Edited version of your written advice

Authorisation Number: 1013029337727

Date of advice: 3 June 2016

Ruling

Subject: Anti-Avoidance Provisions, Capital Gains Tax rollover, Dividend and Capital Streaming

Question 1

Is replacement asset roll-over relief available under Subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) if the shares owned by Taxpayer 1 in Trading Company Pty Ltd (Trading Company) are transferred to Finance Company Pty Ltd (Finance Company)?

Answer

Yes

Question 2

For the purposes of paragraphs 177E(1)(a)(i) and 177E(1)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 1936), does the transfer of the shares referred to above and the payment of a fully franked dividend by Trading Company to Finance Company constitute either a dividend stripping scheme or a scheme having substantially the same effect?

Answer

No.

Question 3

Will Part IVA of the ITAA1936 apply to the transfer of shares from Taxpayer 1 to Finance Company and the payment of a fully franked dividend from Trading Company to Finance Company?

Answer

No.

Question 4

Will section 177EA of the ITAA 1936 apply to the transfer of shares from Taxpayer 1 to Finance Company and the payment of a fully franked dividend Trading Company to Finance Company?

Answer

No.

Question 5

Will the Commissioner make a determination pursuant to section 204-30 of the ITAA 1997 in relation to the payment of the proposed dividend by Trading Company to Finance Company?

Answer

No.

Question 6

Will either section 45A and 45B of the ITAA 1936 apply to the payment of the proposed dividend by Trading Company to Finance Company?

Answer

No.

This ruling applies for the following period

1 April 2016 to 30 June 2017

The scheme commences on

1 April 2016

Relevant facts and circumstances

BACKGROUND

1. Taxpayer 1, along with all of the below mentioned entities within the Group, are residents of Australia for income tax purposes.

Trading Company

2. Trading Company is incorporated. Taxpayer 1 and her/his former spouse, Taxpayer 2 each initially held X% of the issued shares in Trading Company. However, as a result of the property settlement stemming from Taxpayer 1 and Taxpayer 2's divorce, Taxpayer 2 transferred their shares in Trading Company to Taxpayer 1.

a. Capital gains tax (CGT) roll-over relief was applied to the transfer of the shares.

3. Currently, Taxpayer 1 holds X% of the issued share capital of Trading Company, comprising of ordinary shares. Trading Company does not have different classes of shares. The director of the company is Taxpayer 1.

4. Previously, Trading Company has paid dividends to Taxpayer 1of up to approximately $A per annum.

5. Trading Company is a trading company. You state that the business activities of the company carry a level of business risk.

6. Trading Company is the main trading entity within the Group of entities. Trading Company has substantial retained profits. You state that while the majority of the after tax surplus of Trading Company is retained to fund the working capital requirements of the company, part of the surplus is used to lend to other entities within the Group as well as to pay dividends to Taxpayer 1.

a. In the previous income year, Trading Company paid a fully franked dividend of $B.

Finance Company

7. You state that it was recognised that lending funds directly from Trading Company to other entities within the group carried the risk that any financial stress or unforeseen event affecting Trading Company could result in an unexpected calling up of such loans, thereby putting financial pressure on other group entities as well. For this reason, you state that Finance Company was recently incorporated with Taxpayer 1 holding X% of the issued shares in the company.

8. You state Finance Company was incorporated with the intention to interpose the company between Taxpayer 1 and Trading Company such that Finance Company would hold X% of the shares in Trading Company. This would then allow Trading Company to pay dividends to Finance Company. Finance Company could then use the funds to pay dividends to Taxpayer 1 or lend amounts to other entities in the Group.

9. You state it is not intended for Finance Company to undertake any business activities other than the lending of monies within the Group. This would reduce the risk of any loans being called up unexpectedly.

10. You state until recently there has not been a need for significant additional internal funding within the Group. However, this has now changed with the development of a new business venture (explained below).

Trustee Company

11. Trustee Company Pty Ltd (Trustee Company) was incorporated with Taxpayer 1as the sole Director and shareholder of the company.

Venture Trust

12. The Venture Trust, a discretionary trust, was settled with Trustee Company as its Trustee. The named beneficiary of the Venture Trust is Taxpayer 1, with possible beneficiaries including her/his spouse, children and remoter issue, parents, siblings, blood relatives, any trustee of any trust in which a beneficiary has an interest and any company in which a beneficiary has an interest.

13. You state that the Venture Trust was settled for the sole purpose of engaging in a business venture. To this end, Trustee Company acquired land.

Business Venture

14. New plant is in the process of being constructed on the land held by the Venture Trust.

15. The cost of building the new plant is estimated to be approximately $C, resulting in a total project cost of $D. The Group has to date incurred development costs in excess of $E which together with the cost of land makes a total investment to date of approximately $F.

