Private ruling: Franked distributions and franking credits
Date of advice: 24 September 2015
Published: September 2015
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018
Date scheme commenced: 1 July 200X

Ruling: Q1: Will the payment of a franked distribution from Company A, flowing through a unit trust and then through various family trusts, and ultimately out to the beneficiaries of those family trusts, carry the relevant franking credits under Division 207 of the Income Tax Assessment Act 1997 (ITAA 1997) and will the beneficiaries be entitled to a tax offset pursuant to section 207-45 of the ITAA 1997? | A1: Yes

Relevant facts and circumstances: Company A is the family company of the family of persons A and B and the shares in this company are held by Company B as trustee for Trust A. Units in the shareholder are held equally by Trust B, Trust C, Trust D, Trust E and Trust F. Beneficiaries of each of these family trusts are the bloodline of persons A and B and/or any other company or trust in which the bloodline have any pecuniary interest. Company B is a substantial retailer and contractor in a state of Australia. Historically it has adopted a policy of retaining XX% of its after tax profits for further investment to produce further income and security for the family of persons A and B. The applicant of this ruling advises that there is significant concern that some of the tangible assets, particularly the cash that has been accumulated by Company A as after tax profits is exposed to third party claimants in one sort or another. The family is mindful of the need to protect their income flow; to grow the family's assets and to protect the family's assets. It is proposed to invest some but not all of the cash in further income producing commercial property which will be acquired on the open market if and when a suitable property can be found. To ensure that as far as practical the acquisition of the property or properties is protected against future claims from third parties it is proposed to declare a fully franked dividend by Company A. That dividend will flow to Company B as trustee for Trust A and the dividend will flow to the unit holders being those discretionary trusts listed above. It is proposed to pay franked dividends for Company A through to Trust A and that dividend will then flow to the unit holders $XXX each to Trust B, Trust C, Trust D, Trust E and Trust F. Trust B, Trust C, Trust D, Trust E and Trust F will include the dividend in the income of their respective trust estate and distribute it to the relevant beneficiaries in proportion to their entitlements to the income to which grossing up relates. The beneficiaries include 5 companies, one company for each Trust. The five companies will acquire a commercial property. The acquisition will be by the partnership of the five companies. The five companies will share the rents equally. Some of those rents will be reinvested after tax; some will be paid to shareholders for living and other activities. Each of the investment companies will pay tax on what are fully franked dividends but will be claiming tax relief for the amount of franking credit that has flowed from historic transactions of Company A. Trust B, Trust C, Trust D, Trust E and Trust F have made a family trust election in accordance with section 272-80 in Schedule 2F of the Income Tax Assessment Act 1936 (ITAA 1936) and each company beneficiary has made an interposed entity election in accordance with section 272-85 in Schedule 2F of the ITAA 1936.

Relevant legislative provisions: Income Tax Assessment Act 1936 paragraph 97(1)(a). | Income Tax Assessment Act 1936 section 160APHD. | Income Tax Assessment Act 1936 Division 1A of Part IIIAA. | Income Tax Assessment Act 1936 subsection 160APHJ(4). | Income Tax Assessment Act 1936 subsection 160APHJ(5) . | Income Tax Assessment Act 1936 section 160APHL. | Income Tax Assessment Act 1936 subsection 160APHL(7) . | Income Tax Assessment Act 1936 subsection 160APHL(10) . | Income Tax Assessment Act 1936 s ubsection 160APHL(14). | Income Tax Assessment Act 1936 section 160APHM. | Income Tax Assessment Act 1936 section 160APHO. | Income Tax Assessment Act 1936 section 160APHU. | Income Tax Assessment Act 1997 Division 207. | Income Tax Assessment Act 1997 section 207-35 | Income Tax Assessment Act 1997 subsection 207-35(1). | Income Tax Assessment Act 1997 subsection 207-35(3). | Income Tax Assessment Act 1997 subsection 207-35(4). | Income Tax Assessment Act 1997 section 207-45. | Income Tax Assessment Act 1997 section 207-50. | Income Tax Assessment Act 1997 subsection 207-50(3). | Income Tax Assessment Act 1997 subsection 207-50(5). | Income Tax Assessment Act 1997 section 207-55. | Income Tax Assessment Act 1997 s ection 207-57. | Income Tax Assessment Act 1997 section 207-150. | Income Tax Assessment Act 1997 subsection 207-150(1).

