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This edited version has been archived due to the length of time since original publication. It should not be regarded as indicative of the ATO's current views. The law may have changed since original publication, and views in the edited version may also be affected by subsequent precedents and new approaches to the application of the law.

You cannot rely on this record in your tax affairs. It is not binding and provides you with no protection (including from any underpaid tax, penalty or interest). In addition, this record is not an authority for the purposes of establishing a reasonably arguable position for you to apply to your own circumstances. For more information on the status of edited versions of private advice and reasons we publish them, see PS LA 2008/4.

Edited version of your private ruling

Authorisation Number: 1012607865194

Ruling

Subject: Retirement planning proposal

Question 1

Is the franked distribution that flows from the Company to the Fund made as part of a dividend stripping operation within the meaning of paragraph 207-145(1)(d) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Is there a scheme to which Part IVA, and therefore section 177F, of the Income Tax Assessment Act 1936 (ITAA 1936) applies?

Answer

Yes

Question 3

Is there a scheme to which section 177EA of the ITAA 1936 applies?

Answer

Yes

This ruling applies for the following periods:

Year of income ended 30 June 2013

Year of income ended 30 June 2014

Year of income ended 30 June 2015

The scheme commences on:

1 July 2012

Relevant facts and circumstances

Factual arrangement

1. The Taxpayer is a member of the Fund. There is one other member of the Fund. The Taxpayer and the other member are the trustees of the Fund.

2. The Taxpayer has reached retirement age. Both members of the Fund are currently receiving pensions from their respective member accounts in the Fund.

3. The Taxpayer is the principal beneficiary of a Holding Trust. The Taxpayer is the trustee of the Holding Trust.

4. The Holding Trust was established several years ago and owns 100% of the shares in the Company.

5. The Company is a beneficiary of an Investment Trust. As at 30 June 2013, The Company's retained earnings principally consisted of unpaid present entitlements (UPE) from the Investment Trust. A significant proportion of the retained earnings of the Company were derived in connection with the disposal of an interest held in a connected business.

6. Immediately prior to undertaking the arrangement outlined at paragraph 9 below the assets of the Company will be exclusively cash and the Company will have no liabilities.

7. The Taxpayer is the trustee of a Unit Trust. The Unit Trust was recently established. As at 30 June 2013 the total trust funds of the Unit Trust were minimal.

8. 100% of the units in the Unit Trust are owned by the Fund. The members' interests in the Fund include the Fund's investment in the Unit Trust.

9. It is proposed that the following arrangement will be implemented:

10. As a result of the above scheme, the net economic effect is to be an increase of approximately $Y in the value of the assets of the Fund arising from a refund of the unused franking credit tax offset as referred to in paragraph 9(h) above.

11. It is said that the Taxpayer has over recent years made tax deductible donations and intends to continue to do so. It is said those tax deductible donations will equal or exceed the value of the refund of franking credits referred to in paragraph 9(h) above.

12. If the above proposal is not implemented, the Company will progressively pay franked distributions to the Holding Trust which will then be distributed to the beneficiaries of the trust, particularly the Taxpayer. If this were to occur the Holding Trust would not have a taxable capital gain and beneficiaries of the Holding Trust would continue to receive refundable franking credit tax offsets as a result of franked distributions. The Taxpayer is very community minded and committed to her religious principles and intends to make future tax deductible donations over the course of her life that may well total or exceed the size of any dividend from the Company.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177A

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

Income Tax Assessment Act 1997 Subdivision 207-F

Income Tax Assessment Act 1997 Section 207-35

Income Tax Assessment Act 1997 Section 207-45

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-155

Income Tax Assessment Act 1997 Section 295-390

Reasons for decision

Question 1

Summary

13. The Company franked distribution from the Company that flows through to the Fund is made as part of a dividend stripping operation within the meaning of paragraph 207-145(1)(d) of the ITAA 1997. As a consequence the amount of the franking credit on the distribution is not included in the assessable income of either the Unit Trust or the Fund and neither the Unit Trust nor the Fund are entitled to a tax offset because of the franked distribution (paragraphs 207-145(e), (f) and (g) of the ITAA 1997).

Detailed reasoning

Subsection 207-145(1)

14. Subsection 207-145(1) of the ITAA 1997 provides, relevantly, that where a franked distribution is made to an entity in circumstances where (in paragraph (d)) "the distribution is made as part of a dividend stripping operation", then, relevantly:

15. Section 207-155 of the ITAA 1997 defines when a distribution is made as part of a "dividend stripping operation" within the meaning of section 207-145(1)(d) as follows:

16. If the Company franked distribution is a distribution made "as part of a dividend stripping operation" within the meaning of paragraph 207-145(1)(d) of the ITAA 1997, the relevant effect will be that the amount of any franking credit on the distribution will not be included in the assessable income of the Fund and the Fund will not be entitled to a tax offset under section 207-45 of the ITAA 1997.

