Edited version of private advice

Authorisation Number: 1052033243271

Date of advice: 13 September 2022

Ruling

Subject: Frankable distributions

Question 1

Will the dividend paid to Company A shareholders be unfrankable under paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No.

Question 2

Will future dividends declared and paid by Company A that are debited against the amount standing to the credit of the 'Retained Profits Reserve' be unfrankable under paragraph 202-45(e) of the ITAA 1997?

Answer

No.

This ruling applies for the following periods:

Year ending 31 July 2022

Year ending 31 July 2023

Year ending 31 July 2024

The scheme commences on:

1 August 2021

Relevant facts and circumstances

1. Company A is an Australian resident company and the head company of the tax consolidated group.
2. Company A is listed on the Australian Securities Exchange.
3. Company A prepares its accounts on a consolidated basis.
4. Company A has a financial year ending 31 July.
5. Historically, Company A has received intra-group distributions of profit from its subsidiaries that it has then used to pay a dividend to its shareholders. Typically, the profits derived by a subsidiary in an income year are received by Company A as an intra-group distribution in the following income year. For example, a dividend of $X million was paid by a subsidiary to Company A from profits derived in the year ended 31 July 20XX. This intra-group distribution of profit will be recorded as current year earnings for Company A for the year ended 31 July 20XX.
6. All intra-group distributions of profit from a subsidiary to Company A are documented and recorded in minutes.
7. Intra-group distributions of profit received by Company A are combined with its stand-alone financial results for the relevant year with the net result allocated to either a retained profits reserve or an accumulated losses reserve (as applicable).
8. Company A parent entity financial information as disclosed in the consolidated financial statements for the year ended 31 July 20XX set out (relevantly) the following:
   1. Retained profits reserve - pre 20XX $X million
   2. Accumulated losses reserve - 20XX $X million
   3. Retained profits reserve - 20XX $X million
   4. Accumulated losses reserve - 20XX $X million
   5. Retained profits reserve - 20XX: X

The 'Retained profits reserve - pre 20XX', 'Retained profits reserve - 20XX' and 'Retained profits reserve - 20XX' accounts are collectively herein referred to as the 'Retained Profits Reserve'.

9. Company A consolidated group had a total of $X million in accumulated losses for the year ended 31 July 20XX.
10. Company A accounting records reflect a deliberate decision to segregate profits from accumulated losses and the amounts credited to the Retained Profits Reserve have not been netted or offset against accumulated losses, or otherwise been appropriated such that the amount would not be available for distribution as a dividend.
11. Company A accounts receive Audit Committee approval prior to release.
12. Company A announced it would pay a fully franked dividend of X per share (totalling $X million). The dividend was paid.
13. Company A debited the dividend against its 'Retained profits reserve - pre 20XX' account. Accordingly, the balance of this account as reflected in the parent entity note in the audited consolidated financial statements for the period ended 31 July 20XX will be reduced by the amount of the dividend.
14. The amount of the franking credit on the dividend has been debited from Company A's franking account.
15. Company A share capital account was not tainted for the purpose of Division 197 of the ITAA 1997.

Assumptions

16. The dividend and any future dividends declared and paid by Company A will satisfy the requirements of section 254T of the Corporations Act 2001 (Corporations Act).
17. This Ruling will only apply to future dividends distributed by Company A to the extent that the amount of that future dividend does not exceed the amount standing to the credit of the Retained Profits Reserve at the time of determination or declaration and payment of that dividend.
18. The balance of the Retained Profits Reserve after payment of the dividend will not be netted or offset against any future losses, or otherwise appropriated so that it is not available for distribution as a dividend.
19. Future payments of dividends will be debited against the Retained Profits Reserve on a first in first out basis meaning that future dividends will be paid firstly from the balance of the 'Retained profits reserve - pre 20XX' account until exhausted and then subsequently from the 'Retained profits reserve - 20XX' account and so on.
20. Company A will have sufficient franking credits to frank the payment of any future dividend.

Relevant legislative provisions

Paragraph 202-45(e) of the ITAA 1997

Subsection 960-120(1) of the ITAA 1997

Subsection 975-300(1) of the ITAA 1997

Question 1

Will the dividend paid to Company A shareholders on be unfrankable under paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The dividend paid to Company A shareholders will not be unfrankable under paragraph 202-45(e) of the ITAA 1997.

Reasons for decision

1.     In accordance with subsection 202-40(1) of the ITAA 1997, a 'distribution' is a 'frankable distribution' to the extent that it is not unfrankable under section 202-45 of the ITAA 1997.

2.      Relevantly, paragraph 202-45(e) of the ITAA 1997 states the following is unfrankable:

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

3.    What constitutes a 'distribution' made by a company is set out in item 1 of the table in subsection 960-120(1) of the ITAA 1997. A dividend, or something that is taken to be a dividend, under the ITAA 1997 is a 'distribution' by a company.

4.    A 'dividend' is defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as follows:

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;

but does not include [emphasis added]:

(d)  moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders ... 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; or ...

5.    The 'share capital account' of a company is defined by section 975-300 as follows:

(1)    A company's share capital account is:

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

(b)    any other account (whether or not called a share capital account) that satisfies the following conditions:

(i)the account was created on or after 1 July 1998;

(ii)the first amount credited to the account was an amount of

(iii)share capital.

(2)    If a company has more than one account covered by subsection (1), the accounts are taken, for the purposes of this Act, to be a single account.

Is the dividend a Distribution?

