What the new dividend rules mean for
franking credits
31 August 2011
In brief

The ATO has released draft fact sheets outlining its preliminary views on the interaction of the amendments to the
dividend rules and the franking rules.

If a distribution is proposed to occur during the course of a takeover or scheme, a ruling should be sought from the ATO
confirming whether the distribution is frankable.
The ATO has recently released draft fact sheets outlining its preliminary views on the interaction of the amendments to the
dividend rules in section 254T of the Corporations Act 2001 (Cth) and the franking rules in the tax legislation.
These fact sheets were not widely distributed and, if finalised, would not have the status of a public ruling. It is beyond the
scope of this article to discuss the merits, or otherwise, of the ATO’s analysis. For those who are interested in such a
discussion, please see the tax brief1 prepared by our associated tax practice, Greenwoods & Freehills2.
Prior to the amendment to section 254T, a company could only pay dividends out of its profits. Under the changes to
section 254T, a company may not pay a dividend unless:

the company’s assets exceed its liabilities immediately before the dividend is declared and the excess is sufficient for the
payment of the dividend,

it is fair and reasonable to the company’s shareholders as a whole, and

it does not materially prejudice the company’s ability to pay its creditors.
While it is generally accepted that the revised wording of section 254T is intended to provide companies with more flexibility
to pay dividends, there is considerable uncertainty as to what sources of funds can be used to pay dividends under the
revised rules. In particular, can dividend payments be paid out of share capital?
There are broadly three views in relation to the sources of funds:
1.
2.
3.
Broad view: the revised wording allows companies to pay dividends to shareholders out of share capital without
having to comply with chapter 2J of the Corporations Act 2001 (Cth) (ie prior shareholder approval),
Middle view: the revised wording allows companies to pay dividends out of retained earnings and other equity
reserves, even where those accounts have a negative balance or where the amount of the dividend is greater
than the existing positive balance, or
Narrow view: the revised wording allows companies to pay dividends out of retained earnings and other equity
reserves, even where those accounts have a negative balance or where the amount of the dividend is greater
than the existing positive balance, but only if the company has other equity reserves other than share capital to
offset the negative balance.
In summary, the tax legislation defines a dividend to be any distribution by a company to its shareholders other than where
an amount is debited to share capital. However, a dividend is only assessable to the extent it is paid out of profits. Rather
than undertake wholesale amendments to reflect the changes to section 254T, the government simply deemed any
dividend to be a payment out of profits.
The Explanatory Memorandum to the bill amending section 254T indicated that distributions made in accordance with
section 254T would be frankable, subject to the existing ‘integrity rules’. One of those ‘integrity rules’ provides that a
dividend cannot be franked if it is sourced directly or indirectly from share capital.
In the draft fact sheets, the ATO provides two examples of where a dividend is paid by a company without sufficient
retained profits.
In the first example, the dividend is debited against an asset revaluation reserve. In this case the ATO considered that the
asset revaluation reserve is a ‘profit’ account and the dividend is therefore not sourced directly or indirectly from share
capital. Accordingly it is frankable. However, where the dividend is debited against either accumulated losses or a dividend
reserve, the ATO considers this is a distribution sourced from share capital and is therefore unfrankable.
It is unclear what the position would be where the company declares a dividend out of current year profits, but has
significant retained losses.
In the course of a friendly takeover or scheme, the target company will often seek to distribute its franking credit balance to
its existing shareholders by way of a special dividend.
To the extent that this special dividend is paid other than from retained earnings, a ruling should be sought from the ATO
confirming whether the distribution is frankable.
This article was written by Toby Eggleston, Director, Melbourne and James Pettigrew, Director, Sydney of
Greenwoods & Freehills.
Endnotes
1.
2.
Greenwood & Freehills tax brief: 'ATO continues the distribution confusion'
Greenwood & Freehills
More information
For information regarding possible implications for your business, contact
Toby Eggleston
Director, Greenwoods &
Freehills, Melbourne
Direct +61 3 9288 1454
toby.eggleston@gf.com.au
James Pettigrew
Director, Greenwoods &
Freehills, Sydney
Direct +61 2 9225 5979
james.pettigrew@gf.com.au
This article provides a summary only of the subject matter covered, without the assumption of a duty of care by Freehills or Freehills Patent & Trade
Mark Attorneys. The summary is not intended to be nor should it be relied upon as a substitute for legal or other professional advice.
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