Utilising franking tax offsets and effect on losses – corporate tax entities

The following information assists corporate tax entities with franking tax offsets to determine their current year tax loss position. It also explains the extent to which they can utilise prior year tax losses.

When a corporate tax entity receives a franked dividend, the receipt is effectively neutral from a tax perspective. This is because it is entitled to a franking tax offset for the franking credit attached to the dividend. The offset generally matches the tax liability of the dividend income derived.

If a corporate tax entity (such as a company) has taxable income, the franking tax offsets it receives can reduce its income tax liability to nil, but is not refunded if it exceeds its liability. This is likely to occur when the entity's other taxable income is in a net loss position disregarding the dividend income derived.

In this situation, a corporate tax entity doesn't lose these excess franking tax offsets, but can convert the excess franking offsets to an equivalent tax loss. The converted tax loss is then aggregated with any current year tax losses. These current year losses are carried forward to future years along with any other prior year losses.

Where a corporate tax entity has no current year losses (and despite having franking tax offsets it has no excess franking credits) it may be able to choose to deduct an amount of prior year losses. This choice is subject to certain limitations. Alternatively, it may choose not to deduct prior year losses so it can pay enough tax to frank its distributions.

Note: You should record any offset and loss amounts in the income tax return of the corporate tax entity receiving the franked dividend. This includes both the excess franking offset and any current year tax loss created by converting the excess franking offset.

See also  

• Refunding excess franking credits
• Receiving dividends and other distributions
• Income Tax Assessment Act 1997 Division 36 – in particular subdivision 36-A Deductions of losses earlier income years, and subdivision 36-C Excess franking offsets

Converting excess franking tax offsets into a current year loss

A current year tax loss arises when both:

• the taxpayer's allowable deductions exceed their assessable income in the income year
• their excess is greater than any net exempt income (NEI) for the year.

A corporate tax entity will have an amount of excess franking offsets to the extent that its franking tax offsets exceed its income tax liability. In this case, the entity will convert the excess amount to an equivalent amount of tax loss by dividing it by the corporate tax rate (CTR).

This converted tax loss is then aggregated with any current year tax loss under the general provisions. If a corporate tax entity has any NEI, this amount is subtracted from the aggregate loss amount. The final aggregated amount becomes the tax loss for the income year resulting is a current year tax loss.

Note: The term 'excess franking offset' has the same meaning as 'excess franking rebate' as it appears in the company tax return instructions 2016.

The meaning of 'current year tax loss' and 'loss year' for a corporate tax entity with excess franking offsets was modified for a corporate tax entity with an amount of excess franking offset, from 2002.

See also  

• How to claim a tax loss – general information on how losses are set-off against net exempt income.

Method statement to work out tax loss

Follow the steps in the method statement below to work out a corporate tax entity's current year tax loss. These steps also explain how to determine the excess franking credits and to what extent they can be converted to tax losses and form part of the entity's current year tax losses. These calculations are based on the provisions of the Income Tax Assessment Act 1997 (ITAA 1997), particularly section 36-55 of the ITAA 1997.

Method statement – steps to determine current year tax loss and excess franking offsets

Step 1	Work out the current year tax loss (if any) under the general provisions. See section 36-10, 165-70,175-35 or 701-30 of the ITAA 1997 disregarding net exempt income (NEI). See also: How to claim a tax loss
Step 2	Convert the excess franking offsets into a tax loss, using the following approach: (a) Calculate franking tax offsets: add the amount of franking tax offset from receiving franked distributions (including those received indirectly) add the amount of venture capital tax offsets subtract any amount of franking tax offsets that are refundable tax offsets (refer to section 67-25 of the ITAA 1997 Refundable tax offset rules). Note: corporate tax entities will generally not be entitled to refundable franking tax offsets. The sum of this calculation will be the entity's total franking offsets. These are available for consideration in calculating the entity's excess franking offsets. (b) Calculate the amount of income tax: Subtract allowable deductions from assessable income. Then apply the corporate tax rate (the assessable income includes the gross-up amount of franked dividends). Reduce the amount of income tax by all tax offsets (this includes foreign tax credits) with the exception of the following tax offsets franking tax offsets calculated under (a) offsets subject to tax offset carry forward rules offsets subject to refundable tax offset rules offsets subject to franking deficit tax offset rules.   That is, don't reduce the income tax by the above tax offsets but by all other tax offsets. (c) Determine if there is an amount of excess franking offsets: Where the amount of franking tax offsets exceeds the amount of income tax calculated at (b), the amount of the excess franking offsets is equal to the difference. (d) Convert the excess franking offsets into a loss: To convert this excess into a tax loss, divide the excess franking offsets by the corporate tax rate.
Step 3	Add the loss amounts from Step 1 and Step 2. That is add the amount of the loss, if any, under the general provisions plus the tax loss from the converted excess franking offsets.
Step 4	Reduce the amount of loss determined at Step 3 by the entity's NEI (if any). If the result is a: Positive amount – the corporate tax entity is taken to have a current year tax loss equal to that amount. The entity will be able to carry forward its current year tax loss and any prior year tax loss to the next income year. Nil or a negative amount – the corporate tax entity does not have a current year tax loss. It will need to determine whether it can choose to deduct a prior year tax loss. Refer to Limitations on deducting prior year tax losses.

