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On 21 December 2011, the Commissioner of Taxation issued Draft Taxation Ruling TR 2011/D8 (Draft TR) on 'Section 254T of the Corporations Act and the assessment and franking of dividends paid from 28 June 2010'. This article discusses the Draft TR.
Under the Corporations Amendment (Corporate Reporting Reform) Act 2010 (2010 Act), former s 254T of the Corporations Act 2001, which provided that a dividend may only be paid out of profits of the company, was replaced with a new s 254T with effect from 28 June 2010.
The new s 254T provides that a company must not pay a dividend unless:
(a) the company's assets exceed its liabilities [as determined in accordance with accounting standards in force at the relevant time] immediately before the dividend is declared and the excess is sufficient for the payment of the dividend;
(b) the payment of the dividend is fair and reasonable to the company's shareholders as a whole; and
(c) the payment of the dividend does not materially prejudice the company's ability to pay its creditors.
The Draft TR considers the implications of this change to s 254T for the taxation treatment of dividends, in particular, the questions of when a dividend is assessable under s 44 of the Income Tax Assessment Act 1936 (Cth) (ITAA 1936) and when it is frankable under the imputation provisions in Part 3-6 of the Income Tax Assessment Act 1997 (Cth) (ITAA 1997) (together, the ITAA).
The Commissioner also released a copy of the joint opinion of Mr Tony Slater QC and Mr James Hmelnitsky, dated 29 November 2011, obtained by the Commissioner in the process of formulating the Draft TR.
A 'dividend' is defined in s 6(1) of the ITAA 1936 to include any distribution made by a company to any of its shareholders (whether in money or other property) and any amount credited by a company to any of its shareholders as shareholders, but not including moneys paid or credited, or property distributed, by a company to a shareholder where the amount of money or property is (subject to certain exceptions) debited against the amount standing to the credit of the company's 'share capital account'.1 The new s 254T does not affect the specific inclusions or exclusions in this definition. As the definition in s 6(1) is an inclusive one, it also includes the ordinary meaning of 'dividend' (subject to the specific exclusions).
As the Commissioner points out in the Draft TR, the tax law definition is broader than the corporations law meaning and a distribution by a company to a shareholder is prima facie a dividend unless one of the exclusions from the definition applies. He further says that, in determining whether a distribution is debited to the share capital account (so as not to be a dividend for tax purposes), it is necessary to look at the substance of the transaction, from the company's perspective. For example, if a distribution is debited to a new account, producing a negative balance in that account (as in Consolidated Media Holdings Ltd v FC of T  FCA 367, in which the taxpayer debited a distribution to an account entitled 'Share Buy-Back Reserve Account' that had never had a credit balance, creating a negative balance in that account equal to the amount debited - the Federal Court held that the distribution was, as a matter of substance, debited to the share capital account).
The Draft TR also says that a dividend requires an appropriation of profits recognised in the company's accounts - that is, the profits must generally be recognised in the company's accounts for the current year or a prior year and must be available for distribution by way of a dividend. It says that profits that are applied against prior year losses or losses of capital cease to be available for distribution but a current year profit can be available for distribution, even where there are prior year losses, provided the current year profit has not been applied against those losses.
The Draft TR says that the source of profits from which a dividend is paid would usually be expected to be recorded in the directors' minutes of the resolution determining to pay the dividend or accompanying documentation.
Subsection 44(1) of the ITAA 1936 provides that a dividend paid by a company to a shareholder in the company is assessable to the shareholder to the extent that the dividend is paid out of profits derived by the company from any source (in the case of a resident shareholder) or from a source in Australia (in the case of a non-resident shareholder).
As a result of the change to s 254T, s 44(1A) was inserted into the ITAA 1936 to provide that, for the purposes of the ITAA, a dividend paid out of an amount other than profits is taken to be a dividend paid out of profits.
