Under these arrangements, the individual disposes of its shares in a company with retained profits to a holding company, usually by relying on a capital gains tax (CGT) roll-over provision so that the disposal is tax free. The company with the retained profits (Company A) declares a franked dividend to the holding company, which then provides an interest free at call loan to the individual.
Arrangements displaying all or most of the following features will be subject to increased scrutiny by the ATO:
- Company A has retained profits and may have franking credits. An individual holds shares in Company A and may also be the director of the company.
- The individual disposes of its shares in Company A to a holding company and receives shares in the holding company in return, with the disposal occurring tax-free due to a CGT roll-over.
The shares in the holding company are issued at a value equivalent to the net assets of Company A.
- Company A declares a franked dividend to the holding company and pays the dividend via cash, cheque or promissory note.
- The holding company provides a loan to the individual funded by the dividend paid by Company A. The loan is structured so it is not deemed a dividend for the individual under Australia’s Division 7A rules, and so not taxable in the hands of the individual.
Consequences
Potential consequences of these arrangements include:
- Application of Australia’s dividend stripping rules which could result in the loan amount being included in the individual’s assessable income. The dividend stripping rules may also cancel the franking credit on the dividend paid to the holding company.
- The loan being deemed as an assessable dividend under Australia’s Division 7A rules, and so included in the individual’s assessable income. See our article on Division 7A here.
- Australia’s general anti-avoidance provisions may apply.
What should you do?
If you or any of your clients have entered into similar arrangements or are contemplating entering into similar arrangements, we encourage you to contact one of our experts below. We can assist in providing advice, and if necessary, seeking private rulings or making voluntary disclosures.
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Arnold Bloch Leibler is the tax controversy sector leader in end-to-end management of taxation disputes and litigation arising from ATO compliance activities and audits. If you have identified issues or would like assistance in reviewing risks or uncertainties, please contact one of our team members below.
