Edited version of private advice

Authorisation Number: 1051846961570

Date of advice: 4 June 2021

Ruling

Subject: Franking deficits tax offset

Question

Will the Commissioner exercise his discretion under subsection 205-70(6) of the Income Tax Assessment Act 1997 (ITAA 1997) not to apply the Franking Deficit Tax ('FDT') offset penalty in relation to Company A's FDT liability for the year ending 30 June 20XX?

Answer

Yes

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

Relevant facts and circumstances

All legislative references are to the ITAA 1997 unless otherwise stated

Company A is publicly listed on the Australian Securities Exchange (ASX).

Company A is a 'corporate tax entity' (as defined in section 960-115) and therefore a 'franking entity' for the income years ending 30 June 20XX and 20XX (as defined in section 202-15).

Company A paid 70% franked interim dividend on XX 20XX. It had sufficient franking credits to support franking the interim dividend at this rate.

The challenges of the 20XX income year made the task of accurately predicting Company A's final tax position for 20XX difficult.

Company A increased its PAYG income tax instalment rate in its activity statements progressively from 0.00% to 5.00% to 6.40%, which increased the amount of income tax instalments paid before 30 June 20XX.

Company A received in 20XX an unexpected very large tax refund of the PAYG instalments made over the 20XX income year. Therefore, Company A expects that:

(a)  Franking Deficit Tax liability will arise in the 20XX income year under subsection 205-45(2) on the basis that its franking account will be in deficit at the end of that income year;

(b)  Company A will be entitled to the tax offset under subsection 205-70(1) in relation to the FDT for the 20XX income year; and

(c)   the amount of the tax offset under section 205-70(2) will be the amount of the FDT reduced by an amount under Step 1 of the method statement in subsection 205-70(2), unless the Commissioner exercises his discretion under subsection 205-70(6).

Relevant legislative provisions

Section 205-5 of the ITAA 1997

Section 205-30 of the ITAA 1997

Section 205-45 of the ITAA 1997

Section 205-70 of the ITAA 1997

Section 5 of the New Business Tax System (Franking Deficit Tax) Act 2002

Reasons for decision

Pursuant to subsection 205-45(2), an entity is liable to pay FDT if its franking account is in deficit at the end of the income year.

The FDT is imposed by section 5 of the New Business Tax System (Franking Deficit Tax) Act 2002 and is equal to the amount of the deficit.

Company A anticipates having a deficit of $XXX on 30 June 20XX, which will result in an FDT liability of the same amount for that year. FDT is not imposed as a penalty. It is a payment required to make good the amount imputed to shareholders that exceeds the amount available to be imputed. A tax offset is available under section 205-70 where an entity incurs an FDT liability.

In accordance with the Method statement in subsection 205-70(2), a de facto penalty for excessive over-franking is imposed by reducing the tax offset by 30% where the FDT liability for a year exceeds 10% of the total amount of the franking credits that arose in the entity's franking account in the relevant income year.

Company A anticipates that its FDT liability will exceed 10% of the total franking credits for the year. Therefore, the amount of the tax offset under subsection 205-70(2) will be the amount of the FDT reduced by an amount under Step 1 of the Method statement, unless the Commissioner exercises his discretion under subsection 205-70(6).

Paragraph 5.15 of the Corrections to the Explanatory Memorandum to the Tax Laws Amendment (2006 Measures No. 2) Bill 2006 (the EM) explains subsection 205-70(6) as follows:

5.15 This measure was announced by the former Minister for Revenue and Assistant Treasurer in Press Release No. 30 of 10 May 2005. That press release stated that the Commissioner's discretion would apply 'where, broadly, events that caused the over franking were outside of the company's control or were unanticipated and did not involve any broader exploitation of the imputation system'. Subsection 205-70(6) has not been drafted using the same words as the press release. However, it is considered that the wording of the subsection has the same effect as the wording in the press release. [emphasis added]

The ATO published guidance on its website explaining the administrative practice it applied where a deficit arose due to the COVID-19 pandemic for an FDT liability arising in the 20XX-XX income year. Company A's circumstances broadly fall within the conditions of this administrative practice. It stated[1]:

If the deficit in the entity's franking account in the 20XX-XX income year was due to the unexpected business downturn directly related to COVID-19, and the deficit relates to franked dividends paid before 1 March 20XX, the Commissioner will allow the entity to manage their tax affairs as if the Commissioner has exercised the discretion to not reduce the available tax offset. In these circumstances, the full tax offset will be available.

Application to Company A's circumstances

Company A anticipates that it will have a franking deficit of $XXX at the end of the 20XX income year and in the absence of an exercise of the Commissioner's discretion, the amount of the franking deficit tax offset that it is entitled to will be reduced by 30%.

We accept that the events and circumstances that lead to the franking deficit were outside of Company A's control and not readily foreseeable.

The larger refund in the 20XX income year reflects the weaker financial position of Company A in the 20XX income year as opposed to the 20XX. This was due to the severe 20XX/20XX Australian bushfires and the global impact of the COVID-19 pandemic impacting the profitability in the 20XX income year. The scale of these events was unforeseeable, and the effects are continuing.

The events are not due to matters Company A could influence and are not due to improper tax planning, bad management, inadvertent errors, or expansion of business.

The payment of the interim dividend was based on December 20XX predictions at which stage Company A had sufficient funds and retained profits to pay the interim dividend to its shareholders as announced.

Whilst the situation surrounding COVID-19 was fluid in the lead up to the dividend payment date, it was extremely difficult to envisage that the Government would subsequently impose a nation-wide lockdown that would materially disrupt business operations for the rest of the 20XX year.

Company A advised that in the context of the high level of uncertainty in the second half of the 20XX income year, Company A revised its instalment rate upwards and paid additional tax, to reflect a conservative position for the tax that may have ultimately been payable for the 20XX income year.

The second half of the 20XX year was a period of increasing volatility and the material tax refund received by Company A in respect of the 20XX income year as a result of the increased PAYG instalment rates could not have been easily foreseeable.

Consequently, we accept that the expected franking deficit in 20XX income year is due to events that were unanticipated and outside of Company A's control.

Further, being a publicly listed company on the ASX, the Commissioner does not contend that the FDT was as a result of Company A trying to exploit or take advantage of the imputation system at the time the dividends were paid.

Accordingly, the Commissioner will exercise his discretion under subsection 205-70(6) not to apply the 30% reduction to the FDT offset in the year ending 30 June 20XX.

[1] https://www.ato.gov.au/business/imputation/paying-dividends-and-other-distributions/franking-account/franking-deficit-tax/

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