Edited version of private advice

Authorisation Number: 1051577135326

Date of advice: 12 September 2019

Ruling

Subject: Fixed trust, fixed interests and trust losses

Question 1

Will X, as the beneficiary of the X Unit Trust (X UT) have a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will the Commissioner exercise the discretion pursuant to former subsection 160APHL(14) of the ITAA 1936 to treat X, as the beneficiary of the X UT, as having a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the trust holding?

Answer

Yes

Issue 2

Question 3

In respect of franked distributions received does X have both:

a)    a credit in X's franking account equal to the franking credits on the franked distributions under item 3 and 4 of the table in section 205-15 of the Income Tax Assessment Act 1997 (ITAA 1997), and

b)    excess franking offsets equal to the franking credits on the distributions under subsection 36-55(1) of the ITAA 1997 (to the extent they are not recouped against tax payable in the current income year)?

Answer

Yes

Question 4

Is X entitled to convert the excess franking offsets to tax losses to be carried forward to later income years (with no resulting impact to its franking account balance) under subsection 36-55(2) of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods

1 July 2018 to 30 June 2019

The scheme commences on

1 July 2018

Relevant facts and circumstances

The description of facts is dependent on documents and correspondence supplied with the ruling application.

Abbreviations and Definitions

In relation to the Trust, throughout the Ruling Period:

·   It is an Australian unit trust

·   Its Units were not listed on any stock exchange

·   It is not an MIS

·   It is not a widely held unit trust

·   Its Trustee does not hold an AFSL

·   There is only one class of units (ordinary units)

·   The Trustee deals with the Unitholder on an arm's length basis

·   At all relevant times:

·   the Trust has had a trust instrument by way of the Trust Deed

·   all beneficial interests in the income and capital of the Trust have been vested in a single Unitholder

·   as there is a sole Unitholder, all beneficial interests have the same rights to receive the income and capital of the trust

·   the beneficial interests in the income and capital of the Unit Trust can be expressed as a percentage of the total income and capital of the Trust (in this case, 100%)

·   the Trust is not a discretionary trust or a trust with default income or capital beneficiaries, and

·   the Trustee has never exercised a power capable of defeating a beneficiary's interest in the income or capital of the Trust.

·   The existing Units are ordinary units. The Trustee must not issue any Units other than ordinary units.

·   It is not possible to re-classify a Unit of a particular class to a different class under the Trust Deed.

·   It is not possible to stream income or capital to different Members under the Trust Deed.

·   The Trustee cannot redeem Units without the unitholders consent. There is no power of redemption conferred on the Trustee in the Trust Deed. A repurchase of Units can only occur if the Unitholder requests the Trustee to do so in writing. This power cannot be exercised by the Trustee to defeat the Unitholders interests. The repurchase must occur at a price determined on the basis of the net asset value of the Trust Fund according to Australian Accounting Principles. This power has not been exercised.

·   Although part of X's interest in the capital of the Trust may be defeated by the issue of new Units, there will be a commensurate increase in the value of the capital of the Trust given that the issue price will be based on the Trust's net asset value. In the circumstances, the issue of new Units does not erode or diminish the value of X's interest in Trust.

·   The Trustee of the Trust has not and will not exercise any power that is capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income of capital of the Trust.

Ownership and Investments

X is resident and incorporated in Australia and holds shares in numerous Australian incorporated companies. X also holds units in some trusts.

Dividend Income

Both the corporate and trust subsidiaries operate businesses.

Profits from the corporate subsidiaries are returned to X by fully franked dividends.

Trust Distribution Income

Profits from X UT are returned to X by trust distributions. This income includes fully franked dividends received from a subsidiary of the X UT.

Losses

X has carried forward tax losses. These arose from ordinary trading activities and the conversion of excess franking offsets to tax losses.

Conversion of excess franking offsets to losses

Where X's franking offsets to which it is entitled for the year exceeds tax payable the excess is converted to a tax loss to be carried forward to subsequent income years.

Accretion to franking account balance

Notwithstanding excess franking offsets being converted to tax losses, the franking credits continue to be treated as an increase to the franking account balance in X.

Assumptions

The Assumptions that apply throughout the Ruling Period include that:

·   The Trustee will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the trust.

