Edited version of your private ruling

Authorisation Number: 1012456849173

Ruling

Subject: Division 7A and Part IVA

Question and answer

1. Will, under Division 7A, section 109XA of the Income Tax Assessment Act 1936 apply to cause the whole or part of the Distribution to be deemed a dividend to you?

No.

2. Will the provision of Part IVA of the Income Tax Assessment Act 1936 apply to the whole or part of the Distribution?

No.

This ruling applies for the following periods

1 July 2012 to 30 June 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Individual 1, individual 2 and the Trust are all residents of Australia for Australian taxation purposes.

Individual 1 and 2 are currently married, but are separated.

The Orders are proposed as part of the property settlement between individual 1and individual 2 arising out of their separation. The Orders are, in essence, settled between the parties pending the outcome of this ruling request. The Orders will be binding on all the parties to the proceedings.

The Trust

The individual 1 and individual 2 are the only directors and equal shareholders of Company 1.

Company 1 is the trustee for the Trust. The Trust was established by deed and individual 2 is the Appointor and Guardian of the Trust.

The children and grandchildren of the parties are the specified beneficiaries of the Trust. Individual 1 and individual 2 are included in the class of general beneficiaries.

Company 2

Company 2 is a corporate beneficiary of the Trust.

Individual 1 and Individual 2 are the only directors and equal shareholders of company 2.

Company 2 holds an unpaid present entitlement with the Trust.

Property Trust

The Property Trust is a unit trust established by deed.

The Trust holds less than 50% of the Units in the Property Trust. The remaining units are held by:

(i) Individual 2's relative ; and

(ii) Trust Z as less than 50% as a silent investor.

The trustee of Trust Z is Company Z. This company is now controlled by the executor of the estate of Z, individual 3.

The trustee of the Property Trust is Company 3.

Individual 2 and Individual 2's relative are the only directors of Company 3.

There are shares in company 3. Individual 2, Individual 2's relative and individual 3 hold one share each.

The parties agree that, for the purposes of these Orders only, the Trust's unit holding in the Property Trust is valued for an approximate sum.

The parties intend that one half of the units held by the Trust in the Property Trust will vest in individual 1 pursuant to these Orders.

Individual 1 intends to become a silent investor in the Property Trust in a similar manner to Trust Z, and will be bound by the Property Trust Deed.

These Orders will act in conjunction with the Property Trust Deed. In the event that any inconsistency arises between a provision of these Orders and that of the Property Trust Deed, these Orders shall prevail.

Property Partnership

The commercial property, Property 1, is held by the Trust and Trust Z as tenants in common in equal shares.

The Trust and Trust Z manage the lease of Property 1 through a partnership called the Property Partnership.

The parties intend that one half of the Trust's interest in the Property Partnership will vest in individual 1, and that individual 1 will receive a one quarter share in the profit made by the Partnership going forward.

Pursuant to the Orders, the Trust will transfer the Distribution to individual 1. This will occur within fourteen (14) days of the publication of the Orders.

The orders state the following;

Vesting from the Trust

Within 14 days of compliance by the individual 1 with paragraph X of these Orders the parties do all acts and sign all documents necessary to vest in individual 1:

(a) One half of the units held by the Trust in the Property Trust;

(b) One half of the interest held by the Trust in the Property Partnership including but not limited to a one quarter interest in Property 1:

(c) All furniture, chattels, antiques, artwork and jewellery held by the Trust; and

(d) Property 2.

Paragraph X of the orders state the following;

Company 2

Within 14 days of publication of these Orders individual 1 do all acts and sign all documents necessary to:

(a) Transfer to individual 2 all of their right, title, estate or interest in their shareholding in Company 2; and

(b) Resign from any and all positions and/or offices they hold in Company 2 including their position as a director and secretary.

The Trust currently has unpaid present entitlements owed to Company 2.

The unpaid present entitlement of Company 2 will remain unpaid before the earlier of the due date for lodgment and the date of lodgment of the income tax return of the Trust for the year in which the Distribution is transferred to individual 1.

The Trust also currently has unpaid present entitlements owed to individual 1.

Pursuant to the Orders, within fourteen (14) days of individual 2's compliance with the Orders, individual 1 will do all acts and sign all documents necessary to:

(a) transfer to individual 2 their interest in the shareholding in Company 1;

(b) resign from any and all positions and or offices they hold in Company 1; and

(c) renounce any future interest they hold in the Trust (other than their existing unpaid present entitlement as set out in the Orders).

