SMSF dividend stripping in the firing line

SMSF dividend stripping in the taxman’s firing line

The Tax Office has recently warned about the practice known as “dividend stripping”. It has drawn attention to a previously issued taxpayer alert also warning against these arrangements.

Of particular concern is dividend stripping involving the transfer of private company shares to a self-managed superannuation fund (SMSF). The Tax Office says the typical target audience for these arrangements include SMSF members (most commonly those near retirement) who own shares in a private company with substantial accumulated profits already taxed in the company’s hands and at the company’s tax rate.

Under these arrangements the shareholding is transferred to the SMSF, with the private company subsequently channelling franked dividends to the fund instead of to the original shareholder. The SMSF, already concessionally taxed, then receives a partial or total refund of the franking credits (depending on whether the shares are supporting a pension or not).

The mischief at play, as far as the Tax Office is concerned, is about whether the intention of the contrived arrangement may be to “strip” profits (hence the term) from the private company, with the shareholder (or associate) avoiding “top-up” income tax on the dividend income. The SMSF can also receive a refund for unused franking credit tax offset, which is available for tax-free distribution to members.

The taxpayer alert from the Tax Office is said to apply to arrangements that display all or most of the following:

  • a private company has significant previously taxed accumulated profits, which are available to be paid to shareholders as franked dividends (subject to “top-up” tax at marginal individual rates);
  • a shareholder in the company transfers their shares to a 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 member(s), 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 or partially franked dividends;
  • the trustee 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; and
  • 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.

The Tax Office also makes the point that variations to the above can and will occur.

Further, such arrangements may give rise to non-arm’s length income, which can also become a compliance problem for SMSF trustees. Other complications can include CGT consequences, such as transfers below market value, and excess contribution problems.

SMSF trustees who think they may be operating under such dividend stripping arrangements have been encouraged by the Tax Office to seek independent advice or even to apply for a private ruling. It says taxpayers may even want to consider whether to amend any relevant tax assessments, or make a voluntary disclosure, before the compliance net tightens.