Edited version of your private ruling

Authorisation Number: 1012649478908

Ruling

Subject: Retirement planning proposal

Question 1

Are the franked distributions from A Pty Ltd (the Company) to the B Superannuation Fund (the Fund) non-arm's length income of the Fund under section 295-550 of the Income Tax Assessment Act (ITAA 1997)?

Answer

Yes

Question 2

Are the franked distributions 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 ITAA 1997?

Answer

Yes

Question 3

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 4

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 ending 30 June 2014

Year of income ending 30 June 2015

Year of income ending 30 June 2016

The scheme commences on:

1 July 2013

Relevant facts and circumstances

1. Taxpayer 1 and taxpayer 1's spouse have reached retirement age.

2. Taxpayer 1 owns all of the issued shares of A Pty Ltd (the Company). Taxpayer 1, taxpayer 1's spouse and one other family member are the directors of the Company. The Company has received distributions from related discretionary trusts in its capacity as a beneficiary over a number of years. The Company does not presently conduct any trading activities and will not conduct any trading activities in the future.

3. At 30 June 2013 the Company's sole asset is cash (retained earnings). At 30 June 2013 there was $X standing to the credit of the Company's franking account.

4. It is advised that the market value of the shares in the Company is approximately equal to the cash assets of the Company.

5. Taxpayer 1 and taxpayer 1's spouse are the only two members of the B Superannuation Fund (the Fund). C Pty Ltd is the corporate trustee of the Fund. Taxpayer 1 and taxpayer 1's spouse are the directors of C Pty Ltd. Taxpayer 1 and taxpayer 1's spouse are each currently receiving a superannuation income stream benefit (pension) from the Fund.

6. At 30 June 2013 the Fund had total assets of approximately $X including cash, direct property, indirect property and fixed interest.

7. It is intended that the following steps will be implemented:

(a) the shares in the Company will be purchased by the Fund from taxpayer 1 for the market value which is stated to be $X;

(b) the Fund will pay taxpayer 1 for the shares with cash;

(c) the shares will support the continued payment of superannuation income streams to taxpayer 1 and taxpayer 1's spouse by the Fund;

(d) taxpayer 1 is expected to make a net capital gain on the sale of the shares in the Company and will have a tax liability in respect of that capital gain;

(e) at least 45 days after the purchase of the shares, the Company will pay a fully franked distribution to the Fund of $X. The franking credit on this distribution will be approximately $X;

(f) a fully franked distribution of $X per annum will be paid by the Company to the Fund for at least X years. The franking credits on each annual distribution will be approximately $X;

(g) the annual franked distributions, including the franking credits, are said to be exempt from income tax on the basis that a proportion (as worked out under subsection 295-390(3) of the ITAA 1997) of the franked distributions, which would otherwise be assessable income of the Fund, will be exempt from income tax under subsection 295-390(1) of the ITAA 1997 (the relevant proportion is expected to be 100%);

(h) the Fund is also said to be entitled to an annual refund of the unused franking credit tax offsets (which arise from the franking credits of approximately $X per annum);

(i) as a result of these steps, the Fund will receive a net amount of approximately $X per annum for 10 years being the franked distribution of approximately $X and a refund of the unused franking credit tax offset of approximately $X;

(j) taxpayer 1 and taxpayer 1's spouse will be paid superannuation lump sums from the Fund in addition to the superannuation income streams as a result of the annual franked distributions and the refund of the franking credit tax offsets.

8. Taxpayer 1 and taxpayer 1's spouse have advised that the purpose in taking these steps is to increase the liquidity of the Fund to enable the Fund to meet the minimum pension requirements without liquidating the property assets of the Fund.

9. If the steps at paragraph 7 are not undertaken taxpayer 1 and taxpayer 1's spouse will continue to make contributions, both concessional and non-concessional and subject to the caps, to the Fund while they are eligible, to generate sufficient cash flow. Other options would be to look for other suitable investments that would generate similar returns or to liquidate current investments.

