Private ruling: Franking credits
Published: June 2014
Ruling period: Year ended 30 June 2014 | Year ended 20 June 2015
Date scheme commenced: 1 July 2013

Ruling: Q1: Will the Company receive a franking credit for the increased PAYG instalment under section 205-15 of the Income Tax Assessment Act 1997 ? | A1: Yes. | Q3: If the Company franks the liquidator's distribution in reliance on the credit mentioned in Question 1, will the Trust be entitled to a refund of franking credits under section 67-25 of the Income Tax Assessment Act 1997 ? | A3: Please refer to Reasons for Decision.

Relevant facts and circumstances: 1. The Trust was established as a charitable trust and is endorsed for income tax exemption as a charity. Given the level of its income, the Trust has been able to make funding commitments to a number of charities so that they can plan and therefore optimise their own activities. The whole of the trust income each year is used for distributions to charities. 2. The major asset of the Trust is shares in the Company. The Trust is the sole shareholder of the Company and since 2000, the directors of the Company have been employees of the trustee. 3. The Company holds a large portfolio of listed company shares and investments in managed funds and some other relatively minor investments, and its only activity is investing these assets in order to provide income by way of dividends to the trust. Predominantly all of the net income of the Company each year is distributed to the trust by way of dividend. 4. Although the Company is a taxpayer, all of the income tax it pays is ultimately refunded in full to the trust by way of franking credits attaching to the dividends paid by the Company to the trust. Together therefore, the trust and the Company maintain the tax neutrality called for by the charitable purposes they serve. 5. The articles of association of the Company provide that once there are no longer directors associated with X, then the Company should be placed in voluntary liquidation and the assets transferred to the trust. 6. The trustee wishes to carry out this requirement as its duties as trustee also support the wind up. The process required here for tax neutrality is inefficient. It keeps the entities out-of-pocket for a significant period each year. The structure impedes management of a balanced investment portfolio due to realisation of any capital gains being distributed as income under the trust deed, thus diminishing the capital value of the trust. 7. Since franking credit rebates are only available after year end upon application by the trust each year, there is invariable a time lag between tax payments by the Company on its income and refunds to the trust of franking credits attaching to dividends paid by the Company. The money paid in tax is neither invested for nor distributed to charities during this period. 8. The tax payment and refund process necessary for tax neutrality creates an impediment to switching investments, and consequently the Company's portfolio of listed shares cannot be managed to best advantage. Capital gains tax payable by the Company on share sales can only be refunded upon distribution of the gains to the trust by way of dividend. This means that the investment capital represented by the gains would need to be reinvested by the trust in Company shares each time the portfolio is adjusted. This is a cumbersome and inefficient process and there have been questions raised as to whether the trust can treat these payments as income or capital for trust purposes, as all income needs to be distributed. 9. The Company has not been wound up due to concerns that the substantial capital gains tax payable on transfer of the investment portfolio from the Company to the trust would, due to the inefficiencies of the tax payment and refund process described, substantially diminish the funds available for investment and disrupt the trust's distribution commitments. 10. The Company is seeking to increase the amount of the Company's 2010 tax instalment in anticipation of the capital gains to be realised on transfer of the investment portfolio to the trust, and to defer collection of the instalment until 30 June 2014. That will allow the capital gains realised on transfer of the portfolio to be distributed by way of liquidator's distribution to the trust in the 2013/14 financial year as a frankable deemed dividend. The trust will be in the position to claims the associated franking credit refund early in the new financial year. 11. The Company proposes to appoint a liquidator upon receipt of the requested ATO approval. 12. Without being able to structure the process as outlined, the investment portfolio will be substantially diminished to the disadvantage of the charitable trust and those charities relying on its distributions.