16. Due to the level of funding required for the business venture, it was decided to introduce a joint venture participant. It was decided to establish a new corporate structure for the business venture, with the following occurring:

a. incorporation of Holding Company Pty Ltd (Holding Company), with Taxpayer 1 as its Director and the Venture Trust as its sole shareholder, along with incorporation of

b. settlement of the Holding Unit Trust, with Holding Company as its sole unit holder, and

c. incorporation of new companies, with Taxpayer 1 as the sole director and Holding Company as the sole shareholder of each of the companies.

17. Recently, an agreement was entered into with an unrelated party, Group Z. As part of the agreement, Group Z obtained an X% interest in Holding Company, such that the company became the joint venture company.

a. The agreement also provides that as soon as practicable after the execution of the agreement that the land currently owned by the Venture Trust would be transferred to the Holding Unit Trust.

18. An asset transfer agreement between Trading Company and the Holding Unit Trust was also executed in relation to the plant and equipment associated with the business venture.

PROPOSED TRANSFER OF SHARES IN TRADING COMPANY TO FINANCE COMPANY

19. You state that it is proposed that Taxpayer 1 X% shareholding in Trading Company will be transferred to Finance Company for nil consideration. This will result in the interposition of Finance Company between Taxpayer 1 and trading Company.

20. Shortly after the transfer of shares in Trading Company has occurred, it is proposed that Trading Company will pay a fully franked dividend of approximately $F to Finance Company. There are no other benefits being provided other than the fully franked dividend payable from Trading Company to Finance Company.

21. It is expected that the yearly dividends will continue to be paid to Taxpayer 1. However, instead of these dividends being paid from Trading Company, they will be paid by Finance Company.

a. Currently, Taxpayer 1receives a fully franked dividend of $G per month from Trading Company. It is expected that after the restructure, this arrangement will continue, but the dividend will be paid by Finance Company.

b. You state that there has never been any intention for dividends amounting to $F to be paid to Taxpayer 1. You explain that this is due to the fact that:

i. Taxpayer 1 does not require such large payments for their personal use

ii. Taxpayer 1 also receives significant trust distributions.

iii. the majority of the profits have previously been reinvested with Trading Company and other entities in the Group.

22. Finance Company will then lend the dividend received to the Venture Trust to assist with the funding of the new business venture. It is proposed that this loan will be compliant with section 109N of the Income Tax Assessment Act 1936 (ITAA 1936), with the term of the loan being Y years and the benchmark interest rate being charged.

23. Venture Trust will use these funds to reimburse Trading Company for the cost of the land and other project costs incurred to date.

24. You claim that it is not intended that Finance Company will dispose of its shareholding in Trading Company after the payment of the $F million fully franked dividend.

a. You explain that doing so would trigger a large capital gain without the benefit of the X% discount.

Rather, you expect that the Finance Company will retain the transferred Trading Company shares for a considerable period.

25. Trading Company has also provided a number of loans to other related entities within the Group. Other than the loan to the Venture Trust, the remainder of these related party loans are expected to be assigned to Finance Company during the year ended 30 June 20YY.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 subsection 103-25(2)

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 Subdivision 122-A

Income Tax Assessment Act 1997 section 122-15

Income Tax Assessment Act 1997 section 122-20

Income Tax Assessment Act 1997 section 122-25

Income Tax Assessment Act 1997 section 122-35

Income Tax Assessment Act 1997 Subdivision 204-D

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 subsection 960-130(1)

Reasons for decision

Question 1

Is replacement asset roll-over relief available under Subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) if the shares owned by Taxpayer 1in Trading Company Pty Ltd (Trading Company) are transferred to Finance Company Pty Ltd (Finance Company)?

CAPITAL GAINS TAX ROLL-OVER RELIEF

26. Generally, Subdivision 122-A of the ITAA 1997 allows for the roll-over of a capital gain or loss when an individual or trustee disposes of a capital gains tax (CGT) asset to a company in which, just after the disposal, the individual or trustee owns all the shares.

Disposal or creation of assets - wholly owned company

27. In order for an individual to obtain roll-over relief under Subdivision 122-A of the ITAA 1997, the CGT event which triggers the capital gain or loss must be one listed in the table of section 122-15. CGT event A1, being the disposal of a CGT asset, is one of the trigger events listed in the table.

28. Under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. Under subsection 104-10(2) you dispose of a CGT asset if a change of ownership occurs from you to another entity. Shares in a company are CGT assets (section 108-5 of the ITAA 1997).

Application to your circumstances

29. The proposed transfer of Taxpayer 1's shares in Trading Company to a wholly owned company, Finance Company, will trigger CGT event A1 as a change of ownership will occur, effecting a disposal of the shares. CGT event A1 is a CGT event listed in the table of section 122-15 of the ITAA 1997. Therefore this requirement is satisfied.

What is received for the trigger event

30. Under subsection 122-20(1) of the ITAA 1997, the consideration received for the disposal of the shares must be only shares in the wholly owned company or in addition to shares in the wholly owned company, the company undertaking to discharge any liabilities in respect of the shares.

