Question

Tutorial: Partnerships

1, Alpha Ltd is incorporated in Singapore and its shares are listed on the Singapore Stock Exchange. Alpha Ltd’s board, by which the company is managed, is comprised of Australian citizens resident in Singapore. Board meetings are held in Singapore. The company manufactures plastic toys and has factories in both Singapore and Malaysia. 30 million shares have been issued of which 51% are held by Bravo Pty. Ltd., a company incorporated in New Guinea and carrying on business as a wholesaler in Port Moresby and in Townsville. Bravo Pty. Ltd. is a wholly owned subsidiary of Charlie Ltd., a company incorporated in Australia and controlled by Australian residents.

(a)       Is Alpha Ltd an Australian resident company?

(b)       What difference would it make if:

(i)     Alpha Ltd. carried on trading activities in Australia; or

(ii)    the Board of Alpha Ltd. was accustomed to voting as suggested by Echo, an Australian resident who is the managing director of Charlie Ltd. and who has power of appointment and dismissal of Charlie Ltd’s board?

2.         NFS Pty Ltd, a resident company, had a taxable income of $10,000 last tax year on which it paid tax at the applicable company tax rate. In the current tax year it distributed the balance of that income to its shareholders franking the dividends to the greatest extent possible. Its shareholders include:

(1)       David - a resident individual;

(2)       Bravo Ltd - a resident company; and

(3)       Ethel - a non-resident individual.

Each owned 10% of NFS’s issued shares and each was entitled to 10% of any dividend NFS paid.

Required:

(a)       Calculate the amount of company tax paid by NFS Pty Ltd last tax year. (You may assume that there were no tax offsets not mentioned in the fact situation above).

(b)       Calculate the tax payable by each of Bravo Ltd, David and Ethel on the dividends they received from NFS. (Assume that David and Ethel pay tax at the top marginal tax rate. Ignore the Medicare levy.))

(c)        Explain how Bravo Ltd would have treated the franking credits that were attached to the dividend it received from NFS.

3.         A family company XYZ Pty Ltd acquired an asset (with an effective life of 10 years) on 1 July tax year 1 for $100,000 (assume after 2006). It was depreciated using the diminishing value method.

On 1 July tax year 3 it was disposed of for $120,000. That was the company’s only income generating transaction for that year.

On 30 June tax year 3 the company paid a fully franked $10,000 cash dividend to Alex, a shareholder. Alex’s other income in that year was $180,000.

Calculate:

a, the depreciation deductions for the tax years 1 and 2;

b, the company’s taxable income and income tax for tax year 3;

c, the amount of fully franked dividend the company could pay;

d, what tax Alex will have to pay on the $10,000 cash dividend he receives.              

You may assume that:

the company has no carry forward franking account balance

the company’s tax rate was 30%

the marginal rate of tax applicable to individuals with income over $180,000 is 47% (inclusive of levies)

e.         If Alex’s wife Joan held a different class of shares in the company and her other income was only $10,000, what might be your advice, to the Board of Directors on 30 June and why? Would this advice differ if she was a non-resident?

Answer 1

1 a.Is Alpha Ltd an Australian resident company?

Here, Alpha is incorporated in Singapore so by default it is a Singapore resident company. Alpha will also be an Australian resident company, if it carries on a business in Australia and either has its central management and control in Australia or having its voting power controlled by Australian residents. The facts do not suggest that Alpha physically carries on business in Australia, so we would have to prove that its activities (operations and/or strategic planning) are controlled and directed from Australia.

Alpha's board meets and decides policy in Singapore, so it would appear that Alpha is controlled and managed from Singapore. The citizenship of board members is irrelevant. Alpha’s central management and control is not in Australia and thus it cannot be an Australian resident under either of the two remaining tests. Therefore, it is not an Australian resident company and only taxed on Australian-sourced income.

b 1)Alpha Ltd. carried on trading activities in Australia; or

Alpha would still not satisfy the second test because, while it now carries on business in Australia, its central management and control are not here. It might still satisfy the third test if its voting power is controlled by Australian residents. This is a question of fact (Bywater). Bravo ownership in 51% controls after voting power in Alpha. Therefore, we need to determine whether Bravo is an Australian resident.

