Edited version of your private ruling

Authorisation Number: 1012584620773

Ruling

Subject: Dividend Stripping

Question 1

Is the arrangement a scheme to which section 177E (S177) of the Part IVA of the ITAA 1936 applies?

Answer

No

Question 2

Is the arrangement a scheme to which section 177EA (S177) of the Part IVA of the ITAA 1936 applies?

Answer

No

This ruling applies for the following period(s)

1 January 2014 to 1 January 2018

The scheme commences on

1 January 2014

Relevant facts and circumstances

We act for a company which carries on a business. Its founder and only shareholder is in the course of preparing a will. The success of the company has led to an accumulation of substantial funds in the company. It is our clients wish that a substantial part of those funds be bequeathed to her/his grandchildren. It is of course the case that our client in her/his will cannot impose an obligation on the directors of the company to act in accordance with her/his wishes after her/his death. She/he can only achieve her/his wishes to benefit her/his grandchildren with an asset she/he owns at the time of her/his death.
To enable her/his to be in that position we have advised her/him that if a new company was incorporated in which she/he was the only shareholder, the shares in that company would be the requisite asset with which she/he could deal in her/his will. We have further advised her/him that if a dividend access share was created in the capital of the existing company and allotted to the new company and a dividend paid thereon, the cash she/he wants to leave to her/his grandchildren would be available for her/him to leave in her/his will, thus giving them access to the cash as a dividend We are aware of the contents of TD 2013/D5. The purpose of this request is to seek a ruling that the provisions of Section 177E (S177) of Part IVA of the Income Tax Assessment Act 1936 do not apply to the proposal we have given our client. We offer the following in relation to the matter. S177 is directed to overcoming schemes in the nature of dividend stripping or having substantially the effect of such a scheme. We believe that there are fundamental differences between our proposal to our client and dividend stripping and only superficial similarities. A base line difference is that at 30 June 2012 the company's retained profits and cash assets were substantial. Only a small percentage is intended be dealt with in our proposal. In the draft determination (para 14) there is a list of the six common characteristics of a dividend strip, namely

1. A target company with substantial undistributed profits creating a potential tax liability either for the company or its shareholders,
2. The sale or allotment of shares in the target company to another party
3. The payment of a dividend to the purchaser or allottee of the shares out of the company's profits
4. The purchaser or allottee escaping Australian income tax on the dividend so declared
5. The vendor shareholders receiving a capital sum for the shares in an amount the same as or very close to the dividend paid to the purchasers, and
6. The scheme being carefully planned with all the parties acting in concert for the predominant purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company

It is acknowledged in para 17 of the draft determination that in a situation in which there is no vendor shareholder (ie the type of arrangement to which the determination is directed) the fifth characteristic will be satisfied if the substance of the scheme ensures that the target company's profits are directed away from the original shareholders to another party who compensates the original shareholders in a substantially tax free form. The elements of our client's situation that are in common with the above six characteristics are

1. It has substantial undistributed profits which would give rise to a tax liability for the shareholder if distributed in a single sum.

2. The arrangement we propose requires the allotment of a special class share.

3. The arrangement also requires the payment of a dividend to the allottee. The elements that are not in common with the above

4. The allottee will not pay tax on the dividend because the dividend will be fully franked. It will not "escape "tax. On the death of our client her/his shares in the new company will pass to her/his grandchildren and it is expected that the company will pay dividends to its shareholders. On her/his death each grandchild will receive a substantial amount of assessable income on which substantial income tax will be payable.

5. The company's shareholder is not compensated by another party in any form.

6. The sole purpose of our proposal is to enable our client to benefit her/his grandchildren. There is only one party in this, so there is no acting in concert and no avoidance of tax.

The most fundamental difference between the scheme set out in the determination and our proposal to our client is the purpose for which it is done. The scheme clearly has as its purpose the avoidance of tax in an artificial and contrived process. Our proposal enables our client to benefit both her/his spouse and daughter by leaving them the operating company and her/his grandchildren by leaving them funds to help them in their lives. We understand that when a request for a ruling on Part IV A is made it needs to address the eight matters which are referred to in Section 177D to which we now turn:

(lf one can call the creation and allotment of a share and the payment of a dividend thereon a scheme then the manner in which the scheme was entered into is as stated at the start of this sentence.

1. The form and substance of the scheme is as set out above.

2. The scheme will not be carried out unless the response to this request is favorable. If it is, the length of time in which the scheme is carried out will commence when the reply is received and will end more than 45 days therefrom. If the part applies nothing will be done in relation to the proposal

3.The result that would be achieved by the scheme is that our client would have shares in the new company that she/he would bequeath to her grandchildren.

4. If the relevant taxpayer is our client there will be no change in her financial position. If the relevant taxpayer is the company its financial position will be changed by the payment of a dividend.

5. There will be no change in the financial position of any person who has or has had a connection with the relevant taxpayer, being a change that will or may result from the scheme, other than that new company will receive a dividend from the existing company.

