Edited version of private ruling

Authorisation Number: 1011808158377

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Ruling

Question 1

To the extent that Company A realises a forex realisation loss from the transfer of the Receivable to Company G, Company A will be entitled to an allowable deduction under section 775-30. As a result of the operation of Division 170-D, this deduction will not be recognised for tax purposes until the Receivable is extinguished.

Yes.

Question 2

Confirm that Company A will not make a capital gain and will not make a capital loss from the sale of the shares in Company G to Company B.

No.

Question 3

For Company A, will the direct value shifting provisions in Division 725 of the ITAA 1997 apply?

No.

Question 4

For Company A, confirm that the dividend streaming provisions contained in section 204-30 of the ITAA 1997 and section 177EA of the ITAA 1936 do not apply and, as such, the Commissioner will not make a determination under either of those sections.

Section 177EA will not apply.

Section 204-30 will not apply.

Question 5

For Company A, will sections 45A and 45B of the ITAA 1936 apply?

For Company A, will the Commissioner make a determination under section 45C of the ITAA 1936 in relation either of section 45A or 45B?

Section 45A will not apply.

Section 45B will not apply.

Question 6

For Company A, will the Commissioner make a determination under section 177F of the ITAA 1936?

No.

Question 7

For Company A, will the Commissioner make a determination under section 177E of the ITAA 1936?

No.

Question 8

The Commissioner is requested to confirm that Company B will derive no amount of assessable income under section 6-5 or section 6-10 of the ITAA 1997.

Company B will not derive assessable income pursuant to sections 6-5 and 6-10.

The ruling applies for the following period:

Relevant facts and circumstances

Company B will purchase all of the shares in Company G, a newly incorporated subsidiary of Company A. Company B will pay a nominal amount for the shares. Company A and Company B will not be dealing with each other at arm's length in connection with the sale. The share sale will be effected through an agreement which is governed by foreign laws and which will be completed and executed in a foreign jurisdiction.

Prior to the sale, Company A will transfer a Receivable to Company G owed by Company F, a wholly owned subsidiary of Company B. The Receivable was loaned at a market interest rate. Company A and Company F are the parties to the Receivable agreement which was formed in a foreign jurisdiction.

Company A is a resident. Each of Company B, Company F and Company G is a non-resident.

Following the sale, Company G will release Company F from the liability to pay the Receivable.

The Receivable is denominated in a foreign currency. Company A has not made a functional currency election. The Taxation of Financial Arrangement (ToFA) rules will not apply to the Receivable.

The shares on issue in Company A comprise Ordinary Shares held by a range of investors and a Dividend Access Share held by Company E, a wholly owned subsidiary of Company B. Company A has paid all dividends on the Ordinary Shares and to Company E fully franked and expects that all dividends that it will pay to its members in the foreseeable future will be fully franked.

Company B is a wholly owned subsidiary of Company D, a non-resident. Company A and Company D have entered into certain contractual arrangements.

Assumptions

The Assumptions are:

The value of the AUD relative to the Foreign Currency at the time Company A transfers the right to receive the Receivable to Company G will be greater than it was when the Receivable was established.

The cost base and reduced cost base of the Receivable will be the same at the time Company A will transfer the right to receive the Receivable to Company G.

The market value of the shares held in Company G by Company A at the relevant time of the sale of the shares to Company B is the same as the cost base and reduced cost base of the shares.

None of the 'further events' specified in section 170-280 will take place within four years of when Company G releases Company F's obligation to repay the Receivable.

Relevant legislative provisions

Income Tax Assessment Act 1997 section 6-5

Income Tax Assessment Act 1997 section 6-10

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 8-5

Income Tax Assessment Act 1997 Part 3.1

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 section 775-105

Income Tax Assessment Act 1997 section 116-30

Income Tax Assessment Act 1997 Subdivision 170-D

Income Tax Assessment Act 1997 section 170-255

Income Tax Assessment Act 1997 section 170-260

Income Tax Assessment Act 1997 section 170-265

Income Tax Assessment Act 1997 section 170-270

Income Tax Assessment Act 1997 subsection 170-275

Income Tax Assessment Act 1997 section 170-280

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 Division 243

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 section 727-520

Income Tax Assessment Act 1997 Division 727-615

Income Tax Assessment Act 1997 section 775-30

Income Tax Assessment Act 1997 section 775-35

Income Tax Assessment Act 1997 section 775-40

Income Tax Assessment Act 1997 section 960-50

Income Tax Assessment Act 1997 section 960-100

Income Tax Assessment Act 1997 section 960-130

Income Tax Assessment Act 1936 section 45

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177CA

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177F

Taxation Administration Act 1953 Schedule 1 Division 359

Reasons for decision

Question 1

Summary

To the extent that Company A realises a forex realisation loss from the transfer of the Receivable to Company G, Company A will be entitled to an allowable deduction under section 775-30. As a result of the operation of Division 170-D, the deduction will not be recognised for tax purposes until the Receivable is extinguished.

Detailed reasoning

A foreign exchange loss is an allowable deduction pursuant to section 775-30 of the ITAA 1997.

The loss must arise from a foreign exchange realisation event (FRE) and the loss must be attributable to a currency exchange rate effect.

Foreign exchange realisation event (FRE)

FRE 1 takes place as a result of CGT event A1 happening when an entity disposes of foreign currency or of a right (or a part of a right) to receive foreign currency; subsection 775-40(1) of the ITAA 1997.

To determine whether Company A has disposed of foreign currency or of a right (or a part of a right) to receive foreign currency, one must apply subsection 104-10(2) of the ITAA 1997; subsection 775-40(2) of the ITAA 1997.

CGT event A1

Subsection 104-10(2) states:

'You dispose of a *CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law. However, a change of ownership does not occur if you stop being the legal owner of the asset but continue to be its beneficial owner.'

As set out in the 'Relevant facts and circumstances', Company A will transfer the right to receive the Receivable to Company G in exchange for the issue of shares in Company G at market value.

A 'CGT asset' includes any legal or equitable right that is not property; paragraph 108-5(1)(b). A 'CGT asset' includes the right to receive the Receivable as 'any debts owed to you'; fourth dot-point example after subsection 108-5(2). A CGT asset includes part of a CGT asset; paragraph 108-5(2)(a) of the ITAA 1997.

An assignment of one or more contractual rights contained in a contract is usually treated as the disposal of (part of) a CGT asset. The Commissioner considers that the circumstances of the assignment do not warrant departure from the usual treatment. That is, CGT event A1 happens to Company A as a result of the assignment of the Receivable.

Currency exchange rate effect

A forex realisation loss made pursuant to FRE 1 is so much of a capital loss made that is attributable to a 'currency exchange rate effect'; subsection 775-40(6) of the ITAA 1997.

The capital loss arising from a CGT event A1 is worked out pursuant to subsection 104-10(4). A capital loss is made for CGT event A1 when the capital proceeds for the disposal of a CGT asset are less than the reduced cost base of the asset. The capital proceeds for FRE 1 are market value, whether or not market value consideration is provided for the disposal; subsection 775-40(9).

The term 'currency exchange rate effect' is defined in section 775-105 of the ITAA 1997 to mean 'any currency exchange rate fluctuations'; paragraph 775-105(1)(a) of the ITAA 1997. As Company A has not made a functional currency election, the 'effect' and its extent are calculated pursuant to the translation rules set out in section 960-50 of the ITAA 1997 (the standard rules).

As a result of the proposed arrangement, a capital loss will be made as a result of FRE 1 happening to the Receivable that is attributable to a currency exchange rate fluctuation.

To the extent Company A realises a forex realisation loss as a result of the transfer of the Receivable to Company G, Company A will be entitled to a deduction for the loss pursuant to section 775-30 of the ITAA 1997.

As Company A included interest receipts on the Receivable in its assessable income, the forex realisation loss will not be disregarded pursuant to section 775-35 as it will not be made in gaining or producing exempt income or non-assessable non-exempt income pursuant to section 775-35.

To the extent that another provision of Australian income tax legislation allows Company A a deduction for the forex realisation loss, the deduction may only be claimed pursuant to section 775-30; subsection 775-30(4). This includes any deduction for a loss on a traditional security.

The indirect value shifting (IVS) rules will not apply to reduce the forex realisation loss deduction as the loss will not arise from the realisation of an affected interest in the losing entity, Company A.

Timing of deduction

For the purposes of section 775-40 for FRE 1, the time of the CGT event A1 that happens to the Receivable is modified to when the right to receive the foreign currency is disposed of; subsection 775-40(3). The disposal takes place when the assignment takes effect which is the date of the agreement to effect the assignment was entered into or another date as agreed by the parties to the agreement.

