Edited version of private advice

Authorisation Number: 1051683086023

Date of advice: 26 September 2019

Ruling

Subject: Restructure - dividend stripping and general anti-avoidance

Question 1

Whether section 177E of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to the transfer of shares in a trading company to a newly established holding company, the shares in which will be owned by a family trust?

Answer

No - the restructure will not constitute a 'dividend stripping scheme' (or a scheme having substantially that effect) for the purposes of section 177E of the ITAA 1936 because the ordinary characteristics of a 'dividend stripping' scheme will not be apparent if the company does not retain substantial undistributed profits in liquid form prior to the transaction - any retained profits do not exceed the level required to meet ordinary business operations (including outlays required as a consequence of adverse business conditions that are beyond the directors' control), and the market value consideration received from selling the shares is significantly above the undistributed profits retained by the company.

Question 2

Whether section 177D of the ITAA 1936 will apply to the proposed restructure?

Answer

No - the sole and dominant purpose of the arrangement is not to obtain a tax benefit, but rather the restructure has been entered into for asset protection and estate planning purposes and also to make provision for the existing shareholders' eventual retirement.

This ruling applies for the following period:

1 July 2019 to 30 June 2022

Relevant facts and circumstances

The taxpayers, A and B, are 2 individuals who each own 50% of the shares in the Company.

The taxpayers are in the highest marginal tax bracket.

The taxpayers are a married couple who have several children; each of whom has or has had some involvement in the business conducted by the Company.

The Company, which has no tax losses, has, over the years, accumulated sizeable retained earnings and holds valuable business assets. The retained earnings have for the most part been invested in productive business assets and only a small proportion has been retained as working capital (cash).

The taxpayers intend to restructure the ownership of the Company in the manner described below:

·        A discretionary trust will be established with the taxpayers acting in the role as the appointers of the trust. The primary beneficiaries of the trust will be the taxpayers and their children. A corporate trustee will be established, with the taxpayers being the shareholders as well as directors of the corporate trustee. Their adult children may also be appointed as directors of the corporate trustee. A family trust election will be made and one of the two individual taxpayers will be appointed as the specified individual.

·        A new company will be incorporated, the shares in which will be owned by the trust, with the directors being the taxpayers and potentially their adult children. The new company will acquire the shares in the Company for market value consideration and will act as the holding company for the group.

·        The transaction will occur at open market value and the funding of the acquisition of the shares in Company by the new Proprietary Limited company will be undertaken by way of vendor and bank finance (specifically by way of a vendor and bank loan, with the vendor financing 75% of the loan on arm's length terms).

·        The current market value means that the amount the shareholders receive for selling the shares will be substantially higher than the value of the undistributed profits in the company.

·        Once the structure is established a tax consolidated group ('TCG') will be formed between the new company (holding company) and the Company. On consolidation it is likely the tax cost base of goodwill will be reset from $Nil to a higher value through the allocable cost amount ('ACA') resetting process.

·        The taxpayers will apply the CGT Small Business Concessions in respect of the gain arising on disposal of their ownership of the shares in the Company. After applying the retirement exemption it is anticipated that no tax liability will exist.

Dividends continue to be distributed to the existing shareholders prior to the restructure - that is, any retained profit must not be significantly higher than the amount required to meet ordinary business operations. For example, if, following a profitable year, there are adverse business circumstances beyond your control such that all profits are needed to meet business expenses and planned business improvements, then no dividend would be required in respect of those previous year's profits.

Relevant legislative provisions

Section 177D ITAA 1936

Section 177E ITAA 1937

Reasons for decision

Question 1

Summary

The restructure will not constitute a 'dividend stripping scheme' (or a scheme having substantially that effect) for the purposes of section 177E of the ITAA 1936 because the ordinary characteristics of a 'dividend stripping' scheme will not be apparent if the company does not retain substantial undistributed profits in liquid form prior to the transaction - any retained profits do not exceed the level required to meet ordinary business operations (including outlays required as a consequence of adverse business conditions that are beyond the directors' control), and the market value consideration received from selling the shares is significantly above the undistributed profits retained by the company. The mere fact that future profits of the company will flow to the holding company and to the trustee of the family trust through dividends and ultimately to the beneficiaries of the family trust is not sufficient to satisfy section 177E of the ITAA 1936.

Detailed reasoning

DIVIDEND STRIPPING

Section 177E of the ITAA 1936 contains an anti-avoidance provision regarding a scheme to reduce income tax through stripping of company profits.

