Franking credit changes risk unintended consequences

The Association, in its submission to the Senate Economics Legislation Committee, said it supports measures that prevent tax avoidance and the manipulation of the franking system to facilitate the inappropriate release of franking credits.

However, it stated that it is concerned that the amendments contained in Schedule 5 to the Bill – Treasury Laws Amendment (2023 Measures No.1) Bill 2023 – will inadvertently catch many normal and legitimate commercial situations and competitively disadvantaged profitable and growing companies.

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SMSF Association CEO Peter Burgess said the SMSFA’s concerns are based on two factors.

“The legislative amendments include several items that must be ‘tested’ to determine whether a distribution is funded by a capital raising and therefore ineligible for franking,” he said.

“Significantly, the first test stipulates that the distribution must not be consistent with an entity’s established practice of regularly making distributions of that kind.

“But there may be legitimate situations that would not satisfy the ‘established practice’ requirement, including new companies with no established record of paying dividends, those operating in highly volatile and uncertain industries where dividends may only be paid irregularly, or those paying special dividends due to abnormal profits.

“In our opinion, what’s required to avoid the amendments applying to legitimate and normal business operations is a broader list of matters to determine whether a distribution satisfies the requirements of being funded by a capital raising.”

Another test that must be met for a distribution to be funded by a capital raising is the equity issue must have the principal effect of funding the distribution or part of a distribution.

Mr Burgess said companies often reinvest their profits instead of holding them as cash to be distributed to shareholders.

“The Association contends that for these companies reinvesting profits and the raising of capital to pay dividends is merely prudent cash flow management and nothing to do with tax avoidance or the manipulation of the franking system.”

“Disallowing franking in these situations would expose the shareholders to double taxation. Company profits would still be subject to tax, but the shareholder would receive an unfranked dividend with no franking credit to offset the tax paid by the company. The company will have no retained profits – but will have a significant franking credit balance trapped within the company.

“To avoid these unintended consequences, the proposed amendments should be modified to make it clear they will not apply to distributions in situations where a company has made a taxable profit, those profits have been applied in funding the operations of the company, and the company now intends to distribute those profits as a dividend.”