On 12 January 2018, Treasury has released an historical document, under an FOI request, which discusses the potential application, of s 177EA of the ITAA 1936, to a type of “dividend washing” arrangement, which depended on selling shares ex-dividend, and buying another parcel ‘cum-dividend’, during a 2 day Australian Stock Exchange (ASX) trading window, for shareholders to sell their shares ‘cum dividend’ (even though they had just gone ‘ex-dividend’).

Section 177EA is about share trading to get an imputation benefit. When it applies, the Commissioner can deny the imputation benefit (ie. franking credit). At the time of these ‘dividend washing’ arrangements coming to light (about 2012), s177EA was the only provision that could deny the franking credit(s) – if, indeed, that was warranted.

The document released, was a 2014 opinion, on whether s177EA could apply to this type of ‘dividend washing’ arrangement. It is interesting because of its content and sequence in various related events.

  1. Just prior to this opinion, on 30 April 2014, the Commissioner issued tax determination: TD 2014/10, ruling that s177EA would, typically, apply to this type of dividend washing arrangement, to deny the franking credit, on the dividend, from the subsequently acquired parcel of shares.
  2. But behind this apparent confidence, was this 10 May 2014 opinion, that the Commissioner had ‘significant hurdles’ in attempting to apply s177EA to this type of ‘dividend washing’ arrangement. The key reason was the 2012 decision, of the High Court, on the meaning of the central ‘purpose’ test in s177EA. This was in Mills v CofT [2012] HCA 51.
  3. On 29 May 2014, however, the Government introduced a bill, to create a more specific provision to tackle ‘dividend washing’ arrangements of this type – incase s177EA didn’t apply (no doubt spurred by the 2014 ‘significant hurdles’ opinion). This was in the Taxation and Superannuation Laws Amendment (2014 Measures No.2) Bill 2014, which introduced a new imputation provisions: s207-157 of the ITAA97.
  4. Despite the apparent self-doubt, on 21 December 2015, the AAT decided that s177EA could apply to a dividend washing arrangement of this type. This was in the case of The Norman Superannuation Fund v CofT [2015] AATA 914, which the Commissioner gratefully accepted as consistent with his view in TD 2014/10 (see related Tax Month article).

In TD 2014/10, the Commissioner of Taxation set out, what he thought was, a typical ‘dividend washing’ arrangement (which I’ve set out, in full, below). A brief overview is as follows.

  • The Commissioner characterises, this type of arrangement, as one which involves a taxpayer obtaining 2 or more franked dividends, on what, in economic terms, he says is a single parcel of shares (in that, one parcel of shares is swapped, but the shareholder gets for 2 dividends, not 1 and 2 franking credits, not 1).
  • He describes a taxpayer, having relevantly held a parcel of shares (Parcel A), for 45 days, selling that parcel, on an ex-dividend basis, after receiving the dividend and using the franking credits.
  • The taxpayer then uses the sale, and dividend, proceeds, to buy the same number of shares (Parcel B), on a ‘cum-dividend’ basis, in the 2 day ASX window.
  • The taxpayer then receives a second dividend, of the same amount, with the same franking credit, which it can use (assuming it then relevantly holds that Parcel of shares for at least 45 days).
  • The taxpayer, therefore, retains the same number of shares in the same company, but has received 2 dividends, with 2 franking credits (both of which it has been able to use).

At this point, it sounds bad, but I’ve made no mention, yet, of the share price reduction which follows the shares going ‘ex-dividend’. The taxpayer will have suffered this loss as many times as it holds shares over the time when they go ‘ex-dividend’.  These share losses will, also, be relevant in assessing whether the s177EA(3)(e) purpose test applies.

The purpose test, in s177(3)(e) is as follows.

(e)  having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

I note that the relevant ‘purpose’ does not have to be a ‘dominant’ one, but it must be more than ‘incidental’.

In the Mills case, the High Court considered the application of s177EA and the meaning of an ‘incidental’ purpose. That case involved the availability of franking credits, for the holders of Commonwealth Bank ‘PEARLS V Securities’ (perpetual but tradable debt, paying interest that was treated as a frankable dividend for tax purposes). As I noted, in the related Tax Month article:

  • The High Court overturned the Full Federal Court’s decision in [2011] FCAFC 158. The FFC had held that, s177EA deprived ‘PEARLS V’ holders of their franking credits, based on its finding that, in the absence of the franking credit, the distribution rate would be quite unattractive to investors and therefore the “enabling of franking benefits” was something more than an incidental purpose of the scheme.
  • But the High Court rejected this ‘it wouldn’t work without the tax benefit’ approach (normally very effective for the Commissioner).
  • Rather, it held that the ‘purpose‘ for which the PEARLS were issued, was to raise ‘Tier 1’ capital for the bank, and that franking the return was merely ‘incidental’ to that purpose. This effectively turned the ‘not an attractive return – without the franking benefit’ argument on its head, so as to become a weapon for the taxpayer – because the bank could not raise the Tier 1 capital, without and attractive return, which was tax assisted.
  • It was the logic in this case, which the recently released opinion, saw as setting up ‘significant obstacles’ for the Commissioner being able to apply s177EA to this type of ‘dividend washing’ arrangement.