6.      In addition to the definition of 'share capital account' set out in section 975-300, consideration must be had to the tests developed by the court in Commissioner of Taxation v Consolidated Media Holdings Ltd [2012] HCA 55, which provide that an account is a share capital account if:

•       it records transactions into which a company has entered in relation to its share capital; or

•       it records the financial position of a company in relation to its share capital.

7.      Further, the case of Cable & Wireless Australia & Pacific Holdings BV (in liquidatie) v Commissioner of Taxation [2017] FCAFC 71 shows that if a review of a particular account is required in order to understand the share capital of the company, then that account is likely to be a share capital account.

8.      However, where review of a reserve account is not required in order to understand the share capital of a company, then the reserve account is unlikely to be considered a share capital account.

9.      In this case, the Retained Profits Reserve are accounts which are only credited with Company A net profits (that is, its net profits after combining intra-group distributions of profit with its stand-alone financial results). These profits are recognised in Company A audited consolidated financial accounts. The Retained Profits Reserve are therefore not share capital accounts as they are not accounts that keep record of Company A share capital or transactions entered into in relation to Company A's share capital and it will not have a credit entry for an amount of share capital.

10.   The dividend was paid by Company A to its shareholders out of its Retained Profits Reserve and debited against its 'Retained profits reserve - pre 20XX' account. The dividend is therefore a 'dividend' as defined by subsection 6(1) of the ITAA 1936 as it was not debited against an amount standing to the credit of the share capital account of Company A.

11.   The dividend is a 'distribution' for the purposes of considering the application of section 202-45 of the ITAA 1997.

Is the dividend sourced, directly or indirectly, from Company A's share capital account?

12.   Pursuant to paragraph 202-45(e) of the ITAA 1997, a distribution will be unfrankable if it is sourced, directly or indirectly, from a company's share capital account.

13.   Taxation Ruling TR 2012/5 Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010 (TR 2012/5), at paragraph 25, advances the proposition that '...a dividend paid by a company..., as defined for taxation purposes, will not be directly or indirectly sourced in a company's share capital account when it is a lawful division of profit for company law purposes, and hence not a return of capital for company law purposes...'.

14.  Taxation Ruling TR 2012/5 Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010 (TR 2012/5) provides guidance on the franking of dividends.

15.  Paragraph 3 of TR 2012/5 provides that a company is not prevented from franking a dividend paid to its shareholders that is paid out of profits recognised in the company's accounts and available for distribution... merely because the company has unrecouped accounting losses accumulated in prior years or has lost part of its share capital.

16.  Paragraph 45 of TR 2012/5 provides that if profits are applied against prior year losses or losses of share capital or otherwise applied or appropriated, they will cease to be available for distribution by way of a dividend.

17.  Therefore, profits will be available for distribution if they have not been appropriated for other purposes.

18.  The siloing of profits in a dedicated profit reserve is one way of ensuring that profits remain available for dividend distribution (see paragraph 47 and Example 2 at paragraphs 15 and 16 of TR 2012/5) to the extent that the profit reserve is not appropriated for another purpose.

19.  To the extent that profit is not available for distribution and a distribution is made, that distribution would be taxed as an unfranked dividend or a return of share capital (see paragraph 49 of TR 2012/5).

20.  Further, Example 3 of TR 2013/5 (at paragraph 73) demonstrates that profits which have not been recognised in a company's audited financial accounts cannot be distributed as a frankable dividend under paragraph 202-45(e) of the ITAA 1997.

21.   In this case, Company A has created separate Retained Profits Reserve and accumulated loss reserve accounts in which it has credited its net profits and accumulated losses, respectively. The net profits credited to the Retained Profits Reserve are recognised in its audited consolidated financial accounts. The amounts credited to the Retained Profits Reserve have not been netted or offset against accumulated losses or otherwise appropriated such that it is unavailable for distribution as dividend. As such, the profits in the Retained Profits Reserve are considered to be available for distribution.

22.   The dividend of $X million was paid by Company A to its shareholders entirely out of its Retained Profits Reserve and debited in full against its 'Retained profits reserve - pre 20XX' account.

23.   Accordingly, as the dividend was paid out of profits available for distribution, it is not considered to be sourced, directly or indirectly, from Company A's share capital account.

Conclusion

24.   As the dividend was not a distribution sourced, directly or indirectly, from Company A's share capital account, it will not be unfrankable under paragraph 202-45(e) of the ITAA 1997.

Question 2

Will future dividends declared and paid by Company A that are debited against the amount standing to the credit of the 'Retained Profits Reserve' be unfrankable under paragraph 202-45(e) of the ITAA 1997?

Summary

Future dividends declared and paid by Company A that are debited against the amount standing to the credit of the 'Retained Profits Reserve' will not be unfrankable under paragraph 202-45(e) of the ITAA 1997.

Reason for decision

25.   As explained in the detailed reasoning for Question 1 of this Ruling, the amounts standing to the credit of the Retained Profits Reserve are considered to be profits that are available for distribution as a dividend on the basis that:

(i)    Company A has siloed its profits in a dedicated profit reserve to segregate its net profits from its accumulated losses from prior years and the amounts credited the Retained Profits Reserve have not been netted or offset against accumulated losses or otherwise appropriated such that it is unavailable for distribution as a dividend, and

(ii)   the net profits credited to the Retained Profits Reserve accounts are recognised in Company A's audited consolidated financial accounts (in the parent entity disclosures).

26.   Accordingly, future dividends declared and paid by Company A out of the Retained Profits Reserve will not be taken to be sourced, directly or indirectly, from Company A's share capital account and be unfrankable under paragraph 202-45(e) of the ITAA 1997, where the amount of the future dividend does not exceed the amount standing to the credit of the Retained Profit Reserve at the time of determination or declaration and payment of that dividend.