Chapter 2Views on the bill
Introduction
2.1This chapter examines stakeholder views on the provisions of the Treasury Laws Amendment (2023 Measures No. 1) Bill 2023 (the bill). It is informed by the bill’s explanatory materials, submissions received by this inquiry, evidence provided at a public hearing in Sydney on Tuesday, 2 May 2023, and additional material submitted to the committee.
2.2This chapter provides an indicative account of the key issues relating to the bill and concludes with the committee’s views and recommendations. The discussion is separated into the key, high level reforms in relation to the five schedules contained within the bill.
Key issues raised in evidence
2.3Submitters to the inquiry provided feedback in relation to the following aspects of the bill:
Schedule 1: Registration of providers and assisted decision making;
Schedule 2: Sustainability standards;
Schedule 3: Government response to the Review of the Tax Practitioners Board;
Schedule 4: Off-market share buy-backs; and
Schedule 5: Franked distributions funded by capital raisings.
Schedule 1: Registration of providers and assisted decision making
2.4As outlined in Chapter 1, Schedule 1 of the bill seeks to make amendments to the Corporations Act 2001 (Corporations Act) to improve the registration process for financial advisers to allow more than one Financial Services Licensee to register the same financial advice provider; and enable the Australian Securities and Investments Commission (ASIC) to use computer assisted decision making systems when considering applications for financial advisers to be registered. If implemented, the amendments within the schedule would commence on the day after Royal Assent.
2.5Overall, submitters expressed support for Schedule 1 of the bill and its intent. Whilst there was some discussion from stakeholders regarding the proposed implementation timeframe for the measure, as well as other suggested amendments, stakeholder feedback highlighted the benefits of introducing legislation to resolve a weakness in the existing law that may lead to accidental compliance breaches by financial advisers in relation to their registration obligations.
2.6The Law Council of Australia submitted that assisted decision-making processes which are not well designed or carefully implemented could impact individuals and businesses who are affected by decisions made in an automated manner. Nevertheless, the Law Council of Australia acknowledged the purpose of the proposed amendments in Schedule 1 to:
…address the risk of a relevant provider providing personal financial product advice to a retail client without meeting their obligation to be registered on the Financial Advisers Register, which would involve the commission of an offence.
2.7Referring to the commencement date for Schedule 1, the Financial Services Council (FSC) considered that the current timeframe for the passage of the bill may give advisers insufficient time to comply with the obligations. Namely, time to self-register and become an Australian Financial Services License holder. The FSC were also concerned that ASIC would be unable to undertake pre-emptive measures to prepare the industry to comply with the obligations in advance.
2.8The Financial Planning Association of Australia (FPAA) and the Association of Financial Advisers (AFA) shared the same view held by the FSC and requested that the registration requirement within the bill be extended by three to six months after commencement. Alternatively, the FPAA and AFA suggested that ASIC could be permitted to use a facilitative approach to enforce the measure, ‘to allow licensees and financial advisers to comply with the new requirement’.
2.9Lastly, the Australian Shareholders Association (ASA) expressed its support for the changes in Schedule 1 of the bill arguing that they would improve the operation of the registration process for financial advisers by ASIC. The ASA recommended the use of an audit process annually to ensure that the automation tools are working as intended and, importantly, that there are no unplanned consequences.
Schedule 2: Sustainability standards
2.10Schedule 2 of the bill seeks to lay down foundations for the implementation of sustainability reporting standards in Australia, which are currently undertaken on a voluntary basis. The amendments would, among other things, provide the Australian Accounting Standards Board (AASB) with functions to develop and formulate sustainability standards and clarify the Auditing and Assurance Standards Board’s (AUASB) function to develop and maintain relevant auditing and assurance standards for sustainability purposes.
Overall support for the amendments
2.11Submissions to the inquiry expressed support for Schedule 2 of the bill and its objective, noting the importance of the government’s election commitment to ensure that large businesses provide greater transparency in relation to the disclosure of sustainability and climate related financial risks and information.
2.12Noting that the government is moving forward in introducing climate related sustainability disclosure standards in Australia, the FSC welcomed and reaffirmed its support for the proposed reforms. The FSC argued that a disclosure regime is vital to ensuring investment decisions are made in the best long term financial interest of Australians. This will provide investors with greater confidence that companies are considering the risk that climate change poses to their business and operations. Which will, in turn, mean Australia is better placed to attract climate risk aware capital and meet its emissions reduction commitments.
2.13Although questioning long term suitability of the AASB, AUASB and the Financial Reporting Council (FRC) to have permanent responsibility for sustainability stainability standards, the Australian Institute of Company Directors (AICD), expressed its strong support for Schedule 2 of the bill:
The AICD strongly supports the goal of implementing high quality, easy to understand, and comparable sustainability reporting aligned with the developing global baseline of the International Sustainability Standards Board (ISSB)… In our view, the proposed amendments are a necessary precursor to any future Government decision on whether to mandate climate and/or broader sustainability reporting.
2.14The ASA articulated its support for the development of a ‘globally consistent, comparable, reliable, and verifiable corporate reporting system to provide all stakeholders with a clear and accurate picture of an organisation’s ability to create sustainable value over time’. The ASA also noted that the evolution in sustainability reporting will be valuable to aid retail shareholders’ long-term investment decisions, and comparability will enhance efficiency for companies in meeting disclosure expectations.
2.15In its joint submission, Chartered Accountants Australia and New Zealand (CAANZ) and CPA Australia considered the introduction of sustainability standards as an important milestone in Australia’s progress to align with international advancements in consistent sustainability reporting more broadly. While noting the importance of aligning the disclosure framework with international developments, in particular the ISSB global baseline, the joint submission argued that the timely passing of the bill is fundamental to meet domestic expectations of mandatory climate related disclosures and supporting progress to keep pace with international developments.
Schedule 3: Government response to the Review of the Tax Practitioners Board
2.16Schedule 3 of the bill proposes to make amendments to the Tax Agent Services Act 2009 to increase the independence and effectiveness of the Tax Practitioners Board (TPB), to ensure high standards of ethics and competency in the tax profession and streamline the regulation of tax practitioners.
Definition of ‘disqualified entity’ and commencement of code obligations
2.17As outlined in chapter 1, amendments in Part 1 of Schedule 3 would implement Recommendation 4.6 of the TPB Review to introduce obligations relating to the provision of tax agent services. The amendments seek to address an identified gap in the regulation of tax services. Introduction of the proposed new obligations under the Code of Professional Conduct for tax practitioners would regulate and prevent disqualified entities from providing tax agent services.
2.18While there was overall support for the design and inclusion of the provisions relating to disqualified entities within the schedule, the Joint Tax Bodies were concerned that the scope of the definition of ‘disqualified entity’, was too broad. It was argued that the breadth of the wording could introduce ‘uncertainty, create interpretive complexity and potentially anomalous, unintended consequences for both the TPB and tax practitioners’. As such, this could have an undesirable effect of registered practitioners providing tax agent services to the community. Accordingly, the Joint Tax Bodies suggested that the definition be refined, or that the provision is based on the Legal Profession Uniform Law which simply prohibits the provision of legal services on behalf of a disqualified entity.
2.19This view was shared by the Law Council of Australia, who also suggested that the definition of a disqualified entity should be amended to eliminate anomalies and ensure that it is aligned with Recommendation 4.6. It was recommended that an entity should only be deemed as a disqualified entity if the TPB finds that the individual is not a fit and proper person and cease to be a disqualified entity when any non-registration period imposed by the TPB expires.
2.20Noting the proposed commencement date of this provision, the Law Council of Australia and Joint Tax Bodies suggested that Schedule 3 be amended so that proposed Part 4A would apply to entities that become a disqualified entity after the commencement date to avoid retrospective application.
2.21The Law Council of Australia emphasised that retrospective application of the provision would not enable individuals to be aware in advance of the implications of their decisions and would therefore be inequitable. Outlining the practical implications of the application of the provision, the Joint Tax Bodies stated:
As this measure is intended to be an important governance and risk management measure… we believe that a reasonable implementation period is essential to ensure the success and fairness of the measure… Tax practitioners will also need to consider setting up a process by which they determine whether to apply for approval for, or sever the connection with, disqualified entities, so as to avoid breaching the new Code obligations and the existing civil penalty prohibition…
Updated objects clause and Ministers powers
2.22As previously outlined, Schedule 3 also seeks to implement Recommendation2.1 of the TPB Review to modernise the object of the Tax Agent Services Act 2009, and Recommendation 5.1, to enable to the Minister to supplement the existing Code of Professional Conduct. Acknowledging the intent of the proposes changes, submitters made suggestions in relation to the implementation of the above recommendations.