The purpose of the Distribution is to ensure that individual 2 receives B% of the total available assets and individual 1 receives C% of the total available assets.

If the proposed Distribution proceeds, the Trust will account for the transfer of the various assets comprising the Distribution as either:

(a) a disposal for nil consideration; or

(b) a transfer by way of a distribution from the Trust.

The "marriage break-down" CGT rollover in Subdivision 126-A of the Income Tax Assessment Act 1997 (ITAA 1997) would apply to the Distribution from the Trust to individual 1. Accordingly, any capital gain made by the Trust on the Distribution to individual 1 will be disregarded.

Part IVA

In the present case, the "commercial outcome" of the Distribution is to comply with the Orders which result from the proceedings to finalise the property settlement between individual 1 and individual 2 to end the financial relationship between them.

Counterfactual

Paragraph 69 of Practice Statement Law Administration PS LA 2005/24 states:

"The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or an 'alternative postulate'. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. This alternative hypothesis or postulate also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D. The alternative hypothesis(es) or postulate(s) is referred to in this practice statement as the 'counterfactual(s)'. " (Emphasis added)

For the present purposes, there is difficulty postulating what would happen or might reasonably be expected to happen if the entities did not proceed with the arrangements, the subject of the Orders. This is because the Distribution is the subject of the Orders which are to be made by the Family Court, following protracted negotiations in which individual 1 and individual 2 were at all times acting at arm's length, each represented by separate lawyers.

The result of the Orders, in essence, is that individual 1 receives the Distribution (in addition to various other assets). The purpose of the Distribution is to ensure that individual 2 receives V% of the total available assets and individual 1 receives W% of the total available assets.

Neither individual 1 nor individual 2 would personally be in a financial position to make the payment required under the Order. Therefore, it was always the case that the Orders would necessarily require the transfer of assets from the Trust to help finance the separation of individual 1 and individual 2.

The fact that there is not a reasonably identifiable 'counterfactual' in the present case, necessarily leads to the conclusion that the Distribution pursuant to the Orders is not being entered into for the sole or dominant purpose of obtaining a tax benefit (section 177D of the ITAA 1997).

Therefore, the eight factors must be considered against this background (i.e. the absence of a reasonably expected alternative postulate), when applying the purpose test in section 177D(b) of the ITAA 1936.

First Point: The manner in which the scheme will be entered into or carried out

In this context, "manner" includes a consideration of the way in which and the method or procedure by which the particular scheme was established (FCT v Spotless Ltd & Anor 96 ATC 5201).

The Distribution is required to be made by the Trust pursuant to the Orders. The need for the Orders in the first place arises from the separation of individual 1 and individual 2, and the need to divide the property of their relationship between them (including property accumulated during their relationship, but owned by companies and trusts which one or both of them control).

Individual 1 and individual 2 have at all times dealt with each other at arm's length in relation to the property settlement, which arm's length dealing is evidenced by the fact that each of them is, and always has been, represented by a separate set of lawyers and advisers. Further, the amount of the proposed payments to be made to each of them pursuant to the Orders, represent arm's length amounts presumably considered consistent with their entitlements to share in the division of the property of their relationship.

The Orders are consistent with normal commercial or family dealings in the context of a property settlement following the breakdown of a marriage or relationship. The Orders do not contemplate section 109XA applying. Section 109XA happens to be a provision which applies to the circumstances which have arisen as a result of the financial settlement between individual 1 and individual 2 which is expressed in the Orders.

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Second Point: The form and substance of the scheme

The second point to be considered under section 177D(b) of the ITAA 1936 is the form and substance of the scheme.

The entities will be ordered by the Family Court under the Family Law Act to make the payments in the manner contemplated by the Orders.

There is no artificial or contrived actions in the proposed transactions the subject of the Orders for which the only explanation is the pursuit of the relevant tax benefits.

Relevantly, the Orders, as a matter of substance, have the effect of imposing legally binding obligations on the parties to the Orders. The Orders are intended to be final orders in the proceedings to end the financial relationship between individual 1 and individual 2.

The ruling, prevailing or most influential purpose of taxpayers in complying with Family Court orders is typically, as is the case here, to permanently sever the financial connections or relationship between the individuals. The form and substance of such transactions in these circumstances will typically, as is the case here, reflect that prevailing purpose.

