Commonwealth Numbered Regulations - Explanatory Statements

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INCOME TAX ASSESSMENT AMENDMENT REGULATIONS 2004 (NO. 3) 2004 NO. 303

EXPLANATORY STATEMENT

STATUTORY RULES 2004 No. 303

Issued by the authority of the Minister for Revenue and Assistant Treasurer

Income Tax Assessment Act 1997

Income Tax Assessment Amendment Regulations 2004 (No. 3)

Subsection 909-1 (1) of the Income Tax Assessment Act 1997 (the Act) provides that the Governor-General may make regulations prescribing matters that the Act requires or permits to be prescribed, or are necessary or convenient for carrying out or giving effect to the Act.

Paragraph 974-135(8)(d) of the Act provides that regulations may make provisions related to what does not constitute an "effectively non-contingent obligation" under section 974-135 of that Act. Regulations may be made to clarify the meaning of words and phrases and to give guidance on the detailed operation of particular provisions: subsection 974-10(6). The regulations made for the purpose of Division 974 of the Act may specify different rules for different classes of circumstances: subsection 974-10(7). The regulations must be consistent with the objectives stated in subsections 974-10(1) to (3), including determining whether a scheme, or the combined operation of a number of schemes, gives rise to a debt interest or an equity interest on the basis of the economic substance of the rights and obligations arising under the scheme or schemes rather than merely on the basis of their legal form.

The Regulations made for the purpose of paragraph 974-135(8)(d) of the Act clarify that the obligation in respect of the return of investment upon redemption is not an effectively non-contingent obligation for a particular type of share issued by credit unions and mutual building societies, namely a non-cumulative redeemable preference share. This is subject to criteria specified in the Regulations. Where these criteria are satisfied in relation to a share, the income tax law can treat the share as an equity interest for various income tax purposes. In particular, distributions made to members of credit unions and mutual building societies may be frankable.

The former Minister for Revenue and Assistant Treasurer announced the Regulations in Press Release CO 12/03 of 4 March 2003. The Regulations apply to shares issued on or after this date. Details are set out in the attachment.

The Regulations commenced on gazettal.

ATTACHMENT

Details of the Income Tax Amendment Regulations 2004 (No. 3)

The Regulations cover a certain class of shares: non-cumulative redeemable preference shares issued by credit unions or mutual building societies that have certain specified features [item 1, new regulations 974-135A and 974-135B]. The Regulations clarify that the obligations in respect of the returns of investment on such shares is not an effectively contingent obligation if certain requirements are met. This treatment removes an impediment to the frankability of the periodic returns on the shares. There are several requirements in the Regulations to confine their application to this class of shares:

•       the share must satisfy the prudential requirements of the Australian Prudential Regulation Authority (APRA) for tier two capital as set out in APRA Guidance Note AGN 111.2, published September 2000 [paragraphs 974-135A(b) and 974-135B(c)];

•       the share must have a minimum term of 5 years [subparagraphs 974-135A(c)(1) and 974-135B(d)(i)];

•       dividend payments must not be cumulative [subparagraphs 974-135A(c)(iii) and 974-135B(d)(iii)];

•       the shares must have preferential rights to payments over ordinary shares [subparagraphs 974-135A(c)(iv) and 974-135B(d)(iv)],

•       redemption may only occur with board approval [subparagraphs 974-135A(c)(v) and 974-135B(d)(v)]; and

•       if redemption would breach prudential standards, it must be approved by APRA [subparagraphs 974-135A(c)(vi) and 974-135B(d)(vi)].

The Regulations are designed to ensure that franking credits flow only to genuine members. Put another way, the Regulations seek to limit the capacity of investors becoming members of the mutual entities for the sole or dominant purpose of obtaining the benefit of franking credits attached to the preference shares. The Regulations have also taken into account the legal structure under which the mutual entities operate. The relevant requirements are:

•       the terms of the share must be such that dividends may only be paid out of operating profits from the current or previous year and only to the extent permitted by law and the relevant regulatory authorities, such as the Australian Securities and Investments Commission [subparagraphs 974-135A(c)(ii) and 974-135B(d)(ii)];

•       the share must be issued only to members of the credit union or mutual building Society [paragraphs 974-135A(e) and 974-135B(1)];

•       a member and its connected entities (defined in section 995-1(1) of the Act) can hold no more than 10% by value of the shares of that kind issued by that entity [paragraphs 974-135A(f) and 974-135B(g)].

If a share meets the above requirements, the Regulations prescribe that the obligation to return the investment at redemption is not effectively non-contingent.

The Regulations apply to issues of shares and to redemptions that occur on or after 4 March 2003 [paragraphs 974-135A(a) and (d); paragraphs 974-135B(b) and (e)]. However it does not apply to the extent that it would disadvantage any person in the period between 4 March 2003 and the time of notification of the Regulations in the Gazette [item 4].


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