The TD 2014/10 analysis was as follows.

  • The Commissioner assumed that the taxpayer sells and buys exactly the same number of shares (a stark example).
  • He ignores the ‘ex-dividend’ loss on both parcels, looking only at the change-over cash flows (reasoning that the final profit or loss, on this identical replacement parcel, does not need to be broken down into its component parts, as the single economic interest, in this parcel, will not be affected by the ‘wash’).
  • He then assumes some ‘exit’ and ‘entry’ share prices that suit his analysis. He assumes that the loss on a share, going ‘ex-dividend’, is all of the dividend amount and only some of the franking credit value. So, on a share being traded, without a $1,400 franked dividend, the Commissioner assumed that the changeover cost was $1,600 (that is – the whole of the $1,400 dividend and $200 of the $600 franking credit).
  • This gives the Commissioner the spring board to say that the swap in parcels was cash flow negative by $200, but for the $600 franking credit tax off-set (para 9). This is the classic way of trying to demonstrate that it was the tax that drove the transaction and thus deduce ‘purpose’.
  • What happens, however, when those price assumptions are varied.
    • If the changeover price was ‘cash-flow positive’ (ignoring franking credit refunds), then tax is no longer driving the transaction, alone. There is, then, a pre-tax profit, to move the transaction, as well. And this is not an unrealistic possibility. Often the ‘ex-dividend’ drop in price, is less than the dividend itself (as profit making potential of the company, is still the same). Further, taxpayers have the benefit of knowing what the price drop will be, in deciding whether to undertake the wash transaction, given they’re acting with up to 2 day’s hindsight. So, they would be in a position to take profitable transactions and avoid unprofitable ones.
    • If the changeover price was equal to the dividend only (and consumed none of the franking credit benefit), then the changeover will be ‘cash-flow’ neutral. This might mean that the only ‘profit’, is in collecting the 2nd franking credit, but the Commissioner loses the force of saying that there is a ‘cash-flow’ loss, that can only be made good by the franking credit refund.
    • If the changeover price consumed all of the dividend and most of the franking credit, then there would be little overall ‘profit’ in the wash transaction, but equally, the tax effect would be negligible too (making it hard to say that the imputation benefit was more than incidental).
  • And, of course, the taxpayer may not ‘change over’ exactly the same number of shares. This might not change the analysis on the number of shares that were replaced, but it might muddy the waters and combine, with other factors, in a case that was already looking marginal, for being able to apply s177EA.

The Mills/PEARLS situation was compared with this ‘dividend wash’ situation, in para 20 of the 2014 opinion, in the following way (which probably sums up the position).

Subparagraph 177D(b)(ii) compares the form and substance of the scheme. The Commissioner would highlight that the substance of the arrangement is the holding of one economic interest in the corporate tax entity, albeit with a break of up to 48 hours in that holding. This would be contrasted with the form which involves the return of two dividends and sets of imputation benefits in respect of that holding.

The taxpayer would be expected to argue that the legal form of two parcels, separately traded, according to ASX rules and processes, is consistent with the receipt of two dividends and attached franking benefits.

The Norman Superannuation Fund case ended up applying s177EA – resolving the competing positions (above) in favour of the Commissioner. In his ‘Decision Impact Statement’ on this case, the Commissioner notes as follows.

In finding that the Applicants had a non-incidental purpose of obtaining an imputation benefit, SM O’Loughlin identified the following three ‘striking’ features which led him to conclude that the requisite objective purpose could be identified on a holistic analysis:

1.  at any time, the Applicants only had ownership of, and exposure to, one shareholding;

2.  ignoring the imputation benefits, the Applicants cash flow and change of wealth on each integrated transaction was negative. Having regard to those benefits, the cash flow was positive; 

3.  the integrated transactions were carried out on the same day in different markets such that different dividend entitlements would be enjoyed.

The Tribunal also analysed the factors individually, reaching the same conclusion.

This leaves only the custom built s207-157 to consider. If if applies, it activates s207-147, to prevent the shareholder getting a franking credit.

  • It applies to a distribution on a membership interest, in company, that was acquired after that member (or a connected entity) ‘disposed of a substantially similar interest’.
  • This section operated, retrospectively, back to distributions made on, or after, 1 July 2013, even though the Act, which introduced it, did not get Royal Assent until 30 June 2014.
  • Notwithstanding this back dated effect, the distributions in question, in the Norman Superannuation Fund case, pre-dated this new section, which is why the Commissioner applied s177EA and the AAT’s decision was about the application of that section.

