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Dividend Access Shares: Access denied

Tax Telegraph, August Issue

Dividend Access Shares: Access deniedThe ATO’s recent announcement in Taxpayer Alert 2012/4 on dividend access share arrangements highlights the Commissioner’s intention to review private companies that have used these arrangements. In addition, the Commissioner has made it clear that he is prepared to use the anti-avoidance provisions in Part IVA to attack the legitimacy of such arrangements.

As a result, the ATO’s announcement has created a nervous stir in the private market. Clients need to know their risk profile should the ATO focus on their activities. The ATO’s continual interest in family businesses has also caused industry experts to call for tax reform to simplify the system for private groups consisting of private companies and family trusts.

The Commissioner has always had a keen interest in family businesses.  The Commissioner has found family businesses to be a mysterious creature due to the lack of uniformity and transparency that these private companies operate within as compared to the highly regulated and uniform framework that applies to public companies.

Consequently, the Commissioner’s proposed stance on dividend access shares combined with the ATO’s recent activities surrounding trust streaming, unpaid present entitlements and Division 7A reinforces that his sight is firmly fixed on private companies and trusts.  

What is a dividend access share?

Private companies with accumulated profits may issue a new class of shares to associates of the ordinary shareholders of the private company. These new classes of shares are created and often issued for nominal consideration. They do not carry any voting rights but usually carry the opportunity to receive dividends.

Subsequently, when the accumulated profits of the private company are distributed to the new shareholders, the tax paid is often substantially less than what would have been recognised in the hands of the original shareholders.

Although private companies and their advisors may have a commercial rationale for creating such arrangements i.e. asset protection, estate planning or as a performance incentive mechanism for personnel, the Commissioner will be checking to ensure these arrangements have not been set up for a tax avoidance purpose.

The Commissioner’s concerns surrounding dividend access share arrangements

The Commissioner is concerned that some dividend access share arrangements have been carefully planned to avoid or circumvent the rules contained in the Tax Acts. In certain arrangements, the funds represented by the dividend distribution have been:

  • On-lent to the original shareholders
  • Distributed to individuals/trust that may utilise carry forward losses resulting in no further tax being paid and the potential refund of franking credits attached to the dividend
  • Distributed through a series of transactions where the dividend distribution ends up in the hands of the original shareholders and/or their associates with no or minimal tax being paid
  • Distributed to a non-resident and not subject to further tax.

Although private companies are not specifically excluded from achieving the outcomes above, certain tax consequences may arise in relation to these arrangements, such as:

  • The general anti-avoidance rules in Part IVA which include dividend stripping and franking credit benefits
  • Value shifting  integrity provisions
  • Deemed dividend provisions under Division 7A
  • Promoter penalty provisions.

The effect of the ATO’s announcement

Private companies have been assured that they have nothing to worry about if their dividend access share arrangements have been issued for legitimate reasons. However, no guidance is provided as to what may be considered legitimate.

For example:

  1. Does a dividend access share issued to a private company owned by the same shareholders create a tax issue?
  2. Does a dividend access share issued to an employee suggest there is a concern? If not, then does a dividend access share issued to the employee’s family trust create a greater concern if there is an opportunity to distribute to a family company?

Given the current focus on high wealth groups in terms of trusts and Division 7A, the comments have created further uncertainty for taxpayers. Therefore, private groups have been left worried that the Commissioner is coming for them after his recent announcement.

Opportunity for tax reform

It is an opportune time for the Government to bring a sense of certainty and uniformity by introducing an equitable environment for private companies similar to the tax consolidation provisions for public companies. Private companies should not be looking over their shoulders wondering if their dividend access share will be subject to the exercise of the Commissioner’s discretion.

Deloitte Private Tax Leader, David Pring supports this proposition and has commented that this is the perfect opportunity for the Government to create an equitable environment for private businesses. The effect of these reforms will allow private companies to focus on growing their business rather than being engulfed with the burden of compliance. This will not only benefit the businesses but the economy as a whole.

So until such time that an equitable tax system is introduced for private companies, ensure your DAS are in order and they are being issued for a legitimate purpose… otherwise the Commissioner may deny these agreements.

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