Edited version of private ruling

Authorisation Number: 1011464809846

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Ruling

Subject: Issue of redeemable preference shares (RPS)

Question 1

Will the proposed transaction give rise to the direct value shifting rules under Division 725 of the Income Tax Assessment Act 1997 (ITAA 1997) applying and as such cause CGT event K8 (section 104-250) to occur?

Answer

No.

Question 2

Will the proposed transaction give rise to the indirect value shifting rules (IVS) under Division 727 of the ITAA 1997 applying?

Answer

There will be no practical IVS consequences under Division 727.

Question 3

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 IssuerCo) proposes to issue RPS to other companies (RPS's holder) within the same group of companies. The shares will initially be issued at market value with fixed dividend entitlements. The rights to the dividend of the RPS will be varied at any time after the issue for a discretionary dividend entitlement.

If the 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.

The IssuerCo has one class of ordinary shares (with rights to all voting, dividend and capital) which were 100% held by the rulee. All of the shares were issued post-CG. The existing tax cost base of the rulee's interest in the IssuerCo is nominal.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 104-250.

Income Tax Assessment Act 1997 Division 725.

Income Tax Assessment Act 1997 section 725-50.

Income Tax Assessment Act 1997 paragraph 725-50(a).

Income Tax Assessment Act 1997 paragraph 725-50(b).

Income Tax Assessment Act 1997 paragraph 725-50(c).

Income Tax Assessment Act 1997 paragraph 725-50(d).

Income Tax Assessment Act 1997 paragraph 725-50(e).

Income Tax Assessment Act 1997 section 725-55.

Income Tax Assessment Act 1997 section 725-65.

Income Tax Assessment Act 1997 section 725-70.

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

Income Tax Assessment Act 1997 section 725-90.

Income Tax Assessment Act 1997 subsection 725-90(1).

Income Tax Assessment Act 1997 paragraph 725-90(1)(a).

Income Tax Assessment Act 1997 paragraph 725-90(1)(b).

Income Tax Assessment Act 1997 subsection 725-90(2).

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

Income Tax Assessment Act 1997 subsection 725-90(3).

Income Tax Assessment Act 1997 section 725-95.

Income Tax Assessment Act 1997 section 725-145.

Income Tax Assessment Act 1997 subsection 725-145(1).

Income Tax Assessment Act 1997 paragraph 725-145(1)(b).

Income Tax Assessment Act 1997 subsection 725-145(2).

Income Tax Assessment Act 1997 subsection 725-145(3).

Income Tax Assessment Act 1997 subsection 725-155(1).

Income Tax Assessment Act 1997 subsection 725-155(2).

Income Tax Assessment Act 1997 Division 727.

Income Tax Assessment Act 1997 section 727-150.

Income Tax Assessment Act 1997 section 727-100.

Income Tax Assessment Act 1997 section 727-105.

Income Tax Assessment Act 1997 Subdivision 727-C.

Income Tax Assessment Act 1997 section 727-250.

Income Tax Assessment Act 1997 section 727-460.

Income Tax Assessment Act 1997 Subdivision 727-G.

Income Tax Assessment Act 1997 Subdivision 727-H.

Income Tax Assessment Act 1997 Subdivision 727-K.

Income Tax Assessment Act 1997 section 727-855.

Income Tax Assessment Act 1997 section 995.

Income Tax Assessment Act 1936 Part IVA.

Reasons for decision

Question 1

Detailed reasoning

The essence of determining the issue of direct value shifting is the application of reversal exception under section 725-90 of ITAA 1997. However, it is important to first identify the direct value shift to which the exception is to be applied.

A direct value shift: section 725-50 of the ITAA 1997

Direct value shift is defined in section 725-145 of the ITAA 1997.

Subsection 725-145(1) of the ITAA 1997 states:

There is a direct value shift under a scheme involving equity or loan interests in an entity (the target entity) if:

(a) there is a decrease in the market value of one or more equity or loan interests in the target entity; and

(b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and

(c) either or both of subsections (2) or (3) are satisfied.

Subsections 725-145(2) and 725-145(3) of the ITAA 1997 continue that:

One or more ^*equity or loan interests in the target entity must be issued at a ^*discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

Or, there must be an increase in the *market value of one or more ^*equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph.

'Scheme' is defined broadly in section 995 of the ITAA 1997 to mean any arrangement, or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Under the scheme, there will be a decrease in the market value of the equity interests in a company; and the decrease is reasonably attributable to one or more of the things done under the scheme. The decrease occurs at the time when the first of those things just mentioned is done; and there is an increase in the market value of the equity interests in the IssuerCo held by the RPS's holders. The increase is reasonably attributable to the things mentioned above and occurs at or after the time as referred to above.

Thus, there is a direct value shift under the scheme in accordance with section 725-145.

Consequences for a direct value shift: section 725-50 of the ITAA 1997

There can be consequences for a direct value shift where the conditions in section 725-50 of the ITAA 1997 are met. The section states:

A direct value shift under a scheme involving equity or loan interests in an entity (the target entity) has consequences for you under this Division if, and only if:

(a) the target entity is a company or trust at some time during the *scheme period; and

(b) section 725-55 (Controlling entity test) is satisfied; and

(c) section 725-65 (Cause of the value shift) is satisfied; and

(d) you are an *affected owner of a *down interest, or an *affected owner of an *up interest, or both; and

(e) neither of sections 725-90 and 725-95 (about direct value shifts that are reversed) applies.

Note: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if section 725-70 (about material decrease in market value) is satisfied.

The present scheme satisfies the above section.

The reversal exception is to be considered in light of the broader legislative context of the DVS rules and the GVSR, and the other income tax laws. The exception is explained in the Explanatory Memorandum (EM) to the New Business Tax System (Consolidation, Value Shifting, Demergers and Other Measures) Bill 2002:

8.46 The concept of reversal is based on the state of affairs that arises because of the thing, or things, done under the scheme to which the decrease in value of equity or loan interests is reasonable attributable. It must be the case that without the state of affairs the direct value shift would not have happened. A reversal happens where the state of affairs ceases to exist.

8.47 The state of affairs can include the effects and consequences of the things done, as well as the circumstances brought about by those things. A state of affairs can cease to exist partially or gradually over a period of time. If the state of affairs has not fully ceased to exist by the end of the 4 year period, the exception will stop applying.

The purpose of the reversal exception is to provide relief for temporary value shifts. As there is no other specific rule about what a temporary value shift is, the exception is to be interpreted in accordance with its terms as explained in the extrinsic materials.

One key term is 'state of affairs' in paragraph 725-90(1)(a) of the ITAA 1997. The 'state of affairs' is to be distinguished from the thing or things done under the scheme. The state of affairs does not equate to the market value impacts (that is, decreases or increases) which those things cause.

The state of affairs includes the effects, consequences and circumstances brought about by the thing or things done under the scheme where, but for those effects, consequences and circumstances the direct value shift would not have happened. What is a state of affairs will depend on the facts of a particular case.

Another key term is 'cease to exist' in paragraph 725-90(1)(b) and subsection 725-90(2) of the ITAA 1997. The EM indicates that 'a state of affairs can cease to exist partially or gradually over a period of time'. In considering whether a state of affairs has ceased to exist it is important to recall that what is being considered is 'a state of affairs, but for which the direct value shift would not have happened'. Within these parameters, the question of whether a state of affairs has ceased to exist is a question of fact in the circumstances.

There are three structural questions for the reversal exception on the facts of this case.

Firstly, for the purposes of paragraph 725-90(1)(a) of the ITAA 1997, what are the 'one or more thing's referred to in paragraph 725-145(1)(b) [that] brought about a state of affairs, but for which the direct value shift would not have happened?

Secondly, what is the 'state of affairs' referred to in paragraph 725-90(1)(a) of the ITAA 1997 that is brought about by these things?

Thirdly, will this state of affairs cease to exist under the terms of the scheme in the manner described in paragraphs 725-90(1)(b) and subsection 725-90(2) of the ITAA 1997?

In the present case, the things done under the scheme are the company's decision to:

· vary the dividend rights attaching to the RPS; and

· alter dividend policy so that profits (including retained profits) will be distributed rather than retained during the period when the preferential dividend right are on foot.

