Edited version of private ruling

Authorisation Number: 1011454831692

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Ruling

Subject: Issue of redeemable preference shares (RPS)

Question 1

Will the proposed RPS to be issued be regarded as an equity interest pursuant to Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Are dividends paid on the proposed RPS capable of being franked under section 202-40 of the ITAA 1997?

Answer

Yes.

Question 3

Will CGT event H2 (section 104-155 of the ITAA 1997) apply to the proposed issue of RPS?

Answer

No.

Question 4

Will CGT event D1 (section 104-35 of the ITAA 1997) apply to the proposed issue of RPS?

Answer

No.

Question 5

Will any payment of fully franked dividends to the holders of the proposed RPS be considered dividend streaming under Subdivision 204-D of the ITAA 1997?

Answer

No.

Question 6

(a) Will any distribution to the holders of the proposed RPS be considered part of a dividend stripping operation under section 207-155 of the ITAA 1997; or

(b) a scheme for the stripping of company profits within the meaning of paragraph 177E(1)(a) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 7

Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to the holders of the proposed RPS?

Answer

No.

Question 8

Will Part IVA of the ITAA 1936 apply to the proposed transaction?

Answer

No.

This ruling applies for the following period/s:

1 July 2010 to 30 June 2011

The scheme commences on:

During the year ended 30 June 2011.

Relevant facts and circumstances

A company (the rulee) proposes to issue RPS to other companies within the same group of companies. The shares will be initially issued at market value with fix dividend entitlement. The rights to dividend of the RPS will be varied at any time after the issue for a discretionary dividend entitlement.

If dividend entitlement is varied in such a way, a condition contained in the terms of the RPS stipulates that, by the earlier of a director's resolution or 3 years from the issue of the RPS, the rights of the RPS with respect to dividends will be automatically varied such that the RPS dividend entitlement will revert back to the original fixed dividend entitlement.

Relevant legislative provisions

Income Tax Assessment Act 1997 subsection 6(1)

Income Tax Assessment Act 1997 section 104-35

Income Tax Assessment Act 1997 subsection 104-35(1))

Income Tax Assessment Act 1997 paragraph 104-35(5)(c)

Income Tax Assessment Act 1997 section 104-155

Income Tax Assessment Act 1997 subsection 104-155(1)

Income Tax Assessment Act 1997 paragraph 104-155(5)(c)

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 subsection 202-40(1)

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 section204-30

Income Tax Assessment Act 1997 subsection204-30(1)

Income Tax Assessment Act 1997 paragraph204-30(1)(a)

Income Tax Assessment Act 1997 paragraph 204-30(1)(b)

Income Tax Assessment Act 1997 paragraph 204-30(1)(c)

Income Tax Assessment Act 1997 subsection204-30(3)

Income Tax Assessment Act 1997 subsection 204-30(6)

Income Tax Assessment Act 1997 subsection 204-30(8)

Income Tax Assessment Act 1997 Subdivision 204-D

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 paragraph 204-30(1)(a)

Income Tax Assessment Act 1997 paragraph 204-30(1)(b)

Income Tax Assessment Act 1997 paragraph 204-30(1)(c)

Income Tax Assessment Act 1997 section 207-155

Income Tax Assessment Act 1997 subsection 725-70(1)

Income Tax Assessment Act 1997 paragraph 725-90(2)(b)

Income Tax Assessment Act 1997 paragraph 727-50(d)

Income Tax Assessment Act 1997 Division 727

Income Tax Assessment Act 1997 section 960-120

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

Income Tax Assessment Act 1997 Subdivision 974-B

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 section 974-20

Income Tax Assessment Act 1997 subsection 974-20(1)

Income Tax Assessment Act 1997 paragraph 974-20(1)(b)

Income Tax Assessment Act 1997 paragraph 974-20(1)(c)

Income Tax Assessment Act 1997 paragraph 974-20(1)(d)

Income Tax Assessment Act 1997 paragraph 974-20(1)(e)

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 paragraph 974-70(1)(b)

Income Tax Assessment Act 1997 subsection 974-75(1)

