Stimulus measures COVID-19 JobKeeper

Cash flow boost: working with trustee resolutions and franking returns

by Robyn Jacobson, CTA, Senior Advocate

   

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Note: Legislative references in this article are to the Income Tax Assessment Act 1997 (ITAA 1997) unless otherwise stated.

Cash flow boost … have you thought about trustee resolutions and franking returns?

You may not have even thought to draw a link between the COVID-19 economic stimulus measure, the cash flow boost (CFB), and the preparation of trustee resolutions or the possible requirement to lodge a franking return, but there is a nexus. This article provides a general overview and broadly explains why the CFB needs to be considered when preparing trustee resolutions and why a company may have a payment or reporting obligation under the franking rules because of receiving and distributing CFB payments.

Cash flow boost — overview

The CFB was a highly successful economic stimulus measure which provided payments during 2020 of around $35 billion to around 800,000 businesses during the COVID-19 pandemic.

Given effect by the Boosting Cash Flow for Employers (Coronavirus Economic Response Package) Act 20201, the CFB provided total payments of between $20,000 and $100,000 to eligible businesses based on the PAYG withholding amounts reported in activity statements for the period from March 2020 to September 2020.2

Broadly, entities were eligible if they:

  • had an aggregated turnover3 of less than $50 million;
  • made a payment that was subject to a PAYG withholding obligation under Subdivs 12-B, 12-C or 12-D in Schedule 1 to the Taxation Administration Act 1953 (TAA) or Div 13 in that Schedule in relation to an alienated personal services income payment; and
  • evidenced business activity prior to 12 March 20204

Tax treatment on receipt of cash flow boost

The CFB is treated as non-assessable non-exempt income (NANE income) under s 59-905, so it is tax-free to the entity receiving the boost payments.

Treatment on payment of cash flow boost funds

CFB amounts received by an entity can be applied however the entity chooses. The funds may be distributed to a stakeholder or expended on business expenses or new capital assets.

CFB funds applied towards business expenses or the cost of new assets would be reflected in the financial statements in the form of:

  • a deductible expense on the profit and loss statement; or
  • a depreciating asset or CGT asset on the balance sheet, the cost of which would be subject to the capital allowance rules or captured in the cost base of the CGT asset.

Cash flow boost payments received by sole traders, partnerships and trusts

CFB payments received by an entity may not be expended on business expenses or capital assets; they may instead be distributed to the entity’s stakeholders.

Where the CFB payments are received by:

  • a sole trader — the funds are tax-free and already in the hands of the individual;
  • a partnership — the amounts are tax-free profits of the partnership and can be distributed tax-free to the partners;
  • a discretionary trust — the amounts are tax-free to the trust and can be distributed tax-free to the beneficiaries (see the discussion below on trustee resolutions);
  • a unit trust — the amounts are tax-free to the trust and can be distributed tax-free to the unitholders (see the discussion below on trustee resolutions) without triggering CGT event E4, due to the exclusion in s 104-71(1)(a) that reduces the non-assessable part in s 104-70 by any part of the payment that is NANE income. This means that a payment of the CFB to a unitholder will not reduce the cost base of the unitholder’s units by the non-assessable amount nor give rise to a taxable capital gain under CGT event E4.

Trustee resolutions

From a trust law perspective, the trust deed will determine the ‘income of the trust estate’ (IOTE) or the trust’s distributable income. The Commissioner’s views on the meaning of IOTE as that phrase is used in Div 6 of Part III of the ITAA 1936 and related provisions is set out in draft tax ruling TR 2012/D1.

The way the CFB is distributed by a trust will depend on how the trust deed, or the trustee exercising a power under the deed, characterises the CFB amounts.

Most trust deeds can be classified into one of three types:

1. Income of the trust estate defined according to trust law concepts

Under such a deed, if the CFB does not form part of IOTE (which it likely does not), the CFB will be treated as an accretion to trust capital. In this case, the trustee would need to call on their power under the deed to resolve to validly distribute the trust capital to a capital beneficiary and record their decision to distribute the trust capital in a resolution that is separate from the decision to distribute the trust income. Check the deed to determine whether the prior consent of the appointor or guardian is needed to make a capital distribution. A distribution of capital cannot be made to a person who is only an income beneficiary.

2. Income of the trust estate defined according to an income equalisation clause

Under such a deed, where IOTE is taken to be equal to the ‘net income’ as defined in s 95 of the ITAA 1936, the CFB does not form part of IOTE because it is NANE income (see paragraph 103 of TR 2012/D1). Accordingly, the CFB will be treated as an accretion to trust capital. Again, the trustee would need to call on their power under the deed to resolve to validly distribute the trust capital to a capital beneficiary, recording that decision in a separate resolution.

