Private ruling: Frankable distribution
Date of advice: 1 March 2017
Published: August 2017
Ruling period: 1 July 20XX to 30 June 20YY
Date scheme commenced: 1 July 20YY

Ruling: Q1: Will the dividend declared and paid by A Co and debited against the amount standing to the credit of A Co's 20YY profit reserve account not be unfrankable pursuant to paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes

Relevant facts and circumstances: The ruling was based on, and the Commissioner relied on, statements made by the applicant. An Australian resident company ('A Co') has accumulated accounting losses balance of $xxx million as at financial year end 30 June 20XX in its retained earnings/accumulated losses account. For the financial year ending 30 June 20YY, A Co expects to make a profit. A Co intends to declare and pay franked dividends to its shareholders after 30 June 20YY from the profit made in the financial year ending 30 June 20YY ('Dividend Payment'). The profit made in the financial year ending 30 June 20YY will be recorded in A Co's 20YY profit reserve account (20YY Profit Reserve). The directors of A Co will pass a legally effective resolution to pay the Dividend Payment, specifying that the Dividend Payment will be entirely out of the 20YY Profit Reserve account. The balance of the 20YY Profit Reserve will not be offset against the balance of the accumulated losses account. A Co and its directors are entitled under the Corporations Act 2001 ( the Corporations Act) and the constitution of A Co to create a separate 20YY Profit Reserve account on or prior to its directors formally adopting the accounts for 20YY. The creation of the separate 20YY Profit Reserve account will be recorded and recognised in the parent entity note in the consolidated financial statements for 20YY in accordance with the directors' resolution and relevant accounting standards. A Co and its directors are entitled under the Corporations Act and the constitution of A Co to source and debit the proposed Dividend Payment against the separate 20YY Profit Reserve account. Such dividend will not require shareholder approval under Part 2J.1 of the Corporations Act. A Co will debit the proposed Dividend Payment against the separate 20YY Profit Reserve account in accordance with the directors' resolution and the relevant accounting standards. A Co and its directors are entitled under the Corporations Act and the constitution of A Co to retain the separate 20YY Profit Reserve account, notwithstanding the fact that A Co may incur accounting losses in the years following 30 June 20YY.

Relevant legislative provisions: Paragraph 202-45(e) Income Tax Assessment Act 1997

Reasons for decision: Summary: Subsection 202-40(1) of the ITAA 1997 states: A *distribution is a frankable distribution , to the extent that it is not unfrankable under section 202-45. Relevantly, paragraph 202-45(e) of the ITAA 1997 states: The following are unfrankable : … (e) a distribution that is sourced, directly or indirectly, from a company's *share capital account. Subsection 975-300(1) of the ITAA 1997 states: (1) 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. The '20YY Profit Reserve account' is not a 'share capital account' of A Co under section 975-300 of the ITAA 1997 as it is not an account that A Co will keep of its share capital and will not have a credit entry to the account of an amount of share capital, but rather is an account that will consist of a credit entry of its full year profit for the income year ending 30 June 20YY. Distribution? The proposed Dividend Payment will be a 'dividend' made by a company (A Co) to its shareholders as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as it will not be debited against an amount standing to the credit of the share capital account of A Co. The proposed Dividend Payment will therefore be a 'distribution', in relation to a company entity (A Co), as defined in item 1 of the table in subsection 960-120(1) of the ITAA 1997. The proposed Dividend Payment is therefore a distribution for the purposes of considering the application of paragraph 202-45(e) of the ITAA 1997. Sourced, directly or indirectly, from A Co's share capital account? Unlike the definition of dividend in subsection 6(1) of the ITAA 1936, paragraph 202-45(e) of the ITAA 1997 does not require the amount of a distribution to be debited against amounts standing to the credit of the company's share capital account. Rather, it requires the distribution to be 'sourced', directly or indirectly, from it. Guidance as to whether the Proposed Dividend Payments is sourced, directly or indirectly, from A Co's share capital account is provided in Taxation Ruling 2012/5 - Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010 (TR 2012/5). The directors of A Co are expected to pass a legally effective resolution to pay the proposed Dividend Payment and will specify that the payment of the dividend will be paid entirely out of the 20YY Profit Reserve account. The 20YY Profit Reserve account will be entirely separate from the accumulated losses/retained earnings account and the balance of the 20YY Profit Reserve account will not be offset against the balance of the accumulated losses/retained earnings account. Although A Co had accumulated losses of $xxx million as at 30 June 20XX, paragraph 3 of Taxation Ruling TR 2012/5 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. Therefore, the proposed Dividend Payment declared and paid by A Co and debited against the amount standing to the credit of the 20YY Profit Reserve account will not be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997. i.e. it will not be taken to be sourced, directly or indirectly, from A Co's share capital account.