Module 8 Companies and dividends (CPA 105)

CPA 105 Taxation

Module 8 Companies and dividends

Question 1
On 1 August 2007, John Gannon, who lives in Melbourne, received a dividend cheque from ACI Ltd, an English
company, for $85. A dividend statement informed him that $15 overseas withholding tax had been deducted.
He also received a dividend of $75 with an imputation credit of $32 from BXR, an Australian resident company,
and $200 return of capital from BXR from an untainted share capital account. The cost base of his shares in BXR
was $200.

In respect of these transactions, Gannon should declare as assessable income for the year ending 30 June 2008
(assume John is a qualified person for franking credit tax offset purposes):

a. $160.
b. $175.
c. $207.
d. $350.

Question 2
Charter Pty Ltd, a non-dual resident Australian private company, derived taxable income of $200 000 for the year
ending 30 June 2008. The taxable income includes the following three dividends and any associated imputation
credits:

■ a dividend from a resident Australian public company $1000

(dividend statement showed no imputation credit attached to distribution)

■ a dividend from an unrelated Australian private company $1000

(with imputation credit attached of $257)

■ a dividend from a wholly-owned subsidiary company $1000

(with no imputation credit attached)

The net tax payable (taking into account only tax offsets for imputation credits) by Charter Pty Ltd for the year
ending 30 June 2008 is:

a. $58 400.
b. $60 480.
c. $59 743.
d. $58 000.

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Question 3
At 30 June 2008, XYZ Ltd had a debit balance in its franking account of $146 000. This account must be:

a. cleared in seven days by the payment of $62 571.43 to the Commissioner of Taxation.
b. cleared in 28 days by the payment of $146 000 to the Commissioner of Taxation.
c. cleared in one month by the payment of $62 571.43 to the Commissioner of Taxation.
d. cleared by the last day of the month following the end of the income year by the payment
of $146 000.

Question 4
Colmack Pty Ltd had a nil balance in its franking account at 1 July 2007. During the year, the company:

■ received a $1000 dividend from MAG Ltd, with an imputation credit of $171;
■ paid $6000 during the year in company tax instalments under PAYG instalment system;
■ paid a fully franked dividend of $10 000 with imputation credit of $4286 attached.

The balance of the franking account at 30 June 2008 would be:

a. $4335 surplus.
b. $1885 surplus.
c. $2143 surplus.
d. Nil.

Question 5
McMahon & Tate is an advertising company with operations in Australia and the United States. Sixty per cent
of the company’s profits arise from Australian operations. The balance are profits derived from the USA office.
The company has two shareholders, Darren, an Australian resident, and Larry, a US resident, who each hold
one share.

Assuming that the company pays an unfranked distribution of $10 000 (with no imputation credit attached)
per share, which of the following correctly shows the amount to be assessed in Australia? Assume withholding
tax has been deducted from Larry’s distribution:

a. Darren—$6000; Larry—$6000
b. Darren—$6000; Larry—Nil
c. Darren—$10 000; Larry—$6000
d. Darren—$10 000; Larry—Nil

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Question 6
Curtis Rodda, an Australian resident aged 21, received the following amounts all from Australian sources as his
only income for the year ended 30 June 2008:

■ $15 000—Interest income.

■ $10 000—Fully franked dividend from A Co Pty Ltd with an imputation credit of $4286 attached
(an Australian resident).
■ $1200—dividend from B Co Pty Ltd with an imputation credit of $257 attached (an Australian resident).

Ignoring the effects of Medicare, how much tax would Curtis pay or receive as a refund on the above income
after taking into account tax offsets (imputation credits) relevant to this income only? Use 2007/08 tax rates
rounded to the nearest dollar.

a. $720 refund.
b. $900 refund.
c. $3030 payable.
d. $3822 payable.

Question 7
Peno-Amelia Ltd had a nil balance in its franking account at 1 July 2007 and recorded the following transactions
during the year ended 30 June 2008:

■ Receipt of a fully franked dividend of $10 000 carrying an imputation credit of $4286.
■ Refund of $2000 tax paid when the company tax rate was 34 per cent.
■ PAYG instalments of company tax $14 000.
■ Payment of a fully franked dividend of $6000.
■ Payment of fringe benefits tax of $6000.
■ Payment of GST instalment of $2000.