3. Income of the trust estate defined according to a recharacterisation clause

Under such a deed, the trustee determines whether the CFB amount is an accretion to IOTE or trust capital. A positive determination may be required by way of a trustee resolution. The amount would then be distributed to either an income beneficiary or a capital beneficiary according to its character.

Whether the CFB is characterised as an accretion to IOTE by the trust deed (or the trustee exercising a power under the deed) will determine the amount of IOTE to which beneficiaries may be presently entitled. This will, in turn, determine the proportion of taxable income that is assessable to each beneficiary (after streaming of any capital gains or franked distributions) under s 97 of the ITAA 1936.

Cash flow boost payments received by companies

Where the CFB payments are received by a company, the receipt of the CFB is NANE income to the company, but there will be tax implications if the amount is distributed to the shareholders. Nothing in the tax law exempts the payments from tax in the hands of the shareholders, so the distributions to shareholders will be an assessable dividend under s 44 of the ITAA 1936. It makes no difference whether the amounts are distributed before or during the liquidation of a company.

Frankable distributions

A distribution by a company to a shareholder is a frankable distribution to the extent that it is not unfrankable under s 202-45.6

A payment of an amount attributable to the CFB is not specified in the exhaustive list of unfrankable distributions in s 202-45. Accordingly, the payment of the CFB is a frankable distribution, even though it has not been subject to income tax.

In some cases, the payment of the CFB may be made by a company that is a base rate entity (within the meaning of s 23AA of the Income Tax Rates Act 1986) and has excess franking credits due to the reduction in the franking rate since 1 July 2016. If the company has franking credits where the tax was paid at the rate of 30% and can now only frank at the rate of 26% (25% from 1 July 2021), the company may have excess franking credits. These can be utilised by franking the distribution of the otherwise unfranked CFB amount.

In other cases, the payment of the CFB may be made by a company that is unable to frank the distribution as there are insufficient franking credits. This may lead to a range of implications under the benchmark rule.

As always, the declaration and payment of the dividend will need to comply with s 254T of the Corporations Act 2001 and the company constitution.

Benchmark rule

The benchmark rule is set out in Div 203 of the ITAA 1997. Its purpose is to ensure that all distributions by a company within a particular period are franked to the same extent.

A company’s benchmark franking percentage is set by reference to the franking percentage for the first frankable distribution the company makes in the franking period and evidenced by the giving of a distribution statement7. Any subsequent frankable distributions made in the same franking period must be franked at the same percentage. If no frankable distribution is made during the period, there is no benchmark franking percentage.8

If the benchmark rule is breached9:

  • because the franking percentage for the distribution exceeds the benchmark franking percentage (over-franking) — the company is required to pay over-franking tax equivalent to the excess franking credits;
  • because the franking percentage for the distribution is less than the benchmark franking percentage (under-franking) — the company incurs a franking debit in its franking account equivalent to the unused franking credits, meaning those credits are wasted;
  • the distribution is not invalidated — the shareholder is still entitled to claim a tax offset for the franking credit shown on the distribution statement.

Relevance of the benchmark rule to the cash flow boost

Company has not made earlier distribution that year that set the benchmark franking percentage

A company that received CFB payments in the 2020–21 income year may not have made a frankable distribution earlier in that income year. Alternatively, the company may have made a frankable distribution of profits earlier in the income year but did not provide a distribution statement at the time of the distribution — noting that a private company has until the end of four months10 after the end of an income year to give the shareholder a distribution statement setting out information about the distribution including the franking percentage.

In either case, the benchmark franking percentage for the year has not yet been set, and the company could distribute the CFB amount without breaching the benchmark rule.

The benchmark franking percentage could be then set by the company before the distribution statement is required to be given (i.e. by 31 October 2021) taking into account all distributions made during 2020–21. There could however still be disclosure requirements (see below).

Company has made earlier distribution that year that set the benchmark franking percentage

If, however, the company made a frankable distribution earlier in 2020–21, and a distribution statement advising of the franking percentage has already been given to the shareholder during 2020–21, the company has set its benchmark franking percentage for the year.

If the company then distributes the CFB amount and does not or cannot frank the distribution of the CFB amount at the same percentage as the earlier distribution, the company will breach the benchmark rule, resulting in a debit to the franking account11. This could result in the company becoming liable for franking deficit tax12, depending on the balance in its franking account.

A company may apply in writing to the Commissioner of Taxation for permission to depart from the benchmark rule under s 203-55. However, the Commissioner will permit a departure from the benchmark rule only in extraordinary circumstances, which would need to be unforeseeable and beyond the control of the company, its shareholders and directors.

