Edited version of private advice

Authorisation Number: 1052384134034

Date of advice: 17 April 2025

Ruling

Subject: Commissioner's discretion - franking deficit tax

Question

Will the Commissioner exercise his discretion under subsection 205-70(6) of Income Tax Assessment Act 1997 (ITAA 1997) and allow the full franking deficit offset?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20YY

The scheme commenced on:

1 July 20YY

Relevant facts and circumstances

You had PAYG Instalment amounts totalling $XXX,XXX for period ending 30 June 20XX, being:

•                     XXX,XXX from the September 20XX quarter

•                     XXX,XXX from the December 20XX quarter

•                     XXX,XXX from the March 20XX quarter

•                     $0 from the June 20XX quarter

In the original application, you requested the Commissioner apply discretion for the 20XX income year.

In your application, you stated that the franking deficit was caused by the unusually high refund from the 20XX Income tax year.

In March 20XX, you requested the Commissioners discretion be applied to the 202X income year, and not the 202X income year.

You received an income tax refund for the period of 30 June 20XX.

On 30 June 20XX, the following dividend was paid by you to the Directors of the Company:

•                     A fully franked dividend: $XXX,XXX

•                     A fully franked dividend: $XXX,XXX

The activity statements for the periods of: September 20XX, December 20XX, March 20XX and June 20XX were varied using code 21 at label T4 on each Activity Statement.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 205-40

Income Tax Assessment Act 1997 subsection 205-45(2)

Income Tax Assessment Act 1997 subsection 205-70(1)

Income Tax Assessment Act 1997 subsection 205-70(5)

Income Tax Assessment Act 1997 subsection 205-70(6)

Reasons for decision

If an entity's account is in deficit at the end of an income year, subsection 205-45(2) of the ITAA 1997 provides that the entity is liable to pay franking deficit tax. Franking deficit tax is an amount equal to the amount of the deficit in the franking account. The object of applying franking deficit tax is to prevent entities relying on franking credits that they anticipate to arise for an indefinite period into the future.

Subsection 205-70(1) of the ITAA 1997 provides that a corporate tax entity is entitled to a tax offset arising from a franking deficit tax liability for an income year for which it meets certain residency requirements if at least one of the following applies:

•                     the entity has incurred a liability to pay franking deficit tax in that year

•                     the entity incurred a liability to pay franking deficit tax in a previous income year for which it did not satisfy the residency requirements, and the entity has not already received a tax offset in relation to it, or

•                     when the entity was last entitled to a tax offset under the section for a previous income year, that offset exceeded the amount that would have been its income tax liability for that year if it did not have that offset (but had all its other tax offsets).

The amount of the tax offset is usually equal to the amount of the franking deficit tax liability. However, the offset will be reduced by 30% in certain circumstances. The 30% reduction applies where the franking deficit tax liability attributable to certain debits that arose in the franking account for a year is greater than 10% of the total franking credits that arose in the franking account for that year.

Subsection 205-70(5) of the ITAA 1997 is about how the offset reduction applies to a private company's first year of tax liability. It states that the 30% reduction of the franking deficit tax offset does not apply if:

(a)          the entity is a private company for the relevant year

(b)          if the company did not have the tax offset (but had all its other tax offsets) it would have had an income tax liability for the relevant year

(c)          the company has not had an income tax liability for any income year before the relevant year, and

(d)          the amount of the liability referred to in paragraph (b) is at least 90% of the amount of the deficit in the company's franking account at the end of the relevant year.

Subsection 205-70(6) of the ITAA 1997 provides that the 30% offset reduction does not apply if the Commissioner exercises his discretion in the relevant year. The Commissioner will determine this in writing, after receiving an application by the entity. The 30% reduction will not be applied if the franking deficit occurred as a result of events that were outside of the control of the entity.

The Commissioner will generally consider a franking deficit to have arisen due to events outside the taxpayer's control if the events that gave rise to the deficit were not readily foreseeable and could not be influenced or controlled by the company.

For a circumstance to be outside of the taxpayer's or their agent's control or unanticipated, there must have been an event or circumstance which:

•                     was unforeseeable or unexpected

•                     operated alone or together with other circumstances (unusual or not)

•                     was beyond the control of the taxpayer or their agent, and

•                     could not have been avoided by compliance with accepted standards of business organisation and professional conduct.

Examples of circumstances outside of the control or unanticipated are:

1.            A downturn in business that is linked to the reduced offset. There must be evidence of behaviour on the part of the taxpayer that there was an attempt at mitigation, but that the result was unavoidable.

