Edited version of private advice

Authorisation Number: 1052084223094

Date of advice: 3 February 2023

Ruling

Subject: Franked distributions

Question 1

Is the trustee of a deceased estate, (hereafter referred to as 'the Executor') liable to be assessed and pay tax under subsection 98(4) of the Income Tax Assessment Act 1936 (ITAA 1936) on the share of franked dividend income they distributed to the trustee of a testamentary trust (hereafter referred to as 'the Trustee')?

Answer

No.

Question 2

Will section 207-35 of the Income Tax Assessment 1997 (ITAA 1997) apply to include as assessable income of the Executor, the share of the franking credits on the franked dividend income they distributed to the Trustee?

Answer

Yes, section 207-35 applies to include the share of the franking credits as assessable income of the Executor, but paragraph 207-95(1)(c) of the ITAA 1997 reduces the net income of the deceased estate by the same amount.

Question 3

Will the Executor be entitled under section 207-45 of the ITAA 1997 to a tax offset equal to the share of the franking credits on the franked dividend income distributed by them to the Trustee?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

2 July 20XX

Relevant facts and circumstances

1.            The will of a deceased person included the establishment of Testamentary Trust A to receive income from assets held by the deceased at the time of their death.

2.            The assets included share in companies that paid franked distributions to its shareholders in the years ended 30 June 20XX, 20XX, and 20XX.

3.            The Executor of the Estate allocated and paid a share of these franked distributions to Testamentary Trust A.

4.            For the years ended 30 June 20XX, 30 June 20XX, and 30 June 20XX the share of the franked distributions was greater than the share of the franking credits.

5.            The trustee of Testamentary Trust A was a non-resident, as defined in subsection 6(1) of the ITAA 1936, during and at the end of the years ended 30 June 20XX, 30 June 20XX, and 30 June 20XX.

6.            For the years ended 30 June 20XX, 30 June 20XX, and 30 June 20XX the share of the franked distributions received by Testamentary Trust A was greater than the share of the franking credits it received in respect of its share of the franked distributions.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1936 Division 11A

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 paragraph 97(3)(c)

Income Tax Assessment Act 1936 section 98

Income Tax Assessment Act 1936 subsection 98(4)

Income Tax Assessment Act 1936 section 99A

Income Tax Assessment Act 1936 subsection 128A(1AA)

Income Tax Assessment Act 1936 subsection 128A(3)

Income Tax Assessment Act 1936 subsection 128A(3A)

Income Tax Assessment Act 1936 subsection 128A(3D)

Income Tax Assessment Act 1936 subsection 128A(3E)

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1936 subsection 128B(1)

Income Tax Assessment Act 1936 paragraph 128B(3)(ga)

Income Tax Assessment Act 1936 subparagraph 128B(3)(ga)(i)

Income Tax Assessment Act 1936 paragraph 128B(3)(jb)

Income Tax Assessment Act 1936 section 128D

Income Tax Assessment Act 1997 section 6-23

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Subdivision 207-B

Income Tax Assessment Act 1997 subsection 207-20(1)

Income Tax Assessment Act 1997 subsection 207-20(2)

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 subsection 207-35(1)

Income Tax Assessment Act 1997 subsection 207-35(2)

Income Tax Assessment Act 1997 subsection 207-35(5)

Income Tax Assessment Act 1997 subsection 207-35(6)

Income Tax Assessment Act 1997 paragraph 207-35(6)(a)

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 paragraph 207-45(c)

Income Tax Assessment Act 1997 subsection 207-50(4)

Income Tax Assessment Act 1997 paragraph 207-50(4)(a)

Income Tax Assessment Act 1997 paragraph 207-50(4)(b)

Income Tax Assessment Act 1997 subparagraph 207-50(4)(b)(i)

Income Tax Assessment Act 1997 subparagraph 207-50(4)(b)(ii)

Income Tax Assessment Act 1997 paragraph 207-50(4)(c)

Income Tax Assessment Act 1997 section 207-55

Income Tax Assessment Act 1997 subsection 207-55(1)

Income Tax Assessment Act 1997 subsection 207-55(2)

Income Tax Assessment Act 1997 subsection 207-55(3)

Income Tax Assessment Act 1997 subsection 207-55(4)

Income Tax Assessment Act 1997 subparagraph 207-55(4)(a)(ii)

Income Tax Assessment Act 1997 section 207-95

Income Tax Assessment Act 1997 paragraph 207-95(1)(a)

Income Tax Assessment Act 1997 paragraph 207-95(1)(b)

Income Tax Assessment Act 1997 paragraph 207-95(1)(c)

Income Tax Assessment Act 1997 paragraph 207-95(1)(d)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

All legislative references are to the ITAA 1936 unless otherwise indicated.

Issue 1

Question 1

Is the Executor liable to be assessed and pay tax under subsection 98(4) on the share of franked dividend income they distributed to the Trustee?

