former exempting company. Therefore the company must first frank the dividend according to the required franking rules (see Division 4 of Part IIIAA) using its available franking surplus before it can use the balance in its exempting surplus. To do otherwise would be to attract underfranking penalties under section 160APX.

What constitutes franking with an exempted amount?

5.56 Section 160AQF of the ITAA specifies the circumstances in which a dividend may be franked and how it is franked. Broadly, a frankable dividend is franked if a resident company makes a declaration before the reckoning day that the current dividend is a franked dividend to the extent of a certain percentage (not exceeding 100 %).

5.57 The franking rules set out in section 160AQF for franked dividends will be extended to exempted dividends. To determine the exempted amount of a dividend a company needs to make a declaration that a dividend is exempted to the percentage specified in the declaration. [Item 54, new section 160AQFA]

5.58 New subsection 160AQFA(4) provides that a former exempting company may frank a dividend with exempting credits to the extent it is unfranked by franking credits only to the extent the dividend is paid to an eligible continuing substantial shareholder or an employee under an eligible employee share scheme. Where the franked and exempted amounts of the dividend exceeds the amount of the dividend the dividend is taken not to have been franked in accordance with new section 160AQFA . [Item 54, new subsections 160AQFA(3) and 160AQFA(4)]

5.59 New subsection 160AQFA(4) effectively provides that where a former exempting company pays an exempted dividend to a shareholder which is not an eligible shareholder or an employee under an employee share scheme the dividend will not be treated as franked for the purposes of new section 160AQFA . [Item 54, new subsection 160AQFA(4)]

Equal allocation of exempting credits

5.60 To avoid streaming of exempting credits, if a former exempting company opts to pay an exempted dividend to an eligible shareholder (ie. an eligible continuing substantial shareholder or employee under an eligible employee share scheme), it must notionally attach exempting credits evenly across the whole dividend (ie. to all shareholders receiving the dividend). Therefore, if the company exercises the option it will be required when paying a dividend to debit the exempting account to the extent that exempting credits would have gone to all shareholders had they all been eligible to receive exempted dividends. However, notwithstanding this notional allocation of exempting credits, only dividends paid to the shareholders described above will be exempted dividends.

5.61 Moreover, new subsections 160AQFA(5) and 160AQFA(6) provide that a declaration that a dividend is exempted under new section 160AQFA is not effective unless a similar declaration is made in relation to all other dividends paid by the company which are in the same combined class of dividends. [Item 54, new subsections 160AQFA(5) and 160AQFA(6)]

5.62 New section 160AQCNE provides that when a former exempting company pays an exempted dividend there arises to the company an exempting debit equal to the full exempted amount declared under new section 160AQFA .

Example

5.63 Arnold (a non-resident) owns 100% of the shares in Dinkum Ltd (an Australian resident). Therefore, Dinkum Ltd is an exempting company. On 1 January 1998, Arnold disposes of 50% of Dinkum Ltd to Joe (an Australian resident). At that time, Dinkum Ltd ceases to be an exempting company and becomes a former exempting company. On 1March of that year, Dinkum (a June 30 balancing company) pays a company tax instalment of $360 and receives $320 of franking credit and $320 of exempting credit. This is because for half of the relevant income year Dinkum was an exempting company. On 1 April of that year Dinkum pays a $640 dividend to its shareholders. The measures provide that Dinkum is required to exhaust its franking surplus before it can use its exempting surplus. Accordingly, Dinkum pays a partially franked dividend to both Arnold and Joe. The measures also provide that Dinkum is allowed to exempt the unfranked portion of the dividend paid to Arnold because he is an eligible continuing shareholder. However, under the measures, if the exemption of the dividend paid to Arnold is to be effective, Dinkum must notionally exempt the entire dividend, that is, if the dividend to Arnold is exempted, the dividend to Joe must be notionally exempted to the same extent. Accordingly, if Arnold receives a $320 dividend, $160 of the dividend will be franked and $160 will be exempted. However, the dividend received by Joe will only be $160 franked and no part will be exempted (because Joe is not an eligible shareholder). The total exempting debit will be $320.