The definition of 'scheme' is contained in section 177A of the ITAA 1936 and includes any plan, proposal, action, course of action or course of conduct. Given the broad definition, it is considered that the proposed restructure will constitute a scheme for the purposes of the anti-avoidance provisions.

The pre-conditions to the operation of the dividend stripping rules are contained In paragraphs 177E(1)(a)-(d), which state the provisions have effect where:

(a) as a result of a scheme that is, in relation to a company:

(i) a scheme by way of or in the nature of dividend stripping; or

(ii) a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount ) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

A) The four pre-conditions

The Commissioner's view on the nature of dividend stripping schemes is contained in Taxation Ruling IT 2627. The Commissioner identified four pre-conditions that must be satisfied in paragraphs 177E(1)(a)-(d) above, which are:

a) As a result of a dividend stripping scheme or scheme having substantially the same effect, any property of the company is disposed of (paragraphs 6 to 21).

b) The disposal of property represents, in whole or in part, a distribution of profits of the company, regardless of whether the profits existed at the time the property was disposed (paragraph 22).

c) If the profits had been paid as a dividend immediately before the scheme was entered into an amount would, or might reasonably be expected to, have been included in the taxpayer's assessable income (paragraph 24 to 25).

d) The scheme was entered into after 27 May 1981, whether inside or outside Australia.

B) Two limbs of the first pre-Condition

There are two limbs to the application of this the first pre-condition, the difference between them being the method by which profits of the target company are distributed. As stated by the Full Federal Court in Lawrence v Commissioner of Taxation [2009] FCAFC 29 ('Lawrence'):

[52] The first limb is concerned with schemes which are by way of or in the nature of dividend stripping; the second limb is concerned with other schemes, that is, schemes that are not by way of or in the nature of dividend stripping but which are schemes having substantially the same effect.

The Commissioners view in IT 2627 is that in order for a scheme to fall within the second limb 'it would require at a minimum that company profits are effectively distributed to shareholders.' The profits do not need to be distributed specifically to the shareholder, as long as it can be determined that the payment has been made for the benefit of the shareholder or their associate.

It was noted by the Full Federal Court in Lawrence that:

[48] The reference to 'having substantially the effect of' a dividend stripping scheme is to a scheme that would be within the first limb, except for the fact that the distribution by the target company is not by way of dividend or deemed dividend.

Therefore, in order to determine whether the first pre-condition is satisfied, the common characteristics of a dividend stripping scheme must be identified. If the common characteristics exist then the manner in which the profits of the target company are distributed required examination to determine which limb the scheme falls within.

C) Common characteristics of a dividend stripping scheme

The High Court in Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32 ('Consolidation Press') applied the following common characteristics of dividend stripping that had been identified by the Full Court of the Federal Court:

A target company with substantial undistributed profits

The sale or allotment of share to another party

The payment of a dividend to the purchaser or allottee

The purchaser escapes Australian tax on the dividends declared

The vendor receives a capital sum for their shares in an amount the same or very close to the dividends paid to the purchasers; and

The scheme was carefully planned for the predominant if not sole purpose of the vendor shareholders avoiding tax.

It is noted that many of these characteristics are consistent with the description of a dividend stripping scheme provided in Taxation Ruling IT 2627.

In the Federal Court, Hill J held that:

[A] scheme will only be a dividend stripping scheme if it would be predicated of it that it would only have taken place to avoid the shareholders in the target company becoming liable to pay tax on dividends out of the accumulated profits of the target company. It is that matter which distinguishes a dividend stripping scheme from a mere reorganisation.

Therefore, in order to determine whether a scheme will possess the ordinary characteristics of a dividend stripping scheme, it must be determined whether it would only have taken place to avoid the shareholders becoming liable to tax on dividends that they otherwise would have. This requires a consideration of the amount of tax, and the quantum of dividends, that would ordinarily have resulted.

Dominant purpose

Although a plain reading of the words contained in section 177E of the ITAA 1936 do not require determining the purpose for which the scheme was entered, the High Court has held that to constitute dividend stripping the scheme must have as its dominant purpose the avoidance of tax on the distributions of dividends by the target company (see Lawrence v Commissioner of Taxation [2009] FCAFC 29, [33] (Ryan, Stone, Edmonds JJ).