Income Tax Assessment Act 1997 section 974-135

Income Tax Assessment Act 1997 subsection 974-135(1)

Income Tax Assessment Act 1997 subsection 974-135(2)

Income Tax Assessment Act 1997 subsection 974-135(3)

Income Tax Assessment Act 1997 subsection 974-135(6)

Income Tax Assessment Act 1997 subsection 974-135(7)

Income Tax Assessment Act 1997 section 974-160

Income Tax Assessment Act 1997 subsection 995-1(1)

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subparagraph 177D(b)(i)

Income Tax Assessment Act 1936 subparagraph 177D(b)(ii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(iii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(iv)

Income Tax Assessment Act 1936 subparagraph 177D(b)(v)

Income Tax Assessment Act 1936 subparagraph 177D(b)(vi)

Income Tax Assessment Act 1936 subparagraph 177D(b)(vii)

Income Tax Assessment Act 1936 subparagraph 177D(b)(viii)

Income Tax Assessment Act 1936 subsection 177E(1)

Income Tax Assessment Act 1936 paragraph 177E(1)(a)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 paragraph 177EA(3)(e)

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 subsection 177EA(17)

Income Tax Assessment Act 1936 paragraph 177EA(17)(a)

Income Tax Assessment Act 1936 paragraph 177EA(17)(b)

Income Tax Assessment Act 1936 paragraph 177EA(17)(c)

Income Tax Assessment Act 1936 paragraph 177EA(17)(d)

Income Tax Assessment Act 1936 paragraph 177EA(17)(e)

Income Tax Assessment Act 1936 paragraph 177EA(17)(f)

Income Tax Assessment Act 1936 paragraph 177EA(17)(g)

Income Tax Assessment Act 1936 paragraph 177EA(17)(ga)

Income Tax Assessment Act 1936 paragraph 177EA(17)(h)

Income Tax Assessment Act 1936 paragraph 177EA(17)(i)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

Reasons for decision

Question 1

Detailed reasoning

Subsection 995-1(1) of the ITAA 1997 provides that an equity interest in a company has the meaning given by Subdivision 974-C of the ITAA 1997.

Subsection 974-70(1) in Subdivision 974-C of the ITAA 1997 states:

A *scheme gives rise to an equity interest in a company if, when the scheme comes into existence:  

(a) the scheme satisfies the equity test in subsection 974-75(1) in relation to the company because of the existence of an interest; and

(b) the interest is not characterised as, and does not form part of a larger interest that is characterised as, a *debt interest in the company, or a *connected entity of the company, under Subdivision 974-B.

Subsection 974-75(1) of the ITAA 1997 provides that:

A *scheme satisfies the equity test in this subsection in relation to a company if it gives rise to an interest set out in the following table:

 

Equity interests

Item	Interest
1	An interest in the company as a member or stockholder of the company.
2	An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is in substance or effect *contingent on the economic performance (whether past, current or future) of: (a)     the company; or (b)     a part of the company's activities; or (c)     a *connected entity of the company or a part of the activities of a connected entity of the company. The return may be a return of an amount invested in the interest.
3	An interest that carries a right to a variable or fixed return from the company if either the right itself, or the amount of the return, is at the discretion of: (a)     the company; or (b)     a *connected entity of the company. The return may be a return of an amount invested in the interest.
4	An interest issued by the company that: (a) gives its holder (or a *connected entity of the holder) a right to be issued with an *equity interest in the company or a *connected entity of the company; or (b) is an *interest that will, or may, convert into an equity interest in the company or a connected entity of the company.

This subsection has effect subject to subsection (2) (requirement for financing arrangement).

Is there a scheme?

The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the proposed RPS will fall within the ambit of a scheme.

Each proposed RPS will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the interest arising from its issue is an interest covered by items 1and 2 of the table in that subsection. This is because: 

§ in legal form the proposed RPS is a share giving its holder rights as a member of the company (item1).

§ dividends payable on the proposed RPS are subject to the availability of profits (item 2).

