SMSFs & Dividend Stripping Schemes – TA 2015/1
In early 2015, the ATO raised concerns regarding certain private company investments made by Self Managed Superannuation Funds (SMSFs) via Taxpayer Alert 2015/1. This taxpayer alert describes arrangements whereby an SMSF intentionally invests in a private company with large accumulated profits which then flow to the SMSF in the form of franked dividends. This practice, which the ATO liken to dividend stripping, typically features a dividend being paid to the SMSF and as the private company shares support the payment of a member’s pension, the SMSF is entitled to receive a refund of the franking credits attached to the dividends.
The ATO’s contention is that private company shares are being acquired by an SMSF in a contrived scheme with the intention of avoiding tax by channelling the dividends into the SMSF. This, the ATO state, “could lead to the ATO cancelling any tax benefit for the transferring shareholder and/or denying the SMSF the franking credit tax offset”.
In fact, the ATO’s recent offer for trustees to voluntary disclose such schemes, has resulted in a repayment to the ATO of $3,000,000 in franking credits incorrectly claimed by SMSFs.
The ‘dividend stripping’ arrangements which concern the ATO
The taxpayer alert applies to arrangements that exhibit either all or most of the following features:
- A private company has substantial accumulated profits able to be paid as franked dividends to shareholders
- A shareholder transfers shares to their SMSF (or a related party shareholder transfers shares to an SMSF)
- The members have commenced income streams (the fund is in pension phase)
- After the 45 day holding rule the private company pays a dividend to the SMSF
- The SMSF is able to receive a refund of franking credits via the exempt current pension income rules
- The company is then liquidated.
Interestingly, the ATO then widens the net when they also include deviations to the above features, specifically stating that the situations covered in the taxpayer alert may also include those where the SMSF members are not in pension phase. This means that the tax advantage obtained in channelling franked dividends to an SMSF in accumulation phase could also be caught in the dividend stripping net.
How does an SMSF purchase unlisted company shares from a related party?
SMSF trustees are generally prohibited from buying assets from members or related parties under s66 SIS Act 1993, however there are exceptions for some assets such as listed shares and business real property. Although unlisted company shares are typically included in the list of assets SMSFs cannot acquire from a related party, trustees may be able to purchase the unlisted company shares where the company meets specific requirements. The requirements for these types of companies are listed under SIS Reg 13.22C 1994 and are often called non-geared companies. An SMSF may be able to purchase unlisted company shares from a related party if at the time of acquisition:
- the company has no borrowings;
- the company has no charges over assets;
- the company has no interests in another entity, or provide a loan to another entity (other than a deposit with an authorized deposit institution under the Banking Act 1959);
- the company has not purchased non-business real property from a related party of the fund since 11 August 1999
- the company has not acquired non-business real property from a related party in last 3 years
- the company does not directly or indirectly lease assets to related parties (unless the lease relates to business realproperty);
- the company conduct its transactions on an arms’ length basis;
- the company does not conduct a business
It appears the most sinister version of the ‘dividend stripping’ scheme is where a related company with large accumulated profits is stripped back of all its assets to meet the requirements above and then transferred into the SMSF by way of cash purchase or perhaps as an in-specie contribution. After the 45 day holding rule is met and a dividend is paid, the company is wound up. This type of scenario does make it challenging to argue that the arrangement was not a tax avoidance scheme.
What if the company maintains other investments?
There is a question mark over SMSFs acquiring private company shares under SIS Reg 13.22C that also maintain direct property investments in addition to substantial accumulated profits. The ATO amended the Taxpayer Alert 2015/1 later in the 2015 year by noting that some trustees have erroneously relied on certain variances of the typical dividend stripping arrangement that they believed took their SMSF outside the scope of the taxpayer alert. This included situations where the company owned commercial or residential property at the time the shares were purchased by the SMSF. Despite this statement by the ATO, we do believe it is plausible that in certain arrangements an undistributed franking account could be seen as incidental where a company holding assets such as property, is transferred to an SMSF to provide for the retirement of its members.
The ATO continues to focus on dividend stripping arrangements
After the release of the taxpayer alert, the ATO intensified their focus on dividend stripping in SMSFs via their “Offer to SMSF trustees to address dividend stripping arrangements” announcement in November 2015. This offer encouraged SMSF trustees with dividend stripping arrangements in the 30 June 2011 to 30 June 2015 years, to make a voluntary disclosure to correct the tax position without being subject to administrative penalties (although interest charges may apply). Trustees had until 15 February 2016 to apply. The ATO recently announced that they believe there are more SMSFs with dividend stripping operations that either decided not to take up the November 2015 offer or who believe their arrangements do not fall foul of the ATO’s position.
What do we take from the ATO’s continued focus on dividend stripping arrangements?
For those SMSFs that have acquired a private company investment in the past with accumulated profits and have not had their arrangement reviewed – now is the time to do it.
If you are unsure whether you have an SMSF with a private company investment that bears a resemblance to a scheme the ATO has targeted, we recommend you contact us to review the arrangement. The team at Aquila Super are happy to discuss with you any concerns you may have in relation to private company investments and SMSFs.