Summary

The franked distributions are income which satisfies the requirements of section 128D and are therefore non-assessable non-exempt (NANE) income, as defined in section 6-23 of the ITAA 1997.

As the franked distributions are NANE income, the amount the Executor would be liable to be assessed and pay tax on under subsection 98(4) excludes the portion of the franked dividend income the Trustee was presently entitled to in the years ended 30 June 20XX, 20XX and 20XX being the Trustee's share of franked distributions received from the Estate.

Detailed reasoning

Subdivision 207-B of the ITAA 1997 and franked distributions

1.            Franked distributions are brought to tax in accordance with Subdivision 207-B of the ITAA 1997.

2.            Subsections 207-55(1) and (2) of the ITAA 1997 state:

207-55(1) The object of this section is to ensure that:

(a) the amount of a *franked distribution made to a partnership or the trustee of a trust is allocated notionally amongst entities who *derive benefits from that distribution; and

(b) that allocation corresponds with the way in which those benefits were derived.

Note: An entity can derive a benefit from the distribution (and therefore has a share of the distribution) without actually receiving any of the distribution: see subsection (2) of this section and the example at the end of section 207-50.

207-55(2) An entity's share of a *franked distribution is an amount notionally allocated to the entity as its share of the distribution, whether or not the entity actually receives any of that distribution.

3.            That is, section 207-55 of the ITAA 1997 can apply to an entity regardless of whether that entity received any of the franked distribution.[1]

4.            The amount that is to be allocated to an entity[2] is determined under subsection 207-55(3) of the ITAA 1997, which states:

That amount is equal to the entity's share of the distribution as the focal entity in column 3 of an item of the table.

5.            In respect of a trust that received the franked distribution, the relevant item in the table in subsection 207-55(3) of the ITAA 1997 is item 3:

6.         Subsection 207-50(4) of the ITAA 1997 determines the share of a franked distribution in relation to a trustee of a trust and states:

A *franked distribution flows indirectly to the trustee of a trust in an income year if, and only if:

(a) during that income year, the distribution is made to the trustee, or *flows indirectly to the trustee as a partner or beneficiary because of a previous application of subsection (2) or (3); and

(b) the trustee is liable or, but for another provision in this Act, would be liable, to be assessed in respect of an amount (the share amount) that is:

(i) a share of the trust's *net income for that income year under section 98 of the Income Tax Assessment Act 1936; or

(ii) all or a part of the trust's net income for that income year under section 99 or 99A of that Act;

(whether or not the share amount becomes assessable income in the hands of the trustee); and

(c) the trustee's *share of the distribution under section 207-55 is a positive amount (whether or not the trustee actually receives any of that share).

Note: A trustee to whom a franked distribution flows indirectly under this subsection is entitled to a tax offset under section 207-45 and the distribution does not flow indirectly through the trustee to another entity.

7.            The Explanatory Memorandum (EM) to the Tax Laws Amendment (2004 Measures No. 2) Bill 2004 explains how section 207-50 of the ITAA 1997 is to be applied:

10.15 The definition of 'flow indirectly' in section 207-35 will be replaced so that a franked distribution can flow indirectly to an entity where the distribution, or part of the distribution, is exempt income or non-assessable non-exempt income in the hands of the recipient. Under the new definition, a franked distribution will be taken to flow indirectly to a partner in a partnership or to a beneficiary or the trustee of a trust if:

•                     the distribution is made to a partnership or trustee of a trust or flows indirectly to the partnership or to the trustee or beneficiary of the trust as a partner or beneficiary [Schedule 10, item 7, paragraphs 207-50(2)(a), (3)(a) and (4)(a)]; and

•                     one of the following is satisfied:

-              the partner has an individual interest in the partnership's net income or is allowed a deduction for a partnership loss under subsections 92(1) and (2) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(2)(b)]; or

-              the beneficiary has a share of the trust's net income under paragraph 97(1)(a) of the ITAA 1936 or an individual interest in the trust's net income under paragraph 98A(1)(a) or (b) or 100(1)(a) or (b) of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(3)(b)]; or

-              the trustee is liable to be assessed on a share of the trust's net income in respect of a beneficiary under section 98 of the ITAA 1936 or assessed on all or part of the trust's net income for that year under section 99 or 99A of the ITAA 1936 [Schedule 10, item 7, paragraph 207-50(4)(b)]; and

•                     the entity's share of the franked distribution as calculated in new section 207-55 is a positive amount. That is, the entity must have an entitlement to part or all of the franked distribution [Schedule 10, item 7, paragraphs 207-50(2)(c), (3)(c) and (4)(c)].

8.            As the distribution was made to the Estate, paragraph 207-50(4)(a) of the ITAA 1997 is satisfied.

9.            Paragraph 207-50(b) of the ITAA 1997 will apply where a trustee is assessed on a share of their trust's net income in respect of a beneficiary under section 98, 99 or 99A.