2.23In relation the implementation of Recommendation 2.1, the Law Council of Australia submitted that the new words and concept of ‘integrity in the tax system’, are likely to create uncertainty and conflict for practitioners, the TPB and the Australian Taxation Office (ATO). For example, it was argued that the wording in the object clause implies a duty of the practitioner to the ‘integrity of the tax system’, and that the proposed obligations are incompatible with a practitioner’s duty to do what is best for their client subject to the law and, at the same time serve the tax system. Accordingly, the Law Council suggested that:
…any wording to the integrity of the tax system be deleted from the proposed amendment to the object clause. Without those words the object will be clearer and less misleading.
2.24At the same time as expressing its support for continued improvements to the integrity of the tax profession and the TPB’s role in this regard, the Joint Bodies submitted that the integrity of the tax profession should not be confused with the integrity of the tax system, a responsibility which it argued remains with the ATO:
We are concerned that the broad nature of the proposed change to the object clause could reduce, rather than enhance, the independence of the TPB from the ATO, resulting in blended roles for the agencies.
2.25The Law Council of Australia and Joint Tax Bodies also raised concerns in relation to the Minister’s power to amend the Code of Professional Conduct for all registered tax practitioners. Outlining the importance of the Code in relation to the Tax Agents Services Act 2009, both submissions strongly considered that Ministerial changes by legislative instrument would be inappropriate, and contrary to scrutiny principles outlined in the Legislative Instruments Act 2003. Accordingly, it was recommended that, where amendment or supplementation of the Code is to occur, this should be by way of primary legislation only.
Schedule 4: Off-market share buy-backs
2.26As outlined in the preceding chapter, Schedule 4 of the bill seeks to amend the Income Tax Assessment Act 1997 (ITAA 1997) to align the income tax treatment between off-market share buy-backs undertaken by listed public companies with on-market share buy-backs. The schedule seeks to prevent inappropriate streaming of franking credits to shareholders through the current model of off-market share buy-backs undertaken by several large, listed companies in Australia.
Support for the measure
2.27Submissions to the inquiry expressed support for Schedule 4 and its objective to enhance the integrity of the tax system and prevent a risk to revenue. Inquiry participants noted the importance of the proposed measure to protect the dividend imputation system.
2.28The Institute of Public Accountants (IPA) expressed strong support for the proposed amendments and its rationale for its position on the subject matter, reiterating public calls it made in 2016 for change in the best interest of the public. The IPA submitted:
The IPA supports the principle of aligning the tax treatment of off-market share buybacks undertaken by listed public companies with the tax treatment of on-market share buybacks. The streaming advantages of off-market share buybacks is an anomaly in our tax system. Franking credits belong to all shareholders, and streaming credits to a particular shareholder class is usually prohibited as it is inequitable and inconsistent with the fundamental principles of our imputation system…
2.29Presenting evidence to the committee based on the results of academic research and knowledge of international academic literature on corporate capital management, Professors Christine Brown and Kevin Davis succinctly stated:
We believe that the changes proposed are well founded based on economic logic, principles of fair and equitable treatment of shareholders, ease and consistency of regulatory implementation, and strongly support the proposed measures. This is good legislation.
Specific matters raised by stakeholders
2.30A number of inquiry participants from a cross-section of the financial services sector and the community raised concerns with the government’s proposed reforms. Key issues and recommendations raised by stakeholders in relation to Schedule 4 are discussed below.
Uncertainty and unintended consequences
2.31Witnesses and submitters to the inquiry raised concerns that Schedule 4, if enacted, may create uncertainty for shareholders, have unintended consequences, and would go beyond what is necessary to prevent the mischief sought to be addressed—that is, to prevent inappropriate streaming of franking credits to shareholders.
2.32King & Wood Mallesons recommended that amendments should be made to address the specific aspects of off-market share buy-backs to limit the level of streaming of franking credits to entities without impacting public listed companies. Alternative avenues, including changing the ATO’s current practice statement on off-market share-buy backs or the introduction of rules which allow the arrangement to proceed without significant tax penalties and disproportionate outcomes were suggested as ways to resolve the issues that the bill seeks to address.
2.33The different approaches that could be used to deal with the perceived mischief ‘without imposing an effective penalty on undertaking an off-market buy-back by a listed company’ were also raised by the Law Council of Australia. The Law Council of Australia advised that alternative measures include changes to the operation of the so-called ‘at risk rules for participants to benefit through an off-market share buy-back and a more flexible application of the maximum discount.
2.34BURRELL Stockbroking & Superannuation referred to the Review of the Taxation Treatment of Off-Market Buybacks undertaken in 2008 in their evidence. Specifically, they noted the review found that although the current taxation treatment of off-market share buy-backs comes at a cost to revenue, they believe the arrangement ‘add[s] to the efficiency of capital markets and so [has] broader economy-wide benefits’ and ‘should continue to be available to companies as a capital management tool’.
Capital management strategies
2.35The use of off-market share buy-backs and selective reductions of capital resulting in share cancellations as an important capital management tool was another reason considered by King & Wood Mallesons, the Law Council of Australia, Sandon Capital as well as several other stakeholders, to maintain the existing tax treatment of off-market share buy-backs.
2.36The Law Council of Australia explained:
Off-market share buy-backs are an important capital management tool to facilitate and enable unlisted public companies to undertake various transactions. The basis upon which this form of buy-back has been undertaken is heavily regulated by the terms of the ATO’s practice.
2.37Professor Robert Nicol indicated:
If implemented, I expect off-market buy-backs will be discontinued and some companies will choose not to take the on-market option, resulting in some instances of less than optimal capital management reduced profitability, less tax paid and reduced shareholder returns.
2.38Sandon Capital argued that the proposed amendments fail to consider the real and genuine complexities of corporate capital management. It was asserted that a company’s ability to manage its capital management objectives and the reduction of the diversity of the forms of buy-backs that are currently available under the Corporations Act were real risks associated with the measure. Sandon Capital submitted:
If the amendments are enacted as proposed, selective off-market buy-backs will become redundant. They will practically become unusable as a form of capital management. The ability to include a fully franked dividend as part of a selective off-market buy-back is an essential aspect of that form of buy-back. Without that component, there is no differentiating factor and selective off-market buy-backs will offer little to no attraction for either companies or shareholders… The enactment of Schedule 4 will reduce the number of capital management tools available to companies and reduce capital management efficiency.
2.39Articulating that Schedule 4 should be removed to ensure off-market share buy-backs as an efficient form of capital management is maintained, Wilson Asset Management pointed out its view on potential unintended consequences of the bill. The organisation indicated that companies, which in the future may use a legitimate off-market share buy-back as part of a restructure or re-capitalisation, would lose part of their franking account balance or be forced to pay a franking deficit tax if it retained earnings or other reserves in its balance sheet:
These companies will permanently lose the amount of franking that previously would have been distributed to shareholders… To make this legislation more equitable for the capital management of businesses in the future, we suggest the removal of Schedule 4.
2.40However, views on the potential impact on corporate capital management were not shared by all, including the IPA who described off-market share buy-backs as ‘one of many options available’ for corporate capital management:
It’s not as if we’re taking the other options off the table. They can do a pro rata capital distribution, they can make a special dividend or they can engage in on-market share buybacks, so it’s not as if they don’t have other capital management options. We understand that if they have excess cash and they have franking credits then they want to use the best available option. This is one of many.
2.41This view was shared by Professors Christine Brown and Kevin Davis who also noted that many other corporate capital management options would remain available, and that off-market share buy backs are ‘unnecessary’:
We also believe and show in our paper that [off-market share buybacks are] unnecessary for companies' capital management. The same outcomes could be achieved by companies doing a pro-rata payment of franked special dividends and a pro-rata return of capital. That would have exactly the same outcomes for the company but, very importantly, there would be no inappropriate streaming of franking credits and we would not have the associated unfairness for shareholders who don't participate in the off-market buyback, and I think that's a really important point.
2.42In its evidence to the committee, Treasury noted that companies have pursued on-market share buy backs since the announcement of this measure and that companies continue to make franked distributions:
We have seen that there have been some companies that previously have done both off-market and on-market share buybacks have recently done an on-market share buyback. So they're still doing the share buy backs but choosing to do it on market. We have also seen continuation of normal franked distributions happening throughout that period as well.
Tax system integrity
2.43The IPA disagreed with the above perspectives on Schedule 4 of the bill. They noted that refunding excess franking credits comes at a substantial cost for government revenue and that off-market share buybacks are one of the few exceptions whereby streaming is permitted at the taxpayers’ and other shareholders’ expense. Remarking on the view held that the cost to the taxpayer cannot be ignored, the IPA advised the committee:
When the government is running a structural deficit all tax concessions should be evaluated to see whether they remain fit for purpose. Companies have many other options for undertaking other capital management initiatives like pro-rata capital distributions, special dividends, and on-market buybacks, so it is not as though this is the only mechanism of returning excess cash to shareholders.
The current policy of refunding excess franking credits supersizes off-market share buyback opportunities at the publics expense and it is for this reason that we support the alignment of tax treatment with on market share buybacks.
2.44Mr Tony Greco from the IPA commented on the compliance and revenue costs associated with the measure, for example, costs to the ATO with preparing class rulings. Mr Greco also noted there is uncertainty for taxpayers in relation to the number of shares, or price for those shares, they may receive due to the tender process involved in off-market share buy-backs. Discussing the number of companies that have undertaken off-market share buy-backs undertaken in recent times (approximately 37), Mr Greco noted that although small in number, they had a large dollar value, equating to significant impacts on potential revenue.
2.45Professors Christine Brown and Kevin Davis relayed the argument that the proposed amendments would effectively prevent companies from using tax-driven, off-market share buybacks to stream franking credits to zero and low tax rate shareholders, and therefore the schedule should be maintained primarily due to the inequities and cost to the taxpayer.
As well as creating a significant loss to government tax revenue from such streaming, [Tax-Driven-Off-Market-Buybacks] involve significant shareholder inequities. Moreover, the returns of capital and payment of franked dividends involve can be achieved by more standard and equitable capital management techniques rather than these highly structured, complex transactions. Even ignoring the significant tax gains likely, these Tax-Driven-Off-Market-Buybacks are unfair to those shareholders who do not participate.
2.46In evidence to the committee during the public hearing, representatives from the Department of the Treasury (Treasury) confirmed the estimated cost of off-market share buybacks to the budget over the forward estimates. MsDianeBrown stated that the revenue estimated over the forward estimates is $550million, with $150 million in the 2023–24 financial year and $200 million in the following years.
2.47Treasury also disclosed data on the proportion of franking credits that have been dispersed through off-market share buy-backs in recent financial years. Based on a class-ruling from the ATO, Treasury advised that companies have used off-market share buy-backs on 47 occasions equating to a very small fraction of franking credits. In 2019–20, estimates were provided stating that 0.2 percent of franking credits were dispersed in that financial year through off-market share buy-backs, with approximately 98.8 percent distributed in other ways that the schedule would not impact.
Impact on the Australian charitable sector and other beneficiaries
2.48There were mixed views on how the proposed alignment would impact the Australian charitable sector. Some stakeholders argued that by preventing companies from being able to pay franked distributions to their shareholders via an off-market share buyback they would risk reducing the funding available to charities. Other submitters noted that fiscally prudent charities are not able to rely upon the receipt of franked distributions through these means and that the schedule posed no risk to charities in Australia.
2.49Future Generation Australia were concerned that efforts to double philanthropic giving by 2020 would be undermined by changes and that retirees, low-tax investors, including charities who have investment portfolios and benefit from effective and efficient capital markets, will be impacted by these changes, as opposed to large institutional investors and fund managers. In addition, the organisation raised its concerns that should there be a reduction in the receipt of franked dividend payments in Australia, there would be a reduction in philanthropic giving associated with the reduction of personal investment income.
2.50Also noting that individuals that do not pay tax or low tax as well as the charitable sector benefit from off-market share buy-backs, Wilson Asset Management, Listed Investment Companies & Trusts Association Ltd (LICAT), NAOS Asset Management and Professor Robert Nicol were of the view that there would be an impact on Australian charities, as well as individuals that rely on the benefits of the current system, as a result of the proposed amendments.
2.51Summarising the views presented on this point, NAOS Asset Management and Professor Robert Nicol submitted that the impacts would hit some entities particularly hard with possible implications for welfare support. ProfessorRobert Nicol commented:
The principal beneficiaries of these buy-backs where the capital value is set below the clearing price are non or low-tax paying entities—individuals, super funds and charities…. By preventing a buy-back payment being treated as a dividend—whether franked or not—a beneficiary entitled only to participate as to income will be affected. This will seriously affect charities and entitled minors.
2.52However, several inquiry participants disagreed with this perspective and argued that the application of the proposed amendments in Schedule 4 would have no impact on charities.
2.53While noting that charities would not be able to monetarise franking credits, the IPA was of the view that charities should not be relying on when listed companies conduct buy-backs and that it is ‘the cream on top of their current funding’ activity to the advantage of the entity that they are supporting. In summary, the IPA were of the view that off-market share buy-backs are not critical to the charitable sector as, in the best interests of due diligence and proper governance, would not be reliant upon unpredictable dates for the option to purchase off-market buyback schemes.
2.54On this point, Professor Graham Partington stated that whilst charities do benefit from the arrangements, there must be other ways of supporting charities that have lower cost to revenue, stating:
You don’t need to give a free kick to all the other investors in order to support charities… Obviously we all want to support charities, but it’s a rather weak argument to say that we should retain buybacks for the sake of supporting charities.
2.55From the perspective of a board member of charity, Professor Christine Brown alongside Professor Kevin Davis, advised the committee that the proposed alignment in Schedule 4 would have no risk to the work undertaken by the charitable sector in Australia as it stands. Importantly, ProfessorChristineBrown stated that if Schedule 4 was adopted, the receipt of franking credits by charities would not be ruled out, rather, the changes would mean that they would be more equitably distributed.
Equitable shareholder interests
2.56Some stakeholders submitted that the proposed reforms in Schedule 4 would lead to a more equitable division of franked distributions to a greater proportion of shareholders, proportionate to their investments.
2.57For example, the IPA explained the inequitable effect of off-market share buy backs to shareholders, stating:
The fundamental principle of our imputation system is that the franking credits belong to all shareholders, and there's quite a lot of machinery in the tax act which prohibits streaming where those franking credits go to one particular class over another class. We've got all this as part of the imputation system. The off-market doesn't prohibit any shareholder from participation, so what you end up with is the fact that it's optional and they choose not to participate, because there's no incentive for someone with a marginal tax rate at the top level to participate. Whilst it is not illegal, in reality what ends up happening is that those who partake are the ones who can monetarise those franking credits. So you're achieving an outcome which is inconsistent with the franking system.
…
We want to protect that system and we want to maintain its integrity. As I said, with streaming, the franking credits belong to all shareholders, and if it were a normal distribution then all shareholders would partake in the use of those franking credits.
2.58Professor Christine Brown stated that the schedule should be upheld ‘largely because of the inequitable treatment of shareholders and the cost to government tax revenue’.
2.59Professor Kevin Davis made a similar point, emphasising that some shareholders lose as result of the current tax treatment of off-market share buybacks:
Those particular shares are for the loss of the franking credits. It's actually a very subtle and complicated point that who benefits are the shares that were accepted in off-market buyback, but all the other shares, held by people who don't participate or who do participate but only get a small proportion of their holding taken up, lose.
2.60Noting that special dividend payments are an alternative method for companies could use to release franking credits to all of their shareholders, Professor Kevin Davis further stated:
In fact, the law suggests that dividends are meant to be pro rata distributions to shareholders in the company, as opposed to what happens in the case of the off-market buybacks—it's not pro rata; it's just those who participate and have their shares accepted.
2.61Some inquiry participants held the view that these reforms may have greater impacts on shareholders than the bill intends, including changes to the refundability of franking credits and changes to the divided imputation system. Treasury responded to the claims and misunderstandings at the public hearing:
CHAIR: Does schedule 5 make any changes to franking credit refundability?
Ms Brown: No, it makes absolutely no change to franking credit refundability.
CHAIR: Does this schedule make any changes to Australia’s dividend imputation system?
Ms Brown: No, its about the dividend imputation system working as intended.
