The Australian Securities Exchange Ltd (ASX) sometimes operates what is known as a special market independent of 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 (CD) basis (with the right to a dividend) on the special ASX market.
Dividend washing occurs when a taxpayer tries to take advantage of the special ASX trading market to generate an unintended outcome. They do this by:
- selling shares on the ordinary market on an ex-entitlement basis, thereby retaining the right to receive a franked dividend
- purchasing a substantially identical parcel of shares on the ASX special market on a cum dividend basis, conferring an entitlement to the franked dividend on these shares also
- thus receiving a dividend on the original parcel of shares and a corresponding dividend in relation to the substantially identical parcel of shares.
In these circumstances, the tax offset entitlement for any franking credits attached to the second distribution is denied.
Dividend washing can also occur if a connected entity buys or sells either of the parcels of shares. This is 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.
Substantially identical interest
The dividend washing measure applies where a taxpayer acquires a second parcel of shares (the washed interest) that is very alike to the first parcel of shares disposed of (the substantially identical membership interest). A substantially identical membership interest includes an economically equivalent, or fungible, interest. This means that interests may be considered to be substantially identical where they:
- are held indirectly
- are in different forms or classes of shares
- involve different numbers of shares.
In some circumstances, holding shares in two different companies may be a substantially identical interest. For example, 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.
Example: Substantially identical interest
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 shares could be considered to be substantially identical.End of example
Two franked dividends received are corresponding if they 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.
The effect of the dividend washing integrity rule is 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.
You are also not required to include the amount of the franking credits on the shares purchased on the special ASX trading market in your assessable income. You must still declare all assessable dividends in your assessable income.
Where you receive a dividend indirectly 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 to you in the same way as if you had received the dividend directly.
The rule applies to distributions received on or after 1 July 2013.
Example: Dividend washing integrity rule for an individual
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, retaining 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, and is entitled to a franked dividend in relation to these shares.
In this case, 100 of the new parcel of shares is economically equivalent to the original 100 shares. Elizabeth will not be entitled to any of the franking credits attached to the dividend she received for these 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.
Elizabeth is only entitled to the benefit of the franking credits she received for :
- 100 of the original parcel of shares that she sold
- 75 of the new parcel of 175 shares that she has purchased. This assumes no other integrity rules apply (such as the holding period and related payment rules – refer to Anti-avoidance rules).
Elizabeth must include all the dividends received in her assessable income, except for the amount of the franking credits that she is not entitled to.End of example
Exceptions to the rule
The dividend washing integrity rule generally applies to all resident taxpayers, but there is an exception.
The rule generally does not apply to individuals who receive $5,000 or less in franking credits in a year. We call this the small holder exemption.
This exception only applies to dividends received by an individual directly. It does not apply to dividends received indirectly from an 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. This will apply if they have entered into a scheme for the purpose of obtaining franking credit benefits
The general anti-avoidance rules do not usually apply where another specific provision prevents the obtaining of a tax or franking credit benefit. Where dividend washing arrangements involve distributions made before the integrity rule commenced application on 1 July 2013, the general anti-avoidance rules will apply to deny franking credits. Our view on this is explained in Tax Determination TD 2014/10.
- Refunding excess franking credits
- You and your shares
- Tax and Superannuation Laws Amendment (2014 Measures No 2) Act 2014 and Explanatory MemorandumExternal Link
- TD 2014/10 Income tax: can section 177EA of the Income Tax Assessment Act 1936 apply to a 'dividend washing' scheme of the type described in this Taxation Determination?
- Section 207-157 of the Income Tax Assessment Act 1997