Dividend stripping operations

17. A "dividend stripping operation" has been recognised as involving the following characteristics:

18. A scheme may still be a "dividend stripping operation" because the making of a distribution was "by way of or in the nature of dividend stripping" even if it contains features which vary from the paradigm case of dividend stripping, so long as it retains the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45].

19. A difference between a scheme "by way of or in the nature of dividend stripping" and a scheme which has "substantially the effect" of a scheme "by way of or in the nature of dividend stripping" lies in the means adopted to distribute the profits of the target company. Where the means adopted do not involve a distribution, but some other step (such as the purchase by the target company of near worthless assets or assets later rendered near worthless by the target company) this involves a scheme having "substantially the effect" of a scheme "by way of or in the nature of dividend stripping": Lawrence v. FCT at [47] - [52].

Will the Company franked distribution be a distribution made as part of a dividend stripping operation?

20. The payment of the Company franked distribution that flows to the Fund will be made as part of a "dividend stripping operation" within the meaning of paragraph 207-145(1)(d) of the ITAA 1997 because each of the elements of a scheme "by way of or in the nature of dividend stripping" will be present. For the reasons below, each of the central characteristics of a scheme by way of or in the nature of dividend stripping identified in paragraph 17 above are satisfied.

21. First element: The Company has substantial undistributed profits. The Company's sole asset at the time of undertaking the arrangement will be cash deposits represented by retained earnings attributable to UPE from the Investment Trust. Accordingly, the element of a "dividend stripping operation" identified in paragraph 17(a) above is satisfied.

22. Second element: The Holding Trust will sell its shares in the Company to the Unit Trust. Accordingly, the element of a "dividend stripping operation" in paragraph 17(b) above is satisfied.

23. Third element: The Company will pay the Company franked distribution to the Unit Trust which is equal to the value of its retained earnings. Accordingly, the element of a "dividend stripping operation" in paragraph 17(c) above is satisfied.

24. Fourth element: The Company franked distribution will not be subject to tax in the hands of the Unit Trust as the franked distribution is to flow to the Fund. On the assumption that the Company franked distribution is not non-arm's length income of the Fund under either subsection 295-550(4) or (5) of the ITAA 1997, a proportion (as worked out under subsection 295-390(3) of the ITAA 1997) of that income and which would otherwise be assessable income of the Fund is said to be exempt from income tax under subsection 295-390(1) of the ITAA 1997. The relevant proportion of the Fund income that is said to be exempt is 100%. In the result, absent the application of subsection 207-145(1) of the ITAA 1997, the Fund will obtain a refund of the unused franking credit tax offset in relation to the Company franked distribution. Accordingly, the element of a "dividend stripping operation" in paragraph 17(d) above is satisfied. It does not detract from this conclusion that the acquirer of the shares will be the Unit Trust rather than the Fund directly. This is because the Fund owns 100% of the units in the Unit Trust and the franked distribution flows to the Fund with the consequence that neither the Unit Trust nor the Fund is subject to tax on the Company franked distribution.

25. Fifth element: The Holding Trust will receive a capital sum for the the Company shares which is equal to or approximately equal to the value of the Company's retained earnings. Accordingly, the element of a "dividend stripping operation" in paragraph 17(e) above is satisfied. It does not detract from this conclusion that the capital sum is initially recognised as a loan amount due to the Holding Trust by the Unit Trust, and that the loaned amount will be paid to the Holding Trust once the Company franked distribution has been paid to the Unit Trust by the Company.

26. Sixth element: The arrangement proposed and described at paragraph 9 above is carefully planned. It involves all the parties acting in concert for a predominant purpose. The objective purpose of the parties is to obtain:

27. This is because, among other reasons, the value of the Company franked distribution (absent the franking credit tax offset refund) obtained by the Unit Trust will be wholly offset by the liability created by the loan from the Company to purchase the Company shares. It is intended that the distribution will be used by the Unit Trust to pay the Holding Trust the loan amount in relation to the share acquisition. The franked distribution with the attached franking credit flows to the Fund on the basis it is presently entitled, however, the only economic effect of the arrangement for the Fund is the generation of the franking credit tax offset refund as referred to in paragraph 9(h) above.

28. It is no answer to say that the arrangement is undertaken for the purposes of retirement planning and simplification of the Taxpayer's tax affairs rather than for the purposes of avoiding tax. This is because that poses a false dichotomy of the kind referred to in Commissioner of Taxation v. Spotless Services Limited (1996) 186 CLR 404 (FCT v. Spotless) at [415 - 416]. On an objective assessment, the substantial aspect of the arrangement that makes it desirable retirement planning for the Taxpayer and gives rise to the enhanced value is the tax benefits obtained through indirectly channelling the Company franked distribution through to the Fund; namely, refund of the franking credit tax offset referred to in paragraph 9(h) above.