Therefore, pursuant to paragraph 974-70(1)(b) of the ITAA 1997, each proposed RPS will be an equity interest unless they are characterised as debt interests under Subdivision 974-B when they came into existence.

Section 974-20 in Subdivision 974-B of the ITAA 1997 provides the test for a debt interest. Subsection 974-20(1) states:

A *scheme satisfies the debt test in this subsection in relation to an entity if:

(a) the scheme is a *financing arrangement for the entity; and  

(b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(i) the financial benefit referred to in paragraph (b) is received if there is only one; or 

(ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and 

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and  

(e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company).

Is the scheme a financing arrangement? 

As each proposed RPS in the company held by a holder is an equity interest pursuant to item 1 of the table in subsection 974-75(1) of the ITAA 1997 the scheme is not required to satisfy the requirement in paragraph 974-20(1)(a) that it be a financing arrangement.

Does the entity or connected entity receive, or will receive, a financial benefit or benefits under the scheme? 

A financial benefit is defined to mean anything of economic value and includes property and services (subsection 974-160 of the ITAA 1997).

The company will receive a financial benefit, namely the contributions of $X per proposed RPS. Accordingly, paragraph 974-20(b) of the ITAA 1997 is satisfied.

Does the entity have an effectively non-contingent obligation (ENCO) under the scheme to provide a financial benefit or benefits?

An ENCO is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given by section 974-135. There is an ENCO to take an action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action (subsection 974-135(1)). This applies to providing a financial benefit under the scheme, or terminating the scheme (subsection 974-135(2)). 

An obligation is non-contingent if it is not contingent on any event, condition or situation (including the economic performance of the entity having the obligation or a connected entity of that entity) other than the ability or willingness of that entity or connected entity to meet the obligation (subsection 974-135(3) of the ITAA 1997).

An obligation will not be effectively non-contingent merely because some detrimental practical or commercial consequences will arise if the obligation is not fulfilled (subsection 974-135(7) of the ITAA 1997). Furthermore, in assessing whether an obligation of the company in respect of the proposed RPS is effectively non-contingent, regard must be had to the artificiality or contrived nature of any contingency (subsection 974-135(6)).

Each dividend or any discretionary dividend payable under the terms of the proposed RPS (as amended) would constitute a financial benefit within the meaning of section 974-160 of the ITAA 1997 because the dividends are to be paid in cash, being a thing of economic value.

Given that the company's ability to pay either the dividend or any discretionary dividend to the proposed RPS holders will depend on the availability of sufficient profits, the proposed RPS would fail the debt test as there is no ENCO. Whilst the company currently has retained profits available for distribution, this is not sufficient to suggest that the company will always have profits available sufficient to enable payment of the dividend.

Further, the redemption of the proposed RPS (which are perpetual interests) is at the discretion of the director(s) of the company and the exercise of the discretion of the ordinary shareholder in the company. As there is no compulsion on the director(s) and ordinary shareholder to redeem the proposed RPS the obligation is contingent.

Accordingly, there is no ENCO and the proposed RPS do not satisfy the third condition of subsection 974- 20(1) of the ITAA 1997.

The company will therefore not have an ENCO to provide any financial benefits in respect of the proposed RPS. Accordingly, it will not be possible for each proposed RPS to satisfy paragraph 974-20(1)(c) of the ITAA 1997 making consideration of paragraphs 974-20(1)(d) and 974-20(1)(e) unnecessary. Having failed the debt test, each proposed RPS will constitute an equity interest pursuant to Subdivision 974-C.

Question 2

Detailed reasoning

Subsection 202-40(1) of the ITAA 1997 provides that a distribution is a frankable distribution to the extent that it is not unfrankable under section 202-45.