·   The Unitholder is sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the unit trust.

·   X has not had 'materially diminished' risks of loss or opportunities for gain of less than 30% in respect of the C shares i.e. a beneficiary of the trust does not have materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the trustee (refer to former section 160APHM of the ITAA 1936).

·   An arrangement has not and will not be entered into which would result in:

·   Any of Taxpayer Alerts TA 2015/1, (Dividend stripping arrangements involving the transfer of private company shares to a self-managed superannuation fund), TA 2015/2 (Franked distributions funded by raising capital to release franking credits to shareholders) or TA 2018/1 (Structured arrangements that provide imputation benefits on shares acquired on a limited risk basis around ex-dividend dates) applying.

·   A 'related payment' under former section 160APHN of the ITAA 1936.

·   The Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936.

·   Any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying.

·   Fraud or evasion.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 95A(2)

Income Tax Assessment Act 1936 section 98A

Income Tax Assessment Act 1936 section 100

Income Tax Assessment Act 1936 section 177EA(5)

Income Tax Assessment Act 1997 section 36-17

Income Tax Assessment Act 1997 section 36-55

Income Tax Assessment Act 1997 subsection 36-55(1)

Income Tax Assessment Act 1997 subsection 36-55(2)

Income Tax Assessment Act 1997 section 202-5

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 section 202-55

Income Tax Assessment Act 1997 section 202-60

Income Tax Assessment Act 1997 section 202-75

Income Tax Assessment Act 1997 section 202-80

Income Tax Assessment Act 1997 section 205-10

Income Tax Assessment Act 1997 section 205-15

Income Tax Assessment Act 1997 section 205-30

Income Tax Assessment Act 1997 section 207-15

Income Tax Assessment Act 1997 section 207-20

Income Tax Assessment Act 1997 Subdivision B

Income Tax Assessment Act 1997 sections 207-25 to 207-59

Income Tax Assessment Act 1997 subsection 207-150(1)

Income Tax Assessment Act 1997 section 960-115

Corporations Act 2001 section 601GC

Reasons for Decision

Question 1

Summary

The terms of the trust instrument do not provide the Members with a vested and indefeasible interest in so much of the corpus of the Trust as is comprised by the trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

Detailed reasoning

A taxpayer must be a 'qualified person' to be entitled to a franking credit in respect of a dividend. To be a qualified person, a taxpayer must satisfy the 45-day holding period rule. Although the related payments rule is applied by reference to the repealed provisions of the ITAA 1936, the Commissioner has stated in Determination TD 2007/11, which considers imputation, franked distributions and qualified persons, that the ITAA 1936 rules have ongoing application as a result of being 'imported' into the ITAA 1997 regime via the anti-manipulation rule in paragraph 207-145(1)(a) of the ITAA 1997.

In the case of a trust distribution consisting wholly or partly of dividend income, generally the trustee must be a qualified person and, in addition, the beneficiary must be at risk for a prescribed period during the qualification period in respect of the taxpayer's interest in the membership interest from which the dividend income is derived (former section 160APHL of the ITAA 1936).

The effect of deemed long and short positions under former sections 160APHL(7) and (10) relating to shares held is that unless a beneficiary has a fixed interest constituted by a vested and indefeasible interest in the corpus of the trust or an exception applies, a beneficiary in a non-widely held trust will typically have a net position of zero, i.e. not be sufficiently at risk, meaning that franking credits will not pass through the trust (e.g. see ATO ID 2002/122).

Practice Statement PS LA 2002/11: Issues concerning fixed entitlements to a share of the income or capital of a trust provides instruction on former sections 160APA and 160APHD of the ITAA 1936 but not directly to former section 160APHL (only indirectly via the definition of 'widely held trust' which, in part, relies upon the definition of 'fixed trust' in Schedule 2F to the ITAA 1936).

For the purposes of former section 160APHL of the ITAA 1936 the Trust is in the category of 'all other non-widely held trusts' apart from family trusts, deceased estates and employee share scheme trusts.

