Edited version of private advice

Authorisation Number: 1052239184855

Date of advice: 5 April 2024

Ruling

Subject: Franking credit refund eligibility - exempt institution eligible for a refund - integrity rules - Subdivision 207-E

In this edited version, all legislative provisions are in the Income Tax Assessment Act 1997.

Question

Will section 207-120 apply so that section 207-119 prevents the Foundation from being treated as an exempt institution eligible for a refund of franking credits?

Answer

No.

This ruling applies for the following period:

1 July XXXX to 30 June ZZZZ

The scheme commenced on:

1 July XXXX

Relevant facts and circumstances

1.         The X Group established Y Foundation Ltd, which is a company limited by guarantee and is registered with the Australian Charities and Not-for-profits Commission (ACNC).

2.         At 30 June XXXX, the Foundation had a net asset position of approximately $X. It held almost $X in total assets, including cash of over $X. It also had debt of over $X.

3.         The Foundation has received franking credit refunds from franked distributions in several recent income years.

4.         The Foundation expects it will continue to receive franked distributions in future income years.

5.         The Foundation's debt arose when it acquired shares through a related party loan. The shares are in Company Z. The Foundation acquired those shares at market value of $X from another entity in the X Group.

6.         The X Group decided to transfer the Company Z shares into the Foundation because it expects those shares to appreciate significantly over the coming years, helping to grow the Foundation's asset value and achieve its philanthropic goals.

7.         The share acquisition was funded by an X-year interest-free limited recourse loan. The lender has recourse to the shares only, to the exclusion of all other Foundation assets, in seeking repayment. The Foundation may reduce its debt repayment if the shares fall in value, proportionately to the fall.

8.         The Foundation is considering how to repay the loan.

•                The Foundation has decided that loan repayments will be limited to a cumulative maximum of X% of the initial loan balance each year.

•                Repayments are also subject to the Foundation determining it has surplus cash under its cash flow modelling.

9.         The Foundation is considering using its surplus cash reserves (over $X at 30 June XXXX) to fund some loan repayments during the YYYY and ZZZZ income years.

10.      The Foundation expects that its ongoing charitable activities will be funded by other cash on hand, investment income from the Foundation's investment portfolio, and future distributions into the Foundation from the X Group.

11.      The Foundation may make repayments in future years if surplus cash is available.

12.      The Foundation expects that remaining debt will be ultimately repaid out of the proceeds from the future sale of Company Z shares or other assets.

Assumptions

1. The Foundation will fund loan repayments during the YYYY and ZZZZ income years from the cash reserves it had on hand at 30 June XXXX.
2. Total loan repayments for each year will be limited to X% of the original loan balance.
3. The Foundation will only make loan repayments to the extent that cash flow modelling for the Foundation shows sufficient funding for its charitable programs plus debt reduction.
4. The Foundation will only make loan repayments where its directors remain satisfied with Company Z's current valuation and future growth potential.
5. All loan repayments will require board approval.
6. There's no arrangement or understanding in place for loan repayments to be made as a result of or in connection with any actual or planned franked distribution to the Foundation from the X Group.
7. The Foundation, but for section 207-119, would be an exempt entity that qualifies as an exempt institution that is eligible for a refund under section 207-115.

Relevant legislative provisions

Income Tax Assessment Act 1997

Section 207-115

Section 207-119

Section 207-120

Section 207-122

Section 207-124

Section 207-126

Does IVA apply to this private ruling?

Part IVA of the Income Tax Assessment Act 1936 contains anti-avoidance rules that can apply in certain circumstances where you or another taxpayer obtains a tax benefit, imputation benefit or diverted profits tax benefit in connection with an arrangement.

If Part IVA applies, the tax benefit or imputation benefit can be cancelled (for example, by disallowing a deduction that was otherwise allowable) or you or another taxpayer could be liable to the diverted profits tax.

We have not fully considered the application of Part IVA to the arrangement we were asked to rule on, or to an associated or wider arrangement of which that arrangement is part.

For more information on Part IVA, go to our website ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

In these reasons for decision, all legislative provisions are in the Income Tax Assessment Act 1997.

Question

Will section 207-120 apply so that section 207-119 prevents the Foundation from being treated as an exempt institution eligible for a refund of franking credits?

Answer

No.

Summary

13.      Section 207-119 prevents an entity from being treated as an exempt institution that's eligible for a refund of franking credits where any of sections 207-120, 207-122, 207-124, and 207-126 apply.

14.      For section 207-120 to apply, three conditions must be met.

•         Condition 1: a franked distribution is made or flows indirectly to the entity (paragraph 207-120(1)(a)).

•         Condition 2: there is a distribution event in relation to the franked distribution (subsection 207-120(5)).

•         Condition 3: because of the distribution event in relation to the franked distribution, any paragraph in subsection 207-120(2) is satisfied.

15.      On the facts and assumptions of this ruling scheme, we don't think condition 3 is satisfied because of any distribution event in relation to a franked distribution that's made or flows indirectly to the Foundation in the income years ended 30 June YYYY or 30 June ZZZZ. We reach this conclusion because we don't think there's any applicable distribution event. And even if there is an applicable distribution event, we don't think it would trigger any relevant paragraph in subsection 207-120(2).

16.      It follows that section 207-120 doesn't apply and so won't cause section 207-119 to prevent the Foundation from being treated as an exempt institution eligible for a refund of franking credits.

17.      We can't determine whether sections 207-122, 207-124, or 207-126 would apply because the ruling scheme is silent on what distributions the Foundation will receive in the income years ended 30 June YYYY and 30 June ZZZZ. Nothing in the ruling scheme indicates these sections would apply but, without knowing more about the source, form, and any surrounding circumstances attaching to any distributions made in those income years, we can't rule the sections wouldn't apply.