A distribution for a company is a dividend or something that is taken to be a dividend under the ITAA 1936 and ITAA 1997 (Item 1 of the table in section 960-120 of the ITAA 1997). Pursuant to subsection 6(1) of the ITAA 1936, a 'dividend' includes:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and


(b) any amount credited by a company to any of its shareholders as shareholders;


(c) (Repealed by No 63 of 1998)

but does not include:


(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company; or


(e) moneys paid or credited, or property distributed, by a company for the redemption or cancellation of a redeemable preference share if:


(i) the company gives the holder of the share a notice when it redeems or cancels the share; and


(ii) the notice specifies the amount paid-up on the share immediately before the cancellation or redemption; and


(iii) the amount is debited to the company's share capital account;

except to the extent that the amount of those moneys or the value of that property, as the case may be, is greater than the amount specified in the notice as the amount paid-up on the share; or


(f) a reversionary bonus on a life assurance policy.

The company will debit the dividends or any discretionary dividends from the company's retained earnings and will not debit the amount of a dividend or any discretionary dividend on the proposed RPS to the share capital account of the company. Therefore paragraph (d) of the definition of dividend in subsection 6(1) of the ITAA 1936 is not satisfied. Further paragraphs (e) and (f) of the definition of dividend in subsection 6(1) are not relevant. Therefore, a dividend or any discretionary dividend payable under each proposed RPS will be a 'dividend' as defined in subsection 6(1) and will be a frankable distribution to the extent to which it is not unfrankable under section 202-45 of the ITAA 1997 (subsection 202-40(1)).

There is no paragraph within section 202-45 of the ITAA 1997 which apply with the result that a dividend or any discretionary dividend payable is an unfrankable dividend pursuant to that section.

Accordingly, each dividend or any discretionary dividend will not be an unfrankable distribution and, therefore, each will be capable of being franked pursuant to section202-40 of the ITAA 1997.

Question 3

Detailed reasoning

Section 104-155 of the ITAA 1997 states:

(1) CGT event H2 happens if:

(a) an act, transaction or event occurs in relation to a *CGT asset that you own; and

(b) the act, transaction or event does not result in an adjustment being made to the asset's *cost base or *reduced cost base.

Example: You own land on which you intend to construct a manufacturing facility. A business promotion organisation pays you $50,000 as an inducement to start construction early.

No contractual rights or obligations are created by the arrangement.

The payment is made because of an event (the inducement to start construction early) in relation to your land.

Note: This event does not apply if any other CGT event applies: see section 102-25.

(2) The time of the event is when the act, transaction or event occurs.

(3) You make a capital gain if the *capital proceeds because of the *CGT event are more than the *incidental costs you incurred that relate to the event. You make a capital loss if those *capital proceeds are less.

(4) The costs can include giving property: see section 103-5. However, they do not include an amount you have received as *recoupment of them and that is not included in your assessable income.

Exceptions

(5) CGT event H2 does not happen if:

(a) the act, transaction or event is the borrowing of money or the obtaining of credit from another entity; or

(b) the act, transaction or event requires you to do something that is another *CGT event that happens to you; or

(c) a company issues or allots *equity interests or *non-equity shares in the company; or

(d) the trustee of a unit trust issues units in the trust; or

(e) a company grants an option to acquire equity interests, non-equity shares or *debentures in the company; or

(f) the trustee of a unit trust grants an option to acquire units or debentures in the trust; or

(g) a company or a trust that is a member of a *demerger group issues new *ownership interests under a *demerger.

Note: For demergers, see Division 125.

Subsection 104-155(1) of the ITAA 1997 provides that CGT event H2 happens if an act, transaction or event occurs in relation to a CGT asset that you own and the act, transaction or event does not result in an adjustment being made to the asset's cost base or reduced cost base.

However, there will be no CGT event H2 for the proposed holders because of the applicability of paragraph 104-155(5)(c) of the ITAA 1997, a specific exemption which provides that CGT event H2 does not occur when a company issues or allots equity interests in the company.

Given that the company is proposing to issue RPS that constitute an equity interest as determined in Question 1 above, CGT event H2 will not apply to the proposed issue of RPS.

Question 4

Detailed reasoning

Section 104-35 of the ITAA 1997 states:

(1) CGT event D1 happens if you create a contractual right or other legal or equitable right in another entity.

Example: You enter into a contract with the purchaser of your business not to operate a similar business in the same town. The contract states that $20,000 was paid for this.

