Summary

  • The March edition of the Mergers & Acquisitions Update discussed the innovative strategy of companies funding franked special dividends from equity raisings using shareholder rights issues.
  • Since then, the Australian Taxation Office (ATO) has released a Taxpayer Alert expressing concerns about these transactions – without expressing a concluded view about the application of the franking anti-avoidance provisions.
  • In essence, the ATO wants any companies considering these transactions to approach the ATO first.

The March edition of the Mergers & Acquisitions Update discussed the emerging innovative strategy of companies funding franked special dividends from equity raisings using shareholder rights issues.

Since then, the ATO has released Taxpayer Alert TA 2015/2: Franked distributions funded by raising capital to release franking credits to shareholders.1

A taxpayer alert is not a ruling – rather it is a public warning of an activity that causes the ATO concern. Taxpayer alerts are typically very successful in pausing the identified activity, pending finalisation of the ATO view.

In essence, TA 2015/2 is directed at companies paying franked dividends which are funded by the issue of shares. The ATO’s concern is that these transactions may activate s.177EA, the franking credit anti-avoidance provision – in which case either franking credits would be denied to shareholders or a franking debit would arise to the company.

Many companies have a store of franking credits - because not all taxed profits are paid out under their regular dividend policy – and many are under investor pressure to release those profits and franking credits to shareholders. Typically this involves a cash outflow for the company. However, the transactions the subject of TA 2015/2 allow companies to release profits and franking credits in a way that is more or less cash neutral for the company.

The transactions the subject of TA 2015/2 display all – or at least most – of particular identified features.

Seemingly, the taxpayer alert will apply to:

  • special dividends funded by a contemporaneous rights issue involving a corresponding subscription amount,
  • special dividends paid in connection with a fully underwritten dividend reinvestment plan, and
  • share buy-backs funded by a contemporaneous rights issue involving a corresponding subscription amount.

However, the listed features are framed in a general way so as to cast the potential net as widely as possible. The ATO are not prepared at this stage to rule out the taxpayer alert extending to other transactions such as ordinary dividends funded by a rights issue or a fully underwritten DRP. This will be of particular interest to banks that have a practice of underwriting their DRPs.

From a technical perspective, the ATO would need to demonstrate that the company had an objectively determined non-incidental purpose of shareholders obtaining the franking credits – which is a challenge, particularly in light of a recent class ruling to the effect that s.177EA did not apply to a special dividend paid in connection with a fully underwritten dividend reinvestment plan.

A more fundamental question is this: why shouldn’t shareholders be allowed to access franking credits that accrued to the company while they were shareholders? It is difficult to see this as an offensive outcome. Otherwise, franking credits will almost inevitably accumulate and be trapped – unable to be distributed in a way that the ATO finds acceptable. This would seem to involve reading in an additional franking credit wastage principle that was never flagged when s.177EA was introduced.