Reasons for decision: Detailed Reasoning - Grossing up of franking credits: For trusts and trust beneficiaries, section 207-35 of the ITAA 1997 provides (with certain exceptions) for a gross-up amount to be included in their assessable income. For a trustee that receives a franked distribution, the gross-up amount is equal to the franking credit on the franked distribution. For an ultimate recipient of a franked distribution, such as a trust beneficiary, the gross-up amount is equal to their share of the franking credit on the distribution. In the present circumstances, the planned distribution is to flow through a number of entities. Unit Trust The first recipient of the distribution will be the trustee for Trust A as the sole shareholder in Company A. The distribution will include the value of the franking credits on the distribution. Trust A will include in its assessable income pursuant to the operation of subsection 207-35(1) of the ITAA 1997 the amount of the franking credit on the distribution. Family Trusts (beneficiaries of the Unit Trust) Where a franked distribution is made to the trustee of a trust and the franking credit on that distribution is included in the assessable income of the trust pursuant to subsection 207-35(1) of the ITAA 1997 (as per above), a beneficiary of that trust will include so much of the franking credit amount as is equal to their share of the franking credit on the distribution in its assessable income where: • the franked distribution flows indirectly to the beneficiary; and • disregarding Division 6E of Part III of the ITAA 1936, the entity has an amount of assessable income that is attributable to all or part of the distribution (subsections 207-35(3) and (4) of the ITAA 1997). Subsection 207-50(3) of the ITAA 1997 provides that a franked distribution flows indirectly to a beneficiary of a trust, in this case each of the Family Trusts (Trust B, Trust C, Trust D, Trust E and Trust F), where: • the beneficiaries have a share of the Trust A's net income that is covered by paragraph 97(1)(a) of the ITAA 1936, and • the beneficiaries' share of the distribution under section 207-55 of the ITAA 1997 is a positive amount. The unitholders of the Trust A will be presently entitled to a share of the income of the Trust A's trust estate for the purposes of paragraph 97(1)(a) of the ITAA 1936. Where the net income of the Trust A is a positive amount (as assumed) the Family Trusts will be taken to have received the distribution indirectly pursuant to section 207-50 of the ITAA 1997. Accordingly, the Family Trusts will include so much of the franking credit amount as is equal to their share of the franking credit on the distribution. Beneficiaries of the Family Trusts The Trust Deeds for the relevant Family Trusts provide the trustee with the power to apply the income of the trusts to one or more beneficiaries, therefore allowing the trustee to make a beneficiary specifically entitled to the income of the trust under clause 4.2. In addition, the Trust Deeds at clause 9.3 specifically state that any franking credits are to remain attached to the distribution. In order for the amount to be a specifically entitled distribution, the amount of the net economic benefit that the beneficiary can reasonably be expected to receive is required to be recorded in its character as referable to the franked distribution in the accounts or records of the trust. These records include the trust deed, statements of resolution or distribution statements. Franked distributions made by Company A to Trust A will similarly flow indirectly to the beneficiaries of the Family Trust under subsection 207-50(3) of the ITAA 1997. In coming to this conclusion it is determined that the franked distributions flow indirectly through the Family Trusts in accordance with subsection 207-50(5) of the ITAA 1997. The beneficiaries of the Family Trusts to whom the franked distributions flow indirectly will include in their assessable income so much of the franking credit amount as is equal to their share of the franking credit on the distributions, pursuant to subsection 207-35(4) of the ITAA 1997. Each beneficiary will be entitled to a share of the franked distribution and a share of the franking credits as determined by section 207-55 and section 207-57 of the ITAA 1997 respectively. | Detailed Reasoning - Entitlement to tax offset: Pursuant to section 207-45 of the ITAA 1997, where a distribution flows indirectly to an entity that is the ultimate recipient of the