You have created a contractual right in favour of the purchaser. If you breach the contract, the purchaser can enforce that right.

(2) The time of the event is when you enter into the contract or create the other right.

(3) You make a capital gain if the *capital proceeds from creating the right are more than the *incidental costs you incurred that relate to the event. You make a capital loss if those *capital proceeds are less.

Example: To continue the example: If you paid your lawyer $1,500 to draw up the contract, you make a capital gain of:

(4) The costs can include giving property: see section 103-5. However, they do not include an amount you have received as *recoupment of them and that is not included in your assessable income, or an amount to the extent that you have deducted or can deduct it.

Exceptions

(5) CGT event D1 does not happen if:

(a) you created the right by borrowing money or obtaining credit from another entity; or

(b) the right requires you to do something that is another *CGT event that happens to you; or

(c) a company issues or allots *equity interests or *non-equity shares in the company; or

(d) the trustee of a unit trust issues units in the trust; or

(e) a company grants an option to acquire equity interests, non-equity shares or *debentures in the company; or

(f) the trustee of a unit trust grants an option to acquire units or debentures in the trust.

Example: You agree to sell land. You have created a contractual right in the buyer to enforce completion of the transaction. The sale results in you disposing of the land, an example of CGT event A1. This means that CGT event D1 does not happen.

Subsection 104-35(1) of the ITAA 1997 provides that CGT event D1 happens if you create a contractual right or equitable right in another entity.

However, there will be no CGT event D1 for the proposed holders because of the applicability of paragraph 104-35(5)(c) of the ITAA 1997, a specific exemption which provides that CGT event D1 does not occur when a company issues or allots equity interests in the company.

Given that the company is proposing to issue RPS that constitute an equity interest as determined in Question 1 above, CGT event D1 will not apply to the proposed issue of RPS.

Question 5

Detailed reasoning

Section 204-30 in Subdivision 204-D of the ITAA 1997 applies where 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 this section would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a) of the ITAA 1997);

b)  the member would derive a greater benefit from franking credits (favoured member) than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997); and

c)  the other member of the entity will receive lesser imputation benefits (disadvantaged member), or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c) of the ITAA 1997).

Subsection 204-30(8) of the ITAA 1997 sets out the circumstances where one shareholder will be taken to have received a greater benefit than another shareholder.

An 'imputation benefit' is defined in subsection 204-30(6) of the ITAA 1997 as follows:

A *member of an entity receives an imputation benefit as a result of a distribution if:


(a) the member is entitled to a *tax offset under Division 207 as a result of the distribution; or

(b) an amount would be included in the member's assessable income as a result of the distribution because of the operation of section 207-35; or

(c)a *franking credit would arise in the *franking account of the member as a result of the distribution; or

(d) an *exempting credit would arise in the *exempting account of the member as a result of the distribution; or

(e) the member would not be liable to pay *withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f) the member is entitled to a *tax offset under section 210-170 as a result of the distribution.

If all the conditions in subsection 204-30(1) of the ITAA 1997 are satisfied the Commissioner may make one or more determinations under subsection 204-30(3) of the ITAA 1997 as follows:

*(a) that a specified *franking debit arises in the *franking account of the entity, for a specified *distribution or other benefit to a disadvantaged member;

(b) that a specified *exempting debit arises in the *exempting account of the entity, for a specified *distribution or other benefit to a disadvantaged member;


(c) that no *imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination.

The word 'stream' is not defined and therefore takes on its ordinary meaning. The Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 (Imputation EM), which introduced Subdivision 204-D of the ITAA 1997 provides that:

3.28          Streaming is selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.

3.29          The law uses an essentially objective test for streaming, although purpose may be relevant where future conduct is a relevant consideration. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

The Imputation EM notes that it is common for dividend rights to be discretionary, such that shareholders do not have a definite interest in the profits of the corporate entity. Paragraphs 3.36 to 3.38 of the Imputation EM state:

3.36 In most cases, the members less able to benefit from imputation credits have a real interest in the undistributed profits of the corporate tax entity, although the entity may not have yet allocated those profits to the members. However, some corporate tax entities have membership interests where the rights of the members holding those interests are effectively discretionary, since the entity can make distributions to some members to the exclusion of other members at its discretion. In these entities, which are usually family companies or trusts, the members do not have anything, in a sense relevant for streaming purposes, resembling a definite interest in the profits of the corporate tax entity, they have only a possibility of being considered as a possible recipient of distributions.

