Using imputations credits in an entity that does not have retained earnings

I have been asked a few times about using imputations credits in an entity that does not have retained earnings. Well there are a series of ways to do this. What people often try to do in the small end of town is to drop in some tax free income (often using section 23AJ or AH or whatever the new section 23 AJ division in the ITAA97 is – 768???) or in the big end of town they use the consolidation rules to transfer the imputation credits to a group that has untaxed profits…

But I reckon there is a much easier way….

Revalue assets

A company can pay a franked dividend to its shareholders out of an unrealised capital profit of a permanent character recognised in its accounts that is available for distribution, provided that the company’s net assets exceed its share capital by at least the amount of the dividend, and the dividend is paid in accordance with the company’s constitution and without breaching section 254T or Part 2J.1 of the Corporations Act.

So is there an asset you can revalue? Have a look at this example from TR 2012/5:

74. Upwey Ltd has the following balance sheet:

Assets and Liabilities 
Cash            100
Property, plant and equipment            140
Investment in subsidiary            40
Net assets            280                       

Equity
Share capital            190
Accumulated losses            (40)
Permanent and unrealised capital profit reserve            130
Total equity            280

75.  Upwey Ltd is assumed to have a positive franking account balance due to its activities in prior years. Upwey Ltd determines to pay an $80 dividend. To pay the $80 dividend the company makes the following accounting entries:

Dr Permanent and unrealised capital profit reserve                        $80
Cr Cash            $80           

76.  In this example, the company has sourced the distribution from a species of profit account which is ascertained in its accounts, although it does not have any current or retained earnings. The payment of the $80 dividend does not result in net assets being less than share capital either before or after the dividend payment. On this basis, the dividend will be assessable under paragraph 44(1) (a) of the ITAA 1936, and will be a frankable distribution as it will not be sourced indirectly from the share capital account (assuming it satisfies all the other criteria in section 202-45 of the ITAA 1997). However, if Upwey Ltd’s net assets were less than its share capital, either before or after Upwey Ltd makes the distribution from the reserve (on the basis that it is an unrealised capital profit of a permanent character) it may not be frankable as a result of paragraph 202-45(e) of the ITAA 1997 depending on the particular facts and circumstances.

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About Ken Mansell

As a stay at home Dad most of the week this is my way of pretending I am still the tax counsel of ASX and SEC listed companies, working at big 4 firms, working at the Federal Treasury, on the Henry Review and at Parliament House for the previous government.
This entry was posted in Income Tax, Legislation, Planning Idea, Rulings. Bookmark the permalink.

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