2.62Treasury also provided evidence based on ATO data to the committee demonstrating the ‘incredibly small proportion’ of franking credits that are distributed via off-market share buy backs, and the limited number of transactions that have occurred.
CHAIR: Are you able to tell us what proportion of franking credits have been dispersed through off-market share buy backs in recent financial years?
Ms Brown: The data that I have indicates that it’s an incredibly small proportion. The data I’m relying on is class-ruling data from the ATO that shows that, since 2006-07, 32 companies have used off-market share buybacks on 47 occasions. This has meant a distribution of a very small fraction of franking credits. We’ve estimated that at around 0.2 per cent in 2019020.
CHAIR: Okay. So 0.2 per cent of franking credits that were dispersed in the financial year 2019-20 were dispersed through off-market share buybacks.
Ms Brown. That’s right.
ATO Guidance
2.63In their submissions and evidence during the public hearing, King & Wood Mallesons, The Tax Institute, and the Law Council of Australia sought more clarity on a practical level, through the issuance of clear and revised guidance, to address issues relating to the application of Division 16K of the ITAA 1936 of on-market and off-market share buy-backs by listed public companies.
2.64The Law Council of Australia submitted that without further guidance from the ATO, there is significant concern that the alteration to the rules dealing with off-market share buy-backs may inadvertently force some amount of the proceeds of a buy-back price for on-market share buy-backs to be sourced from profits. This, they argued, would not be an appropriate outcome. The Law Council of Australia warned:
…if the measure is to proceed, the Taxation Committee believes it will be critical for the ATO to issue clear and revised guidance in relation to the issues associated with the administration of off-market share buy-backs and on-market share buy-backs by listed public companies. The administration of these rules should not apply so as to create an inappropriate penalty through franking credit wastage.
2.65In evidence provided to the committee during the public hearing, the ATO noted that should the bill pass, appropriate support and guidance would be provided to address key issues raised by stakeholders.
Schedule 5: Franked distributions funded by capital raisings
2.66As outlined in Chapter 1, Schedule 5 seeks to amend the ITAA 1997 to prevent certain distributions to shareholders funded directly or indirectly by capital raisings from being frankable to address concerns raised in the ATO’s Taxpayer Alert 2015/2.
2.67The proposed amendments would ensure that arrangements could not be put in place to release franking credits that would otherwise remain unused where they do not significantly change the financial position of the entity.
Views on the proposed amendments
2.68Inquiry participants raised concerns with the proposed reforms in relation to limiting the ability of companies to issue franked dividends by disallowing the use of franking credits on certain distributions that are funded by capital raising activities.
2.69Whilst appreciating that the proposed amendments in Schedule 5 aim to prevent tax avoidance and misuse of the established franking system, submitters opposed the current scope of the schedule arguing that it is too broad and could prevent a company from paying fully franked dividends, which they argued, would likely lead to a number of unintended consequences and negative outcomes for Australian companies with regard to their resultant capital management decisions.
2.70While several submissions argued that the policy should be rejected outright, options were proposed by participants to modify the measure to address concerns raised and are outlined in more detail below.
Policy intent of Schedule 5
2.71As outlined in Chapter 1, a Taxpayer Alert (TA 2015/2) was issued by the ATO in May 2015 in relation to franked distributions funded by capital raisings. The alert highlighted concerns that arrangements are being used by companies for the purposes of releasing franking credits or streaming dividends to shareholders. Schedule 5 of the bill seeks to amend the ITAA 1997 to prevent entities from manipulating the imputation system to facilitate the inappropriate release of franking credits.
2.72In its evidence to the committee during the public hearing, the ATO provided a background on the issuance of TA 2015/2 which underpins the proposed amendments contained in Schedule 5 of the bill:
Fundamentally, the issue that we were concerned about at the time was that franking dividends were paid in artificial and contrived circumstances when there was no change in the net asset value of the entity.
…
…when we saw these sorts of arrangements in the marketplace—which ultimately gave rise to Taxpayer Alert 2015/2—it seemed to us to be an odd occurrence insofar as there was no change to the financial position of the company making the distribution, because the cash that was going out the door in the form of the distribution was essentially being replaced by a raising of capital in the form of equity interest. The only significant consequence of seeing that transaction is the release of franking credits in circumstances.
2.73Commenting on the underpinnings of the legislation on this measure, Treasury explained the rationale for implementation of the schedule and its intent to provide clarity within the law on the basis of stakeholder feedback:
I think the existence of both the alerts, followed by the announcement to legislate, followed by the development and subsequent introducing of legislation, has made clear the kind of behaviour that's expected. If there wasn't to be that legislation, it would send a signal that the behaviour that had been witnessed before the alert issued in 2016 could be allowed to resume. So I think this bill is about actually continuing to suppress that activity that isn't consistent with the kind of operation of the tax system that we're looking for.
Following the issuance of the taxpayer alert, we did have interest from stakeholders in clarity about how that action by the ATO and, then, subsequently, when there was a government announcement, how the government announcements would work. They expressed interest in having clarity upfront when they were making a distribution or receiving a dividend and how that distribution was going to be treated. Some of those expressed interest in having a specific provision in the bill to provide that clarity, rather than relying on the anti-avoidance powers under the legislation, because anti-avoidance provisions result in the tax commissioner issuing a determination after a dividend has been released or after a dividend has been made, if, in the taxing circumstances, he or she forms the view that that was captured by the anti-avoidance measures. So the legislation was designed to create that upfront certainty that a taxpayer could rely on and make a self-assessment when they are issuing a distribution.
Scope of the measure
2.74A number of submitters expressed concerns that the scope of the proposed measure and suggested that consideration should be made to redrafting the bill with a more defined scope.
2.75The Tax Institute, CA ANZ, King & Wood Mallesons, the Law Council of Australia and Professor Robert Nicol, among other submitters, argued that Schedule 5 will have a broader application than the original policy intent of the 2016–17 MYEFO announcement, suggesting that further explanation and clarity is required regarding its scope and purpose. Stakeholders indicated that if the provisions as they are presently drafted are not amended to tighten their scope, the ATO would need to clarify the application of the law through the use of its general powers of administration, a situation, in which they argued was not appropriate.
2.76On this point, The Tax Institute submitted:
…the scope of the provisions contained in Schedule 5 is broader than the original policy intent, potentially impacting commercial arrangements such as employee share schemes (ESS), dividend re-investment plans (DRPs), and unfairly penalising companies with an infrequent distribution pattern… We recommend that the Committee should request that Government reconsider the scope of the proposed measure and ensure it only targets the category of transactions that are contrived and results in appropriate access to franking credits.
2.77King & Wood Mallesons argued that the current drafting sets a low threshold to capture distributions, creates commercial uncertainty and an administrative burden and made the following recommendation to the committee:
If Schedule 5 of the bill is enacted, its scope should be limited to apply to the transactions initially referred to in TA 2015/2. Most importantly, in applying the ‘principle effect’ and ‘purpose’ tests, the assessment of whether the provisions apply should be based on the issue of equity interest as a whole and the distribution as a whole.
ATO guidance that clearly states when a distribution will fall under the scope of the sections will be also important if Schedule 5 is enacted.
2.78Similarly, the Australian Banking Association (ABA) commented that the schedule creates some uncertainty about whether certain capital raisings could be deemed unfrankable despite those capital raisings not being intended to fund any dividend or distribution. They argued that legislative certainty and clarity is vital for banks regarding raising capital and ensuring that market-standard capital management actions are not inadvertently caught by the bill. Whilst stating that they had no problem with the enactment of additional legislation and the policy intent of measure, the ABA suggested three simple amendments be made to the bill and EM to provide assurance that banks need to avoid unintended consequences. The ABA submitted:
…that it is not the intent of this bill to introduce uncertainties on capital raisings and seeks to ensure that the bill supports the existing sound capital management and Prudential Standards. Any additional uncertainty that impacts capital raising activities of banks should be minimised through clarifications to the bill and EM.
…
There are a couple of changes that we've suggested in the submission that I think will address the concern. One is that change that I'd mentioned about considering applicable regulatory requirements which would cover prudential requirements from APRA. The other change is around the effect and purpose test and sort of moving and providing clarification around what indirect funding and partial contributions will probably address most of the concern … The mischief that I understand the government is seeking to achieve with this bill is where the amount effectively being raised is then offset through distributions to pay out those franking credits. So those suggested amendments in our submission should address the key concerns that our member banks have raised.
