Edited version of private advice

Authorisation Number: 1052362875214

Date of advice: 20 March 2025

Ruling

Subject: Dividends franked with exempting credits by exempt or former exempt entities

Question 1

Assuming X becomes an Australian tax resident, will section 208-240 treat dividends franked with exempting credits by G to be franked in the hands of X?

Answer 1

No.

Question 2

Assuming X becomes an Australian tax resident, will section 208-230 treat dividends franked with exempting credits by G to be franked in the hands of M?

Answer 2

No.

This ruling applies for the following period:

30 June 20XX and 30 June 20XX

Relevant facts and circumstances

X was an Australian tax resident. In XX year, X ceased to be an Australian tax resident when they moved overseas to live in a house they purchased there. X has since not returned to Australia.

M Pty Ltd is an Australian tax resident company and X has owned 100% of the shares in M Pty Ltd at all times.

G Pty Ltd is also an Australian resident company for tax purposes.

In XX year, X owned X% of the shares in G Pty Ltd as the nominee owner or bare trustee on behalf of M Pty Ltd and another person the other X%.

On xx year, X owned all the shares in G Pty Ltd i.e. they owned X% of the shares on behalf of M Pty Ltd and X% of the shares in their own right.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 6

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 208-20

Income Tax Assessment Act 1997 section 208-50

Income Tax Assessment Act 1997 section 208-60

Income Tax Assessment Act 1997 section 208-115

Income Tax Assessment Act 1997 section 208-130

Income Tax Assessment Act 1997 section 208-155

Income Tax Assessment Act 1997 section 208-175

Income Tax Assessment Act 1997 section 208-225

Income Tax Assessment Act 1997 section 208-230

Income Tax Assessment Act 1997 section 208-240

Does IVA apply to this private ruling?

Part IVA of the ITAA 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 considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies, we will need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

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-avoidancerule for income tax'.

Reasons for decision

Question 1

Assuming H becomes an Australian tax resident, will section 208-240 treat dividends franked with exempting credits by G to be franked in the hands of H?

Summary

Section 208-240 will not treat dividends franked with exempting credits by G to be franked in the hands of H because they would not be an eligible continuing substantial member in relation to the distribution.

Detailed reasoning

Section 208-240 is in Division 208, which is intended to prevent franking credit trading schemes involving corporate tax entities that are effectively owned by persons for whom franking credits have little value (i.e. non-residents or tax-exempt entities).

The Division contains provisions relating to corporate entities that are exempting entities and former exempting entities. It operates so that distributions by these types of entities will not be subject to the usual rules applicable to the receipt of a franked distribution under the imputation system.

The usual rules are in Division 207 and provide for a gross-up and tax offset. Division 207 will not apply to distributions by exempting entities and former exempting entities unless Division 208 expressly provides for Division 207 to apply.

Exempting entities

Section 208-20 provides that an exempting entity is a corporate tax entity effectively owned by prescribed persons. Prescribed persons are non-residents and income tax-exempt entities, although the term extends to include interposed entities through which non-residents and income tax-exempt entities hold their interests.

An entity is effectively owned by prescribed persons at a particular time if:

•                     at least 95% of the accountable membership interests in the entity, or at least 95% of the accountable partial interests in the entity, are held by or for the benefit of prescribed persons; or

•                     it is reasonable to conclude that the risks and opportunities arising from the holding of those shares or interests substantially accrue to prescribed persons.

H has been a non-resident and a prescribed person since XXX year. H also owns 100% of the shares in M. Accordingly, M has been an exempting entity since XXX year as H owns at least XX% of its shares and H has been a prescribed person since then. In addition, G has been an exempting entity since XXX year as M and H then owned at least XX% of its shares and both were prescribed persons then.

Former exempting entities

Section 208-50 provides that a former exempting entity is a corporate tax entity if it has, at any time, ceased to be an exempting entity and is not again an exempting entity.

M and G will become former exempting entities when H becomes a resident of Australia, at which time H and M will no longer be prescribed persons.

When H becomes a resident of Australia again, neither M nor G will effectively be owned by prescribed persons. Each will cease to be an exempting entity and they will become former exempting entities.

Franking credits not normally available on distributions by former exempting entities

Where an exempting entity ceases to be effectively owned by prescribed persons, and is taken to be a former exempting entity, the franking account (of the entity when it was an exempting entity) is converted to an exempting account. Section 208-60 provides that former exempting entities can frank distributions with exempting credits.

Section 208-225 provides that distributions franked with an exempting credit by a former exempting entity are only subject to the usual imputation rules in Division 207 if that is expressly provided for in Subdivision 208-H.