The tax avoidance purpose is ordinarily that of enabling the shareholders to receive profits of the company in a substantially tax-free form (see Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32, [129] (Gleeson CJ, Gaudron, Gummow, Hayne, Callinan JJ). Determining the purpose of an arrangement depends upon objective facts and is not concerned with the subjective motivation of the taxpayer. It is the dominant purpose of a person who entered into or carried out the scheme that must be determined in this manner (see Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32, [129] (Gleeson CJ, Gaudron, Gummow, Hayne, Callinan JJ)).

Application

A) Quantum of undistributed Profits

The tangible assets of the Company primarily comprise cash & cash equivalents of $X and property, plant and equipment of $X. Cumulatively these two assets represent 82% of the total assets of the company (i.e. $X + $X / $X = 81.7%).

Total creditors for the Company are $X (i.e. $X = $X (Trade Creditors) + $X (Creditors - C.M.), representing a debt-to-equity ratio of 0.26 (i.e. Total Debt ($X) / Total Equity ($X) = 0.2639).

Retained earnings of $773,484 existed in the company as at 30 June 2018. This indicates that retained earnings have been used to fund the acquisition of property, plant and equipment over the course of the business, instead of earnings being paid to shareholders in the form of dividends.

B) Dividends expected

Based on the net profits after tax for the 2018 financial year, retained earnings represent approximately 1.7 years' worth of net profits (i.e. $X / $X = 173%). However, in the 2017 and 2018 financial years the company paid dividends representing 112% and 92% respectively of the net profit after tax.

Therefore, based on the dividend distribution pattern for the recent financial years, it would be difficult to predicate the restructure on the basis that it has only taken place to avoid the shareholders becoming liable to tax on the dividends of the Company.

If the dividend distribution pattern continues up to the restructure, or retained profits do not exceed the level required to meet ordinary business operations (including outlays required as a consequence of adverse business conditions that are beyond the directors' control), then it is unlikely the scheme would satisfy either of the two limbs for the first pre-condition, because it would not exhibit the common characteristics of a dividend stripping scheme identified above.

C) Amount received for shares

Another common characteristic of a dividend stripping scheme that may be present is the shareholders receiving a capital sum for their shares for an amount very close to dividends paid to the holding company.

If the shares are sold for their market value then the discounted present cash flows of the business should be substantially greater than only 1.7 years' worth of net profits that are reflected in retained earnings, particularly given the Company intends to expand its operations. The current market value of the shares is significantly above the undistributed liquid profits retained by the Company.

D) Purposes for restructure

The taxpayers have advised that although they intend to retain their current level of involvement and positions in the business, their purpose for the restructure is estate planning and asset protection. However, several other purposes for the restructure have been expressed in the PBR application. Whilst the taxpayer's subjective motivation or intentions are not determinative, and the dominant purpose will be determined from an objective analysis of the facts, each of the potential purposes expressed by the taxpayers has been analysed below.

It is not unreasonable to conclude that a motive behind the proposed scheme appears to be for the taxpayers to access funds in the most tax-effective manner while providing for their retirement (the tax benefits). Other alternatives to the scheme exist:

·        they could just borrow the money (however, the interest wouldn't be deductible);

·        pay themselves dividends from the Company (however, this would not be not very tax effective and in any event the Company may need the money), or;

·        sell the Company to an external third party (but then the family business is gone).

The taxpayers have elected to sell the shares in the Company to a related entity. This would allow the taxpayers to retain full control over everything, the interest on the loan is deductible to the related entity, they access the CGT concession to reduce their capital gain, place the proceeds from the sale into superannuation, and all profits from that point forward can be distributed to beneficiaries of the trust in a tax effective manner. Fundamentally, this demonstrates a purpose of tax minimisation.

Asset protection

The PBR application indicates that the purported dominant purpose of the taxpayers entering into the restructure is asset protection.

It is unclear how the restructure will afford greater asset protection than the existing structure. Furthermore, it is unclear which assets specifically are being protected: the personal assets of the taxpayers; the shares held by the taxpayers; the assets of the Company, or; some other assets.

Company

It is quite common for entities to structure their business affairs using holding companies and operating companies to minimise risks. As it is the Company that hires employees, enters into contracts and deals with customers etc., it is the entity that bears the liabilities. As such, holding assets etc. through a holding company protects assets held in the holding company from claims by creditors of the Company should the operating company begin to perform poorly, incur liabilities or become insolvent.

In this case, shifting retained earnings from the Company to the holding company will protect it from creditors. But in itself the payment of dividends from the Company to the holding company will merely enable profits to be retained in one company rather than another.

