Overview – This Taxpayer Alert describes arrangements where a private company with accumulated profits channels franked dividends to a self-managed superannuation fund (SMSF) instead of to the company’s original shareholders. As a result, the original shareholders escape tax on the dividends and the original shareholders or individuals associated with the original shareholders benefit as members of the SMSF from franking credit refunds to the SMSF.

What is the issue? – The ATO is concerned that contrived arrangements are being entered into by individuals (typically SMSF members approaching retirement) so that dividends subsequently flow to, and are purportedly treated as exempt from income tax in, the SMSF because the relevant shares are supporting pensions. The intention is for the original shareholders of the private company and/or their associates to avoid ‘top-up’ income tax on the dividend income; and for the SMSF to receive a refund of the unused franking credit tax offset, which is available for tax free distribution to its members.

This arrangement has features of dividend stripping which could lead to the ATO cancelling any tax benefit for the transferring shareholder and/or denying the SMSF the franking credit tax offset.

What are the ATO’s concerns?

(a)     The ATO considers that the main anti-avoidance provisions for arrangements of this type are whether:

(i)      the franked dividends received by the SMSF may be part of a dividend stripping operation under paragraph 207-145(1)(d) of the Income Tax Assessment Act 1997 [denying the franking credit to the SMSF shareholder].

(ii)     the arrangement may be a scheme by way of or in the nature of, or have substantially the effect of, dividend stripping to which section 177E of the Income Tax Assessment Act 1936 applies [taxing the previous shareholders on the dividend].

(iii)    the arrangement may be a scheme to obtain imputation benefits to which section 177EA of the 1936 Act applies [also denying the franking credit to the SMSF].

(b)     The ATO considers that arrangements of this type may also give rise to non-arm’s length income for the SMSF under section 295-550 of the ITAA 1997 [so that the SMSF’s dividend income is taxed at maximum marginal rates].

(c)     Other compliance issues for arrangements of this type may include:

(i)      capital gains tax consequences, such as transfers below market value [giving the transferor a deemed capital gain];

(ii)     ordinary dividend or deemed dividend consequences;

(iii)    superannuation regulatory issues, including non-arm’s length dealings between members or associates and the SMSF, and/or

(iv)    excess contributions tax consequences [fund tax on under value at which the SMSF acquired the shares].

[TA 2015/1] [LTN 81, 30/4/15]