Edited version of your written advice

Authorisation Number: 1012903091785

Date of advice: 30 October 2015

Ruling

Subject: Dividend

Question 1

Will paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997) prevent the franking of the dividend proposed to be paid by Entity A?

Answer

No.

Question 2

Will Entity A be an 'exempting entity' for the purposes of section 208-195 of ITAA 1997 at the time of the payment of the dividend?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June xxxx.

The scheme commences on:

During the income year ended 30 June xxxx.

Relevant facts and circumstances

The dividend is proposed to be fully franked.

The dividend will be sourced entirely from Entity A's profits. Entity A will not debit the dividend against its share capital account.

The share capital account of Entity A is untainted for the purposes of Division 197 of the ITAA 1997.

The dividend will be a dividend that complies with the requirements of the Corporations Act 2001 (Corporations Act), including section 254T of the Corporations Act.

The dividend will be a dividend paid in accordance with Entity A's Constitution.

The financial statements will show that the current year profit of Entity A will not be offset or netted off against the accumulated losses account and those accounts will disclose this profit as available for distribution.

Relevant accounts were prepared in accordance with Australian International Financial Reporting Standards.

The only class of shares in Entity A is ordinary shares.

Assumption

More than 5% of the shares in Entity A will be held, and have always been held directly by (and for the ultimate benefit of) Australian residents until the dividend payment date.

Relevant legislative provisions

Income Tax Assessment Act 1997 Paragraph 202-45(e)

Income Tax Assessment Act 1997 Section 208-195

Reasons for decision

Question 1

All legislative references in this 'Reasons for decision' are to the ITAA 1997 unless otherwise indicated.

Paragraph 202-45(e) states that 'a distribution that is sourced, directly or indirectly, from a company's share capital account' is an unfrankable distribution.

The term 'distribution', in respect of a company, is defined in section 960-120 to mean 'a dividend, or something that is taken to be a dividend, under this Act'.

Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides the definition of 'dividend' where it relevantly states:

dividend includes:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and

(b) any amount credited by a company to any of its shareholders as shareholders;

but does not include:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company, or

(e) …..

Subsection 6(4) of the ITAA 1936 provides an exception to paragraph (d) of the definition of dividend. Subsection 6(4) states:

Paragraph (d) of the definition of dividend in subsection (1) does not apply if, under an arrangement:

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed.

In the present case, the dividend will be sourced from profits of the company rather than the share capital account.

Paragraph 202-45(e)

As mentioned above, paragraph 202-45(e) provides that a distribution that is sourced, directly or indirectly, from a company's share capital account is an unfrankable distribution.

The term 'share capital account' is defined to have the meaning given in subsection 975-300(1) as:

A company's share capital account is:

(a) an account that the company keeps of its share capital; or

(b) any other account (whether or not called a share capital account) that satisfies the following conditions:

(i) the account was created on or after 1 July 1998;

(ii) the first amount credited to the account was an amount of share capital.

Paragraph 3 of Taxation Ruling TR 2012/5 Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010 (TR 2012/5) states:

Paragraph 202-45(e) of the ITAA 1997 does not prevent a company from franking a dividend paid to its shareholders that is paid out of profits recognised in the company's accounts and available for distribution, and is paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act, merely because the company has unrecouped accounting losses accumulated in prior years or has lost part of its share capital. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936.

'Profits' are defined in paragraph 2 of TR 2012/5 as follows:

'Profits' means profits recognised in a company's accounts which are available for distribution by way of dividend. Profits include: (i) revenue profits from ordinary business and trading activities, dividends received from other companies, and realised capital profits recognised in the statement of financial performance in a company's accounts…

Paragraphs 46 and 47 of TR 2012/5 states that:

46. For the purposes of administering the taxation and franking of dividends under the ITAA 1936 and the ITAA 1997, profits are generally considered to be available for distribution as a dividend if they have not been appropriated or earmarked for other purposes. Prima facie, offsetting or netting profits against accumulated losses may amount to an appropriation of those profits for that purpose, rendering the profits unavailable for distribution as a dividend. There are various ways in which profits may be identified as not earmarked or appropriated for purposes other than payment of a dividend.

47. One way of ensuring that profits are available for dividend distribution for taxation purposes is, as a result of a directors resolution reflected in the accounts or approving the accounts, to carry the profits for a particular year to a separate profit reserve in the statement of financial position and the statement of changes in equity in a company's accounts, rather than to reduce the balance of accumulated losses carried forward by offsetting or netting the profits against the accumulated losses account in those statements. (See Example 2 at paragraphs 15 and 16 of this Ruling).

The financial statements will show that the current year profit of Entity A will not be offset or netted off against the accumulated losses account and those accounts will disclose this profit as available for distribution.