2.79Shaw and Partners Financial Services submitted:
It appears that the legislation as it is currently drafted will unintentionally catch many situations of legitimate company operation and could accordingly delay or discourage the normal processes of capital raising, investment, and economic growth within Australia.
2.80At the same time as recognising and acknowledging the intent of the proposed amendments—to prevent situations of intended tax avoidance and manipulation of the franking system—LICAT were of the view that the bill does not sufficiently distinguish between acceptable activities and the mischief it properly seeks to address.
2.81CA ANZ and CPA Australia submitted:
We believe the drafting in Schedule 5 is unnecessarily broad, making it difficult for companies to practically apply proposed section 207–159 of the ITAA 1997. The lack of specificity in the provisions and insufficient guidance in the EM means that companies will be heavily relying on the ATO to provide sufficient certainty to enable companies to progress with their capital management strategies.
2.82Recommendations made by CA ANZ and CPA Australia as well as The Tax Institute were also endorsed by the IPA and the Law Council of Australia, stating that the schedule needs to be better targeted to address the practical implications of the bill as drafted.
2.83Summarising its views, Gilbert + Tobin succinctly stated that the schedule would create uncertainty and would be impracticable, at least in the context of public market transactions:
Schedule 5 creates unwarranted uncertainty and lacks simplicity, imposing a significant compliance burden on shareholders. Moreover, the level of evidence demanded by Schedule 5 may be well beyond the reasonable reach of the majority of shareholders. These factors combine to make Schedule 5 an unworkable provision…
2.84Concerned that the measure would apply to an entire distribution even if the tests are only satisfied in relation to part of the distribution, the FSC recommended that the measure should only apply to the part of a distribution that is funded by a capital raising – that is, the part of a distribution that meets the tests in Schedule 5. The FSC added that uncertainties in relation to the schedule could be reduced through ATO guidance ‘with substantial safe harbours for companies, combined with a speedy and efficient tax ruling system’.
2.85Notwithstanding its own concerns and those raised by others during the inquiry, The Tax Institute importantly stated:
Schedule 5 of the bill contains a measure that proposes to deny franking credits for certain distributions that are funded by capital raising. The measure has created a lot of discussion and misunderstanding within the tax profession and the broader community about its rationale and intended scope and operation.
It should be noted that the proposed measure is not, in our view, a general attack on franking credits or the broader imputation system. Rather, it is intended to target a narrow spectrum of arrangements which were predominately entered into to allow companies to release excess franking credits and stream dividends to shareholders without a notable change to the company’s underlying economic position, net asset position, or otherwise impacting the rights of shareholders. Arrangements of concern are described in detail by the ATO in Taxpayer Alert 2015/2…
2.86The ATO addressed more specific concerns raised by stakeholder raised above, stating that it would be unlikely that the measure would capture genuine dividend re-investment plans:
… one would expect that the majority of dividend reinvestment plans that have been going on since day zero would not have the purpose and effect test satisfied, but one would need to look at the particular arrangements that have been entered into.
…
There may be other facts and circumstances related to those plans that, in fact, might mean that it is not a genuine release of surplus cash for the entity, which might mean that there's a lack of commercial purpose in those circumstances that might result in that dividend reinvestment plan actually falling foul of the integrity rules.
2.87In relation to concerns raised regarding impact on ordinary and accepted commercial arrangements, Treasury advised the committee that:
The bill is directed towards distributions that do not reflect a genuine commercial or economic basis. If the distribution occurs in the ordinary course based upon the usual commercial considerations that is consistent with the intent of the imputation system, the legislation does not seek to disturb that.
Established practice and purpose and effect tests
2.88Schedule 5 to the bill seeks to add distributions funded by capital raisings to the list of distributions that are unfrankable. The first requirement for the amendments to apply to make a distribution unfrankable is that a distribution must not be consistent with an established practice of the entity of making distributions of that kind on a regular basis. This requirement would be satisfied either if the entity has no established practice of making distributions of that kind, or if it does have such a practice, the distribution is not made at a time or in a manner that accords with that practice.
2.89In determining whether an established practice of making distributions exists and what it involves, among any other relevant factors, regard would have to be had to the nature, timing and amount of past distributions, any explanations made by the entity for making distributions, as well as the franking credits attached to them and the extent to which past distributions are franked.
2.90Overall, inquiry participants thought that the established practice test should be narrowed, could create uncertainty and made suggestions to tighten and define the test.
2.91Noting that companies’ cashflows and profits vary over months and years, whereas the suggestion that established practice may treat them as a consistent annuity, the ASA recommended that established practice be defined, and a set of parameters incorporated in the bill to reference the variations of company experiences. The ASA submitted:
If the definition for the established practice in relation to dividend payments remain loose, we see the risk of an administrative and financial burden for shareholders whose companies inadvertently fall foul of the legislation. Taxpayers will be required to amend their tax returns and super funds amend their allocations to beneficial holders dating back to however long it takes for the transaction to be classified.
2.92Similarly, Professor Graham Partington amongst other academics, had doubts about the implementation of the test, and noted that it as currently drafted, ‘it is not clear what an established practice is, and certainly, there are many companies that will not have an established practice’.
2.93The Tax Institute considered that the test would be very easily satisfied by private groups that do not have a normal practice of paying regular distributions, even though the purpose of distributions made is to facilitate a change in ownership rather than to manipulate the availability of franking credits. It was argued that ‘as currently drafted, this requirement is likely to significantly and disproportionately impact private groups by creating additional uncertainty around private company investment transactions’.
2.94Despite holding the view that the established test is not narrow enough, TheTaxInstitute nevertheless advised the committee of its preference to improve the schedule, and then have ATO guidance issued relating to the legislation, as opposed to guidance based on the TA 2015/2 alert. On this point, Mr Scott Treatt stated ‘good guidance comes from good law’.
2.95The SMSF Association noted that there may be legitimate situations that would not satisfy the established practice requirements but would nonetheless be captured under the definition. For example, newly established companies that have no established record of paying dividends, companies operating in volatile industries where dividends may only be paid irregularly, companies which are restructuring or pay dividends due to abnormal profits, or ordinarily reinvest their profits and raise capital as part of their normal cash flow management practices. To avoid potential uncertainties and the application of the amendments to ‘legitimate and normal business operations’ the SMSF Association suggested that:
…the proposed considerations in subsection 207-159(2) should be extended to include a broader list of matters which will be taken into account when considering whether a distribution satisfies the requirements… Without this modification, this subsection is too narrow and ambiguous and risks competitively disadvantaging profitable and growing companies.
2.96Also outlining a number of ordinary circumstances where companies may be inadvertently be captured by the established practice test, LICAT suggested that the bill be amended to capture specific circumstances of tax evasion it targets.
2.97The Association of Independent Retirees (AIR) were concerned that reliance on established practice in making distributions does not provide sufficient discretion for an entity to change the nature of distributions due extraordinary financial circumstances, such as those that occurred during the COVID-19 pandemic with the support of the Australian Prudential Regulation Authority (APRA) and in conjunction with capital raisings through the issue of share equity. The AIR submitted:
The legislative tests do not contemplate the need for entities to react to challenging corporate circumstances that require unusual capital raising, equity issue and franked distributions.
…The tests for consideration of relevant distributions should include circumstances that relate to exceptional economic events that require unplanned capital raisings or distributions.
2.98The ABA noted the ability under proposed section 207-159(30) to refer to a legitimate past practice would not be deemed compliant under the bill when determining future compliance, unless that past practice complies with the other proposed provisions of section 207-159(1). Accordingly, the ABA considered that past distributions should be considered under the bill, regardless of whether those distributions would have complied with section 207-159(1), submitting:
The ABA seeks to ensure that there are no limits to the consideration of established practice when applying the provisions of this bill. Therefore, the ABA recommends that section 207-159(3) be removed from the bill so that both regulators and banks are not constrained when considering the established practice of paying distributions. The removal of section 207-159(3) would not impact the effectiveness of section 207-159(1), distributions that do not comply with these provisions will still be deemed unfrankable.
2.99The ABA reasoned that the current scope of the bill creates uncertainty as to the use of Dividend Reinvestment Plans (DRPs) and fully or partially Underwritten Dividend Reinvestment Plans (UDRPs), which it argued ‘are important and market-standard methods in which banks raise capital to meet their capital management requirements for the purposes of APRA’s prudential standards’. Accordingly, the ABA suggested amendments are made in order to clarify the impact of the bill.
