ATO warning: access company profits tax-free scheme

The ATO has recently issued a Taxpayer Alert warning that it is reviewing arrangements where an individual taxpayer accesses the profits of a private company in tax-free form through the use of an interposed holding company. It notes that the Alert will apply to all arrangements when, viewed objectively, there is an indication that the dominant purpose of the arrangements is for the individual to avoid tax.

According to the ATO, these arrangements generally have the following features but may also include variations where the shares in the first company are pre-CGT shares or a holding company is interposed between a trustee shareholder and a company:

A private company (company A) has retained profits on which it may have paid tax at the corporate rate. Shares in company A are held by an individual who may also be a director of company A.
The individual disposes of their shares in company A to another private company (interposed company), receiving shares in the interposed company in return.
The shares in the interposed company are issued at a paid-up amount being the same as, or similar to, the net assets of company A which includes the retained profits of the first company.
The individual applies a CGT roll-over, to disregard for tax purposes any capital gain on the disposal of those shares in company A.
Company A declares a franked dividend to the interposed company and discharges its liability to pay the dividend by way of cash, cheque, or promissory note.
The interposed company then provides a loan to the individual, sourced from the dividend received. The loan may be interest-free and repayable at call.
Neither the interposed company nor company A have sufficient distributable surplus for Income Tax Assessment Act 1936 (Cth) (ITAA 1936) Div 7A to treat the loan made to the individual as a deemed dividend (whether directly from the interposed company or indirectly from company A).
In some cases, company A could be wound up after the payment of the dividend to the interposed entity with the loan remaining uncalled and outstanding.
The individual will have then obtained an amount tax-free in the form of a loan as opposed to without the interposed entity.

As outlined in the above scenario, Company A could have provided its accumulated profits to the individual by simpler means, such as paying a dividend or providing an interest-free, unsecured loan (assessable as a deemed dividend under ITAA 1936 Div 7A), both of which attract tax consequences for the individual. Hence, when viewed objectively, the purpose of the interposed entity appears to have a dominant purpose of avoiding tax.

Besides the general anti-avoidance provisions in ITAA 1936 Pt IVA, the ATO will be actively reviewing these and similar arrangements to look for intention to repay the loan to decide whether the amount may be assessable under Div 7A. In addition, if the arrangements are found to be a “dividend stripping” scheme or operation, various legislation could apply to include the amount of the loan in the individual’s assessable income, and cancel the franking credit on the dividend paid to the interposed company.