Let's start by going back in time. It's early 2019, we exist in the unknown bliss of 'normality' before our unprecedented bushfire season, the life altering impact of COVID-19 and what will become a third year of flooding due to consecutive La Niña weather events. It was a simpler time, with our news cycle focusing on an upcoming Federal election and Labor trying to promote their policy of preventing the refunding of excess franking credits. MinterEllison has Chris Bowen in our offices explaining all the detail to our clients. History remembers Labor's loss resting primarily on this policy and, following a subsequent review, the new leader of the Labor party – now Prime Minister, Anthony Albanese – scrapped the franking credits policy, seemingly for good.
Fast forward to 2022, we are still trying to figure out what 'normal' is, another La Niña event is on the horizon and Labor won the Federal election in a landslide. With the release of the Government's first budget tomorrow, the Government has already set out to make economic changes in an area that proved too contentious only a few years ago – franked dividends.
Background and significant retrospectivity application
As part of the former Liberal Government's 2016‑17 Mid‑Year Economic and Fiscal Outlook, an integrity measure was announced to prevent the distribution of franking credits where a distribution to shareholders is funded by particular capital raising activities. This was in response to the Australian Taxation Office's concerns raised in the Taxpayer Alert TA 2015/2: Franked distributions funded by raising capital to release credits to shareholders. Despite this announcement, nothing was ever implemented, legislated or discussed further – until now.
The Government has reinvigorated the previous Government's announcement and decided to action the integrity measure. Not only has actioning this measure been proposed but, in its current form, it will have retrospective application of almost six years and extend beyond the initial concerns raised in the taxpayer alert (while there has been significant concern raised with a number of aspects of the measure, the retrospectivity may be at the top of the list and thus the most likely to change).
Proposed Legislation
The Government released the exposure draft legislation, Treasury Laws Amendment (Measures for a later sitting) Bill 2022: Franked distributions funded by capital raisings and the associated draft explanatory memorandum on 14 September 2022. Together, the draft materials aim to prevent companies from attaching franking credits to a distribution where the distribution is funded by a capital raising.
This would have the effect of denying the investor the tax offset for the franking credit and expose purportedly franked dividends paid to foreign shareholders to a withholding tax liability.
The detail
Distributions will be unfrankable if 'funded by capital raisings'.
Under the proposed changes, a distribution is funded by a capital raising if all of the following three criteria are satisfied:
- the distribution is not consistent with an established practice of making distributions of that kind (or there is no existing practice);
- there is an issue of tax equity (e.g. shares) before, at or after the distribution was made; and
- either: a) the principal effect of the issue of any equity interest was funding of the distribution; or b) any entity that issues (or facilitated the issuance of) the equity did so for a purpose (other than an incidental purpose) of funding part of the distribution in question.
The measures provide specific factors to be considered to determine whether there is a practice of making distributions (including integrity provisions which exclude from the 'established practice' prior distributions which go towards the mischief the amendments seek to prevent).
MinterEllison observations
- Putting aside the concerning retrospective aspect, there are a number of other aspects that warrant further consideration:
- The measures add significant further complexity that taxpayers will need to consider every time prior to seeking to frank a dividend;
- Dividend reinvestment plans could easily be caught by the rules (creating different tax liabilities for those investors who participate in the dividend reinvestment plan and those that don't);
- Share (and non-share) buy backs with a deemed dividend component may be caught where there is a related tax equity issuance;
- Care will need to be taken when any form of tax equity (not just shares) is issued (including by related entities) to ensure that the issuance doesn't impact the ability to frank distributions;
- Australian Taxation Office guidance will be required on the application of the purpose and effect provisions; and
- Where the law has retrospective effect, it is not clear how in practice the law will be administered. For example, will each impacted investor have to amend their relevant income tax returns?
If this measure is legislated, it also begs the question – by implementing this change, are we going to see a gradual move away from the imputation system? A cynic might suggest that it could be just the start.
Update:
The draft bill regarding the proposed integrity measures relating to franked distributions was amended and then passed by both houses of Parliament on 16 November 2023. Please see our updated analysis on franked distributions funded by capital raisings.
