On 16 November 2023, the Federal Government passed legislation which denies the benefit of franking credits on certain distributions funded by (equity) capital raisings.
The legislation has been passed following a public consultation process. The drafting of the Bill as originally introduced into Parliament raised concerns about the potential for unintended and significant consequences of the proposed legislation. The legislation as passed contains a number of significant differences from that Bill.
The intent of the most important changes are:
- the denial of franking credits applies to a distribution if the capital raising funds at least a substantial part of the distribution (rather than any part of the distribution); and
- if the provision applies, only the portion of the distribution that is funded by the capital raising will be unfrankable.
This seeks to address two of the major concerns which had been expressed in relation to the Bill.
A copy of the legislation as passed can be found here. The Explanatory Memorandum and Supplementary Explanatory Memorandum can be found here and here.
Start date delayed
The measures will apply to distributions made on or after the day after the legislation receives Royal Assent.
Scope of the legislation
The changes to the Bill, from when it was first introduced, include:
- Gateway into the provisions - substantial part: The principal effect, and the purpose, of the issue of the equity must be the direct or indirect funding of a substantial part of the relevant distribution or a relevant part of the distribution. While it seems that this amendment is intended to narrow the scope of the provisions, in our view it may inadvertently broaden them as the test also applies to a substantial part of a “relevant part”.
- Proportionate application of the provision: Under previous iterations of the Bill, the entire distribution ceased to be frankable if the gateway conditions were met. This effect was disproportionate to the mischief the rules were seeking to address. The legislation now addresses this by providing that the measures can apply to a “relevant part” of a distribution. That is, it is intended that only the portion of the distribution that is funded by the capital raising will be unfrankable.
While the intent of the legislation to provide for a more proportionate response compared to previous versions of the Bill is welcome, the drafting does not, in our view, provide the desired level of clarity.
- No application where equity issued in response to a direction from APRA or ASIC: A distribution funded by an equity raising will not be unfrankable where the issue of equity is a direct response to a requirement, direction or recommendation from APRA or ASIC.
The terms of the Explanatory Memorandum have been expanded to adjust previous examples.
Key concerns remain
The changes to the scope of the legislation are designed to provide a more sensible outcome in relation to the operation of the legislation. However, there remains significant concerns that the drafting of the legislation does not properly reflect the expressed outcome as set out in the terms of the Explanatory Memorandum. The amendments seek to reflect both:
- an alteration to the gateway requirements to the operation of the provision; and
- an adjustment to the scope and nature of the operation of the provisions when they apply.
The drafting does not, in our view, make it clear that this outcome is achieved.
- Interaction with current dividend policy is inappropriate: Despite being raised as a concern in the Senate Economics Legislation Committee inquiry, the legislation may apply where:
- there is any variance from an existing dividend policy; or
- the entity does not have a practice of making distributions of the same type as the distribution to which the rules apply, on a regular basis.
This remains a very low standard, creates ambiguity as to the scope of the operation of the provision, and imposes potentially inappropriate commercial limitations on the flexibility of companies to pay dividends. Companies should ensure they have adequate procedures in place to assess the application of these provisions whenever a distribution is paid outside of regular practice or in a manner that departs from the existing dividend policy.
- Dividend reinvestment plans and family or commercial dealings of private companies may still be caught: The Supplementary Explanatory Memorandum states that:
- dividend reinvestment plans undertaken for normal commercial purposes; and
- family or commercial dealings of private companies to facilitate the departure of one or more shareholders from the company,
are not intended to be caught. While this is a welcome statement, the legislation does not include any specific drafting to address these matters.
Australian Taxation Office (ATO) guidance
We consider it will be critical that the ATO provides guidance that clearly indicates that the relevant law is to be administered in a manner consistent with the statements in the Explanatory Memorandum, notwithstanding the potential ambiguity in the drafting of the relevant provisions.
This guidance will be important to minimise the risk of the application of the provisions in unintended circumstances.
It is important to note that the gateway to the operation of the relevant provision is still dependent on any kind of variation from an existing dividend policy.
In the event that there is no dividend policy, the provisions may apply to any distributions made.
As we have noted in our previous submissions to the Senate Economics Legislation Committee and during the consultation process, we regard this as a significant concern in relation to the potential operation of the provision.
It appears on the face of the legislation that it is sufficient that there is any difference between any existing dividend policy and the distribution in question (i.e. the difference does not need to be material).
It would be helpful if the ATO were to provide guidance that it will only administer the measure in respect of a distribution:
- where there is an existing distribution policy – where the distribution is significantly or materially different from that distribution policy; and
- where there is no existing distribution policy – where the distribution is significantly greater than that which might reasonably be expected to have been paid.
We are here to help
Please reach out to your usual KWM tax contact to discuss the impact of these rules on your business.
Want to know more?
You can find our previous alerts and statements on this topic, as well as our submission to the Senate Economics Legislation Committee below:
- Submissions in response to the Senate Economics Legislation Committee inquiry
- Banks relieved as Senate report urges a government rethink on franking credits crackdown
- Where are my franking credits? Senate economics committee publishes findings on proposed franking measures
- Full steam ahead: Federal Government presses ahead with capital management measures
- Announced but unenacted tax measures keep Australian taxpayers in the dark
- Uncertainty on franking: Treasury revives old franking credit announcement