2.            Unusual events which interrupt the ordinary course of business such as:

•                    protracted audits undertaken by the Tax Office which may hinder the preparation, lodgement and payment of income tax

•                    reviews or objections in relation to specific taxation issues which cause unexpected or unavoidable refunds resulting in large franking debits to the franking account

•                    situations resulting in unexpected or unavoidable refunds which trigger franking debits in the franking account

•                    substituted accounting periods which have the effect of shortening the income year and hence shortening the period within which sufficient franking credits can be generated

•                    liquidations, whether voluntary or not, which may shorten the income year and hence shorten the period within which sufficient franking credits can be generated, or

•                    take-overs or consolidation of entities that trigger the consolidation rules obliging the joining entity to determine and pay any outstanding franking deficit tax at the joining time.

3.            Circumstances which give rise to special consideration.

Where the entity does not provide sufficient evidence of events which fall into one of the three categories which warrant the favourable exercise of the discretion, then the Commissioner cannot make a determination under subsection 205-70(6) of the ITAA 1997.

The following do not meet the legislative requirements of 'unanticipated circumstances' or circumstances 'beyond the entity's control':

•                     improper tax planning

•                     bad management

•                     inadvertent errors, and

•                     expansion of business

Application to your circumstances

As set out above, the ATO guidance on subsection 205-70(6) has stated that the Commissioner does not consider that a franking deficit arising due to improper tax planning, bad management and inadvertent errors to be circumstances that are unanticipated or beyond the entity's control.

For a circumstance to be outside of the taxpayer's or their agents control or unanticipated, there must have been an event or circumstance which:

•                     was unforeseeable or unexpected

•                     operated alone or together with other circumstances (unusual or not)

•                     was beyond the control of the taxpayer or their agent, and

•                     could not have been avoided by compliance with accepted standards of business organisation and professional conduct.

Examples of circumstances that are unexpected, or outside the entity's control

1.            A downturn in business that is linked to the reduced offset. There must be evidence of behaviour on the part of the taxpayer that there was an attempt at mitigation, but that the result was unavoidable.

2.            Unusual events which interrupt the ordinary course of business such as:

•                    protracted audits undertaken by the Tax Office which may hinder the preparation, lodgement and payment of income tax

•                    international reviews or objections in relation to specific taxation issues which cause unexpected or

•                    unavoidable refunds resulting in large franking debits to the franking account

•                    situations resulting in unexpected or unavoidable refunds which trigger franking debits in the franking account

•                    substituted accounting periods which have the effect of shortening the income year and hence shortening the period within which sufficient franking credits can be generated

•                    liquidations, whether voluntary or not, which may shorten the income year and hence shorten the period within which sufficient franking credits can be generated, or

•                    take-overs or consolidation of entities that trigger the consolidation rules obliging the joining entity to determine and pay any outstanding franking deficit tax at the joining time.

3.            Circumstances which give rise to special consideration such as where a combination of circumstances create an unusual situation that calls for leniency. No example is given.

The following facts are relevant in considering whether the circumstance are considered to be unexpected, or outside of your control.

•                     You made payments to your income tax account, in respect to your anticipated tax liability for income year 20XX.

•                     You calculated your franking account balance prior to making the decision on how much of the distribution would be franked. Based on these calculations you determined that you had sufficient franking credits to fully frank the 2 distributions.

Therefore, the Commissioner considers that the circumstances that led to the franking deficit arising were an inadvertent error and/or an internal governance error within your control. A franking deficit arising from the payment of a fully franked dividend prior to a franking credit arising for the Company could have been anticipated. Consideration of the ramifications of making the decision to pay a fully franked dividend prior to the accrual of franking credits was within the control of the Company.

Commissioners Discretion

The Commissioner has acknowledged that you took immediate action to rectify the franking deficit as soon as it was brought to attention. There is no suggestion that you intended to exploit the imputation system. However, the Commissioner's discretion is limited to making a decision as to whether the event or events which caused the excess were outside the control of the company.

Whilst we acknowledge the company had been operating for a number of income years, it would be expected that the directors, with careful monitoring and discussion with their tax professional, would have identified that there would be insufficient franking credits available in the franking account at the end of the 20XX income year and to initiate the appropriate variations to the affected BAS accordingly.

It is therefore not justified for the Commissioner to exercise his discretion to make a determination under subsection 205-70(6) of the ITAA 1997.