Consultation paper - Capital raised for the purpose of funding franked distributions

Your feedback

This paper invites your feedback on any priority areas for future ATO public advice and guidance related to the new integrity measure addressing franked distributions funded by capital raisings.

Closing date for comment: 16 February 2024

Provide feedback: by email to Virginia.Gogan@ato.gov.au

Contact officer: Virginia Gogan, 03 8632 4643

We encourage you to raise any other relevant issues or specific concerns about matters discussed in this paper or the measure. Your responses may be made available to the public on the ATO website unless you indicate that you would like all or part of your response to remain in confidence. Automatically generated confidentiality statements in emails do not suffice for this purpose. Confidential elements should be marked or provided in a separate document.

Purpose of paper

The ATO is seeking your feedback on whether there are priority issues where ATO public advice and guidance is needed to help entities understand whether the new law addressing franked distributions funded by capital raising applies to their circumstances.

The extent to which feedback helps to achieve this objective will inform prioritisation and allocation of resources.

Background

The integrity measure preventing certain distributions funded by capital raising from being frankable was recently enacted through amendments contained in the Treasury Laws Amendment (2023 Measures No. 1) Act 2023External Link.

This is intended to discourage arrangements that feature the raising of capital to fund the payment of franked distributions and the release of those franking credits in a way that does not significantly change the financial position of the entity. These arrangements are those that are entered into for a purpose (other than an incidental purpose) and with the principal effect of accelerating the release of franking credits to members of entities in circumstances that cannot be explained by existing distribution practices, and which are typically artificial or contrived. The absence of any meaningful change to the financial position of the entity will usually be a feature of such arrangements.

Broadly, the measure makes a distribution or part of a distribution) unfrankable where all of the following conditions are satisfied:

• the distribution is not consistent with an established practice of the entity of making distributions of that kind on a regular basis
• there has been an issue of equity interests in the entity or another entity (whether before, at or after the time at which the relevant distribution was made)
• it is reasonable to conclude in the circumstances that
  • the principal effect of the issue of any of the equity interests was the direct or indirect funding of a substantial part of the relevant distribution or the relevant part of a distribution
  • any entity that issued or facilitated the issue of any of the equity interests did so for a purpose (other than an incidental purpose) of funding a substantial part of the relevant distribution or the relevant part of a distribution
• the issue of the equity interests was not a direct response in order to meet a requirement, direction or recommendation from the Australian Prudential Regulation Authority or Australian Securities and Investments Commission.

The measure specifies matters that must be considered when determining whether a distribution is consistent with an established practice of the entity, and when determining the principal effect of the issue of equity interests and the purpose of an entity involved in an issue of equity interests.

The measure applies to relevant distributions made on or after 28 November 2023.

Following the release of the exposure draft law for consultation, the scope of the measure has been amended to address a number of issues raised in consultation that the measure could be argued to apply more widely than intended, as well as the inclusion of additional explanation and examples in the explanatory memorandum.

When providing a submission, we invite stakeholders to consider the changes to the measure, and the additional examples and explanation in the explanatory memorandum as part of identifying practical examples of where uncertainty arises.

Consultation questions

The ATO invites interested parties to lodge written submissions on the questions in this section.

When responding to the questions:

• be clear which question(s) or topic(s) your response relates to. It is not necessary to respond to all questions.
• be as specific as possible in your responses to ensure your feedback can be fully considered.
• provide clear examples of the particular commercial issues or transaction types and include a description of how guidance would assist you in understanding the tax outcomes.
• note that submissions that are outside the scope of this consultation may not be considered.

Consistency of distribution with an established practice

1. Are there common scenarios or issues where ATO public advice and guidance would assist entities in determining whether:
   1. the entity has a practice of making distributions of that kind on a regular basis
   2. whether a particular distribution is in accordance with that practice?

If you consider that guidance is needed, please provide detailed commentary on common scenarios where guidance would assist taxpayers in identifying whether a distribution was in accordance with an entity’s established practice for making distributions of that kind on a regular basis.

Principal effect and purpose of issuing equity interests

2. Section 207-159(4) identifies the matters to be taken into account when considering whether the principal effect of the issue of any of the equity interests was the direct or indirect funding of the relevant distribution or a substantial part of the relevant distribution (or the relevant part of the distribution), and the purpose of the entity that issued or facilitated the issue of the equity interests.
3. Are there common scenarios or issues where ATO public advice and guidance is needed to assist entities in determining whether:
   1. the principal effect of the issue of equity interest was the direct or indirect funding of a substantial part, or relevant part, of the distribution
   2. the purpose (other than an incidental purpose) of issuing equity was funding a substantial part of the relevant distribution, or relevant part of the distribution.
4. This may include addressing potential application to specific practical scenarios, such as those involving dividend reinvestment plans, or third-party takeovers or acquisitions. If you consider that guidance is needed, please provide detailed commentary on the practical scenarios that should be addressed.

Family or commercial dealings of private companies

5. Paragraph 5.45B of the supplementary explanatory memorandum explains that while it is intended that contrived arrangements undertaken by closely held companies to release franking credits to their shareholders are captured by these amendments, 'family or commercial dealings of private companies where the capital raising and distribution are initiated to facilitate the departure of one or more shareholders from the company' are not intended to be affected by the operation of the measure. The explanatory memorandum also establishes that existing anti-avoidance provisions will still need to be considered in relevant instances.
6. We invite feedback on whether ATO public advice and guidance is needed to address the operation of the measure to family or commercial dealings of private companies.
7. If you consider that guidance is needed, please provide detailed commentary on the practical scenarios that should be addressed; including any common scenarios that you consider would fall within the scope of 'family or commercial' dealings for the purposes of the measure.

Proportion of the distribution funded by capital raising

8. The new measure applies where a capital raising funds at least a substantial part of the distribution, and only applies to the portion of the distribution that is funded by the capital raising.
9. The ATO is considering approaches that may be used to determine the portion that is funded by the capital raising, where it is not the entire distribution.
10. We invite feedback on:
    1. any guidance that you consider would be useful and practical in respect of determining whether a substantial part of a distribution has or has not been funded by a capital raising.
    2. practical examples of how entities account for the use of different amounts where capital is raised for multiple purposes (even where none of those purposes is to fund a distribution).
    3. any methodologies that you consider would be practical to calculate the portion of a relevant distribution that is funded (particularly indirectly funded) by a capital raising.
    4. any practical suggestions about how a taxpayer might evidence the extent to which a distribution is funded, or not funded, by a capital raising, such as the documentation required, or the span of time that should be considered.

Other feedback

11. Please provide any other feedback relevant to the consultation topic that you would like us to consider in preparing any ATO public advice and guidance.