CHAPTER 5
Schedule 5 – Franking of dividends by exempting companies and former
exempting companies
5.1 In the Budget of 13 May 1997, the Government announced that it would
introduce legislation that would prevent the trading in franking credits
The draft legislation was not introduced into the House of Representatives
until 2 April 1998.
5.2 Arthur Andersen [1] stated in their submission
that under Senate Standing Orders the government must introduce the Bill
within six calender months after the date of the announcement for the
bill to be effective from that date. The order reads as follows:
23. Taxation bills - retrospectivity
Where the government has announced, by press release, its intention to
introduce a bill to amend taxation law, and that bill has not been introduced
into the Parliament or made available by way of publication of a draft
bill within 6 calendar months after the date of that announcement, the
Senate shall, subject to any further resolution, amend the bill to provide
that the commencement date of the bill shall be a date that is no earlier
than either the date of introduction of the bill into the Parliament or
the date of publication of the draft bill. [2]
5.3 Arthur Andersen state that the earlier date of effect will impact
on shareholders who in 1997 lodged tax returns indicating that the dividends
they received were franked only to discover that if this legislation passes
unamended, their past tax returns maybe incorrect and they could be financially
disadvantaged. [3]
5.4 Mr Don Green of Arthur Andersen raised several concerns relating
to franking credits of dividends by exempting companies and former exempting
companies. These are:
The package of measures should not be introduced in a piecemeal fashion
but in one comprehensive bill so as to create investor certainty and expectation
of results when investing in the stockmarket.
The budget announcements of May 1997 indicated that the government would
introduce measures to prevent the trading in franking credits by companies
wholly owned by non-residents. When the Bill was introduced into Parliament
on 2 April 1998 the scope of the legislation had departed significantly
from the governments initial announcement. The measures now applied to
companies that are only 95% owned by non-residents and this would deny
franking credits to dividends paid before 2 April to shareholders.
The bill contains measures that allow so-called exempting companies to
pay franked dividends from franking credits balances within 12 months
of becoming an exempting company. However, the respective date of the
legislation limits this to a one-month rule rather than 12 month rule.
This problem would be alleviated if the exempt company were allowed 12
months from the day the Bill is passed as law.
The Australian industry and institutional investors are concerned that
the effect of these measures will favour non-resident shareholders. A
company that becomes an exempting company and has its franking balance
affected is likely to become less attractive to Australian investors and
could effectively see ownership of Australian companies fall into non-resident
hands.
The broad definition of accountable shares could have the effect of denying
franking credits where there is a genuine level of ownership by Australian
shareholders.
In support of the last two points an example was provided of an international
professional partnership that is operating in Australia in a corporatised
form.
Under the provisions contained in schedule 13, an eligible employee share
scheme defines that share to be one that is held only by an employee.
So we have a conceptual shift from two sections of the act that tax the
discount that might be received to another section that now says any dividends
received must be received by the employee. What will then happen is that,
if the share that may have previously been issued five or 10 years ago
is not held by that employee, under the new rules any dividends they receive
will be unfranked dividends, which effectively means that you have a very
high tax rate of about 60 per cent.
So for an Australian resident company with employee share schemes paying
franked dividends, there is a pass through effect, which is intended by
the legislation and the imputation system. If you happen to be owned by
a non-resident company now and a previously acceptable arrangement is
now deemed to be unacceptable, the employee is the one who is going to
be penalised and subjected to around 60 per cent tax rate on those dividends
that come through. This will happen. Employee share schemes are designed
to reward employees. If a foreign takeover of an Australian company happens
and those employees still retain those shares, they are the people who
are going to be penalised. That is the thrust of the submission in regard
to the employee share schemes. [4]
Government Response
5.5 In an exchange the government advised the committee that:
Senator Kemp—Franking credit trading schemes allow franking credits
to be inappropriately transferred by, for example, allowing the full value
of franking credits to be accessed without bearing the economic risk of
holding the shares. This reduces the natural wastage of franking credits,
which is a design feature of the imputation system and the consequent
revenue loss.
A significant source of credits for trading is to be found in companies
which are owned by shareholders for whom franking credits have limited
or no value, principally non-residents and tax exempts. The introduction
of a rule that limits this source of franking credits available for trading
reduces the need to anticipate and forestall the development of new techniques
for trading in franking credits. Are there any questions?
ACTING CHAIR—It appears not. I raised the issue of the 95 per cent
foreign ownership, rather than 100 per cent foreign ownership, triggering
this provision. Does anyone want to comment on that?