However, where Company A is entitled to claim a deduction for the forex realisation loss, the time when it may claim the deduction is deferred when the conditions in section 170-255 of the ITAA 1997 are satisfied. Section 170-255 is contained in Subdivision 170-D which is concerned with 'Transactions by a company that is a member of a linked group'.

For deductions, subsection 170-255(1) has four (4) conjunctive paragraphs [(a), (b), (d) and (e)]. Three (3) of the paragraphs [(b), (d) and (e)] possess disjunctive requirements for which only one requirement per paragraph needs to be satisfied.

Subsection 170-255(1) states that Subdivision 170-D applies if:

'(a) an event (the deferral event) happens involving a company (the originating company) and another entity; and

(b) one or more of the following apply:

(ii) the deferral event would have resulted in the originating company becoming entitled to a deduction in respect of the disposal of a CGT asset or of an interest in a CGT asset; … and …

(d) one of the following applies:

(i) the originating company is an Australian resident at the time of the deferral event; … and

(e) at the time of the deferral event, the originating company is a member of a *linked group and one of the following applies:

(i) the other entity is a company that is not a connected entity of the originating company and is a member of that linked group; …'

All of the above-mentioned elements of subsection 170-255(1) apply to the assignment by Company A of the Receivable to Company G.

Therefore, Subdivision 170-D will apply to Company A in respect of the assignment of the Receivable to Company G.

The immediate consequence of Subdivision 170-D applying will be that Company A will disregard the deduction for the forex realisation loss at the time of the deferral event; section 170-270.

The subsequent consequence of the application of Subdivision 170-D will be that Company A is instead taken to have become entitled to the deduction immediately before the time when one or more of five (5) 'new events' specified in paragraphs 170-275(1)(a)-(e) happens. If more than one new event happens, the entitlement arises at the time of the earliest event; subsection 170-275(1).

The relevant 'new event' specified in subsection 170-275(1) is:

'(a) the CGT asset acquired by the other entity referred to in paragraph 170-255(1)(a) (the relevant CGT asset), or a greater than 50% interest in it, ceases to exist; [or]

None of paragraphs 170-275((1)(b)-(e) will also apply in the circumstances of the arrangement.

Therefore, Company A will be taken to have become entitled to the deduction immediately before the time when Company G extinguishes the Receivable by way of releasing Company F from the obligation to repay the Receivable.

Question 2

Summary

Company A will not make a capital gain and will not make a capital loss from the sale of the shares in Company G to Company B.

Detailed reasoning

On the same day, Company A will firstly transfer the Receivable to Company G in exchange for the issue of shares at market value and will secondly sell the shares to Company B for nominal value.

The shares in Company G will have the same market value at the time of sale as their cost base or reduced cost base at the time of their issue.

Subsection 116-30(2) of the ITAA 1997 sets out the CGT market value substitution rule that applies when there are capital proceeds such as nominal value. The relevant part of the subsection states:

'The capital proceeds from a CGT event are replaced with the market value of the CGT asset that is the subject of the event if:

'(b)  those capital proceeds are more or less than the market value of the asset and:

'(i)  you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event; or …'

'(The market value is worked out as at the time of the event.)'

The shares in Company G constitute CGT assets; section 108-5 and refer to second dot-point example following subsection 108-5(2).

The sale of the shares in Company G constitutes a CGT event A1 for disposal of a CGT asset and the time of the event is when the agreement is entered into; subsection 104-10(1) and paragraph 104-10(3)(a) of the ITAA 1997.

The capital proceeds for the disposal of shares held in Company G at nominal value are less than their market value. At the relevant time, Company G will hold a valuable asset being the right to receive the Receivable from Company F and Company G will possess substantial market value.

In the circumstances of the proposed sale of shares in Company G, Company A and Company B will not be dealing with each other at arm's length in connection with the sale.

As the relevant elements of subsection 116-30(2) are met, the capital proceeds of nominal value are replaced with market value.

As the capital proceeds matches the cost base or reduced cost base of the shares (as per the relevant assumption above), Company A will not make a capital gain nor will Company A make a capital loss as a result of CGT event A1 happening upon the disposal of the shares.

Question 3

Summary

For Company A, the direct value shifting provisions in Division 725 of the ITAA 1997 will not apply.

Reasoning

Subsection 725-145(1) states that:

'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) and (3) are satisfied.'