As at 30 June 2008, which of the following correctly represents the balance of the franking account?

a. $32 382 CR.

b. $14 521 CR.
c. $13 715 CR.
d. $21 714 CR.

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Question 8
Which of the following distributions is a frankable distribution?

I. Return of capital distribution from an untainted share capital account.

II. Deemed dividends in relation to excessive payments made by a private company to its shareholders.
III. Distribution funded from profits of the corporate tax entity.
IV. Distribution made in relation to off-market buy backs of equity interests where the amount paid in
respect of the buy-back exceeds the market value of the equity interest.

a. III only.
b. III and IV only.
c. IV, III and II only.
d. I, III and II only.

Question 9
The balance sheet at 30 June 2008 of Shady Pty Ltd, a company wholly-owned by Mr and Mrs Sting,
was as follows:

Assets Liabilities
Cash at bank 10 Creditors 10 000
Shares—BHP 5 000 Capital
Loan B 94 990 Share capital 10 000
Retained earnings 80 000
$100 000 $100 000

Loan B was made by the company to its shareholders, Mr and Mrs Sting, on 1 July 2007. The loan was interest
free with no repayments of capital due until demanded. Assuming the loan is not repaid by the due date of
lodgment of the company’s tax return, what is the deemed dividend amount? (Assume that balance sheet values
reflect market values.)

a. Nil.
b. $80 000.
c. $90 000.
d. $94 990.

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Question 10
What is the full potential tax consequence of a private company making an excessive payment (in respect of
services rendered) to an associated person of the private company?

a. No consequence as the Commissioner cannot tell a taxpayer how much to pay for a given product or
service.
b. The total payment may be non-deductible.
c. The excessive component of the payment may be non-deductible.
d. The excessive component of the payment may be non-deductible and deemed to be a dividend.

Question 11
As at 20 June 2008, Careless Pty Ltd had a debit balance in its franking account of $42 857. On 25 June 2008,
the company recorded the receipt of a fully franked dividend of $25 000. Assuming there are no other
transactions, how much franking deficit tax will be payable.

a. $9643.
b. $32 143.
c. $75 000.
d. $13 776.

Question 12
For the year ending 30 June 2008, Telstar Pty Ltd has provided you with the following information:

■ Balance of franking account at 1 July 2007 $8 571 CR

■ Total amount of company tax paid during the year under PAYG instalment $75 000

■ Fully franked dividends received with imputation credit attached of $8571 $20 000

■ Partially franked dividend received with imputation credit of $4286 attached $20 000

■ Payment of fully franked dividend $150 000

What is the balance of Telstar’s franking account at 30 June 2008 (to the nearest whole dollar)?

a. $132 143 CR.

b. $49 285 DR.
c. $32 142 CR.
d. $53 572 DR.

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Question 13
Filta Pty Ltd wants to make a $10 000 distribution of which $6000 represents the frankable part and $4000 the
unfrankable part of the distribution. Filta Pty Ltd allocates $2571 franking credit to the distribution.

What is the franking percentage for the distribution?

a. 100%.
b. 60%.
c. 42.85%.
d. 64.27%.

Question 14
Fizz Pty Ltd wants to make a $10 000 frankable distribution. What is the maximum franking credit that Fizz Pty Ltd
could allocate to this frankable distribution?

a. $2143.
b. $10 000.
c. $5152.
d. $4286.

Question 15
Zero Pty Ltd has a benchmark franking percentage for the current franking period of 80 per cent. Zero Pty Ltd
makes a fully franked distribution of $700 within the current franking period. What is the amount of over-
franking tax that Zero Pty Ltd will be required to pay?

a. Nil.
b. $60.
c. $80.
d. $20.

Question 16
Assume Met Pty Ltd’s franking account balance is $3000 debit balance at the end of the income year. During the
income year, Met Pty Ltd’s franking account had $10 000 of franking credits posted to it.

What is Met Pty Ltd franking deficit tax offset entitlement?

a. Nil.
b. $2100.
c. $3000.
d. $10 000.

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Question 17
Which of the following statements (I through IV) are true?

