In general, amounts treated as dividends under Division 7A are not frankable, and the recipient is not entitled to a tax offset in relation to the dividend.
A franking account is an account that a corporate tax entity (for example, a company) maintains to keep a record of the income tax credits (known as franking credits) that it can pass on to its shareholders.
A franking credit arises in the franking account when a corporate tax entity makes a payment of a pay as you go(PAYG) instalment or income tax, receives a franked distribution (directly or indirectly) or incurs a liability to pay franking deficit tax. A franking debit arises in the franking account in various circumstances, including where a corporate tax entity receives a refund of income tax or makes a franked distribution.
Some exclusions may apply to Division 7A amounts incurred
Where an amount treated as a dividend under Division 7A arose because of an honest mistake or inadvertent omission, the Commissioner may exercise a discretion to allow the relevant private company to frank the deemed dividend. Where the Commissioner exercises the discretion and the private company franks the deemed dividend, the private company's franking account will be debited as if it had franked an ordinary distribution.
Set off of subsequent dividends
If a Division 7A dividend paid by a private company to a shareholder or their associate is wholly or partly set off by a subsequent dividend the company pays to that shareholder or associate, the lesser of the following is not treated as a dividend:
- the unfranked amount of the subsequent dividend
- the amount that is set off.
The balance (if any) of the subsequent dividend is still a dividend, so the shareholder or their associate retain any franking credits allocated to it.
Effect on the private company
However, the whole amount of the subsequent dividend is subject to the normal franking rules, so the company must frank the dividend to the required extent (see Imputation - the benchmark and anti-streaming rules).
In the income year ended 30 June 2015, Rossi Pty Ltd makes a loan of $1,000 to Alana, a shareholder of Rossi Pty Ltd. This is treated as a Division 7A dividend paid to Alana on 30 June 2015. In the income year ended 30 June 2016, Rossi Pty Ltd distributes an unfranked dividend (the subsequent dividend) of $1,000 to Alana which is set off against her $1,000 loan. Alana had not made any repayments of the loan.
The effect of the set off is that no amount of the subsequent dividend of $1,000 is treated as a dividend. Accordingly, Alana is not required to include the subsequent unfranked dividend in her 2016 tax return.
End of example
Assume the same facts as in Example 1 except that the subsequent dividend is a frankable distribution with a franking percentage of 35%.
The effect of the set off is that the unfranked amount of the subsequent dividend (that is, $650) is not treated as a dividend and is not included in Alana's 2016 tax return. The franked amount of $350 is included in her assessable income along with the franking credit allocated to the dividend of $150 (calculated as $1,000 x 30/70 x 35%). Alana is also entitled to a tax offset of $150.
End of example
Franking implications where private companies are treated as paying dividends to shareholders and shareholders' associates under Division 7A of Part III of the Income Tax Assessment Act 1936.