10.          Subparagraph 207-50(4)(b)(i) of the ITAA 1997 applies where a trustee is liable to be assessed under section 98. Subsection 98(4) states:

If:

(a) a beneficiary of a trust estate (the first trust estate) who is presently entitled to a share of the income of the first trust estate:

(i) is, in respect of that share of the income of the first trust estate, a beneficiary in the capacity of a trustee of another trust estate; and

(ii) is not a beneficiary to whom subsection 97(3) applies; and

(b) a trustee of the other trust estate is a non-resident at the end of the year of income;

the trustee of the first trust estate is to be assessed and is liable to pay tax in respect of so much of that share of the net income of the first trust estate as is attributable to sources in Australia at the rate declared by the Parliament for the purposes of this subsection.

Note: If the trust estate's net income includes a net capital gain, Subdivision 115-C of the Income Tax Assessment Act 1997 affects the assessment of the trustee.

11.          This provision replaced a former subsection 98(4) via the Tax Laws Amendment (2007 Measures No. 3) Bill 2007. Paragraphs 10.15 to 10.18 of the EM to this Bill explains the intent of the rewrite of section 98:

10.15 Subsection 98(2A) will now set out the circumstances in which a trustee is taxed in relation to a non-resident company or individual beneficiary [Schedule 9, item 1, subsection 98(2A)]. Subsection 98(3) will now provide the rules for determining the rates of tax that a trustee pays in relation to the share of the net income of those beneficiaries [Schedule 9, item 1, subsection 98(3)].

10.16 The rewritten provisions do not change the way a trustee is taxed in relation to non-resident company and individual non-trustee beneficiaries. The trustee is taxed on a non-resident beneficiary's share of the net income of the trust whether attributable to Australian or foreign sources for the period the beneficiary is a resident. The trustee is taxed only on net income of the trust attributable to Australian sources (excluding dividends, interest and royalties) for the period the beneficiary is a non-resident. [Schedule 9, item 1, subsections 98(2A) and (3)]

Extending the liability of trustees

10.17 These amendments extend a trustee's liability to pay tax to include the case where a non-resident beneficiary is a trustee of another trust and is presently entitled to income of the first trust. The trustee of the first trust is assessed on net income of the trust attributable to Australian sources (other than dividends, interest and royalties) for an income year if a trustee of the other trust is a non-resident at the end of that income year. If the other trust has more than one trustee, the amendments will apply if at least one trustee is a non-resident at that time. [Schedule 9, item 1, subsection 98(4)]

Dividends, interest and royalties

10.18 A beneficiary is liable, under the withholding tax rules in Division 11A of Part III, for tax on Australian dividends, interest and royalties to which they are presently entitled while a non-resident. The withholding tax is collected from the trustee under the pay as you go withholding rules in the Taxation Administration Act 1953. Income taxed under the withholding tax rules or excluded from those rules is not treated as assessable income and is therefore not taxed again to the trustee or beneficiary under either the current or new rules.

12.          As detailed in paragraph 10.17 of the EM, subsection 98(4) applies where a non-resident beneficiary is a trustee of another trust and is presently entitled to income of the first trust at the end of the income year. The subsection also applies where there is more than one beneficiary and one of the beneficiaries is a non-resident at the end of the income year

13.          Although paragraph 10.18 of the EM discusses Division 11A in respect of the amount assessed for the purposes, when applying subsection 207-50(4) of the ITAA 1997 Division 11A is not considered. This is because under subparagraph 207-50(4)(b)(ii) of the ITAA 1997 you determine if the trustee is liable or, but for another provision in this Act, would have been liable, to be assessed under section 98.

14.          The Commissioner in paragraphs 66 to 68 and 74 to 76 of TD 2012/22 set out his view as to how Subdivision 207-B of the ITAA 1997 applies to allocate to beneficiaries a franked distribution of a trust:[3]

66. For the 2010-11 and later income years, capital gains and franked distributions included in the net income of a trust are brought to tax in accordance with Subdivisions 115-C and 207-B of the ITAA 1997 respectively.

67. As a result of modifications under Division 6E of Part III of the ITAA 1936 (Division 6E), the balance of the net income (that is the net income excluding amounts attributable to capital gains and franked distributions) of the trust is still assessed under Division 6 effectively in the manner described in paragraphs 57 to 59.

68. Division 6E adjusts the rules in Division 6 to ensure that capital gains and franked distributions are not taxed twice (that is, once as a result of the operation of Subdivisions 115-C or 207-B of the ITAA 1997 and again by reason of Division 6). In broad terms the effect of Division 6E is to carve out net capital gains and franked distributions from the operation of Division 6 by excluding net capital gains and franked distributions from the trust's net income, and any amount relating to these things is excluded from the income of the trust estate. Example 11 illustrates.

Subdivision 207-B of the ITAA 1997

74. Franked distributions of a trust are allocated to beneficiaries and the trustee in accordance with the rules in Subdivision 207-B of the ITAA 1997. These rules differentiate between entities with a specific entitlement to all or part of a franked distribution and other entities. Trustees cannot be specifically entitled to a franked distribution.

