The Commissioner of Taxation (Commissioner) has issued Draft Taxation Ruling TR 2011/D8 (Draft Ruling), which is about the taxation of dividends paid in compliance with section 254T of the Corporations Act 2001 (Corporations Act) from 28 June 2010. In particular, the Draft Ruling sets out the Commissioner’s preliminary view about the assessment and franking of dividends and the circumstances in which a dividend will be paid out of profits.
The release of the Draft Ruling was foreshadowed in the recent discussion paper which considered proposed changes to the test for paying dividends (Discussion Paper). Mallesons released an alert on the Discussion Paper, which can be found here.
There has been considerable uncertainty around the assessment and franking of dividends since section 254T was amended (effective 28 June 2010) and, more importantly, since the Australian Taxation Office released draft fact sheets in June this year on the impact of section 254T on the tax treatment of dividends. Whilst there remain some outstanding practical issues as to when a dividend will be frankable, the Draft Ruling goes some way to resolving the current tax uncertainty faced by Australian corporates.
The Commissioner’s views regarding the assessment and franking of dividends
In the Draft Ruling, the Commissioner provides his views on the assessment and franking of dividends in three broad cases. However, the Commissioner notes that the proper treatment of a dividend payment for taxation assessment and franking purposes is, in each case, a question of the application of the Corporations Act and the Taxation Acts to the facts and circumstances of the particular payment.
A dividend paid out of current trading profits
A company that pays a dividend to its shareholders:
in accordance with its constitution and without breaching section 254T or Part 2J.1 of the Corporations Act; and
out of current trading profits recognised in its accounts and available for distribution,
is not prevented by section 202-45(e) of the Income Tax Assessment Act 1997 from franking the dividend merely because the company’s net assets are of a value less than its share capital or the company has unrecouped prior year accounting losses. That dividend will be assessable income of its resident shareholders.
The Commissioner now recognises that prior accumulated losses do not have to be recouped before a dividend can be paid out of current year profits. However, if profits are applied against prior year losses or losses of share capital, or are otherwise applied or appropriated, the Commissioner considers that a dividend paid from such profits would be unfrankable if the company’s net assets were less than its share capital.
Therefore, the method of accounting for current year profits will be critical in determining whether a dividend paid out of such profits will be frankable. For example, in the Commissioner’s view, carrying the balance of a current year profit to the company’s continuous profit and loss account may represent an appropriation of the current year profit to make good past losses, such that a dividend paid from such profits is no longer frankable.
A dividend paid out of an unrealised capital profit account
A company that pays a dividend to its shareholders:
in accordance with its constitution and without breaching section 254T or Part 2J.1 of the Corporations Act; and
out of an unrealised capital profit of a permanent character recognised in its accounts and available for distribution,
is not prevented by section 202-45(e) from franking the dividend provided the company’s net assets exceed its share capital by at least the amount of the dividend. That dividend will be assessable income of its resident shareholders.
However, the Commissioner is of the view that in circumstances where a company has a deficiency of net assets below its share capital, whether a dividend can be paid out of an unrealised capital profit, and whether it would be a frankable distribution, depend on the specific circumstances of the loss of subscribed capital, the nature of the unrealised profit, whether the company’s accounts reveal other profits and losses, and the interpretation of section 254T.
A distribution that is an unauthorised reduction and return of share capital
A distribution (even if it is labelled as a dividend) paid by a company to its shareholders that does not comply with section 254T or Part 2J.1 of the Corporations Act, is an unauthorised reduction and return of share capital that, depending on the particular facts and circumstances of the payment:
The effect of the new section 254T of the Corporations Act
The Commissioner also sets out in the Draft Ruling that, consistent with legal advice received from Counsel, he believes that the better view is that the procedures to approve a share capital reduction in Part 2J.1 of the Corporations Act would also have to be met for a company to pay a dividend not prohibited by section 254T that was sourced from share capital. Central to this position is the Commissioner’s further view that, for the purposes of the Corporations Act and company accounting, dividends can only be paid from profits. In other words, the Commissioner is of the view that section 254T imposes three specified additional prohibitions on the circumstances in which a dividend can be paid, rather than broadening the ability to pay a dividend, as inherently a dividend can only be paid out of profits.
Curiously, the Commissioner’s views seem inconsistent with those recently expressed by Treasury in the Discussion Paper, being that the test for paying a dividend in section 254T is a circumstance where a reduction in capital is ‘otherwise authorised’ by the law. The Commissioner’s view also seems inconsistent with the intent of the amendments to section 254T (as evidenced in the explanatory materials to the amending legislation) to permit dividends to be paid out of the share capital account.
The Discussion Paper notes stakeholder concerns in this regard and invites stakeholder comments on whether a legislative amendment or note is needed clarifying that satisfying the test for paying a dividend in section 254T is a circumstance where a reduction in capital is authorised by law. If such a legislative amendment is made or note introduced, this may require the Commissioner to re-consider his views on this point, and possibly his view on the assessment and franking of certain distributions of a company.
We are intending to make submissions to the Australian Taxation Office on the Draft Ruling. Please do not hesitate to contact us if there are any issues or concerns that you would like us to highlight as part of this process.