1. Their use raises several taxation issues, including direct value shifting, the debt/equity rules, dividend streaming, Div 7A, dividend stripping and general anti-avoidance issues. Further, their liberal use has now been curtailed by the issue of a recent taxpayer alert, TA 2012/4.
2. The use of these shares must be supported by credible evidence, and careful drafting of the documents relating to the creation and issue of the shares, as well as declarations of dividend and subsequent payment, are critical, as is TA 2012/4.
3. Division 725-direct value shifting
Value shifting has been around since, at least, the days of planning to reduce the burden of death duties. The argument is that the holder of dividend access shares has no ability to call for payment of the dividend, even once it is declared by the directors. They are in no better position than that of a beneficiary of a discretionary trust.
Where dividend access shares are issued, a direct value shift only has consequences if (s 725-50 ITAA97) applies.
In addition, the direct value shift rules will only apply in relation to an interest that loses value (a down-interest) of at least $150, 000.00 (s 725-70). So Div 725 does not apply if the amount involved is less than $150,000.
I will broadly deal with the provisions of s 725.
Firstly, changing the company’s constitution to allow the issue of dividend access shares does not cause any increase in the market value of any shares as the dividend access shares are not issued at that point and the rights attaching to existing shares have not been altered.
Secondly, the issue of dividend access shares themselves arguably does not cause a value shift because:
- The dividend access shares are not issued at a discount as their value is limited to their issue price of say $1.00; and
- There has been no increase or decrease in the market value of any equity or loan interests in the company issuing the dividend access shares, since the value passed to the holders of dividend access shares is equal to the issue price paid for the shares.
Thirdly, for there to be a value shift, some shares must lose value and there must be a contemporaneous increase in the value of one or more equity or loan interests in the entity. The legal rights attaching to dividend access shares are virtually the same as those of a discretionary object of a trust. ie. just a right to be considered: zero value or at least the value is too uncertain to be quantified.
Where a dividend is declared in favour of the holders of the dividend access shares which are not paid until some time after the declaration, the question arises as to whether there may be an increase in the value of the dividend access share between the time of the declaration of the dividend and the payment of the dividend.
If the constitution of the company allows the directors to cancel a dividend which has been declared but not paid, there can be no increase in value of the dividend access share or decrease in value of other shares. In the absence of any value attaching to the shares, there is, in fact, no value shift. The market value of the up interest (being the dividend access share) does not increase, even with the declaration of a dividend, given that the holder of such shares cannot call for payment of any dividends declared (on the basis that the company constitution provides for cancellation of the declared dividend at the discretion of the directors).
Fourthly, if the dividend access shares are redeemed or cease to exist in accordance with the terms of their issue, within four years of issue, then the requirements of s 725-90 will be satisfied and Div 725 will not apply. However section 725-95 provides that the exclusion in s 725-90 will not operate if any shares in the company issuing the dividend access shares are sold while the dividend access shares are still on issue.
4. Division 974 – debt/equity rules
The debt/equity rules in Div 974 ITAA97 were introduced as a result of various instruments being offered by public entities that had both debt and equity characteristics. The debt/equity provisions provide rules that characterise an interest as either debt or equity in accordance with the economic substance of the particular interest.
But dividend access shares are not designed in any respect to be equivalent to a loan. Dividends may be paid to the holder of the shares at the discretion of the directors while they are on issue and the shares will be automatically redeemed within the four-year period for an amount equal to their issue price.
5. Subdivision 204-D – dividend streaming
Subdivision 204-D contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another. For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members.
In the majority of cases, dividend access shares are issued either to the trustee of one or more discretionary trusts or to a company wholly owned by such trusts on the same terms and for the same price. On the basis that the only dividends declared are fully franked dividends, there will be no streaming.
6. Part IVA and dividend stripping
The anti-avoidance provisions in Pt IVA ITAA36 must be considered in relation to the issue of dividend access shares. The provisions have two main components:
(1) Dealing with tax benefits; and
(2) Dealing with dividend stripping.
In relation to its first component, it is obviously difficult to speculate as to whether Pt IVA would have application in any given circumstances. However, it needs to be borne in mind that a court can only make decisions on the basis of the evidence actually before the court. In the majority of cases, assertions of positions for asset protection, for example, need to be supported by evidence, as opposed to statements.
In relation to the dividend stripping component (s 177E), the term dividend stripping was extensively considered in the Full Federal Court in the decision in Lawrence v FCT [2009] FCAFC 29. The essence of the decision in Lawrence’s case is that, in order for an arrangement to be covered by s 177E, it must include each of the following factors:
- A company with substantial undistributed profits; and
- The distribution of those profits; and
- The shareholders or associates of the shareholders receiving a capital payment or benefit, funded by the profits of the target company; and
- The arrangement having the predominant, if not the sole, purpose of the shareholders avoiding tax.
It is clear that the simple payment of a dividend is not sufficient to trigger the operation of the provisions.
Firstly, there is unlikely to be evidence that the dominant purpose is to avoid tax. Secondly, as regards the issue of receiving a capital payment, paras 9 and 10 of IT 2627 are relevant and provide that a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated profits. The stripper pays the vendor’s shareholders a capital sum that reflects those profits and then draws off profits by having paid to it, a dividend (or liquidation distribution) from the target company.
It can be seen that dividend access shares do not involve any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result.
7. Conclusion
Dividend access shares are a legitimate tool to be used for achieving asset protection, estate and succession planning objectives, as well as generally increasing flexibility currently afforded by existing structures. These purposes, however, must be able to be supported by credible evidence. Drafting of the documents relating to the creation and issue of the dividend access shares, as well as declarations of dividend and subsequent payment, are critical, and to state the obvious, for ‘risk assessment’, TA 2012/4 cannot be ignored.