31. In addition, subsection 122-20(2) of the ITAA 1997 requires that the shares received in the wholly owned company cannot be redeemable shares. The market value of the shares must be substantially the same as the market value of the shares disposed of, less any liabilities the company undertakes to discharge.

32. As outlined in ATO Interpretative Decision ATO ID 2004/94 Income Tax - Capital gains tax: Subdivision 122-A rollover: no consideration received (ATO ID 2004/94), section 122-20 does not require that consideration must be received for the disposal of an asset to a company in order to obtain the roll-over. Rather, it provides that if there is consideration received for the disposal, then that consideration must be either non-redeemable shares in the company or non-redeemable shares in the company and the company's undertaking to discharge any liabilities in respect of the asset.

Application to your circumstances

33. You state that it is not intended that any consideration will be provided for the transfer of the shares in Trading Company. As section 122-20 of the ITAA 1997 can only apply in circumstances where consideration is paid, the provision will not apply to your proposal.

Other requirements that must be satisfied

34. Section 122-25 of the ITAA 1997 lists further requirements that must also be satisfied for roll-over relief to be available under Subdivision 122-A, relevantly being that:

a. the individual must own all the shares in the company just after the time of the disposal of their shares to the company (subsection 122-25(1))

b. the disposal of the asset is not one listed in the table in subsection 122-25(2)

c. the ordinary and statutory income of the recipient company must not be exempt from income tax because it is an exempt entity for the income year the roll-over occurs (subsection 122-25(5)), and

d. the company and individual are Australian residents at the time of disposal (paragraph 122-25(6)(a)).

Application to your circumstances

35. Taxpayer 1 already owns all the shares in Finance Company. Therefore, just after the transfer of Taxpayer 1's shares in Trading Company to Finance Company, she/he will continue to own X% of the shares in Finance Company and the requirement in subsection 122-25(1) will be satisfied.

36. None of the exceptions in the table in subsection 122-25(2) of the ITAA 1997, which lists certain assets for which the roll-over is not available, apply to your circumstances.

37. Subsection 122-25(5) of the ITAA 1997 is satisfied as the ordinary or statutory income of Finance Company will not be exempt from income tax.

38. The residency requirement under paragraph 122-25(6)(a) will be satisfied as both Taxpayer 1 and Finance Company will be Australian residents at the time of the share transfer.

Company undertakes to discharge a liability

39. Section 122-35 of the ITAA 1997 provides additional requirements if a CGT asset has been disposed of and the company has undertaken to discharge a liability in respect of it.

Application to your circumstances

40. Section 122-35 of the ITAA 1997 does not apply to your circumstances as Finance Company is not discharging a liability in respect of the shares of Trading Company.

Conclusion

41. In conclusion, the transfer of the Trading Company shares from Taxpayer 1 to a wholly owned company, Finance Company, in the circumstances described in the facts, will enable Taxpayer 1to roll-over any capital gain or loss as specified in Subdivision 122-A of the ITAA 1997 should he so choose. The choice to obtain roll-over relief under Subdivision 122-A does not require a specific election. The way in which Taxpayer 1 prepares his income tax return is sufficient evidence of making the choice, as per subsection 103-25(2) of the ITAA 1997.

Question 2

For the purposes of paragraphs 177E(1)(a)(i) and 177E(1)(a)(ii) of the Income Tax Assessment Act 1936 (ITAA 1936), does the transfer of the shares referred to above and the payment of a fully franked dividend by Trading Company to Finance Company constitute either a dividend stripping scheme or a scheme having substantially the same effect?

SCHEMES TO REDUCE TAX- STRIPPING OF COMPANY PROFITS

42. Section 177E of the ITAA 1936 is an anti-avoidance provision that is designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme having substantially the same effect as a dividend stripping scheme.

Scheme

43. The first requirement of subsection 177E(1) is that there is a scheme by way of or in the nature of dividend stripping or, in the alternative, there must be a scheme having substantially the same effect.

44. Subsection 177A(1) defines a scheme as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

45. The definition of scheme is broad, however to satisfy subsection 177A(1) and establish that a scheme exists, it is necessary that an agreement, arrangement, understanding, plan, proposal, action, course of action or course of conduct exists.

Application to your circumstances

46. You claim that in order to fund the development of the business venture, the following actions have, or will, take place:

a. incorporation of Trustee Company

b. settlement of the Venture Trust and appointment of Trustee Company as trustee

c. incorporation of Finance Company

d. proposed transfer of X% of the shares in Trading Company from Taxpayer 1 to Finance Company for nil consideration

e. proposed payment of a fully franked dividend of approximately $F by Trading Company to Finance Company

f. execution of a proposed section 109N of the ITAA 1936 compliant loan agreement between Finance Company (as lender) and the Venture Trust (as borrower) for $F million, and

g. proposed repayment of $F million by the Venture Trust to the entities in the Group such that the existing loans are repaid in full.

47. If implemented, these steps are agreements, arrangements, plans, course of actions and the like and as such, constitute a scheme for the purposes of subsection 177A(1) of the ITAA 1936.

