ATO Interpretative Decision

ATO ID 2002/350

Income Tax

• This document incorporates revisions made since original publication. View its history and amending notices, if applicable.

Issue

Was the payment of a dividend made in the course of a transaction, operation, undertaking, scheme or arrangement by way of dividend stripping pursuant to section 46A of the Income Tax Assessment Act 1936 (ITAA 1936)?

Decision

Yes. The Commissioner is satisfied that the payment of the dividend was made in the course of a transaction, operation, undertaking, scheme or arrangement by way of dividend stripping pursuant to section 46A of the ITAA 1936.

Facts

Acquiring Co purchased 100% of the interest in a company (Target Co), which held a number of wholly owned operating subsidiaries. The acquisition was financed entirely by a short-term bridging loan obtained from a bank.

Following acquisition, Target Co and its subsidiaries sold various assets and realised profits. During the course of the restructure Target Co received dividends from various subsidiaries, which included distribution of profits generated from the sale/transfer of businesses and other assets. The profit amounts generated by the group during the course of the restructure had not been recognised in the accounts of Target Co or its subsidiaries prior to Acquiring Co purchasing the group. Target Co used the dividends from the subsidiaries, together with part of the profits it made on its sales of subsidiaries and other assets to pay a dividend to Acquiring Co. Finally, Target Co was sold to an offshore company.

The dividend and the consideration on sale approximated the amount paid by Acquiring Co on acquisition of Target Co.

For tax purposes, Acquiring Co included the dividend in its assessable income and claimed a rebate in respect of the dividend pursuant to section 46 of the ITAA 1936. In the following year (the year in which Target Co was sold), Acquiring Co returned a carry forward net capital loss in relation to the disposal of Target Co.

Reasons for Decision

For the purposes of section 46A of the ITAA 1936 a "dividend" does not include a dividend unless the payment of the dividend arose out of, or was made in the course of, a transaction, operation, undertaking, scheme or arrangement that the Commissioner is satisfied was by way of dividend stripping (section 46A(1) of the ITAA 1936).

The term "dividend stripping" is not defined in the ITAA 1936. The Explanatory Memorandum (EM) to the introduction of section 46A of the ITAA 1936 referred to subsection (3) as stating matters which the Commissioner is obliged to consider in determining whether there has been a dividend strip 'in a case potentially within the scope of the section'. The EM continues as follows:

'The subsection thus directs the Commissioner to consider features common to dividend stripping as the term is ordinarily understood. These features do not exist in normal commercial transactions, e.g., in the purchase in the ordinary way of shares cum div. and the subsequent sale of those shares.'

In effect, the subsection requires the Commissioner to consider those features which are common to most dividend stripping operations. The EM states:

'In its simplest form, a dividend-stripping operation involves the purchase by a share-trading company of shares in another company which has accumulated profits. A payment of a dividend is then made to the share-trading company which, in effect, wholly or substantially recoups its outlay on purchase of the shares that are then resold for a reduced price or are retained at a reduced value for income tax purposes.'

These features were present in this case. The purchaser, Acquiring Co, purchased shares in another company, Target Co, which had accumulated profits (although unrealised). A payment of a dividend was then made to Acquiring Co which, in effect, wholly or substantially recoups its outlay on purchase of the shares that were then resold for a reduced price. Whilst the EM refers to a dividend stripping operation carried out by a share-trading company and it is accepted that Acquiring Co is not a share-trading company, the operation of section 46A of the ITAA 1936 was extended in 1987 to ensure that the intercorporate dividend rebate will be reduced or denied, as appropriate, where a dividend is paid in the course of a dividend stripping operation where the relevant property is acquired after 19 September 1985.

FC of T v. Consolidated Press Holdings Ltd (No 1) 91 FCR 524 (the CPH case), which dealt with the stripping of company profits under section 177E of the ITAA 1936, can provide guidance in identifying a dividend stripping scheme. In the CPH case, the Full Federal Court stated that the central characteristics of a dividend stripping scheme, as identified by reference to established case law decisions, were^[F1]:

(a)

A target company with substantial accumulated profits;

(b)

The sale of the shares in the target company to another party;

(c)

The payment of dividends to the purchaser out of the target company's profits;

(d)

The purchaser escaping Australian tax on the dividends so declared;

(e)

The vendor shareholders receiving a capital sum approximating the dividend paid by the target; and

(f)

A scheme carefully planned and carried through by the stripper and a number of other persons acting in concert.

(a) A target company with substantial accumulated profits.

It is considered that Target Co was a company with significant accumulated profits, although these profits had not yet been booked at the date it was acquired. Target Co's accounts just prior to acquisition recorded assets at historical cost, however it was acquired for its market value (2.5 times historical cost).

