Private ruling: Frankability of dividend
Published: May 2015
Ruling period: 1 July 2014 to 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the proposed Dividend be a frankable distribution within the meaning of section 202-40 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: The Company is an Australian incorporated and tax resident company. The Company proposes to declare and pay a dividend (proposed Dividend) to for the relevant year. The proposed Dividend will be funded entirely by from the Company's cash reserves. The accounting entry to record the proposed Dividend will be: Debit Retained Earnings Credit Cash The Company's balance sheet for the relevant year indicates net assets greater than share capital. The Company's retained earnings account has a credit balance which represented realised trading profits of the Company. There have been no direct or indirect transfers of amounts from the Company's share capital account to its retained earnings account. The Company's financial report for the relevant year shows current year and prior year losses. The total accumulated losses are segregated in the loss reserve account and have not been applied or offset against retained earnings. Carrying forward the losses from prior years in a segregated loss reserve account and not applying or offsetting the losses against retained earnings is valid and effective legally and under Australian accounting standards. The Company's cash account will be sufficient to pay the proposed Dividend. The Company has a franking account balance and it is intended that the proposed Dividend will be fully franked. The proposed Dividend will not be unfrankable under paragraphs 202-45(a) to (d) and paragraphs 202-45(f) to (j) of the ITAA 1997. No dividends were paid during the relevant financial year. Assumptions The proposed Dividend will be paid in accordance with section 254T of the Corporations act 2001 . The Company's directors will pass a legally effective resolution to pay the proposed Dividend specifying that the payment of the proposed Dividend is being paid entirely out of retained earnings account. Declaration and payment of the proposed Dividend will not be contingent on any subsequent proposed transactions.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsection 6(1) | Income Tax Assessment Act 1936 Subsection 6(4) | Income Tax Assessment Act 1997 Section 202-40 | Income Tax Assessment Act 1997 Section 202-45 | Income Tax Assessment Act 1997 Paragraph 202-45(e) | Income Tax Assessment Act 1997 Section 960-120 | Income Tax Assessment Act 1997 Subsection 975-300(1)

Reasons for decision: Summary: All legislative references are to the Income Tax Assessment Act 1997 unless otherwise specified . Under section 202-40 a distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45. Section 202-45 lists the distributions that are unfrankable: (b) a distribution to which paragraph 24J(2)(a) of the Income Tax Assessment Act 1936 applies that is taken under section 24J of the Income Tax Assessment Act 1936 to be *derived from sources in a prescribed Territory, as defined in subsection 24B(1) of the Income Tax Assessment Act 1936 (distributions by certain *corporate tax entities from sources in Norfolk Island); (c) where the purchase price on the buy-back of a *share by a *company from one of its *members is taken to be a dividend under section 159GZZZP of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place; (d) a distribution in respect of a *non-equity share; (e) a distribution that is sourced, directly or indirectly, from a company's *share capital account; (f) an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15; (g) an amount that is taken to be a dividend for any purpose under any of the following provisions: (i) unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a *private company); (ii) (Repealed by No 79 of 2007) (iii) section 109 of that Act (excessive payments to shareholders, directors and associates); section 47A of that Act (distribution benefits - CFCs); (h) an amount that is taken to be an unfranked dividend for any purpose (v) under section 45 of that Act (streaming bonus shares and unfranked dividends); (vi) because of a determination of the Commissioner under section 45C of that Act (streaming dividends and capital benefits); (i) a *demerger dividend; (j) a distribution that section 152-125 or 220-105 says is unfrankable. For section 202-40 to apply, the proposed Dividend must be a 'distribution' and not unfrankable under section 202-45. In this case, the circumstance in paragraph 202-45(e) is of relevance. The meaning of 'distribution' and the circumstance in paragraph 202-45(e) will be considered in turn below. | Detailed Reasoning - Distribution: The term 'distribution', in respect of a company, is defined in section 960-120 to mean 'a dividend, or something that is taken to be a dividend, under this Act'. Subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) provides a definition of 'dividend' where it relevantly states: dividend includes: (a) any distribution made by a