The ATO has published draft Ruling TR 2011/D8 about the taxation of dividends paid in compliance with section 254T of the Corporations Act 2001 and the circumstances in which a dividend will be paid out of profits.

The dividends test in Section 254T was amended in 2010 to replace the profits-based test with a net assets test.

The ruling is:

1. A company that pays a dividend to its shareholders, in accordance with its constitution and without breaching section 254T or Part 2J.1 of the Corporations Act, that is paid out of current trading profits recognised in its accounts and available for distribution, is not prevented by paragraph 202-45(e) of the ITAA 1997 from franking the dividend merely because the company has unrecouped prior year accounting losses or has lost part of its share capital. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936.5

4. A company that pays a dividend to its shareholders, in accordance with its constitution and without breaching section 254T or Part 2J.1 of the Corporations Act, that is paid out of an unrealised capital profit of a permanent character recognised in its accounts and available for distribution, is not prevented by paragraph 202-45(e) of the ITAA 1997 from franking the dividend provided the company’s net assets exceed its share capital by at least the amount of the dividend. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936.6

5. A distribution (even if it is labelled as a dividend) paid by a company to its shareholders, that does not comply with section 254T or Part 2J.1 of the Corporations Act, is an unauthorised reduction and return of share capital that will be taxed as a CGT event under the capital gains tax provisions in Part 3-1 of the ITAA 1997, or will be taxed as an assessable unfranked dividend, depending on the particular facts and circumstances of the payment.