1. Companies and shareholders Companies Definition of accompany •   Income tax is payable by each individual and company s4-1

•   Has a flat tax rate 30% •   Income year starts on 1st July •   “Company” s995-1

(a)  A body of corporate (b)  Any other unincorporated associations (e.g. limited

partnership)/ body of persons •   Does not include partnerships or joint ventures •   Public companies are generally listed on stock exchange

103A(2) •   Private companies are not public companies 103A(1) •   Can apply 20 person 75% test although a public listed company

if less than 20 people has the ownership of more than 75% of the company will be a private company 103A(2)

Public officer •   Every company carry on business or deriving property income in Australia must appoint a public officer s252

•   Must be a resident and natural person above 18 •   Responsibilities

(1)  documents served them (2)  Answerable to all obligations imposed on the company (3)  Same penalty if the company defaults

Residency

•   Residents of Australia for the tax purpose will be taxed on income from all sources s6-5(2) •   Foreign residents will be taxed on income from Australian sources only s6-5(3)

Place of incorporation test •   A company incorporated in Australia under the corporation Act 2001(Cth) is automatically a tax resident of Australia regardless of any other factors

Central management and control test (1)  The company must carry on a business in Australia, AND •   Consideration of where the activities of the company

are carries in •   TR 2004/15, commissioner draws distinction between

operational activities and the one that is passive in its dealings

o   Operational activities => where the activities take place (e.g. trading goods and service, manufacturing and mining)

o   Passive dealing => where the decisions are made (e.g. investment and income from assets and dividends)

(2)  The companies central management and control must be in

Australia •   Consider where the “real control” of the company

take place

o   Where the actual high level decision making are made

o   Where the monitoring of overall corporation performance occurs

•   Malayan shipping Co Ltd (1946) : Sometimes the place where the central management activities of a investment company takes place is the place where their operating activities take place

•   Koitaki Para Rubber states(1940): day today control over the business operations of accompany does not amount for central management and control of a company

•   Bywater investment (2015): Central management and control in Australia where company directors carried out the wishes of their Sydney based accountant without independent judgment.

Controlling shareholder test (1)  voting power is controlled by shareholders who are resident of Australia ( based on definition of resident in s6(1) Income assessment act 1936.) >50% of the voting power at general meeting => only consider the name of the shareholder in the share registry not the actual beneficial owner: Patcorp investment (1976)

(2)  Company is carry on business in Australia Taxation of dividends Taxing provision •   S44ITAA36: assessable income of a resident shareholder in a company includes

(a)  dividends paid to the shareholder by the company out of profits derived by it from any source AND

(b)  all no share dividends paid to the shareholder by the company

S44 ITAA36 Key issues Shareholder •   includes “members or stockholder” s6ITAA36

•   entry on company’s register of members necessary to constitute member ship control Patcorp investment (1976)

•   Deemed shareholder under Div 974 categories the interest based on the economical circumstance as it (debt interest and equity interest => share repayment only occur if they make profits and the company has discretion to pay or not)

Dividend •   S6(1) definition

(a)  any distribution made by the company to its shareholder whether money or other property AND

(b)  any amount credited by the company to its shareholders as shareholders (if both shareholder and a employee dividend only constitute amount paid as shareholders)

•   Excludes => money paid or credited by the company to a shareholder where the amount is debited against the “share capital account” => this case constitute return of capital

Share capital account

•   An account which the company keeps its share capital: s975-300. •   Tainted share capital account

(a)  occur when the company capitalize profits and other transfers in to the share capital account: s197-50

(b)  Anti avoidance rules apply (1)  dividends deemed to be paid out of the profits so assessable:s44(1B) (2)  Franking debits arise in the company’s franking account when an amount is

transferred to its share capital account => resulting in tanting the account (3)  Distributions coming out of tained account is un-frankable s202-45(e)

Non share dividends •   Non share dividend are broadly distributions made by the company to holders of its “non share equity interest” : s974-115 & 974-120.

•   Non share equity interest means the interest in the company that is not a share in the company but classified as “equity” s995-1

•   Shares + non share equity interest = equity interest Paid •   “paid” means credited or distributed s6(1)

•   dividend is paid when its credited and irrevocable : Brookton co-operative society (1981)

Profits •   Income including exempt income will be profits so taxed as dividend in the shareholders hand

•   Slater Holding (198); gifted amount so not taxable income for the company but when its distributed to the shareholders loss the nature and become out of profits => dividends taxable under s44.