The first limb of paragraph 177E(1)(a)

48. There are two limbs to subsection 177E(1). Subparagraph 177E(1)(a)(i) (the first limb) requires there to be "a scheme by way of or in the nature of dividend stripping".

49. Dividend stripping is not a defined term, however its meaning is considered in Taxation Ruling IT 2627 Income Tax: Application of Part IVA to dividend stripping arrangements, which states at paragraphs 8 to 10:

8. The term 'dividend stripping' has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression.

9. However it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current year's profits that are represented by cash or other readily-realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company.

10. No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result.

50. A dividend stripping operation has been recognised by the courts as involving the following characteristics:

a. a target company, which had substantial undistributed profits creating a potential tax liability either for the company or its shareholders

b. the sale or allotment of shares in the target company to another party

c. the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits

d. the purchaser or allottee escaping Australian income tax on the dividend so declared

e. the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains liability at the relevant time), and

f. the scheme being carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of their vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company.

51. "It is … by reference to the presence or absence of those characteristics that the schemes in the present case should be examined for consistency with the broad description contained in para (a)(i) of s 177E(1)" (Lawrence at 395 per Jessup J).

Application to your circumstances

52. The arrangement proposed involves the following characteristics which the courts have identified as being common among dividend stripping schemes:

a. the target company is Trading Company, which has substantial retained earnings

b. the transfer of Taxpayer 1's shares in Trading Company, representing X% of the issued capital of the company, to Finance Company

c. the payment of a fully franked dividend of $F by Trading Company to Finance Company

d. no additional tax liability being incurred as the dividend received by Finance Company will be fully franked, and

e. the arrangement has been carefully planned with Taxpayer 1 the sole shareholder of Trading Company and Finance Company.

53. However, it is questionable whether the arrangement is being entered into for the dominant purpose of avoiding tax.

a. It is the Commissioner's view that the dominant purpose of the proposed arrangement is not to avoid tax (see explanation below at paragraphs 64 and 65).

54. The scheme also does not meet the criteria that the vendor shareholder, Taxpayer 1, will receive a capital sum for his shares that is the same as the dividends paid to the purchaser, Finance Company. In this case, Taxpayer 1 will receive no direct consideration for the transfer of the Trading Company shares to Finance Company.

55. Given that the proposed arrangement does not meet all the criteria identified by the courts needed to be considered a dividend stripping scheme, subparagraph 177E(1)(a)(i) of the ITAA 1936 has not been satisfied.

The second limb of paragraph 177E(1)(a)

56. Subparagraph 177E(1)(a)(ii) (the second limb) requires there to be "a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping". In Lawrence, Jessup J explained at [77]:

It seems that the parliament wanted to catch "variations" on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. This is, in my view, a significant indication of parliamentary purpose, since it treats such an effect as distinct from the result of a scheme of the kind contemplated: s 177E does not require that shareholders themselves, as a "result" of the scheme, receive the profits distributed by way of the disposal of property in question.

57. In Lawrence at [62] Jessup J also referred to the Full Court decision in Commissioner of Taxation of the Commonwealth of Australia v Patcorp Investments Limited (1976) 140 CLR 247 which stated that:

The terms of the first limb of s 177E(1)(a) suggest that a scheme may fall within its scope, even though not all the elements of a dividend stripping scheme are present. The use of the words "by the way of or in the nature of" suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provide it retains the central characteristics of a dividend stripping scheme.

Application to your circumstances

58. Although the proposed arrangement does not satisfy subparagraph 177E(1)(a)(i) of the ITAA 1936, it is still necessary to consider whether it is one which has substantially the effect of a scheme by way of or in the nature of a dividend stripping scheme as required by subparagraph 177E(1)(a)(ii).

59. The proposed scheme does not have the effect of placing the profits of Trading Company in the hands of Taxpayer 1 in a tax free or tax advantaged form. The shares that Taxpayer 1 currently owns in Finance Company will increase significantly in value. Despite this, her/his net economic position with regard to Trading Company and its profits will be identical before and after the execution of the arrangement.

60. Moreover, Taxpayer 1 will receive monthly fully franked dividends of $G after the implementation of the scheme, but from Finance Company rather than Trading Company. As such her/his pre and post arrangement tax position will not change. As these dividends will be fully franked, there will be no tax advantage gained by Taxpayer 1 in the payment of the dividends from Finance Company rather than Trading Company. Consequently, subparagraph 177E(1)(a)(ii) of the ITAA 1936 is not satisfied.

Dominant purpose

61. For the arrangement to be a scheme to which subsection 177E(1) of the ITAA 1936 applies, a tax avoidance purpose is required. In Commissioner of Taxation v Consolidated Press Holdings Ltd and Others (No 1) (1999) 91 FCR 524 their Honours said (at 570 [174]):

In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.

62. As Jessup J said in Lawrence, those observations "apply equally to para (a)(ii), in the context of which a tax avoidance purpose is just as necessary" (at 403;[88]).