I. A private company must give a distribution statement to the recipient on or before the day on which the
distribution is made.
II. A private company must give a distribution statement before the end of four months after the end of the
income year in which the distribution is made.
III. A private company only needs to provide a distribution statement if a franking credit has been allocated
to the distribution.
IV. A public company is required to give a distribution statement to the recipient on or before the day on
which the distribution is made.

a. I and III only.

b. I and IV only.
c. II and III only.
d. II and IV only.

Question 18
Text Pty Ltd in year 1 incurred a tax loss of $10 000. The shareholders in Text Pty Ltd at this time were as follows:

A. 35%
B. 25%
C. 40%

In year 3, Text Pty Ltd wants to apply the tax loss incurred in year 1 against its taxable income in year 3.
Shareholders in Text Pty Ltd in year 3 are as follows:

A. 25%
B. 20%
C. 15%
D. 40%

Which of the following statements is correct?

I. Text Pty Ltd cannot use the tax loss in year 1 against its taxable income in year 3 as it fails the continuity
of ownership test (COT).
II. Text Pty Ltd has satisfied the COT and can utilise its tax losses in year 3.
III. Text Pty Ltd cannot satisfy COT as shareholder D was not a shareholder in Year 1 when the losses
were incurred.
IV. Text Pty Ltd needs to fail the COT before it can claim the tax loss using the same business test.

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a. I only.
b. II and III only.
c. II and IV only.
d. III only.

Question 19
Assume Met Pty Ltd’s franking account balance is $1000 debit balance at the end of the income year. During the
income year, Met Pty Ltd franking account had $12 000 of franking credits posted to it.

What is Met Pty Ltd’s franking deficit tax offset entitlement? (Assume that Met Pty Ltd meets its franking deficit
liability by the due date.)

a. Nil.
b. $700.
c. $1000.
d. $12 000.

Question 20
Which of the following statements (I through IV) are true?

I. Any entity in receipt of fully franked dividend is automatically entitled to an imputation tax offset.
II. Only qualified persons are entitled to an imputation tax offset unless an exemption applies.
III. The gross-up and tax offset treatment does not apply to a direct recipient of a franked dividend where
the recipient is not a qualified person in relation to the distribution.
IV. A small shareholder that is a natural person, whose tax offset entitlements does not exceed $5000 for the
income year, does not have to satisfy the holding period rule and/or related payments rule in order to be
a qualified person.

a. I and III only.

b. I and IV only.
c. II, III and IV only.
d. II and IV only.

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Solutions

Question 1
Correct Answer: c

Assessable income:
$
Cash dividend from ACI Ltd $85 plus $15 withholding tax 100
Cash dividend from BXR 75
Grossed up for imputation credit 32
207

A $200 return of capital from an untainted share capital account is not a dividend. (See the definition of
‘dividend’ in s.995-1(1), particularly meaning given by s.6(1) paragraph (d) ITAA 36 and the definition of
‘share capital account’ in s.6(1) and s.6D ITAA 36). The $200 would be assessed under the CGT provisions.
However, as cost base is equal to the return of capital, no overall gain arises.

Question 2
Correct Answer: c

The net tax payable by Charter Pty Ltd is:

$ $
Tax at 30% on a taxable income of $200 000 60 000
Less Tax offset for imputation credits
Dividend from a resident public company NIL
Dividend from an unrelated private company 257
Dividend from wholly-owned subsidiary NIL
Net tax payable 59 743

Question 3
Correct Answer: d

As XYZ Ltd has a debit balance in its franking account at year end, it becomes liable for franking deficit tax
liability (s.160AQJ(1B)).

The amount of the franking deficit is equal to the sum of the franking deficit that existed at the end of the
entity’s income year. The franking deficit tax liability must be paid and a franking account tax return must be
lodged by the last day of the month following the end of the income year.

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Question 4
Correct Answer: b

Debit Credit Balance

Balance at 1 July 2007 0
Receipt of partially franked dividend with imputation credit of $171 171 171 CR
Payment of company tax $6000 6 000 6 171 CR
Payment of fully franked dividend 4 286 1 885 CR

Question 5
Correct Answer: d

ITAA36 s.44 provides that the assessable income of a shareholder shall:

a. if he is a resident, include dividends paid to him by the company out of profits derived by it from any
source; and
b. if he is a non-resident, include dividends paid to him by the company out of profits derived by it from
sources in Australia.