A 'fixed interest' in the Trust holding is defined in former subsection 160APHL(11) of the ITAA 1936 as 'a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.' [emphasis added]

No vested and indefeasible interest

The Trust Deed of the X UT contains the following clauses by which a Unitholder's interest in a share of the corpus of the Trust may be defeased:

·   Additional Units may be issued. The saving rule in former subsection 160APHL(13) of the ITAA 1936 will be satisfied by the issue price being determined on the basis of the net asset value of the unit trust according to Australian accounting principles.

·   The Trust Deed may be amended. Any ability to amend the Trust Deed, whether requiring unanimous approval or not, will constitute a power capable of defeating a beneficiary's interest in the income or capital of the Trust. As noted by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [106]:

it follows [from unit holders' ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

Interest in so much of the corpus of the trust as is comprised by the trust holding

Former section 160APHL provides that in calculating the extent of a beneficiary's interest, it is necessary to distinguish between the interest of a beneficiary in shares held by a widely-held trust, and the interest of a beneficiary in shares held by other trusts.

The Trust is not a 'widely held trust' for the purposes of former section 160APHD of the ITAA 1936.

This necessitates that a 'look through' approach will be required to determine the interest that a Member has in each of the underlying shares in the Trust [refer to paragraphs 4.26, 4.77 and 4.88 of the EM which accompanied the Taxation Laws Amendment Bill (No. 2) 1999.]

Although the method of calculating the interest that a Member has in the trust holding differs as between widely-held trusts and trusts other than widely-held trusts, the beneficiaries of both types of trusts do have an interest in the trust holding.

X does have a vested interest in a share of the capital of the Trust but not an indefeasible interest in a share of the capital of the trust. (Note: The terms 'corpus' and 'capital' are considered to be synonymous for current purposes.)

Therefore, it follows that X does not have a vested and indefeasible interest in so much of the corpus (capital) of the Trust as is comprised by the trust holding.

Question 2

Summary

The terms of the Trust instrument do not provide the beneficiaries with a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the Trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936. However, the Commissioner considers it is reasonable to exercise the discretion in former subsection 160APHL(14) of the ITAA 1936 to treat X, as the beneficiary of the X UT, as having a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the Trust holding.

Detailed reasoning

As the beneficiary (Unitholder) of the Trust does not have a vested and indefeasible interest in so much of the corpus (capital) of the unit trust as is comprised by the Trust holding (being the Trustee's ownership of shares) pursuant to former subsection 160APHL(11) of the ITAA 1936, the only way that the beneficiaries can have such a vested and indefeasible interest is if the Commissioner exercises the discretion in former subsection 160APHL(14).

The requirements to be satisfied in respect of the discretion are contained in former subsections 160APHL(14)(a), (b) and (c) of the ITAA 1936.

In terms of former paragraph 160APHL(14)(a)

The taxpayer has an interest in so much of the corpus of the Trust as is comprised by the Trust holding

Former paragraph 160APHL(14)(a) of the ITAA 1936 contains a 'threshold' condition that the taxpayer has an interest in the corpus of the Trust.

An interest for these purposes is considered to be a 'vested interest' and not a 'contingent' interest. An example of a contingent interest is one that relies upon the exercise, or the non-exercise, of a trustee's discretion in relation to the income or capital of a trust.

Vested interests in the Trust Deed

A clause of the deed effectively provides that the Beneficiaries shall be entitled to the Trust Fund in proportion to their unitholding.

A clause of the deed effectively provides that upon termination of the X UT, each Unit Holder will have an immediate and indefeasible vested interest in the Unit Holder's Proportion of the capital of the Trust Fund to be distributed.

A clause effectively provides that the Trustee may, from time to time, pay the capital of the Trust Fund to the beneficiaries proportionately.

A clause of the Trust Deed effectively defines 'Trust Fund' as including 'investments and property'. As such, any shares held by the Trustee of the X UT would form a part of the capital of the X UT which equates to the 'corpus' of the Trust for current purposes.

The undivided equitable interest in the Trust Funds the Unitholder has constitutes the requisite interest in the corpus of the Trust as is comprised by the Trust holding for current purposes.

Further, interests of the Unitholders are not contingent. That is, the Trust is not a discretionary trust or a trust with default capital beneficiaries - such that, no beneficial interest in the capital of the Trust is capable of being defeated, partly or wholly, by the exercise of a power of appointment of capital by the Trustee or other done.