•   Anti avoidance ** dividends paid out of an amount other than profits is also deemed to be a dividend paid out of the profits for income tax purpose: s44(1A)

Deemed dividend (ONLY for private companies) Division 7A ITAA1936

But capped at the distributable surplus s109Y Un- frankable under imputation tax system s202-45(g)

•   1st consider whether a private company •   Private companies are not public companies 103A(1) •   Can apply 20 person 75% test although a public listed company if less than 20 people has the ownership of more than 75% of the

company will be a private company 103A(2)

•   2rd issue is to determine whether the entity is a shareholder or an associate of the share holder

Excessive salaries or fees paid to the shareholder (s109(1)) •   To the extend that salaries or fees for services provided by a

shareholder (or associate) is excessive that proportion -   is deemed to dividend to the shareholder -   is not deductible by the company

Payments to shareholders (s109C) •   109C(3) Payment to the entity means (a)  payment to the extent that is to the entities, on behalf of the

entity (b)  credited amount (c)   transfer of property to entity and can be to a 3rd party as

constructive receipt on behalf of the shareholder •   loan is excluded and dealt with 109D and can convert to a

loan before lodgment date 109D(4A) •   109C(2): dividend is equal to the amount paid •   109CA: payment includes provision of assets

Exemptions

•   109J(a) payment for discharge on obligation of private company (c)  not more than would have been required to discharge the

obligation under the arm’s length dealing •   109K Inter company payments and loans not treated as

dividends

Loan to shareholder (109D) •   If the company made a loan to its shareholder or associate and the loan is not repaid by the “lodgment date” of the income year the amount of the outstanding loan is deemed to be dividend.

•   “lodgment date”: earlier of the due date or actual lodgment date of the company’s income tax return

Exemptions

•   109K loan is made to a corporate shareholder •   109N

(a)   the agreement of the loan is made by writing (b)  rate of interest equals or exceeds benchmark interest rate

(5.4%) (c)  The term of the loan does not exceed the maximum term

for that kind of loan worked out under subsection 3 •   109M (a) in the ordinary course of the private company’s

business make loans (b) on usual terms on which the private company make similar loans to parties at arms length.

Debt forgiven (109F) •   Debt owed by shareholder of privet companies that are forgiven constitute deemed dividend 109F

•   Although not explicitly say reasonable person conclude that is likely that the creditor will not go after the debt and have not sued with in 6 years”=> forgiven

•   “Debt parking” may also constitute forgiven debt if the right to collect debt transfers to the relative of the debtor and that person doesn’t recover debt

Exemption

•   109G(1) debt owned by another company •   109G(2) debtor becomes bankrupt because of part x of

bankruptcy act 1966. •   109G commissioner will just ignore the forgiven debt due to

financial hardship Other factors to consider •   109RB: Commissioner may disregard the operation of the

division or allow the distribution to be franked if the dividend is made due to a honest mistake.

•   109Z the amount deemed as dividend under Div 7A taken to be paid to the tax payer as a shareholder of the private company out of the profits of the company

•   109ZC: deemed dividend will not be subjected to double taxation

Deemed dividend for liquidator distributions •   47(1) distribution to the shareholder by a liquidator are in general deemed to be dividend paid out of profits to the extent that they represent income derived by the company before or during liquidation

•   Based on s6(1) return of capital is excluded from dividend •   When shares are redeemed or cancelled => CGT event C2

generally applies S104-25 •   If capital proceeds > cost base => capital gain => this will be

reduced by any amount that has already been captured as assessable income under s47: 118-20.

Imputation system (Pt3-6 ITAA97) and outlined s200-5

Gross up and offset mechanism •   Assessable income of residents in company includes dividends paid to the shareholders out of profits derived by the company from any source (s44).

•   Operating as a “gross up and offset mechanism”. (ONLY FOR AUSTRALIAN RESIDENTS)

1.   Amount of franked distribution/ dividend included in the AI (s44 ITAA36)

2.   Amount of franking credits attached to the distribution also included in AI (s207-20(1)) ITAA97)

3.   Amount of franking credits claimed as tax offset for the income year (s207-20(2) ITAA97) – to claim tax offset individual /company must be a AU resident (s160A).