Individuals

Given that the personal assets of the taxpayers are already largely protected due to the business being carried on through a company (rather than as sole traders), the most likely asset protection justification is that the restructure would protect the shares from seizure in the event of personal bankruptcy.

However, it is unclear to what degree asset protection exists in relation to the shares, or to the beneficial interest therein, if the proposed restructure does take place.

Increase scope of business

Another motivation for the restructure that is suggested in the PBR application is to enable the company to increase the size and production of its business and to facilitate the expansion into other areas of NSW. Following the restructure, the taxpayers advised the new structure would provide flexibility and quarantine risk through new subsidiary entities being established under the holding company.

Given the business is already run through a company, it is unclear why new subsidiary companies could not be created under the current structure which would achieve this objective.

Modern technologies

The taxpayers' PBR application also indicates that the proposed restructure will facilitate investment in more modern technology.

It is unclear how the restructure would assist facilitating this, or why the ability to invest in modern technology is more limited under the existing structure. Who the ultimate legal owner of the shares is does not appear to have any bearing on whether investment in modern technology is capable.

Potential outside investment

The taxpayers stated that '[t]he restructure would provide opportunities for potential outside investment'. The PBR application states that under the restructure the proposed holding company would provide for efficient exit of subsidiary entities and the allocation of business units (subsidiaries) to the taxpayers' children who are working on that aspect of the business.

It is unclear why the potential for outside investment does not exist in the current structure, or how any investment would otherwise be limited. As noted above, the business is being carried on by a corporation under which subsidiary entities could be created, or additional shares could be issued to outside investors. There is no apparent reason why the proposed restructure would facilitate the creation of subsidiaries in a manner that cannot achieve outside investment or the allocation of business units via subsidiaries.

Notwithstanding, it is accepted that investors may prefer to invest through a holding company for the asset protection it affords - it would/may quarantine their investments from the risks associated with the Company. And if the family and new investors were to invest in new distinct business activities through distinct entities owned by the holding company, rather than through entities owned by the Company, the success or otherwise of each subsidiary would not impinge on the solvency of the other entities. (Whereas, if the Company were to establish its own subsidiary ventures, a failure by the Company would enable creditors to claim the value represented by shares in the subsidiaries.)

Estate planning and fair remuneration

The taxpayers have advised that the restructure will assist with estate planning and ensuring that their children are remunerated on the basis of their effort rather than equally benefitting from any future profits derived by the business. Under the proposed restructure, the children would receive discretionary trust distributions instead of dividends.

It is unclear why the distribution of profits on the basis of effort cannot be achieved under the current arrangement. Various alternative methods of achieving this outcome could be implemented under the current structure, including: only issuing shares to the children who contribute to the business; issuing different classes of shares with different dividend rights; employing the children who contribute to the business and creating an employee share scheme. Other options to achieve this objective also exist. However, it is recognised that a family trust would provide the year to year flexibility needed to tailor the rewards given to family members for their contribution to the business in that year. If instead different classes of shares were created and dividends were channelled selectively to holders of particular classes of shares, this could have dividend streaming implications.

In terms of estate planning, it is unclear how the new structure would provide the taxpayers with more scope to distribute their assets upon their death. They will cease being the legal owners of the shares under the proposed structure, and all decisions regarding profit distribution will reside with the corporate trustee. The taxpayers will be the sole shareholders of the corporate trustee, and this is fundamentally no different to being the sole shareholders of the Company. The taxpayers will have the ability to bequeath the shares to their children under either structure. However a family trust would serve to simplify the arrangements upon death as the family trust would continue to own the shares in the holding company.

An objective analysis of the facts indicates that the explanations regarding fair distributions and estate planning are not particularly strong individually. Neither explanation would, in isolation, amount to a dominant purpose of the scheme. Both of these objectives can be achieved under the current structure, compared to the tax benefits that can be obtained from the restructure.

Legal action by uninvolved children

The taxpayers have also advised that they are concerned their children who are not involved in the business may seek to take action against the business following their death, and this action would be detrimental to the other children who are involved in the business.

It is unclear how the new structure would prevent any of the children from seeking legal action against either the business or in relation to any trust distributions under the proposed restructure. The possibility of challenging the validity of the trust or the distributions therefrom exists.

Partner of child

The taxpayers advised they are concerned that a partner, or future partner, of their children may seek to obtain financial advantage through association with the children. The taxpayers allege that this financial advantage would not be easily facilitated under the proposed restructure, where the shares in the Company are held by a discretionary trust.