63. The High Court in Federal Commissioner of Taxation v Spotless Services (1996) established that where a scheme makes no commercial sense without the tax benefits, there is a greater likelihood of concluding that it is entered into for the sole or dominant purpose of obtaining a tax benefit. Factors which suggest the scheme had been entered into for commercial reasons or as part of ordinary family dealings will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven.

Application to your circumstances

64. You claim that the dominant purpose of the proposed arrangement is to reduce Trading Company's commercial risk from lending to other entities in the Group. You claim that the interposition of Finance Company will not do anything other than to introduce a holding/subsidiary corporate structure. Finance Company will not undertake trading activities or commercial risk.

65. The Commissioner accepts your contentions and concludes that the dominant purpose of the proposed arrangement is not one to obtain tax benefits. Together with the fact that the scheme does not meet the criteria of a dividend stripping scheme, or one having substantially the same effect, section 177E of the ITAA 1936 has no application.

Question 3

Will Part IVA of the ITAA1936 apply to the transfer of shares from Taxpayer 1 to Finance Company and the payment of a fully franked dividend from Trading Company to Finance Company?

SCHEMES TO REDUCE TAX

66. Part IVA of the ITAA 1936 (Part IVA) is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit.

Scheme

67. Part IVA requires the consideration of a 'scheme', which, as discussed in question 2 above is defined in subsection 177A(1) of the ITAA 1936 as:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

68. Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart [2004] (Hart); per Gummow and Hayne JJ:

[The] definition is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.

Tax Benefit

69. There must be a tax benefit obtained by the taxpayer in order for Part IVA to potentially apply. Section 177C of the ITAA 1936 broadly provides that a tax benefit in relation to a scheme relates to:

a. amounts not being included in assessable income that would otherwise have been included in assessable income

b. amounts included as an allowable deduction that would otherwise not have been included as an allowable deduction

c. capital losses incurred that would otherwise not have been incurred

d. foreign income tax offsets being allowable that would otherwise not have been allowable, and

e. no liability to withholding tax on an amount that would otherwise have had a liability.

Dominant purpose

70. Part IVA also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D of the ITAA 1936 refers to the purpose of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer.

71. The meaning of the purpose is clarified by subsection 177A(5), which explains that, where there are two or more purposes, the purpose includes the dominant purpose:

A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.

72. When determining whether the purpose of the scheme was to enable a tax benefit, the Commissioner must also have regard to the following eight factors specified in subsection 177D(2):

a. the manner in which the scheme was entered into or carried out

b. the form and substance of the scheme

c. the time the scheme was entered into and the length of time during which the scheme was carried out

d. the result that, but for the operation of Part IVA, would be achieved by the scheme

e. any change in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme

f. any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer

g. any other consequence for the relevant taxpayer, or for any person referred to in paragraph 72.f of the scheme having been entered into or carried out, and

h. the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph 72.f.

73. Focussing on the various elements of Part IVA should not obscure the way in which the Part as a whole is intended to operate. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person in entering into or carrying out the scheme, and the existence of the tax benefit, must be considered against a comparison with reasonable alternative schemes capable of carrying out the commercial objectives of the arrangement.

74. In summary, section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, after having regard to the eight specified factors, it would be concluded that any person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the relevant taxpayer to obtain the tax benefit.

75. The identification of a tax benefit requires consideration of the tax consequences of a 'counterfactual', or alternative hypothesis, that would have resulted had the scheme not been entered into. As stated by Gummow and Hayne JJ in Federal Commissioner of Taxation v Hart [2004] at [66]:

When [section 177C(1)] is read in conjunction with [former] s177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in [former] s177D(b) will require consideration of what other possibilities existed.

76. Guidance for identifying the counterfactuals of the scheme can be found in Practice Statement PS LA 2005/24: Application of the General Anti-Avoidance Rules (PS LA 2005/24). In particular, paragraph 74 lists the following considerations for determining the counterfactuals:

a. the most straightforward way of achieving the commercial and practical outcomes

b. commercial norms, such as standard industry behaviour

c. social norms, such as family obligations

d. behaviour of the parties around the time of the scheme compared with the period of the scheme's operation, and

e. actual cash flow.

77. PS LA 2005/24 further explains that if:

a. the scheme had no effect other than obtaining the tax benefit, it is reasonable to assume that nothing would have happened if it was not carried out (paragraph 75), and

b. a tax benefit is obtained in connection with the scheme which also achieves a wider commercial objective, then it would be reasonable to expect that in absence of the scheme the wider commercial objectives would have been pursued by an alternative arrangement (paragraph 76).

78. In Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531 the Court explained that although the Commissioner has to consider each of the factors provided by former subsection 177D(b), this doesn't mean that each of the factors must point to the dominant purpose, stating that:

Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against that [former] s177D requires in order to reach the conclusion to which 177D refers.

79. The Commissioner's support of this view is provided in PS LA 2005/24 which states at paragraph 88 that all factors of subsection 177D(2) need to be taken into account with regard to the relevant evidence, and weighed together, to identify the dominant purpose of the scheme.

