ATO Tightens Stance on Capital-Raised Franked Distributions

The ATO has finalised its position on distributions funded by capital raising, confirming that some such payments will be deemed unfrankable under s 207-159 of the Income Tax Assessment Act 1997 (ITAA 1997).

The move reinforces the regulator’s focus on integrity and commercial purpose in corporate distribution strategies.

The ATO’s Compliance Approach

The ATO’s Practical Compliance Guideline (PCG 2025/3) now outlines when a capital-funded distribution may breach the integrity rule under s 207-159.

This guideline complements Taxpayer Alert TA 2015/2, originally issued in 2015, which warned against private company structures using new capital—via debt or equity—to fund shareholder distributions, especially where payments are debited to share capital accounts instead of retained earnings.

The finalised guidance formalises nearly a decade of ATO scrutiny into capital management strategies that create franked dividends disconnected from genuine profit generation.

When a Franked Distribution Becomes Unfrankable

Effective from 28 November 2023, the legislation applies to distributions that fail to meet one or more of the ATO’s prescribed criteria:

- Established practice: The entity either lacks a consistent pattern of making such distributions or the current payment departs from prior practice.

- Equity issuance: New equity interests (by the company or related entities) are issued around the time of the payment.

- Principal purpose: The equity raising’s main or substantial purpose is to directly or indirectly fund the distribution.

- Regulatory compulsion: The equity issue was not required by APRA or ASIC regulatory capital obligations.

If these conditions are triggered, the related distribution will lose its franking eligibility, irrespective of the company’s franking account balance.

Why It Matters — Risks and Implications

For Shareholders

- No franking credit offset: Recipients cannot use franking credits to reduce tax, as the payment is deemed unfrankable.

- Higher effective tax: Individuals and entities are taxed on the full distribution amount without offset for company tax already paid.

- Non-residents: May face withholding tax exposure, given these distributions fall outside the imputation system.

For Companies

- No franking debit: The unfrankable payment won’t reduce the franking account balance.

- ATO scrutiny: The regulator will examine transactions that appear contrived, circular, or inconsistent with historical practices.

- Penalties and adjustments: Non-compliance with PCG 2025/3 may result in penalty assessments and tax recharacterisation under Part IVA.

Takeaway

This finalised guidance is a clear signal: the ATO is intensifying its focus on capital management transparency.

Boards and advisers should reassess whether any recent or planned equity-funded distributions could be viewed as tax-driven rather than commercially justified.

Where there is doubt, documented rationale and alignment with genuine capital-management objectives will be critical.

Contact us

We can help you with navigating through the changes that may apply to your situation. For further discussion, please feel free to contact our office.