ATO cracks down on dirty SMSFs, warning against ‘dividend washing’

The Australian Tax Office has sent caution letters to the operators of 2000 SMSFs about illegal ‘divided washing’ practices, as trustees are again being told to take heed of warnings or risk facing tough new penalties.

The advice follows a string of recent warnings about SMSF trustee obligations and the introduction of weighty new penalties brought in at the start of this month.

In a speech given at the CPA Conference yesterday, ATO assistant commissioner Matt Bambrick revealed the tax office had sent around 2000 self-amendment letters to SMSFs it identified as having potentially implemented a share trading strategy known as dividend washing.

The warning cautioned SMSF trustees that such a practice was a breach of tax rules.

Bambrick told SmartCompany the letter outlined the ATO’s concerns with the dividend washing arrangement it believes some SMSF’s have entered into.

“It advises them to self-amend and says if they don’t self-amend, they risk being audited by the ATO and having penalties applied,” says Bambrick.

Crowe Horwath tax director Tim Holloway told SmartCompany dividend washing, which is based on a specific tax ruling, is a strategy to gain double franking credits on shares.

“It occurs where you have any type of entity that owns shares in a company, which then sells those shares ex-dividend,” says Holloway.

“Which means, when the shares go to a new owner, the new owner does not have the entitlement to get the franking credits. Even though they’re selling the shares, the previous owner still has an entitlement to the franking credits.”

Holloway explains that when an entity then buys the same number of shares in the same company, on what is called “special market”, which trades on a different basis to the normal market, they are effectively buying shares that still have an entitlement to the franking credit and therefore doubling their credits, despite owning the exact same amount of shares.

“They have the credits attaching to the shares they sold, and they have managed to actually get credits because they bought on this special market,” says Holloway.

“The ATO holds the view that the only reason you’ve done this, is to get that benefit of the double franking credits, because if you didn’t get that benefit the transactions would not be commercial,” he says.

Holloway says while it is hard to tell how common the practice is, the fact the ATO sent out 2000+ letters implies it has seen incidences of dividend washing, or what look to be dividend washing.

“Clearly they are a few of these incidences and the ATO are acting upon it,” says Holloway.

Holloway says the penalty the ATO might impose on an SMSF found to be dividend washing would depend on whether the actions were found to be done on purpose.

“If they feel that it’s deliberate, then you can get hit with pretty significant penalties,” says Holloway.

In his speech, Bambrick highlighted additional “emerging risks” for SMSFs to be aware of, including: the potential to contravene purposes tests by attending overseas SMSF conferences; dividend stripping, where a company distributes retained earnings to a member just as they retire; and illegal early release of super benefits.

Bambrick said the new penalty regimes allowed the ATO to impose penalties that were more in line with a breach than it previously could.

“The accuracy and independence of SMSF auditors has always been critical to our compliance monitoring but now we’ll be relying even more on these auditors to identify and rectify minor breaches,” said Bambrick.

“In dealing with non-compliance by SMSF trustees, we may take one or several courses of action, depending on the seriousness of the contravention and the circumstances involved.”