There is still considerable uncertainty on whether a
purported dividend is in fact sourced out of a company's share
The Commissioner has released Income Tax Ruling TR 2012/5 which
deals with the taxation implications of the new section 254T of the
Before it was amended, section 254T provided that a dividend
could only be paid out of the profits of the company. There was a
view amongst some that the so-called "profits test" was
inadequate. Companies with sufficient free cash flow to pay
dividends to shareholders were frustrated in doing so, as profits
were eroded by expenses resulting from fair market value based
The new section 254T was intended to be a more flexible
requirement which allows companies to pay dividends if certain
solvency criteria are met. It provides that a company must not pay
a dividend unless:
the company's assets exceed its liabilities immediately
before the dividend declaration and the excess is sufficient for
the dividend payment;
the dividend is fair and reasonable to members as a whole;
creditors are not materially prejudiced.
Notwithstanding the clear expression of intent behind the
enactment of section 254T, the language of the section is
restrictive rather than permissive.
The Commissioner's view as expressed in the Ruling is that,
notwithstanding section 254T, the dividend must be paid out of
either current year or accumulated profits.
However, the Corporations Law definition of dividend is not used
for income tax. Under the income tax law, there is a stand-alone
definition of dividend which, essentially, provides that a dividend
includes any distribution made by a company to any of its
shareholders (as shareholders) but not where it is debited against
an amount standing to the credit of the share capital account of
For most part the ruling is concerned with the application of
section 202-45(e) of the Income Tax Assessment Act 1997. That
section provides that a distribution is not a frankable
distribution if it is sourced directly or indirectly from the
company's share capital account.
Clearly, the circumstances where an amount is either directly or
indirectly debited to a capital account will be relevant to the
gateway issue as to whether there is a dividend at all, and then
whether it is frankable. (If there is a dividend, then it will be
no impediment to assessability under section 44(1) that the
dividend is not paid out of the company's retained earnings
account – section 44(1A)).
A frankable dividend?
The ruling clarifies that "nimble dividends" (ie.
dividends paid out of current year earnings by a company with
accumulated losses) are frankable in certain circumstances:
provided the dividend is paid by resolution by the directors at
the same meeting at which they approve the accounts, the dividend
will have been made prior to appropriation of current year profits
against accumulated losses, so that the dividend will be regarded
as being frankable;
the situation is clearer where a separately identifiable
profits reserve is created out of current year profits –
which may be carried forward in the accounts separately from the
accumulated loss account and will remain available for the payment
The company may pay a frankable dividend out of a unrealised
capital profit account of a permanent character recognised in its
accounts and available for distribution, provided that the
company's net assets exceed its share capital by at least the
amount of the dividend.
The Commissioner suggests in the Ruling that a distribution made
in breach of section 254T won't be frankable. This does not
seem justifiable as a blanket proposition given that a breach of
section 254T does not necessarily mean that an amount has been
sourced even indirectly from share capital.
What if the amount is unfrankable?
Where a distribution is sourced out of share capital, then the
tax consequences may be either that:
in the circumstance where the distribution contravenes section
202-45(e) but is not regarded as being a debit to the share capital
account in the sense contemplated in the tax law definition of
dividend, the amount will be an assessable dividend for tax, but
will not be frankable; or
if the amount is not a tax law dividend because it is regarded
as having been debited against the share capital account, then the
distribution will be taxed under the capital gains tax rules.
Clearly there is much uncertainty which remains to be resolved
in this fundamental area of law. Much of the uncertainty results
from lack of clarity around if and where a purported dividend is in
fact sourced out of a company's share capital.
Clayton Utz communications are intended to provide
commentary and general information. They should not be relied upon
as legal advice. Formal legal advice should be sought in particular
transactions or on matters of interest arising from this bulletin.
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