Obligation to debit exempting account for previously declared dividends

5.64 Circumstances may arise where, before it becomes a former exempting company, a company declares a dividend to be class A or class C franked under section 160AQF based on its current franking surplus, but, because the reckoning day of the dividend is after it becomes a former exempting company, when it comes to pay the dividend it no longer has a franking surplus but instead has an exempting surplus. For example, where an exempting company declares a dividend to be 100% franked and before the dividend is paid it is sold to a taxable resident, the company may not be able to frank the dividend because the franking surplus has been reduced to zero and converted to an exempting surplus.

5.65 Ordinarily, section 160AQF declarations cannot be varied (subsection 160AQF(2)). However, to prevent companies being obliged to frank their dividends by more than the available franking surplus, new subsection 160AQF(3) allows declarations to be varied where the declaration was made before a company becomes a former exempting company but the dividend to which the declaration relates (or at least one of the dividends if there is more than one) has a reckoning day after that time. In these cases, the declaration can be varied to take into account the new franking surplus. [Item 53, new subsection 160AQF(3)]

5.66 In addition, new section 160AQCNJ allows for the avoidance of an underfranking debit if a former exempting company pays a frankable dividend and:

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although paid afterwards, the reckoning day of the dividend is before the company became a former exempting company; or

•

subsection 160AQE(3) applies (ie. the current dividend was a committed future dividend in respect of an earlier dividend and the earlier dividend was over-franked thus requiring the current dividend to be franked to the same extent as the earlier dividend); or

•

subsection 160AQE(4) applies (ie. the current dividend is paid on the same day as another dividend but is paid under a different resolution and the other dividend is over-franked).

5.67 Under new section 160AQCNJ an exempting debit arises equal to the difference between the amount by which the dividend is franked and the amount to which the required franking rules requires it to be franked. The dividend is then deemed to be franked to the required extent, but only for the purposes of determining whether an underfranking debit arises under section 160APX. To prevent a double debiting, the exempting debit arising under new section 160AQCNJ is reduced by the amount of any actual exempting debit arising under new section 160AQCNE . [Item 51, new section 160AQCNJ]

Tax treatment of dividends paid by exempting companies and former exempting companies

5.68 As explained above, all franked dividends paid by exempting companies are generally exempt from dividend withholding tax only, while former exempting companies can pay exempted dividends to certain shareholders only. Broadly speaking only employees under certain employee share schemes, or continuing substantial shareholders who were able to benefit from franked dividends paid when the relevant company was an exempting company (eg. a life assurance company shareholder which is part of the same company group).

5.69 Other than for the exceptions explained below, exempted dividends paid by former exempting companies and franked dividends paid by exempting companies are for all intents and purposes unfranked dividends in the hands of residents.

5.70 For non-resident shareholders, however, such dividends will carry the same entitlement to an exemption from dividend withholding tax as ordinary franked dividends. Accordingly the measures provide that where a former exempting company pays an exempted dividend to a shareholder, the dividend is exempt from dividend withholding tax for that portion of the dividend that has been declared to be exempted in the same way it would have been had it been franked in the ordinary way. [Item 10, amended paragraph 128B(3)(ga)]

Dividends paid to individuals and life assurance companies

5.71 Under section 160AQT of the ITAA, resident individual shareholders who receive franked dividends are required to include in their assessable income the amount of the imputation credit together with the amount of the dividend (ie. the grossed-up amount of the dividend). The shareholder is then entitled to a franking rebate equal to the amount of the imputation credit under section 160AQU. This rule is affected by the measures when the company paying the dividend is an exempting company or a former exempting company.

