ATO Interpretative Decision

ATO ID 2005/67

Income Tax

Issue

Will the Commissioner exercise his discretion under section 203-55 of the Income Tax Assessment Act 1997 (ITAA 1997) to permit the entity to frank two distributions at a franking percentage that differs from the entity's benchmark franking percentage for that franking period?

Decision

No. The Commissioner will not exercise his discretion under section 203-55 of the ITAA 1997 to permit the entity to frank two distributions at a franking percentage that differs from the entity's benchmark franking percentage for that franking period as the required extraordinary circumstances do not exist.

Facts

Company A, company B and company C are all Australian resident public companies and ultimately 100% subsidiaries of Foreign company, a foreign company listed on an overseas stock exchange.

The Australian companies have a substituted accounting period which commences on 1 January and concludes on 31 December each year.

The Australian companies are franking entities and will have franking periods of six months ending 30 June and 31 December.

The Australian companies propose to form a Multiple Entry Consolidated (MEC) group retrospectively from 1 January 2004 with Company A as the provisional head company.

In August 2004, company B paid to Foreign company a distribution that, in an abundance of caution, was franked to 0%. At that time, the MEC group had not finalised its franking account balance to take into consideration tax consolidation and therefore was unable to determine whether sufficient franking credits existed to frank the distribution to 100%. Subsequent to the August 2004 distribution, the MEC group determined that there were sufficient franking credits to frank the August 2004 distribution to 100%.

Company B and company C propose to make, by 31 December 2004, distributions franked to 100%.

Reasons for Decision

Section 203-25 of the ITAA 1997 provides that all frankable distributions made by a corporate tax entity within a franking period must be franked to the franking percentage set as the benchmark for that period. This is called the benchmark rule.

The Commissioner has the power to permit a departure from the benchmark rule under section 203-55 of the ITAA 1997. Subsection 203-55(1) of the ITAA 1997 provides that Commissioner may, on application by an entity, permit the entity to frank a distribution at a franking percentage that differs from the entity's benchmark franking percentage for the franking period in which the distribution is made.

Subsection 203-55(2) of the ITAA 1997 further provides that the Commissioner's powers under this section may only be exercised in extraordinary circumstances.

In determining if the requisite extraordinary circumstances exist, subsection 203-55(3) of the ITAA 1997 requires that the Commissioner have regard to the following:

(a)

The entity's reasons for departing, or proposing to depart, from the benchmark rule.

Company A's reason for seeking permission to depart from the benchmark rule is that, as the proposed MEC group were uncertain as to the extent of franking credits available to them at the time of the August 2004 distribution, company B, in an abundance of caution, franked the distribution to 0%. Subsequently, the group determined that sufficient franking credits were available to fully frank the distribution and therefore now wish to frank two proposed distributions to 100%.

At the time of the August 2004 distribution, the group was contemplating tax consolidation, a feature of which is the pooling of franking credits of member companies into the head company. Thus, the group was aware of the tax consequences of consolidation at the time the distribution was made.

(b)

The extent of the departure, or proposed departure, from the benchmark rule

Company A has sought the Commissioner's permission to frank the proposed distributions at a franking percentage of 100%, despite a benchmark franking percentage of 0%. This is a significant departure.

(c)

If the circumstances that give rise to the entity's application are within the entity's control, the extent to which the entity has sought the exercise of the Commissioner's powers under this section in the past.

The circumstances that gave rise to company A's application appear to have been within its control. As a group considering tax consolidation, the companies should have been aware of the impact of consolidation upon the franking accounts of the various members joining the consolidated group.

A survey of the status of the franking accounts of the various joining members would have provided Company A with a reasonable indication of the proposed group's capacity to frank the distribution. This would have enabled company B to make a more informed decision in relation to the franking of the August 2004 distribution, as section 719-435 of the ITAA 1997 deems a distribution made by a member of a consolidated group other than the provisional head company, as having been made by the provisional head company (company A).

(d)

Whether a member of the entity has been or will be disadvantaged as a result of the departure, or proposed departure, from the benchmark rule.

The benchmark franking percentage of 0% established by the August 2004 distribution resulted in the sole shareholder of company B, Foreign company, incurring a liability to withholding tax.

Should the Commissioner exercise his discretion, it is not known whether the ability to make subsequent franked distributions will be affected, resulting in a disadvantage to those members that received distributions franked to 0% and incurred a liability to withholding tax.

(e)

Whether a member of the entity will receive greater imputation benefits than another member of the entity because a distribution franked at a franking percentage that differs from the benchmark franking percentage for the franking period is made to one of them.

In the event that the Commissioner exercises his discretion to permit a departure from the benchmark franking percentage, the proposed distributions by company B and company C will be exempt from withholding tax pursuant to paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936 (ITAA 1936).

The members of company C can be seen to have clearly derived a greater imputation benefit than those of company B, as all distributions received by them during the franking period would have been franked to 100%, while only a proportion of the distributions received by the members of company B would have been franked to 100%.

(f)

Any other matters that the Commissioner considers relevant.

The Explanatory Memorandum to the New Business Tax System (Imputation) Act 2002 provides further guidance as to what constitutes extraordinary circumstances. It states at paragraph 2.69:

The power to permit a departure from the benchmark rule will be exercised by the Commissioner only in extraordinary circumstances. Thus, the circumstances justifying a departure would generally need to be unforeseeable and beyond the control of the entity, its members and controllers.

As a structural anti-streaming measure, the benchmark rule, along with the general anti-streaming measures contained in Division 204 of the ITAA 1997, seeks to ensure that over time, the benefit of franking credits are generally spread evenly across members in proportion to their ownership interest in the entity. In order to secure the integrity of these measures a departure from the benchmark franking rule ought not to be entertained except in unforseen circumstances that were beyond the contemplation of the taxpayer.

As discussed in the paragraphs above, the group's decision to consolidate was not unforeseeable and was within its control.

Therefore, the Commissioner will not exercise his discretion under section 203-55 of the ITAA 1997 as this discretion may only be exercised in extraordinary circumstances which do not exist in this case.

Year of income:  Year ending 31 December 2004

Legislative References:
Income Tax Assessment Act 1936
   paragraph 128B(3)(ga)

Other References:
Explanatory Memorandum - New Business Tax System (Imputation) Act 2002

Keywords
Commissioner's discretion
Consolidation
Consolidation - franking
Distributions
Dividend streaming arrangements
Frankable dividends
Franking accounts
Franking credits
Imputation system
Unfranked dividends

Siebel/TDMS Reference Number:  4387895

Business Line:  Public Groups and International

Date of publication:  25 February 2005

ISSN: 1445-2782