As provided by CD 4 of the Income Tax Act 2007 (the Act) a dividend is a transfer of value from a company to a person because that person has a shareholding in the company.

CD 5(1) of the Act states that a transfer of value to a person occurs when:

• A company provides money or money’s worth to the person; and
• Where the person provides money or money’s worth in exchange for money or money’s worth from the company and the market value of what the company has provided is more than what the person provided.

It is well established in case law (see Dawson v CIR) that money or money’s worth requires that the transfer be of a benefit that can be redeemed directly or indirectly for money. Given this, non-cash dividends arise where the transfer of value is not cash but is transferable either directly or indirectly into cash and the reason for the transfer was the persons shareholding in the company.

If there has been a transfer of value, the next step is to assess whether the transfer occurred because of a person’s shareholding in the company. Inland Revenue notes that a good indication of when a transfer is caused by a shareholding is if the terms of the arrangement that results in the transfer are different from the terms on which the company would enter a similar arrangement if no shareholding was involved.

Significantly for small and medium sized enterprises where shareholder-employees are common, if the transfer of value is caused by an employment relationship and not a shareholding in the company, then it will not be a dividend. Instead, the benefit will be subject to the employment income or fringe benefit tax rules. Inland Revenue, notes that where a person is both an employee and a shareholder an indication that the transfer of value was not a dividend is that the employee was the only shareholder to receive the transfer of value or in other words no other shareholder received the non-cash transfer.

Further, shareholders in a look-through company are treated as receiving all income and incurring all deductions personally. Given this, distributions from the company to shareholder in a look-through company are ignored for tax purposes

.The interpretation statement explicitly provides examples of certain transactions that are and are not dividends. These are outlined below.

Specific transactions treated as dividends

• Making a bonus in lieu (s CD 7);
• Issuing a share under a profit distribution plan (s CD 7B);
• Making a taxable bonus issue (s CD 8);
• Dividends arising under specific avoidance provisions (s CD 11); and
  • Shares are disposed of in substitution of a dividend (that is dividend stripping arrangements) (s GB 1);
  • Where the company employs a relative of a director or shareholder to provide services, and the income payable to the relative is excessive (s GB 23); and
  • Where a close company provides remuneration for services to a shareholder, director, or relative of a shareholder or director who is not an adult employed substantially full-time in the business who participates in the management or administration of the company, and the Commissioner considers the remuneration is excessive (s GB 25).
• Providing non-cash dividends to shareholders (s CD 20).

Inland Revenue points of some key exclusions that are likely to apply in the context of small and medium sized enterprises. Namely, the exclusion for a transfer of value that is treated as a fringe benefit (s CD 32), non-taxable bonus issues (s CD 29), a flat owning company making residential property available to a person (s CD 31).

Further, as previously mentioned if a non-cash transfer is made because of an employment relationship it will not be a dividend and is subject to the employment income and/or fringe benefit rules instead.

Section CD 38 of the Act provides that the formula for a dividend is: 

Value from company – value from person

In both cases the value is the market value of the money or money’s worth provided by each party. A common transfer for small and medium sized enterprises is “making property available”.

With regards to making property available the interpretation statement states that the Commissioner’s view is that by allowing a shareholder to use a property that the company owns, the company is providing the shareholder with a right to use that property which is a chose and action and not a service. Services are excluded from being a transfer of value under s CD 5(3) but a chose in action is not. Generally, the value of dividend should be calculated using the fringe benefit tax rules (e.g. the value that would ordinarily be charged to customers).

Where the property is a loan, the amount of the dividend is generally the difference between a market rate of interest (“benchmark rate”, often using the prescribed rate of interest for fringe benefit tax purposes) and the actual amount of interest on the loan.

One special rule for loans is that an amount repaid during the tax year is treated as having been applied in repayment on the later of the start of the company’s tax year or the day the loan was made if the amount is repaid by applying salary, wages, extra pay dividends or interest payable by the company to the borrower.

One of the risks of not spotting potential non-cash dividends before they arise is that an ordinary company cannot attach imputation credits retrospectively to a non-cash dividend. The operation of the benchmark dividend rules means that if the non-cash dividend is the first dividend of the year and no imputation credits were attached then for all subsequent dividends there must also be no imputation credits attached. If an unimputed non-cash dividend is paid after the first benchmark dividend of the year, there will be a deemed debit to the imputation credit account despite the shareholder not receiving the credits. While the benchmark dividends rules can be overridden this can’t be done retrospectively, so it creates an administrative hurdle that can be easily avoided by being aware of the non-cash dividend rules.

In summary IS 21/05 – Non-cash dividends is a good restating on the rules regarding non-cash dividends. Whilst the statement does not provide anything ground-breaking in its interpretation of the rules, it is effective in showing when the types of non-cash transactions that small and medium sized enterprises enter into should be treated as dividends for tax purposes.

Please contact your local Deloitte advisor if you have any queries.