Assessing dividend income, and miniming death tax

Summary: If a dividend is declared in one tax year and paid in another, when should it be recorded as income received?

Key take-out: The Tax Office has specific guidelines on recording income, and on taxing super accounts passed to beneficiaries.

Question: In the recent webcast, “The super franking question”, you stated that dividends should be taken up when declared, not paid. It was my understanding that individuals take up dividends on a receipt basis and companies use an earnings basis. Not to confuse the issue, I understand that trust distributions are taken up when declared, not on a paid basis, regardless of the entity. Can you please confirm whether my understanding is correct and on what basis should SMSF use to take up dividends?

Answer: From a legal point of view dividends received by companies, trusts, and SMSFs must be shown as income when they are declared, rather than when they are received. When it comes to individuals there is a practical reason why dividends should be shown as income when they are declared, as compared to most other income earned by individuals that is only taxable when it is received.

One of the main exceptions to individuals paying tax only when income is received is when investments are sold that result in a taxable capital gain. When individuals sell an asset, such as property or shares, any profit made on the transaction is taxable in the year that the contract to sell the asset was entered into.

For example, an individual selling shares on 30 June in 2018, that did not receive the proceeds of the sale until the first week of the 2019 financial year, must include any gain or loss made on the sale of the shares in the 2018 financial year.

The same principle applies to when a property is sold. An example would be a rental property that is sold under a contract entered into on April 30, 2018, with a settlement date of July 31, 2018, any gain or loss made on the sale of the property must be declared in the 2018 tax return.

When it comes to share dividends the practical reason why dividends should be shown as income when they are declared by the company, rather than when they are received by the shareholder, is because each company that pays a dividend must advise the ATO when it declares a dividend payable to shareholders. Included in the information provided to the ATO is the date the dividend was declared, the amount of the dividend paid to each shareholder, and the tax file number of each shareholder.

The ATO uses this information provided by companies to ensure that shareholders are declaring dividend income and paying tax. This means a company that declares a dividend in the 2018 financial year, that is not received until the 2019 financial year, will advise the ATO of the dividend was declared as payable to the shareholders in the 2018 financial year.

When taxpayers use the cash method of accounting and only include dividends received in bank in each financial year, they leave themselves open to a please explain letter from the ATO. This is because the data matching done automatically by the ATO will disclose a discrepancy between the value of dividends shown on a person’s tax return and what the ATO has been advised.

The fact that you could be receive a compliance letter is supported by what the ATO’s states on their website, “We may send you a letter about your dividend income if a company reports they paid dividends to you, but this does not match the amount declared in your tax return.

The letter will include a schedule showing the relevant information from your tax return compared with information we hold.

If the income has been declared in an associated tax return (for example, a partnership, trust, company or superannuation fund), you need to advise us of the tax file number (TFN) and dividend amounts shown on that tax return.

You should ask the company to record that TFN on their register. This will help match the dividends to the correct tax return in future.”

Question: My wife and I are both 61, have account-based pensions in our SMSF, the total value is split 50/50 between us, and in the event that I died she is my beneficiary and vice a versa. However, we were wondering what planning could we do to minimise the tax payable on our super fund by our non-dependent children, in the event that we both died at the same time?

Answer: On the basis that you both are receiving account-based pensions this must mean you have met a condition of release and therefore can access your superannuation whenever you want. One of the few strategies that could assist you in reducing income tax payable on your superannuation should you both die at the same time, is called a re-contribution strategy.

Superannuation is made up of two different types. The first is taxable superannuation that has resulted from concessional or tax-deductible contributions made by employers and individuals, plus accumulated income earned on the superannuation.

The second type of superannuation is tax-free superannuation, which results from non-concessional after-tax super contributions being made, and also includes such things as downsizing super contributions and small business capital gains tax concession contributions.

Under this strategy you would each take $100,000 as a partial commutation of your account-based pension. After receiving the $100,000 you would each make a non-concessional contribution, and then a new pension would be started from the non-concessional contribution immediately.

You could each payout and re-contribute $100,000 each year until the financial year you both turn 65. In that year you could each take $300,000 as a partial commutation of your original account-based pension and make a non-concessional contribution of $300,000 prior to turning 65.

You should definitely seek professional advice before using a re-contribution strategy as you need to make sure that you are eligible, because of the ban on making non-concessional contributions once a person’s total superannuation balance reaches $1.6 million. You also need the advice to make sure you get the timing right with regard to starting and stopping the account-based pensions made up of the tax-free super.

If you have a question for Max Newnham please email it directly to max@taxbiz.com.au