The ATO’s Tax Alert TA 2015/1 states that the Commissioner may apply the dividend stripping provisions in Part IVA to an arrangement where an individual transfers private company shares to a self-managed superannuation fund of which they are a member. But the ATO has ignored a critical provision in the superannuation law.
The Tax Alert gives the following facts:
1. A private company (the 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).
2. A shareholder in the company transfers their shares (the shares) in that company 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.
3. The trustee of the SMSF treats the shares as supporting the payment of pensions to the member(s) of the SMSF (and therefore all or part of the income from the shares is regarded as exempt income of the SMSF).
4. 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.
5. 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.
6. 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 arrangement may also include one or more of the following characteristics or variations:
7. The shareholder may transfer the shares to the SMSF as an in specie contribution and/or the SMSF may purchase the shares from the shareholder using:
(a) existing SMSF assets
(b) funding obtained from a limited recourse borrowing arrangement (LRBA) or some other form of financial accommodation, including paying for the shares using dividends received under the arrangement, or
(c) a combination of the above.
8. The company may make one or more distributions of franked dividends to the SMSF.
9. Distributions of franked dividends may also be made to other shareholders, if the SMSF does not hold 100% of the shares in the company.
10. The SMSF may receive franked dividends indirectly from the company, such as through a unit trust.
11. The SMSF (or another superannuation fund) may pay a superannuation benefit to enable the members to repay any outstanding shareholder or associate loans from the company prior to the acquisition of the shares by the SMSF.
12. A member of the SMSF may be in the accumulation phase and not receiving a pension, meaning that relevant franked dividends and attached franking credits will be assessable at 15%, resulting in a partial refund of the unused franking credit tax offsets to the SMSF.
Subsection 66(1) of the Superannuation Industry (Supervision) Act 1993 (SIS Act) prohibits an SMSF acquiring an asset from a related party of the fund. A member of the fund or a trust controlled by that person is a related party – sections 10 and 70B of the SIS Act. The principal exceptions to the subsection 66(1) prohibition for an SMSF are listed shares and business related property – subsection 66(2). The penalty for not complying with the prohibition is imprisonment for not more than 1 year – subsection 66(4) of the SIS Act. No monetary penalty applies.
Oddly, the prohibition and its associated penalty for its breach are not mentioned in Tax Alert 2015/1. The arrangement of an SMSF member transferring their private company shares to their SMSF clearly breaches subsection 66(1) of the SIS Act. One may have expected that a jail penalty for a breach of SIS would be a greater disincentive not to enter into such an arrangement than any threat of Part IVA applying.