Bravo is incorporated in PNG so fails the first test. It carries on business in Townsville so the first element of both the second and third tests is satisfied. For the second test, there are no details of where the directors’ meetings are held or where the superior directing authority is located.

However, we know that Bravo’s voting power is controlled by Charlie Ltd. Charlie is an Australian resident because it is incorporated in Australia. Bravo is therefore an Australian resident company, and, because it controls the voting power in Alpha, Alpha is also an Australian resident for tax purposes.

As Alpha is both Australian and Singapore resident, the Australia-Singapore Double Tax Agreement (DTA) will break the impasse.

2) the Board of Alpha Ltd. was accustomed to voting as suggested by Echo, an Australian resident who is the managing director of Charlie Ltd. and who has power of appointment and dismissal of Charlie Ltd’s board?

In Esquire Nominees, the directors of Esquire Nominees (a Norfolk Island company with board meetings held there) were strongly influenced by the advice that they received from Australian-based accountants. However, the accountants only suggested what should be done and did not direct what is to be done.

Therefore, the court held that central management and control remained with the board on Norfolk Island.

In Bywater, one person in Sydney performed all of the trades on the ASX and directed each board member in each of the companies in question. There the court found that this was "rubber-stamping decisions actually made elsewhere" and distinguished this one the facts from Esquire Nominees. The place of central management and control was, as a matter of fact and degree, in Sydney where the appellant made the substantive decisions.

Here, the scenario more closely resembles Esquire Nominee than Bywater, and even if Alpha’s board was accustomed to voting as suggested by Echo, it would still have its central management and control where the board meets and decides (in Singapore). The board appears to be doing more than "rubber-stamping" decisions made by Echo. Consequently, it would still not be an Australian resident.

2.a)Calculate the amount of company tax paid by NFS Pty Ltd last tax year. (You may assume that there were no tax offsets not mentioned in the fact situation above)

As per Section s4 -10(3) Income Tax = (Taxable income x rate) – Offsets (rebates)

Income Tax: $10,000 x 30% = 3,000 as per the applicable rate.

Profit after Tax $10,000 – 3,000 = $7,000

Distribution    $7,000

b)Calculate the tax payable by each of Bravo Ltd, David and Ethel on the dividends they received from NFS. (Assume that David and Ethel pay tax at the top marginal tax rate. Ignore the Medicare levy.))

Each owned 10%

When a corporate tax entity pays income tax, it receives a franking credit equal to the amount paid (s.205-5(2)). These credits are transferable to shareholders when that entity paid a franked distribution (s.205-5(3)). A company cannot pass that full benefit on via its dividend if it has already paid a franked dividend at a lower rate during the franking period (the “benchmark rule”) (s.203-5(1)).

The maximum amount of franking credit that can be attached to a dividend is (s.202-60(2)).

                                        Bravo                       Davis                    Ethel          

                                          Ltd

Dividend

(s44(1)(a))                            $700                       $700                      $700

Gross-up for

Franking credit

(s207-20(1))                     $300                         $300

Taxable Income              $1000                       $1000

                                        @30%                      @45%

Tax                                  $300                         $450

Less tax offset for

Franking credit

(s207-20(2))                    $300                         $300

Income tax                      $0                             $150

Here there is no evidence that a previous dividend was paid during the period so the benchmark franking percentage is unlikely to have been set, and therefore the dividend can be franked to the full $300.

c   Explain how Bravo Ltd would have treated the franking credits that were attached to the dividend it received from NFS.

Taxable incomes of dividend recipients is increased by both the cash amount plus the franking credit. Where a company is the recipient, the franking credit is added to that entity’s franking credit account (s.205-15). Where an individual is the recipient, she or he may offset this against tax payable, or apply for a refund from the ATO.

