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On 21 June, the Australian Tax Office (ATO) issued two draft 'fact sheets' relating to the taxation of the payment of dividends. This follows amendments to section 254T of the Corporations Act designed to allow companies to pay dividends based on balance sheet and solvency tests, rather than dividends needing to be paid out of profits.
In the draft 'fact sheets', the ATO has expressed the view that 'dividends' paid otherwise than out of profits might not be treated as frankable dividends for tax purposes. This is because such payments could, on the ATO's analysis, be regarded as being sourced out of share capital (based on the definition of 'dividend' in section 6 of the Income Tax Assessment Act 1936). This is despite a specific amendment to section 44(1A) to deem dividends paid other than out of profits as being dividends paid other than out of profits as being dividends out of points for tax purposes.
The ATO also expresses the view that where nets assets are less than paid up capital, dividends will necessarily be sourced from share capital.
Whether or not one accepts the ATO's logic, the issue is acute for companies that have accumulated losses - which can arise from corporate restructuring transactions, as well as from trading losses.
It appears that the ATO does not accept that a dividend out of current year profits can be franked where accumulated losses exist. In our view, such a position is not correct as a matter of corporate law because in Australia at least, the retained earnings account is not a running account, and losses do not have to be made up before current year profits can be made available for dividend. This is a well established principle of corporate law. If the ATO does not reconsider its position, it may be that the Government will need to move to amend the tax legislation to clarify the position.
However, regardless of the correctness of the ATO's view, it appears that the ATO will accept that a 'lost capital reduction' under section 258F of the Corporations Act - or if that is not available for any reason than a capital reduction under section 256B of the Corporations Act, whereby the capital of the company is reduced by the amount of accumulated losses, will solve the problem, and permit dividends from current year earnings to be franked.
Companies with accumulated losses should now be considering capital reductions to ensure dividends from current year profits can be ranked.
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