Edited version of your private ruling

Authorisation Number: 1012494432672

Ruling

Subject: Frankability of a Dividend

Question

Will paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997) prevent the franking of a dividend declared by the directors of Company X out of current year profits recognised in the accounts of that company for the period from 1 July 2013 to 31 July 2013, notwithstanding the accumulated accounting losses as at 30 June 2013?

Answer

No.

This ruling applies for the following period:

1 July 2013 to 30 June 2014

The scheme commences on:

Income year ended 30 June 2014

Relevant facts and circumstances

1. Company X is a publicly listed company on the Australian Securities Exchange (ASX).

2. Company X’s group has historically generated significant profits. However, the group processed a large impairment charge for the year ended 30 June 2013.

3. As a consequence of these impairment charges, the legal entity balance sheet of Company X at 30 June 2013 disclosed a retained loss balance in the company’s accounts for the year ended 30 June 2013.

4. Company X announced that subject to market conditions, it expected to declare a dividend at the time of the full year results release in August 2013.

5. A number of subsidiaries within the Company X’s group have positive retained earnings balances based on legal entity accounts. One such directly held subsidiary is Company Y which had a positive retained earnings balance in its legal entity accounts at 30 June 2013.

6. Company Y’s accounts have been prepared in accordance with the Corporations Act 2001 and applicable Australian Accounting Standards and will be factored into the consolidated accounts of Company X’s group as at 30 June 2013.

In July 2013, Company Y paid a dividend up to Company X. This amount is equal to the Company Y’s current year profits of the stand alone legal entity for the 30 June 2013 year. The declaration of the dividend was approved at a meeting of the directors of Company Y.

7. Company X has prepared legal entity interim accounts for the period from 1 July 2013 to 31July 2013, including profit and loss statement, balance sheet, statement of cash flows and statement of changes in equity. The set of accounts has been prepared in accordance with the Corporations Act 2001 and applicable Australian Accounting Standards. In preparing the accounts, to ensure full compliance with Australian Accounting Standards, the company has gone through the same internal review and analysis process as they undertook in preparing their full year accounts as at 30 June subject to the requirement that the accounts be audited.

8. Company X’s accounts as at 31 July 2013 will not be audited. The accounts will include the dividend paid by Company Y in July 2013 as revenue of Company X and show a net distributable current year profit after tax. This profit has been set aside for future distribution in an account called “current year profit” and will not be offset against accumulated losses.

9. In August 2013, the directors of Company X will review the legal entity accounts for the month ending July 2013 and consider the payment of a dividend (to be paid in September 2013) out of the current year profit recognised in the July 2013 accounts. The dividend will not exceed the amount of the current year profit after tax determined in Company X’s legal entity accounts for the month of July 2013.

10. The proposed dividend will be paid by Company X out of profits recognised in the company’s accounts and available for distribution. The dividend will be paid in accordance with the constitution of the company.

11. The company has stated that it will meet the conditions prescribed in section 254T and Part 2J.1 of the Corporations Act 2001 in relation to payment of the dividend. The company will have sufficient current year profits from which to pay the dividend and the company’s assets will exceed its liabilities by an amount in excess of the proposed dividend.

12. It is forecasted that Company X will have sufficient franking credits to fully frank the proposed dividend.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1);

Income Tax Assessment Act 1997 Section 202-5;

Income Tax Assessment Act 1997 Paragraph 202-5(a);

Income Tax Assessment Act 1997 Paragraph 202-5(b)

Income Tax Assessment Act 1997 Section 202-15;

Income Tax Assessment Act 1997 Paragraph 202-20(a);

Income Tax Assessment Act 1997 Section 202-40;

Income Tax Assessment Act 1997 Paragraph 202-40(1)

Income Tax Assessment Act 1997 Section 202-45;

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

Income Tax Assessment Act 1997 Section 960-115;

Income Tax Assessment Act 1997 Section 960-120; and

Income Tax Assessment Act 1997 Subsection 975-300.

Detailed reasoning

1. An entity can frank a distribution if certain conditions are satisfied. Section 202-5 of the ITAA 1997 sets out the conditions under which an entity can frank a distribution and it states:

An entity franks a distribution if:

a) the entity is a franking entity that satisfies the residency requirement when the distribution is made; and

b) the distribution is a frankable distribution; and

c) the entity allocates a franking credit to the distribution.