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 50-5 | Income Tax Assessment Act 1997 Subdivision 50-B | Income Tax Assessment Act 1997 Section 67-25 | Income Tax Assessment Act 1997 Section 202-15 | Income Tax Assessment Act 1997 Section 205-15 | Income Tax Assessment Act 1997 Subsection 205-15(1) | Income Tax Assessment Act 1997 Section 205-25 | Income Tax Assessment Act 1997 Paragraph 205-25(1)(a) | Income Tax Assessment Act 1997 Section 205-45 | Income Tax Assessment Act 1997 Subsection 205-45(2) | Income Tax Assessment Act 1997 Section 207-115(2) | Income Tax Assessment Act 1997 Section 207-20 | Income Tax Assessment Act 1997 Section 207-117 | Income Tax Assessment Act 1997 Section 207-155(2) | Income Tax Assessment Act 1997 Section 960-115 | Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision: Summary: Under section 205-15(1) of the ITAA 1997, a franking credit will arise in the Company's franking account for the increased PAYG instalment paid prior to the 30 June 2014. | Detailed Reasoning - Detailed reasoning: Subsection 205-15(1) contains a table in which it is set out when a credit arises in the franking account of an entity and the amount of the credit. In terms of item 2 of the table a credit arises in the franking account of the entity if the entity pays income tax and the entity satisfies the *residency requirement for the income year for which the tax is paid; and the entity is a *franking entity for the whole or part of that income year. A credit of that part of the payment that is attributable to the period during which the entity was a *franking entity arises on the day on which the payment was made. The asterisked terms *residency requirement and *franking entity are defined in subsection 995-1(1). The term *residency requirement has the meaning given by section 205-25. In terms of paragraph 205-25(1)(a) an entity satisfies the residency requirement for an income year in which an event specified in a relevant table occurs, if the entity is a company, the company is an Australian resident for more than half of the 12 months immediately preceding the event if the event occurs before the end of the income year. With respect to the credit in the franking account upon the payment of income tax, the Company meets the residency requirement as it is a company which is incorporated in Australia and "is an Australian resident company at all relevant times for Australian income tax purposes". That is to say it will be a resident in all years from the year ending 30 June 2014 to the year ending 30 June 2015 inclusive. The term *franking entity has the meaning given by section 202-15. Section 202-15 reads: An entity is a franking entity at a particular time if: (a) it is a *corporate tax entity at that time: and (b) it is not a *life insurance company that is a *mutual insurance company at that time; and (c) in a case where the entity is a company that is a trustee of a trust - it is not acting in its capacity as trustee of the trust at that time. A *corporate tax entity is defined in subsection 995-1(1) as having the meaning given by section 960-115. The Company is a corporate tax entity because one of the meanings of the term corporate tax entity is that "the entity is a company at that time". Further the Company is neither a life insurance company nor a mutual insurance company at that time the Company is not the trustee of a trust. Accordingly, the conditions set out in item 2 in the table in subsection 205-15(1) are met so that a credit will arise in the franking account of the Company upon the payment of the PAYG instalment by the Company. | Summary: Based on the assumption that the PAYG instalment will be paid on the same date that the liquidator makes a distribution the Company will not be liable for franking deficit tax. | Detailed Reasoning - Detailed reasoning: On the basis that the PAYG instalment will be paid on 30 June 2014, the franking account will not be in deficit at the end of the income tax year under 205-45(2). Subsection 205-45 requires that an entity is liable to pay franking deficit tax if its franking account is in deficit at the end of the income year. This will not be the case under the current facts and assumptions. | Summary: Under section 67-25 of the ITAA 1997, the Trust will be entitled to a refund of franking credits that are attached to the liquidator's distribution. | Detailed Reasoning - Detailed reasoning: Under the general rule in section 207-20 of the ITAA 1997, an entity which receives a franked distribution is entitled to a tax offset for the income year in which the distribution is made. Holders who are entitled to a tax offset under Division 207, in respect of franking credits received, will also be subject to the refundable tax offset rules in Division 67, unless specifically excluded from the refundable tax offset rules under section 67-25. The Trust is a corporate tax entity, which is not ordinarily entitled to a refund due to section 67-25(1C) of ITAA 1997. However, as an income tax exempt charity it qualifies as an exempt institution that is eligible for a refund under section 207-115(2). Section 67-25(1C)(a) therefore exempts the Trust from the section 67-25(1C) restriction. The Trust qualifies as an exempt institution that is eligible for a refund under section 207-115(2) because: • the Trust is a "registered charity" under the table in section 50-5 of ITAA 1997; • the Trust is exempt from income tax under Subdivision 50-B following the Commissioner's endorsement of the Trust as a charitable entity; and • the Trust satisfies the residency requirement in section 207-117 since it has a physical presence in Australia and incurs expenditure and pursues its objectives principally in Australia, and will have done so at all times during the 2013/14 income year. The Trust will therefore be entitled to a refund of the franking credits that will be attached to the liquidator's distribution.

Question 2: In determining whether any franking deficit tax is payable under section 205-45 of the Income Tax Assessment Act 1997 , will the Commissioner take into account the franking credit mentioned in Question 1?