Cancellation of tax benefit

80. Where the Commissioner has made a determination under paragraph 177F(1)(a) of the ITAA 1936 that an amount is to be included in a taxpayer's assessable income, subsection 177F(2) provides that this amount shall be deemed to be included in the taxpayer's assessable income.

Application to your circumstances

81. As mentioned in paragraph 47, your proposed arrangement satisfies the requirements for a scheme pursuant to subsection 177A(1) of the ITAA 1936.

82. To establish whether there is a tax benefit associated with the proposed arrangement, it is necessary to consider what is reasonably expected to occur, including the tax outcomes, if the scheme is not entered into. Taking into account the factors listed in paragraph 74 of PS LA 2005/24, the Commissioner accepts your contention that there are three reasonable counterfactuals to your proposed scheme, being:

a. Trading Company will continue lending amounts to entities in the Group such that nothing will change from the current arrangement.

b. Trading Company will pay a fully franked dividend to Taxpayer 1, which she/he can then on-lend.

i. To ensure that the after tax amount received by Taxpayer 1 is sufficient to meet the current loans of $F, the before tax dividend paid by Trading Company will need to be approximately $H, and

c. Trading Company will lend funds to Finance Company, which will then on-lend these amounts to other entities in the Group.

83. The Commissioner accepts your contention that although Trading Company could pay a fully franked dividend to Taxpayer 1, which could then be on-lent to other entities, this is not a reasonably likely possibility given the other two counterfactuals identified. Consistent with paragraph 74 of PS LA 2005/24, the other two counterfactuals would achieve the same outcome without raising such a significant tax liability to Taxpayer 1. These counterfactuals are more straightforward ways of achieving the commercial and practical outcomes.

84. Given this, the Commissioner accepts that there remains only two reasonable counterfactuals, being those summarised at paragraphs 82.a and 82.c above. Neither of these counterfactuals satisfy the requirements for a tax benefit pursuant to section 177C of the ITAA 1936. That is, the tax outcome differential between these alternatives and the proposed arrangement is nil.

85. As no tax benefit is obtained from the scheme, it is not necessary for the Commissioner to have regard to the eight factors specified in subsection 177D(2) of the ITAA 1936 as Part IVA cannot apply in these circumstances.

Question 4

Will section 177EA of the ITAA 1936 apply to the transfer of shares from Taxpayer 1 to Finance Company and the payment of a fully franked dividend from Trading Company to Finance Company?

SCHEMES TO REDUCE TAX - CREATION OF FRANKING CREDIT OR CANCELLATION OF FRANKING CREDITS

86. Section 177EA of the ITAA 1936 is a general anti-avoidance rule that safeguards the operation of the imputation system. It is directed at franking credit trading involving the transfer of franking credits on a dividend from investors who cannot fully use them to investors who can. If the section applies, the Commissioner may debit the company's franking account or deny the franking credit benefit to the recipient of the dividend.

87. Specifically, subsection 177EA(3) of the ITAA 1936 provides that for section 177EA to apply, the following must be present:

a. there is a scheme for the disposition of shares, or interest in shares, in a company

b. a franked distribution has been paid, or expected to be paid, directly or indirectly

c. the shareholder would, or could reasonably be expected to, receive imputation benefits from the distribution, and

d. having regard to the circumstances of the scheme it would be concluded that the scheme was entered into for the purpose of enabling a taxpayer to obtain imputation benefits.

88. The meaning of the term 'scheme for a disposition' is provided in subsection 177EA(14) and includes, but is not limited to, the following:

a. issuing or creating membership interests

b. entering into any contract, arrangement or the like which affects the legal or equitable ownership of membership interests or interests in membership interests

c. creating, varying or revoking a trust in relation to the membership interests or interests in the membership interests

d. creating, altering or extinguishing a right, power or liability attaching to a membership interest or interest in a membership interest, and

e. substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding the membership interest or interest in the membership interest.

89. Paragraph 177EA(3)(e) of the ITAA 1936 provides relevant circumstances that must be considered in determining whether a person has the requisite purpose and includes, but is not limited to, the factors listed in subsection 177EA(17). These relevant circumstances cover a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposal and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose to obtain an imputation benefit.

90. The requisite purpose is further explained in paragraph 8.124 of the Explanatory Memorandum (EM) to the Taxation Laws Amendment Bill (No. 3) 1998 that accompanied the introduction of section 177EA as follows:

One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (ie. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings.

91. Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the scheme seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders.

Application to your circumstances

92. The transfer of Taxpayer 1's shares in Trading Company to Finance Company is a transaction that affects the legal ownership of the membership interests in Trading Company, thereby satisfying the definition of a scheme for a disposition of membership interests pursuant to subsection 177EA(14) of the ITAA 1936, and paragraph 177EA(3)(a) is satisfied. As the scheme will also involve the payment of a $F franked distribution by Trading Company, paragraph 177EA(3)(b) will also be satisfied.