In terms of former paragraph 160APHL(14)(b)

Apart from this subsection, the interest would not be a vested or indefeasible interest

As discussed above, although a Unit Holder's interest in the corpus (Trust Fund) of the trust is vested, the Trust Deed contains certain clauses by which a Unitholder's interest in a share of the corpus of the Trust may be defeased.

In terms of former paragraph 160APHL(14)(c)-

Having regard to the factors prescribed in former paragraph 160APHL(14)(c):

These factors are:

(i) the circumstances in which the interest is capable of not vesting or the defeasance can happen and

(ii) the likelihood of the interest not vesting or the defeasance happening, and

(iii) the nature of the trust, and

(iv) any other matter the Commissioner thinks relevant.

Clauses in the Trust Deed which contain powers which cause a beneficiary's interest in the income or capital of the Trust to be defeasible

The meaning of the term 'vested and indefeasible' (in the context of former section 16APHL of the ITAA 1936) has been judicially considered in Re Soubra and Federal Commissioner of Taxation - (8 October 2009) - [2009] AATA 775; 2009 ATC 10-113; (2009) 77 ATR 946. In that case the Tribunal referred to the meaning of the term 'vested and indefeasible' as follows (at 3154 and 3155):

32. Section 160APHL(11) provides that for the purposes of subsection (10), a taxpayer's interest in the trust holding is a fixed interest to the extent that the interest is constituted by a vested and indefeasible interest in so much of the corpus of the trust as is comprised by the trust holding.

33. As Hill J explained in Dwight v Commissioner of Taxation 92 ATC 4192; (1992) 37 FCR 178, the words vested and indefeasible in the context of trust law are technical legal words of limitation, which have a well understood meaning to property conveyancers. He said, at 192:

'... Estates may be vested in interest or vested in possession, the difference being between a present fixed right of future enjoyment where the estate is said to be

vested in interest and a present right of present enjoyment of the right, where the estate is said to be vested in possession:

Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490 at 496 per Griffith CJ, at 501 per Isaacs J. A person with an interest in remainder, subject to a pre-existing life interest, has an interest which is vested in interest, but being a future interest is not yet vested in possession. That person's interest will vest in possession on the death of the life tenant. In the present context the word 'vested' is used in contradistinction to contingent.

An interest is said to be defeasible where it can be brought to an end and indefeasible where it can not....'

34. As Mr Sest submitted, the use of the conjunctive phrase vested and indefeasible indicates the right must be absolute: see Saunders v Vautier (1841) 49 ER 282. Mr Sest submitted an interest is defeasible where it is subject to a condition subsequent. He cited the following examples where this may occur:

(a) where that is the effect of the trust deed;

(b) where a beneficiary interest is disposed of by the trustee in the course of administration of the trust prior to vesting day;

(c) where there exists a contingency that the person may not be a beneficiary as at the vesting date; and

(d) where the beneficiary's vested interest is able to be divested by the exercise of a power by the trustee (or any other person).

In Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 the Federal Court considered the term in the limited context of amending the constitution of a registered managed investment scheme under section 601GC of the Corporations Act 2001.

The term 'vested and indefeasible' also appears in subsection 95A(2) of the ITAA 1936 and has been considered in that context by the courts - refer to Estate Mortgage Fighting Fund Trust v FC of T 2000 ATC 4525; Walsh Bay Developments Pty Ltd v Commissioner of Taxation (1995) 95 ATC 4378; Dwight v Commissioner of Taxation (1992) 92 ATC 4192; Harmer v FC of T (1991) 173 CLR 264; 91 ATC 5000. Also relevant are MSP Nominees Pty Ltd v Commissioner of Stamps (SA) (1999) 198 CLR 494; 99 ATC 4937; Queensland Trustees Ltd v Commissioner of Stamp Duties (1952) 88 CLR 54; and Glenn v Federal Commissioner of Land Tax (1915) 20 CLR 490

In terms of former subparagraph 160APHL(14)(c)(i)

The circumstances in which the defeasance of the interest can happen (in respect of the particular clauses of the Trust Deed) are:

Issue of new units

·   the price of further Units issued will be determined on the basis of the net asset value of the trust according to Australian accounting principles. The saving rule in former subsection 160APHL(13) of the ITAA 1936 will be satisfied..