Subsection 725-145(2) is concerned with the issue of shares in the target entity at a discount. No shares are issued at a discount in the arrangement.

Subsection 725-145(3) states:

'…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.'

The term 'equity or loan interest' for the purposes of section 725-145 is defined in section 727-520. Without detailing the definition, a key matter for the arrangement is that a 'loan interest' (or a 'primary loan interest') in an entity is 'a loan to the entity'. That is, the relevant loan interests are loans made to a target entity and not loans made by a target entity. Therefore, the Receivable owed to Company A by Company F is a 'loan interest' to which the Direct Value Shifting rules in Division 725 apply where Company F is a target entity for the purposes of the rules.

There will be a direct value shift in the arrangement if, as a result of one or more things done under the arrangement, there is simultaneously (and also reasonably attributable to one or more things):

· a decrease in the market value of one or more equity or loan interests in a target entity; and

· an increase in the market value of one or more equity or loan interests in the target entity.

Company A will be subject to the Direct Value Shifting rules in Division 725 if there is a simultaneous increase in one or more equity or loan interests and decrease in one or more equity or loan interests where Company A holds one of the (increasing or decreasing) interests.

When Company A transfers the Receivable to Company G in exchange for the issue of shares in Company G at market value, there is no simultaneous increase and decrease in the market value of one or more equity or loan interests held in either Company G or Company F which would be attributable to the transfer.

When Company disposes of the shares in Company G for a nominal amount, there is no simultaneous increase and decrease in the market value of one or more equity or loan interests held in either Company G or Company F which would be attributable to the disposal.

Further, when Company G releases Company F from the obligation to repay the Receivable, equity interests in Company G will be held by Company B and loan interests will be held in Company F by Company G. Company A will not hold any equity or loan interests in Company G, Company F or Company B at this time and therefore the Direct Value Shifting rules in Division 725 will not apply to Company A as a result of the release as Company A will not hold an equity or loan interests in a target entity at this time.

Question 4

Summary

For Company A, neither section 204-30 of the ITAA 1997 nor section 177EA of the ITAA 1936 will apply and therefore the Commissioner will not make a determination under either of the sections.

Reasoning

Section 204-30

Section 204-30 provides the Commissioner with the power to make a determination when an entity streams distributions or distributions and other benefits.

Any strategy undertaken by an entity to direct the flow of franked distributions to members who can most use them would constitute streaming. For the purposes of section 204-30, there must be a streaming of distributions (or a streaming of distributions and the giving of other benefits) to members in such a way that one member derives a greater benefit from franking credits (within subsection 204-30(8)) than another member and that the other member receives lesser imputation benefits (within subsection 204-30(6)) than the first member.

The members of Company A are Ordinary Shareholders and Company E: subsection 960-130(1) of the ITAA 1997; Patcorp Investments Ltd v. Federal Commissioner of Taxation.

Company A has paid all dividends on the Ordinary Shares and to Company E fully franked and expects that all dividends that it will pay to its members in the foreseeable future will be fully franked. On that basis, there is no streaming of franked dividends.

Nor is there streaming in relation to the other benefit which will be provided by Company A under the arrangement. Company A will dispose of the shares in Company G to Company B at less than market value. The benefit is provided to Company B which is not a member of Company A. The only reference in section 204-30 to an other benefit being provided to an entity which is not a member is contained in paragraph 204-30(2)(d) which exemplifies a payment made or property given to a person on a member's behalf as being an other benefit. While Company D wholly owns Company B which in turn wholly owns Company E, it cannot be said that the benefit that Company A provides to Company B is provided on behalf of or for the benefit of Company E.

As the benefit is not provided by Company A to a member, it will not be a dividend and will not carry franking credits, and it is not be streamed for the purposes of section 204-30.

Therefore, the Commissioner will not make a determination pursuant to subsection 204-30(1) that one or more of the remedies set out in subsection 204-30(3) will apply.

Section 177EA

Subsection 177EA(3) states that section 177EA applies if:

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

either:

(b) 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.'

For section 177EA to apply, each of the five requirements in paragraphs 177EA(3)(a) - (e) must be present.