21 January 2018

[Treasury website: dividend washing; TT site – Treasury Dividend Washing briefing/opinion; FJM; LTN 10, 16/1/18; Tax Month January 2018]

Study questions (*answers below)

  1. Was the news item, here, that a 2014 opinion, was released, under FOI legislation, on the possible application of s177EA, to a dividend washing’ arrangement?
  2. Section 177EA is part of the General Anti-Avoidance Provisions, in Part IVA of the ITAA36, but can it disallow a franking credit, if the section applies?
  3. Did the Commissioner’s tax determination: TD 2014/10 issue after this 2014 opinion?
  4. Does the arrangement have to have a more than ‘incidental’ purpose (of giving the taxpayer an imputation benefit) for s177EA to apply?
  5. In the Mills case, did the High Court decide that, the holders of the CBA’s ‘PEARLS V’ securities, could not get franking credits because, the return on the securities was unattractive, with out franking credit?
  6. Did the Commissioner, in TD 2014/10, put his case that the shareholder had a single economic interest that was ‘cash-flow negative’ without the 2nd franking credit?
  7. Did the Norman Superannuation Fund case resolve this issue in favour of the taxpayer?
  8. Does, the more recently introduced, s207-157 turn on there being ‘substantially identical interests’?


[*answers:1.yes;2.yes(that’s what its for);3.no(before);4.yes(s177EA(3)(e));5.no(ItOverTurnedThatDecision);6.yes;7.no(theOpposite);8.yes]

‘Dividend washing’ arrangement ruled on in TD 2014/10

2. The trustee for the Payton self managed superannuation fund (Payton) holds an interest, being a parcel of 10,000 shares, in ZCF Limited (ZCF) that is listed on the Australian Securities Exchange (ASX) (Parcel A). Payton has held Parcel A for at least 45 days.

3. On 12 August 2013 ZCF announces a fully franked dividend of 14c per share with a franking credit of 6c per share. Shares in ZCF will go ex-dividend (in that they will trade without an entitlement to receive this dividend) on 27 August 2013.

4. On 27 August 2013 Payton sells Parcel A (10,000 shares) for $5.00 each on an ex-dividend basis on the normal ASX market; Payton’s proceeds from the sale are $50,000.

5. Payton uses the proceeds received from the sale of Parcel A to purchase a further 10,000 ZCF shares (Parcel B) on a ‘Special Market’ 2 operated by the ASX for $5.16 per share; the total cost of this transaction is $51,600. 3 The Parcel B shares purchased on the Special Market include the rights to receive the franked dividends announced by ZCF on 12 August 2013. This is known as shares trading on a ‘cum-dividend’ basis.

6. The Special Market is open for trading from 27 August 2013 to 28 August 2013. ZCF Shares purchased on the Special Market can trade at a premium because shares purchased on this market include the rights to receive the franked dividends announced by ZCF on 12 August 2013.

7. On 14 October 2013 Payton receives franked dividends of $1,400 with franking credits of $600 in respect to both Parcel A and Parcel B; as such Payton receives dividends totalling $2,800 including franking credits of $1,200.

8. The result of the above transactions undertaken by Payton, excluding brokerage fees, is:

(a)    a cost of $1,600 which is the difference between the proceeds from the sale of Parcel A and the purchase of Parcel B ($50,000 – $51,600), and
(b)    additional dividends of $1,400 from Parcel B.

9. Without the additional franking credits of $600 attached to the dividends on Parcel B, the trades referred to in paragraphs 4 and 5 would result in a loss of $200.

10. After undertaking the trades referred to in paragraphs 4 and 5 Payton still holds the same number of shares in ZCF. Parcel B will be held by Payton for at least 45 days after the date of purchase.

11. The application of Part IVA depends on the facts of the particular case. However, a ‘dividend washing’ scheme that includes the key elements as described in paragraphs 2 to 10 of this draft Determination, would likely be a scheme entered into for a more than incidental purpose of enabling a participant to obtain an imputation benefit for the purposes of paragraph 177EA(3)(e) in respect of the acquisition of the same, or substantially similar, quantity of Parcel B shares.

12. In situations where a more than incidental purpose of obtaining an imputation benefit is present, the Commissioner is entitled to make a determination pursuant to paragraph 177EA(5)(b) to deny an imputation benefit to Payton in respect of the franked distribution received on the parcel B shares. The effect of such a determination4 would be to unwind the usual ‘gross up’ and ‘tax offset’ treatment of the receipt of a franked distribution. Payton would thus include the $1,400 cash amount of the dividend received on the parcel B shares in its assessable income, but would not include the attached $600 franking credit in its assessable income and would not be entitled to a tax offset in respect of the $600 franking credit.5

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