Bills Digest No. 149  1998-99 Taxation Laws Amendment (Demutualisation of Non-insurance Mutual Entities) Bill 1999


Numerical Index | Alphabetical Index

WARNING:
This Digest was prepared for debate. It reflects the legislation as introduced and does not canvass subsequent amendments. This Digest does not have any official legal status. Other sources should be consulted to determine the subsequent official status of the Bill.

CONTENTS

Passage History
Purpose
Background
Main Provisions
Endnotes
Contact Officer and Copyright Details

Passage History

Taxation Laws Amendment (Demutualisation of Non-insurance Mutual Entities) Bill 1999

Date Introduced: 11 March 1999

House: House of Representatives

Portfolio: Treasury

Commencement: Upon the Royal Assent

Purpose

Taxation Laws Amendment (Demutualisation of Non-insurance Mutual Entities) Bill 1999 (the Bill), introduces a generic taxation framework applying to demutualisations of mutual non-insurance organisations.

The framework:

  • Applies to a demutualisation that occurs under one of three specified methods
  • Will only apply to those demutualisations where broad continuity of beneficial interest is maintained
  • Provides that CGT will not apply to the surrender by a member of membership interests in the demutualising entity. Any CGT liability will therefore be deferred until the disposal of the demutualisation shares
  • Establishes for CGT purposes, the date and cost of acquisition of shares (including bonus shares) acquired by members as part of the demutualisation process, and
  • Will allow demutualising entities to retain any franking account surpluses accumulated before demutualisation.

The proposed amendments will apply to demutualisations that are completed on or after 12 May 1998.

Background

1. Mutual company

A mutual company is a company without issued capital stock owned by its members.(1)

A mutual company's ownership structure distinguishes it from conventional corporations. Voting rights in most companies are determined by shareholdings, with one vote per share. Mutuals have one vote per member regardless of each member's financial commitment to the company.

In a mutual company ownership arises from membership, which is based upon the acquisition of a product or service from the company rather than by the contribution of capital.

Many mutually owned financial organisations were originally established as cooperatives. Members pooled resources to achieve specific objectives, such as providing life insurance or low-cost housing finance.

Mutuals distribute profits through bonuses, or reduced premiums and charges. Profits are also commonly reinvested in the company. The accretion of reserves in this way is the main avenue available to build capital.

The decision to demutualise may be driven by many factors including the need to access external capital to finance expansion, diversification or to enable the mutual to compete more effectively in the market.

2. 'Mutual entity' for the purposes of the Income Tax Assessment Act 1936

For the purposes of the Income Tax Assessment Act 1936 (ITAA36) (pursuant to new section 326-10) an entity will be a mutual entity if:

  • It is a body corporate
  • It is not an insurance company or a mutual affiliate company
  • It is not carried on for the object of securing a profit
  • It does not have shareholders, and
  • It does not hold property in which its members have a disposable interest, except in the event of winding up.

Main Provisions

Schedule 1 - Income Tax Assessment Act 1936

Part 1 - Insertion of Schedule 2H - Demutualisation of mutual entities other than insurance companies

1. Application

New Division 326 sets out the taxation consequences of the demutualisation of mutual entities other than insurance companies.

Under new Subdivision 326-A, new Division 326 will apply to demutualisations if the following criteria are satisfied:

  • The demutualisation resolution day was 4 February 1999 or later
  • The entity was a resident immediately before the resolution
  • The demutualisation was implemented in one of three specified methods
  • The continuity of beneficial interest test is satisfied, and
  • The demutualisation was or is completed on or after 12 May 1998.

2. Three methods of demutualising

The proposed framework will apply to a demutualisation that occurs under one of three methods specified in new Subdivision 326-B.

2.1 Direct method - issue of demutualisation shares directly to members
(New section 326-45)

Under this method ordinary shares of one class in the entity are issued within the limitation period to existing members. In return membership rights in the entity are extinguished.

Shares of the same class may also be issued to new members.

2.2 Holding company method - holding company interposed between mutual entity and members
(New section 326-50)

Under this method, shares of one class in the entity are issued within the limitation period to a holding company.

Shares of one class in the holding company are then issued within the limitation period to existing members. In return membership rights in the entity are extinguished.

Shares of the same class may also be issued to new members.

2.3 Distributing trust method - distributing trust interposed between mutual entity and members
(New section 326-55)

Under this method, the entity issues special shares (which carry only voting rights in respect of the entity) within the limitation period to the trustee of a distributing trust to hold for the benefit of existing and new members.