First requirement - 'scheme for the disposition of membership interests'

The meaning of the term 'scheme for the disposition of membership interests' is set out in subsection 177EA(14) as follows:

'A scheme for a disposition of membership interests or an interest in membership interests includes, but is not limited to, a scheme that involves any of the following:

(a) issuing the membership interests or creating the interest in membership interests;

(b) entering into any contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests;

(c) creating, varying or revoking a trust in relation to the membership interests or interest in membership interests;

(d) creating, altering or extinguishing a right, power or liability attaching to, or otherwise relating to, the membership interests or interest in membership interests;

(e) substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding or owning the membership interests or having the interest in membership interests;

(f) the membership interests or interest in membership interests beginning to be included, or ceasing to be included, in any of the insurance funds of a life assurance company.'

Shares held in Company A

The arrangement will not result in Company A issuing membership interests or creating an interest in membership interests for any ordinary shareholder or for Company E for the purposes of paragraph 177EA(14)(a). None of the 'affects' on membership interests described in paragraphs 177EA(14)(b)-(e) inclusive will take place for any ordinary shares or for the Dividend Access Share. The arrangement will not affect the treatment of any ordinary shareholder or of Company E for the purposes of the taxation treatment of the funds of a life assurance company.

Therefore, section 177EA will not apply in respect of membership interests held in Company A as the first requirement, a 'scheme for the disposition of membership interests', will not be present.

Shares held in Company G

For Company G which is wholly owned by Company A, the requirement of either subparagraphs 177EA(3)(b)(i) or 177EA(3)(b)(ii) will not be present. Company G will not pay a frankable distribution, nor will Company G have such a distribution payable and Company G will not be expected to pay a frankable distribution for the purposes of subparagraph 177EA(3)(b)(i). Further, no such paid, payable or expected (to be paid) frankable distribution will flow indirectly for the purposes of subparagraph 177EA(3)(b)(ii).

Therefore, section 177EA will also not in respect of the shares held in Company G as the second requirement, a 'frankable distribution in respect of the shares held in Company G' will not be present.

Conclusion for section 177EA

As all of the requirements of subsection 177EA(3) do not apply to the shares held in Company A and do not apply to the shares held in Company G, section 177EA will not apply to the arrangement and accordingly the Commissioner will not make a determination pursuant to subsection 177EA(5).

Question 5

Summary

Section 45A and section 45B of the ITAA 1936 will not apply to Company A and therefore the Commissioner make a determination under section 45C of the ITAA 1936.

Reasoning

Section 45A

Subsection 45A(1) of the ITAA 1936 states:

'This section applies in respect of a company that, whether in the same year of income or in different years of income, streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that:

' (a) the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

'(b) it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends.'

Section 45A does not apply if either section 45 (for the streaming of bonus shares and unfranked or minimally franked dividends) or subsection 45(5) (where the capital benefit is the provision of shares and it is reasonable to assume that disadvantaged shareholders have received or will receive fully franked dividends) applies.

Meaning of provision of a capital benefit

Subsection 45A(3) states that a reference to the provision of a capital benefit is a reference to any of the following:

'(a) the provision to the shareholder of shares in the company;

(b) the distribution to the shareholder of share capital or share premium; or

something that is done in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) held by the shareholder.'

Provision of a capital benefit

Section 45A does not apply as a result of the arrangement as Company A will not provide a capital benefit as defined in subsection 45A(3) to a shareholder because:

Company A will not provide shares in Company A to one or more Ordinary Shareholders or to Company E for the purposes paragraph 45A(3)(a);

Company A will not make a distribution to one or more Ordinary Shareholders or to Company E of share capital or of share premium for the purposes of paragraph 45A(3)(b); and

Company A will not do something in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) held by one or more Ordinary Shareholders or by Company E.

Conclusion for section 45A

As Company A does not provide a capital benefit to one or more ordinary shareholders or to Company E for the purposes of subsection 45A(3), the requirement in paragraph 45A(1)(a) is not met. As all of the requirements of subsection 45A(1) are not present, section 45A does not apply.

It is not necessary to consider whether section 45 or subsection 45(5) applies.

Section 45B

Section 45B was introduced in response to changes to the Corporations Law to ensure those changes did not allow companies and their shareholders to gain a tax benefit through distributing profits as preferentially taxed capital rather than dividends. A stated purpose of the section is to ensure that certain payments made in substitution for dividends are treated as dividends for taxation purposes: paragraph 45B(1)(b).