5.72 New subsection 160AQTA(1) provides that section 160AQT does not apply in relation to franked dividends paid by an exempting company. Therefore, with the exception of certain employee share schemes and life assurance companies (explained below), franked dividends paid by exempting companies (and exempted dividends paid by former exempting companies) to residents are to be treated as unfranked dividends for the purposes of section 160AQT (ie. shareholders do not gross-up the dividend and therefore are not allowed a rebate under section 160AQU). [Item 61, new subsection 160AQTA(1)]

Dividends paid to life assurance companies

5.73 Unlike other corporate shareholders, section 160AQT(1A) and (1C) provide that a gross-up amount is included in the assessable income of a life assurance company (and therefore a franking rebate is available) where a franked dividend is paid on its statutory fund assets.

5.74 To ensure that this treatment can continue where the life assurance company is an exempting company or former exempting company and it receives a dividend from a subsidiary (ie. a franked dividend paid by an exempting company or an exempted dividend paid by a former exempting company), new sections 160AQTA and AQTB provide for an exception to the general rule preventing resident shareholders receiving a franking benefit from an exempted dividend or a franked dividend paid by an exempting company. The exception applies where such a dividend is paid to a life assurance company and, in relation to the dividend-paying company, the life assurance company and the dividend-paying company are members of the same effectively wholly-owned group, or the life assurance company holds substantially all the risks and opportunities associated with more than 5% of the shares in the dividend-paying company. In these circumstances, new subsection 160AQTA(2) provides that section 160AQT does apply in relation to the franked dividend paid by the exempting company, while new subsection 160AQTB(1) provides that an exempted dividend paid to a life company is to be treated as franked for the purposes of subsections 160AQT(1A) or 160AQT(1C). [Item 61, new sections 160AQTA and 160AQTB]

5.75 Consistent with the application of section 160APP in relation to franking credits, new sections 160APPA and 160AQCNF provide that where a life assurance company receives a franked dividend from an exempting company, or an exempted dividend, on shares held in its statutory fund the credit arising is reduced by 80%.

5.76 To prevent life companies acquiring exempting companies or former exempting companies as a means of effectively converting exempting credits and unusable franking credits into franking benefits, new subsections 160AQTA(4) and 160AQTB(2) limit the life company concession to credits generated during the time when the life company held shares in the other company: only credits attributable to that period will be able to confer a franking benefit. [Item 61, new subsections 160AQTA(4) and 160AQTB(2)]

Employee share schemes

5.77 New subsection 160AQTA(5) provides that where a franked dividend is paid by an exempting company on shares issued to employees under an employee share scheme (ESS), section 160AQT applies in relation to the dividend. New subsection 160AQTB(3) provides that where an exempted dividend is paid by a former exempting company on shares issued to employees under an ESS the exempted dividend is to be treated as a franked dividend. [Item 61, new subsections 160AQTA(5) and 160AQTB(3)]

5.78 A taxpayer will be taken to acquire a share in a company under an eligible ESS if:

•

the share is acquired by the taxpayer in respect of, or for, or in relation directly or indirectly to, any employment of the taxpayer;

•

the taxpayer is an employee of the company or of a subsidiary company of the company;

•

all the shares available for acquisition under the scheme are ordinary shares or preference shares with substantially the same rights attached to them as ordinary shares;

•

immediately after the acquisition of the shares, the taxpayer does not hold a legal or beneficial interest in more than 5 per cent of the shares of the company; and

•

immediately after the acquisition of the shares, the taxpayer is not in a position to cast, or control the casting of, more than 5 per cent of the maximum number of votes that might be cast at a general meeting of the company. [Item 42, new section 160APHBH]

Intercorporate dividends

5.79 New subsection 160APP(1AAA) provides that franked dividends paid by exempting companies to corporate shareholders will generally not result in a franking credit arising to the company under section 160APP. Moreover, amended subsection 46F(2) applies so that generally franked dividends paid by exempting companies to a private company shareholder will be treated in the same way as an unfranked dividend for the purposes of determining eligibility for a rebate of tax under section 46. [Item 3 and Item 4, amended subsection 46F(2) and new subsection 160APP(1AAA)]

5.80 However, new section 160APPA provides that where an exempting company (first company) pays a franked dividend to another exempting company (second company) a franking credit equal to the franked amount of the dividend will arise to the second company if:

•

both the relevant companies are members of the same effectively wholly-owned exempting company group; or [Item 44, new paragraph 160APPA(1)(b)] having regard to any arrangement with respect to the relevant shares as stated in new subsection 160APPA(3) , the risks and opportunities associated with holding more than 5% of the shares (other than finance shares, dividend access shares and shares which do not carry the right to receive dividends) in the first company substantially accrue to the second company. [Item 44, new paragraph 160APPA(1)(b) and new subsection 160APPA(3)]

5.81 New subsections 160APPA(4) to (6) are equivalent to the provisions in section 160APP. Therefore, for example, no franking credit arises to the second company if the dividend paid by the first company is wholly exempt income of the second company, and no franking credit arises if the dividend was paid as part of a dividend stripping operation. [Item 44, new subsections 160APPA(4)-(6)]

5.82 Similarly new section 160AQCNF provides that where an exempting company receives an exempted dividend there arises to the company a franking credit equal to the exempted amount of the dividend. New section 160AQCNF also provides that when a former exempting company receives an exempted dividend there arises to the company an exempting credit equal to the exempted amount of the dividend. Therefore, if a former exempting company receives a $100 dividend from its continuing wholly-owned subsidiary which is franked to 80% and exempted to 20% it will credit its franking account with $80 and its exempting account with $20. [Item 51, new sections 160AQCNE and 160AQCNF]

Trusts and partnerships

5.83 Division7 of Part IIIAA contains provisions designed to ensure that franked dividends received indirectly through partnerships and trusts are treated in the hands of partners and beneficiaries in the same way that such dividends would have been treated if received directly. In other words where a partnership or trust derives franked dividends, that income retains its character when it is distributed to a partner or beneficiary.

5.84 To provide for residents who, contrary to the general rule, can gain franking benefits from exempted dividends and franked dividends paid by exempting companies (certain exempting company and former exempting company shareholders, life companies, and certain employees), new sections 160AQZC and 160AQZB allow credits to be passed through a trust or partnership holding shares on behalf of such persons. To the extent that distributions representing such dividends are then made to the beneficiary or partner, the tax treatment will be the same as if the dividends were paid directly to the beneficiary or partner. [Item 63, new sections 160AQZC and 160AQZB]

5.85 Provisions corresponding to those in Division 7 to allocate the credits attached to the dividends have not been included because those provisions require the trustee or partnership to gross-up franked dividends received and thereby receive higher assessable income: this would not be appropriate if not all the beneficiaries would be entitled to receive franking benefits from the exempted dividends and dividends paid by exempting companies.

5.86 Accordingly new sections 160AQZC and 160AQZB treat exempting company franked dividends and exempted dividends paid to a trust or partnership as unfranked dividends. However, where the assessable income of a beneficiary or partner includes an amount attributable to the dividends, the beneficiary or partner is deemed, for the purposes of determining whether they are entitled to a franking rebate, a franking credit or an exempting credit, to have been paid directly so much of the dividends as their assessable income from the trust or partnership is attributable to. The beneficiary or partner is also deemed to hold the share in respect of which the dividend was paid, which will allow a franking rebate to flow through to, for example, an employee of a company where a share issued under an eligible employee share scheme is held by a trustee on the employees behalf.

5.87 All beneficiaries or partners are treated as being eligible to benefit from the relevant dividend in proportion to their respective interests in the total income of the trust or partnership. Therefore, the assessable income of each beneficiary or partner is deemed to be attributable to the relevant dividend to the extent of their share of the total income of the trust or partnership. For example, suppose there are two beneficiaries of a trust who are each entitled to half the net income of the trust (say, $5,000). If the trust receives an exempted dividend of $1,000 then each beneficiary is deemed to receive a $500 exempted dividend for the purpose of determining their entitlement, if any, to a franking credit or rebate or exempting credit, irrespective of how the trustee purports to distribute it. [Item 63, new subsections 160AQZB(4) and 160AQZC(4)]

Payment of franking deficit tax, franking additional tax and deficit deferral tax by former exempting companies

5.88 Section 160AQJ of the ITAA imposes a liability to franking deficit tax (FDT) on a company where its franking account balance is in deficit at the end of its franking year. Sections 160AQJA (applicable to life assurance companies) and 160AQJC (applicable to other companies) impose a liability to deficit deferral tax (DDT) where an instalment of tax paid in the income year is refunded in the following franking year and a franking deficit would have arisen if the refund had occurred at the end of the previous franking year.