 

Limitations on deducting prior year tax losses

A corporate tax entity that has no current year tax loss (despite having franking tax offsets, it has no excess franking credits) can choose to deduct prior year tax losses in an income year, subject to certain limitations. Alternatively, it may choose not to deduct prior year losses so it can pay enough tax to frank its distributions, also subject to certain limitations.

The limitation applies where the method statement used to determine current year tax losses with franking tax offsets results in a nil or negative amount.

A corporate tax entity will only have a choice in how much prior year tax losses it can deduct where:

• the entity's total assessable income exceeds the entity's total deductions and the entity does not have net exempt income – see example 2 and example 3
• the entity's total assessable income exceeds the entity's total deductions and the entity has net exempt income – see example 4.

However, a corporate tax entity will not have a choice in how much prior year tax losses it can deduct where its total deductions exceed the entity's total assessable income.

See also:

• How to claim a tax loss

Limits to prior year tax losses an entity can choose

Where there is a choice, there are two limits restricting when a corporate tax entity can choose the amount of prior year tax losses it applies. This stands whether or not it has net exempt income.

These restrictions prevent the refreshing of prior year tax losses into current year tax losses. This impacts on the application of the tests for deductibility of prior year tax losses, specifically the continuity of ownership tests.

See also  

• Companies information under How to claim a tax loss.

Limits

There are two limits where an entity cannot deduct prior year tax losses. The entity must apply one of these limits.

Limits where an entity can't deduct prior year tax losses

Limit	Description and choice
Limit 1	Where there is an amount of excess franking offsets – the choice is limited to a nil amount. The entity must choose a nil amount if, disregarding tax losses, the entity would have an amount of excess franking offsets for that year. The choice is limited to a nil amount. This is because the tax on taxable income has already been fully absorbed by the franking tax offset. If Limit 1 applies, the entity will be in a nil tax payable position.
Limit 2	Where there is no amount of excess franking offsets – the entity must not choose an amount of prior year losses that would result in excess franking offsets. If, disregarding tax losses, the entity would not have an amount of excess franking offsets for that year, the entity must not choose an amount of prior year tax losses that would generate excess franking offsets for that year. Limit 2 will need to be considered where there is an amount of income tax payable after applying the franking tax offsets. Refer to Determining the extent of prior year losses that can be used.

Determining the extent of prior year losses that can be used

An entity will need to consider Limit 2 when determining what the amount of prior year losses that can be used against income tax payable (after applying the franking tax offsets).

Limit 2 will apply to restrict the losses deducted so that excess franking offsets are not generated to avoid refreshing prior year tax losses to current year losses.

Rules for optional use of prior year tax losses

Determine if Limit 2 applies

Follow these steps to determine if Limit 2 applies: (a) Calculate franking tax offsets. (b) Calculate the amount of income tax. (Note that this amount does not take into account the franking tax offsets.) Note: Calculate (a) and (b) in same way as you would in determining excess franking credits in Step 2 (a) and Step 2 (b) in the method statement to determine current year losses. (c) Determine the amount of income tax payable after applying franking tax offsets against income tax: Where the amount of income tax exceeds the amount of franking tax offsets –this amount is the income tax payable. Limit 2 may apply. Go to paragraph (d) below. (d) Calculate the maximum prior year tax loss amount that can be utilised without generating excess franking offsets: Divide the amount of the income tax payable by the corporate tax rate. This will yield the maximum prior year tax loss amount that can be utilised that would not generate excess franking offsets. Making a choice The entity can choose an amount of prior year tax loss (if available) that does not exceed this maximum amount. The entity can choose a nil amount. If they choose nil, the entity will have income tax payable which will generate franking credits. It will carry forward any unused prior year tax losses.

Example 2

Example 3

Example 4

This information provides an explanation and examples of how franking offsets can be used to reduce a corporate tax entity's income tax liability and how excesses can be converted into current year losses. It also explains the limitations on choosing to utilise prior year losses for an income year when an entity cannot convert its excess franking tax offsets to a current year loss.