In October 2022 we provided our insights on the Government's draft legislation which proposed changes to franked dividends and capital raisings. Since then, the following things have occurred:

• on 25 October 2022 the Government publicly announced its October 2022-23 Budget, which included mention of an 'Improving the integrity of off-market share buy-backs' measure;
• exposure draft legislation implementing the off-market share buy-back integrity measure was released for public consultation on 17 November 2022;
• the draft Treasury Laws Amendment (2023 Measures No. 1) Bill 2023 (Bill) was introduced to Parliament on 16 February 2023 which included the proposed changes to off-market share buy-backs and franked dividends; and
• after some back and forth, the Senate passed the Bill subject to some amendments along with a supplementary explanatory memorandum, which the House of Representatives subsequently agreed to on 16 November 2023. The Bill passed the Parliament on 16 November 2023 and awaits Royal Assent.

These amendments are discussed below, highlighting the change to the implementation date of the rules as they relate to selective reductions of capital, as well as focusing on the changes made to the rules regarding frankable distributions funded by a capital raising and the updated explanatory memorandum.

Off-market share buy-backs / selective reductions of capital

The Senate amendments in Schedule 4 of the Bill (Off-market share buy-backs) simply involve a change to the implementation date of when the legislation will apply to selective reductions of capital. Originally, Part 2 of Schedule 4 was set to apply to any off-market buy-backs or selective reductions of capital announced to the market on or after the day this new integrity measure was announced.

As this was announced as part of the October 2022-23 Budget, the Government took the relevant date to be 25 October 2022. However, the Budget announcement did not specifically refer to the amendments to selective reductions of capital. The inclusion of the selective reductions of capital changes only became apparent when the exposure draft legislation was released for public consultation on 17 November 2022. Accordingly, without an amendment, any selective reductions of capital announced between 25 October 2022 and 17 November 2022 would be subject to the amendments, despite the 25 October 2022-23 measure not referring to such reductions.

As such, to ensure listed public companies can make fully informed capital management decisions, only distributions made as part of a selective reduction of capital announced after the legislation was released (i.e. on or after 18 November 2022) are considered unfrankable.

The start date in respect of off-market share buy-backs remains unchanged (broadly, 25 October 2022).

Franked distributions

The Senate amendments in Schedule 5 of the Bill (Franked distributions funded by capital raisings) follow submissions received from multiple stakeholders regarding their concerns of the earlier draft. Relevantly, these amendments include changes to the implementation date of when the legislation will apply, alteration of the capital raising principal effect test, introduction of proportionality in relation to the amount of unfrankable distributions as well as exceptions based on regulatory requirements.

Date of application

Originally, Schedule 5 was set to have significant retrospective application to franked distributions funded by capital raisings of almost 6 years, back to when this integrity measure was first announced in order to address concerns raised in the ATO’s Taxpayer Alert 2015/2.

However, this was subsequently amended in the draft bill and further amended by the Senate to a much more reasonable date, being the day following assent of the Bill. This change will provide greater certainty in relation to transactions that have already commenced and will ensure the amendments do not impact transactions that cannot be reversed.

Principal effect test & proportionality

When introduced, the Bill applied to render a distribution unfrankable where the principal effect of the issue of any equity interest was the funding of the whole or any part of the distribution. Now, a distribution will only be unfrankable where;

• the principal effect of the issue is to fund, either directly or indirectly, the whole or a substantial part of the distribution; and
• the entity undertook the capital raising with a purpose to fund at least a substantial part of the distribution.

The meaning of 'substantial' will depend on the facts and circumstances of each case, however a relevant factor will include the proportion of the distribution funded by the capital raising. The proportion does not need to be the majority but must be more than a minor part of the distribution. This means that distributions funded by capital raisings in a small or minor way will likely remain frankable, subject to the other criteria being satisfied.

Further, the changes now limit the amount of the distribution that is unfrankable only to the portion funded by the capital raising. The revised explanatory memorandum states that where the principal effect of the capital raising is to fund the entire distribution, then the entire distribution will be unfrankable (albeit, in this context, the explanatory memorandum is silent on the need to also satisfy the purpose test).

Regulatory requirements

A further condition has been introduced concerning the issuance of equity interests in direct response in order to meet a requirement, direction or recommendation from either APRA or ASIC. Where equity is issued in that scenario, any distribution funded by such an issuance will not be rendered unfrankable.

Explanatory memorandum updates

In addition to the above amendments, a supplementary explanatory memorandum to the Bill was released which corrects the original explanatory memorandum. The supplementary explanatory memorandum clarifies;

• when an entity has an established practice of making distributions of a particular kind (which may impact whether the provisions apply); and
• how dividend reinvestment plans are impacted.

Determining the existence of an 'established practice'

For the purposes of evidencing an established practice of distributions under section 207-159(1)(a), section 207-159(3) states that certain previous distributions must be disregarded (being distributions that themselves would be caught by the rules).

The original explanatory memorandum has been corrected to reflect the principal that, when considering if an established practice exists, past distributions to which the amendments would apply must not be considered. This ensures that any prior practice involving the sort of mischief the amendments seek to prevent does not protect future distributions funded by capital raisings.

Dividend reinvestment plans and family dealings

The original explanatory memorandum discusses several factors to consider when determining the effect and purposes of Schedule 5 to the Bill. The revised explanatory memorandum clarifies that dividend reinvestment plans undertaken for normal commercial purposes are not intended to be affected by the amendments.

Similarly, the revised explanatory memorandum clarifies that family or commercial dealings of private companies to facilitate the departure of one or more shareholders from the company (for example, as part of a succession plan) are also not intended to be impacted.

An example relating to banks with a dividend reinvestment plan has also been corrected to clarify that dividend reinvestment plans and underwritten dividend reinvestment plans do not automatically have the principal effect and purpose of funding a related dividend. This altered the original example which implied that banks should avoid dividend reinvestment plans or underwritten dividend reinvestment plans if there is a risk the dividend will not materially change the company's financial position.

Please get in touch with the MinterEllison tax team if you have any questions in relation to the Bill and how it might impact you and your interests.