Tax Insight: New Bill to Amend Imputation

Summary

A Bill was introduced into Parliament on 16 February 2023 to give effect to two changes, both of which will restrict shareholders” access to franking credits. The measures affect special dividends occurring in conjunction with a capital raising and off-market share buy-backs undertaken by listed public companies. There has been some adjustment to the draft versions of the provisions, but the thrust of the measures remains the same.

Special dividends funded from the issue of new equity

The treatment of special dividends occurring in conjunction with a capital raising was first raised as a matter of concern by the ATO in a 2015 Taxpayer Alert. In December 2016, Scott Morrison (the first time he was Treasurer) announced that the Government would enact legislation to deny franking credits for such distributions with effect from 19 December 2016. The matter lay dormant until September 2022, when Treasury released an Exposure Draft of legislation to give effect to the announcement. More detail on the background to this measure is in our Tax Insight available here.

The Bill will make a dividend an unfrankable distribution where 3 conditions are met:

1. the company makes a distribution not in accordance with its usual practices for that kind of distribution (a “pattern of distributions” test);
2. there is an issue of equity interests either by the entity or another entity; and
3. it is reasonable to conclude “having regard to all relevant circumstances” that

1. 1. the principal effect of issuing any of the equity interests was to fund the relevant distribution, directly or indirectly, and in whole or in part; and
   2. the entity that issued, or facilitated the issue of, the equity interests did so for a purpose (other than an incidental purpose) of funding the relevant distribution or part of the relevant distribution (a “purpose and effect” test).

There was extensive consultation on this measure, particularly with regard to curtailing the unintended consequences arising from the drafting, and the formulation in the Bill differs from the Exposure Draft in 3 main respects.

First, and very importantly, the 3^rd test now requires that both the purpose and the effect of the issue of equity was to fund the relevant distribution. This must be the purpose of the entity that issued (or facilitated) the equity interests.

There was a serious concern under the earlier version that the rule could be enlivened if one party to a deal raised equity to finance a transaction and directly or indirectly it could be concluded that the principal effect or incidental purpose was that the other (unrelated) party happened to use the funds raised to pay a dividend. The requirement that the entity raising the funds must have the purpose of financing the dividend paid by the recipient should reduce this exposure to some extent. For example, a bank raising equity funds which it loans to an unrelated company to pay a distribution should, absent more, not be sufficient to trigger these provisions. However, a buyer raising equity to acquire a target which pays a pre-sale dividend may still be at risk.

Secondly, the Bill adds to the list of factors which must be considered in reaching the conclusion that the purpose and effect of the capital raising is to fund the distribution. The list of factors to examine now includes a requirement to:

• compare the movements and balances in the franking account with the profile of profits and share capital of the entity; and
• compare the entities which subscribed for the new equity (or didn’t) and the entities which received the distribution (or didn’t); and
• if the entity making the relevant distribution is not the entity raising the equity, consider the nature and extent of the relationship between those entities.

Thirdly, the new rules will apply to distributions made on and after 15 September 2022; the Exposure Draft had back-dated the measure to distributions occurring from 19 December 2016.

The Explanatory Memorandum to the Bill contains examples of transactions which are regarded as abusive and others which are treated as innocuous, but as with most examples in EMs, they are at the ends of the spectrum and give little guidance about the hard cases in the middle.

While the amended Bill is an improvement on the earlier draft, it seems likely that companies with dividend reinvestment plans will now need to talk with the ATO before paying a special dividend to get ATO clearance.

And it worth noting, the effect of the provision is dramatic: if the rule is triggered, all of the distribution is unfrankable, not just the part referable to the funds raised via the new equity issue.

Buy-backs by listed companies

The proposal to deny franking credits for off-market share buy-backs undertaken by listed public companies was a surprise announcement in the October 2022 Budget. Treasury released an Exposure Draft of the legislation to deliver this measure in December 2022. More background to this measure is in our Tax Insight available here.

There was consultation on this measure after the Exposure Draft was released but the Bill differs only in regard to drafting style, not any changes of substance.

The main provision in the Bill proposes that none of the amount received by a shareholder in an off-market buy-back will be deemed to be a dividend if the buy-back is being undertaken by a listed public company. Since a buy-back by a listed public company does not give rise to a dividend for corporate law purposes, and is now not “taken to be a dividend” for tax purposes, the payment is not a “distribution” and so is not frankable.

In addition, a new franking debit is inserted to require a listed public company in an off-market buy-back to debit to its franking account to the extent that the buy-back price is not debited against the share capital account (even though none of the buy-back price is a frankable distribution). The amount of the debit is set at the company’s benchmark, or 100% if the company does not have a benchmark.

The legislation expands the scope of these rules from share buy-backs (and the accompanying cancellation of the share which happens under the Corporations Act), to include share cancellations occurring as part of a selective reduction of capital. A new provision will make unfrankable “a distribution by a listed public company that is consideration for the cancellation of a membership interest … as part of a selective reduction of capital.”

The Bill leaves most of the existing legislative framework for share buy-backs in place:

• the company undertaking the buy-back will still not trigger income, deduction, gain or loss,
• the tax treatment for shareholders in on-market transactions still generates only gain or loss, and not a dividend, and
• the tax treatment of shareholders in off-market transactions remains unaffected for companies that are not listed public companies.

The amendments will apply to buy-backs and selective share cancellations undertaken by listed public companies announced to the market after 25 October 2022.