4.   Shareholder entitled to a refund if Tax offset > Tax payable for the income year (s67-25 ITAA97)

5.   If the shareholder is a company credit the franking account (s205-15 ITAA97).

 

Entity can frank distributions only if (s202-5ITAA97)

 1.   It’s a AU RESIDENT “FRANKING ENTITY”

(corporate tax entity that is taxed under income tax law s960-115ITAA97).

2.   The distribution is a “FRANKABLE DISTRIBUTION” (dividend s960-120(1)ITAA97).

-   Frankable distribution to the extent its not un-frankable: 202-40

-   Unfrankable distributions listed in 202-45 ITAA1997 (e.g. deemed dividend under Div 7A Pt3 ITAA36, distribution in respect of non equity share)

Maximum franking credits attached (202-60(2)) 𝑓𝑟𝑛𝑘𝑎𝑏𝑙𝑒  𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛  ×

𝑐𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒  𝑡𝑎𝑥  𝑟𝑎𝑡𝑒  1 − 𝑐𝑜𝑟𝑝𝑜𝑟𝑎𝑡𝑒  𝑡𝑎𝑥  𝑟𝑎𝑡𝑒  

•   Company can decide on whether or not frank the distribution and how much franking credits attached and should give the shareholders franking % of the distribution. S202-75 & 202-80.

Franking account S205-10:corporate entities must maintain a franking account

Franking debits s205-30

Franking credits s205-15

Franking deficit tax •   Allows corporate tax entities to tax based on anticipated franking credits s205-45(1)

•   If the franking account is at deficit need to pay franking deficit tax (debits > credits): 205-45(2)

•   Tax is equal to the amount of deficit •   As a credit balance arise due to the payment of franking

deficit tax the debit balance cancel off •   Not penalty as amount is available to offset against

future income tax liability :205-70(1) •   Penalty imposed if excessive deficit (if exceeds by 10%

the total amount of franking credits in the income year 205-70(2)). Then the amount of tax offset generated by the franking deficit tax is reduced by 30%.

Implication on various shareholders Resident corporate shareholders •   Subjected to gross up and offset mechanism

•   Credit arise in its franking account 205-15ITAA1997. •   NOT ENTITLED TO REFUND

(a)  Excess franking offset => carried forward loss

-   entity with current carried forward loss can choose the amount of loss to be utilized in the current income year s36-17.

-   Can choose to utilize non of the loss or any amount up to a maximum above which would generate excess franking credit

(b)  Excess franking offset => current year loss - If the entity has a excess franking offset due to deductions in the current year in the general excess franking offset is converted in to tax loss at the prevailing corporate tax rate 36-55ITAA97.

Resident partnerships and the trusts as shareholders •   207-B trace the franked distributions trough partnerships or trust that are not corporate entities. (1)  When the partnership received the franked

distribution will follow the gross up and offset rule to figure out the partnerships taxable income 207-35

(2)  Each partner would share the net income or less according to partnership agreement

(3)  Would also be entitled to a tax offset equal to the amount of its share of franking credits s207-45

•   Any loss at the trust level cant be distributed to the beneficiaries so franking credit is loss if the trust is at a loss position

Non resident shareholder •   Gross up and offset does not apply 207-70 •   Franked dividend paid to a non resident is generally non-

assessable non-exempt income 128D •   Non residents may be subjected to withholding tax on

unfranked part of dividend •   Franked dividend flow indirectly through partnership and

trust to a non resident can deduct from the assessable

income an amount equal to its hare of franking credit attributable to distribution 207-95.

Integrity measures

Anti-streaming rule (s204-30; s177EA) Stop companies from selectively distributed franked (resident

shareholder) /un-franked dividends (non- resident shareholders): 203-15

Maximum franking credit rule Maximum amount of income tax that the company making a distribution could have paid on the underlying profits at the current tax rate (s202-55) Calculates as (s202-60(2)).