Assumptions

10. The Company will no longer be a beneficiary of the discretionary trusts (as mentioned in paragraph 2).

11. There will be no further distributions to the Company from related entities, such as the discretionary trusts mentioned at paragraph 2, following the acquisition of the shares in the Company by the Fund.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

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 section 207-20

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 section 207-155

Income Tax Assessment Act 1997 section 295-545

Income Tax Assessment Act 1997 section 295-550

Reasons for decision

Question 1

Summary

12. Leaving aside considerations of section 207-145 of the ITAA 1997 and Part IVA of the ITAA 1936 as dealt with in the subsequent questions, the franked distributions from the Company to the Fund would be non-arm's length income of the Fund under subsection 295-550(2) of the ITAA 1997. The franked distributions would therefore not be exempt as current pension income under either subsection 295-385(1) or 295-390(1) of the ITAA 1997.

Detailed reasoning

13. In accordance with section 295-545 of the ITAA 1997 the income of a complying superannuation fund is split into a 'non-arm's length component' and a 'low tax component'.

14. The note to subsection 295-545(1) of the ITAA 1997 explains that a concessional rate (15%) of tax applies to the low tax component, while the non-arm's length component is taxed at the highest marginal tax rate (45%). These rates are set out in the Income Tax Rates Act 1986.

15. Subsection 295-545(2) of the ITAA 1997 provides that the non-arm's length component for an income year is the entity's non-arm's length income for that year less any deductions to the extent that they are attributable to that income. The phrase 'non-arm's length income' has the meaning given by section 295-550 of the ITAA 1997.

16. Dividends paid to an entity by a private company, along with ordinary or statutory income reasonably attributable to such a dividend (such as the franking credits), are non-arm's length income of the entity unless the amount is consistent with an arm's length dealing (subsection 295-550(2) of the ITAA 1997).

17. Subsection 295-550(3) of the ITAA 1997 requires consideration of the following matters when deciding whether an amount is consistent with an arm's length dealing:

(a) the value of shares in the company that are assets of the entity; and

(b) the cost to the entity of the shares on which the dividend was paid; and

(c) the rate of that dividend; and

(d) whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend; and

(e) whether the company has issued any shares to the entity in satisfaction of a dividend paid by the company (or part of it) and, if so, the circumstances of the issue; and

(f) any other relevant matters.

18. The Commissioner has issued Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income. This Ruling refers to former section 273 of the ITAA 1936 which concerned 'special income' (now termed non-arm's length income) and continues to provide the ATO view so far as the new provision (section 295-550 of the ITAA 1997) expresses the same ideas as section 273.

19. In the facts of this case the shares are to be purchased at their stated market value, such that the shares are reflected at that market value in the members' accounts. This is a relevant consideration under paragraph 295-550(3)(a) of the ITAA 1997 and the acquisition of shares at market value is consistent with an arm's length dealing.

20. The rate of the dividend (paragraph 295-550(3)(c) of the ITAA 1997) is also relevant and refers to the amount of the dividend (or dividends) paid per share over a period of time (e.g. annually) by a company. In this case the dividend rate reflects the distribution of all of the assets of the Company over a period of time.

21. As the Fund is the only shareholder there is no comparison to be made as between the rate of dividends paid to the Fund and the rate of dividends paid to any other shareholder (paragraph 295-550(3)(d) of the ITAA 1997).

22. Other relevant factors (paragraph 295-550(3)(f) of the ITAA 1997) to consider include the market value of the shares as compared with the dividend rate and the rate of return on investment and also the level of investment risk undertaken by the Fund in relation to the dividend rate and the rate of return.

23. It is considered that taking into account the acquisition of the shares at the stated market value, the dividend rate, the rate of return, the lack of risk and the certainty that all of the assets of the Company will be paid to the Fund as fully franked dividends given all parties are related, the dividend income of the Fund is non-arm's length income.

• The Fund has minimal or nil investment risk as the only asset of the Company is cash, the Company has no liabilities and there are no trading or investment activities being conducted by the Company.