distribution, as in the case of the beneficiaries of the relevant Family Trusts, they will be entitled to a tax offset equal to their share of the franking credit on the distribution. However, for a beneficiary of a trust estate to be entitled to a tax offset in respect of a franked distribution that has flowed indirectly to them, subsection 207-150(1) of the ITAA 1997 requires they must be a qualified person in relation to the distribution paid for the purposes of former Division 1A of Part IIIAA of the ITAA 1936. Qualified persons rule For a beneficiary of a non-widely held trust to be a qualified person for the purposes of former Division 1A of Part IIIAA of the ITAA 1936 (specifically, former section 160APHO of the ITAA 1936), they must hold their interest in shares on which a dividend has been paid at risk for not less than 45 days during the primary qualification period where no related payments have been made. (The Family Trusts in this matter would constitute non-widely held trusts for the purposes of former Division 1A as they would not be a widely held trust as defined in former section 160APHD.) In circumstances where the franked distribution flows through a number of trusts, the holding period rule must be satisfied at both the trustee and beneficiary level (as former section 160APHU of the ITAA 1936 provides that a beneficiary cannot be a qualified person unless the trustee is also a qualified person). Trust A Thus, at the first instance, the trustee of Trust A would need to be a qualified person with respect to its ownership of shares in Company A. The trust would need to satisfy the qualification period in former section 160APHO of the ITAA 1936 that is Trust A would need to hold its shares in Company A at risk as described in accordance with former section 160APHM for a period of at least 45 days. The net position of the trustee of the Trust A in relation to the shares held in Company A is calculated by adding the Trust A's 'long position' in the shares and 'short positions' in the shares (former subsection 160APHJ(5) of the ITAA 1936). A long position includes shares in relation to themselves with a delta of +1. At the time the trustee of the Trust A acquires the shares in Company A their net position is 1 (former subsection 160APHJ(4) of the ITAA 1936). Family Trusts (beneficiaries of the Trust A) With respect to the beneficiaries of the Trust A (the Family Trusts), it is necessary to determine the nature of their interest in the shares in Company A. In the present circumstance, former section 160APHL would allocate a position to the beneficiaries of the Trust A in respect to their interest in the shares to the extent that the beneficiaries have a vested and indefeasible interest in the Company A shares. An examination of the Trust Deed would indicate that such an interest does not exist. However, in the circumstances the Commissioner would exercise the discretion available to him in former subsection 160APHL(14) of the ITAA 1936 to determine the interest to be taken to be vested and indefeasible. As such, the beneficiaries (the Family Trusts) would be capable of being qualified persons if they hold their interest for the primary qualification period, as assumed. Beneficiaries of the Family Trusts As the trustee of each Family Trust is a qualified person, it is necessary to consider whether the beneficiaries of each Family Trust are also a qualified person. Former subsection 160APHL(7) of the ITAA 1936 provides that at a taxpayer's interest in a share is a long position with a delta of +1 in relation to itself. Former subsection 160APHL(10) of the ITAA 1936 explains that in certain circumstances the taxpayer will have an additional short position equal to the taxpayer's long position that arose under former subsection 160APHL(7). However as there are family trust elections in place the additional short position otherwise imposed by subsection 160APHL(10) of the ITAA 1936 will not be deemed. The beneficiaries would be taken to have a position with a delta of +1 with respect to their interest in the Company A shares pursuant to the operation of former section 160APHL of the ITAA 1936. If this position is held at risk for the relevant qualification period, the beneficiaries are also capable of being qualified persons with respect to the franked distribution that flows indirectly to them. As such, subsection 207-150(1) of the ITAA 1997 would not operate to deny a tax offset entitlement in the circumstances of the distribution described in this ruling.