2.100This view was also shared by the Law Council of Australia and The Tax Institute, which both suggested some of the consequences of DRP’s need to be clarified. In addition, The Tax Institute stated that the disregard of historical transactions is likely to further broaden the scope of the measure and result in a greater number of distributions being inappropriately captured by the amendments:
For example, DRPs offered prior to the commencement of the measure would not be within scope. However, DRPs offered from the commencement of the measure could be caught by the measure, especially if previous DRPs are disregarded from forming part of the established practice.
2.101Wilson Asset Management were of the view that redrafting the bill would be essential to ensure that the legislation provided clarity to the circumstances in which it could apply and would act as a clear anti-avoidance measure as intended by Treasury. Shaw and Partners Financial Services and Wilson Asset Management indicated that the application of the test could have the potential for companies that do have pre-existing distribution policies to have a competitive advantage and may impact small and medium companies as a result. Accordingly, recommendations to redraft the bill were made so that it is limited to the Taxpayer Alert TA 2015/2 as published on 7 May 2015. Providing revised wording for the proposed section 207-159 in additional information offered to the committee.
2.102In relation to the above concerns regarding the test, the FSC noted changes made to the schedule as a result of Treasury’s consultation process were an improvement to the exposure draft legislation, in particular to the test moving from a broader purpose or effect test to a narrower purpose and effect test about whether the capital raising is being done specifically to make franked distributions.
2.103Stating that the bill would prevent companies of any size entering into artificial and contrived arrangements to raise capital for no commercial purpose and use this capital to fund franked dividends to shareholders, Treasury confirmed that the schedule is not intended to provide a competitive advantage to larger established companies over small to medium enterprises.
2.104Treasury advised the committee that the legislation has been designed to allow for a broad range of individual circumstances to be taken into account in applying the established practice test.
Schedule 5 includes a list of factors to be considered when determining whether the established practice test is met, including any explanations given by the entity for making the distribution and any other relevant consideration.
While new start-ups may not be able to satisfy the established practice test initially, the issuance of the relevant equity interest must also have both the ‘effect and purpose’ of directly or indirectly funding all or part of the relevant dividend payment. This means arrangements will not be captured because they do not satisfy the ‘established practice’ test.
2.105The purpose and effect test was another test that Treasury stated would need to be met for a distribution to become targeted by the measure, further ensuring that legitimate activities are not captured by the measure:
While new start-ups may not be able to satisfy the established practice test initially, the issuance of the relevant equity interest must also have both the ‘effect and purpose’ of directly or indirectly funding all or part of the relevant dividend payment. This means arrangements will not be captured because they do not satisfy the ‘established practice’ test.
2.106Treasury elaborated on changes made to the introduced bill following exposure draft constitution which refined the purpose and effect test to further rule out any incidental capture of legitimate business activity by the measure:
The biggest change that has occurred to the purpose and effect test since the exposure draft and the revised bill is that it became an 'and' test instead of an 'or' test. So, under the exposure draft version, if either it was found to have a principal effect of funding the distribution or the equity was raised for the purpose of funding the distribution, then it could be subject to this measure. The feedback from stakeholders was that this was too broad, and a number of them did request that it be made an 'and' test so that it wouldn't impede normal commercial practices. That has happened in the bill. It now requires both the principal effect and the purpose test to be demonstrated. The difference between them is that the principal effect goes to what outcome it has, whereas the purpose test goes to intent. Now, to be caught by this legislation, there would need to be both the intent that the equity was raised to fund the distribution and that that was the outcome of the arrangement.
Implications of removing refundable franking credits
2.107A number of stakeholders raised concerns that the proposed measure, if enacted in its present form, may have unintended consequences impacts on individuals, companies, and the economy at large.
Tax avoidance and debt vs equity raising
2.108Professor Robert Nicol was concerned that the proposed measure would reduce the incentive for Australian equity investors to invest in Australian companies, stating:
One of the key factors in where to invest will change, quite likely to the detriment of Australian companies seeking funds. Equally important would be the effect on investment decisions by Australian companies.
2.109Academics participating in the inquiry argued that the imputation system has helped reduce the level of tax avoidance in Australia and warned the committee that implementation of the measure by ‘winding back imputation’ could result in the level of tax avoidance significantly increasing. Dr Ian Langford submitted:
I would predict that a flight to international tax havens would become part of the strategic calculus for some entities operating in Australia presently if this bill is adopted as currently proscribed. The proposed changes contemplated in [schedule] 5 risk significant unintended consequences for the economy and capital markets, with flow on effects for how Australia might generate the capabilities needed in the coming decades; I urge you to consider removing it entirely.
2.110As well as raising concerns about the potential for tax avoidance, submitters were also concerned that some of the potential unintended consequences of the legislation could far outweigh the anticipated economic benefits.
2.111Fidelity International stated that the proposed changes could lead to a reduction in the dividend payout ratio in Australia and that the changes suggested could lead to certain companies reducing their investment and capital expenditure as companies would need to preserve additional cash to maintain regular dividends.
2.112Shaw and Partners Financial Services, ASA and the SMSF Association among others asserted that the proposed legislation could have the effect of encouraging medium sized companies to take on debt rather than raise equity to finance their growth activities. The ASA warned that the potential for companies to favour debt to a greater degree would also increase the risk of insolvency at some point in time.
The SMSF Association mentioned that raising debt may not also be possible or desirable for companies and that raising capital is often a preferred option as it frees up cash from previously earned reinvested profits and enables the company to avoid the costly and undesirable need to sell assets.
2.113Accordingly, the SMSF Association recommended that the amendments in Schedule 5 should not apply in situations where a company has legitimately earned profits and seeks to distribute those profits to its shareholders.
2.114Although noting that the measure could be more targeted so that the administrative compliance approach is better for taxpayers, the FSC expressed support for measures to avoid tax avoidance in cases where it is occurring stating that ATO guidance on the matter after the passing of the legislation ‘could be better if the law was better as well’.
2.115The Tax Institute noted that the existing anti-avoidance provisions ‘are not able to target all variations of the arrangements of concern’ which resulted in the former government’s 2016–17 MYEFO announcement; a targeted anti-avoidance measure to discourage taxpayers from entering into such arrangements and referred to in TA 2015/2.
2.116In its evidence to the committee, the ATO addressed the concerns discussed above, clarifying that the measure would have risk or material impact on increasing debt levels stating the proposition ‘is highly contestable at best’ and that a ‘shift to debt funding does not necessarily result in more tax avoidance’. The ATO noted:
a company that needs additional capital has no obligation to pay discretionary dividends that would exacerbate this need;
companies that undertake capital raisings which have material economic or commercial consequences beyond the mere funding of a distribution are not expected to be caught by the measure;
the cost of debt versus the cost of equity is a significant factor among others that entities consider when making decisions; and
the measure is expected to have limited application in practice even if there is a capital raising that involves issuing equity.
2.117In relation to submissions made suggesting that more debt funding would lead to greater opportunities to reduce or avoid tax, the ATO highlighted the numerous anti-avoidance rules contained in taxation laws which companies must consider when undertaking corporate funding and distribution transactions. For example, anti-streaming, thin capitalisation, transfer pricing and general anti-avoidance rules. The ATO also noted from a compliance perspective that are well placed and successful at detecting and addressing tax avoidance matters such as in the case of Chevron Australia Holdings Pty Ltd v Commissioner of Taxation.
2.118Importantly, Treasury informed the committee that Schedule 5 is not designed to interfere with a company’s ability to choose between debt or equity financing to fund its operations and that the measure would apply in circumstances where the funds raised are not intended to be retained by the company. Treasury verified that the schedule would apply rather, in specific circumstances, to companies that raise capital just to release unused franking credits to shareholders. Treasury stated that the measure is not expected to impact companies’ financing decisions, and would not:
…prevent companies from raising capital for commercial purposes, including paying ordinary dividends in accordance with their regular dividend policy or special dividends that have a commercial purpose (other than to distribute franking credits).
Economic impacts
2.119The Tax Institute, Corporate Tax Association and the Law Council of Australia submitted that the complexity of the measure and the associated economic benefit would be disproportionate to the perceived mischief and the new obligations that would be imposed on taxpayers. The Tax Institute commented:
Noting that the measure was estimated to raise only approximately $10million over the forward estimated period, there is a significant widespread concern that for what is a relatively small amount of expected revenue, the measure will have a disproportionate economic impact and increase in compliance costs for businesses.
