Exempting entity thresholds and timeframes

What makes a corporate tax entity exempting?

For practices advising corporate groups, the key point is that the threshold is not a rough indicator. On its page last updated 1 December 2016, the ATO sets the test at 95% or more effective ownership by prescribed persons and also considers arrangements affecting where risks and opportunities substantially accrue.

Which people count as prescribed persons?

The same ATO page defines prescribed persons broadly. They include tax-exempt companies or natural persons, non-residents, partnerships or trusts where all partners or beneficiaries are exempt from tax or are non-resident, and the Commonwealth, states and territories. That matters because the ownership analysis is not limited to direct shareholders on a register.

When does an entity become a former exempting entity?

A former exempting entity is, in the ATO's words, "a corporate tax entity that has ceased to be an exempting entity and has not again become an exempting entity." This status change is the key timeframe in the rules, and practices need to establish whether historic credits may be affected after the transition.

The cost of getting the ownership or distribution analysis wrong is also set out in the ATO integrity rules. Where the imputation system has been manipulated, the ATO says that "a tax offset will be denied." It adds that direct recipients are not grossed-up, while indirect recipients may receive a deduction or reduction instead.

On its integrity page last updated 28 November 2023, the ATO also says the small shareholder exemption is subject to a $5,000 threshold. That threshold concerns the exemption described in the integrity material, rather than the 95% exempting-entity ownership test.

What should practices review first?

Before a filing deadline, practices should document the ownership position and the status transition point. A recorded workflow can make the review repeatable, while the Knowledge centre offers plain-English articles on Australian practice obligations.

1. Check whether prescribed persons directly or indirectly hold 95% or more of accountable membership interests or accountable partial interests.
2. Review known arrangements that could mean risks and opportunities from holding membership interests substantially accrue to prescribed persons.
3. Identify whether the entity ceased to be an exempting entity and has not again become one.

Practices should also check whether the entity falls within a modified-rule category named by the ATO. The rules are modified for integrity purposes where an entity or group member is a New Zealand company that chose to enter the Australian imputation system, or where the entity is part of a consolidated group or MEC group.

How are exempting credits treated after a status change?

Exempting entities apply franking credits to frankable distributions in the same way as ordinary companies, but the ATO says franked distributions they make are generally treated as unfranked distributions. Once an entity becomes former exempting, Division 208 targets accumulated exempting credits so they are not used for franking credit trading.

Under Division 208 consequences described by the ATO, an exempting company's accumulated credits can be quarantined when it becomes a former exempting entity. They move into a separate exempting account and the entity starts a new franking account. A recipient is denied an imputation benefit from an exempting credit unless it was a member immediately before the status change.

The ATO describes franking credit trading as credits being diverted from the true economic owners of membership interests to others who can benefit most from them. In that context, Division 208 limits when a distribution franked from an exempting company's franking account can give rise to imputation-system benefits. This explains why the ownership history and transition date need clear supporting records. It also distinguishes the former exempting entity rules from the separate qualified person test mentioned on the trading page for taxpayers.

For accounting and bookkeeping practices, the safest advice supported by these sources is narrow and practical. Confirm whether the 95% ownership threshold is met, test whether known arrangements shift risks and opportunities to prescribed persons, identify whether the entity has ceased to be exempting without becoming one again, and escalate modified-rule cases early.

DeskMate can help a practice with the repetitive administrative preparation around this review by gathering, chasing, matching, formatting and filing information, while treatment, exceptions, advice and approvals stay with people.