Edited version of your private ruling

Authorisation Number: 1012573910997

Ruling

Subject: Franking credits

Question 1

Does subsection 205-15(4) of the Income Tax Assessment Act 1997 (ITAA 1997) apply to reduce the franking credits for the PAYG instalments made by the Company prior to the day on which it receives a refund of income tax for the income year?

Answer

No

This ruling applies for the following periods

Income year ended 30 June2013

Income year ended 30 June2014

Income year ended 30 June2015

Income year ended 30 June2016

Income year ended 30 June2017

The scheme commences on

1 July 2012

Relevant facts and circumstances

The Company is incorporated in Australia.

It is a resident company with an income tax year ending 30 June.

The Company qualifies as a corporate tax entity and is a franking entity.

The Company maintains its franking account in chronological order on a tax paid basis.

At any point in time, the Company has an up to date record of its franking account balance so that it is in a position to determine the level of fully franked dividends that can be paid to shareholders.

The Company has paid its PAYG instalments.

The Company will also pay a further PAYG instalment The amount of this PAYG instalment will be calculated based on the turnover of the company for the quarter multiplied by the ATO notified instalment rate.

The Company will credit its franking account for the PAYG instalments on the day on which the payments are made.

The Applicant has advised that the Company is likely to receive a refund of income tax which includes a refundable tax offset in respect of its research and development activities (R&D), referred to as R&D refundable tax offset. This refund will be received upon lodgement of the Company's income tax return.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 202-15

Income Tax Assessment Act 1997 Section 205-15

Income Tax Assessment Act 1997 Subsection 205-15(1)

Income Tax Assessment Act 1997 Subsection 205-15(4)

Income Tax Assessment Act 1997 Section 205-25

Income Tax Assessment Act 1997 Section 205-30

Reasons for decision

Part 3-6 of the ITAA 1997 is about The Imputation System.

The imputation system allows Australian corporate tax entities to pass on to their members' credit for income tax they have paid. Transactions are recorded in a franking account based on the underlying tax.

Franking credits will arise in the franking account in the following circumstances:

• The company pays a PAYG instalment

• The company pays income tax

Franking debits will arise in the franking account in the following circumstances:

• The company franks a distribution

• The company receives a refund of income tax

Franking Credits

Pursuant to subsection 205-15(1) of the ITAA 1997, relevant items in the table state:

• Item 1 states that an entity will have a credit arising in their franking account where an entity pays a PAYG instalment and the entity satisfies the residency requirement for the income year in relation to which the PAYG instalment is paid and the entity is a franking entity for the whole or part of the relevant PAYG instalment period.

• Item 2 states that an entity will have a credit arising in their franking account where an entity pays income tax and the entity satisfies the residency requirement for the income year for which the tax is paid and the entity is a franking entity for the whole or part of that income year.

Franking Debits

Pursuant to section 205-30 of the ITAA 1997 an income tax refund generally creates a franking debit in the franking account.

Subsection 205-30(1) of the ITAA 1997, item 2 of the table states:

• an entity will have a debit arising in their franking account where an entity receives a refund of income tax and the entity satisfies the residency requirement for the income year to which the refund relates and the entity was a franking entity for the whole or part of the income year to which the refund relates.

However, under paragraph 205-30(2)(b), where part of an income tax refund results from the research and development (R&D) refundable tax offset no debit to the franking account will arise in respect of that part.

Research and Development Tax Offset

Pursuant to paragraph 205-30(2)(b), no debit will arise in an entity's franking account on that part of a refund received by an entity that is attributable to the R&D refundable tax offset. This is because an amount refunded to a company in the form of the R&D refundable tax offset is not a return of an amount paid or applied by the company to satisfy its liability to income tax pursuant to section 205-20 and section 205-35 of the ITAA 1997. There is no amount that has been returned to the company because the R&D tax offset arises from the operation of the law, and not from a payment made by the company in satisfaction of an income tax liability.

Instead, any refund attributable to the R&D refundable tax offset will give rise to a 'deferred franking debit' as described at paragraph 3.198 through to paragraph 3.201 in the Tax Laws Amendment (Research and Development) Act 2011 Explanatory Memorandum - REPS - Chapter 3 - Tax offsets for research and development (EM) and as described at page two in the Franking Account Tax Return and Instructions 2013 (FTRI). The deferred franking debit amount will then require further consideration under subsection 205-15(4) when the company subsequently pays income tax or PAYG Instalments.

Relevant extracts from the EM and FTRI are provided below.