75. If there is some part of a franked distribution to which no beneficiary is specifically entitled, a beneficiary or the trustee will be taken to have a share of the franked distribution equal to that franked distribution multiplied by their 'adjusted Division 6 percentage' of the income of the trust estate in the relevant income year.

76. Similarly to capital gains, this means that where no entity is specifically entitled to any capital gain or franked distribution of the trust, each beneficiary will generally be assessable on their proportionate share of the net franked distributions of the trust and attached franking credits, and the trustee will generally be similarly assessed where there is no income of the trust estate or income of the trust estate to which no beneficiary is presently entitled.

15.          As the Trustee was a non-resident as the end of the years ended 30 June 20XX, 20XX and 20XX, was presently entitled to income of the Estate in their capacity as the trustee of Testamentary Trust A, and is not a type of beneficiary identified in paragraph 97(3)(c),[4] subsection 98(4) will apply to assess the Executor on Testamentary Trust A's share of the Estate's net income.

16.          As the Executor is liable under subsection 98(4) for Testamentary Trust A's share amount, paragraph 207-50(4)(b) of the ITAA 1997 is satisfied.

17.          Paragraph 207-50(4)(c) of the ITAA 1997 requires that the trustee's share of the distribution under section 207-55 of the ITAA 1997 be a positive amount: Column 2 in item 3 of subsection 207-55(4) of the ITAA 1997, where 'positive amount' is referenced, states 'the trust has a positive amount of *net income for that year'.

18.          'Net income' of a trust estate is defined in section 95:

net income, in relation to a trust estate, means the total assessable income of the trust estate calculated under this Act as if the trustee were a taxpayer in respect of that income and were a resident, less all allowable deductions, except deductions under Division 393 of the Income Tax Assessment Act 1997 (Farm management deposits) and except also, in respect of any beneficiary who has no beneficial interest in the corpus of the trust estate, or in respect of any life tenant, the deductions allowable under Division 36 of the Income Tax Assessment Act 1997 in respect of such of the tax losses of previous years as are required to be met out of corpus.

A trust may be required to work out its net income in a special way by Division 266 or 267 in Schedule 2F to this Act or Division 275 of the Income Tax Assessment Act 1997.

19.          The Executor paid the share amount to Testamentary Trust A. The Executor could only have made the payment if there was a positive amount.

20.          As paragraph 207-50(4)(c) and all the other paragraphs of subsection 207-50(4) of the ITAA 1997 have been satisfied, and the distribution was made to the Estate, then under column 1 in item 3 of the table in subsection 207-55(3) of the ITAA 1997, the Executor is the focal entity in respect of Testamentary Trust A's share of the franked distribution.

21.          Column 3 of item 3 of subsection 207-55(3) of the ITAA 1997 thus provides that the Executor's 'share of the franked distribution' is the amount determined in accordance with subsection 207-55(4).

22.          Subsection 207-55(4) of the ITAA 1997 states:

For the purposes of column 3 of item 3 of the table in subsection (3), the amount is the sum of:

(a) so much of the amount worked out under column 2 of item 3 of the table in subsection (3) to which:

(i) unless subparagraph (ii) applies - the focal entity is *specifically entitled; or

(ii) if the focal entity is the trustee and has the share amount because of the operation of section 98 of the Income Tax Assessment Act 1936 in respect of a beneficiary (see subparagraph 207-50(4)(b)(i)) - the beneficiary is specifically entitled; and

(b) if there is an amount of the *franked distribution to which no beneficiary is specifically entitled - that amount multiplied by:

(i) unless subparagraph (ii) applies - the focal entity's *adjusted Division 6 percentage of the income of the trust for the relevant income year; or

(ii) if the focal entity is the trustee and has the share amount because of the operation of section 98 of the Income Tax Assessment Act 1936 in respect of a beneficiary (see subparagraph 207-50(4)(b)(i)) - the beneficiary's adjusted Division 6 percentage of the income of the trust for the relevant income year.

23.          Guidance as to the interpretation of subsection 207-55(4) of the ITAA 1997 is included in paragraphs 2.125 to 2.127 of the EM to the Tax Laws Amendment (2011 Measure No. 5) Bill 2011 as follows:

2.125 Where a trust receives a franked distribution and the distribution flows through the trust to a beneficiary, the amendments to item 3 mean that the beneficiary's share of the franked distribution is now calculated under subsection 207-55(4) as the sum of:

•                     the amount of the franked distribution to which the beneficiary is specifically entitled (see paragraph 2.133); and

•                     the beneficiary's proportionate entitlement to any part of the franked distribution to which no beneficiary is specifically entitled.