A ‘franking entity’ is defined in section 202-15 of the ITAA 1997 to include a ‘corporate tax entity’. A ‘corporate tax entity’, pursuant to section 960-115 of the ITAA 1997, includes a company.

2. Company X is a company listed on the ASX, incorporated in Australia and an Australian resident for tax purposes. Furthermore, at the time of the distribution to be made by Company X, it will remain an Australian resident under paragraph 202-20(a) of the ITAA 1997. Therefore, Company X will be a franking entity for the purposes of paragraph 202-5(a) of the ITAA 1997.

3. The distribution also needs to be a frankable distribution (paragraph 202-5(b) of the ITAA 1997). The kinds of distributions that can be franked are defined in section 202-40 of the ITAA 1997 as distributions and non-share dividends, unless it is specified that they are unfrankable under section 202-45 of the ITAA 1997.

4. Paragraph 202-40(1) of the ITAA 1997 states that:

‘(1) A *distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45.’

5. Paragraph 202-45(e) of the ITAA 1997 specifically makes the following unfrankable:

‘a distribution that is sourced, directly or indirectly, from a company’s *share capital account’

6. Accordingly, a ‘distribution’ is a frankable distribution to the extent that it is not ‘sourced, directly or indirectly, from a company’s share capital account’. To determine whether the dividend to be paid by Company X is a frankable distribution pursuant to section 202-40 of the ITAA 1997, a starting point is to define the relevant terms according to income tax law.

7. A ‘distribution’ that is made by a company, as referred to in section 202-40 of the ITAA 1997 is defined in section 960-120 of the ITAA 1997 as:

‘a dividend, or something that is taken to be a dividend, under this Act.’

8. Subsection 6(1) of the Income Tax Assessment act 1936 (ITAA 1936) provides a definition of ‘dividend’ and it 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;…’

9. The term ‘share capital account’ as referred to in paragraph (d) of the definition of dividend in subsection 6(1) of the ITAA 1936, is defined in subsection 975-300(1) of the ITAA 1997 as ‘an account that the company keeps of its share capital’ or ‘any other account…[where] the first amount credited to the account was an amount of share capital’.

10. The distribution to be made by Company X will constitute an amount of money to be paid to its shareholders. Further, the applicant has also confirmed that the whole amount of the distribution will be debited in full to the “current year profit” account of Company X and not against any amount standing to the credit of its share capital account. Hence, the distribution to be made by Company X will be a dividend pursuant to subsection 6(1) of the ITAA 1936 and therefore a ‘distribution’ as defined in section 960-120 of the ITAA 1997.

11. As set out above, paragraph 202-45(e) of the ITAA 1997 makes a distribution ‘sourced, directly or indirectly, from a company’s share capital account’ unfrankable. The question of whether a distribution is ‘sourced, directly or indirectly, from a company’s share capital account’ is one based in fact and law.

12. In the present case, Company X has recorded an amount of accumulated losses on its 30 June 2013 financial accounts as a consequence of a series of impairment charges.

13. A number of subsidiaries within the Company X’s group have positive retained earnings balances based on stand alone legal entity accounts. One such directly held subsidiary is Company Y which had a positive retained earnings balance in its legal entity accounts at 30 June 2013.

14. In July 2013, Company Y paid a dividend to Company X. This amount is equal to Company Y’s current year profits for the 30 June 2013 year.

Company X’s accounts as at 31 July 2013 include the dividend paid by Company Y as revenue of Company X and show a net distributable current year profit after tax.

In August 2013, the directors of Company X will review the legal entity accounts for the month of July 2013 and pass a resolution declaring a dividend to be paid in September 2013 out of the current year profit recognised in the July 2013 accounts.

15. The dividend will not exceed the amount of the current year profit after tax determined in the Company X’s legal entity accounts for the month of July 2013.

16. As Company X will source the dividend proposed to be paid to its shareholders from available current year period profits and the directors of Company X will review the legal entity accounts and pass a directors resolution declaring that the profits will be carried to a separate account ready for distribution as a dividend, paragraph 202-45(e) will not prevent the franking of a dividend declared by the directors of Company X out of current year profits recognised in the company’s accounts for the period from 1 July 2013 to 31 July 2013 and that are available for distribution, notwithstanding the accumulated accounting losses as at 30 June 2013¹.

17. Company X will have sufficient franking credits to fully frank the proposed dividend, thereby completing the requirements in section 202-5 of the ITAA 1997.

¹ Paragraph 3 of Taxation Ruling 2012/5