Repurchase units

·   the repurchase price of will be determined on the basis of the net asset value of the trust according to Australian accounting principles. The saving rule in former subsection 160APHL(13) of the ITAA 1936 will be satisfied.

Trust Deed may be amended

·   Any ability to amend the Trust Deed, whether requiring unanimous approval or not, will constitute a power capable of defeating a beneficiary's interest in the income or capital of the Trust. As noted by Stone J in Colonial First State Investments Ltd v Commissioner of Taxation [2011] FCA 16; (2011) 192 FCR 298; 81 ATR 772; 2011 ATC 20-235 at [106]:

it follows [from unit holders' ability to amend the Constitution] that the members could vote to terminate the present right to a share of income and capital.

An amendment, whether approved by Unit Holders or effected by the Trustee's own act, could also permit the amendment of clauses which currently do not contain defeasible powers to do so.

In terms of former subparagraph 160APHL(14)(c)(ii)

The likelihood of the defeasance happening

·   Trust Deed may be amended

It is noted that:

·   The Trustee effectively requires 100% Unitholder approval to amend the Trust Deed.

·   The Assumptions that will apply throughout the Ruling Period include that:

·   The Trustee will not exercise a power capable of defeating a beneficiary's interest to defeat a beneficiary's interest in the income or capital of the X UT.

As such, the likelihood of a beneficiary's interest being defeated due to the existence of the amendment clause is considered to be low.

In terms of former subparagraph 160APHL(14)(c)(iii)

The nature of the Trust

·   The unit trust is a closely-held Trust. It has a single Unitholder.

In terms of former subparagraph 160APHL(14)(c)(iv)

Any other matter the Commissioner thinks relevant

·   The discretion in former subsection 160APHL of the ITAA 1936 (14) pertains to the utilisation of a tax offset for a share of the franking credit on a franked distribution. It was introduced as a part of integrity measures aimed at defeating franking credit trading schemes.

·   The EM which accompanied the introduction of former subsection 160APHL(14) outlined the purpose of the integrity measures:

4.6 One of the underlying principles of the imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves: a degree of wastage of franking credits is an intended feature of the imputation system.

4.7 In substance, the owner of shares is the person who is exposed to the risks of loss and opportunities for gain in respect of the shares. However, franking credit trading schemes allow persons who are not exposed, or have only a small exposure, to the risks and opportunities of share ownership to obtain access to the full value of franking credits, which often, but for the scheme, would not have been used at all, or would not have been fully used. Some of these schemes may operate over extended periods, and typically involve a payment related to the dividend which has the effect of passing its benefit in economic terms to a counterparty. The schemes therefore undermine an underlying principle of imputation.

·   As such, when considering the exercise of the discretion in former subsection 160APHL(14) of the ITAA 1936 the Commissioner must be mindful not to undermine the intended effect of the integrity measures themselves.

·   It is noted that certain assumptions have been included which will prevent the purpose of the integrity measures from being undermined, namely:

·   The Unitholders will be sufficiently exposed to the risk of loss or opportunity for gain in respect of the shares in the unit trust as explained by ATO Interpretative Decision ATO ID 2014/10.

·   An arrangement will not be entered into which would result in:

·  any of Taxpayer Alerts TA 2015/1, TA 2015/2 or TA 2018/1 applying

·  a 'related payment' under former section 160APHN of the ITAA 1936

·  a beneficiary of the Trust having materially diminished risks of loss or opportunities for gain of less than 30% in respect of shares held by the Trustee (refer to former section 160APHM of the ITAA 1936)

·  the Commissioner making a determination under paragraph 177EA(5)(b) of the ITAA 1936

·  any of paragraphs 207-150(1)(c) to (h) of the ITAA 1997 (inclusive) applying, or

·  fraud or evasion.

Conclusion

The beneficiaries of the X UT do not have a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the Trust holding, for the purposes of former subsection 160APHL(11) of the ITAA 1936.

