Amendments to the share capital tainting provisions in the Income Tax laws which treat distributions from share capital accounts as dividends in certain circumstances were announced today by the Assistant Treasurer, Senator Rod Kemp.
The amendments, which will benefit companies and shareholders, are to apply from 1 July 1998.
Broadly speaking, the amendments will ensure that:
- a share capital account does not become tainted by the merger of tainted share premiums with share capital unless the share capital account ceases to be more than the tainted share premium account total at the time of the merger;
- all debt for equity swap arrangements which should qualify for the exception to the tainting rule do so; and
- the delayed crediting of share capital to the share capital account does not trigger the tainting rule.
Further details of the proposed amendments are provided in the attachment.
CANBERRA
20 November 1998
Contact:
Penny Farnsworth
Assistant Treasurer’s Office
(02) 6277 7360
Haydn Daw
Australian Taxation Office
(02) 6216 1467
ATTACHMENT
TAINTING RULE: TAXATION LAWS AMENDMENT (COMPANY LAW REVIEW) ACT 1998
Merging Tainted Share Premium Accounts with Share Capital
Under the Taxation Laws Amendment (Company Law Review) Act 1998 a share capital account to which amounts other than share capital have been transferred (a ‘tainted share capital account’) is treated as a profit account, and distributions from it are treated for tax purposes as dividends. This is to prevent companies from transferring profits to the share capital account and then distributing profits as share capital. A similar rule applied to share premium accounts before their abolition on 1 July 1998 by the Company Law Review Act 1998: in cases where the share premium account contained amounts other than share premiums (‘tainted share premium accounts’) the share premium account was also treated as a profit account.
Under section 1446 of the Company Law Review Act 1998 share premium accounts existing on 1 July 1998 were merged into the share capital account. A transitional issue has arisen as a result of this merger because when a tainted share premium account is merged into the share capital account, the account becomes a tainted share capital account.
To prevent companies from being adversely affected in these situations, the Government has decided to amend the tax laws so that a share capital account is not tainted by the merger of tainted share premium accounts under section 1446 of the Company Law Review Act 1998. The law will also be clarified to ensure that no franking debit is incurred in such cases.
However, to ensure that the merger of tainted share premium accounts does not confer an undue tax advantage by sanctioning the transfer of profits to share capital, the share capital account will be treated as if it were tainted during periods when the amount standing to the credit of the share capital account is equal to the balance of the tainted share premium account merged in it (i.e. nothing remains in it other tainted share premiums).
For this purpose the balance of the tainted share premium account will be the amount standing to the credit of the tainted share premium account when it was merged with the share capital account on 1 July 1998, less any subsequent distributions during periods when the share capital account is treated as tainted under this rule. This will prevent the distribution of existing tainted amounts as share capital, while allowing companies to continue to distribute untainted share capital as such. Companies will also continue to have the opportunity to untaint the account through the ordinary tainting rules (i.e. record franking debits and/or pay untainting tax).
These amendments will not override the potential application of the ordinary tainting rules of the Act. Therefore if a company transfers profits to a share capital account in which is merged a tainted share premium account, the ordinary rules will continue to treat the entire account as a tainted share capital account unless the company has taken the necessary measures to untaint it.
Example
For example, if a company had a tainted share premium account totalling $400,000 on 1 July 1998, and paid-up share capital of $600,000, it would thereafter have a share capital account of $1,000,000 with a tainted share premium account balance of $400,000. As long as the total of the share capital account is more than $400,000 (and no fresh tainting amounts are transferred to it) distributions from it will be treated as distributions of share capital.
If the company made a distribution of $700,000 from the share capital account, leaving a total of $300,000, $600,000 will be treated as a distribution of share capital, but $100,000 will be treated as an unfranked, non-rebateable dividend because the distribution reduces the share capital account to less than the tainted share premium account balance of $400,000.
The new tainted share premium account balance in this example will be $300,000. If no fresh share capital is raised, all subsequent distributions from the share capital account would also taken to be dividends because the share capital account total is not greater than the tainted share premium account balance.
However, if the company raised fresh capital of $200,000, the share capital account total would be $500,000, which is greater than the new tainted share premium account balance of $300,000; and as long as subsequent distributions did not reduce the share capital account to less than the new balance (and there is no fresh tainting of the share capital account) they will be treated as distributions of share capital.
Debt for equity swaps
The income tax law also provides an exception to the tainting rule where an amount is transferred to a share capital account under a debt for equity swap. The exception reflects the fact that no undue tax advantage can arise by companies transferring amounts which only represent a liability, as distinct from a profit, to the share capital account, and then making a distribution from that account.
To achieve this, the tainting rule adopts the existing definition of debt for equity swap in section 63E of the Income Tax Assessment Act 1936. However, for technical reasons some debt for equity swaps fail to qualify as the definition is currently expressed. To ensure that all arrangements which should qualify do so, the Government will be amending the income tax law so that for the purposes of the tainting rule a debt for equity swap will include all arrangements whereby an amount or part of amount of a debt owed by a company is discharged, released or otherwise extinguished in return for the issue of shares to the creditor, provided the amount of the debt transferred to the share capital account does not exceed the lesser of the value of the shares issued to the creditor and the amount of the debt.
Delayed crediting of share capital
Under the rules formerly applicable to share premium accounts before 1 July 1998, a share premium account did not become tainted when share premiums were credited to another account and then transferred to the share premium account, provided they could be identified in the books of the company at all times as such a premium. However it is arguable that the new rules have not continued this treatment in respect of the operation of the share capital account.
To clarify that this is not the case, the Government will amend the income tax law so that the delayed crediting of share capital to the share capital account will not trigger the tainting rule, provided the amount transferred was identifiable in the books of the company at all times as share capital.