Private ruling: Frankable distributions
Date of advice: 9 December 2015
Published: February 2016

Ruling: Q1: Will the dividend be a frankable distribution under section 202-40 of the Income Tax Assessment Act 1997 ? | A1: Yes

Relevant facts and circumstances: Company C is an unlisted public company and a resident for Australian taxation purposes. Company C has paid dividends to its shareholders in previous years. Company C proposes to declare and pay a fully franked dividend. Company C intends to pay a dividend from one or two reserves. Company C will not debit any part of the dividend against its share capital account. Company C has sufficient balance in its franking account to fully frank the dividend.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 202-5 | Income Tax Assessment Act 1997 Section 202-40 | Income Tax Assessment Act 1997 Section 202-45 | All legislative references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated. Summary | The dividend will constitute a frankable distribution under section 202-40.

Reasons for decision: Summary: Section 202-5 sets out the following must be present when a distribution is franked: • the entity is a franking entity, that is, it is a corporate tax entity, and an Australian resident when the distribution is made • the distribution is a frankable distribution, and • the entity allocates a franking credit to the distribution. Section 202-40 provides that a distribution is a frankable distribution, to the extent that the distribution is not unfrankable under section 202-45. A 'distribution' by a company is defined in subsection 960-120(1) as: … a dividend, or something taken to be a dividend, under this Act. Pursuant to section 995-1, the term 'dividend' has the meaning: … given by subsections 6(1) and (4) and 6BA(5) and section 94L of the Income Tax Assessment Act 1936. The Commissioner is satisfied that the dividend will be a distribution that constitutes a 'dividend' as defined pursuant to subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) as: • Company C will make the distribution to its shareholders in money [paragraph (a) of definition], and • No part of the distribution will be debited to amounts standing to the credit of the share capital account of Company C [paragraph (d) of definition]. Section 202-45 provides: The following are unfrankable: (a) (Repealed by No 101 of 2003) (b) a distribution to which paragraph 24J(2)(a) of the Income Tax Assessment Act 1936 applies that is taken under section 24J of the Income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); (iv) section 47A of that Act (distribution benefits - CFCs); (h) an amount that is taken to be an unfranked dividend for any purpose: (i) under section 45 of that Act (streaming bonus shares and unfranked dividends); (ii) 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. Each of these paragraphs is considered in turn below. Paragraph 202-45(b) Paragraph 202-45(b) refers to paragraph 24J(2)(a) of the ITAA 1936 which is concerned with dividends paid by Territory companies or dividends sourced from Territories. As the dividend will not arise from a prescribed Territory and Company C is not a Territory company, neither paragraph 24J(2)(a) of the ITAA 1936 nor paragraph 202-45(b) is relevant to the dividend. Paragraph 202-45(c) Paragraph 202-45(c) is concerned with dividends which form part of an off-market share buy-back price pursuant to section 159GZZZP of the ITAA 1936 when the price exceeds the market value of the share at the time of the buy-back worked out as if the buy-back neither took place nor was never announced. The dividend does not form part of a price for the buy-back of shares and therefore paragraph 202-45(c) will not apply to render the dividend an unfrankable distribution. Paragraph 202-45(d) Paragraph 202-45(d) is concerned with distributions in respect of non-equity shares. Subsection 995-1(1) provides that a non-equity share means a share that is not an equity interest in the company. As the shares in Company C will remain ordinary shares which constitute equity interests, paragraph 202-45(d) is not relevant for the proposed dividend. Paragraph 202-45(e) Paragraph 202-45(e) is concerned with a distribution that is sourced, directly or indirectly, from a company's share capital account. The dividend will be debited to, and therefore sourced from, one or two reserves of Company C. The ATO is satisfied that neither of the reserves form part of the share capital account or records one or more entries against the share capital account. Further, no part of the dividend will be debited to the share capital account of Company C. Therefore, the dividend will not be sourced, directly or indirectly, from its share capital account and therefore paragraph 202-45(e) will not apply. Paragraph 202-45(f) Paragraph 202-45(f) provides that an amount is unfrankable if it is taken to be an unfrankable distribution under section 215-10 or section 215-15. Section 215-10 applies to non-share dividends paid by an authorised deposit-taking institution (ADI) and section 215-15 applies non-share dividends that are unfrankable if profits are not available. As Company C is not an ADI and the dividend will be paid on ordinary shares (rather than on equity interests that are not shares), paragraph 202-45(f) is not relevant for the dividend. Paragraph 202-45(g) Paragraph 202-45(g) is concerned with distributions subject to Division 7A, section 109 and section 47A of the ITAA 1936. Subparagraph 202-45(g)(i) Division 7A of the ITAA 1936 relates to distributions to entities connected with a private company. Section 103A of the ITAA 1936 sets out criteria used to identify when there is a private company. Subsection 103A(1) of the ITAA 1936 provides that a company is a private company if the company is not a public company in the relevant year of income. As Company C is not a private company, Division 7A of the ITAA 1936 is not applicable and therefore subparagraph 202-45(g)(i) is not relevant. Subparagraph 202-45(g)(iii) Section 109 of the ITAA 1936 is considered when a private company pays or credits an amount to an associated person. As discussed for subparagraph 202-45(g)(i) above, Company C is not treated as a private company, therefore section 109 of the ITAA 1936 will not apply and in turn subparagraph 202-45(g)(iii) is not relevant. Subparagraph 202-45(g)(iv) Section 47A of the ITAA 1936 applies when a company distributes an amount after 3 June 1990 and is a CFC and resident of an unlisted country at the distribution time. As Company C is not a CFC, neither section 47A of the ITAA 1936 nor subparagraph 202-45(g)(iv) is relevant. Paragraph 202-45(h) This paragraph renders a distribution as unfrankable where the distribution is taken to be an unfranked dividend under section 45 of the ITAA 1936, or due to a determination made by the Commissioner under section 45C of the ITAA 1936. Subparagraph 202-45(h)(i) Section 45 of the ITAA 1936 applies when a company streams the provision of shares (other than shares to which subsection 6BA(5) of the ITAA 1936 applies) and the payment of minimally franked dividends, in a way that results in some but not all shareholders receiving shares, and some or all of the other shareholders receive or will receive minimally franked dividends (which are either unfranked dividends or dividends franked at less than 10%). Company C will not issue any bonus shares and will fully frank the dividend. Further, the dividend will be paid to all shareholders of Company C. Accordingly, neither section 45 of the ITAA 1936 nor subparagraph 202-45(i) will apply. Subparagraph 202-45(h)(ii) Section 45C of the ITAA 1936 applies when the Commissioner makes a determination under subsection 45A(2) or 45B(3) of the ITAA 1936. Should section 45C of the ITAA 1936 apply, the remedy is to treat a distribution of share capital or some other capital benefit as a dividend (which is unfrankable under this subparagraph). Sections 45A and 45B apply to distributions of share capital and other capital benefits. As the dividend is not a distribution of share capital or some other capital benefit, subparagraph 202-45(h)(ii) will not apply. Paragraph 202-45(i) Paragraph 202-45(i) is not relevant as the dividend is not a demerger dividend. Paragraph 202-45(j) Paragraph 202-45(j) is not relevant as Company C is not subject to small business relief under section 152-125, nor is Company C a 'NZ franking company' as defined in section 220-30 for the purposes of section 220-105. | Detailed Reasoning - Conclusion: As the dividend that Company C will pay is not an unfrankable distribution pursuant to section 202-45, the dividend will constitute a frankable distribution under section 202-40.