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). 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. (10 marks, maximum 300 words).

Please Answer

Answer 1

Answer:

As per Section 47 of ITAA 36, Distributions by liquidator to a shareholder of a company during its liquidation to the degree that they reflect income obtained (before or after the liquidation) from a corporation other than income reasonably used to offset a loss of paid-up capital are considered to be dividends paid by the shareholder by comp for the purposes of this Act.

In the scenario given, Paul received dividends from the company that was declared insolved and wound up. That is why for the company the above scenario is true. The company has paid Mr. Paul unfranked dividends of $3,000 in investment of $4,000, as can be seen here. This means that the dividend received by him is $0.75 per share. The taxability of the same relies on the dividend type; That is, Franked or Unfranked. Franked dividend has a tax credit attached whereas an unfranked dividend does not have a tax credit attached.

When firms pay a portion of their income as dividends, shareholders pay marginal tax on their income. But if it has paid income tax at the level of the company already, the tax bureau will give a personal tax credit to shareholders called a "franking credit." Industries pay 30% tax, leaving 70% cash which can be returned to shareholders as a dividend. When the dividend is franked, it requires a 30% credit, which is the tax already paid by the corporation. Whereas, on the other hand, it does not include any tax credit if it is a non-franked dividend. This means that the $3,000 in total is treated as investment revenue and Mr Paul will be taxed on his total revenue and respective slab rates.