Franking credit trading
Franking credit trading occurs when franking credits are diverted from the true economic owners of the membership interests to others with more use for the credits.
Franking credit trading is addressed by:
Exempting entity rules
An exempting entity is a corporate tax entity that is 95% or more effectively owned by entities that can't fully use franking credits (generally non-residents or tax exempt bodies).
When an entity ceases to be an exempting entity, it becomes a former exempting entity.
Exempting entity rules exist to ensure that franking credits of exempting entities and former exempting entities are not the target of franking credit trading. These rules:
- result in franked distributions from exempting entities generally being treated as unfranked, except for distributions made:
- to certain exempting entities
- on shares acquired under an eligible employee share scheme
- quarantine credits of an exempting company that becomes a former exempting entity by moving them into a separate account called an exempting account, and requiring the entity to start a new franking account
- result in distributions from a former exempting entity franked with exempting credits generally being treated as unfranked, except for distributions made:
- to certain exempting or former exempting entities
- to a member of the entity immediately before it became a former exempting entity
- on shares acquired under an eligible employee share scheme.
Qualified person test
The qualified person test ensures only the true economic owners of shares benefit from franking credits attached to distributions made from the shares. If the test is not satisfied, the shareholder is not entitled to a franking credit tax offset.
A shareholder generally meets the qualified person test if they satisfy the holding period rule or, where applicable, the related payments rule, or where the small shareholder exemption applies.
Holding period rule
The holding period rule requires shares to be held ‘at risk’ for a continuous period of at least 45 days (90 days for preference shares) during the qualification period.
The 45 day and 90 day periods don't include the day of acquisition or, if the shares have been disposed of, the day of disposal. Also excluded are days where the financial risk of owning the shares is materially diminished. For example, the financial risk may be reduced through arrangements such as hedges, options and futures.
The qualification period begins the day after the shares are acquired, and ends 45 days after the ex-dividend date.
Because of the way the qualification period is defined, the holding period rule only needs to be satisfied once per parcel of shares – that is, if a shareholder is a qualified person for a distribution from shares under that rule, they will also qualify for subsequent distributions from those same shares, unless the related payments rule applies.
If a shareholder purchases substantially identical shares over a period, the holding period rule applies a ‘last in first out’ method to establish which shares satisfy the holding period rule.
Related payments rule
This rule applies to a distribution on shares when there is an obligation to pass on the value of the distribution to someone else.
The related payments rule requires shares to be held ‘at risk’ for at least 45 days (or 90 days for preference shares) during the relevant qualification period. Like the holding period rule, the day of acquisition and, if relevant, disposal, is excluded, as are any days of diminished risk.
The qualification period begins 45 days before the ex-dividend date and ends 45 days after.
The rule applies to each distribution on those shares where a related payment is made.
Small shareholder exemption
An individual shareholder is also a qualified person if the small shareholder exemption applies – that is, if they have a total of less than $5,000 franking credits in an income year. In this case they are entitled to franking credits for all shares that satisfy the related payments rule, without having to satisfy the holding period rule.
Dividend washing rule
The dividend washing integrity rule prevents taxpayers from obtaining franking credits if they have engaged in dividend washing.
Dividend washing is a practice through which taxpayers seek to claim two sets of franking credits by selling shares held on the Australian Securities Exchange (ASX) and then effectively repurchasing the same parcel of shares on a special ASX trading market. The timing of this transaction occurs after the taxpayer becomes entitled to the dividend, but before the official record date for dividend entitlements.
The operation of the integrity rule means that if you receive a dividend as a result of dividend washing, you are:
- not entitled to a tax offset for the franking credits associated with the dividend received on the equivalent parcel of shares purchased on the special ASX trading market
- not required to include the amount of the franking credits on those shares in your assessable income.
The integrity rule applies to distributions received on or after 1 July 2013. However, for distributions made before this date, the Commissioner of Taxation may apply section 177EA of the Income Tax Assessment Act 1936 to deny franking credit benefits received through dividend washing arrangements.
Restrictions on franking credit trading are designed to prevent franking credits being diverted from the true economic owners of the membership interests to others with more use for the credits.