Benchmark franking rule and disclosure rule 1.   Benchmark franking rule

•   All distributions with in the franking period must be

franked to the bench mark franking %(s203-25)

•   Benchmark franking % % which the 1st frankable distribution for the period was franked (s203-30)

•   Franking % 𝑓𝑟𝑎𝑛𝑘𝑖𝑛𝑔  𝑐𝑟𝑒𝑑𝑖𝑡𝑠  𝑎𝑙𝑙𝑜𝑐𝑎𝑡𝑒𝑑  𝑡𝑜  𝑓𝑟𝑎𝑛𝑘𝑎𝑏𝑙𝑒  𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛  𝑚𝑎𝑥𝑖𝑚𝑢𝑚  𝑓𝑟𝑎𝑛𝑘𝑖𝑛𝑔  𝑐𝑟𝑒𝑑𝑖𝑡𝑠  𝑓𝑜𝑟  𝑡ℎ𝑒  𝑑𝑖𝑠𝑡𝑟𝑖𝑏𝑢𝑡𝑖𝑜𝑛  

•   Franking period

(a) private company – income year (1 July -30 June) (s203-45) (b) Public company – 2, 6month franking periods 1st 6 month period (1 July -31 Dec ) following 6 month period ( 1 Jan – 30 June) in the year (s203-55).

•   Breach of benchmark rule (a)  Franking % > benchmark franking % →Over

franking tax (s203-50(1)(a) (penalty so can’t credit to the franking account or no tax offset)

(b)  Franking % < Bench mark franking % →under- franking debit to company franking account so a penalty as it cancel off otherwise available credit (s203-50(1)(b))

•   Can deviate if the commissioner permits but such permissions may be given only in extraordinary circumstances 203-55

2.   Disclosure rule •   Entity must notify the commissioner if benchmark

franking % differs significantly (>20%) between two franking periods (s204-75).

•   FCT can request further information to investigate (s204-80)

Qualified person •   207-145(1)(a) if not a qualified period franking credits cant be added to the AI and not offset is available.

•   So effectively who bears the risk of holding the share enjoy the benefit of the distribution

(a)  should hold the ordinary share at least 45 days (b)  If preference shares holding period is 90days

Loss recoupment test

Company losses •   Given DEDUCTIONS > AL + exempt income = Tax loss

for income year (s36-10 ITAA97). •   Companies are entitled to carry forward revenue losses

(s36-17) and capital losses (s102-15) for the deduction against future AI/ capital gains BUT the company must satisfy one of the following test. (revenue losses; s165-10 & capital losses s165-96)

v   Continuity of ownership test (s165-12) OR v   Small business test (s165-13)

Continuity of ownership test (s165-12) •   Company has to maintain the same majority of owners during the test period and satisfied if during the ownership test period (From the start of the “LOSS YEAR” to the end of the “income year” s165-12(1)). >50% of

v   VOTING POWER in the company AND v   RIGHTS TO DIVIDENDS of the company AND v   RIGHTS TO CAPITAL DISTRIBUTIONS Are BENEFICIALLY held by SAME PERSON.

•   Anti avoidance provisions v   “Same share same owner rule” (s165); transfer of

ownership between existing shareholders is a change of ownership

v   Deemed to be failed if during the period person controls directly or indirectly to get tax benefits (s165-15)

v   Should be the same beneficial owner so need to trace to the ultimate individual owner

•   Get a concessional treatment for listed companies Div166

(just need to satisfy the continuity of the ownership at certain designated points of time during the ownership test period)

Same business test (s165-13) Back up option if continuity ownership test fails

•   Satisfy if the company carries on the “SAME BUSINESS” DURING THE INCOME YAER as it did IMEDIATELY prior to failure of continuity ownership test (s165-210(1)).

•   Not satisfies if the company derives AI from (165-210(2)). 1.   A business of kind it did not carry on before the test

time OR 2.   A transaction of kind it had not entered into before the

test time.

•   Test time = Time the company fails the Continuity ownership test (s165-13)

•   Avondale Motors (1971): should be an identical business not just similar business.

•   AGC (Advances) LTD: Still carry on the same business even it has changed name and address.

•   TR 1999/9: Can change some parts but the identity of the business should remain the same.

•   Anti avoidance provision (s165-210(3)): where company entered in to new business JUST before the test time so that company will pass the test deemed as failing same business test,

 

Unrealized losses •   People transfer shares in the company that held assets with unrealized losses

•   So even though there was a majority change of ownership in the company the two tests will not apply as there was no REALISED losses in the company at the time of ownership change.

•   The unrealized losses may then be realized by the company by disposing the assers.

•   So s165-115B disallow up to the amount of unrealized net loss subsequent realization of losses from those CGT assets that the company held at change over time.