This issue takes place before the issue of ordinary shares.

After the issue of the ordinary shares to the trustee, in return for which membership rights are extinguished, the rights attaching to the special shares must become the same as those attaching to ordinary shares. The special shares must then be treated as ordinary shares.

3. Continuity of beneficial interest

New section 326-60 states that the continuity of beneficial interest test must be satisfied before Division 326 applies to a demutualisation.

The continuity of beneficial interest test is satisfied if:

  • At least 90% of the ordinary shares that are issued in connection with the demutualisation are issued to existing members, and
  • The net assets of the entity on the resolution day are distributed in the form of shares to existing members to broadly accord with their mutual participation.

4. CGT consequences

New Subdivisions 326-C to 326-N deal with the myriad of potential CGT implications for demutualisation.

Generally the proposed measures will:

  • Provide that a capital gain or loss arising from the surrender of a membership interest in a mutual organisation will be disregarded (New section 326-65)
  • Ensure that on the issue of demutualisation shares, no amount is included in a member's assessable income (New section 326-245)
  • Prescribe the date and cost of acquisition of shares (including bonus shares) acquired by members in an entity (including its holding company) as part of the demutualisation process (New Subdivisions 326-D and 326-E)

    Basically cost bases will be determined by reference to whether a member is a pre-CGT member or a post-CGT member.

    Generally for pre-CGT members the cost of acquisition will be determined by reference to the member's share of the market value of the entity immediately before demutualisation. For post-CGT members, the cost will be determined by reference to the non-deductible costs incurred by the member in acquiring and maintaining membership.
  • Provide that where a member acquires a right to the issue of shares and the member disposes of that right or interest otherwise than by receiving the shares, the date and cost of acquisition will be determined as if the member had disposed of the shares in the entity (New Subdivision 326-G)
  • Ensure that where the distributing trust method of demutualisation is used and special shares are converted to ordinary shares, no disposal will be taken to have occurred for CGT purposes (New Subdivision 326-H), and
  • Ensure that a payment out of the assets of a demutualised entity after demutualisation to a shareholder will not be taken to be a payment of a dividend. The payment will not be assessable as a dividend but the cost base of the shares will be reduced by the amount of the payment. If the payment is more than the share's cost base the shareholder will make a capital gain. (New section 326-225)

Part 2 - Consequential amendments

1. Franking account surpluses can be retained on demutualisation

Amendments to sections 160ARDM and 160ARDQ will allow demutualising entities to retain any franking account surpluses accumulated prior to demutualisation.

From 1 July 1998, special rules apply where a company 'taints' its share capital account by transferring amounts to it from other accounts. If a company's share capital account is tainted, distributions debited to that account are treated as unfrankable and unrebatable dividends.

Pursuant to amendments inserted by Items 2 and 3 an amount transferred to a share capital account in connection with a demutualisation will not taint the share capital account.

Schedule 2 - Income Tax Assessment Act 1997

1. Consequential amendments to CGT provisions concerning acquisition and cost base.

Amendments to sections 109-60 and 112-97 by Items 2 and 3 confirm that:

  • there is an acquisition for CGT purposes in relation to a demutualisation on the demutualisation resolution day.
  • the general rules about cost base and reduced cost base of an asset are modified by new Division 326.

Endnotes

  1. Graham Bannock, R E Baxter & Ray Rees, A Dictionary of Economics, Penguin Books, p. 294.

Contact Officer and Copyright Details

Lesley Lang
30 March 1999
Bills Digest Service
Information and Research Services

This paper has been prepared for general distribution to Senators and Members of the Australian Parliament. While great care is taken to ensure that the paper is accurate and balanced, the paper is written using information publicly available at the time of production. The views expressed are those of the author and should not be attributed to the Information and Research Services (IRS). Advice on legislation or legal policy issues contained in this paper is provided for use in parliamentary debate and for related parliamentary purposes. This paper is not professional legal opinion. Readers are reminded that the paper is not an official parliamentary or Australian government document.

IRS staff are available to discuss the paper's contents with Senators and Members
and their staff but not with members of the public.

ISSN 1328-8091
© Commonwealth of Australia 1999

Except to the extent of the uses permitted under the Copyright Act 1968, no part of this publication may be reproduced or transmitted in any form or by any means, including information storage and retrieval systems, without the prior written consent of the Parliamentary Library, other than by Members of the Australian Parliament in the course of their official duties.

Published by the Department of the Parliamentary Library, 1999.

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