The ATO has released details of "dividend access share" arrangements that it considers to be dividend stripping schemes under the tax law anti-avoidance provisions. These arrangements aim to allow ordinary shareholders of a private company and/or their associates to derive the economic benefit of significant profits accumulating in the private company in a substantially (if not entirely) tax-free form.
These arrangements involve a number of features, but principally include the company issuing a new class of shares to another entity (eg another company controlled by the original shareholders) for nominal consideration, and the company declaring and paying fully franked dividends on the new class of shares of an amount approximately equal to the accumulated profits in the company. The ATO says these arrangements generally result in a reduction or elimination of the taxation liabilities that would normally arise with the payment of dividends (that is, if those dividends were paid to the company's ordinary shareholders).
The Commissioner is of the view that under such circumstances, he can exercise his power to cancel all or part of the tax benefit obtained from these schemes.
Taxation Determination TD 2014/1 states broadly the Commissioner's view that a dividend access share arrangement of the type described in the determination is a scheme "by way of dividend stripping" or "in the nature of dividend stripping" within the meaning of s 177E of Pt IVA of the Income Tax Assessment Act 1936. As a consequence, it states that Pt IVA is capable of applying to such arrangements. The determination was previously issued as Draft Taxation Determination TD 2013/D5 and remains largely the same.
Specifically, the determination outlines the following type of arrangement:
- a private company (target company) has accumulated significant profits that have been subject to income tax at the company tax rate. Its ordinary shares are held by an individual who is also the director;
- the target company's constitution is amended to allow for the creation of a new class of shares that have rights to receive dividend distributions at the discretion of the company directors, have no voting rights and are subject to rights of the target company to redeem the shares within four years of the issue date;
- the shareholder of the target company may then incorporate new companies or trusts or employ existing companies or trusts and issue the target company's new shares to those entities. The interposed entities are controlled by the target company's shareholder;
- the target company then declares and pays a fully franked dividend on the new class of shares approximately equal to the accumulated profits in the target company, and the dividend is satisfied by way of a promissory note; and
- subsequently, a series of transactions are carried out to effectively deliver the economic benefit of the target company's profits to the original shareholder or their associates in a tax-free or substantially tax-free form. According to the ATO, some examples include the following:
- the new shares are issued to a company that does not need to pay tax on the dividend as there are enough franking credits to offset the liability. The company is wholly owned by a discretionary trust, which allows the target company's shareholder to direct any subsequent dividend distributions by the company to tax-preferred entities (ie non-resident associates, other related individuals with lower marginal tax rates and/or entities with carried-forward losses); or
- where the new shares are issued to the trustee of a discretionary trust, the trustee appoints the net income of the trust to a second trust without immediately paying out the entitlement, creating an unpaid present entitlement (UPE). The trustee of the second trust then appoints its net income to a private company beneficiary without immediately paying out that entitlement (ie creating a UPE of the private company). Notwithstanding any consequences under Div 7A, the UPE remains an asset of the private company beneficiary indefinitely. In many such arrangements, the assets represented by the fully franked dividend on the new class of shares are lent by the trustee of the trust to the original shareholder and/or their family for personal use under an interest-free loan repayable only on demand by the trustee company, which is controlled by the target company's shareholder.
According to the determination, while the application of Pt IVA depends on the facts of each case, the Commissioner considers that a dividend access share arrangement that includes all the elements above is a scheme "by way of or in the nature of dividend stripping" under s 177E. The Commissioner notes, however, that the absence of one or more factors as set out above could result in a different conclusion being reached.
The determination states that in deciding whether there is a scheme under Pt IVA, it is necessary to determine whether there is an objective purpose of tax avoidance in respect of the scheme.
Further, it states that a simple assertion that another non-tax purpose exists will not of itself conclusively determine the issue.
Therefore, the determination indicates that the Commissioner will consider:
- whether the alleged non-tax purpose could have been achieved in a simpler and/or more commercially usual manner; and
- whether a particular arrangement suggests a tax avoidance purpose, ie whether the arrangement has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits from the target company.
The determination applies both before and after its date of issue.
Source: ATO Taxation Determination TD 2014/1, law.ato.gov.au/atolaw/view.htm?DocID=TXD/TD20141/NAT/ATO/00001&PiT=99991231235958.