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The Australian Treasury has released an Exposure Draft of legislation which will further curtail the ability of companies to frank distributions. If enacted in its proposed form it could well impact special dividends paid in conjunction with M&A transactions.


  • Proposed changes to the tax legislation will make dividends funded by equity raises unfrankable.
  • The drafting is broader than originally announced in 2016.
  • If passed in its current form, the changes could impact the frankability of a special dividend paid in conjunction with an M&A transaction.


The background to the announcement lies in special dividends paid by Harvey Norman, Tabcorp and others which the ATO was unhappy with, and which led the ATO to issue a taxpayer alert, TA 2015/2: Franked distributions funded by raising capital to release credits to shareholders (the TA). The thrust of the TA was that the ATO was concerned where a company with retained and taxed earnings, at about the same time, both (i) paid a special dividend which was franked (or undertook an off-market share buy back), and (ii) undertook a capital raising in some form. According to the TA, the transaction, “may attract the operation of the anti-avoidance rule in section 177EA of the Income Tax Assessment Act 1936 or other anti-avoidance rules.” The taint of avoidance arose in the ATO’s mind from its view that, “there is minimal net cash inflow to or outflow from the company [and] the net asset position of the company remains essentially unchanged…

In December 2016 the Government announced it would introduce a new measure to address, “distributions declared by a company to its shareholders outside or additional to the company’s normal dividend cycle (a special dividend), to the extent it is funded directly or indirectly by capital raising activities which result in the issue of new equity interests …” The announcement specifically referred to the scenario outlined in the TA and said the new measure would apply to distributions made from 19 December 2016. The implication of the Government’s announcement was that the ATO had some doubts about the cogency of its view that the transaction would be amenable to challenge under s. 177EA of the ITAA 1936.

Equity-funded special dividends largely ceased after the announcement of the Taxpayer Alert in 2015, so it is somewhat surprising that the Government has now picked this up after 7 years of inattention.

Treasury has released an Exposure Draft of legislation which will make a dividend an unfrankable distributions where the following 3 conditions are met:

  1. the company makes a distribution in circumstances that are not in accordance with its usual practices for that kind of distribution (a “pattern of distributions” test);
  2. there is an issue of equity interests either by the entity or another entity; and
  3. it is reasonable to conclude ‘having regard to all relevant circumstances’ that either –
    1. the principal effect of the issue of any of the equity interests was the direct or indirect funding of the relevant distribution or part of the relevant distribution; or
    2. any entity that issued, or facilitated the issue of, any of the equity interests did so for a purpose (other than an incidental purpose) of funding the relevant distribution or part of the relevant distribution (a “purpose or effect” test). (our emphasis)

The new rules will apply to distributions made on and after 19 December 2016.


While the announcement of these changes was targeted in response to equity raisings that were clearly linked to dividend payments, they could have wider implications in M&A transactions.

The drafting is incredibly broad applying where:

  • any part of the equity issue has the requisite purpose or effect of funding any part of the distribution;
  • the equity issue can happen before or after the distribution was made;
  • the equity issue can be made by any company – not simply the payer of the dividend; and
  • the purpose of anyone who facilitates the equity issue can be sufficient.

Examples of where these proposed rules could apply in an M&A context include:

  • a company sells an asset and uses the sale proceeds to pay a special dividend. The buyer funds the purchase in part through an equity raise;
  • a scheme of arrangement where the target wants to pay a special dividend pre-implementation. The buyer funds the acquisition via equity raise and loans funds to the target to pay the dividend;
  • pre-IPO dividend where part of the IPO proceeds will be used to replenish working capital; or
  • a post IPO dividend where the company has no history of paying dividends (eg it was previously owned by a private equity fund).

Finally, at a more general level, it is not obvious that there is any real problem here: the company has retained profits, it has paid tax, it is franking a dividend in accordance with the existing rules, and the benefit of the franking is going to the people who were shareholders when the profits were earned and the tax was paid (the incoming equity holders did not enjoy the special dividend). The ‘mischief’ appears to arise when a company decides to release its franking credits to their proper owners using funds raised by someone issuing equity rather than debt.

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Toby Eggleston

Partner, Melbourne

Toby Eggleston