6. There is no other consequence for either our client or the existing company or any other person.

7. There is a connection between our client, the existing company and the new company in that our client is or would be a shareholder in both companies and the new company would hold a dividend access share in the existing company

Finally, for ultimate caution, we ask that you confirm our view that the provisions of Section 177EA do not apply to our proposal as each member of the existing company would derive the same benefit from the receipt of a franked dividend.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 Section 177EA

Reasons for decision

Question 1

Is the arrangement a scheme to which section 177E (S177) of the Part IVA of the ITAA 1936 applies?

Detailed reasoning

For the arrangement to be a scheme to which Part IVA of the ITAA 1936 applies, it must be shown that, having regard to all the matters listed in paragraph 177D (b) of the ITAA 1936, your sole or dominant purpose or the sole or dominant purpose of some other party, in entering the arrangement was to obtain a tax benefit. As discussed by the High Court in Federal Commissioner of Taxation v. Spotless Services (1996) 186 CLR 404; 96 ATC 5201; (1996) 34 ATR 183 at CLR 416; ATC 5206; ATR 188; ATR 183 (Spotless Services), the sole or dominant purpose of a taxpayer in entering into a scheme is 'their most influential and prevailing or ruling purpose'.

Spotless Services established that where a scheme makes no commercial sense without the tax benefits, there is a greater likelihood of concluding that it is entered into for the sole or dominant purpose of obtaining a tax benefit. Factors which suggest the scheme has been entered into for commercial reasons will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven.

The relevant question in applying Part IVA of the ITAA 1936 is not whether you or another person would not have entered the scheme 'but for' the tax benefit, but what was your dominant purpose in entering the scheme.

Based on the available evidence, a reasonable person would more likely than not conclude that your sole or dominant purpose in entering the scheme was for a reason other than obtaining a tax benefit. Consequently, Part IVA of the ITAA does not apply to the scheme.

Section 177E of the ITAA 1936 is an anti-avoidance provision that is designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme with substantially the same effect as a dividend stripping scheme.

The term 'dividend stripping' has no precise legal meaning. In its traditional form, a dividend stripping operation occurs when shares in a company with retained profits are acquired, usually by a share trader who pays the existing shareholders a capital sum reflecting the value of the retained profits. The new shareholders then liberate those profits through the payment of a dividend post acquisition. Generally, the new shareholders who derive dividend income from the company would not be liable to tax upon those dividends.

Therefore, a scheme by way of, or in the nature of, dividend stripping, or one that has substantially the effect of a scheme by way of, or in the nature of, dividend stripping, would be one that has the effect of delivering a shareholder's entitlement to a dividend in a tax advantaged manner.

Subparagraph 177E (1) (a) (i) of the ITAA 1936 refers to a scheme by way of or in the nature of dividend stripping.

Income Tax Ruling IT 2627 discusses the general anti-avoidance provisions in Part IVA of the ITAA 1936 and dividend stripping arrangements. In IT 2627, the Commissioner states that the term 'dividend stripping' has no precise legal meaning.

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 liquidation distribution) from the target company.

It was held in the Commissioner of Taxation v. Consolidated Press Holdings Ltd and Others (No 1) [1999] FCA 1199; (1999) 91 FCR 524; (1999) 42 ATR 575; 99 ATC 4945 (the CPH Case) that the placement of section 177E of the ITAA 1936 within Part IVA of the ITAA 1936 is important when interpreting the meaning of dividend stripping. The legislature had used the language of tax avoidance in section 177E of the ITAA 1936 to supplement the general anti-avoidance provisions. Therefore the dominant purpose of the scheme is determinative of whether there is a scheme by way of or in the nature of dividend stripping.

Based on a consideration of all relevant facts it is not considered that this arrangement has the characteristics of a dividend stripping scheme, your client's dominant purpose in entering the arrangement is to benefit her/his grandchildren by leaving them funds to help them in their lives, rather than to obtain a tax benefit. Consequently, the arrangement is not a scheme by way of or in the nature of a dividend stripping scheme.

It is not considered that section 177E of the ITAA 1936 has any application in relation to the purposed arrangement.

Question 2

Is the arrangement a scheme to which section 177EA (S177) of the Part IVA of the ITAA 1936 applies?

Detailed reasoning

The circumstances which are relevant in determining whether a person has the requisite purpose as referred to in paragraph 177EA (3) (e) of the ITAA 1936 include, but are not limited to, the factors listed in subsection 177EA (17) of the ITAA 1936.

These relevant circumstances encompass a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposition and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose of enabling the relevant taxpayer to obtain an imputation benefit.

The requisite purpose is further clarified when read in conjunction with the objective of section 177EA of the ITAA 1936 which is set out in paragraph 8.124 of the Explanatory Memorandum (EM) to the Bill which led to the enactment of section 177EA. (Taxation Laws Amendment Bill (No.3) 1998) stated that:

One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (i.e. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings.

Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the scheme seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders as envisaged in the preceding extract of the EM.

Conclusion

Having regard to the terms and circumstances of the scheme, the requirements of section 177EA of the ITAA 1936 have not been satisfied.

It is not considered that section 177EA of the ITAA 1936 has any application in relation to the purposed arrangement.

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