Accordingly, the whole of the dividend paid to Darren will be assessable under s.44(1)(a) and while 60 per cent
of the dividend paid to Larry would normally be assessable under s.44(1)(b), s.128D would apply to make the
dividend non-assessable (see below).

Double tax treaties, which exist between Australia and other countries, govern the taxing rights of various
authorities in such circumstances. As determination of the source of profits out of which dividends are paid is
often a practical impossibility, the general rule established by double tax treaties is that a dividend will have a
source in the country of residence of the company paying the dividend.

Unfranked dividends paid to a non-resident by an Australian resident company will be subject to withholding
tax. The ATO will collect tax on dividends paid to non-residents via the franking system or the withholding tax
system. Section 128D of ITAA provides that an unfranked dividend upon which withholding tax is payable
shall not be included in the assessable income (i.e. s.128D ‘takes out’ of assessable income any dividends
included by s.44). It also provides that fully or partially franked dividends shall not be included in the assessable
income to the extent to which they are franked.

Fully franked dividends, whilst not subject to withholding tax, are treated as if they are subject to withholding
tax for the purposes of the s.128D exemption. Partially franked dividends are ‘partially’ excluded. The unfranked
portion of partially franked dividends would be subject to withholding tax.

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Question 6
Correct Answer: a

Curtis’ taxable income would be calculated as follows:

$
Interest income s.6-5 15 000
A Co Pty Ltd s.44 10 000
Imputation credit 4 286
B Co Pty Ltd s.44 1 200
Imputation credit 257
Total 30 743
Tax on $30 743 (excluding Medicare levy) 3 822.90
Less imputation tax offset (4286)
(257)
Tax refund (720)

Option B is wrong as the 50 per cent franked dividend is treated as if it were fully franked, that is taxable income
of $31 000, tax = $3900 less imp. rebates of $4800 = ($900).

Option C is wrong as this is the tax payable assuming the dividends were unfranked, that is taxable income of
$26 200, tax = $3030.

Option D is wrong as this is the tax payable before imputation rebates ($3822).

Question 7
Correct Answer: c

The franking account of Peno-Amelia would appear as follows:

Debit Credit Balance

Balance 0
Receipt of fully franked dividend 4 286 4 286 CR
Refund of tax when tax rate was 34% 2 000 2 286 CR
PAYG instalment of tax 14 000 14 000 16 286 CR
Payment of a fully franked dividend 2 571 13 715 CR

The balance would be $13 715 CR.

Option A is incorrect as the credit for tax paid is calculated as $14 000 and not $32 667 ($14 000 × 70/30).

Option B is incorrect as the debit for the tax refund is $2000 and not $2806.

Option D is incorrect as both fringe benefits tax and GST are not included in the franking account.

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Question 8
Correct Answer: a

Only frankable distributions may be franked. A distribution will be frankable unless it is specifically listed as
being unfrankable. Distributions I, II and IV are all distributions that are specifically listed as being unfrankable
distributions.

Question 9
Correct Answer: b

Subject to s.109Y ITAA 36, a loan to a shareholder that is not repaid at the end of the tax year is a deemed
dividend unless the agreement is in writing, the interest payable on the loan exceeds the benchmark rate and the
loan period does not exceed the maximum term as defined in s.109N(3).

While the amount of the shareholder loan in this case is $94 990 the distributable surplus is only $80 000.
Accordingly, the deemed dividend can be no greater than the distributable profits (s.109Y). Therefore,
the answer is $80 000. Deemed dividends under Division 7A are not frankable, unless the Commissioner
exercises his discretion to frank a deemed dividend under s.109RB.

All other options are incorrect.

Calculation of distributable surplus

Assets
Cash $10
Shares $5 000
Loan $94 990
Total assets $100 000

Less Liabilities $10 000

$90 000

Less Prior Division 7A loans —

Less Paid-up capital ($10 000)
Less Repayment prior to
Division 7A loans —

$80 000

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Question 10
Correct Answer: d

Section 109 ITAA 36 operates where excessive payments are made to shareholders, directors and associated
persons of a private company. The effect of the section is that the amount of the payment which exceeds what
the Commissioner considers reasonable (for the service performed or the product provided) will not be
deductible and shall be deemed to be a dividend paid by the company.

