The ATO recently issued draft tax determination TD 2014/D1, which considers the application of Part IVA to such dividend washing schemes. In formulating the draft determination, the Commissioner has indicated by way of the following example how section 177EA of the Income Tax Assessment Act (ITAA) 1936 would apply to such arrangements:
Dividend washing example
The Smith Super Fund holds 10,000 shares in ZCF Limited (ZCF), a listed company on the Australian Securities Exchange (“Parcel A”). The fund has held Parcel A for at least 45 days.
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.
On that day, the fund trustee sells Parcel A (10,000 shares) for $5.00 each on an ex-dividend basis on the normal ASX market, receiving $50,000 proceeds from the sale. The proceeds received from the sale of Parcel A are used to purchase a further 10,000 ZCF shares (Parcel B) on a ‘Special Market’ operated by the ASX for $5.16 per share (total $51,600).
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. 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.
On 14 October 2013, the fund receives franked dividends of $1,400 with franking credits of $600 in respect to both Parcel A and Parcel B ($2,800 franked dividends and $1,200 of franking credits).
The result of the above transactions undertaken by the fund trustees, excluding brokerage fees, is:
• 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
• additional dividends of $1,400 from Parcel B.
Without the additional franking credits of $600 attached to the dividends on Parcel B, the trades undertaken by the fund trustee would have resulted in a loss of $200. However, after undertaking these trades, the fund still holds the same number of shares in ZCF. Parcel B will be held by the fund for at least 45 days after the date of purchase.
ATO concerns with the scheme
The ATO has highlighted within TD 2014/D1 that it is apparent that the benefit obtained through the imputation credits on Parcel B is a more than an incidental purpose in entering into or carrying out the scheme. As the example above shows, the only advantage to paying a premium on the cum-dividend shares via a Special Market is to obtain the right to additional dividend and franking credit (i.e. paying a premium will result in a loss on the transaction). It is quite apparent that timing of the transaction is very precise to obtain a tax benefit, and the trustee is driven by tax considerations and is not akin to an ordinary trade. For a super fund trustee, the franking credit benefit obtained could be anywhere from 15 per cent in accumulation phase up to 30 per cent when paying pensions.
The potential outcome
It has been indicated within the draft determination that where section 177EA applies to a dividend washing scheme, the Commissioner may make a determination under paragraph 177EA(5)(b) that no imputation benefit is to arise in respect of the distribution or a specified part of a distribution that is made, or flows indirectly, to the holder of the shares (the same or substantially similar quantity of Parcel B shares) purchased on the Special Market on a cum-dividend basis as part of the dividend washing scheme.
Aaron Dunn is managing director at the SMSF Academy and author of The Dunn Thing