• There is no risk that the dividends won't be paid given the non-arm's length relationship that exists between all parties involved.

• During the period of time the shares are held by the Fund it will, for minimal or nil investment risk, realise all of the assets of the Company giving it a return of 100% based on the stated market value of the shares (in total) being approximately $X and an after tax return in excess of 100% (i.e. with the refund of the unused franking credit tax offsets).

• The market value of the shares is said to be commensurate with its cash assets which takes no account of the statutory right to the franking credit tax offsets and the subsequent refunds that are conferred on the Fund as a result of the transactions.

24. Therefore, subsection 295-550(2) of the ITAA 1997 would apply to the Fund with respect to its receipt of the franked distributions from the Company. The franked distributions would not be exempt current pension income of the Fund (under subsection 295-385(1) or 295-390(1) of the ITAA 1997).

Question 2

Summary

25. The franked distributions from the Company to the Fund are made as part of a dividend stripping operation within the meaning of paragraph 207-145(1)(d) of the ITAA 1997. Consequently the amount of the franking credit on each of the distributions is not included in the assessable income of the Fund under section 207-20 of the ITAA 1997 and the Fund is not entitled to tax offsets under Subdivision 207-F because of the distributions (paragraphs 207-145(e) and (f) of the ITAA 1997).

Detailed reasoning

Subsection 207-145(1) of the ITAA 1997

26. 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 207-145(1)(d)) 'the distribution is made as part of a dividend stripping operation', then, relevantly:

(a) (in paragraph 207-145(1)(e)) the amount of the franking credit on the distribution is not included in the assessable income of the entity under section 207-20 or 207-35 of the ITAA 1997; and

(b) (in paragraph 207-145(1)(f)), the entity is not entitled to a tax offset under Subdivision 207-F because of the distribution.

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

A distribution made to a *member of a *corporate tax entity is taken to be made as part of a dividend stripping operation if, and only if, the making of the distribution arose out of, or was made in the course of, a *scheme that:

(a) was by way of, or in the nature of, dividend stripping; or

(b) had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

28. If the franked distributions from the Company to the Fund are 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 distributions will not be included in the assessable income of the Fund and the Fund will not be entitled to tax offsets under Subdivision 207-F of the ITAA 1997.

Dividend stripping operations

29. A 'dividend stripping operation' has been recognised as involving the following characteristics:

(a) a company with substantial undistributed profits (target co);

(b) a sale or allotment of shares in target co to another party;

(c) the payment of a dividend to the purchaser or allottee of shares by target co;

(d) the acquirer escaping Australian income tax on the dividend so declared;

(e) the vendor shareholder receiving a capital sum for their shares in an amount the same as or very close to the dividend paid out; and

(f) the transactions being carefully planned, with the parties acting in concert for the predominant purpose of avoiding tax on the distribution of dividends by target co.

See Commissioner of Taxation v. Consolidated Press Holdings Ltd [1999] FCA 1199; (1999) 91 FCR 524 (FCT v. CPH (FFC)) at [136] - [137] and [157], Commissioner of Taxation v. Consolidated Press Holdings Ltd [2001] HCA 32; (2001) 207 CLR 235 (FCT v. CPH (HC)) at [126] and [129]; and Lawrence v. Federal Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277 (Lawrence v. FCT) at [42] - [43].

30. 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].

31. 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 franked distributions from the Company to the Fund be distributions made as part of a dividend stripping operation?

32. The payment of the franked distributions from the Company 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 (identified in paragraph 29 above) of a scheme 'by way of, or in the nature of, dividend stripping' will be present.

33. First element: The Company has substantial undistributed profits. Its only asset is cash (retained earnings). This creates a potential tax liability for taxpayer 1in relation to the retained earnings. If the franked distributions were paid to taxpayer 1, under subparagraph 44(1)(a)(i) of the ITAA 1936, he would be assessed on an amount reflecting the retained earnings. Accordingly, the element of a dividend stripping operation identified in paragraph 29(a) above is satisfied.