29. Furthermore, the fact that the trustee or the beneficiaries of the Holding Trust will be assessed on an amount reflecting a net capital gain or a share of a net capital gain in relation to the sale of the the Company shares to the Unit Trust does not mean that a "dividend stripping operation" cannot arise. In Lawrence v. FCT, the Full Court of the Federal Court observed at [44] that "notwithstanding the advent of comprehensive taxation of capital gains, this characteristic remains relevant because the methods of calculating capital gains invariably lead to a lower amount of tax".

30. The fact that the Taxpayer intends to use the benefits obtained from the channelling of the Company franked distribution through to the Fund to make tax deductible donations or that the Taxpayer would make tax deductible donations if the Taxpayer were to receive franked distributions as beneficiary of the Holding Trust absent the proposal (referred to in paragraph 9 above) is irrelevant to the question of whether the proposal objectively has a tax avoidance purpose.

Question 2

Summary

31. There is a scheme to which Part IVA and therefore section 177F of the ITAA 1936 applies. The Commissioner may make a determination under section 177F of the ITAA 1936 that has the effect of cancelling the tax benefit.

Section 177E of Part IVA of the ITAA 1936

32. Where the conditions of subsection 177E(1) of Part IVA of the ITAA 1936 are satisfied, paragraph 177E(1)(e) provides that the relevant scheme "shall be taken to be a scheme to which this Part applies". This has the result that the Commissioner is empowered to issue a determination cancelling a tax benefit under section 177F of the ITAA 1936.

33. The conditions in subsection 177E(1) of the ITAA 1936 are to the following effect:

(b) the scheme is one:

(c) a result of the scheme is that property of the target co is disposed of;

(f) the scheme was entered into after 27 May 1981.

See FCT v. CPH (FFC) at [118] - [123].

34. As noted above, if those conditions are satisfied, the scheme is taken to be one to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e)), and the taxpayer shall be taken to have obtained a tax benefit referable to an amount not being included in the assessable income of the taxpayer in the year of income: FCT v. CPH (FFC) at [124] - [127].

Are the conditions of subsection 177E(1) of the ITAA 1936 satisfied in relation to the franked distribution that flows from The Company to the Fund?

35. For the following reasons, each of the conditions in paragraphs 177E(1)(a) to (d) of the ITAA 1936 referred to in paragraph 33 above are satisfied.

36. First condition: The breadth of the definition of "scheme" in section 177A of the ITAA 1936 has been judicially noted: British American Tobacco Australia Services Ltd v. Federal Commissioner of Taxation [2010] FCAFC 130; (2010) 189 FCR 151 at [30]. It includes any "scheme, plan, proposal, action, course of conduct, or course of action". The matters in paragraph 9 above clearly constitute a scheme within the meaning of subsection 177A(1) of the ITAA 1936.

37. Moreover, the "scheme" described in paragraph 9 above is plainly a "scheme that is in relation to a company"; namely, the Company.

38. For this reason, the first condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(a) above is satisfied.

39. Second condition: For the reasons given above in paragraphs 20 to 30, the "scheme" is one by way of or in the nature of dividend stripping. For this reason, the second condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(b) above is satisfied.

40. Third condition: Subsection 177E(2) of the ITAA 1936 provides as follows:

41. The scheme involves the payment by the Company of the Company franked distribution to the Unit Trust and thus is a scheme the result of which is the disposal of property of The Company within the meaning of paragraph 177E(2)(a) of the ITAA 1936 (see paragraph 9(d) above).

42. Accordingly, the third condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(c) above is satisfied.

43. Fourth condition: As noted in paragraph 9(d) above, the Company franked distribution is to be paid in the amount which represents all of the Company's retained earnings. Therefore, the Commissioner has formed the view that the Company franked distribution will represent, in whole or in part, a distribution of the profits of The Company. For this reason, the fourth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(d) above is satisfied.

44. Fifth condition: If, before the scheme described in paragraph 9 is entered into, The Company paid a franked distribution equal to its retained earnings to its then shareholder, being the Holding Trust, it is reasonable to expect that an amount would have been included in the assessable income of the beneficiaries of the Holding Trust. For this reason, the fifth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(e) above is satisfied.

45. Sixth condition: The scheme is to be entered into after 27 May 1981. Therefore, the sixth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 33(f) above is satisfied.

46. For those reasons, if the scheme in paragraph 9 above is entered into, it will be taken to be a scheme to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e)) and the beneficiaries of the Holding Trust will be taken to have obtained a tax benefit in connection with the scheme, being the amount which, had the Company paid the franked distribution prior to entering into the scheme, would have formed part of their assessable income (paragraphs 177E(1)(f) and (g) of the ITAA 1936).