5.89 New section 160AQCNO provides that a deficit in the exempting account at the end of the franking year results in a nil balance in that account and a franking debit of the deficit amount in the franking account of the company. Therefore, a deficit in an exempting account at the end of a franking year (or, for DDT purposes, a deficit that would have arisen if the refund had been received before the end of the year) effectively gives rise to the same taxes and penalties as an equivalent deficit in a franking account. [Item 51, new section 160AQCNO]

Exempting account: records and information

5.90 Division 12 of Part IIIAA contains provisions that require companies to keep relevant records for a period of five years. The records include documents relevant for the purpose of ascertaining a companies franking account balances (paragraph 160ASC(b)).

5.91 Amended paragraph 160ASC(b) provides references to the exempting account balance that is to be maintained by former exempting companies. [Item 64, amended paragraph 160ASC(b)]

Special measures for Commonwealth owned bodies

5.92 New section 160AQCNP provides the Treasurer with a discretion which effectively allows former exempting companies which were formerly wholly-owned by the Commonwealth to use their exempting credits to pay ordinary franked dividends. [Item 51, new section 160AQCNP]

5.93 New subsection 160AQCNP(2) stipulates that in deciding whether to exercise the discretion in favour of a company, the Treasurer will have regard to:

•

whether the discretion is necessary to allow the company to pay fully franked dividends after the company is sold (ie. if the discretion were not applied would the relevant company have or accrue sufficient franking credits to fully frank its dividends); [Item 51, new paragraph 160AQCNP(2)(a)]

•

whether the ability to pay franked dividends is central to achieving a successful sale; [Item 51, new paragraph 160AQCNP(2)(b)]

•

whether the cost to the revenue from exercising the discretion is expected to be largely offset by the increase in the sale price; [Item 51, new paragraph 160AQCNP(2)(c)] and

•

any other factors the Treasurer considers relevant. [Item 51, new paragraph 160AQCNP(2)(d)]

5.94 The exercise of the discretion by the Treasurer in favour of a company may be made conditional upon compliance by the relevant company with certain stipulated conditions. For example, receiving a written commitment from the relevant company that:

•

it will not vary its forecast dividend paying policies (ie. the amount of the dividends, the frequency of dividends and the proportion of profits it pays out as dividends) in the post-sale period; and

•

its tax payments will be in accordance with the tax law. [Item 51, new subsection 160AQCNP(6)]

5.95 New subsections 160AQCNP(4) and 160AQCNP(5) provide that when exercising the discretion in favour of a company, the Treasurer will specify, after the end of the relevant franking year, the value of exempting credits that can be transferred to the franking account. This transfer is deemed to have taken place immediately before the end of the year. The prevailing balance in the exempting account provides the upper limit on the amount that can be transferred. [Item 51, new subsections 160AQCNP(4) and 160AQCNP(5)]

Short-term ownership by non-residents or tax exempt entities

5.96 New subsection 160APHBE(2) provides that if a company becomes effectively wholly owned by prescribed persons and, within 12months, there is a change in ownership so that it ceases to be so owned, then that change in ownership does not result in the company becoming a former exempting company. In determining whether a company has been an exempting company for less than 12 months, any relevant periods before the commencement of the measure will be taken into account. [Item 42, new subsection 160APHBE(2)]

5.97 Similarly, new subsections 160AQCNI(3) to 160AQCNI(5) provide that if a former exempting company becomes an exempting company for less than twelve months, upon its reversion to a former exempting company, instead of converting the whole of its franking surplus or deficit to an equivalent exempting amount, the company will be able to retain the franking surplus or deficit it would have had if it remained a exempting company instead of becoming an exempting company for the relevant period: the remainder is to be converted to an exempting amount. [Item 51, new subsections 160AQCNI(3) to 160AQCNI(5)]