•   Un-realized loss is calculated by (a)   individual asset method => add up realized gains/loss of

each CGT assets of the company (b)  Global method => s165-115E global market valuation of

all CGT assets against total cost base of the assets

Tax consolidation

WHOLLY OWNED GROUPS •   WHOLLY OWNED GROUPS can be treated as a single tax entity.

1.   Head company: AU RESIDENT company subjected to normal corporate tax rate that is NOT a subsidiary of any other AU company (s703-15(2)).

2.   Subsidiary company: 100% owned based on beneficial interest (cant be as a trustee)AU RESIDENT company, partnership or trust (s703-15(1)).

•   Company can elected to form tax consolidation group (s703-10) but the choice is IRRECOVERABLE (s703-5).

•   When election made by the head company “One-in-all-in”. •   Single entity rule: All subsidiaries are treated as they are

“Divisions” of the head company for tax purpose and will have one single tax return, assets of the subsidiaries are deemed to be held directly by the head company and the intra group transactions are ignored (s701-1 ITAA97).

•   Head company lodge a single tax return excluding inter group transactions and liable for groups tax liability but if the head defaults each subsidiary member is liable for groups tax liability (s721-15).

•   Policy objective of subsidiaries (a)  prevent double taxation of the same economic gain

realized by the consolidate group (b)  prevent duplication of the same economic loss realized by

a consolidate group (c)   to reduce compliance costs and improve business

efficiency

Entry history rule •   Head company inherit tax attributes of the subsidiary •   Everything that happened in relation to subsidiary before it

becomes a subsidiary member is taken to have happened in relation to the head company 701-5

Exit history rule •   Applies when the subsidiary leaves the group •   Ensure that subsidiary can inherit relevant tax attributes from

the head company 701-40. Tax liability •   Head company has the primary obligation to pay the groups tax

•   If the head company fails to pay the tax all of its subsidies are jointly and severally liable 721-15

•   Relevant even the subsidiary has been the member of the group just for part of the period

•   Group members can avoid joint and several liability if valid tax sharing agreement is in place.

•   Tax sharing agreement requirement (a)  allocate amount of tax liability => should be reasonable (b)  should not entered in to the agreement with purpose to

prejudice the recovery of group liability.

Pre consolidation losses •   pre consolidation losses of a subsidiary can be transferred to the head company if modified continuity ownership test or same business test satisfied at the joining time (s707-120).

•   Amount of loss is subjected to available fraction rule (s707-310) •   𝑃𝑟𝑒  𝑐𝑜𝑛𝑠𝑜𝑙𝑖𝑑𝑎𝑡𝑒𝑑  𝑙𝑜𝑠𝑠𝑒𝑠  𝑢𝑡𝑖𝑙𝑖𝑧𝑒𝑑  𝑏𝑦  𝑡ℎ𝑒  𝑐𝑜𝑚𝑝𝑎𝑛𝑦   =

𝑎𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒  𝑓𝑟𝑎𝑐𝑡𝑖𝑜𝑛  ×  ℎ𝑒𝑎𝑑  𝑐𝑜𝑚𝑝𝑎𝑛𝑦  𝑡𝑎𝑥𝑎𝑏𝑙𝑒  𝑖𝑛𝑐𝑜𝑚𝑒  𝑓𝑜𝑟  𝑡ℎ𝑒  𝑦𝑒𝑎𝑟    

•   𝑣𝑎𝑖𝑙𝑎𝑏𝑙𝑒  𝑓𝑟𝑎𝑐𝑡𝑖𝑜𝑛 = ?@ABC  DE  FGC  HBIHJK@LM  ?@ABC  DE  FGC  NGDAC  OLDBP  

  𝑣𝑎𝑙𝑢𝑒  𝑡ℎ𝑒  𝑠𝑢𝑏𝑠𝑖𝑑𝑎𝑟𝑢  ℎ𝑎𝑠  𝑏𝑜𝑢𝑔ℎ𝑡  𝑡ℎ𝑒  𝑔𝑟𝑜𝑢𝑝

•   If the subsidy member leaves the group it cant take away the remaining losses from the group (s707-410) that amount stays with the head company.

 Tax cost setting rule

Subsidiary joins the consolidate group •   Allocation of the head company acquisition costs of the membership interest in the subsidiary to the underlying assets

•   Reset cost base of assets Subsidiary leaves the consolidate group •   Reconstitute cost base of the membership interest