[Schedule 2, item 23, subsection 207-55(4)]

2.126 Where a trustee is liable to be assessed and pay tax in respect of a beneficiary under section 98 of the ITAA 1936 (or would be so liable but for another provision in the Act such as Division 6E), subparagraph 207-55(4)(a)(ii) operates to treat the trustee as being specifically entitled to the amount of the franked distribution to which the relevant beneficiary is specifically entitled. [Schedule 2, item 23, paragraph 207-55(4)(a)]

2.127 A beneficiary's proportionate share of that part of a franked distribution to which no beneficiary is specifically entitled, is calculated in accordance with paragraph 207-55(4)(b). This amount is the amount of the franked distribution multiplied by the beneficiary's adjusted Division 6 percentage. Again allowance is made for circumstances where a trustee is assessed in respect of a beneficiary under section 98 of the ITAA 1936. [Schedule 2, item 23, subparagraphs 207-55(4)(b)(i) and (ii)]

24.          In applying subsection 207-55(4) of the ITAA 1997, the amount the Executor include as their share amount is the amount the Trustee, as a beneficiary of Estate, was specifically entitled to under subparagraph 207-55(4)(a)(ii) of the ITAA 1997 in the years ended 30 June 20XX, 20XX and 20XX.

Interaction between subsection 98(4) Division 11A

25.          In determining the amount that flows through to the Executor under Division 207 of the ITAA 1997, Division 11A was not examined. However, as explained in paragraph 10.18 of the EM, where a beneficiary is liable to have an amount withheld under the withholding rules in Division 11A in respect of a dividend, the income taxed under the withholding rules in Division 11A is not taxed again under subsection 98(4).

26.          Section 128D of Division 11A operates to ensure income taxed under the Division 11A withholding rules is not taxed:

Income other than income to which section 128B applies by virtue of subsection (2A), (2C) or (9C) of that section upon which withholding tax is payable, or upon which withholding tax would, but for paragraph 128B(3)(ga), (jb) or (m), section 128F, section 128FA or section 128GB, be payable, is not assessable income and is not exempt income of a person.

Note: An amount of interest paid to a person by a temporary resident is non-assessable non-exempt income: see section 768-980 of the Income Tax Assessment Act 1997.

27.          With reference to the note to section 128D, section 6-23 of the ITAA 1997 defines the term 'non-assessable non-exempt income' (NANE income, as above) as:

An amount of *ordinary income or *statutory income is non-assessable non-exempt income if a provision of this Act or of another *Commonwealth law states that it is not assessable income and is not *exempt income.

Note: Capital gains and losses on assets used to produce some types of non-assessable non-exempt income are disregarded (see section 118-12).

28.      Section 128D was inserted, via the Income Tax and Social Services Contribution Assessment Bill (No 3) 1959. Clause 8 of the EM to this Bill explains the reason the provision was introduced and its effect on assessable income when dividend withholding tax was first introduced:

Clause 8: Dividends.

This clause proposes a drafting amendment to section 44(1) of the Principal Act.

Under that provision, dividends paid to non-resident shareholders out of profits having a source in Australia are assessable income, except where the dividends are exempt from tax by reason of succeeding provisions of the section.

With the adoption of a dividend withholding tax it will be necessary to exclude from assessable income those dividends that bear withholding tax. This result will be achieved by a proposed new provision - section 128D - in the Principal Act (see clause 18). In order to avoid any inconsistency between the new provision and section 44(1), clause 8 will ensure that section 44(1) operates to treat dividends as assessable income only if this is not in conflict with the new section 128D.

The practical effect will be that dividends subject to withholding tax will not also be taxed as assessable income unless the shareholder elects to have that course followed and claim a credit to remove the double taxation.

29.          With reference to Division 11A and a trust beneficiary that is presently entitled to a dividend, subsection128A(3) states:

For the purposes of this Division, a beneficiary who is presently entitled to a dividend, to interest or to a royalty included in the income of a trust estate shall be deemed to have derived income consisting of that dividend, interest or royalty at the time when he or she became so entitled.

30.          In respect of the term 'income' under Division 11A, subsection 128A(1AA) states:

In this Division and in an Act imposing withholding tax:

income includes a royalty and a dividend.

31.          In applying subsection 128A(3) and subsection 128A(1AA),a beneficiary is deemed to be entitled to the dividend when they become presently entitled to it, and the dividend is the 'income' referred to in section 128D.

32.          Section 128D requires that section 128B, as modified by section 128D, apply to the income.

33.          One of these modifications is that section 128D will apply if an amount would have been required to be withheld under 128B but for paragraph 128B(3)(ga) excluding the income from withholding.

34.          Subsection 128B(1) states:

Subject to subsections (3), (3A), (3D) and (3E), this section applies to income that:

(a) is derived, on or after 1 January 1968, by a non-resident; and

(b) consists of a dividend paid by a company that is a resident.

Note: An amount declared to be conduit foreign income is an amount to which this section does not apply: see sections 802-15 and 802-17 of the Income Tax Assessment Act 1997.

