Dividend washing integrity rule
The dividend washing integrity rule prevents taxpayers from obtaining franking credits if the taxpayer has engaged in dividend washing.
Dividend washing is a practice through which taxpayers seek to claim two sets of franking credits by selling shares held on the Australian Securities Exchange (ASX) and then effectively repurchasing the same parcel of shares on a special ASX trading market. The timing of this transaction occurs after the taxpayer becomes entitled to the dividend, but before the official record date for dividend entitlements.
The integrity rule means that where you receive a dividend as a result of dividend washing, you are:
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- not entitled to a tax offset for the franking credits associated with the dividend received on the equivalent parcel of shares purchased on the special ASX trading market
- not required to include the amount of the franking credits on those shares in your assessable income.
The integrity rule applies to distributions received on or after 1 July 2013. When distributions have been made before 1 July 2013, the Commissioner of Taxation may apply section 177EA of the Income Tax Assessment Act 1936 to deny franking credit benefits received through dividend washing arrangements.
What is dividend washing?
Dividend washing occurs if you:
- sell shares while retaining the right to receive a franked dividend
- repurchase an equivalent parcel of shares that also has a franked dividend attached, using a special ASX trading market.
The special ASX trading market operates independently from the normal ASX market – shares that are trading on an ex-dividend basis (without the right to a dividend) on the normal ASX market may be traded on a cum-dividend basis (with the right to a dividend) on the special market.
You have received a dividend as a result of dividend washing if:
What is a substantially identical interest?
A substantially identical interest includes an economically equivalent, or fungible, interest. This means that interests may be considered to be substantially identical under the rule where they:
- are held indirectly
- are in different forms or classes of shares
- involve different numbers of shares.
What is a corresponding dividend?
The integrity rule applies where the two franked dividends received are corresponding – that is, the dividends have ultimately arisen from the same source, or from closely connected sources.
This would occur when both dividends arise from a company declaring various dividends for different types of shares (such as preference or ordinary shares) in connected processes, or in relation to profits that arose over the same period.
How does the integrity rule apply?
The integrity rule prevents taxpayers from obtaining two sets of franking credits, which may otherwise provide a tax benefit where the tax offset received from the additional franking credits is greater than the amount of tax payable on the additional dividend.
The integrity rule means that if you receive a dividend as a result of dividend washing, you are:
- not entitled to a tax offset for the franking credits associated with the dividend received on the shares purchased on the special ASX trading market
- not required to include the amount of the franking credits on the shares purchased on the special ASX trading market in your assessable income (however, you must still declare all assessable dividends in your assessable income).
Who does the integrity rule apply to?
The integrity rule generally applies to all resident taxpayers, but there is an exception.
The integrity rule generally does not apply to individuals who receive $5,000 or less in franking credits in a year, which we call the small shareholder exemption.
Note: This exception only applies when the dividend that was received as a result of dividend washing has been received by the individual directly. It does not apply where the dividend flows indirectly to an individual through their interest in a trust or partnership.
However, individuals who receive $5,000 or less in franking credits in an income year may still be subject to the general anti-avoidance rules if they have entered into a scheme for the purpose of obtaining franking credit benefits.
When does the rule apply from?
The integrity rule applies to distributions received on or after 1 July 2013.
If you have distributions made before 1 July 2013, the general anti-avoidance provisions apply to deny franking credit benefits received through dividend washing arrangements.
How does the rule apply where the dividend is received indirectly, such as through a partnership or trust?
When a taxpayer indirectly receives a dividend as a result of dividend washing – for example, as a partner in a partnership, or as a beneficiary of a trust – the integrity rule applies so that they are treated in the same way as a taxpayer that receives the dividend directly.
This means that the taxpayer who indirectly receives a dividend as a result of dividend washing will not be entitled to the franking credits from the dividend and will not be required to include the amount of the franking credit in their assessable income.
How do the rules apply where the share trades are made by connected entities?
When a connected entity sells a substantially identical interest, the integrity rule can apply to deny franking credit benefits to the entity that receives the dividend as a result of dividend washing.
However, the integrity rule will only apply if it can be objectively concluded that either transaction took place only because at least one of the entities expected that the other transaction had occurred or would occur.
Elizabeth, an Australian resident taxpayer, holds 100 ordinary shares in OT Ltd. On 14 April 2015, OT Ltd declares it will pay a franked dividend of 10 cents to all holders of its ordinary shares.
Elizabeth sells her shares shortly after the shares start trading ex-dividend, meaning that she retains the right to receive a franked dividend in relation to the 100 shares that she has sold.
After selling the shares, Elizabeth purchases 175 ordinary shares in OT Ltd on the special ASX trading market. Elizabeth is now also entitled to a franked dividend in relation to the 175 newly purchased shares.
As Elizabeth has sold her original shares and then purchased new shares, she will not be entitled to the benefit of the franking credits received in relation to the new shares, to the extent that:
- she has a substantially identical interest in the new parcel of shares
- the dividend attached to the original parcel of shares is a corresponding dividend.
In this case, 100 of the new parcel of shares is economically equivalent to the original 100 shares. However, as Elizabeth has purchased a parcel of shares that goes beyond her original parcel, her interest in the remaining 75 new shares is not substantially identical to the original parcel.
As a result, Elizabeth is entitled to the benefit of the franking credits she received for both:
- 100 of the original parcel of shares that she sold
- only 75 of the new parcel of 175 shares that she has purchased, assuming that no other integrity rules apply, such as the holding period and related payment rules – refer to Anti-avoidance rules.
As a result, Elizabeth will not be entitled to any of the franking credits attached to the dividend she received for the remaining 100 shares purchased on the special ASX trading market. Elizabeth must include the dividend in her assessable income, but she does not need to include the amount of the franking credits that she is not entitled to in her assessable income.
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What if I buy and sell shares in two different companies?
In some circumstances, the rule may apply if you, or an entity connected to you, held shares in two different companies, if the interests are substantially identical and corresponding dividends are received.
The rule provides for the case where one company is predominantly owned by the other company, or where shares in one company can be exchanged at a fixed rate for shares in the other company.
Anne sold 100 shares in Z Ltd, and then repurchased shares in Y Ltd. If Z Ltd was predominantly owned by Y Ltd, or shares in Y Ltd could be exchanged at a fixed rate for shares in Z Ltd, then the dividend washing rule may apply.
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How does the integrity rule interact with the application of general anti-avoidance provisions?
The specific integrity rule does not affect the application of general anti-avoidance rules where distributions are made before 1 July 2013.
The general anti-avoidance rules will generally not apply where the specific integrity rule prevents the taxpayer from claiming a franking credit tax offset, because the general anti-avoidance rules apply where the taxpayer would otherwise receive a tax or franking credit benefit.
However, the operation of the general anti-avoidance rules is not affected where the specific integrity rule does not prevent the taxpayer from claiming a franking credit benefit.
The ATO’s view on the application of general anti-avoidance rules to dividend washing arrangements is explained in Tax Determination TD 2014/10External Link and media releases dated 3 October 2013 and 30 April 2014.
The dividend washing integrity rule prevents taxpayers from obtaining a tax benefit from additional franking credits received when dividends are received a result of dividend washing.
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