The accounting facts on dividends

In one of my recent columns I answered a question from a subscriber about when dividends should be declared for income tax purposes. My answer had been based on information I gleaned from the ATO website, and my own experience from having looked after many proprietary limited companies.

When it comes to dealing with the implications of declaring a dividend in a proprietary limited company, the year in which the dividend should be declared by the shareholder has generally been regarded as the tax year in which the shareholder has become presently entitled to receive the dividend and not when the cash is paid to the shareholder.

In my answer relating to dividends paid or declared by public companies I stated that individuals only had to declare dividends when they are received, but there existed the likelihood that the information received by the ATO from public companies could lead to a taxpayer receiving a please explain letter.

This answer led to a flurry of correspondence from subscribers stating that they believed I was wrong and that tax only needs to be paid on dividends when the cash is received. The following question is a good example,

“I read an answer that you provided on the InvestSMART website about the dividend income received by an SMSF being assessable when it was declared. Like the person who asked the question I thought that you had made a mistake in the recent ‘super franking credit’ webcast.

I have had my SMSF audited for 13 years now and always declared dividend income on the date that it is paid, mainly banks with their 2nd July payments, although declared in June previous financial year. I have never had a complaint from the auditor on this matter”.

As a result of the controversy and confusion I had caused by my answer, and in an attempt to clear the matter once and for all, I contacted the ATO media and asked the following two questions:

Question 1. When it comes to a company receiving dividends I have read on the ATO website that they must use the accrual method and include dividends in the year they are declared and not when they are received.

There is a widely held belief that individuals only include dividends when they are received and not based on the date they are declared.

Can you please advise what method should the following taxpayers include dividends as income, ie cash or accrual?

- Pty Ltd companies

- Discretionary trusts

- Unit trusts

- SMSFs

- Individuals

Answer 1. Under tax law, a dividend is included in a shareholder’s assessable income in the year the dividend is paid or credited to the shareholder. When a dividend is derived does not generally depend upon what type of entity holds the shares.

The cash/accruals distinction is relevant to taxpayers deriving certain types of income (such as interest) and not to the special rules regarding the taxation of dividends.

The mere declaration of a dividend (which is not yet paid or credited) does not generally mean that it is assessable income to the shareholder.

Question 2. Does the ATO, for data matching and prefilled reports, use the declaration date of a dividend or the payment date?

I received these answers from the ATO, which I was advised could be attributed to an ATO spokesperson.

Answer 2. Dividend data the ATO receives from companies and intermediaries includes the date of payment as described under tax law, being the date the dividend is paid or credited to the shareholder. This is the date that is used to determine the relevant financial year for pre-fill and data matching purposes.

The answers provided by the ATO would appear to back up the responses I received from subscribers, effectively saying that dividend income was only taxable when it was received, and the ATO when assessing whether a taxpayer had declared all of their income use the date the dividend was paid.

I must admit to still being slightly cautious given that the words “paid or credited” were repeated in both answers, and the qualification of “generally” was used in their first answer.

In an effort to clear up the matter I checked the information shown on the “pre-fill report” we download from the ATO, which discloses the information they have received from companies and other institutions, as to what income they expected a number of our clients to declare in their income tax return.

The amounts shown for dividends received by these matched with the dates that the dividends were expected to be paid, and not when the dividends were declared or credited.

The only time that I can see there will be a conflict with what the ATO expects to be declared on an individual’s tax return, and when someone declares the dividend on a return, is when a dividend cheque has gone missing and is not received and banked until later year.

It is interesting to note that the timing of when dividend income should be declared for income tax purposes differs from when trust distribution income must be declared. There is a taxation determination, TD 94/72, that unequivocally states:

1. A distribution by the trustee of a unit trust is included in the assessable income of a unitholder in the year of income in which the unitholder is presently entitled to a share of the income of the unit trust, rather than the year in which the distribution is received by the unitholder.

2. Unless a provision in the trust deed states otherwise, a unitholder is entitled to a share of the income of a unit trust at the end of the period during which the income is derived.

3. Accordingly, a unitholder must include in assessable income for a particular year of income the share of net trust income to which the unitholder is entitled in that year of income, e.g. half-yearly or quarterly distributions. The date on which the distribution statement or actual payment is received by the unitholder is not relevant (see also paragraph 10 of Taxation Ruling IT 2497).

So, in summing up, and not wanting to add to the confusion, our income tax system requires dividend income to be declared on a tax return when it is received when the share is held directly by a taxpayer, but if the shareholding is held through a trust the dividend received via the trust distribution must be declared in the year the trust distributes its income and not when it is paid.