Question

Due to COVID-19 impact, Watson Co becomes insolvent and placed into voluntary liquidation by its directors. Dissolve liquidators have been appointed as the company liquidators. On the winding up of the Watson Co, Dissolve liquidators have started distributions and paul as ex-shareholder of Watson Co received $7,200 from the liquidators, which was inclusive of $3,000 unfranked dividend pursuant to the provision of Income Tax Assessment Act 1963, section 47(1) of Australian tax law. This distribution to Paul was from his $4,000 investment in the shares of Watson Co on 2nd February 2019. Required: With reference to relevant provisions of ITAA 97 and ITAA 36, critically analyze the tax consequences of the above scenario for Paul regarding australian tax laws.

Answer 1

As per ITAA 36, Section 47,

Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

In the given scenario, Paul has received dividends from the company that has been liquidatd and declared insolvent. Hence the above scenario holds true for the company. As we can see here, company has paid unfranked dividends to Mr. Paul to the extend of $ 3,000 for the investment of $4,000 made by him. This means, he has received a dividend of $0.75 per share from the company. The taxability of the same depends on the type of dividend; ie, franked dividend or iunfranked dividend.

• A Franked Dividend means the dividend has a tax credit attached to them whereas
• An Unfranked Dividend does not have a tax credit attached to it.

When companies pay part of their earnings in the form of dividends, shareholders pay tax on the income at their marginal tax rate. But if the company has already paid tax on the income at the company level, the tax office gives shareholders a personal tax credit called a “franking credit”.

Companies pay tax at 30% which leaves 70% cash which can be paid as a dividend to shareholders.

If it’s a Franked Dividend, it will include a credit of 30% which represents the tax that has already been paid by the company.

Whereas on the other hand, if it is an unfranked dividend, it will not include any tax credit. This means, the entire $3,000 will be treated as income from investments and it will be taxed for the assessee, Mr Paul based on his toal income income and the respective slab rates.