EM states:

Imputation

3.198 Generally, a franking debit arises in an entity's franking account when, so far as is relevant, the entity receives a refund of income tax (item 2 in the table in section 205-30 of the ITAA 1997). A refund of income tax includes the amount of any tax offset which the entity is entitled to under Division 355, to the extent that the tax offset is refunded to the entity. [Schedule 3, items 94 and 95, section 205-35]

3.199 If a company's franking account is in deficit at the end of an income year, the entity is liable to pay franking deficit tax (section 205-45). A company's franking account could be in deficit at the end of an income year because a franking debit arises when the entity receives a refund of a tax offset which the entity is entitled to under Division 355. This would have the effect of immediately clawing back the tax offset that is refunded.

3.200 To prevent this outcome, a franking debit will not arise in an entity's franking account under item 2 in the table in section 205-30 to the extent that a refund of income tax is attributable to the refund of a tax offset which the entity is entitled to under Division 355. The franking debit is effectively deferred. [Schedule 3, item 93, subsection 205-30(2)]

3.201 Generally, a franking credit arises in an entity's franking account when, so far as is relevant, the entity pays a pay as you go (PAYG) instalment or income tax (items 1 and 2 in the table in section 205-15). However, where a debit has not been made to an entity's franking account because a refund of income tax is attributable to the refund of a tax offset which the entity is entitled to under Division 355, a franking credit will not arise in respect of the payment of a PAYG instalment or income tax until these deferred franking debits are recovered. [Schedule 3, items 91 and 92, subsections 205-15(1) and (4)]

FTRI states:

• R&D entities entitled to the R&D refundable tax offset

• A corporate tax entity which satisfies certain requirements may be eligible for the research and development (R&D) refundable tax offset under Division 355 of the ITAA 1997. Special rules ensure that the amount of R&D tax offset refunded is not immediately clawed back as a result of the entity becoming liable to franking deficit tax, due to a debit normally arising in an entity's franking account at the time of receiving a refund of income tax. The franking debit that usually arises when a refund of income tax is received is effectively deferred (deferred franking debits) in relation to refundable R&D tax offset amounts.

A corporate tax entity receiving the R&D refundable tax offset will not record any franking credit in its franking account for either future PAYG instalments, or payments of income tax until such time as any prior deferred franking debits are effectively offset by these types of franking credits. Other types of franking credits are not affected by these rules.

In your circumstances

The Company is incorporated in Australia. It is a resident company with an income tax year ended 30 June. The Company qualifies as a corporate tax entity under section 960-115 of the ITAA 1997 and as a franking entity under section 202-15 of the ITAA 1997.

The Company had paid all its PAYG instalments by the due date.

The Company will also pay a further PAYG instalment The amount of this PAYG instalment will be calculated based on the turnover of the company for the quarter multiplied by the ATO notified instalment rate.

The Company will credit its franking account for the PAYG instalments on the day on which the payments are made.

The Company is likely to receive a refund of income tax for the relevant income which is attributable to the R&D refundable tax offset. This refund will be received upon lodgment of its income tax return.

To the extent this refund is attributable to the R&D refundable tax offset to which the Company is entitled under Division 355 dealing with R&D, no debit to the Company's franking account will arise. Instead, to the extent of refund attributable to this offset any debit that would occur to the franking account but for paragraph 205-30(2)(b) is effectively deferred, this is referred to as a 'deferred franking debit' amount. The existence of a deferred franking debit amount means a credit will not arise in the Company's franking account until the deferred franking debit amount is recovered or essentially 'offset' by potential credits to the franking account that arise when the Company subsequently makes payment of income tax or PAYG instalments.

The application of the method statement above requires the Company to 'look back' each time it makes a payment (not when it receives a refund) of income tax or PAYG Instalments and offset the amount that would have generated a credit to the franking account first against any deferred franking debit amounts before crediting the franking account with any balance that is left.

At the time of paying the PAYG Instalment amounts as stated above the Company had not received the said refund of income tax from lodgment of its income tax return. This means that there is no 'deferred franking debit' and the Company rightly credited its franking account on the day on which it made the PAYG Instalment payments or will make the payment, on the basis that the Company has no prior year deferred franking debit amounts.

As stated above, where a refund is received by the Company on lodgment of its income tax return on or about the due date and to the extent the refund is attributable to the R&D refundable tax offset which the Company is entitled to under Division 355 dealing with R&D, there should be no debit to its franking account and the amount of refund attributable to the R&D tax offset will create deferred franking debits to be recovered when the Company makes any future income tax or PAYG instalment payments. When the Company pays its next PAYG instalment, it will then need to apply the method statement under subsection 205-15(4) as stated above. The Company will be required to offset any potential credit against the deferred franking debit amount before crediting its franking account with any balance that might be left.

Other references (non ATO view)

Tax Laws Amendment (Research and Development) Act 2011 Explanatory Memorandum - REPS - Chapter 3 - Tax offsets for research and development

Franking Account Tax Return and Instructions 2013 (NAT 1382-6.2013)