34. Second element: There will be a sale or allotment of shares in the target co to another party. Taxpayer 1 will sell all of the shares in the Company to the Fund. Taxpayer 1 will receive a capital sum for those shares

35. There is nothing in the concept of a scheme by way of or in the nature of a dividend stripping operation which would require that the sale or transfer involve a share trader or be a company-to-company transaction attracting an inter-company dividend rebate. In FCT v. CPH (FFC) at [136], the Full Court referred to a dividend stripping operation involving a sale and allotment to individuals. Accordingly the element of a "dividend stripping operation" in paragraph 29(b) above is satisfied.

36. Third element: The Company will pay franked distributions to the Fund equal to the value of the Company's retained earnings. The fact that the franked distributions are paid to the Fund over several years and not as a single distribution is merely a "variation on the paradigm" which will not remove the scheme from satisfying the central characteristics of a "dividend stripping operation": FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45]. Alternatively, the scheme will have "substantially the effect" of a scheme "by way of or in the nature of dividend stripping". Accordingly, the element of a dividend stripping operation in paragraph 29(c) above is satisfied.

37. Fourth element: On the assumption that the franked distributions are not non-arm's length income of the Fund (within the meaning of section 295-550 of the ITAA 1997) the franked distributions are said to be exempt income of the Fund under section 295-390 of the ITAA 1997. In the result, absent the application of subsection 207-145(1) of the ITAA 1997 the Fund will obtain refunds of the unused franking credit tax offsets (arising from franking credits) in relation to the franked distributions.

38. The reference in FCT v. CPH (FFC) at [136] to various different means by which tax can be escaped (including application of an inter-company dividend rebate) was not an exhaustive description of the means by which tax can relevantly be escaped on the dividend by a dividend stripping operation. Accordingly, the element of a dividend stripping operation in paragraph 29(d) above is satisfied.

39. Fifth element: Taxpayer 1 will receive a capital sum of approximately $X for the sale of the shares in the Company to the Fund. That capital sum approximately equals the dividend amounts that are to be paid out by the Company to the Fund. Accordingly, the element of a "dividend stripping operation" in paragraph 29(e) above is satisfied. It is not significant that the payments are spread over a number of dividends, rather than paid at once. This is no more than a "variation on the paradigm" which does not remove the scheme from one satisfying the central characteristics of a "dividend stripping operation".

40. Sixth element: The sixth element of a dividend stripping operation identified in paragraph 29 above is satisfied for the following reasons:

(a) The arrangement proposed and described at paragraph 7 above is carefully planned. It involves all the parties acting in concert. The parties are all related, being taxpayer 1and their family members, or companies controlled by them.

(b) From the point of view of the Fund, the principal or pre-dominant economic effect of the arrangement proposed and described at paragraph 7 above is obtaining tax benefits: namely, the attraction of the exemption in subsection 295-390(1) of the ITAA 1997 to the franked distributions and generating refunds of the unused franking credit tax offsets of $X per annum. Those tax benefits overwhelmingly provide the explanation for the increase in the cash flow and value of the Fund as a result of the arrangement.

(c) From the point of view of the vendor shareholder (taxpayer 1), the principal or predominant effect of the proposed arrangement is the substitution of a capital amount for the disposal of the shares instead of franked distributions with a resultant lower incidence of tax (under the applicable capital gains tax provisions): see Lawrence v. FCT at [44]. If the retained earnings of the Company were paid as franked distributions by the Company, then taxpayer 1could expect to incur a larger tax liability. The dividend and franking credit tax offset refund amounts are available for subsequent tax free distribution as superannuation benefits to taxpayer 1 and taxpayer 1's spouse.