Dividend statements

5.98 Section 160AQH provides that companies paying dividends to shareholders need to give a dividend statement specifying the extent to which a dividend is franked or unfranked. Amended section 160AQH requires that dividend statements provided to shareholders of former exempting companies set out, in addition to the other information specified by section 160AQH, the exempted amount of the dividend. [Items 56 to 59, amended section 160AQH]

5.99 Exempting companies are required to give a statement to their shareholders advising them that only certain shareholders (eg. eligible life assurance companies or employees under an eligible employee share scheme) are entitled to the franking benefits on a dividend paid by the company. [Item 59, new subsection 160AQH(2)]

5.100 As with the current section 160AQH, companies will also be required to provide such other information as is set out in the approved form (see paragraph 160AQH(c)).

5.101 For exempting companies and former exempting companies that paid dividends after announcement of the measures but before introduction of this Bill into Parliament, the Commissioner is given a discretion to ratify dividend statements notwithstanding that they fail to comply with the provisions of amended section 160AQH . This will ensure that companies that have made a genuine attempt to comply with the dividend statement requirements will not be penalised. [Item 80]

Amendments relating to dividend streaming and schemes to confer a franking benefit

5.102 The Bill makes various amendments to allow the anti-streaming rule in proposed section 160AQCBA to apply to exempting credits in an equivalent way to the way it applies to franking credits. [Items 45 to 50, new paragraph 160AQCBA(3)(a), new subsections 160AQCBA(8) to 160AQCBA(12) and new subsections 160AQCBA(16) and 160AQCBA(17)]

5.103 Similarly, the general anti-avoidance rule in proposed section 177EA will be amended so that it applies to schemes where one of the purposes (other than an incidental purpose) of the scheme is to obtain a tax advantage in relation to exempted dividends. [Items 65 to 72, new paragraph 177EA(5)(a), new subsections 177EA(10), 177EA(16), 177EA(18) and 177EA(20)]

Consequential amendments

5.104 Various other consequential amendments are made to the ITAA1936 to take account of the fact that dividends can now be franked under section 160AQF or new section 160AQFA . [Item 7, Item 62 and Items 73 to 79]

TITLE OF PROJECT: Franking credit trading: Limiting the source of franking credits

Regulation Impact Statement

1. Specification of policy objective

5.105 The policy objective is to prevent franking credit trading by limiting the source of franking credits available for trading.

2. Identification of implementation options

Background

5.106 One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot use them at all or relatively little (including non-residents and tax exempt entities) to others who can use them or have a relatively greater use for them, undermines this principle.

5.107 A significant source of credits for trading is to be found in companies which have controlling shareholders for whom franking credits have limited or no value, principally non-residents and tax exempt entities.

5.108 Accordingly, among the measures aimed at preventing franking credit trading announced in the 1997 Budget, the Government announced a measure preventing such companies passing on franking credits or rebates from 13 May 1997.

Implementation Options

5.109 The measure prevents companies that are effectively wholly-owned by non-resident or tax-exempt shareholders providing franking credits or rebates to residents and quarantines the franking surpluses of companies which were formerly wholly-owned by non-residents or tax exempt entities.

5.110 Option One would be to provide that companies subject to the measure would continue to frank their dividends with franking credits according to the required franking rules contained in Division 4 of Part IIIAA. However, subject to certain exceptions relating to employee share schemes and life companies, a franked dividend paid to a resident by a company subject to the measure would not carry an entitlement to any franking rebate or franking credit. Non-resident shareholders receiving franked dividends from such companies will be relieved from dividend withholding tax to the extent that they would have been so relieved had the dividend been a franked dividend paid by a company not subject to the measure. Companies which were formerly wholly-owned by non-residents or tax exempt entities would be required to quarantine their franking surpluses or deficits in an exempting account.