3.37 In these cases, the receipt of a franked distribution by one class of members does not imply that the other classes of members who have not received a franked distribution have deferred distribution of their share in the profits. More commonly it is reasonable to assume that they have simply missed out on any share in the profits. This is not streaming; all members with an actual share of the profits have appropriately received franked distributions.

3.38 In general, therefore, the distribution of franked and unfranked distributions by a closely-held family company or trust among family members is unlikely to be streaming.

Given that the company is issuing a single class of proposed RPS to the other companies, where a dividend is paid to all holders of the proposed RPS, the dividend streaming rules will not apply. In the present case:

§ the 'other member' is the ordinary shareholder of the company. The payment of dividends to the other companies will not result in them receiving a greater benefit from franking credits than the ordinary shareholder would.

§ no streaming is occurring. As noted in paragraph 3.37 of the Imputation EM above, the payment of franked dividends to one class of shareholder and no dividends to another is not streaming.

§ if a discretionary dividend is declared it will be paid to all of the holders of the proposed RPS.

Consequently, on the basis of the above analysis, the payment of fully franked dividends to the holders of the proposed RPS will not be considered the 'streaming' of imputation benefits under Subdivision 204-D of the ITAA 1997.

Question 6(a) and (b)

Detailed reasoning

Section 207-155 of the ITAA 1997 states:

A distribution made to a *member of a *corporate tax entity is taken to be made as part of a dividend stripping operation if, and only if, the making of the distribution arose out of or was made in the course of, a *scheme that:

(a) was by way of, or in the nature of, dividend stripping; or

(b) had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

Subsection 177E(1) of the ITAA 1936, whilst more expansive, is couched in similar terms. The following discussion is considered relevant in determining the outcome for each of the legislative provisions.

The term dividend stripping is not defined. However, Taxation Ruling IT 2627 provides, at paragraphs 9 and 10, a general description rather than an exhaustive definition:

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 years' 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.

Under the proposed scheme, there is no payment between the existing shareholder and the proposed RPS holders reflecting the profits retained in the company. Furthermore, there will be no release of profit to shareholders in a non-taxable form. That is, the fundamental elements of a dividend stripping operation are absent.

Accordingly, the distributions to the proposed RPS holders will not be considered part of a dividend stripping operation or scheme under either section 207-155 of the ITAA 1997 or paragraph 177E(1)(a) of the ITAA 1936.

Question 7

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain an imputation benefit. In these circumstances, subsection 177EA(5) enables the Commissioner to make a determination with the effect of either:

§ imposing franking debits or exempting debits on the distributing entity's franking account; or

§ denying the imputation benefit on the distribution that flowed directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Paragraphs 177EA(3)(a) to (d)

The conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 are satisfied because:

(a) the issue of the proposed RPS will constitute a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936).

Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, a 'scheme for the disposition of membership interests or an interest in membership interests' includes a scheme that involves the issuing of membership interests.

The term 'membership interests' is defined in section 960-135 of the ITAA 1997 as:

If you are a *member of an entity:

(a) each interest, or set of interests, in the entity; or

(b) each right, or set of rights, in relation to the entity;

by virtue of which you are a member of the entity is a membership interest of yours in the entity.

At item 1 of the table in subsection 960-130(1) of the ITAA 1997, a 'member' of an entity that is a company is 'a member of the company or a stockholder in the company.' However, subsection 960-130(3) of the ITAA 1997 provides that an entity is not a member of another entity just because the entity holds one or more interests or rights relating to the other entity that are *debt interests.

The issuance of the proposed RPS involves the issuing of membership interests because once a proposed RPS is issued, the holders become members in the company as the proposed RPS are not debt interests.