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Third Point: The time at which the scheme will be entered into and the period of time during which the scheme will be carried out

The third point to be considered under section 177D(b) of the ITAA 1936 is the time at which the scheme was entered into and the length of the period during which the scheme was carried out.

In Hart & Anor 2002 ATC 4608, Hill J said that an example of a case where timing would be most relevant to Part IVA of the ITAA 1936 would be a scheme involving a flurry of activity around the end of the tax year directed at obtaining a deduction in that year.

In the present case, the timing of the entering into the Orders and the carrying out of the proposed transactions the subject of the Orders is not in any way tax driven so as to enable any or all of the entities or any other taxpayer to obtain a tax benefit.

Rather, the proceedings, and the proposed Orders, are intended to finalise the property settlement between them as soon as possible and in the most commercially satisfactory way, by avoiding the need for lengthy and protracted litigation.

This points to the conclusion that the requisite purpose in section 177D of the ITAA 1936 does not exist.

Fourth Point: The result in relation to the operation of the ITAA36 and the ITAA97 that, but for Part IVA, would be achieved by the scheme

The fourth point to be considered for the purposes of section 177D(b) of the ITAA 1936 is the result in relation to the operation of the ITAA 1936 and the ITAA 1997 that, but for Part IVA of the ITAA 1936, would be achieved by the scheme.

In the present case, the results in relation to the operation of the ITAA 1936 and the ITAA 1997 that, but for Part IVA of the ITAA36, would be achieved by the scheme as set out above.

Whilst the transactions the subject of the Orders do result in one of the entities obtaining, aside from the application of Part IVA, a tax free amount, these results must be weighed against other aspects of the arrangement in order to determine the dominant purpose of the relevant entity, In FCT v Mochkin 2003 ATC 4272 at 4289 the Full Federal Court stated:

"91. The result in relation to the operation of the ITAA that, apart from Part IVA, would be achieved by the scheme, included the distribution of income generated by Daccar and Ledger to the beneficiaries of the No 1 and No 2 Trusts. As I have already noted, it is difficult to see how the result of the scheme, in the sense in which that term was used in s 177D(b}(iv,), could be said to be tax neutral Viewed objectively, the result sought by the scheme, so far as the ITAA was concerned, was the opportunity to distribute net commission income derived by Daccar and Ledger in a tax effective manner. This result nonetheless must be weighed against other aspects of the scheme in order to determine the Taxpayer's dominant purpose."

In the present case, when the relevant tax benefits are considered in conjunction with the first and second point, this fourth point is essentially neutral.

Fifth, Sixth and Seventh Points - the effect of the scheme

The fifth, sixth and seventh points focus on the non-tax effects of the scheme, not only for the relevant taxpayer, but also for all connected parties. These points look to the practical financial, legal, economic and any other outcomes achieved by the scheme for the taxpayer and connected parties.

In summary, the Distribution the subject of the Orders to which the ruling request is concerned, essentially results in a transfer of assets from the Trust to individual 1, resulting in an increase in property held by individual 1 and a decrease in money and/or property held by the Trust. However, these consequences are commercial in character when considered in context, relevantly being that they reflect the Orders to be made by the Family Court in order to permanently sever the financial relationship between individual 1 and individual 2.

It is generally accepted by the ATO that the fifth, sixth and seventh points of subsection 177D(b) will often require consideration in conjunction with the second point (paragraph 106 of PS LA 2005/24), i.e. the form and substance of the scheme. In the present case, when the relevant tax benefits are considered in conjunction with the second point, the fifth, sixth and seventh points are essentially neutral.

Eighth point - the nature and connection between the relevant taxpayer and any person connected with the taxpayer

Paragraph 110 of PS LA 2005/24 provides that:

"The existence of any connection between the taxpayer and those other persons is relevant to the identification of the other factors, such as the manner of the scheme, the form and substance of the scheme, and the tax, financial and other consequences of the scheme ".

In the present case individual 1 and individual 2 were in a relationship for many years and that relationship has ceased. Individual 2 as the appointor (being the person that can hire and fire the trustee of the Trust) and the guardian (being the person whose consent is required for the trustee to exercise certain powers) of the Trust, was and is in essence, the controller of the Trust. However, the connection between the parties in the present case is essentially neutral as regards determining the requisite purpose in section 177D(b) of the ITAA36 when considered in conjunction with the first three points.