5.111 Exceptions relating to employee share schemes and life companies are necessary because the policy objective of the measures is to prevent franking credit trading and not to inhibit legitimate employee share schemes and disadvantage life assurance policy holders. The absence of the exceptions would result in the legislation going beyond the Governments policy objective.

5.112 Option Two would require that companies subject to the measure have their franking accounts cancelled and in its place the company would create a balance of the same amount in an equivalent exempting account. Companies subject to the measure would therefore frank their dividends with exempting credits just as they currently frank dividends with franking credits. Dividends received by residents franked with exempting credits would have no tax effects for such shareholders. Dividends received by non-residents franked with exempting credits would provide a dividend withholding tax-exemption.

3. Assessment of impacts (costs and benefits) of each implementation option

Impact group identification

5.113 The measure will impact on companies who are effectively wholly-owned, or have, since 13 May 1997, been wholly-owned by non-residents or tax exempt entities, and their tax advisers (eg. members of the legal and accounting professions).

5.114 The measure will also impact on the ATO (in administering the rule, for example, information campaigns), the Government (in that the revenue base will be protected) and non-residents and tax-exempt shareholders (whose ability to transfer franking credits will be limited).

5.115 It is not possible to provide any data on the numbers of taxpayers in particular stakeholder groups or the extent of their interests. This is because shares are often held through complicated trust, nominee, or group company arrangements where the underlying ownership is difficult to trace.

Analysis of the costs and benefits associated with each implementation option

5.116 Option One is preferred because the measure can be implemented more simply without the need, for most companies, to create a separate exempting account: this minimises compliance costs for those companies, as well as significantly limiting the number of amendments required to the ITAA 1936.

5.117 Option Two would involve greater compliance costs and complexity than Option One without any commensurate additional benefits.

5.118 Companies which are required to comply with the measures (ie. companies which are wholly-owned by non-residents or tax exempt entities) will not incur additional compliance costs because they will be franking their dividends in accordance with Part IIIAA. These companies will, however, incur some administrative costs as they will be required to change their dividend statements to reflect that the dividends do not give rise to a franking credit or rebate but only provide a dividend withholding tax-exemption. Reliable data on the extent of these costs is not available but they will not be significant.

5.119 In addition, some costs may be incurred in determining whether a company is subject to the measure. However, these costs would be one-off and not significant. Reliable data on the extent of these costs is also not available.

Taxation revenue

5.120 The measure will protect the revenue base used for the forward estimates, by removing opportunities for significant future expansion of franking credit trading and mis-use of the intercorporate dividend rebate. In the absence of the measure, to the extent that the revenue base would not be protected, there would be a significant revenue loss compared to the forward estimates. The measure will assist in preventing this loss to the revenue. No reliable data on the amount by which this revenue loss would be reduced is available. However, extrapolating from cases known to the ATO, the loss is likely to be significant.

5.121 Reliable data on the size of the franking credit trading market, the extent of revenue loss and the amounts of revenue involved in particular franking credit trading transactions is not available because franking credit trading transactions are often hidden amongst commercial transactions and conducted during the course of ordinary share trades.

Consultation

5.122 The ATO and Treasury held extensive consultations with peak bodies representing taxpayers and the investment community (including bodies representing the tax profession, the ASX, merchant banks, superannuation and investment funds) shortly after the Budget announcement on matters relating to the holding period rule. Issues relating to limiting the source were also raised at these consultations. Following from these discussions the exemptions for life insurance companies and eligible employee share schemes were developed.

5. Conclusion

5.123 The measure limiting the source of franking credits available for trading is an important element of the franking credit trading measures announced in the 1997-98 Budget.

5.124 By choosing Option One this policy objective is implemented in a way that, as far as possible, minimises administrative and compliance costs while providing taxpayers with certainty (through a self-executing provision).

5.125 The ATO will closely monitor developments to detect any emerging possibility of significant revenue loss/deferral or unreasonable compliance costs arising from the rule. In addition, the ATO has consultative arrangements in place to obtain feedback from professional associations and the business community and through other taxpayer consultation forums.