Edited version of private advice

Authorisation Number: 1012647497563

Ruling

Subject: Proposed payment of a dividend

Question 1

If the company undertakes a capital reduction involving a transfer from the share capital account to its retained earnings account as lost capital pursuant to section 258F of the Corporations Act 2001 will a dividend subsequently paid be unfrankable under paragraph 202-45(e) of the Income Tax Assessment Act 1997?

Answer

No

This ruling applies for the following periods:

20 June 2014 to 30 June 2015

The scheme commences on:

20 June 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

You are an Australian resident company listed on the Australian stock exchange.

As at 30 June 2013, you had accumulated losses.

You undertook a major restructure and change in accounting policies which led to a material write-down of intercompany loans and research and development assets. A write-down was undertaken for unamortised research and development expenditure. This amount contributed to the net loss for accounting purposes. This amount was treated as non-deductible for tax purposes and was not carried forward as a deductible tax loss. This write-down contributed significantly to the accumulated losses.

You are the head entity of a tax consolidated group.

Entity B is the only operational entity within the consolidated group.

Entity B has retained profits.

Entity B has generated significant profits for the group.

Due to the profitability of Entity B, the Group has been in a taxable position. The Group incurred a taxation liability. These tax payments have resulted in franking credits being available to attach to any distributions made by you.

You propose the following transaction:

1. To undertake a capital reduction using section 258F of the Corporations Act 2001;

2. Entity B will pay a dividend to you; and

3. You will then pay a fully franked dividend to your shareholders.

Section 258F Adjustment

You have obtained advice from your accountant and lawyer that the proposed capital reduction is in accordance with section 258F of the Corporations Act 2001.

Relevant legislative provisions

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

Income Tax Assessment Act 1997 Subsection 197-50(1).

Income Tax Assessment Act 1997 Subsection 975-300(1).

Income Tax Assessment Act 1997 Section 960-120.

Corporations Act 2001 Section 258F.

Corporations Act 2001 Section 254T.

Reasons for decision

Section 202-45 of the ITAA 1997 lists the distributions from a company that are unfrankable. In particular, paragraph 202-45(e) of the ITAA 1997 specifically states one such circumstance to be where:

a distribution that is sourced, directly or indirectly, from a company's share capital account.

The meaning of share capital account is defined in section 995-1 of the ITAA 1997 to have the meaning in subsection 975-300(1) which provides that:

a company's share capital account is:

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

The EM at paragraphs 6.10-6.11 provides guidance on the intended operation of paragraph 202-45(e) of the ITAA 1997 where it explains that:

6.10 A distribution will be sourced directly from a company's share capital account if an accounting debit is made to the share capital account for the making of the distribution.

6.11 A distribution will be sourced indirectly from a company's share capital account if, for example, a company transfers an amount from its share capital account into a distributable profits reserve and subsequently makes a distribution to shareholders that is debited against the distributable profits reserve in circumstances where it is reasonable to conclude that the distribution represents the amount transferred from the share capital account.

From the language of paragraphs 6.10 and 6.11, it is clear that the new provision is intended to prevent an amount from being transferred from a company's share capital account to another account for distribution to shareholders.

Thus, the legislative policy and intention that underlies paragraph 202-45(e) of the ITAA 1997 is to prevent the situation where a company distribution to shareholders is sourced directly or indirectly from the share capital account.

There are a number of elements which must be satisfied for paragraph 202-45(e) of the ITAA 1997 to have application, which can be listed as follows:

a) There must be a distribution;

b) There is an accounting debit made to the share capital account; and

c) The distribution has been sourced from the share capital account, either directly or indirectly.

Distribution

The meaning of a distribution for a company includes a dividend for the purposes of section 960-120 of the ITAA 1997.

In the current circumstances, you intend on making a fully franked dividend to shareholders and therefore will make a distribution.

Debit Share capital account

It is proposed that you will debit an amount to your share capital account and a corresponding credit in your retained profits account. This proposed accounting entry will be made in order to reduce the accumulated losses presently disclosed in your accounts.

The proposed accounting entry would, in essence, reduce your share capital. From a Corporations law perspective, section 258F of the Corporations Act 2001 allows a company to reduce its share capital by cancelling any paid-up capital that is lost or is not represented by available assets. You have stated that it considers it has been in a position in which the accumulated losses represents permanently lost capital resulting from the write-off in the financial year of unamortised research and development expenditure.

The Distribution has been sourced from the share capital account

Where the distribution has been sourced from your share capital account, the distribution will be an unfrankable distribution.

As stated above the EM to paragraph 202-45(e) of the ITAA 1997, at paragraph 6.11 supports that the test as to whether a distribution is sourced indirectly from a company's share capital account (in circumstances where the share capital account is debited and retained profits is credited and a subsequent distribution to shareholders is made by way of debiting retained profits) is whether it is reasonable to conclude that the distribution represents the amount transferred from the share capital account.

Paragraph 3 of Taxation Ruling 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.

The above statement concludes that in circumstances where a company has accumulated losses or lost part of its share capital, it can still pay a dividend out of profits and such a dividend is not prevented by paragraph 202-45(e)of the ITAA 1997 as being unfrankable.

In the current circumstances, you, after reducing your share capital under section 258F, will remain in a retained losses position. However, it is proposed that Entity B will pay you a dividend which will result in you having a retained profits amount. It is then proposed that you will pay a dividend to the shareholders. Following the payment of the dividend, you will still have a retained profit amount.

It is the Commissioner's opinion that if you make a dividend payment, it would not be considered reasonable that the amount represents an amount transferred from a share capital account.

Conclusion

Paragraph 202-45(e) of the ITAA 1997 will not prevent the proposed dividend being frankable in relation to the proposed transactions that you plan on undertaking. As such, any amounts paid out of your retained profits will not be treated as an unfrankable distribution pursuant to paragraph 202-45(e) of the ITAA 1997.