As noted above, it is the dominant purpose of the people who enter into or carry out the scheme that must be determined, based on an objective assessment of the facts and not their subjective motivation (see Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32, [89] (Gleeson CJ, Gaudron, Gummow, Hayne, Callinan JJ)).

The objective facts indicate that a certain and immediate tax benefit will be achieved from the restructure. No objective facts evidence a motivation of any third party to obtain a financial advantage from the taxpayers' children because of the current structure.

It is also unclear why such a third party would not also seek to obtain a financial advantage under the proposed structure, or why they would be less able to. The shares in the holding company will ultimately be owned by someone upon the taxpayers' death, and trust deeds can be varied.

Nonetheless, the use of trusts to legally protect assets in the event of a relationship breakdown is not an uncommon consideration. And the ownership of the shares in the holding company by the trustee may have estate planning advantages and may insulate the family's assets against future relationship breakdowns of the taxpayer's children.

Conclusion

The Commissioner accepts that the proposed restructure is unlikely to constitute a scheme that demonstrates the common characteristics of a dividend stripping scheme where the retained profits do not exceed the level required to meet expenses as they fall due, meet planned business expansion or capital improvement requirements, or in recognition of adverse business conditions that are beyond the directors' control. This is particularly the case if dividends in the order of 80%-100% of net profit after tax continue to be distributed to the existing shareholders prior to the restructure (allowing for adverse market conditions beyond the directors' control), and provided the shareholders receive an amount for disposal of their shares that is commensurate with the market value of the company (given the market value of the company is considerably in excess of retained profits on hand).

In the event that excessive profits are retained prior to restructure (for reasons other than the profitability of the business being significantly impacted by events/factors beyond the directors' control), and/or the amount the taxpayers receive for disposing of their shares is less than or very close to any undistributed profits in the Company, the scheme will likely exhibit the common characteristics of dividend stripping and it becomes necessary to consider the dominant purpose for entering into the scheme.

The taxpayers have advised their motivation for the restructure was predominantly asset protection. However, subjective motivation is not the relevant measure to determine the dominant purpose, as this must be determined based on an objective analysis of the facts.

If the dominant purpose for entering the scheme is for the tax benefits, the scheme would fall to either the first or second limb of the first pre-condition, depending on whether the profits are distributed by way of dividend or some other manner.

Question 2

Summary

The sole and dominant purpose of the arrangement is not to obtain a tax benefit, but rather the restructure has been entered into for asset protection and estate planning purposes and also to make provision for the existing shareholders' eventual retirement.

While the fact future dividends will flow to the holding company and ultimately to the beneficiaries of the family trust is likely to have been a relevant purpose behind the scheme (restructure), it is not considered the dominant purpose. It is also notable that the mere payment of dividends from the company to the new holding company will not produce any tax benefit in itself that is not currently achieved by retaining profits in the original company. Accordingly the real issue is whether the ultimate enjoyment of future profits by the beneficiaries of the trust, rather than the current individual shareholders, is the 'dominant purpose' behind the scheme.

There is another potential 'tax' benefit that would result from the scheme. The taxpayers are keen to gain access to funds to finance their retirement and lifestyle pursuits. The sale of their shares to the newly created holding company, which will borrow the necessary funds, will effectively provide the shareholders with private monies financed by debt that will give rise to deductible interest for the holding company whilst allowing the shareholders to retain effective control over the business. However, the other purposes that are non-tax related appear more significant, at least in aggregate.

It is also notable that the tax system expressly recognises that businesses restructure on occasion and contains provisions that facilitate this. While there are specific anti-avoidance provisions such as 177E of the ITAA 1936, the mere disposal of shares by shareholders at full market value to another entity would be unlikely to be within scope for the purposes of 177D of the ITAA 1936.

Detailed reasoning

GENERAL ANTI-AVOIDANCE

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

Part IVA requires the consideration of a 'scheme', which 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.

Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart (2004) 55 ATR 712 (Hart), per Gummow and Hayne JJ:

[43] [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 azxlso (by its reference to "action" in the singular) the taking of but one step.

Tax Benefit

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

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.

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.

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 (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme). in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme

(f) any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme) 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 (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(f).

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.

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.

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 Hart:

[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.

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.

PSLA 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).

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.

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

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

The proposed arrangement would satisfy the requirements for a scheme pursuant to subsection 177A(1) of the ITAA 1936.

