The ATO has finalised its compliance approach in relation to the integrity measure in s 207-159 of ITAA 1997, which operates to make certain distributions funded by capital raising unfrankable.
The ATO has finalised the Practical Compliance Guideline PCG 2025/3, which outlines the types of arrangements that may be at a risk of non-compliance with the s 207-159 of the Income Tax Assessment Act 1997 (ITAA 1997).
The new guideline should be read along with the Taxpayer Alert TA 2015/2, issued by the ATO in May 2015, addressing their concerns regarding arrangements where private companies raise funds (often through debt or equity) to make distributions to shareholders, particularly where the distributions are debited to the share capital account rather than retained earnings.
Types of distributions under scrutiny
In effect from 28 November 2023, s 207-159 of the ITAA 1997 applies to deem certain distributions funded by capital raising activities unfrankable if they fail to meet a prescribed criterion.
The legislative restrictions may apply if the relevant distribution does not meet the following requirements as outlined in the PCG 2025/3:
- Consistency with established practice — the entity does not have an established practice of making distributions of that kind, or, if it does have an established practice, the relevant distribution does not align with that practice.
- Equity interests issued — there must be an issuance of equity interests by the company or related entities around the time of the relevant distribution.
- Principal effect and purpose — the equity interests were issued for a purpose (other than incidental) to directly or indirectly fund a substantial part of the relevant distribution.
- No regulatory requirement — the equity issuance is not a direct response to regulatory requirements from APRA or ASIC.
Next steps
This finalised guidance is ATO’s reminder that arrangements lacking genuine commercial purpose and designed primarily for tax advantage may be subject to anti-avoidance rules and recharacterisation.
There may be many implications for arrangements where s 207-159 applies to a dividend distribution.
Implications for shareholders include:
- Shareholders receiving an unfrankable distribution do not receive a tax offset for the franking credits, as there are none attached to the distribution. This means they cannot reduce their tax liability using franking credits.
- Without franking credits, shareholders may face a higher effective tax rate on the distribution, as they must pay tax on the full amount of the distribution without any offset for tax already paid by the company.
- Non-resident shareholders may be subject to withholding tax on unfrankable distributions, as these distributions do not benefit from the imputation system that typically reduces or eliminates withholding tax.
Implications for the distributing entity include:
- No franking debits get recorded for an unfrankable distribution.
- The ATO will closely examine distributions that appear artificial or contrived, particularly that do not align with an entity’s historical distribution practices, non-compliance with the guidelines may lead to penalties and adjustments in tax obligations.
We can help you with navigating through the changes that may apply to your situation. For further discussion, please feel free to contact our office.