SMSFA highlights potential consequences of franking credit changes

The SMSF Association has raised concerns about a proposed legislative change that would exclude certain distributions funded by capital raisings being eligible for franking credits.

In particular, it was concerned that amendments contained in Schedule 5 to the Treasury Laws Amendment (2023 Measures No.1) Bill 2023, introduced to the Senate in March, would “inadvertently catch many normal and legitimate commercial situations and competitively disadvantaged profitable and growing companies”.

Among other proposals, the reforms would prevent certain distributions funded by capital raisings from being frankable, in a bid to ensure arrangements cannot be put in place to release franking credits that would “otherwise remain unused where they do not significantly change the financial position of the entity”, per the government’s statement.

Peter Burgess, chief executive of SMSFA, said their concerns stemmed from two factors.

VIEW ALL

View all

“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 explained. 

“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.”

The association, which comprised 1.1 million SMSF members and a range of financial professionals, believed a broader list of matters was required to determine whether a distribution satisfied the requirements of being funded by a capital raising.

Additionally, another test that would have to be met for a distribution to be funded by a capital raising was the equity issue must have the principal effect of funding the distribution or part of a distribution. 

Burgess added that companies often reinvested 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,” he said.

Disallowing franking in these situations would expose the shareholders to double taxation, he argued.

“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”.