93. Paragraph 177EA(3)(c) of the ITAA 1936 will also be satisfied as Finance Company will receive franking credits associated with the $F dividend.

94. However, having regard to the circumstances of the proposed scheme, it is not being entered into for the purpose of enabling Finance Company to obtain the franking credits. The Commissioner accepts that the purpose of the scheme is one of a commercial nature such that the corporate structure of the Group is being adjusted to minimise the potential risk associated with the loans already provided by Trading Company to other entities in the Group. Although franking credits will be obtained by Finance Company, this is merely a transferring of credits from one corporate entity to another. When dividends are paid by Finance Company to Taxpayer 1, she/he will have access to the same franking credits that she/he would have earlier been entitled to prior to the arrangement. Consequently, as this criteria is not met and section 177EA of the ITAA 1936 does not apply to your proposed scheme.

Question 5:

Will the Commissioner make a determination pursuant to section 204-30 of the ITAA 1997 in relation to the payment of the proposed dividend by Trading Company to Finance Company?

DIVIDEND STREAMING

95. Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another.

96. Subsection 204-30(1) of the ITAA 1997 gives the Commissioner the power to make a determination if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, in such a way that:

a. an imputation benefit is, or apart from section 204-30 would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a))

b. the member ('favoured member') would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b)), and

c. the other member ('disadvantaged member') of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c)).

97. If subsection 204-30(1) of the ITAA 1997 is satisfied, subsection 204-30(3) of the ITAA 1997 enables the Commissioner to make one or more written determinations with the following effects:

a. imposing franking debits in the distributing entity's franking account

b. imposing exempting debits on the distributing entity's exempting account, and

c. denying the imputation benefit on the distribution that flowed directly or indirectly to the favoured member.

98. Subsections 204-30(7) to 204-30(10) of the ITAA 1997 are directly relevant to the application of paragraph 204-30(1)(b).

99. Subsection 204-30(7) of the ITAA 1997 provides that subsection 204-30(8) lists some of the cases in which a member of an entity derives a greater benefit from franking credits than another member of the entity. It is not an exhaustive list.

100. Subsection 204-30(8) of the ITAA 1997 then states that:

A member of an entity derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution giving rise to the benefit is made, and not in relation to the first member:

(a) the other member is a foreign resident;

(b) the other member would not be entitled to any tax offset under Division 207 because of the distribution;

(c) the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled;

(d) the other member is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e) the other member is a corporate tax entity at the time the distribution is made, but cannot use franking credits received on the distribution to frank distributions to its own members because:

(i) it is not a franking entity; or

(ii) it is unable to make frankable distributions;

(f) the other member is an exempting entity.

101. Subsections 204-30(9) and 204-30(10) of the ITAA 1997 provide a member of an entity will derive a greater benefit from franking credits than another member, when a distribution is made by an exempting entity or the distribution is franked with an exempting credit or venture capital credit.

102. The term 'member' of an entity is defined in subsection 960-130(1) of the ITAA 1997. Item 1 of subsection 960-130(1) describes the member of a company to be a member of the company or a stockholder in the company.

103. The term 'streaming' is not defined for the purposes of Subdivision 204-D of the ITAA 1997. However, guidance on the meaning of the term can be found in the Explanatory Memorandum (EM) to the New Business Tax System (Imputation) Bill 2002, which states that streaming is 'selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits'.

104. In providing guidance on when a member derives a greater benefit from imputation credits, paragraph 3.42 of the EM states that 'a difference in marginal tax rates of members of a corporate tax entity does not, by itself, indicate that some members derive a greater benefit from imputation credits than others.'

Application to your circumstances

105. After the transfer of the shares to Finance Company, it is proposed that Trading Company will pay a fully franked dividend, with no other benefits being provided. At the time of the dividend payment, Finance Company will own X% of the shares in Trading Company. As such, Finance Company is a member of Trading Company under subsection 960-130(1) of the ITAA 1997

106. Prior to the transfer of the shares to Finance Company, Taxpayer 1 owned X% of the shares in Trading Company. As such, Taxpayer 1 was a member of Trading Company under subsection 960-130(1) of the ITAA 1997.

107. Taxpayer 1 and Finance Company were the only two members of Trading Company during the franking period in which the proposed franked dividend will be paid. However, they were not members at the same time.

108. The three paragraphs of subsection 204-30(1) of the ITAA 1997 are key to the making of any determination in relation to dividend streaming.

Paragraph 204-30(1)(a) of the ITAA 1997

109. As a resident company recipient of a franked distribution, it is expected that a franking credit will arise in the franking account of Finance Company. Consequently, upon receipt of the distribution, Finance Company will be taken to have received an imputation benefit under paragraph 204-30(6)(c) of the ITAA 1997, thus satisfying paragraph 204-30(1)(a).

Paragraph 204-30(1)(b) of the ITAA 1997

110. Paragraph 204-30(1)(b) of the ITAA 1997 requires examining whether Finance Company, who will receive the imputation benefit, will be taken to derive a greater benefit from franking credits than another member of Trading Company, Taxpayer 1. This in turn requires a consideration of the factors in subsection 204-30(8) for the income year the franked distribution is made.