Question 11
Correct Answer: b

As at 30 June 2008, the franking deficit would be $42 857 – $10 714 = $32 143. The receipt of a fully franked
dividend would give rise to a franking credit thus reducing the debit balance.

Franking deficit tax is equal to the sum of the franking deficit in its franking account at the end of the entity’s
income year.

The other incorrect options are calculated as follows:

a. 30% of $32 143 = $9643.

c. This is the amount of the franking deficit × 70/30.

d. $32 143 × 30/70 = $13 776.

Question 12
Correct Answer: c

Debit Credit Balance

Opening balance 8 571 CR
Payment of company tax 75 000 83 571 CR
Receipt of fully franked dividends 8 571 92 142 CR
Receipt of partially franked dividends 4 286 96 428 CR
Payment of fully franked dividend 64 286 32 142 CR
Therefore, the answer is C, $32 142 CR.

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Question 13
Correct Answer: a

The franking percentage is a measure of the extent to which a frankable distribution has been franked. It is
expressed as a percentage of the frankable distribution, instead of the whole distribution. The franking
percentage is the lesser of 100 per cent or the amount calculated using the following formula:

Franking credit allocated

to the frankable distribution
× 100%
Maximum franking credit
that can be allocated for
frankable portion of distribution

$2571
× 100 = 100%
$2571

Question 14
Correct Answer: d

The maximum franking credit is calculated as follows:

Amount of the Corporate tax rate

×
frankable distribution 100% – Corporate tax rate

30%
= $10 000 × = $4286
100% – 30%

Question 15
Correct Answer: b

Zero Pty Ltd benchmark franking percentage was 80 per cent so the frankable distribution of $700 should have
had a franking credit of $240 attached.

Zero Pty Ltd allocated $300 franking credit which resulted in a franking percentage of 100 per cent. Zero Pty Ltd
has over-franked the distribution and an over-franking tax will be imposed.

The amount of the over-franking tax will be equivalent to the franking credit allocated in excess of the
benchmark.

(100% – 80%) × $700 × (30% ÷ 70%) = $60

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Question 16
Correct Answer: b

As Met Pty Ltd’s franking deficit at the end of the year was more than 10 per cent of all the franking credits that
arose during the year, its franking deficit tax offset entitlement is reduced by 30 per cent
($3000 less $900 ($3000 × 0.30)).

Question 17
Correct Answer: d

Statement I is incorrect, as private companies have up to four months following the end of the income year in
which to provide a recipient with a distribution statement.

Statement III is incorrect as a distribution statement must be provided regardless of whether any franking credit
has been allocated.

Question 18
Correct Answer: c

Text Pty Ltd has satisfied the COT:

Shareholding that
Shareholding Shareholding counts towards COT
Year 1 Year 2 Year 3
A. 35 25 25
B. 25 20 20
C. 40 15 15
D. — 40 —
100 100 60

Text Pty Ltd shareholders in year 3 own more than 50 per cent of the same shares which were owned in year 2
when the loss was incurred.

Also, a private company must fail the COT before it can use the same business test. The ownership test period
is the period from the start of the loss year to the end of the income year in which the loss is to be deducted for
the purposes of working out whether a company has satisfied COT. Due to the difficulty widely held companies
may have in tracing ownership of their shares, the rules for establishing continuity of ownership are made
simpler. Also, companies do not have to identify the exact date of failure of COT.

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Question 19
Correct Answer: c

As Met Pty Ltd’s franking deficit at the end of the year was less than 10 per cent of all the franking credits that
arose during the year, its franking deficit tax offset entitlement is not reduced by 30 per cent.

Question 20
Correct Answer: c

The first statement is incorrect. Only qualified persons are eligible for an imputation tax offset unless an
exemption applies. All other statements are correct.

Distributions of franked dividends directly are not subject to gross-up and tax-offset where the shareholder
does not qualify as a qualified person.

The small shareholder exemption means that shareholders do not have to satisfy the holding period and/or
related payments rule in order to be a qualified person.

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