In accordance with paragraph 68 of TR 2012/5, the presence of accumulated losses and a deficiency of a company's net assets below its share capital does not change the character of an amount of profits ascertained in a company's accounts, or a dividend paid out of such an amount. TR 2012/5 states that previous case law establishes that prior accumulated losses do not have to be recouped before a dividend can be paid out of current year profits and that this case law is applicable to the new section 254T of the Corporations Act and Division 202.

Conclusion

The financial statements will be prepared in accordance with the Corporations Act and applicable Australian Accounting Standards (satisfying the definition of 'Accounts', as defined in paragraph 2 of TR 2012/5).

The dividend will be paid by Entity A out of profits recognised in the company's accounts and available for distribution. In addition, the dividend will be paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act.

On this basis, paragraph 202-45(e) will not prevent the franking of the dividend to be declared by the board of directors of Entity A out of current year profits and recognised in the financial statements of that entity, notwithstanding that Entity A had accumulated accounting losses.

Question 2

Section 208-195 provides that Division 207 (which provides for franking credits to be included in shareholders' assessable income and provides for a tax offset equal to the credit) will not apply to 'a distribution by an exempting entity'.

Section 208-20 states that a corporate tax entity is an exempting entity at a particular time if it is effectively owned by 'prescribed persons' at that time.

ATO Interpretative Decision ATO ID 2003/1104 Income Tax Exempting entities: 'accountable membership interests' states:

… Subsection 208-25(1) of the ITAA 1997 provides that an entity is effectively owned by prescribed persons at a particular time if at that time no less than 95% of the accountable membership interests or accountable partial interests in the entity are held by, or held indirectly for the benefit of, prescribed persons.

Accountable membership interests are defined in subsection 208-30(2) of the ITAA 1997 as those membership interests that are not excluded membership interests. Accountable partial interests are similarly defined in subsection 208-35(2) of the ITAA 1997 as those partial interests that are not excluded partial interests.

Excluded membership interests (or excluded partial interests) are those interests that, having regard to a number of factors listed in subsection 208-30(3) of the ITAA 1997 (or subsection 208-35(3) of the ITAA 1997 for partial interests) including the rights attaching to the interests and any arrangement in respect of those interests, it would be reasonable to conclude that the interest is not relevant in determining whether the entity is effectively owned by prescribed persons because holding the interest does not involve the holder bearing the risks, or result in the accrual to the holder of the opportunities, of ownership of the entity that ordinarily arise from, or ordinarily attach to, the holding of membership interests in the entity.

In other words, an interest is excluded if, upon weighing the factors listed in subsection 208-30(3) of the ITAA 1997 (or subsection 208-35(3) of the ITAA 1997), a reasonable person would conclude that the interest does not expose the holder of that interest to the risks and opportunities that ordinarily arise from share ownership.

The risks and opportunities that ordinarily arise from share ownership are those that expose the holder of the interest to the performance of the company. Some of the indicia of share ownership include that the holder has a right to dividends in the event the company is profitable and the directors declare them, the holder has voting rights in proportion with his or her interest in the company and that the value of the shares broadly track the performance of the company (that is, the holder is exposed to capital risk).

In this case the effect of the contract of sale and call option is that the C Class Shares do not involve either Australian Purchaser or Non-resident bearing the risks or accruing the opportunities of ownership of the Entity that ordinarily attach to share ownership. Although Non-resident is exposed to the capital risk attaching to the interest, it does not benefit from the voting or dividend rights for five years. Similarly, Australian Purchaser does not participate to the same extent in the risks and opportunities of share ownership because the capital risk is borne by Non-resident. Australian Purchaser's capital investment in the Entity is effectively protected by the call option.

The only class of shares in Entity A is ordinary shares. The ordinary shareholders of Entity A are exposed to the capital risk, right to dividends and voting rights. The ordinary shareholders will have these rights until the dividend payment date. On the basis that the only class of shares in Entity A is ordinary shares, this applies to all of the issued share capital of Entity A.

Broadly, sections 208-40 and 208-45 provide that a prescribed person is a:

• foreign resident entity or an entity that would receive a distribution from the relevant tested company as exempt income or non-assessable non-exempt income; or

• resident entity that is substantially owned by a foreign resident entity or an entity that would receive a distribution from it as exempt income or non-assessable non-exempt income.

In applying section 208-195, Entity A will determine whether it is an exempting entity at the time it actually pays the dividend to its shareholders.

More than 5% of the shares in Entity A will be held, and have always been held directly by (and for the ultimate benefit of) Australian residents until the dividend payment date.

Accordingly, Entity A will not be an 'exempting entity' (section 208-195), nor would it be a 'former exempting entity' because it has never ceased to be an 'exempting entity' (section 208-50).

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