18.      In the same fashion, our ruling that section 207-120 doesn't apply is premised only on the facts and circumstances set out in the ruling. Additional facts and circumstances relevant to any franked distribution may mean this private ruling has no effect.

Detailed reasoning

Section 207-119 denies exempt entities from receiving franking credit refunds where related integrity provisions apply.

19.      Broadly, franking credits attach to franked distributions. Franked distributions are grossed-up to include a franking credit amount to reflect corporate tax paid by the entity making the distribution. Recipients include the grossed-up amount in their assessable income and claim an offset equal to the franking credit.

20.      The effect of Subdivision 207-D is to cancel the gross-up and tax offset rules applying to franked distributions where the recipient wouldn't be taxed.

21.      However, Subdivision 207-E allows certain exempt entities to apply the usual franking credit rules. Broadly, Subdivision 207-E excludes an entity from the cancelling rules in Subdivision 207-D where it qualifies as an 'exempt institution that is eligible for a refund'.

22.      Section 207-115 lists the circumstances in which an entity is an 'exempt institution that is eligible for a refund'. That list includes where the entity is a registered charity which is endorsed as exempt from income tax under Subdivision 50-B and satisfies the residency requirement. See subsection 207-115(2).

23.      We've assumed that the Foundation qualifies as an exempt institution that is eligible for a refund under section 207-115.

24.      There are integrity rules which may prevent an entity being treated as an exempt institution that is eligible for a refund. Section 207-119 says an entity won't be treated as an exempt institution that is eligible for a refund if any of sections 207-120, 207-122, or 207-124 apply to the entity in relation to the distribution. There's a similar rule in section 207-126 applying to beneficiaries of a trust.

On these facts, we don't think the loan or the loan repayments from cash reserves in the 2024 and 2025 income years would trigger section 207-120.

25.      Section 207-120 makes an entity ineligible where it receives a franked distribution in listed circumstances which arise because of a distribution event. Subsection 207-120(1) says the section applies to an entity (known as the 'ineligible entity') if a franked distribution is made (or flows indirectly) to the entity, and subsection 207-120(2) applies 'because of a distribution event' in relation to the franked distribution.

26.      Subsection 207-120(5) explains the concept of 'distribution event'. It says that a 'distribution event' in relation to a franked distribution is:

•                an act, transaction, or circumstance

•                that has happened, will happen, or may reasonably be expected to happen

•                as part of, in relation to, or as a result of

•                the payment or receipt of the distribution (or a related trust share amount, or an arrangement entered into in association with the distribution or trust share amount).

27.      The listed circumstances in subsection 207-120(2) (loosely paraphrasing) include where:

•                an entity makes a payment, transfers property, or incurs a detriment, disadvantage, liability or obligation

•                an entity become liable to do any of those things

•                an entity is reasonably expected to do or become liable to do any of those things

•                an entity receives a distribution but the amount or value of the benefit is less than the value of the distribution when made

•                the distribution flows indirectly, and the amount or value of the benefit is (will be, or may reasonably be expected to be) less than the amount or value of the entity's trust share amount

•                the entity making the distribution, an interposed entity, or an associate obtains a benefit, advantage, right or privilege.

28.      Here, there's no distribution event that would trigger section 207-120. On the facts and assumptions of this ruling scheme, we don't think either the loan or its repayments (if those repayments are made in the YYYY and ZZZZ income years but sourced from cash reserves as at 30 June XXXX) are closely connected enough to any franked distributions the Foundation will receive in those income years so as to qualify as a distribution event. The Foundation won't be obliged to make loan repayments out of any franked distributions it receives in the YYYY and ZZZZ income years. Furthermore, it wouldn't necessarily be reasonable to expect the Foundation to use any franked distributions it will receive in the YYYY and ZZZZ income years to make future loan repayments.

29.      Even if there was a distribution event, the absence of any obligation or reasonable expectation that the franked distributions would be directed towards repaying the loan means none of the paragraphs in subsection 207-120(2) would apply.

30.      This is a decision on these facts alone and only applies to the YYYY and ZZZZ income years. The answer in subsequent income years may change if a pattern was to emerge whereby it became reasonable to expect that franked distributions would be used to make loan repayments.

We can't rule on sections 207-122, 207-124, and 207-126 because their operation depends on future distributions.

31.      Broadly, section 207-122 denies franking credits where the entity receives a distribution in the form of property (other than money) but doesn't get immediate and unconditional title, custody, and control of that property.

32.      Section 207-124 denies franking credits where the entity:

•                has entered an arrangement as part of or in association with the distribution

•                which requires it or another entity to acquire money or property (other than the distribution)

•                from the entity making the distribution, an interposed entity, or an associate of those entities.

33.      Section 207-126 applies to a beneficiary of a trust if the sum of distributions to the beneficiary relating to a franked dividend is less than their trust share amount.

34.      It isn't apparent that any of these provisions would apply here. The scheme facts don't mention:

•         any distribution made in the form of property

•         any connected arrangement requiring an entity to acquire money or property

•         whether the Foundation will receive distributions from a trust, and if so, whether there will be any mismatch between the distribution and the Foundation's trust share amount.

35.      Nevertheless, we can't rule on whether any of these provisions will apply during the YYYY and ZZZZ income years. That would require us to make assumptions about whether the Foundation will receive distributions in those years, the source of any distributions, the form they take, and the circumstances surrounding them. We don't think it's appropriate to make those assumptions, because the assumptions alone would determine the ruling outcome.

Conclusion: section 207-120 doesn't apply to prevent the Foundation from receiving franking credit refunds.

36.      Section 207-120 won't apply and so won't cause section 207-119 to prevent the Foundation from being treated as an exempt institution eligible for a refund of franking credits during the YYYY and ZZZZ income years.