The anti-avoidance provisions and SMSFs
It's critical that SMSF practitioners understand when the anti-avoidance provisions apply to dividends received by an SMSF.
So, when is this the case? When the contribution is part of a dividend stripping scheme!
Specifically, what the ATO is focusing on in TA 2015/1 are arrangements under which a person transfers the shares in a private company with accumulated profits into a superannuation fund. This transfer could have occurred as either an in-specie contribution of the shares or an outright purchase of the shares by the superannuation fund.
The company then declares a dividend after the fund has moved to pension mode, at this stage the fund income derived is exempt current pension income. However, the attached franking credits that had accumulated in the company give rise to a large refund of tax for the fund in the year that dividend is declared.
What are the factors that the ATO will consider when deciding whether an arrangement is caught by the dividend stripping provisions?
These factors are:
A private company that has significant, previously-taxed, accumulated profits that are available to be paid to shareholders as franked dividends.
A shareholder in the company transfers their shares in that company to an SMSF, of which the shareholder or their associate is a member. There may be more than one shareholder who transfers shares to the SMSF.
The trustee of the SMSF treats the shares as supporting the payment of pensions to the members of the SMSF (and therefore all or part of the income from the shares is regarded as exempt income of the SMSF).
After the SMSF satisfies the 45-day holding period rule, the company distributes its accumulated profits to the SMSF as fully and partially franked dividends.
The trustee of the SMSF treats the franked dividends and the attached franking credits as exempt income, which entitles the SMSF to a refund of the unused franking credit tax offsets.
The company may be liquidated or deregistered after the value of the shares is substantially reduced (or reduced to nil) by the payment of the franked dividends
Under what circumstances can a related party transfer shares in a private company to an SMSF of which they are a member?
Normally, Section 66 of the Superannuation Industry (Supervision) Act 1993 (SIS Act) prevents a fund from acquiring an asset from a related party. However, this is a specific exemption to this rule contained in Section 66(2) of the SIS Act that permits the purchase of units in a unit trust or shares in a private unlisted company provided that trust or company complies with the requirements outlined in Division 13.3A of the SIS Regulations.
Further, provided the company or trust continues to comply with the requirements of Division 13.3A, then the investment in the trust or company will not be treated as an in-house asset under Part 8 of the SIS Act.
If the shares in a private company were transferred to an SMSF today, it would need to comply with the following rules at the time of purchase and thereafter:
The company does not have a borrowing.
There is no charge over any asset of the company.
The company does not lend to members or invest in other entities.
The company has not purchased non-business real property from a related party of the fund since 11 August 1999.
The company has not acquired non-business real property which has been owned by a related party of the fund within the last three years.
The company does not run a business.
The company conducts all transactions on an arm’s length basis.
The company does not hold an interest in any other entity (including listed companies and trusts).
The company does not lease, directly or indirectly property to a related party, unless that property is business real property.
Compliance with the above rules means that any company transferred to an SMSF would have had a very simple balance sheet?
The facts outlined in the Taxpayer Alert indicate that in most circumstances the companies whose shares are being transferred hold no assets other than a bank account and an undistributed franking account balance. In other words, it is difficult to see how the transfer of the shares could result in anything other than a franked dividend distribution being received by the fund, which potentially triggers the “dividend stripping provisions”.
So does this mean that the dividend stripping provisions will always apply when company shares are transferred to an SMSF while holding a franking account balance?
No. The ATO acknowledges this when they state in the Alert that they have issued private binding rulings that did not apply the dividend stripping provisions to these types of arrangements.
We have also structured arrangements where the shares in private companies were transferred to a super fund with an undistributed franking account in place. However, the difference between the facts outlined in the Taxpayer Alert and those of our clients was that in the case of our clients, the companies also owned commercial property.
So the companies were being transferred as a mechanism to transfer the commercial property into the fund. It was anticipated that rent from the property transferred within the company would contribute towards the retirement income of the client.
In both cases the ATO reviewed the above transactions and did not consider it appropriate to apply the anti-avoidance provisions.
So what do we learn from this?
That the opportunity to transfer an interest in a related trust or company remains an important option in structuring your client’s retirement plans. However, it is an area that can be complex and specialist advice should always be obtained.
In circumstances where you are unsure as to the likely result, it may also be prudent to obtain a private binding ruling.
Mark Wilkinson, director, Wilkinson Superannuation