The section applies if the three requirements set out in subsection 45B(2) are met: if there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a)) and under which a taxpayer - who may or may not be the recipient of the capital benefit - obtains a tax benefit (paragraph 45B(2)(b)) and, having regard to certain specified relevant circumstances of the scheme, it would be concluded that a person entered into or carried out the scheme for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

Even were it put that there would be a provision of a capital benefit in the form of 'the provision of ownership interests in a company to a person' for the purposes of paragraph 45B(2)(a) by way of the disposal by Company A of shares in Company G to Company B for less than market value, section 45B would not apply as a person does not obtain a tax benefit.

Subsection 45B(9) provides that a person obtains a tax benefit if tax or any other amount payable by the person would be less than would have been payable had the capital benefit been an assessable dividend. The capital benefit provided by Company A to Company B. As Company B is not a member of Company A and does not hold non-share equity interests in Company A, there can be no assessable dividend passing from Company A to Company B and a tax benefit cannot be measured or determined. There is therefore no tax benefit for the purposes of paragraph 45B(2)(b) under the arrangement.

As all the elements of subsection 45B(2) are not present, section 45B would not apply to the arrangement.

Accordingly, the Commissioner will not make a determination pursuant to subsection 45B(3) that section 45C applies to treat a capital benefit as an unfrankable dividend.

Question 6

Summary

The Commissioner will not make a determination under section 177F of the ITAA 1936 for Company A.

Reasoning

For the Commissioner to make a determination pursuant to section 177F, there must be:

A scheme;

A tax benefit for the purposes of section 177C (or from avoiding withholding tax for the purposes of section 177CA); and

A conclusion having regard to certain factors set out in paragraph 177D(b) that a person entered into the scheme for a dominant purpose of enabling a taxpayer to obtaining a tax benefit.

Scheme

For the purposes of Part IVA of the ITAA 1936 which contains sections 177F, 177C, 177CA and 177D, a 'scheme' as defined in section 177A means:

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

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

The arrangement set out in the Relevant facts and circumstances above will constitute a 'scheme' for the purposes of Part IVA.

Tax benefit

The term 'tax benefit' for the purposes of Part IVA is defined in subsection 177C(1) refers to the following concepts:

The non-inclusion of an amount of assessable income that would have been included, or might reasonably be expected to have been included, in a taxpayer's assessable income for a year of income;

The allowance of a deduction where the whole or part of the deduction would not have been allowed, or might reasonably be expected not to have been allowed, to a taxpayer during a year of income;

A capital loss incurred by a taxpayer where the whole or part of the loss would not have been incurred, or might reasonably be expected not to have been incurred, by a taxpayer during a year of income; and

The allowance of a foreign income tax offset where the whole or part of the offset would not have been allowed, or might reasonably be expected not to have been allowed, to a taxpayer during a year of income;

if the scheme had not been entered into or carried out.

The tax benefit is measured from what would have resulted if the scheme had not been entered into or carried out, and an alternative scheme called a 'counterfactual', was instead carried out.

The counterfactual must achieve the same commercial outcomes as the scheme carried out and must be reasonably predictable or reasonably expected for the person to have carried out, rather than a mere possibility.

Counterfactual

Relevant alternative transactions or counterfactuals to the arrangement would have been for Company A to transfer the Receivable directly to Company D for nominal consideration or for Company A to waive the liability to pay the Receivable for nominal consideration.

The above alternative transactions or counterfactuals were not pursued because adverse foreign tax implications would have arisen. No such adverse foreign tax implications would arise from the arrangement.

If the arrangement were not to take place, the alternative transaction or counterfactual would only have the same commercial outcome as the arrangement if the Receivable were to come to an end. This may take place by way of a transfer or waiver of the Receivable, or by way of a transaction similar to the arrangement. The manner adopted may also involve the payment of dividends to Company E.

Regardless of whether one or more of these alternative transactions are properly reasonably predictable, the Receivable coming to an end:

Will also result in Company A not including interest income on the Receivable in its assessable income;

Will also result in Company A not including an amount in its assessable income - where the manner in which the Receivable is transferred or waived for nominal consideration is considered to be 'debt forgiveness' - an amount for the debt forgiveness. For completeness, neither Division 243 nor Division 245 for specific debt forgiveness situations would have applied to include an amount in Company A's assessable income if the Receivable came to an end by way of a debt forgiveness.

