ATO alert on “dividend access share arrangements”

The ATO has issued Taxpayer Alert TA 2012/4 warning taxpayers about arrangements where accumulated profits of a private company are distributed substantially tax-free to an entity associated with the ordinary shareholders of the private company.

Broadly, the ATO says the arrangements the Alert applies to have the following (or substantially similar) features:

• a private company has accumulated significant profits that are subject to income tax at the company tax rate;
• the company’s ordinary shares are held by one or more individuals who may also be the company’s directors;
• a tax intermediary then recommends the private company create a new class of shares that has some or all of the following characteristics:

-        a right to receive a dividend distribution at the discretion of the company’s directors;

-        a lack of any voting rights or rights to participate in surplus assets of the company upon its winding up;

-        a right by the company to redeem the new shares within four years of the issue date; and/or

-        a right by the company to abolish dividend entitlements on new shares within four years of the shares’ issue date;

• the new shares are then issued at nominal consideration to another entity or entities that are closely associated with the ordinary shareholders in the company;
• significant profits of the company are then distributed as a dividend to the entity or entities, in most instances with franking credits attached;
• a series of transactions is then entered into as a means of transferring the economic benefits of all or some of the dividends to the control of the ordinary shareholders of the private company with a purpose of securing a better tax outcome;
• in some cases, the transactions may be delayed for some time (ie planned to spread over a four-year period) and/or involve the use of promissory notes and/or “round robin” bank facilities;
• in certain arrangements, the dividend received by the entity or entities may be:

-        lent to the ordinary shareholders or their associates;

-        distributed to a trust, or individual who has carried forward tax losses, which may result in no tax being paid and may generate a refund of franking credits;

-        distributed through a series of trusts and companies and may ultimately end up in the hands of, or the control of, the ordinary shareholders and/or their family in a manner that attracts no or minimal additional tax; or

-        distributed to a non-resident who is not subject to any Australian tax, with the non-resident then lending a comparable amount back to the private company; and

• the ordinary shareholders and their advisers may indicate that there is a commercial rationale for the arrangement, such as asset protection.

The ATO says a taxing event may generate a capital gain under CGT event K8 for the ordinary shareholders of the private company by virtue of the direct value shifting rules in Div 725 of the Income Tax Assessment Act 1997 (ITAA 1997). It says the arrangements may also be a scheme by way of, or in the nature of, or that has substantially the effect of, dividend stripping under s 177E of the ITAA 1997.

In addition, the ATO says the arrangements may be a scheme to which Pt IVA may apply. Any entity involved with these arrangements may be a promoter of a tax scheme for the purposes of Div 290 of Sch 1 to the Taxation Administration Act 1953, and the ATO says that where the entity involved is also a tax practitioner, they will be referred to the Tax Practitioners Board under the Tax Agent Services Act 2009.

Sources: ATO Taxpayer Alert TA 2012/4 http://law.ato.gov.au/atolaw/view.htm?docid=%22tpa%2Fta20124%2Fnat%2Fato%2F00001%22;

ATO media release 2012/27, 12 July 2012 www.ato.gov.au/corporate/content.aspx?doc=/content/00326141.htm