Section 208-240 provides that Division 207 applies to a distribution franked with an exempting credit made by a former exempting entityas if it were a franked distribution if:

a)            a corporate tax entity other than a former exempting entity became an exempting entity; and

b)            immediately before the entity became an exempting entity all the accountable membership interests and accountable partial interests were beneficially owned (whether directly or indirectly) by individuals who were Australian residents; and

c)             the entity became an exempting entity because some or all of the individuals ceased to be Australian residents; and

d)            the entity becomes a former exempting entity because all of the individuals are or have become Australian residents; and

e)            an amount attributable to a distribution franked with an exempting credit made by the entity is included in the assessable income of such an individual; and

f)              all the accountable membership interests or accountable partial interests in the entity were, throughout the period beginning when the entity became an exempting entity and ending when the amount was received by the individual mentioned in paragraph (e), beneficially owned (directly or indirectly) by that individual; and

g)            the individual is an eligible continuing substantial member in relation to the distribution.

H will not be an eligible continuing substantial member when G makes any distribution to them because they will not be a foreign resident.

Section 208-155 sets out the test for determining whether a member of a former exempting entity is an eligible continuing substantial member in relation to a distribution made by the former exempting entity. Applicable to this question is a requirement that, at both the time when the distribution was made, and the time immediately before the entity ceased to be an exempting entity, the member was a person who is a foreign resident (paragraph 208-155(3)(a)).

H will not be a foreign resident when the distribution is made. The requirement in paragraph (g) will not be met and cannot be ignored. Therefore, as H will not be an eligible continuing substantial member in relation to the distribution, the imputation rules in Division 207 will not apply.

Question 2

Assuming H becomes an Australian tax resident, will section 208-230 treat dividends franked with exempting credits by G to be franked in the hands of M?

Summary

Section 208-230 will not treat dividends franked with exempting credits by G as franked distributions in the hands of M because the distributions will not give rise to an exempting credit for M.

Detailed reasoning

Division 208 is concerned with preserving the integrity of the imputation system as observed in question one.

Whilst dividends franked with an exempting credit by a former exempting entity are generally treated as unfranked (section 208-225), the exception in section 208-230 is considered here.

M and G will cease to be exempting entities and become former exempting entities when H becomes a resident of Australia. Section 208-230 provides most relevantly (and with our emphasis added) that Division 207 applies to a distribution franked with an exempting credit made by a former exempting entityas if it were a franked distribution if ...

(c)           the distribution flows indirectly to a former exempting entity and gives rise to an exempting credit for that entity;

Flows indirectly to M through to H (as trustee)

Section 208-175 provides that a distribution franked with an exempting credit is taken to flow indirectly to an entity if, had it been a franked distribution, it would have been taken to have flowed indirectly to the entity under section 207-50.

Section 207-50(3) provides that a franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

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

(b)           the beneficiary has this amount for that income year (the shareamount):

(i)            a share of the trust's net income for that income year that is covered by section 97(1)(a) of the ITAA 1936 or ...

These requirements in section 207-50(3) will be met. G will make a distribution to H and M, as lone beneficiary of the bare trust, will become presently entitled to that distribution. The result is that section 97(1)(a) of the ITAA 1936 includes an amount in the assessable income of M. Therefore, the distribution will flow indirectly to M.

Gives rise to an exempting credit for M

The table in section 208-115 sets out when an exempting credit arises for a former exempting entity. Item 4 in the table is relevant where a distribution franked with an exempting credit flows indirectly to the entity. It requires the entity through which the distribution flows to be an 'eligible continuing substantial member' in relation to the distribution. This requires H to be an 'eligible continuing substantial member' because the distribution flows through them.

Section 208-155 sets out the test for determining whether a member of a former exempting entity is an eligible continuing substantial member in relation to a distribution made by the former exempting entity. This is the same test we considered in question one. However, we now consider it through a lens where paragraph 208-155(3)(e) is most relevant, as the distribution is to a trustee (H) of a trust in which an interest was held by a former exempting entity (M). The test turns on whether M would be entitled to a franking credit or tax offset if it is assumed that:

(a)          G is an exempting entity when the distribution is made; and

(b)          the distribution is franked; and

(c)           M is an exempting entity (rather than a former exempting entity).

Section 208-130 outlines when a credit arises in the franking account of an entity because of its status as an exempting entity or former exempting entity. If the above assumptions are made, M would be entitled to an indirect franking credit under item 7 of the table in section 208-130 where (with our emphasis):

(a)           a distribution made by an exempting entity flows indirectly to the entity (the ultimate recipient); and

(b)           the recipient of the distribution is an eligible continuing substantial member in relation to the distribution; and

(c)           except for the fact that the ultimate recipient is not an eligible continuing substantial member in relation to the distribution, it would have been entitled to a franking credit because of the distribution had the distribution been made to the ultimate recipient.

The recipient of the distribution is H and H is not an eligible continuing substantial member in relation to the distribution. We recognise this definition is circular. That is, in determining whether H is an 'eligible continuing substantial member' for the purposes of applying Item 4 in section 208-115, recourse must be had to whether H is also an 'eligible continuing substantial member' (using the same definition) for the purposes of applying Item 7 in section 208-130. However, it is not a requirement we can ignore.

Consequently, because H would not be an eligible continuing substantial member, the distribution would not give rise to an exempting credit for M and section 208-230 will not treat dividends franked with exempting credits by G as franked distributions in the hands of M.