(b) frankable distributions are expected to be payable to the holders (paragraph 177EA(3)(b) of the ITAA 1936).

The dividends or any discretionary dividends to be paid in respect of each proposed RPS will be frankable distributions (refer Question 2 above).

(c) franked distributions are expected to be paid to the holders (paragraph 177EA(3)(c) of the ITAA 1936). The company has advised that it is expected that distributions will be paid and that those distributions will be fully franked to the extent franking credits are available in its franking account.

(d) it is reasonable to expect that an imputation benefit will be received by the relevant taxpayers (the proposed holders) as a result of distributions made to holders, given that the company expects to frank the dividends or any discretionary dividends on each proposed RPS (paragraph 177EA(3)(d) of the ITAA 1936).

An 'imputation benefit' is defined in subsection 204-30(6) of the ITAA 1997 as follows:

A *member of an entity receives an imputation benefit as a result of a distribution if:

(a) the member is entitled to a *tax offset under Division 207 as a result of the distribution; or

(b) an amount would be included in the member's assessable income as a result of the distribution because of the operation of section 207-35; or

(c) a *franking credit would arise in the *franking account of the member as a result of the distribution; or

(d) an *exempting credit would arise in the *exempting account of the member as a result of the distribution; or

(e) the member would not be liable to pay *withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f) the member is entitled to a *tax offset under section 210-170 as a result of the distribution.

Each of the other companies (the proposed holders) are Australian residents for tax purposes, Therefore, in the present case, it is probable that imputation benefits will be received by the holders.

Accordingly, the issue is whether having regard to the relevant circumstances of the scheme, it would be concluded that a person, or one of the persons, who entered into or carried out the scheme, did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Paragraph 177EA(3)(e)

The term 'incidental purpose' is not defined in the income tax legislation and therefore takes its ordinary meaning. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1998 (EM No. 3) at paragraph 8.76 states the following in this regard:

A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident. For example, when a taxpayer holds shares in the ordinary way to obtain the benefit of any increase in their share price and the dividend income flowing from the shares, a franking credit benefit is generally no more than a natural incident of holding the shares, and generally the purpose of obtaining the benefit simply follows incidentally a purpose of obtaining the shares: it is therefore merely an incidental purpose.

The EM No. 3 also provides the following example (at paragraph 8.77):

…if a taxpayer, being a company, entered into a scheme involving the disposition of shares for the immediate purpose of obtaining a tax advantage for itself (for example, one deriving from an allowable deduction and the inter-corporate dividend rebate) and another, substantial, purpose of obtaining franking credits (which will ultimately benefit its shareholders), the fact that the taxpayer may regard the immediate benefit of the first tax advantage as more important than the deferred benefit of obtaining the franking credits does not mean that the second purpose is merely incidental to the first.

The test in terms of paragraph 177EA(3)(e) of the ITAA 1936 is an objective purpose. Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances, some may or may not be present at any one time in any one scheme.

Having regard to the relevant objective circumstances of the scheme listed in subsection 177EA(17) of the ITAA 1936, it is considered the requisite purpose does not exist because the franking benefits received by the other companies will follow as an incident to the main purpose of the scheme, that is, the distribution of the retained profits from the company to the other companies. Accordingly, section 177EA of the ITAA 1936 will not apply to any distribution of fully franked dividends to the holders of the proposed RPS.

Question 8

Detailed reasoning

Part IVA of the ITAA 1936 applies to any scheme that has been carried out or is entered into for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme. The application of Part IVA requires all of the following conditions to be present:

I. a scheme has been carried out or entered into after 27 May 1981;

II. a taxpayer has or will obtain a tax benefit in connection with the scheme; and

III. the dominant purpose of the scheme was to enable the taxpayer to obtain a tax benefit.

Based on the information provided and the conditions required for Part IVA of the ITAA 1936 to apply, a conclusion cannot be formed that the scheme was entered into for the dominant purpose of obtaining a tax benefit. The proposed transaction is to be undertaken with the intention of succession planning. On this basis Part IVA will not have application to the proposed transaction.

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