Conclusion

Whilst the tax consequences will follow from the transactions, the subject of the Orders, this should come as no surprise "having regard to the reality that the tax laws affect the shape of nearly every transaction" (FCT v Mochkin 2003 ATC 4272 at 4282).

In the present case, it is entirely appropriate in reaching a view as to the requisite purpose in section 177D, to weigh up the commercial and practical side of the arrangements against any perceived tax benefits (FCTv Mochkin 2003 ATC 4272 at 4288), and to form a "global assessment of purpose" (FCT v Consolidated Press Holdings Ltd & Anor 2001 ATC 4343 at 4360).

It is submitted that an objective assessment of all of the facts leads to the conclusion that the transactions the subject of the Orders are not intended to be undertaken for the sole or dominant purpose of obtaining a tax benefit (section 177D of the ITAA 1936).

Relevantly, in the present case the "ruling, prevailing or most influential purpose" (FCT v Spotless Services Ltd & Anor 96 ATC 5201 at 5206) of the entities in complying with the Orders is to comply with legally binding obligations so as to permanently sever the financial connection or relationship between individual 1 and individual 2 to allow them to get on with their lives.

The Orders of the Family Court are consistent with normal commercial or family dealings in the context of a property settlement following the breakdown of a marriage or relationship.

The Orders do not contemplate section 109XA applying. Section 109XA happens to be a provision which applies to the circumstances which have arisen as a result of the financial settlement between individual 1 and individual 2 which is expressed in the Orders.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 109C(3)

Income Tax Assessment Act 1936 subsection 109XA(1)

Income Tax Assessment Act 1936 subsection 109XA(7)

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177A(3)

Income Tax Assessment Act 1936 subsection 177A(5)

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 subsection 177C(1)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Reasons for decision

Subsection 109XA(1) of the Income Tax Assessment Act 1936 (ITAA 1936) treats certain payments, including transfers of property, made by trustees as deemed dividends where:

(a)  a trustee makes a payment to a shareholder or an associate of a shareholder of a private company (except a shareholder or associate that is a company) (the actual transaction); and

(b)  the payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain; and

(c)  either:

(i)        the company is presently entitled to an amount from the net income of the trust estate at the time the actual transaction takes place, and the whole of that amount has not been paid to the company before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place; or

(ii)       the company becomes presently entitled to an amount from the net income of the trust estate after the actual transaction takes place, but before the earlier of the due date for lodgement and the date of lodgement of the trustees return of income for the trust for the year of income of the trust in which the actual transaction takes place, and the whole of the amount has not been paid to the company before the earlier of those dates.

Payment is defined in subsection 109C(3) of the ITAA 1936 and includes a transfer of property to the shareholder or associate of the shareholder.

Section 109XA(7) of the ITAA 1936 defines unrealised gain as follows:

Unrealised gain, in relation to a trust estate and an actual payment, means any unrealised gain, whether of a capital or income nature, but does not include an unrealised gain to the extent that it has been or would be included in the assessable income of the trust, apart from this Division, for:

(a) a year of income before the year in which the actual payment was made;

(b) the year of income in which the actual payment was made; or

(c) the year of income following the year in which the actual payment was made.

Subsection 109XA(7) of the ITAA 1936 carves out certain payments which are otherwise included in assessable income and clarifies that both capital and income unrealised gains are included.

Apart from these matters, the phrase unrealised gain is not defined for the purposes of Subdivision EA and adopts its ordinary meaning.

The Macquarie Dictionary defines the words realise and gain in the relevant context as follows:

(i) "realize" to mean to bring as proceeds, as from a sale; the goods realised $1000; and

(ii) "gain" to mean profit or advantage.

The ordinary meaning of the phrase realised gain is therefore to have a profit or advantage that has materialised in the form of proceeds from a sale.

Further, the Explanatory Memorandum to the Tax Laws Amendment (2004 Measures No. 1) Bill 2004 provides at paragraph 8.13:

For the purposes of these rules, realisation will be taken to have occurred when a gain converts into a recoverable debt.

The meaning of the phrase unrealised gain can be summarised as:

A gain is unrealised when an item which has increased in value has not been ventured, either in whole or in part, in a transaction to obtain a return that reflects that increase in value; or has been ventured into such transaction but the return is yet to convert into a recoverable debt.

