ATO Interpretative Decision
ATO ID 2009/62
Income Tax
Converting excess franking offsets of a Pooled Development Fund to a tax lossFOI status: may be released
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This ATO ID has been amended to include references to paragraph 23(2)(ba) of the Income Tax Rates Act 1986 which has effect from 25 June 2008.
This ATOID provides you with the following level of protection:
If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
For the purposes of step 2 of the Method Statement in subsection 36-55(2) of the Income Tax Assessment Act 1997 (ITAA 1997), does the reference to 'corporate tax rate' mean 30% for the relevant income years?
Decision
Yes. 30% is the applicable tax rate for the purposes of step 2 of the Method Statement in subsection 36-55(2) of the ITAA 1997 for the relevant income years in accordance with the definition of 'corporate tax rate' in subsection 995-1(1) of the ITAA 1997.
Facts
The taxpayer is a company that is a Pooled Development Fund (PDF) as defined in subsection 995-1(1) of the ITAA 1997.
For the 2006-07 income year, the taxpayer reported a tax loss in its tax return, which was carried forward to subsequent income years.
In respect of the 2006-07 income year (the relevant income year), the tax losses resulted from the taxpayer having 'excess franking offsets' as defined in subsection 36-55(1) of the ITAA 1997.
The taxpayer has been a PDF since its establishment.
Reasons for Decision
Section 36-55 of the ITAA 1997 allows for the conversion of excess franking offsets to a tax loss. To calculate the amount of tax loss, a taxpayer is required to follow the Method Statement under subsection 36-55(2) of the ITAA 1997, which provides:
Method Statement
- Step 1.
- Work out the amount (if any) that would have been the entity's *tax loss for that year under section 36-10, 165-70, 175-35 or 701-30 if the entity's *net exempt income for that year (if any) were disregarded.
- Note: See section 36-20 for the calculation of net exempt income.
- Step 2.
- Divide the amount of *excess franking offsets by the *corporate tax rate.
- Step 3.
- Add the results of step 1 and 2.
- Step 4.
- Reduce the result of step 3 by the entity's *net exempt income for that year (if any).
- The result of this step is taken to be the entity's *tax loss for that year. However, if the result of this step is nil or a negative amount, the company does not have any tax loss for that year.
When applying step 2 of the Method Statement, the reference to 'corporate tax rate' means 30%, regardless of whether the taxpayer's taxable income is subject to the general corporate tax rate of 30% or a concessional rate of tax for the reasons explained below.
Application of section 36-55 of the ITAA 1997 to a PDF
Section 36-55 of the ITAA 1997 applies to a PDF because a PDF is a corporate tax entity, as per the definition in subsection 995-1(1) of the ITAA 1997.
PDFs are generally taxed at either 15% or 25%, depending on the type of income they derive. This difference in tax rate from the corporate tax rate of 30% raises the issue of whether step 2 in the Method Statement in subsection 36-55(2) of the ITAA 1997 above is referring to 30%, 15% or 25%.
'Corporate tax rate' is defined in subsection 995-1(1) of the ITAA 1997 as:
the rate of tax in respect of the taxable income of a company covered by subsection 23(2) of the Income Tax Rates Act 1986.
Subsection 23(2) of the Income Tax Rates Act 1986 (ITRA 1986) provides:
The rate of tax in respect of the taxable income of a company not being:
is 30%.
Therefore, the rate of tax of a company covered by this section is 30%. Accordingly, the plain meaning of the phrase 'corporate tax rate' for the purposes of subsection 36-55(2) of the ITAA 1997 means 30%.
In the present context, this plain meaning is supported by the following statements in the Supplementary Explanatory Memorandum (the Supplementary EM) to the Taxation Laws Amendment Bill (No. 5) 2003, which inserted section 36-55 into the ITAA 1997:
5.1 The amendments contained in Schedule 8 will ensure that corporate tax entities are no longer required to use up ('waste') losses that could be deductible in a later year of income against franked dividend (effectively tax-free) income.
...
5.3 Secondly, corporate tax entities will be able to treat a current year loss that would otherwise be used up against franked dividend income as a tax loss for that income year and be able to carry forward the tax loss for consideration as a deduction in a later year of income [emphasis added].
In addition, the Supplementary EM sets out the 'policy objective' of the amendments as follows:
5.65 The overall objective is to ensure that corporate tax entities have the full benefit of deducting current and prior year losses against taxable income.
It is important to note that the policy intent of section 36-55 of the ITAA 1997 is not to preserve excess franking offsets, but rather to preserve any loss that would result if the dividend income was quarantined. The reference to excess franking offsets is merely the mechanism to allow for the preservation of these losses.
The example below illustrates the 'losses' that section 36-55 of the ITAA 1997 intends to preserve:
Example 1
A PDF has other assessable income of $100 and allowable deductions of $200 for an income year. In addition, the PDF receives a fully franked dividend of $70 (with a $30 franking credit attached). All of the assessable income of the PDF is SME assessable income and therefore the PDF's taxable income is subject to tax at 15%.
If the dividend income was quarantined, the tax treatment of the PDF would be as follows:
| Assessable income: | ||||
| Dividend | 70 | Other assessable income | 100 | |
| Gross-up | 30 | Less Deductions: | 200 | |
| Total assessable income: | 100 | Tax loss: | (100) | |
| Tax @ 15%: | 15 | |||
| Franking offset: | 30 | |||
| Tax payable: | Nil | |||
| Excess franking offset: | 15 |
Section 36-55 of the ITAA 1997 aims to preserve the above tax loss of $100. Due to the concessional tax rate of the PDF, excess franking offsets result for the PDF. It is not the object of section 36-55 to preserve the above excess franking offset of $15. There is no mechanism in the Tax Acts specifically designed to allow the PDF to recoup this excess franking offset of $15. Accordingly the PDF should be entitled to deduct a tax loss of $100 in the subsequent year of income.
Rather than quarantining the dividend income, this $100 tax loss is preserved by section 36-55 of the ITAA 1997 in the following way:
| Assessable income: | |
| Other assessable income | 100 |
| Dividend | 70 |
| Gross-up | 30 |
| Total assessable income: | 200 |
| Less deductions | (200) |
| Taxable income: | Nil |
| Excess franking offset: | 30 |
| Divide by 'corporate tax rate' | 30% |
| Tax loss to be carried forward | (100) |
Therefore, 'corporate tax rate' means 30% for the relevant income year for the purposes of step 2 of the Method Statement in subsection 36-55(2) of the ITAA 1997, regardless of the tax rate applicable to the taxpayer's taxable income.
Date of decision: 30 June 2009Year of income: Year ended 30 June 2007
Legislative References:
Income Tax Assessment Act 1997
section 36-55
subsection 36-55(1)
subsection 36-55(2)
subsection 995-1(1)
section 23
subsection 23(2)
Other References:
Supplementary Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 5) 2003
Keywords
Franking credits
Tax loss
ISSN: 1445-2782