Tax benefit

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, a counterfactual to your proposed scheme, would be:

·        To dispose of the shares to an unrelated party at market value.

·        To dispose of the shares to the trustee of the newly established trust at market value.

Arguably, one of the tax benefits to be obtained is from streaming franked dividends to beneficiaries in a tax effective manner. In broad terms, the tax benefit would be the difference between franked dividends being paid to the two taxpayers and streaming of the franked dividends to beneficiaries of the trust, and the difference between the highest marginal tax rate and a lower tax rate applying (if the beneficiary is not in the highest marginal tax bracket).

Making the holding company a beneficiary of the trust and streaming distributions to that entity may expose the trustee to section 100A of the 1936.

It is noted the fact that a taxpayer pays less tax if one form of the transaction rather than another is adopted, does not by itself demonstrate that Part IVA applies (paragraph 109 of PS LA 2005/24).

Dominant purpose

To determine if your purpose in entering into the arrangement is to obtain a tax benefit, consideration of the eight factors specified in subsection 177D(2) is provided below:

I. The manner in which the scheme is entered into or carried out

The scheme is a relatively straightforward arrangement - and one that is not uncommon.

II. The form and substance of the scheme

The commercial reality of the scheme is the same as the legal form of the scheme, in that the retained earnings will be held in a company. The difference is that shares will be held by the trustee of the family trust which, amongst other things, facilitates the streaming of franked dividends to beneficiaries of the trust (who include persons other than the taxpayers).

III. The time at which the scheme was entered into and the length of the period during which the scheme will be carried out

The scheme will be carried out in a short period of time.

IV. The result in relation to the operation of this Act, but for this part, would be achieved by the scheme

As a result of the scheme, persons other than the taxpayers may receive the benefit of franked dividends by way of trust distributions.

V. Any change in the financial position of the relevant taxpayer that has resulted, will result, or may be reasonably expected to result, from the scheme

The taxpayer's financial position will not be the same before and after the implementation of the scheme - they will have capital gains from the sale of the shares (albeit very concessionally taxed), the benefit of the concessionary tax treatment of placing those proceeds in superannuation, and the potential benefit of distributions to beneficiaries of the trust in a tax effective manner.

VI. Any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

The trustee of the family trust will acquire an asset (through its shareholding in the holding company).

The beneficiaries of the trust (other than the taxpayers) may benefit from the streaming of franked dividends.

VII. Any other consequences for the relevant taxpayer or person connected

After the scheme has been implemented, the taxpayers will be able to maintain control of and continue to run their business.

VIII. The nature of any connection between the relevant taxpayer and any person referred to in subparagraph (vi)

The beneficiaries of the trust (other than the taxpayers) - mainly their children who will be involved in the business who may enjoy franked dividend distributions under the new arrangement.

Conclusion

Based on the available evidence and having regard to the eight factors in section 177D of the ITAA 1936, a reasonable person would more likely than not conclude that there are 'tax benefits' in entering into this scheme - including accessing CGT concessions to reduce their capital gain from the disposal of their shares, access concessionary tax treatment in respect of those proceeds through the superannuation regime, generating interest deductions for the holding company, and all profits under the new arrangement can be distributed to beneficiaries of the trust in a tax effective manner.

However, the sole or dominant purpose of this arrangement is not to obtain a tax benefit: it is to restructure a business for asset protection (and other things such as succession planning). Taking into account the various considerations, it is reasonable to accept that asset protection is a valid and significant reason for this restructure. The tax benefits (incidental or otherwise) would not lead to the conclusion that the arrangement was entered into for the sole or dominant purpose of obtaining a tax benefit. These considerations include that:

·        the sale of shares at market value means that the taxpayers will be properly subject to CGT on the disposal of the shares at market value;

·        the retained earnings could have remained in the Company;

·        the holding company affords asset protection from creditors etc. of the Company;

·        having the trustee hold the shares in the holding company will protect the family's assets from partners of the taxpayers children and allow control over flow of dividends to beneficiaries;

·        the acquisition of the shares by the holding Company is funded by a bank loan and vendor finance on an arm's length basis.

A key consideration here is that there is no difference in the retained earnings sitting in the Company or the holding company - it would be as if they were not paid out at all. The retained earnings can remain in the Company - whether or not the trustee holds the shares directly in the Company or indirectly through the holding company.

As the sole or dominant purpose in entering the scheme was for a reason other than to obtain a tax benefit, Part IVA of the ITAA 1936 will not apply to the scheme.

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