111. As both Taxpayer 1 and Finance Company are Australian residents, paragraph 204-30(8)(a) of the ITAA 1997 is not satisfied.

112. Taxpayer 1 and Finance Company will both be entitled to a tax offset for the imputation credits and therefore, paragraph 204-30(8)(b) of the ITAA 1997 is not satisfied.

113. Paragraph 204-30(8)(c) of the ITAA 1997 examines whether the amount of income tax that, apart from Division 204, would be payable by Taxpayer 1 (the other member) because of the distribution is less than the tax offset to which Taxpayer 1 would be entitled. Given that Taxpayer 1 is an Australian resident natural person, she/he would be entitled to a refund of any imputation credits in excess of tax payable. Therefore paragraph 204-30(8)(c) will not apply.

114. As Taxpayer 1 is a natural person rather than a corporate entity or exempting entity, paragraphs 204-30(8)(d), (e) and (f) of the ITAA 1997 will not apply.

115. For the reasons stated above, paragraph 204-30(1)(b) will not apply to the present case. Finance Company will not derive a greater benefit than Taxpayer 1 in relation to the franking credits from the proposed franked dividend.

116. Further to the above considerations, it is noted that Finance Company would pay tax on any franked dividend at a lesser rate than Taxpayer 1, an individual resident member of the company. The fact that tax may be paid at differing rates by different members of the company will not by itself be sufficient grounds for a determination of dividend streaming to be made.

117. For completeness, subsections 204-30(9) and 204-30(10) of the ITAA 1997 are not relevant in the present case, as the distribution is not made by an exempting entity, and the distributions are not franked with an exempting credit or venture capital credit.

118. As paragraph 204-30(b) of the ITAA 1997 does not apply, the requirements of section 204-30(1) have not been met.

119. Accordingly, the payment of the proposed fully franked dividend from Trading Company to Finance Company is not a transaction where the Commissioner will make a determination pursuant to section 204-30 of the ITAA 1997.

Question 6:

Will either section 45A or section 45B of the ITAA 1936 apply to the payment of the proposed dividend by Trading Company to Finance Company?

STREAMING OF DIVIDENDS AND CAPITAL BENEFITS

120. Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

121. Subsection 45A(3) of the ITAA 1936 provides that the term 'provision of a capital benefit' to a shareholder in a company refers to the following:

a. the provision of shares in the company to the shareholder

b. the distribution of share capital or share premium to the shareholder, or

c. something that is done in relation to a share that increases the value of a share held by the shareholder.

Application to your circumstances

122. In the present case, the only benefit being provided by Trading Company under the proposal is a fully franked dividend. There is no provision of a capital benefit to a shareholder of Trading Company, and accordingly, section 45A of the ITAA 1936 has no application to the proposed dividend from Trading Company to Finance Company.

SCHEMES TO PROVIDE CERTAIN BENEFITS

123. Section 45B of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where certain capital payments are paid to shareholders in substitution for dividends.

124. Paragraph 45B(1)(b) of the ITAA 1936 states the purpose of section 45B is that relevant amounts are treated as dividends for taxation purposes if certain payments, allocations and distributions are made in substitution for dividends.

125. Specifically, subsection 45B(2) of the ITAA 1936 provides that section 45B will apply where:

a. there is a scheme under which a person is provided with a capital benefit by a company

b. under the scheme a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit, and

c. having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit.

126. A 'scheme' is defined in subsection 177A(1) of the ITAA 1936 as:

a. any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

b. any scheme, plan, proposal, action, course of action or course of conduct.

127. Subsection 45B(5) of the ITAA 1936 provides that a person will be 'provided with a capital benefit' if:

a. they are provided with an ownership interest in a company

b. they receive distributions in share capital or share premium, or

c. something is done that increases the value of their ownership interest (which may or may not be the same ownership interest).

Application to your circumstances

128. It is proposed that Taxpayer 1 will transfer his shares in Trading Company to Finance Company and, shortly after the transfer, Trading Company will pay Finance Company a fully franked dividend. This arrangement satisfies the broad definition of a scheme pursuant to subsection 177A(1) of the ITAA 1936.

129. The provision of ownership interests in Trading Company to Finance Company, for nil consideration, meets the definition of a capital benefit under paragraph 45B(5)(a) of the ITAA 1936.

130. However, the ownership interests being provided to Finance Company are being provided by Mr Taxpayer, an individual. Therefore paragraph 45B(2)(a) of the ITAA 1936 is not satisfied as the capital benefit is not being provided by a company.

131. The only other benefit being provided by Trading Company under the scheme is a fully franked dividend to Finance Company. This dividend does not meet the definition of a capital benefit under subsection 45B(5) of the ITAA 1936.

132. Therefore paragraph 45B(2)(a) of the ITAA 1936 will not be satisfied and accordingly, section 45B has no application to your proposal.

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