2.120Professor Robert Nicol raised his concerns about the possible economic impacts and there could be unintended consequences as a result. Professors Christine Brown, Kevin Davis and Graham Partington emphasised that classifying dividends as unfranked due to a capital raising will risk effects that are far from minor, and it is possible for there to be substantial effects even if the revenue initially raised by the legislative change is small.
The expected revenue impact of the proposed change is given in the explanatory memorandum as $10 million per year. As a consequence of the proposed change there are risks of less investment in Australia and hence less employment, a higher cost of capital, high corporate leverage, increased tax avoidance, and handicapping of growth stocks and small companies. These effects are clearly undesirable. The magnitude of the effects is difficult to assess since they will depend on the implementation of the legislation, the expectations of managers and investors, and their behavioural response to those expectations. Perhaps the effects will be very small, but there is a clear risk of substantial adverse outcomes and losses to revenue that exceed the gain.
2.121This view was also echoed by Mr Geoff Wilson, Chairman and Chief Investment Officer of Wilson Asset Management during the public hearing:
I believe the risks that could result, should schedule 5 be implemented as it stands, are too great to justify the $10 million per year of saving in the forward estimates. As clearly articulated in the various submissions… the elimination or total redrafting of chapter 5 will remove these unintended consequences.
2.122There was also some discussion by stakeholders as to the reliability of measure’s costing as undertaken by Treasury in relation to the current measure within the bill and the measure as costed in 2015, with the primary concern being that it may not have taken into account behavioural changes as a result of the proposed measure.
2.123Addressing these concerns, Treasury outlined that when the measure was first costed in 2016–17, estimates drew from ATO estimates (assumed that they were reflective of future patterns) of annual value of franked distributions funded by capital raisings, the average tax rates faced by shareholders receiving franked distributions and the average characteristics of share registered. Treasury informed the committee that the measure’s costing was updated in late 2022 to reflect the revised start date of 15 September 2022 stating:
There has been minimal activity associated with franked distributions funded by capital raisings observed by the ATO since the measure’s announcement in 2016. This is consistent with taxpayers changing behaviour in response to the retrospective start date as announced in the 2016-17 MYEFO.
As a result, Treasury estimated that the change in start date had no impact on revenue but would continue to protect future revenue at risk if the government did not legislate this measure.
Schedules 4 and 5: Stakeholder engagement and Consultation process
Submissions received by Individual stakeholders
2.124The committee received a large number of personal accounts and concerns about the removal of franking credits from individual submitters. Many retirees and other investors contested the proposed measure in Schedule5, stating that the policy made the existing dividend imputation system inequitable and would have a detrimental impact on them.
2.125Speaking to the committee as a self-funded retiree and a certified practising accountant who has assisted small to medium sized businesses with a considerable reliance on the Australian franking credit system, Mr Lawrence Banks stated:
Along with the companies and clients that I have assisted, I have personally relied on franking credits and participated in off-market buybacks, which are vital in providing income for self-funded retirees and small business owners, particularly at the time of the small business owners’ own retirement.
The franking credits system has been exceptionally important in promoting equity funding over debt funding, and more so in these days of high costs of debt funding, and assisted small enterprises to grow and invest further in Australian businesses, resulting in significant economic growth for the country… It’s strongly suggested—I know this is too simple—that the existing franking credits system stay in place as it is and that changes to it do not become an unintended consequence of the current proposed legislation.
2.126Mrs Kerrie Bible expressed her views on the measures in Schedules 4 and 5 of the bill as follows:
Schedule 4 concerns off-market share buybacks. In the past, we have participated in these to generate cash flow and to fund out living expenses. Now we find there could be a retrospective franking debit. We are reasonably low-income earners and rely on our superannuation income and franking credits to keep us off the government age pension. Now we find our entitlement to these franking credits in jeopardy, and we may have to amend our tax returns going back years if the taxation department disallows it. It’s much easier to put your hand out once a fortnight to receive the age pension—no worries.
Schedules 5 concerns franked dividends funded by capital-raising. We are concerned about this purely subjective legislation of established practice. Taken to the extreme, it can be interpreted by the taxation department any way it likes at any time, and that means several years after the dividend has been paid and recognised for tax purposes. This also means expensive extra costs in accounting fees… How can the tax department say, if there is a capital-raising, then it is unfrankable if the company has not paid a regular dividend? Businesses have good and bad years. During COVID, many companies didn't pay a dividend for a considerable time. My husband and I were on the receiving end of this drastic decrease in income.
2.127As a self-funded retiree and self-managed super fund, Mr Peter Jones raised his objections to the proposed legislation on the basis that it would directly impact the dividend imputation system that, he argued, incentivises and benefits shareholders. Mr Jones stated:
Like so many Australians, I have in retirement relied on franking credits paid on shares held in my own name and in my superannuation fund to fund my lifestyle. I pay tax on both entities, and the proposed changes will result in even less monies being available to fund my retirement. I'm self-funded, and I'm not in receipt of any government pension. The current system has worked well since its implementation. The proposed changes will result in inhibiting the development of Australia's economy and return us to a situation even more detrimental to those of the pre-1987 era. Not only are investors to be taxed on capital gains but they are also to be taxed at a prohibitive rate on dividends. This will encourage investors to abandon investing in the Australian share market. The franking system has been an important part of supporting Australia since its introduction in 1987. It has stopped double taxation, promoted equity over debt for Australian companies and encouraged shareholders and companies to invest in Australia and employ Australians.
I respectfully ask that my concerns be considered and that the changes to the franking credit legislation be abandoned.
2.128Recommending that Schedules 4 and 5 of the bill be withdrawn in their entirety, Mr Robert Oser explained to the committee that there are numerous benefits to the current imputation system in Australia that should be considered in respect to the proposed amendments. The rationale for Mr Oser’s beliefs outlined his rationale:
My reason is that fiscal policy should be evaluated from the standpoint of what benefit it brings to the community and whether it helps the economy to grow. The economic cake needs to become larger so that it can be sliced up without leaving anyone worse off and benefiting others. This test is not satisfied by schedules 4 and 5.
As others have said, the imputation system is working well and has been since 1987. Subject to the emasculation by governments Liberal, coalition and Labor, the policy motivation for choking off the flow of franking credits is that the imputation system should be regarded as a tax concession… Companies and shareholders are said to be exploiting tax loopholes to distribute franking credits when the fundamental purpose of the imputation system is to do exactly that…
If enacted, there will be a backdoor tax increase for low- to middle-income taxpayers, superannuation and pension funds, charities, universities and also the Future Fund. Any individual earning in excess of a taxable income of $45,000 pays top-up tax when receiving franked dividends. This represents about 88 per cent of resident individuals in the year 2019-20.
2.129Conversely, these views were not shared by all submitters, with one inquiry participant arguing the following:
I support the intent of the proposed changes.
Some people and organisations are concerned about the unintended consequences and the proposed legislation will have on capital markets, small-to-medium sized Australian companies and Australian retail shareholders. I take a different view, I believe that appropriate taxation is a public good, and when used properly can promote beneficial behaviours and decrease harmful behaviours.
…
The proposed legislation has minimal significant unintended consequences, as it is drafted it will ensure that company operations are legitimately taxed.
The legislation will properly tax the normal process of capital raising, investment and economic growth in Australia by companies that benefit from infrastructure and resources held by the Commonwealth of Australia.
…
Companies will be encouraged to manage debt and equity more prudently during a time of economic instability, creating an enormous risk for the Australian economy.
The proposed laws will close tax loopholes… Large companies already use their structures to avoid paying tax in Australia, the proposed laws may decrease this tax avoidance.
...
Self-funded retirees and those who have a self-managed super fund are at minimal risk from the changes as they generally have diverse portfolios and multiple income streams…
2.130In light of the evidence from stakeholders through submissions received and individual accounts through evidence at the public hearing, Treasury told the committee that the proposed amendments contained in Schedule’s 4 and 5 of the bill would make ‘absolutely no change to franking credit refundability’ and would make no changes to Australia’s dividend imputation system. Rather, the changes are ‘about the dividend imputation system working as intended’:
…this bill is about making sure the integrity of the system works as intended. What we’re concerned about are arrangements that are contrived and cause a cost to government revenue that is greater than intended by the operation of the imputation system.