Application of subsection 109XA(1)

For subsection 109XA(1) of the ITAA 1936 to operate all elements under the subsection must be satisfied.

a) A payment is made by the trustee to the shareholder or associate of a shareholder of a private company.

You stated the following;

This element is satisfied as we are instructed that:

(a) the Distribution from the Trust to individual 1 would constitute a payment for the purposes of I09XA(1); and

(b) individual 1 is a shareholder of the Company, which is a private company that is a beneficiary of the Trust from which it is owed an unpaid present entitlement.

b) The payment is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain.

You stated the following;

The Distribution will not be made in reduction or discharge of a present entitlement for the following reasons:

(a) Individual 1 currently has an unpaid present entitlement owed to them by the Trust. It appears that no additional unpaid present entitlement would be created by the Distribution to individual 1 pursuant to the Orders for either nil consideration or as a distribution to them as a beneficiary.

(b) Therefore, to the extent that the market value of the Distribution exceeds individual 1's unpaid present entitlement, the payment (i.e. the Distribution to individual 1), would not be made in reduction or discharge of a present entitlement. Accordingly, section 109XA should not apply to the Distribution to individual 1 to the extent that the value of the Distribution exceeds the amount of individual 1's presently existing unpaid present entitlement.

The Distribution will not be wholly or partly attributable to an amount that is an unrealised gain for the following reasons:

(a) The Distribution from the Trust to individual 1 would not result in an unrealised gain to the Trust (for the purposes of section 109XA(1)) as any gain or loss in relation to the Distribution will be "realised" by the Trust when the assets comprising the Distribution are transferred to individual 1.

(b) The Distribution to individual 1 will cause a capital gain arising to the Trust as a result of the application of the market value substitution rules in Division 116 of the ITAA 1997. However, as the CGT marriage roll-over relief applies, no amount will be assessable to the Trust (i.e. the capital gain will be disregarded).

(c) However, the gain on the Distribution would not be an unrealised gain within the meaning of section 109XA(7) because the gain would be realised. In this regard there is still a realised gain on the Distribution by the Trust, albeit that the gain is disregarded for tax purposes only because of the specific relief provided by the marriage breakdown roll-over.

(d) Therefore, there is a realised gain, as opposed to an unrealised gain for the purposes of subsection 109XA(l). As the gain is realized, the Distribution from the Trust to individual 1 would not be a "payment [which] is a discharge of or a reduction in a present entitlement of the shareholder or associate that is wholly or partly attributable to an amount that is an unrealised gain".

c) The private company has an unpaid present entitlement in the net income of the trust estate before the earlier of the due date for lodgment and the date of lodgment of the trusts tax return for that income year;

You stated the following;

This element is expected to be satisfied as we are advised that Company 2 has unpaid present entitlements owed to it by the Trust which is likely to remain unpaid before the earlier of the due date for lodgment and the date of lodgment of the trust's tax return for the year in which the Distribution from the Trust to individual 1 takes place.

Accordingly, although the trustee will make a payment to Individual 1 which satisfies the first element of subsection 109XA(1) of the ITAA 1936, the payment will not be made to discharge or reduce any present entitlement in unrealised gain.

Consequently, as the second element of subsection 109XA(1) of the ITAA 1936 has not been met not all conditions of in subsection 109XA(1) of the ITAA 1936 have been met and the subsection will not apply to the trust distributions to individual 1.

Application of Part IVA

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance provision that can apply in certain circumstances. Part IVA gives the Commissioner the power to cancel a 'tax benefit' (or part of a 'tax benefit') that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

In broad terms, Part IVA will apply where the following requirements are satisfied:

· there is a scheme (see section 177A)

· a taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme (see section 177C)

· the dominant purpose of a person who entered into or carried out the scheme, or any part of the scheme, was to enable the relevant taxpayer to obtain a tax benefit in connection with the scheme, or to enable the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (paragraph 177D(b)).

The application of Part IVA depends on a careful weighing of all the relevant facts and surrounding circumstances of each case.

In your case, what you are proposing is a 'scheme' capable of attracting the operation of Part IVA. However, when considered in conjunction with the factors in paragraph 177D(b) of the ITAA 1936, all these factors either point against the application of Part IVA or are neutral. Therefore, Part IVA will not apply to this arrangement.

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