(d) It is no answer to say that the arrangement is undertaken for the purposes of providing cash flow to pay for the superannuation benefits for taxpayer 1 and taxpayer 1's spouse rather than for the purpose 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 aspect of the arrangement that makes it desirable for cashflow planning for taxpayer 1 and taxpayer 1's spouse is the tax benefits obtained through the channeling of the franked distributions through the Fund: namely, the exemption of the franked distributions and the refund of the franking credit tax offsets referred to in paragraphs 7(h) and (i) above. The only additional cash added to the Fund is through the refund of the franking credit tax offsets since the Fund has to initially purchase the shares with existing cash assets of the Fund.

(e) The cashflow objective could be more simply achieved by the Company distributing its assets by way of franked distributions to taxpayer 1. The relevant difference being the tax effects achieved by the arrangement proposed and described at paragraph 7 above would not be achieved.

(f) Furthermore, the fact that Taxpayer 1 may be assessed on a net capital gain made in respect of the disposal of the shares in the Company to the Fund 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'.

Question 3

Summary

41. 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 that has the effect of cancelling the tax benefit.

Detailed reasoning

Section 177E of Part IVA of the ITAA 1936

42. 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'; and paragraph 177E(1)(f) provides that 'the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme' with the result that the Commissioner is empowered to issue a determination cancelling the tax benefit under section 177F of the ITAA 1936.

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

(b) there is a 'scheme' of the kind defined in subsection 177A(1) of the ITAA 1936 that is in relation to the company (target co);

(c) the scheme is one:

(i) by way of or in the nature of dividend stripping; or

(ii) having substantially the same effect as dividend stripping;

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

(e) the Commissioner forms the opinion that the disposal of property by the target co represents in whole or in part a distribution whether to a shareholder (called the vendor shareholder) or another person of profits of target co;

(f) had the target co, immediately before the scheme was entered into, paid a dividend out of profits equal to the amount of profits represented by the target co's disposal of property (the 'notional amount'), the notional amount would or might reasonably be expected to have been included by reason of the payment of the dividend in the assessable income of a taxpayer in a year of income; and

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

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

43. 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 the notional 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 distributions from the Company to the Fund?

44. For the following reasons, each of the conditions in paragraphs 177E(1)(a) to (d) of the ITAA 1936 referred to in paragraph 43 above is satisfied.

45. 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 steps in paragraph 7 above clearly constitute a scheme within the meaning of subsection 177A(1) of the ITAA 1936.

46. The scheme described in paragraph 7 above is plainly a 'scheme that is in relation to a company', namely A Pty Ltd.

47. For this reason, the first condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(a) above is satisfied.

48. Second condition: For the reasons given above in paragraphs 32 to 40 the steps set out in paragraph 7 above involves a 'scheme' 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 43(b) is satisfied.

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

Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to:

(a) the payment of a dividend by the company;

(b) the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid);

(c) a bailment of property by the company; and

(d) any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company.

50. The scheme, involves the payment by the Company of the franked distributions to the Fund 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 paragraphs 7(h) and (i) above).

51. Accordingly, the third condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(c) above is satisfied.

52. Fourth condition: As noted above in paragraphs 7(h) and (i), the franked distributions are to be paid in an amount totaling, approximately $X which represents the Company's retained earnings. Therefore, the Commissioner has formed the view that the franked distributions 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 43(d) above is satisfied.

53. Fifth condition: If, before the scheme described in paragraph 7 above was entered into, the Company paid a franked distribution out of profits to its then shareholder being taxpayer 1, it is reasonable to expect that an additional amount would have been included in his assessable income equal to the value of the (grossed up) franked distributions. For this reason, the fifth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(e) above is satisfied

54. 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 43(f) above is satisfied.

55. For those reasons, if the scheme in paragraph 7 above is entered into, there will be taken to be a scheme to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e) of the ITAA 1936). Further, taxpayer 1 will be taken to have obtained a tax benefit in connection with the scheme, being the amount which, had the Company paid franked distributions prior to entering into the scheme, would have formed part of his assessable income (paragraph 177E(1)(f) and (g)).

Question 4

Summary

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

Detailed reasoning

Section 177EA of the ITAA 1936

57. Subsection 177EA(5) of the ITAA 1936 gives the Commissioner the power (relevantly, in paragraph 177EA(5)(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.