However, pursuant to the requirements of former subparagraphs 160APHL(14)(c)(i), (ii) and (iii) it is considered appropriate that the Unitholder should be treated as having a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the Trust holding.

In summary, as:

·   the Trust Deed contains only minor provisions that may constitute defeasible powers

·   the Trustee will not exercise a power capable of defeating a Unitholder's interest to defeat a Unitholder's interest in the income or capital of the Trust

·   the likelihood of defeasance is low, and

·   there is little likelihood that a franking credit trading scheme will ensue.

There is a reasonable case for the Commissioner to exercise the discretion under former subsection 160APHL(14) of the ITAA 1936 to treat X as having a vested and indefeasible interest in so much of the corpus of the X UT as is comprised by the Trust holding throughout the Ruling Period.

Issue 2

Franking credits and excess franking offsets

Question 3

Summary

X receives a credit in its franking account equal to the franking credits on the franked distributions it receives directly and indirectly; and also has excess franking offsets equal to the franking credits on the distributions to the extent they are not utilised against tax payable in the current income year.

Detailed reasoning

A franking credit arises in X's franking account in respect of franked dividends it receives.

As a company X satisfies the meaning of a corporate tax entity (CTE) in section 960-115 of the ITAA 1997. It has a franking account in accordance with section 205-10, and is a franking entity in accordance with section 202-15.

Under item 3 of the table in section 205-15 of the ITAA 1997, a credit arises in the franking account of X, a resident company, when it receives a franked distribution and X is entitled to a tax offset because of the distribution under Division 207.

Division 207 of the ITAA 1997 outlines the effect of receiving a franked distribution. It contains a general rule in section 207-20 for when a corporate tax entity makes a franked distribution to one of its members:

a)    an amount equal to the franking credit on the distribution is included in the member's assessable income; and

b)    the member is entitled to a tax offset equal to the same amount.

Section 207-15 of the ITAA 1997 outlines the general rule under section 207-20 does not apply to a trustee who receives a franked distribution (unless they are a corporate tax entity) or to an entity that a franked distribution flows to indirectly. Nor do these rules apply to a beneficiary that receives a share of a franked distribution (because the distribution flows indirectly to the taxpayer).

X as a company is entitled to tax offsets for dividends it receives directly. However the dividends it receives via the unit trust are not received directly. It is not entitled to tax offsets on these dividends under Subdivision 207-A of the ITAA 1997.

The Explanatory Memorandum for Division 207 [contained in New Business Tax System (Imputation) Act 2002] (EM) explains in chapter 5 the effect of receiving a franked distribution. Subdivision 207-B of the ITAA 1997 in sections 207-25 to 207-59 sets out the consequences for:

·   a trust receiving franked distributions directly

·   and for an entity that receives a share of a franked distribution indirectly (those flowing through a trust and distributed to beneficiaries).

The franked distributions X receives via the unit trust flow indirectly from a trust to a beneficiary. Under section 207-35 of the ITAA 1997 where a franked distribution is made to a unit trust, the trusts assessable income for the year includes the franking credit under subsection 207-35(1).

Under subsection 207-35(4) of the ITAA 1997, X as beneficiary of the trust will include in assessable income its share of the franking credit on the distribution.

Under section 207-45 of the ITAA 1997 X as a corporate tax entity is entitled to a tax offset for that income year that is equal to its share of the franking credit on the franked distribution that flows to it indirectly in an income year. The note at section 207-45 explains:

The entities covered by this section are the ultimate recipients of the distribution because the distribution does not flow indirectly through them to other entities. As a result they are also the ultimate taxpayers in respect of the distribution and are given the tax offset to acknowledge the income tax that has already been paid on the profits underlying the distribution.

Subsection 207-50(3) of the ITAA 1997 sets out that a franked distribution flows indirectly to a beneficiary of a trust in an income year if during that income year, the distribution is made to the trustee of the trust and the beneficiary has for that income year (i) a share of the trust's net income under paragraph 97(1)(a) of the ITAA 1936, or (ii) an individual interest in the trust's net income covered by section 98A or 100 of the ITAA 1936.

Section 207-55 of the ITAA 1997 ensures the amount of a franked distribution made to the trust is allocated notionally amongst entities who derive benefits from that distribution, and that the allocation corresponds with the way in which those benefits were derived.