(b) The sale of the shares in the target company to another party.

Target Co's shareholders sold Target Co shares to Acquiring Co.

(c) The payment of dividends to the purchaser out of the target company's profits.

Once acquired, Target Co and its subsidiaries began to dispose of their assets. The subsidiaries paid dividends to Target Co from the profits on the sale of assets. Target Co then paid a dividend to Acquiring Co.

(d) The purchaser escaping Australian tax on the dividends so declared.

For tax purposes, Acquiring Co included the dividend in its assessable income and claimed a rebate under section 46 of the ITAA 1936 in respect of this dividend.

(e) The vendor shareholders receiving a capital sum approximating the dividend paid by the target.

It is submitted that the absence of this typical, rather than essential, feature does not take the subject arrangement out of section 46A of the ITAA 1936 where it is evident that it was carried out to exploit the dividend rebate provisions in order to finance the acquisition cost of the takeover. It should be noted that the dividend and the consideration on sale approximated the amount paid by Acquiring Co on acquisition.

(f) The scheme was carefully planned and carried through by the stripper and a number of other persons acting in concert.

It is acknowledged that there were genuine commercial reasons for the takeover and subsequent restructure. However, the manner in which the restructure was undertaken and the very substantial dividend payment attract tax ramifications of a kind that section 46A of the ITAA 1936 was enacted to address. It is considered that the takeover, subsequent restructure and extraction of funds as a whole indicate that the arrangement was carefully planned and carried through.

Subsection 46A(3)

Subsection 46A(3) of the ITAA 1936 directs attention to several factors which are required to be taken into account by the Commissioner in considering whether a dividend should be regarded as having arisen out of a 'transaction, operation, undertaking, scheme or arrangement by way of dividend stripping'.

Paragraph 46A(3)(a):

Paragraph 46A(3)(a) of the ITAA 1936 requires whole or substantial reimbursement of the amount paid for the shares. In this case, it is considered that there was a substantial reimbursement of the cost of the shares. While the dividend payment did not reimburse the taxpayer in full in respect of the outlay on the shares, the dividend payment provided it with a considerable, substantial and significant reimbursement on its outlay on the shares.

Paragraph 46A(3)(b):

The requirement in paragraph 46A(3)(b) of the ITAA 1936 is satisfied as the dividend payment is considered to have substantially contributed to the reduction in the value of Target Co shares, immediately upon its payment to Acquiring Co.

Paragraph 46A(3)(c):

In relation to paragraph 46A(3)(c) of the ITAA 1936, Acquiring Co's right to receive dividends is not limited as to the total amount that may be paid, the source of the profits from which dividends may be paid, or the period during which the dividends may be paid.

Paragraph 46A(3)(d):

Paragraph 46A(3)(d) of the ITAA 1936 calls for a consideration of "any other relevant matters" in determining whether the payment of the dividend was made in the course of a dividend stripping operation. The following matters were considered:

(i) AASB 1015: Accounting for the acquisition of assets

Acquiring Co's consolidated accounts show that it treated the dividend as having been paid out of the pre-acquisition reserves of Target Co. In following the requirements of this accounting standard, Acquiring Co has acknowledged that the payment of the dividend resulted in an immediate reduction in the value of the shares in Target Co and that the profits (from which the dividend was paid) existed prior to acquisition.

(ii) Exhausted cash reserves

It is relevant to note that Target Co exhausted its then available cash reserves in order to make loans and pay the dividend to Acquiring Co, which used these funds to repay the loan provided by the bank to purchase the Target Co group.

(iii) Dividends required to service loan

The very substantial and short term nature of the loan obtained by Acquiring Co to fund the acquisition of Target Co would indicate that, short of further equity injection by Acquiring Co's parent company, the servicing of the interest payments and repayment of principal would require the profits of Target Co to be distributed up by way of dividends. Acquiring Co was formed for the purpose of the acquisition and apart from royalty income on the intellectual property acquired after the Target Co acquisition, it had no other income sources from business activities to service the loan.

Year of income:  30 June 1997

Legislative References:
Income Tax Assessment Act 1936
   section 46
   section 46A

Case References:
Federal Commissioner of Taxation v. Consolidated Press Holdings Ltd
   2001 ATC 4343
   47 ATR 229

Related Public Rulings (including Determinations)
IT 2627

Other References:
Explanatory Memorandum for Income Tax Assessment Bill (No. 3) 1972

Keywords
Dividend stripping
Dividend rebates
Profits

Business Line:  Public Groups and International

Date of publication:  28 March 2002

ISSN: 1445-2782