ATO letter – participation in a franking credits arrangement

You may have received a letter from the ATO entitled “Your participation in a franking credits arrangement” and wondering whether it applies to you and whether you need to do anything – such as amend your SMSF annual returns.

This letter has been prompted by the the previous Labor Government’s intention to close a loophole which enable an investor (via the assistance of their broker) to effectively obtain twice the amount of franking credits on the same parcel of shares.

The following article was posted today (24 March 2014) by Patrick Durkin in the Financial Review:

Thousands of fund managers, stockbrokers and sophisticated investors have been hit with warning letters threatening audits and heavy penalties if they do not confess to over-claiming franking credits on shares.

Leading figures within the finance industry are fuming that the Australian Taxation Office believes it can use data matching to trawl back as far as 2010 to compare tax deductions with individual share trading records.

“Our information indicates you, or an entity closely associated with you, participated in a franking credit arrangement,” Deputy Commissioner Tim Dyce writes in one of the 3000 letters sent by the ATO. “In this case, two sets of franking credits have been claimed on what is effectively the same parcel of shares.”

Treasurer Joe Hockey announced in November last year that the ­government would close down a “loophole” which allowed “double ­dipping” on franked dividends in an effort to claw back $60 million in tax over the next four years. But the ­government has always maintained that the change, which is yet to be enacted, would only apply from July 1 last year.

nvestors are shocked that the ATO is now seeking to retrospectively apply the law for at least the past four years under a government directive to recover as much as tax as possible before this year’s May budget.

Tax experts warn that in many cases, investors may not even be aware that their fund manager or broker engaged in the practice on their behalf in an effort to maximise their yield from share investments.

Regardless, investors have been warned that they have just one month to come forward and confess or face the full force of the ATO’s powers.

“If we receive a request to amend your tax return by the above date a ­penalty will not be applied,” the ATO’s Mr Dyce writes in the letters sent last Wednesday and received by investors on Friday.

“If you do not respond by the above date, we may take further compliance action that could result in an audit. ­Penalties may apply in relation to amendments that result from audit activity.”

BROADER CRACKDOWN

The crackdown is part of a broader campaign to retrieve billions of dollars in unpaid tax, including a deal set to be announced which offers wealthy individuals with income and assets in offshore tax havens an amnesty to come clean and avoid jail.

Dividend washing allows investors to double the tax benefit they receive on franked dividends.

It occurs when a taxpayer sells shares in a company on the ordinary market after a franked dividend has been announced. Within days they buy back a similar parcel of shares in the same company which entitles them to the franked dividend on the new shares.

The growing practice was first revealed in The Australian Financial Review and led to Labor’s plans for a crackdown on dividend washing in last year’s May budget. But the practice has been commonly used by stockbrokers and fund managers for years without any concerns being raised by the ATO before.

The new law will apply from July 1, 2013, to investors who have franking credit tax offset entitlements in excess of $5000. Small shareholders will be excluded. However, experts said that the ATO was relying on a broader anti-avoidance provision to examine share trades which pre-date the newlaw.

Alarmed stockbrokers and fund managers said that they will consider acting on behalf on multiple clients in order to bring a legal case to challenge the ATO’s authority.

Allens law firm partner Larry Magid said that investors needed to weigh up coming forward or face paying 25 per cent more than the original amount claimed.

“No one wants to pay tax that they didn’t think they had to,” Mr Magid said. “People thought that before July last year they were home free but I think that was probably optimistic.

“The government needs all the revenue they can get and every dollar counts.

“Voluntary disclosure does mean the reduction in any penalty but the ­problem is you have to actually fess up and say that you have paid a shortfall in tax.”

Deloitte tax partner David Pring said the ruling may affect people who have no knowledge that dividend washing is being done in their name.

“Taxpayers need to check in with their brokers and fund managers whether this practice is being undertaken on their behalf,” he warned.

The original article from the Financial Review is available here:  http://www.afr.com/p/national/ato_franking_credit_crackdown

A copy of the letter being sent is as follows:

ATO Letter - Franking credits

Why is this happening?

The ATO has been given the go ahead to start chasing investors (including SMSF trustees) after the release of a draft tax determination (TD 2014/D1) which basically outlaws the practice.  The most gob-smacking and far reaching feature of this draft determination is following sentence regarding the date of effect: When the final Determination is issued, it is proposed to apply both before and after its date of issue.

Both before and after.  This makes the determination retrospective – which is quite unusual, however we need to remember that a tax determination is purely the ATOs interpretation of the applicable law – it is not a retrospective piece of legislation or a ruling.

I have received this letter, what should I do?

In some cases, we understand that you as the investor (or SMSF trustee) may not have had any knowledge of the double-dipping of franking credits – many brokers we know of use the strategy to maximise the returns on portfolios – especially with SMSFs due to the low tax environment.  At the time the brokers or investment managers had no other guidance around the legitimacy of the strategy – provided they have complied with the 45 day rule, the client was entitled to the additional franking credits.

Each case needs to be looked at on its merits.

If it is apparent that you or your SMSF has claimed franking credits it was not entitled to, then amended tax returns will need to be lodged – and soon.  The ATO has provided only until the 24th of April 2014 to lodge amendments without incurring penalties and fines.

We will be working with our clients and their brokers and advising you on what needs to happen.

If you have received a letter like the sample above, you need to give us a call on 1300 889 282 as soon as possible.

Kris Kitto
General Manager

Updates:

30 April 2014 – The determination has been finalised unchanged from the draft: TD 2014/10

Director at Superfund Partners. I love working in the SMSF space. Self-managed super funds are more than just a savings vehicle - they enable people to truly take control of their financial situation which is key to achieving happiness. Leading the Superfund Partners team is a privilege - they are a great crew and they always put others first.