Question 3

Summary

47. There is a scheme to which section 177EA of the ITAA 1936 applies. The Commissioner may therefore determine (under paragraph 177EA(5)(b) of the ITAA 1936) that no imputation benefit arises for the Fund in respect of that distribution.

Detailed reasoning

Section 177EA of the ITAA 1936

48. Subsection 177EA(5) of the ITAA 1936 gives the Commissioner the power (relevantly, in paragraph (b)) to determine that no imputation benefit is to arise in respect of a distribution or specified part of a distribution that is made or flows indirectly to a relevant taxpayer.

49. In Mills v. Federal Commissioner of Taxation [2012] HCA 51; (2012) 87 ALJR 53 (Mills v. FCT) at [59], it was pointed out that subsection 177A(3) "is an exhaustive statement of the jurisdictional facts that are necessary and sufficient for s177EA to apply so as to found an exercise of power by the Commissioner to deny a franking credit under s177EA(5)(b)".

50. The "jurisdictional facts" can be relevantly identified as follows:

51. The "relevant circumstances" are defined in subsection 177EA(17) of the ITAA 1936 to include 11 matters, the last of which (in paragraph 177EA(17)(j)) includes the eight matters in paragraphs 177D(2)(a) to (h) of the ITAA 1936.

52. Section 177EA of the ITAA 1936 was considered by the High Court in Mills v. FCT. The following propositions emerge from the judgment of Gageler J (with whom the other members of the Court agreed):

Application of paragraphs 177EA(3)(a) - (d) of the ITAA 1936

53. It is clear that the "jurisdictional facts" in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 and described in paragraphs 50(a) to (d) above are satisfied. This is because:

54. Accordingly, the question as to whether the power to make a determination under subsection 177EA(5) will arise turns on whether the relevant purpose in paragraph 177EA(3)(e) is present.

Is it more than an incidental purpose of the scheme to enable the Fund to obtain an imputation benefit?

55. As was observed in Mills v. FCT, the relevance of each of the factors in subsection 177EA(17) of the ITAA 1936 and the probative weight they bear will differ in each case (at [61]).

56. Some of the "relevant circumstances" in subsection 177EA(17) of the ITAA 1936 can be put aside as irrelevant. Because the Unit Trust will be the sole shareholder in the Company, there is no question of it deriving a "greater benefit" than other persons who hold membership interests. Thus, the circumstances in paragraphs 177EA(17)(b), (c) and (d) can be put to one side. Equally, the scheme described in paragraph 9 above does not involve the issue of non-share equity and so the matter in paragraph 177EA(17)(e) can be put to one side. These matters are generally concerned with "dividend streaming" arrangements: see Mills v. Federal Commissioner of Taxation [2011] FCAFC 158; 198 FCR 89 at [43]

57. Some of the "relevant circumstances" in subsection 177EA(17) of the ITAA 1936 point, at least to some extent, against the existence of the relevant purpose. The consideration paid to the Holding Trust for the shares in the Company does not appear to have been calculated by reference to any imputation benefits (cf., paragraph 177EA(17)(f)). The Company franked distribution does not appear to be equivalent to receipt of an amount in the nature of interest (cf., paragraph 177EA(17)(h)). The Company franked distribution appears to be paid from taxed and not untaxed profits (cf., paragraph 177EA(17)(ga)). These matters, to the extent that they bear probative weight, point against the relevant conclusion as to purpose.

58. The following matters in subsection 177EA(17) of the ITAA 1936 point towards the existence of the relevant purpose:

59. Turning to the matters in paragraphs 177D(2)(a) to (h) of the ITAA 1936 which are picked up by paragraph 177EA(17)(j) of the ITAA 1936, the following are relevant:

60. Overall, the balance of matters points towards a conclusion that a more than incidental purpose of the scheme is to enable the Fund to gain the benefit of a franking credit tax offset refund. The critical factor in an assessment of purpose is the absence of any explanation for the implementation of the scheme other than to ensure that the franking credits of the Company are channelled to the ultimate economic owner (the Taxpayer) of the Company through the Fund and thus with the benefit of the exemption in section 295-390 of the ITAA 1997, which gives rise to the consequent refund of the franking credit tax offset. As observed above, this is the net effect of the scheme.

61. It is no answer to say that the main purpose of the scheme is the maximising of the Taxpayer's retirement benefits or simplifying her tax affairs. That draws the same false dichotomy as was rejected in FCT v. Spotless. This is because it is the tax effect referred to above which achieves the maximisation of retirement benefits over that which would otherwise be achieved (see paragraph 28 above). Moreover, The Taxpayer's intention to make tax deductible donations is irrelevant for the reasons given in paragraph 30 above.


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