ATO increases scrutiny on dividend arrangements of private companies

| September 18, 2012

The government should simplify corporate tax and stop focusing on areas where there is a technical argument. David Pring, Deloitte Private Tax Leader says this will act to increase the tax burden on private business.

In July, Tax Commissioner Michael D’Ascenzo announced that the ATO will be examining dividend access share arrangements whereby a private company with substantial accumulated profits issues a new class of shares to associates of the private company’s ordinary shareholders for nominal consideration.

The ATO announcement said the new shares often carry no voting rights but include the opportunity, not the right, to receive a dividend. The accumulated profits of the private company are then distributed to the new entity or entities and they pay less tax than would have been the case if the dividends were paid to the original shareholders of the private company.

Commissioner Michael D’Ascenzo said the ATO is concerned that these arrangements are set up with the dominant purpose of avoiding tax. He said while some arrangements may be claimed to be done for commercial and other non -tax purposes, they will be closely examining whether the way these arrangements have been set up would show a tax avoidance purpose.

The ATO announcement shows that the ATO is prepared to use the anti-avoidance rules of Part IVA to increase its scrutiny on dividend family arrangements. 

This announcement will create further confusion for many business owners, who are somewhat in the dark on future transactions as it has been announced that Part IVA is being changed but it hasn’t yet been announced how it will be changed.

With the level of ATO activity around trusts, unpaid present entitlements, Division 7A, losses and now dividend access shares, business owners need to take stock of their tax risks and have their house in order before the knock on the door.

Rather than focusing on areas where there is a technical argument to increase the tax burden on private business, the government should take the opportunity to create an equitable environment for private businesses in a similar way that tax consolidation provided a simpler environment for corporate Australia.

By introducing a more equitable system, private businesses could operate with less tax risk and spend more time productively growing their business, benefiting the economy as a whole.

A simpler system would also be easier for the ATO to administer and would provide more certainty for government, the ATO and business owners.

Unlike corporate groups that generally consist only of companies and can be treated as one taxpayer by using the consolidation rules, private businesses are often a collection of companies, partnerships and trusts that have grown up over a period of time.

If the family group was considered in its entirety, issues like dividend access shares would disappear as they would simply be transactions within a single tax group.  However since each entity with the group is currently considered individually, with the exception of 100 per cent owned subsidiaries of a company,  this results in entities with trapped losses or a mismatch of expenses that leave different entities with different tax profiles.

It is this uneven and disjointed tax framework that leads to issues like dividend access share arrangements being created and scrutinised. 

This opinion piece was first published on Deloitte Private Matters and is reproduced here with the kind permission of the author.