As no other amount will not be included in Company A's assessable income pursuant to the arrangement, there is no 'tax benefit' from the non-inclusion of an amount in Company A's assessable income if an alternative transaction were to take place where the Receivable comes to an end for the purposes of paragraph 177C(1)(a); and

Will also give rise to Company A obtaining a foreign exchange loss deduction equivalent to that which will be obtained pursuant to the arrangement as discussed above for Ruling 1. As no other deduction will be obtained by Company A as` a result of the arrangement, there is no 'tax benefit' from the allowance of a deduction to Company A compared to (the extent of) a deduction that would otherwise arise if an alternative transaction were to take place where the Receivable comes to an end for the purposes of paragraph 177C(1)(b).

As discussed for Ruling 2, the arrangement will not result in Company A incurring a capital loss for the disposal of shares held in Company G for a nominal amount due to the operation of the CGT market value substitution rule in section 116-30. Similarly, the transfer of the Receivable by Company A to Company G in exchange for the issue of shares in Company G for market value will not result in Company A incurring a capital loss. As Company A will not make a capital loss under the arrangement, no 'tax benefit' in the form of incurring a capital loss need be considered compared to a counterfactual for the purposes of paragraph 177C(1)(ba).

The arrangement will not result in a foreign income tax offset becoming allowable to Company A. Therefore, no 'tax benefit' in the form of obtaining a foreign income tax offset need be considered compared to a counterfactual for the purposes of paragraph 177C(1)(bb).

The avoidance of a debit to Company A's franking account balance is not a 'tax benefit' for the purposes of section 177F as it is not specified as a 'tax benefit' in section 177C for the purposes of Part IVA.

The arrangement will not result in Company A avoiding a liability to withholding tax as Company A is a resident of Australia and would not be liable to withholding tax as a result of undertaking an alternative transaction pursuant to which the Receivable will come to an end for the purposes of section 177CA.

Therefore, as one of the required elements being 'a tax benefit' will not be present, the Commissioner will not make a determination pursuant to section 177F in respect of the arrangement, regardless of how the Receivable comes to an end.

Question 7

Summary

The Commissioner will not make a determination under section 177E of the ITAA 1936 for Company A.

Reasoning

The relevant part of subsection 177E(1) states that for the section to apply:

'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; …'

For section 177E to apply, each of paragraphs 177E(1)(a)-(d) must be present.

Scheme by way of or in the nature of dividend stripping

The ATO-view on dividend stripping is set out in Taxation Ruling No. IT 2627: Income tax: Application of Part IVA to dividend stripping arrangements. IT series rulings are administratively binding on the Commissioner.

Paragraphs 8 - 11 of IT 2627 state:

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

9. However, it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current 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.

11. Where one step in the scheme includes the purchase of shares or an issue of shares, it will usually be the case that the vendor shareholder, the company, or an assignee or associate will receive some consideration for the transfer or issue. It is not necessary that the consideration represents the full market value of the shares. Determining whether such an acquisition forms part of the scheme is very important. If it does, then the effect of applying Part IVA will normally be the inclusion of an amount in the assessable income of the previous shareholders.'

Under the arrangement, Company B will purchase the shares in Company G for a nominal amount and therefore Company B will not pay Company A a capital sum that reflects the Receivable and will not therefore not release to Company A in non-taxable form the profit inherent in the Receivable transferred to Company G.

Accordingly, for the purposes of subparagraph 177E(1)(a)(i), the arrangement will not give rise to a scheme by way of or in the nature of dividend stripping for Company A.

Scheme having substantially the same effect of a scheme by way of or in the nature of dividend stripping

Paragraphs 13 - 17 of IT 2627 states:

'13. For a scheme to fall within the subparagraph, it would require at a minimum that company profits are effectively distributed to shareholders.

14. The examples advanced in the Explanatory Memorandum concerned the removal of profits of the target company by way of irrecoverable loans to the shareholder rather than by way of a dividend or liquidator's distribution. This is because the liberation of profits into shareholders' hands is required for a scheme to have substantially the effect of a dividend stripping scheme but the methods may vary.

15. The Explanatory Memorandum also identified payments, not to the shareholder, but to an associate of the shareholder. Again, the person to whom the profits are released is not vital but the relationship to the shareholder may be. Similarly, it would not matter if the profits were paid to an independent party so long as, in doing so, the payment can be said to be for the benefit of the shareholder or of an associate.

16. Consider, for example, a company with substantial accumulated profits owned by an individual who sells assets to the company for approximately ten times their real market value. This may not strictly be a scheme by way of, or in the nature of, dividend stripping since there is no dividend or liquidator's distribution. However, it may well be a scheme having substantially the effect of such a scheme since it could involve the removal of profits of a company in a non-taxable form.