Consultation on the proposed amendments
2.131As outlined in Chapter 1, Treasury undertook consultation processes in relation to the exposure draft legislation and accompanying explanatory material for Schedules 4 and 5 of the bill. Some stakeholders, including Wilson Asset Management, Professors Christine Brown and Kevin Davis, ASA, King & Wood Mallesons raised concerns with the consultation process and feedback received to inform any changes to the bill arguing that improvements to the drafting of the bill may not be nuanced enough.
2.132At the same time, stakeholders acknowledged and welcomed amendments made to tighten the bill based on feedback on the exposure draft during the consultation process. The FSC commented:
The FSC welcomes changes in this Schedule 5 from the previous draft of this proposal contained in a consultation draft released in September 2022. In particular, the FSC welcomes the limitation of the retrospectivity of this measure.
2.133Upon implementation of the bill, the ATO outlined the support and guidance that it would provide to companies to ensure that legitimate business practices are not impacted should the bill pass. In particular, the ATO confirmed that targeted consultation and engagement with stakeholders that have been involved throughout the development of the measure would be undertaken ‘to tease out the highest-priority issues in respect of which businesses may require guidance from the ATO’. Assuring the committee that appropriate guidance on the bill would be prepared after the passage of the bill, representatives from the ATO stated:
We expect, having observed and being involved with this hearing as well, that we’re already aware of many of the issues that have been put by stakeholders. We’re coming to the consultation very well informed about what some of the key issues might be.
2.134In its evidence to the committee, Treasury provided details of the consultation processes undertaken on the exposure draft legislation. In relation to Schedule5, approximately 2100 submissions were received from a broad range of stakeholders who had an opportunity to raise suggestions they had to align the bill with its intent, ensure that it would not unintentionally capture a wider range of circumstances that it should, and address examples in the EM to help illustrate how the bill would operate. Similarly, Treasury noted that a public consultation process for Schedule 4 of the bill was undertaken. Approximately 300 Submissions were received from individuals, the tax advising community as well as individual companies who expressed their views on the proposed legislation.
Committee view
2.135The committee would like to thank all the stakeholders who took the time to submit to the inquiry and appear at the public hearing.
Schedule 1: Registration of providers and assisted decision making
2.136The committee considers that the proposed amendments to the Corporations Act in regard to the registration of providers and assisted decision making will improve the operation of the registration process and will enable ASIC to deliver a high standard of service in an effective and efficient manner.
2.137The committee acknowledges commentary in relation to the timeline for the implementation of the legislation, however, the committee welcomes the support for the proposed amendments in Schedule1 of the bill to address the risk of a relevant provider providing personal financial advice without meeting their obligation to be registered on the Financial Advisers Register.
2.138Given the introduction of the requirement for all relevant financial advice providers who provide personal financial advice to be registered on the Register under the Financial Sector Reform (Hayne Royal Commission Response—Better Advice) Act 2021, the committee is firmly of the view that the amendments contained in Schedule 1 are necessary.
Schedule 2: Sustainability standards
2.139The committee welcomes the broad support for the intent of Schedule 2 of the bill to provide the AASB with functions to develop and formulate sustainability standards and clarify the AUASB’s function to develop and maintain relevant auditing and assurance standards for sustainability purposes in Australia.
2.140The implementation of sustainability reporting standards has been warmly welcomed by stakeholders who have commented on the importance of government’s election commitment to ensuring large businesses and financial institutions provide greater transparency in relation to disclosure of sustainability and climate related financial risks and information. The committee agrees that this schedule contains a vital measure to improve transparency, manage systematic risks and align capital flows towards climate and sustainability goals.
Schedule 3: Government response to the Review of the Tax Practitioners Board
2.141The committee welcomes the bill implementing the key recommendations of the TPB Review which will play a crucial role in increasing the independence and effectiveness of the TPB, ensuring high standards of ethics and competency in the tax profession and modernise the regulation of tax practitioners.
2.142The committee notes submissions by industry stakeholders regarding the retrospective operation of the measure, object clause and Ministerial powers. The committee considers that the implementation of the measure is the first step in the process and that ongoing consultation over the coming months on further changes will ensure that regulators can appropriately respond to emerging issues.
2.143The committee believes that the amendments contained in Schedule 3 of the bill are long overdue reforms to the TPB and will help streamline the regulation of tax practitioners.
Schedule 4: Off-market share buy-backs
2.144The committee welcomes the broad support forSchedule 4 of the bill to align the tax treatment of off-market share buy-backs with the tax treatment of on market-share buy-backs for publicly listed companies.
2.145Specifically, the committee welcomes the calls for change from a public interest approach to ensure the tax treatment for off-market share buy backs is equitable and there is consistency with regulatory implementation.
2.146The committee agrees that the schedule specifically improves the integrity of the dividend imputation system and would result in a greater and fairer provision of franked distributions to shareholders in proportion to their economic interest.
2.147The committee is persuaded by evidence from stakeholders that the cost to the taxpayer cannot be ignored and that a range of options are available to undertake capital management initiatives that are more equitable and do not come at a cost to the community.
2.148Specifically, the committee notes that companies who have previously undertaken off-market share buy-backs have commenced on-market buy backs since the announcement of this measure.
2.149The committee welcomes evidence from the ATO that appropriate guidance would be provided on the measure should the bill be passed and encourages stakeholders to participate in consultation on this.
2.150The committee is assured by evidence from stakeholders that there would minimal impact to the charitable sector and notes that charities should not be reliant on companies conducting off-market share buy backs to fund their initiatives. The committee agrees that the current arrangements in place are not critical to the charitable sector and is encouraged by the fact that charities will continue to receive regular and special franked distributions from companies.
2.151The committee believes that the aligning the tax treatment of share buy-backs will enhance the integrity of the tax system so that listed public companies will no longer be able to exploit the tax rules to buy back their own shares at a discount subsided by Australian taxpayers. The committee considers that in the current fiscal environment allowing the current arrangements to continue where loop holes exist, presents an ongoing risk to revenue if not addressed.
Schedule 5: Franked distributions funded by capital raisings
2.152The important integrity measure contained in Schedule 5 of the bill will ensure both Australia’s financial services and tax system are working as intended.
2.153The committee notes the support for the initiation of this schedule to permanently eliminate the mischief and agrees that legislation is a more sound and reliable measure than relying on the ATO alert and guidance.
2.154The committee is of the view that there is a strong public policy case in support of Schedule 5. The committee believes that in principle, legislation in this area will provide good direction and clarify how the ATO deals with this matter.
2.155Importantly, the committee notes and thanks inquiry participants for the range of comments, feedback, and suggestions they provided in relation to ensuring the bill meets its intention and that any unintended consequences are avoided.
2.156The committee is convinced by evidence that potential unintended consequences will not be realised, and notes that Treasury has engaged in an extensive consultation process with industry and individual stakeholders to ensure that this does not occur.
2.157The committee is convinced that, though some smaller companies may not meet the ‘established practice test’, the existence of the ‘purpose and effect’ test will ensure that these companies are not automatically and unintentionally captured by the measure.
2.158The committee also notes that the ATO will have a large number of factors to take into consideration, when determining whether a distribution should be affected by the measure.
2.159Specifically, the committee is persuaded by the evidence from Treasury and the ATO that the measure would not result in an increase in tax avoidance and cause a material risk to increasing debt levels. It is satisfied that the measure will not affect the vast majority of taxpayers.
2.160Despite this, the committee believes that some of the feedback provided in submissions and to the hearings are worthy of further consideration by the Government and the Parliament to further improve the bill. Doing so will ensure the measure is targeted at the type of activity originally identified by the Australian Taxation Office, and reduce stakeholder concerns of unintended consequences.
2.161The committee recognises that there is a level of misunderstanding within the community about the rationale and application of the bill. The committee is reassured that the proposed amendments will improve the integrity of the imputation system by ensuring companies are unable to enter into contrived arrangements to artificially distribute excess franking credits.
2.162The committee is satisfied that Schedule 5 of the bill will support the intended purpose of the franking system and agrees with evidence that companies should be investing and distributing profits based on sound economic and commercial reasoning, not because of a tax loophole at the cost to the Budget.
2.163The committee recommends that Schedules 1, 2, 3 and 4 be passed unamended.
2.164The committee recommends the Australian Government consider opportunities to clarify Schedule 5 of the bill to ensure it appropriately targets the identified behaviour and addresses feedback provided to the committee.