Clarification of the "dividend" definition

(Clauses 5, 57(4) and (5), 100 and 107)

Summary of proposed amendment

The definition of “dividend” is being amended to make it clear that certain transactions are not treated as dividends for tax purposes.

Application date

The amendments will apply from the beginning of the 2005–06 income year.

Key features

Both the Income Tax Act 2004 and the Income Tax Act 2007 will be amended so that it is clear that certain transactions are not dividends for tax purposes.

The transactions are listed below.

Rights issues

Companies can offer their shareholders rights to buy new shares, generally at a discount to the market value.

It is proposed that legislative changes be made to make it clear that the discounted amount is not a taxable dividend for those shareholders that exercise the right, and that the right itself (which has value and may in some cases be traded or renounced) is not a taxable dividend.

The policy rationale for ensuring that rights and discounted shares issued under a rights issue are not treated as dividends is that the company does not give up anything of value. A rights issue involves the company raising new equity when the shareholders invest new funds in the company.

Premiums paid under bookbuild arrangements

Following a rights issue, a bookbuild can take place. A bookbuild involves the rights of non-participating shareholders (who chose not to participate or were not entitled to participate) being offered to other investors who pay a premium for them. The original shareholder is paid all or part of this premium for giving up their rights.

It is proposed that changes be made to make it clear that premiums paid under bookbuilds are not dividends for tax purposes. From a policy perspective, a bookbuild should not be treated as a dividend because, like a rights issue, the company does not give up anything of value.

Share splits

A share split involves a company diluting its shareholding whereby the shareholding proportions are retained but the shareholding is split into a greater number of shares.

It is proposed that an amendment be made to the definition of “bonus issue” so that share splits that involve a subdivision of shares (that takes place under the Companies Act 1993) can be excluded from the dividend definition. Currently, only bonus issues that involve the issue of new shares can be excluded from the definition of “dividend” for tax purposes. However, a subdivision of shares does not necessarily involve the issue of new shares.

From a policy perspective, a share split should not be treated as a taxable dividend because the company does not give up anything of value. Furthermore, in a share split, the shareholder is generally not involved in a transaction with the company.

Background

The current dividend definition is based on the policy that, in general, distributions from a company to a shareholder should be taxed if there is a transfer of value to the shareholder and the transfer is made in recognition of the shareholder’s ownership interest in the company (instead of, for example, an employer/employee relationship between the company and shareholder).

Currently, there are views that the legislation is unclear on whether the transactions described above fall within the definition of “dividend”. The proposed changes do not involve a change in policy but are being made to clarify the policy intent for the specified transactions.