35.          Subparagraph 128B(3)(ga)(i) excludes the franked part of a dividend from being an amount on which tax must be withheld under section 128B(1).

36.          Under section 128D an amount excluded under subparagraph 128B(3)(ga)(i) is included as income to which section 128D will apply.

37.          Although issued in respect of the reference to paragraph 128B(3)(jb) in subsection 128D, the rationale at the conclusion of the reasons for decision in ATO ID 2009/78[5] equally applies when examining the reference to paragraph 128B(3)(ga) in subsection 128D:

However, because the dividends, non-share dividends and interest derived by the taxpayer is income to which paragraph 128B(3)(jb) of the ITAA 1936 applies, that income is excluded from being income that is subject to withholding tax by the operation of this paragraph.

Therefore, the dividend and interest income received by the taxpayer is income upon which withholding tax would, but for paragraph 128B(3)(jb) of the ITAA 1936, be payable under subsections 128B(4) and 128B(5) of the ITAA 1936. Accordingly, this income is not assessable and not exempt income of the taxpayer under section 128D of the ITAA 1936.

Application of Division 11A to a trustee of a trust

38.          In respect of subsection 128B(1), subsections 128B(3), (3A),[6] (3D)[7] and (3E) contain exclusions to the requirement to withhold. Subsection 128B(3E) includes a reference to a payment being paid to a person in their capacity as trustee:

This section does not apply to income that consists of a dividend that:

...

is not paid to the person in the person' s capacity as trustee...

39.          As this subsection includes a reference to receiving a dividend in the capacity as a trustee of a trust, it is clear that subsection 128B(1) applies where a dividend is paid to a person in their capacity as a trustee of trust.

40.          Paragraph 128B(3)(ga) does not contain a reference to the dividend being paid to a person in their capacity as a trustee, so the capacity in which a person receives a dividend, including where it was received in their capacity as a trustee, is not a requirement under paragraph 128B(3)(ga).

Application of subsection 98(4) to the Executor of the Estate

41.          As the Trustee was a non-resident at the end of the income years ended 30 June 20XX, 20XX and 20XX, subsection 98(4) will apply in respect of the share of the Estate's income that trustee was presently entitled to in each of those income years.

42.          As subsection 98(4) applied to the Executor, under subsection 207-50(4) of the ITAA 1997 Testamentary Trust A's share of the franked distributions, flows through to the Executor.

43.          At the end of each income year, when Testamentary Trust A was entitled to a share of the franked distributions, the following statutory provisions, outside of subsection 207-50(4) of the ITAA 1997, apply to the Executor's share amount:

•                     as a beneficiary of the Estate, subsection 128A(3) deems Testamentary Trust A as having derived the dividend income when Testamentary Trust A is presently entitled to dividend income of the Estate;

•                     as the Trustee was a non-resident when the dividend was deemed to have been derived, and it was derived on or after 1 January 1968, subsection 128B(1) applies; but

•                     subparagraph 128B(3)(ga)(i) excludes the franked part of a dividend from the operation of subsection 128B(1), and thus there is no requirement to withhold from franked parts of dividends; and

•                     even though there was no requirement to withhold, the franked part of a dividend excluded under subparagraph 128B(3)(ga)(i) is included when determining whether a dividend is NANE income under section 128D; which means

•                     any franked parts of dividends that Testamentary Trust A is entitled to is NANE income under section 128D.

44.          In determining the amount that the Executor will be assessed on, they do not include as assessable income in the years ended 30 June 20XX, 20XX and 20XX the share of the franked distributions that under subsection 207-55(3) of the ITAA 1997 is allocated to the Executor.

Question 2

Will section 207-35 of the ITAA 1997 apply to include as assessable income of the Executor, the share of the franking credits on the franked dividend income they distributed to the Trustee?

Summary

Subsection 207-35 of the ITAA 1997 applies to include in the Executor's assessable income the franking credits received in respect of Testamentary Trust A's share of the franked distributions.

Paragraph 207-95(1)(c) of the ITAA 1997 applies to reduce the net income of the Estate by the franking credit amount in respect of Testamentary Trust A's share of the franked distributions because the Testamentary Trust's share of the distributions is NANE income.

As paragraph 207-95(1)(c) reduced the net income of the Estate by the same amount included in the assessable income under subsection 207-35, the amount that the Executor is assessed on under subsection 98(4) will, in effect, not include the franking credits received in respect of Testamentary Trust A's share of the franked distributions.

Detailed reasoning

45.      Subsection 207-20(1) of the ITAA 1997 states:

If an entity makes a *franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the *franking credit on the distribution. This is in addition to any other amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act.

46.          Subsection 207-35(1) of the ITAA 1997 applies if:

(a) a *franked distribution is made in an income year to an entity that is a partnership or the trustee of a trust; and

(b) the entity is not a *corporate tax entity when the distribution is made; and

(c) if the entity is the trustee of a trust - the trust is not a *complying superannuation entity when the distribution is made;

the assessable income of the partnership or trust for that income year includes the amount of the *franking credit on the distribution.