company to any of its shareholders, whether in money or other property; and (b) any amount credited by a company to any of its shareholders as shareholders; but does not include: (d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company, or (e) ….. Subsection 6(4) of the ITAA 1936 provides an exception to paragraph (d) of the definition of dividend. Subsection 6(4) states: Paragraph (d) of the definition of dividend in subsection (1) does not apply if, under an arrangement: (a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and (b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed. In this case, the proposed Dividend will be a dividend as defined in subsection 6(1) of the ITAA 1936 as it is a cash distribution that will be debited to retained earnings account. The facts of the case do not give rise to the circumstance referred to in subsection 6(4) of the ITAA 1936. Accordingly, the proposed Dividend will be a distribution for the purposes of section 202-40. | Detailed Reasoning - Paragraph 202-45(e): Paragraph 202-45(e) of the ITAA 1997 provides that a distribution that is sourced, directly or indirectly from a company's share capital account is an unfrankable distribution. The term 'share capital account' is defined in subsection 975-300(1) as: A company's share capital account is: (a) an account that the company keeps of its share capital; or (b) any other account (whether or not called a share capital account) that satisfies the following conditions: (i) the account was created on or after 1 July 1998; (ii) the first amount credited to the account was an amount of share capital. Paragraph 3 of Taxation Ruling TR 2012/5 Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010 states: Paragraph 202-45(e) of the ITAA 1997 does not prevent a company from franking a dividend paid to its shareholders that is paid out of profits recognised in the company's accounts and available for distribution, and is paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act, merely because the company has unrecouped accounting losses accumulated in prior years or has lost part of its share capital. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936. Generally, distributions that are made out of realised profits can be franked. However, the payment of a dividend out of profits is not a requirement for a distribution to be frankable under section 202-40. Profits must be recognised in a company's accounts and be available for distribution by way of dividend. Profits can be recognised in the company's annual financial statements for the preceding year or in properly prepared half yearly or interim financial statements for the current financial year. The source of the profits from which a dividend will be paid would usually be expected to be recorded in the directors' minutes of the resolution determining to pay or declaring a dividend or in the documentation that accompanies or supports the resolution, or in the notes to the accounts. Profits are generally considered to be available for distribution as a dividend if they have not been appropriated or earmarked for other purposes. One way of ensuring that profits are available for dividend distribution for taxation purposes is, as a result of a directors resolution reflected in the accounts or approving the accounts, to carry the profits for a particular year to a separate profit reserve in the statement of financial position and the statement of changes in equity in a company's accounts, rather than to reduce the balance of accumulated losses carried forward by offsetting or netting the profits against the accumulated losses account in those statements. In the present case, the proposed Dividend is debited to retained earnings and funded from the Company's existing cash balance. The Company's retained earnings balance in the relevant year represents realised trading profits from previous years. The Company's carried forward losses from the current year and prior year were transferred to a separate loss reserve rather than reducing or offsetting the losses against retained earnings. The Company's financial statements indicate that prior year profits have not been offset or netted against accumulated losses in the accounts. Additionally, there are no facts to suggest that prior year profits have been or will be applied against accumulated losses. Based on the assumption that the proposed Dividend will be a valid dividend paid in accordance with section 254T of the Corporations Act 2001 and that the Company's directors pass a legally effective resolution specifying that the proposed Dividend is being paid entirely out of the Company's retained earnings account, it can reasonably be concluded that the proposed Dividend is neither directly nor indirectly sourced out of share capital. Accordingly, the proposed Dividend will not be unfrankable under paragraph 202-45(e). | Detailed Reasoning - Conclusion: As the proposed Dividend is not an unfrankable distribution under section 202-45, the proposed Dividend will be a frankable distribution under section 202-40.