Disclosure requirements

Significant variations between benchmark franking percentages may indicate the presence of streaming, so a company is required to make a disclosure to the ATO under Subdiv 204-E of the ITAA 1997 if its benchmark franking percentage varies by more than 20%13 between successive franking periods in which frankable distributions are made.

The entity must make the disclosure by lodging a franking return by the last day of the month following the end of the income year.

Relevance of the disclosure requirements to the cash flow boost

Example 1

Assume that a company made a frankable distribution in 2019–20, and its benchmark franking percentage was 100%. Further assume that, in 2020–21, it distributes the CFB but this is not franked. The company will have varied its franking percentage by 100 percentage points between the two years. As this exceeds the 20% allowable threshold, the company will need to disclose this variation to the ATO.

Example 2

Assume that a company made a frankable distribution in 2019–20, and its benchmark franking percentage was 100%. Further assume that, in 2020–21 it makes two distributions each of $50,000 — one fully franked and the other an unfranked distribution of the CFB. The company will need to determine the ‘average’ franking rate across the two distributions. Based on these numbers, the franking percentage would be 50%. The company will have varied its franking percentage by 50 percentage points. As this exceeds the 20% allowable threshold, the company will need to disclose this variation to the ATO.

Franking return

A franking account tax return (franking return) must be lodged14 by a franking entity that is:

  • liable to pay franking deficit tax (because it has a deficit balance in its franking account at the end of the income year);
  • liable to pay over-franking tax (because the franking percentage for a distribution exceeded the permitted benchmark franking percentage);
  • obliged to disclose a significant variation in its benchmark franking percentages; or
  • given a written notice to do so by the Commissioner.

By when must a franking return be lodged?

Where an amount is payable, the franking return must generally be lodged by the last day of the month following the end of the income year — typically 31 July. This is also the date by which franking deficit tax and over-franking tax is payable.

However, according to the ATO website (QC 34542), companies have a lodgment date of 31 October when both of the following apply:

  • the franking account return is a disclosure only (no amount payable); and
  • the company is a 30 June balancer.

This may be summarised as follows:

TABLE 1: Requirement to lodge a franking return

Circumstance

Payment or reporting obligation

Lodgment and/or payment date
(assumes 30 June balancer)

Company has a franking deficit in its franking account as at 30 June (includes where a franking debit arising from the company franking a distribution in contravention of the benchmark rule exceeds the franking credits in the account)

Liable to pay franking deficit tax and lodge a franking return

By 31 July

Company is liable to pay over-franking tax

Liable to pay over-franking tax and lodge a franking return

By 31 July

Company’s benchmark franking percentage has varied by more than 20% across franking periods and there is no amount payable

Required to disclose the variation in a franking return

By 31 October

 

Footnotes

1 Enacted on 24 March 2020 as Act No. 23 of 2020.

2 The amount of the second CFB (based on activity statements lodged for the tax periods from June to September 2020) was determined by the amount of the first CFB (based on activity statements lodged for the tax periods from March to June 2020).

3 As calculated under s 328-115 of the ITAA 1997.

4 By having an ABN on 12 March 2020 and satisfying the requirement in either s 5(5) (about assessable income from business) or s 5(6) (about taxable supplies) of the Boosting Cash Flow for Employers (Coronavirus Economic Response Package) Act 2020.

5 Inserted into the ITAA 1997 by Schedule 3 to the Coronavirus Economic Response Package Omnibus Act 2020, enacted on 24 March 2020 as Act No. 22 of 2020.

6 See s 202-40.

7 Under s 203-45, a private company’s franking period is the same as its income year. A company that is not a private company may have two franking periods within an income year, typically each of six months duration, but this will vary depending on the length of the company’s income year (see s 203-40).

8 Section 203-30.

9 Section 203-50.

10 A private company that makes a frankable distribution must give a distribution statement to the shareholder within four months of the end of the income year (typically 31 October). A company that is not a private company must give the distribution statement on or before the day the distribution is made: see s 202-75.

11 Item 3 of the table in s 205-30.

12 Section 205-45.

13 This percentage can vary depending on the number of franking periods since a frankable distribution was made. For example, if a company makes a frankable distribution in period 1, followed by no frankable distribution in period 2, followed by a frankable distribution in period 3, the variation threshold for notifying the ATO is 40%.

14 Each year, the Commissioner issues a legislative instrument under s 214-15 requiring each company to which the legislative instrument applies to lodge a franking account return.

DISCLAIMER: The material and opinions in this article should not be used or treated as professional advice and readers should rely on their own enquiries in making any decisions concerning their own interests.