47.          Applying subsection 207-35(1) of the ITAA 1997, the assessable income of the Estate includes the franking credits on the distributions received.

48.          Subsection 207-35(2) of the ITAA 1997 states:

The amount is in addition to any other amount included in that assessable income in relation to the distribution under any other provision of this Act.

Note: The amount will affect the income tax liability of a partner in the partnership, or a beneficiary or the trustee of the trust: see Divisions 5 and 6 of Part III of the Income Tax Assessment Act 1936.

49.          This subsection explains that there is an additional amount of assessable income which will impact the income tax liability of a beneficiary or the trustee of the trust under Division 6.

50.          Subsection 207-35(5) of the ITAA 1997 states:

Subsection (6) applies if:

(a) a *franked distribution is made, or *flows indirectly, to the trustee of a trust in an income year; and

(b) the assessable income of the trust for that year includes an amount (the franking credit amount) that is all or a part of the additional amount of assessable income included under subsection (1) in relation to the distribution; and

(c) disregarding Division 6E of Part III of the Income Tax Assessment Act 1936, the trustee of the trust is liable to be assessed (and pay tax) in respect of an amount (the assessable amount) under section 98, 99 or 99A of that Act in relation to the trust.

51.          As the Executor is liable to be assessed under section 98 on the Testamentary Trust's share of the Estate's net income, the requirements of subsection 207-35(5) of the ITAA 1997 has been satisfied. Subsection 207-35(6) of the ITAA 1997 states:

Despite any provisions in Division 6 of Part III of the Income Tax Assessment Act 1936, for the purposes of that Division, increase the assessable amount by so much of the franking credit amount as is equal to:

(a) if the trustee of the trust is liable to be assessed (and pay tax) under section 98 of that Act - the sum of:

(i) the trustee's *share of the *franking credit on the distribution in respect of the beneficiary; and

(ii) the amount mentioned in section 207-37; or

(b) if the trustee of the trust is liable to be assessed (and pay tax) under section 99 or 99A of that Act - the sum of:

(i) the trustee' s share of the franking credit on the distribution; and

(ii) the amount mentioned in section 207-37.

52.          In subsection 207-35(6) of the ITAA 1997, it is paragraph (a) that would apply to the Executor and the Executor will be required to include as assessable income the share of franking credits on Testamentary Trust A's share of the franked distributions.[8]

53.          Section 207-95 of the ITAA 1997 applies to a distribution that flows indirectly to an entity and subsection 207-95(1), and states:

If:

(a) a *franked distribution *flows indirectly to an entity in an income year; and

(b) the entity' s *share of the distribution would, in its hands, be *exempt income or *non-assessable non-exempt income (whether or not it had actually received that share);

then, for the purposes of this Act:

(c) subsection (2), (3) or (4) (as appropriate) applies to the entity in relation to that income year; and

(d) the entity is not entitled to a *tax offset under this Division because of the distribution; and

(e) if the distribution flows indirectly through the entity to another entity - subsection 207-35(3) and section 207-45 do not apply to that other entity.

Note: This section can therefore apply, for example, where the entity is a partner in a partnership that has a partnership loss and the entity does not actually receive any of the distribution.

54.          In respect of paragraph 207-95(1)(a) of the ITAA 1997, 'flow indirectly' is a defined term,[9] and subsection 207-50(4) applies to treat the Testamentary Trust's share as flowing indirectly to the Estate, i.e., this condition its satisfied. Testamentary Trust A's share is NANE income of the Estate (as set out above), and thus the condition in paragraph 207-95(1)(b) of the ITAA 1997 is also satisfied.

55.          As both paragraphs 207-95(1)(a) and 207-95(1)(b) of the ITAA 1997 are satisfied, paragraph 207-95(1)(c) of the ITAA 1997 directs an entity to the appropriate subsection which, for the Executor as trustees of a trust, is subsection 207-95(4) of the ITAA 1997, which states as follows:

If the *franked distribution *flows indirectly to the entity as the trustee of a trust under subsection 207-50(4), the entity's share amount in relation to the distribution that is mentioned in that subsection is to be reduced by the lesser of:

(a) that share amount; and

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

Example:

A franked distribution of $70 is made to a partnership.

Under section 207-35, an additional amount of $30 is included in the partnership's assessable income because of the distribution.

The partnership has 2 equal partners, X and Y. X is a foreign resident individual whose share of partnership's net income for the income year is $50 (share of distribution of $35 and share of franking credit of $15). That share of distribution is not assessable income and not exempt income under section 128D of the Income Tax Assessment Act 1936.

X' s assessable income of $15 (share of franking credit) is reduced to nil because of the deduction of $15 under subsection (2). Because of subsection (1), X is not entitled to a tax offset under section 207-45.

56.      The EM to the Tax Laws Amendment (2004 Measures No. 2) Bill 2004 explains how section 207-95 is to be applied. Paragraph 10.34 and table 10.1 are as follows:

10.34 The adjustment to the entity's assessable income is set out in Table 10.1. The adjustment is a deduction where the distribution flows indirectly to a partnership or beneficiary and a reduction when it flows indirectly to a trustee. Where a franked distribution flows indirectly to the trustee of a trust, reduction rules apply (as opposed to deduction rules) because the deductions of the trust have already been taken into account in determining the trust's net income.

Table 10.1

57.          Paragraph 10.35 of the EM to the Tax Laws Amendment (2004 Measures No. 2) Bill 2004 explains the reason for the lesser amount in subsection 207-54(4) of the ITAA 1997:

The 'lesser of' rule that applies in the case of trusts ensures that a beneficiary or trustee is unable to create a loss as a result of the adjustment to remove the effect of a franking credit from an entity's assessable income.

58.          In respect of the Testamentary Trust's share of the franked distributions, in each relevant income year the amount of that distribution, as referred to in subsection 207-50(4) of the ITAA 1997, will be higher than the franking credits on the Testamentary Trust's share of the franked distributions.

59.          Applying paragraph 207-95(1)(c) of the ITAA 1997, in each relevant income year the Estate reduces its net income by the share of the franking credit on the Testamentary Trust's share of the franked distributions.

60.          This will be equal to the amount that is assessable to the Estate under subsection 207-20(1) of the ITAA 1997 and the overall effect is that the assessable income of the Executor will not include the share of franking credits on the Testamentary Trust's share of the franked distributions.

Question 3

Will the Executor be entitled under section 207-45 of the ITAA 1997 to a tax offset equal to the share of the franking credits on the franked dividend income distributed by them to the Trustee?

Summary

The Executors are not entitled to a tax offset under paragraph 207-90(1)(d) of the ITAA 1997.

Detailed reasoning

61.          Subsection 207-20(2) of the ITAA 1997 states:

The receiving entity is entitled to a *tax offset for the income year in which the distribution is made. The tax offset is equal to the *franking credit on the distribution.

62.          Section 207-45 sets out entitlement to the tax offset when the franked distribution flows indirectly to an entity. In relation to a trustee of a trust, under paragraph 207-45(c) the trustee is entitled for the relevant income year to a tax offset if the trustee is liable to be assessed on a share of the trust's net income under section 98.

63.          As determined in Question 1, the Executors would be liable to be assessed on the Testamentary Trust's share of the Estates net income under subsection 98(4). However, the Executors are not assessable on the Testamentary Trust's share of the franked distribution because the Testamentary Trust's share of the franked distribution is NANE income by the operation of section 128D.

64.          As determined in Question 2, a tax offset is not available where a trustee is not assessed on the franked distribution that is NANE income.[10] As paragraphs 207-95(1)(a) and 207-95(1)(b) of the ITAA 1997 were satisfied, paragraph 207-95(1)(d) of the ITAA 1997 applies to the Executors. This provision states that if the entity's share of the distribution would, in its hands, be NANE income then, for the purposes of the ITAA 1997:

the entity is not entitled to a *tax offset under this Division because of the distribution

65.          Therefore, the Executor is not entitled to the tax offset under subsection 207-20(2) in respect of the share of franking credits on Testamentary Trust A's share of the NANE franked distributions.

[1] In this instance the Executor paid the franked distribution it received to beneficiaries using the percentages set down in Appendix A of their resolution.

[2] The positive amount referred to in paragraph 207-50(4)(c).

[3] Taxation Determination TD 2012/22 Income tax: for the purposes of paragraph 97(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) is a beneficiary's share of the net income of a trust estate worked out by reference to the proportion of the income of the trust estate to which the beneficiary is presently entitled.

[4] Listed beneficiary types are a body, association, fund or organization the income of which is exempt from tax by virtue of the operation of Subdivision 50-A or section 51-5, 51-10 or 51-30 of the Income Tax Assessment Act 1997; or an organization the income of which is exempt from tax by virtue of a regulation in force under the International Organisations (Privileges and Immunities) Act 1963.

[5] ATO Interpretative Decision ATO ID 2009/78 Income Tax Non-assessable and Non-exempt Income - Dividends: non-share dividends and interest of a superannuation fund for foreign residents.

[6] Subsection 128B(3A) impacts the application of subparagraph 128B(3)(ga)(i) and could result in an amount having to be withheld. this would not impact the application of section 128D.

[7] Under subsection 128B(3D), section 128 does not to a demerger dividend to which section 45B does not apply.

[8] As the Executor's share is NANE income the effect of this subsection is to include the trustee's share of the franking credit's as assessable income of the Executor.

[9] Subsection 995-1(1) of the ITAA 1997 provides that 'subsections 207-50(2), (3) and (4) set out the circumstances in which a *franked distribution flows indirectly to an entity'.

[10] Subsection 207-95(1) of the ITAA 1997