X satisfies the residency requirement and no exceptions apply therefore it is entitled to a tax offset when a franked distribution flows indirectly to them in an income year.

The credit in X's franking account is equal to the franking credits on the dividends. The 'franking credit on the distribution' will be the amount on the distribution statement, provided it does not exceed the maximum franking credit in section 202-60 of the ITAA 1997.

The table in section 205-15 of the ITAA 1997 provides for the amount and timing of the credit which arises in the franking account of X:

·   For those it receives directly item 3 of the table applies which provides that the credit arises in the franking account on the day the distribution is made.

·   Franking credits in respect of the dividends which flow indirectly through a trust (in accordance with subsection 207-50(3)) arise in X's franking account pursuant to item 4 of the table in section 205-15.

X is a franking entity. It is entitled to a tax offset under section 207-45 of the ITAA 1997 in respect of the dividends that flow to it indirectly. The credit in X's franking account is equal to the franking credits on the dividendsthat flow indirectly to it. As X is entitled to 100% of the income of the unit trust, it is entitled to 100% of the franking credits attached to the franked distributions which flow through the unit trust to X.

Excess franking offsets

Section 36-55 of the ITAA 1997 describes how amounts of tax offsets to which a CTE is entitled under Division 207 of the ITAA 1997 may be converted to a tax loss.

An entity has excess franking offsets to the extent the franking offsets the entity is entitled to for the year (except refundable offsets) exceed the amount of income tax the entity would have to pay on taxable income for the year.

As outlined, X is entitled to franking offsets under Division 207 equal to:

(a) the franking credits on the dividends it receives directly; and

(b) its share of the franking credit on the unit trust distribution.

X's franking offsets on the dividends and trust distributions it receives are not refundable.

Where the income tax X would have to pay is less than the amount of franking offsets, the amount of offsets above the income tax is the 'excess franking offset'.

X is entitled to both a franking account credit and excess tax offsets

X is entitled to a credit in its franking account equal to the sum of:

(i) the franking credits on the dividends from its corporate subsidiaries; and

(ii) the franking credit on the dividends flowing to it from the unit trust (collectively, all franking credits on distributions X receives).

In addition to X receiving a credit to its franking account it will have an excess franking offset if there is:

(i) an amount of income tax payable in that year and the franking offset exceeds tax payable; or

(ii) nil tax payable

Question 4

Summary

X is entitled to convert excess franking offsets to tax losses with no resulting impact on its franking account balance.

Detailed reasoning

As already established, X will have excess franking offsets where the total amount of franking offsets which it is entitled to for the year exceeds the amount of income tax they would have to pay on taxable income for the year under section 36-55 of the ITAA 1997.

Subdivision 36-C of the ITAA 1997 contains the process for how excess franking offsets may be converted into an amount of a tax loss for the entity. It allows a CTE to identify the amount of any excess unused franking offsets and convert them into a tax loss, which can be deducted in a later income year under section 36-17.

Subsection 36-55(2) of the ITAA 1997 provides how to work out the amount of a tax loss where excess franking offsets are converted. If an entity has an amount of excess franking offsets for an income year; that is a positive amount after it applies the method statement in the subsection then the entity is taken to have a tax loss for that year equal to the positive amount, and that year is taken to be a loss year for the entity.

Where excess franking offsets are converted into an amount of tax loss, this tax loss is aggregated with any other tax loss for the year (if applicable) and the aggregated amount becomes the tax loss for the income year.

Where there are franking offsets on dividends and distributions received by X they are used to reduce their current year tax payable amount. Further, where X has excess franking offsets because they exceed tax payable on taxable income, the excess can be converted to a tax loss.

Franking Debit does not arise from converting Excess Franking Offsets

A franking debit does not arise in the franking account of X in respect of the conversion of excess franking offsets to losses.

Section 205-30 of the ITAA 1997 provides the circumstances in which franking debits arise in the franking account of an entity.

The conversion of excess franking offsets to tax losses to be carried forward to later income years has no impact on the franking account balance. Accordingly there is no debit in the franking account balance of X in respect of the conversion of excess franking offsets to losses.