Mr Walmsley—When the measures were announced, it was said that immaterial
shareholdings were going to be ignored because it was quite clear that
there were a lot of foreign owned companies that were very close to being
100 per cent owned—99.9 or whatever. Naturally, when the word `immaterial'
was used in the press release, everybody immediately started phoning up
to say, `What is that number?' They certainly did not want it left as
immaterial.
So we did some work—I cannot claim that it has been absolutely exhaustive
but we did as much work as we could—testing the actual level of ownership
by very small interests. As far as we could see, there was nothing at
95 per cent; in other words, they were all closely clustered around 99
and 98. Then you had to go to fairly significantly larger interests before
they started appearing at all.
Actually, the evidence given today explains that. By the time that a
company has acquired 95 per cent of an Australian company, it almost invariably
moves to complete control so all you have left are funny shares like financing
shares, employee share schemes and, sometimes, directors qualifications
shares. I think you mentioned the example of Mitsubishi. I would have
to go back and check that but I do not think that is still the case.
ACTING CHAIR—It was Chrysler, not Mitsubishi. It was the old Chrysler.
Mr Walmsley—I do not think that was the case. I seem to recall that
we were actually vaguely aware of the sort of scenario that had happened.
It is clear that it does not matter where you put a figure; you always
run a risk of having some sort of inappropriate effect. But, as far as
we could work out, 95 was the best figure. There did not seem to be anybody
on 95.
Anything bigger than five per cent is starting to look quite material.
All the other real shareholdings were very close to being completely trivial.
That is the reason for it.
You also raised this issue: if there were a five per cent holding, why
shouldn't they get their franking credits? The answer to that would be
that they should get their franking credits in point of policy. In fact,
before we put the proposal to government that the threshold be around
100 per cent, the possibility was explored of breaking up franking accounts.
If you had 75 per cent owned by a non-resident and 25 per cent owned by
residents, could we take away 75 per cent and leave the other 25 per cent
because, conceptually, it not only is fairer but also enables you to knock
a lot more of these unusable franking credits which are available for
trading.
The problem was that it was very complicated because, as soon as you
start getting any sorts of dealings in shares between residents and non-residents
with levels going up and down, the adjustments become horrendous. We thought
it really was not practicable to do this except at the level of near as
dammit to 100 per cent ownership. Those same sorts of practical problems
would actually arise, assuming that there was a real five per cent minority
held by residents, if you attempted to let those credits pass through
to them. You would need very complicated legislation.
So, essentially speaking, the decision has been made here that there
do not appear to be any significant real world cases around the five per
cent mark. Therefore you can favour simplicity over equity and say, `We're
just not allowing any franking credits at all for these under five per
cent minorities.' In practice, no-one is going to be disadvantaged and
it should all work reasonably well. I have to say that I have not had
any submissions from taxpayers on this point. No-one has come up to us
and said, `We're 95.1 per cent and the other 4.9 are owned by dinky-di
Aussie residents,' so I think we got that part right—in short. [5]
5.6 Mr E Pickering raised with the Committee the issue of Schedule 5.
He cited a case where:
an Australian company has been owned 51 per cent by a foreign financial
institution and 49 per cent by an Australian company which in turn has
been owned 100 per cent by a trust for the benefit of about 150 senior
employees of the original company.
In late 1996, the overseas company agreed to buy back the Australian
employees' shares. In early 1997, those employees agreed to that deal
and, in April 1997, a contract was signed. The contract agreed to buy
back the shares over a period of at least four years from 1997. The delayed
buyback was designed to enable payment for the shares from profits generated
during that period as well as, and most importantly, ensuring the continued
loyalty of the employees during the buyback period. Senators would be
well aware that the real capital of these sorts of institutions is their
senior staff. At this time, the contract complied with the tax laws as
they stood. The buyback program entailed the projected use of about $110
million of deemed dividends. [6]
5.7 The issue identified was that the contract had been entered into
under the previous legislation but the amending legislation imposes a
new system that significantly reduces the value of the contract to the
Australian parties by applying to the outstanding dividends.
5.8 Mr Walmsley advised the Committee
The scenario which Mr Pickering is addressing is one where, on budget
day, there was a company and its shares had been sold, in effect: a contract
had been done to the non-residents. So it was wholly owned by the non-residents,
but residents were being passed dividends with franking credits. That
is in fact the scenario which the legislation is intended to address.
[7]
Footnotes
[1] Submission No3, p.3.
[2] Procedural Orders of Continuing Effect,
Rule No.23, Standing Orders, p. 118.
[3] Submission No. 3, p.43.
[4] Evidence p. E 72.
[5] Evidence p E.124.
[6] Evidence p. E 2.
[7] Evidence p. E 12.