Here, Bravo Ltd and David are residents and receive $700 cash plus $300 credit. Both their incomes include the cash dividend and the franking credit for a total of $1000. For Bravo Ltd, no additional tax is payable as its rate of tax is also 30%. It is no franking credit for Bravo because they are not paying tax( tax payable come up zero). David, however, pays tax at the top marginal rate and therefore his tax liability will be $450 less the offset of $300. David’s tax liability from the dividend from NFS is $150.

3a)the depreciation deductions for the tax years 1 and 2;

s.40-72 depreciation deduction = base value x days held / 365 x 200% x asset’s effective life

Y1                    100,000 x 20% (S 40-70=200/10%)                        $20,000

Y2                    (100,000 - 20,000) x 20%                                           $16,000

Adjustable value 1/7/Y3 = $64,000 (S 40-70)

(ignore and depreciation claim for day 1/7/Y3)

b.the company’s taxable income and income tax for tax year 3;

Taxable Income – Y3

Balancing charge on disposal ($120,000 - $64,000)(s.40-285)          $56,000

Company Income Tax Payable

$56,000 @ 30%                                                                                  $16,800

Distributable After Tax Profit

Profit on sale included in the balancing charge                                  $56,000

Less tax payable                                                                                 (16,800)

                                                                                                            $39,200

c.the amount of fully franked dividend the company could pay;

Franking Account Credit

(from payment of company tax) (s.205-15)    $16,800          

company can pay a $39,200 cash dividend fully franked without incurring FDT.

d. what tax Alex will have to pay on the $10,000 cash dividend he receives.          You may assume that: the company has no carry forward franking account balance the company’s tax rate was 30% the marginal rate of tax applicable to individuals with income over $180,000 is 47% (inclusive of levies)

Alex

He receives a $10,000 fully franked dividend. Taxable income:

Cash dividend                                                                         $ 10,000

s.202-60 franking credit (10,000 x 30/70)                            $   4,285

Other income                                                                          $180,000

                                                                                                $194,285

Tax on the dividend will all be taxed at the marginal rate of 47% because Alex’s other income already puts him over the $180,000 threshold.

Tax on $14,285 @ 47%                                                          $6,713.95

Less s.207-20 franking offset                                              $4,285

Tax payable on the dividend                                                   $2,428.96

e)If Alex’s wife Joan held a different class of shares in the company and her other income was only $10,000, what might be your advice, to the Board of Directors on 30 June and why? Would this advice differ if she was a non-resident?

Joan

Pay the dividends to her as she is taxed at a lower marginal rate of tax. Her taxable income would then be $10,000 + $10,000 + $4,285 = $24,285 on which the tax payable would be completely absorbed by the LITO of $445 and franking offset of $4,285 and she would be entitled to a refund. (Note: the ATO accepts that the non-refundable Low Income Tax Offset (LITO) is deducted from the tax payable first and then the refundable franking offset.)

Tax refund = $[(24,285 – 18,200) x 19%] - $445 - $4,285 = $3,575

Had she been a non-resident then incentive to stream unfranked dividends to her as she would probably be taxed at only 15% withholding tax (WHT) in Australia and no refunds would be available. Thus, the franking credits would be wasted. Also, the WHT would likely have been creditable overseas so the WHT exemption results merely in a revenue transfer to a foreign treasury.

However, ahe can only pay her unfranked dividends (even though a credit balance in the franking account) if no other franked dividends are paid this franking period. Then the benchmark franking percentage is set at zero. Then in the next period could pay franked dividends to a resident (assuming different share classes) but need to watch the disclosure rule in s.204-75 and the general anti-streaming rules in SD 204D.

If we are not pay her frank dividend, then we cannot pay him frank dividend later in the year. And if we pay him frank dividend next year, we need to report the ATO why it was greater than 20% difference in the franking percentage from this year to next year and explain why. But need to watch the disclosure rule in s.204-75 and the general anti-streaming rules in SD204D.