Tis’ the season for guidance from the ATO – Draft guidelines released regarding capital raised for the purposes of funding franked distributions

On 4 December 2024, the Australian Taxation Office (ATO) released a new draft practical compliance guideline: Practical Compliance Guideline 2024/D4 – Capital raised for the purposes of funding franked distributions – ATO compliance approach (the Guideline). The Guideline concerns the ATO’s compliance approach in respect of the legislation enacted in November 2023 denying the benefit of franking credits on certain distributions funded by (equity) capital raisings (the Provisions). The draft Guideline is open for comments until 31 January 2025.

Key Guidance

Criteria

The Guideline reiterates the four criteria that must be satisfied for a distribution to be subject to the Provisions:

The distribution is not consistent with established practice.
There is an issue of equity interests.
The principal effect and purpose of the issue of equity was the funding of a substantial part of the distribution.
The issue of equity interests is not a direct response to meet a requirement, direction or recommendation from APRA or ASIC.

White, Green and Red Zone Arrangements

The Guideline identifies white, green and red zone arrangements. White zone distributions are those where the ATO has provided specific guidance to the taxpayer that the relevant distribution is frankable or the arrangements have otherwise been reviewed and given a low risk or high assurance rating. For distributions in the white zone, there is no need for a taxpayer to self-assess its risk level. The green zone represents low risk distributions (see further below). Where the distribution falls in the green zone, the ATO will generally not apply compliance resources to review the arrangement with respect to the Provisions (other than to confirm the green zone requirements are met). Red zone distributions are those arrangements that are a high risk of contravening the Provisions and will attract ATO compliance resources (including reviews and audits).

The Guideline outlines five green zone arrangements where the ATO will generally not apply compliance resources other than to confirm the features of the relevant arrangement. These arrangements are outlined at [31] and exist where:

1. The distribution is consistent with the practice over the preceding 3 years of distributions paid in relation to the relevant class of shares. In determining whether the distributions are “consistent”, regard is to be had to the timing, amount, and franking percentage of the distribution.

The reason for the distribution is not a factor under this scenario.

The ATO has stated that, in determining whether a distribution is consistent with established practice, the payment of a distribution in accordance with board-endorsed or published dividend policies will not, by itself, be sufficient (i.e. regard must be had to the actual practice of regular distributions).

2. The distribution is made under an arrangement involving a dividend reinvestment plan (whether underwritten or not) that is undertaken for normal commercial purposes, where it is not an artificial or contrived arrangement.

The impact of the Provisions on dividend reinvestment plans was raised throughout the consultation and legislative process as a key concern with the breadth of the legislation.

The ATO has taken this concern on board and specified circumstances where dividend reinvestment plans will be considered green zone arrangements. The examples include where:

there is an established dividend reinvestment plan that has been in operation for a significant period of time; and
a dividend reinvestment plan that has been suspended is re-commenced on an ongoing basis.

In each example the dividend reinvestment plan is undertaken for normal commercial purposes. By contrast, under the Guideline a temporary dividend reinvestment plan that is fully unwritten is identified as not meeting the requirements of being undertaken for a normal commercial purpose and is instead considered to be an artificial or contrived arrangement.

3. The issue of equity interests funded (directly or indirectly) is less than 5% of the entire franked distribution paid to all eligible shareholders.

4. The issue of equity interests by entities regulated by APRA is to meet minimum regulatory requirements, or to maintain a reasonable buffer beyond the minimum regulatory requirements. This includes additional Tier 1 capital issued in connection with the redemption of another instrument.

The Guideline clarifies that the issue of the relevant equity interest may, in certain circumstances, occur in advance of APRA requirements coming into effect (rather than it being necessary to wait for the relevant requirement to have commenced) or in anticipation of expected market conditions which may impact on APRA compliance.

5. If you are a private company, the distribution was made under an arrangement where the capital raising and distribution are initiated to facilitate the departure of one or more shareholders from the company (for example, succession planning and shareholder exits).

A key concern raised in the mergers and acquisitions context is that there are no constraints on the identity of the entity issuing the equity interest. This has created uncertainty in cases where a buyer raises equity as part of funding an acquisition which is used in part to fund a distribution by the Target. Scenario 5 provides that such an arrangement will be a “green zone” arrangement provided that:

the target company is a private company; and
the principal effect and purpose of the capital raising is to facilitate the departure of a shareholder.

Importantly, the example does not provide guidance to deal with the position if there is a continuing shareholder as part of a sale of the target and the scenario does not apply to public companies. While the distribution may meet other green zone scenarios (e.g. scenario 3 above), where this is not the case, uncertainty remains.

The Guideline recognises that distributions may fall within more than one green zone scenario.

Importance of documentation

Finally, the Guideline serves as a useful reminder of the importance of good documentation. The Guideline provides two examples of arrangements which do not fall under the white or green zones, but the documentation demonstrates that the purpose of the equity raising is not to fund the relevant distribution. In these circumstances, the legislation will not operate to deny franking credits in respect of the distributions.

We are here to help

Please reach out to your usual KWM tax contact to discuss the impact of the legislation and this guidance on any capital raisings and distributions.

Want to know more?

A copy of the legislation as passed can be found here. The Explanatory Memorandum and Supplementary Explanatory Memorandum can be found here and here.

You can find our previous alerts and statements on this topic, as well as our submission to the Senate Economics Legislation Committee, below: