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For the maximum benefit to be gained from the use of a private company it is important to carefully consider who will be a shareholder of the company. Factors such as tax on dividends, tax on disposal of the shares, asset protection and estate planning are all likely to be considered in determining who will be a shareholder.
In many instances, a company may be established with a particular share structure (for instance, a single individual as shareholder) for the purposes of simplicity and minimising establishment costs during the start-up phase. However, as the company grows and becomes more profitable (and valuable) the existing shareholders may no longer be considered appropriate.
In such situations, it is not uncommon for the ‘restructure’ of a company’s shareholdings to be considered by business owners.
One option for ‘restructuring’ would be for the existing shareholders to sell their shares to another person or entity (for example, a discretionary trust). However, often tax, stamp duty or other impediments may make the transfer of shares from one shareholder to another unfeasible.
As an alternative, the issue of new shares in the company to a new shareholder may be considered. In many instances, the issue of additional ‘ordinary shares’ may be too expensive given the value that may be inherent in ordinary shares. If the ordinary shares were to be issued for less than market value consideration, detrimental tax implications may arise under the value shifting and employee share scheme provisions.
For the above reasons, issuing a ‘dividend access share’ may be attractive to some clients. However, the tax implications of issuing such a share need to be considered in detail prior to proceeding with the implementation of any arrangement.
What is a dividend access share?
Broadly, a dividend access share is a particular class of shares which has the following features:
- A right to participate in dividends paid on that class of shares (if the directors of the company choose to pay a dividend on that class);
- No right to vote; and
- No right to participate in surplus assets on windup of the company.
By virtue of the limited rights attaching to the shares (and a discretionary dividend entitlement), it is often argued that the market value of a dividend access share is nominal. This makes financing the acquisition of a dividend access share more achievable, given the fact that the incoming shareholder may only be required to pay nominal consideration for the acquisition of the share.
Tax issues to consider
While the ability to issue a dividend access share may be achievable for the purchaser given the nominal cost, numerous tax implications can arise which require careful analysis and planning.
The ATO have recently released a draft taxation determination (TD 2013/D5) which considers some of the Part IVA implications of issuing dividend access shares (and subsequently paying dividends on the shares). In the draft determination, the Commissioner outlines his view that dividend access shares can be used in a manner which will not result in the Part IVA anti-avoidance rules applying.
However, the Commissioner considers that particular arrangements involving profits of the company ending up in the hands of a taxpayer who will pay less tax than the existing shareholders may result in the dividend stripping rules under Part IVA being applied to the arrangement. The implications of this are that any tax benefit obtained under the transaction will be denied, along with the imposition of penalties (up to 90% of the tax shortfall) and interest.
While the draft determination considers some of the Part IVA issues, other tax issues should also be considered prior to issuing a dividend access share (or any other class of share). These tax issues can include:
- Losses: if the company has losses, the continuity of ownership test often will be failed as a result of issuing the dividend access shares. The ability to recoup the tax losses would then be dependent on passing the same business test, which may be challenging to pass;
- Value shifting: loss adjustments, cost base reductions and partial realisation of an interest in an entity can occur if the value shifting rules apply;
- Debt/equity rules: depending on the specific terms of the dividend access share, it may be considered a debt interest under the debt/equity rules which can result in the inability to frank any distributions paid on the share;
- Pre-CGT status: the issue of new shares may result in implications arising for the company if it has assets which were acquired pre-CGT; and
- Small business CGT concessions: by issuing a dividend access share, it is often the case that no shareholders in the company will be eligible to access the small business CGT concessions on the disposal of their shares in the company because they will not meet the definition of a CGT concession stakeholder. This will also impact on the company’s ability to access the retirement exemption or 15 year exemption if the company realises a capital gain.
When can a dividend access share be effective?
Despite the Commissioner seeking to apply the Part IVA anti-avoidance provisions to certain dividend access share arrangements, there are still a number of circumstances where a properly implemented dividend access shares arrangement can be effective. Some of these circumstances may include:
- Employee share schemes: by making the employees shareholders of the company, the interests of the employees and the shareholders are aligned, achieving greater benefits for the company and a sharing of these benefits with the employees. A dividend access share can make this possible without the employee requiring large sums of money to acquire the share;
- Ordinary family dealings: situations such as divorce proceedings can sometimes require assets of a company to be transferred to a party who is not an existing shareholder of the company. A dividend access share potentially can be used to achieve the court ordered requirements; and
- Shares issued upon setup: often the adverse tax issues which can apply to dividend access shares arise because the shares are only issued at a point in time when the company has significant retained profits. If the dividend access shares are issued when the company is formed, it is likely that may of the adverse tax implications may not arise.
As with any structuring or restructuring issue, the short, medium and long term outcomes need to be carefully considered before deciding on whether a dividend access share is appropriate.
Should you require further information regarding dividend access shares, please contact your William Buck advisor.