Section 202-40 of the ITAA 1997 provides that a dividend is 'frankable' for the purpose of the imputation provisions, except to the extent that it is not frankable under s 202-45. That is, any dividend (whether paid out of profits or otherwise) is prima facie frankable unless it is an amount that is specified to be unfrankable under s 202-45. Relevantly, s 202-45(e) provides that a dividend that is sourced, directly or indirectly, from a company's share capital account is unfrankable. Thus:
The Draft TR says that s 44(1A) does not have the effect that s 202-45(e) will never apply, as the test under that paragraph is not whether the dividend is paid out of profits but whether it is directly or indirectly sourced from the share capital account. A profit that is deemed to be paid out of profits under s 44(1A) could still be sourced directly or indirectly from profits for this purpose.
A payment by a company to a shareholder in respect of their shares that is notan assessable dividend gives rise to a CGT event G1at the time of the payment.2 Under this CGT event, the shareholder's cost base in the relevant shares is reduced by the amount of the payment and, if the payment exceeds that cost base, the cost base is reduced to nil and the shareholder makes a capital gainequal to the excess (but a capital loss cannot arise).
The Draft TR says the better view is that:3
It goes on to say that, if s 254T did authorise the payment of a dividend out of an amount other than profits, the tax consequences would be that the dividend is assessable to a resident shareholder by virtue of s 44(1A) and would not be prevented from being frankable by virtue of s 202-45(e), provided that the company's net assets exceeded its share capital by at least the amount of the dividend.
The Draft TR rules in relation to the following 3 general cases of distributions by a company to its shareholders:
1. Dividend paid in compliance with s 254T4 out of current trading profits recognised in the company's accounts and available for distribution, where company has unrecouped prior year accounting losses or has lost part of its share capital - the Draft TR says that such a dividend is:
2. Dividend paid in compliance with s 254Tout of an unrealised capital profit of a permanent character recognised in the company's accounts and available by distribution - the Draft TR says such dividend is:
3. Distribution (even if labelled a 'dividend') that does not comply with s 254T and is an unauthorised reduction and return of capital - the Draft TR says that such a dividend is (depending on the particular facts and circumstances of the payment) either:
It is the third category above in respect of which the Draft TR gives little guidance or certainty and is perhaps the most controversial.
The Draft TR gives 5 examples, as follows:
The Draft TR confirms that the following dividends remain frankable:6
The Draft TR says whether a dividend can be paid out of unrealised profits and whether such a dividend is frankable is a question of fact and law, depending on the specific circumstances of the loss of subscribed capital, the nature of the unrealised losses, whether there are any other profits or losses in the company's accounts and the interpretation of s 254T, saying that this issue cannot be dealt with in the ruling. This is not particularly helpful and leaves unacceptable uncertainty. At the very least, further examples dealing with these types of cases should be included in the ruling.
The Draft TR also does not deal with the application of specific anti-avoidance rules such as s 45B (the so-called 'dividend substitution rule') or s 177EA of the ITAA 1936 in the context of the new s 254T.
Submissions on the Draft TR were due by 24 February 2012.
1 The 'share capital account' is the account (whatever called) that the company keeps of its share capital - essentially, moneys up for the issue of shares by the company. However, a share capital account that is 'tainted' by virtue of amounts having been transferred to it from another account of the company (such as a profit account) is not a 'share capital account' for this purpose.
2 Section 104-135 of the ITAA 1997.
3 This may not be consistent with Treasury's view of the effect of s 254T, as indicated in its Discussion Paper entitled 'Proposed Amendments to the Corporations Act'', issued on 30 January 2012, dealing with concerns expressed about the changes to the Corporations Act , including the new test for payment of dividends in s 254T.
4 And also, as noted in the Draft TR, in accordance with the company's constitution.
5 It is noted that there is also a 'residual' CGT event (i.e. CGT event H2) under s 104-155, which applies where an act, transaction or event occurs in relation to a CGT asset that does not result in an adjustment being made to its cost base (as happens under CGT event G1). Under this CGT event, a capital gain arises equal to the capital proceeds received for the event minus any incidental costs incurred in relation to the event (i.e. with no allowance for the rest of the cost base of the asset). It is, however, difficult to see how CGT event H2 could apply here.
6 Uncertainty in this regard was created by Draft Fact Sheets issued by the Commissioner in June 2011.
7 For example, it has been suggested that, if an annual running balance of the accumulated profits and losses is kept, with the current year profits simply being carried to that balance, this may be regarded as an application of those profits such that they are not available for distribution as a dividend.
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