The relevant 'state of affairs' is that the IssuerCo will make substantial distributions of profits to the RPS holders.

The removal of the preferential dividend rights, which is planned to happen within three years of the earliest of the change of dividend policy and commencement of those rights.

Conclusion

Since the direct value shift has no consequences in this case as shown above, there is no CGT event K8.

Question 2

Detailed reasoning

What is the IVS?

Under section 727-150 of the ITAA 1997 there will be an indirect value shift (IVS) when the market value of economic benefits provided by one entity (the losing entity) to another entity (the gaining entity) exceeds the market value of benefits provided by the gaining entity in connection with a scheme. The benefits provided by the losing entity are referred to as the 'greater benefits.'

From the description of the scheme above, prima facie, there is at least one or more indirect value shifts as a result of: (1) the alteration of the dividend rights of the RPS and; (2) distribution of dividends via the dividend access rights of the RPS to each of the RPS's holders.

The IVS times for these value shifts would be the earliest time when all the 'parameters of the indirect value shifts under a scheme are known. That is, it is known between, or among, which entities the shift or shifts occur, each losing and gaining entity is in existence, it is possible to identify all the economic benefits, the provision of the benefits are not contingent, and the full amount of the value shift can be worked out'.

Division 727 of the indirect value shifting provision also covers, under Subdivision 727-K of the ITAA 1997, circumstances where an equity or loan interest in a prospective losing entity would be realised before any IVS time (presumed indirect value shift) (section 727-855 of the ITAA 1997).

As provided by the applicant, we understand that no realisation event will happen to equity interests before the IVS times. Thus, the presumed indirect value shift in Subdivision 727-K of the ITAA 1997 will not apply.

As to IVS under section 727-150 of the ITAA 1997, with respect to (1) alteration of the RPS's rights, the economic benefits (in terms of the anticipated benefits from receiving dividend distributions) are greater than the market value of the economic benefits that are received in return. Thus, there is an IVS under section 727-150 at the alteration of the RPS's rights.

At the time of the distributions of dividends the market value of the economic benefits (that is, the entitlement to share in a distribution of dividends) provided by the IssuerCo to each of the RPS holders would be greater than the economic benefits it receives in return (nil). Thus, there is an IVS under section 727-150 of the ITAA 1997.

Consequences of IVS

An IVS may have consequences (for owner(s) of the 'affected interests') under section 727-100 of the ITAA 1997 when the losing entity is a company or trust, the losing and gaining entity are controlled by the same entity or they have common owners and they were not dealing at arm's length in providing some of the benefits. However, an IVS does not have consequences if any of the exclusions in Subdivision 727-C of the ITAA 1997 applies.

For both cases of IVS above, the relevant entities concerned are controlled by the same entity in accordance with the 'ultimate controller test' under section 707-105 of the ITAA 1997 and they were not dealing at arm's length in providing the benefits mentioned above. The rulee is an owner of the affected interests in the losing entity and thus the IVS Division applies.

As to the IVS at the time of the alteration of the RPS, no exclusion under section 727-250 of the ITAA 1997 would apply thus the IVS would have consequences theoretically. However, there will only be practical consequences for the equity interests in the IssuerCo held by the rulee if an adjustment were calculated for those interests under the adjustment method that is chosen for the IVS. In this regard it is noted that the shares held by the rulee in the IssuerCo were issued at a nominal value (post-CGT), and that under two of the three applicable adjustment methods (the adjustable method applied on a 'loss-focused basis' in Subdivision 727-H of the ITAA 1997 and the realisation method under Subdivision 727-G of the ITAA 1997) there will be practical consequences for an interest in the losing entity if the effect of an indirect value shift is to cause the interest to be in a position where they could be realised at a loss for tax purposes.

In relation to the IVS at (2) - the distribution of dividends, the anti-overlap provisions under section 727-250 of the ITAA 1997 would apply so that there are no consequences for the IVS.

Conclusion

There will be no practical IVS consequences under Division 727 of the ITAA 1997 applying to the present scheme.

Question 3

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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