17. Another example that is considered to come within section 177E is the case of a cashed up company under a scheme of arrangement under sections 181 and 183 of the former Companies Act or sections 315 and 317 of the new code pursuant to which the assets and liabilities of the company are transferred to a newly incorporated company. The target company is dissolved without being wound up and its shareholders given paid-up shares in the new company to the value of the assets of the target company. The profits stripped from the target company show up in the hands of the vendor shareholders in the form of the paid-up shares in the new company.'

The arrangement does not result in the effective distribution of profits to Company A. While it might be said the arrangement will result in the removal of profits of Company A which might also be said to be paid or released to entities associated in some way with Company A, the liberation of profits in non taxable form is concerned with the disposal of shares or assets and not with the subsequent dividend, liquidator's dividend or in the arrangement, the subsequent release from the liability to pay the Receivable.

Accordingly, for the purposes of subparagraph 177E(1)(a)(i), the arrangement will not give rise to a scheme having substantially the same effect of a scheme by way of or in the nature of dividend stripping for Company A.

As one of the requirements for section 177E to apply will not be present in the arrangement, being the requirement in paragraph 177E(1)(a) that there will be a scheme by way of or in the nature of dividend stripping for Company A, or a scheme with substantially the same effect, section 177E will not apply to the arrangement.

The Commissioner will not make a determination in respect of the arrangement under section 177E of the ITAA 1936 to Company A.

Question 8

Summary

Company B will not derive an amount of assessable income under section 6-5 or section 6-10 of the ITAA 1997.

Reasoning

Company B is a non-resident for Australian income tax purposes and will be subject to Australian income tax if it has Australian sourced income or if a provision of Australian income tax legislation states that certain income has an Australian source when received by a non-resident, regardless of whether the income is 'income according to ordinary concepts' or 'statutory income'; subsections 6-5(3) or 6-10(5).

Ordinary income

Company B is purchasing all of the shares in Company G, a non-resident company, for a nominal amount. Company G will possess Receivable asset. The purchase will be effected through an agreement which is governed by foreign laws and which will be completed and executed in a foreign jurisdiction.

Company B is not a party to the Receivable agreement. Where the Receivable agreement was formed has no affect on the source of any income or gains made by Company B on the acquisition of shares in Company G. The Receivable agreement was formed in a foreign jurisdiction. As per ATO ID 2004/904 which states:

'The purchase and sale of shares normally involves entering into contracts and the contract is formed where the final act regarded as completing the contract occurs - Tallerman and Co Pty Ltd v. Nathan's Merchandise (Vic) Pty Ltd (1957) 98 CLR 93. Thus, where the postal acceptance rule applies, the contract is considered to be made in the place where the acceptance is posted, and in other cases the contract is made at the place where acceptance is communicated to the offeror.'

It is reasonable to conclude that the purchase of shares in Company G by Company B is on capital account and is not furthering a business of purchasing shares at less than market value or purchasing shares as trading stock.

Company B will not derive an amount of ordinary income as a result of the arrangement. It is not necessary therefore to consider whether ordinary income is sourced in Australia or is otherwise included in the assessable income of Company B for Australian income tax purposes.

Statutory income

A non-resident includes in its assessable income for Australian income tax purposes any statutory income that has an Australian source or that a provision of Australian income tax legislation includes in its assessable income; subsection 6-10(5).

A CGT event does not happen to Company B as a result of the arrangement nor will any other item of statutory income relevant to the arrangement apply to include an amount in the assessable income of Company B. Further, a forex realisation event does not happen to Company B as a result of the arrangement. In addition, any traditional security outcome for the Receivable will not apply to Company B.

No amount will be included in the assessable income of Company B by a provision that is not about ordinary income as a result of the arrangement. No relevant provision specifically includes an amount in the assessable income of a non-resident in circumstances similar to those of Company B under the arrangement and no other statutory provision will apply to include an amount in the assessable income of Company B as the relevant income will not have an Australian source.

ATO view documents

TR 2009/3

TR 96/14

TD 93/86

IT 2627

ATO ID 2007/137

ATO ID 2004/904

Other references (non ATO view, such as court cases)

Patcorp Investments Ltd v. Federal Commissioner of Taxation (1976) 140 CLR 247

FC of T v Peabody (1994) 181 CLR 359

PS LA 2003/3

PS LA 2005/24

PS LA 2008/10

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