58. 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 177EA(3) of the ITAA 1936 '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)'.

59. The 'jurisdictional facts' can be relevantly identified as follows:

(a) there is a scheme for the distribution of membership interests, or interests in membership interests, in a corporate tax entity (paragraph 177EA(3)(a) of the ITAA 1936). This includes entering into a contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interests in membership interests (paragraph 177EA(14)(b));

(b) a frankable distribution has been paid, or is payable, or expected to be payable in respect of the membership interest or has flowed indirectly, or flows indirectly, or is expected to flow indirectly in respect of the interest in membership interests (paragraph 177EA(3)(b));

(c) the distribution was, or is expected to be, a franked distribution (paragraph 177EA(3)(c));

(d) except for section 177EA, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, an imputation benefit as a result of the distribution (paragraph 177EA(3)(d)). An 'imputation benefit' includes receipt by the taxpayer of a tax offset under Division 207 of the ITAA 1997 or, in the case of a corporate taxpayer, a franking credit arising in the franking account of the taxpayer (subsection 177EA(16));

(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' (paragraph 177EA(3)(e)).

60. 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.

61. 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):

(a) the relevance of the 'relevant circumstances' in subsection 177EA(17) lies in the extent to which they are probative of the ultimate question of purpose (at [61]);

(b) the circumstances referred to in subsection 177EA(17) are not exhaustive of the circumstances that might be probative of that ultimate question. They are nevertheless mandatory relevant considerations. Where they exist, they must be taken into account and their degree of relevance will vary according to the extent to which they are probative of the ultimate question (at [61]);

(c) the reference to purpose in paragraph 177EA(3)(e) may, but need not, be that of the issuer. A purpose is a consequence intended by a person to result from some action and, in this context, refers to a consequence intended by the person in entering into or carrying out a scheme for the disposition of relevant interests. A person will often intend a single action to have multiple consequences (at [63]);

(d) a purpose is an 'incidental purpose' within the meaning of paragraph 177EA(3)(e) if it does no more than follow from some other purpose. A purpose can be incidental even when it is central to the design of a scheme if the design is directed to the achievement of another purpose (at [64] and [66]);

(e) the reference to 'enabling' in paragraph 177EA(3)(e) refers to 'supplying with the requisite means or opportunities' to the end of obtaining an imputation benefit (at [65]);

(f) a relevant purpose within the scope of paragraph 177EA(3)(e) need not be a 'dominant purpose'; a 'dominant purpose' is sufficient but not necessary to supply the relevant jurisdictional fact. It does not follow that 'a purpose which does no more than further or follow from some dominant purpose is incidental' (at [66]);

(g) counterfactual analysis is not antithetical to the assessment of purpose in paragraph 177EA(3)(e). Consideration of alternatives may assist the drawing of conclusions in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if it does exist, whether it is incidental to some other purpose (at [66]);

(h) in the case of a capital raising, if the franking of distributions serves no purpose other than to facilitate the capital raising, then the purpose is an incidental purpose within the meaning of paragraph 177EA(3)(e) (at [67]); and

(i) in the assessment of purpose in subsection 177EA(3), each of the factors in subsection 177EA(17) need not be analysed individually, so long as they are all taken into account, where probative, in a global assessment of purpose (at [73]).

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

62. It is clear that the 'jurisdictional facts' in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 and described in paragraphs 60(a) to (d) above are satisfied. This is because:

(a) there is a 'scheme for the disposition of membership interests' as the relevant scheme involves the sale of shares in the Company by taxpayer 1 to the Fund (see paragraph 7(a) above). Accordingly, the jurisdictional fact in paragraph 177EA(3)(a) is satisfied;

(b) it is expected that the distributions to the Fund will be frankable distributions and they are expected to be franked distributions (see paragraphs 7(e) and (f) above). Accordingly, the jurisdictional fact in subparagraph 177EA(3)(b)(i) and paragraph 177EA(3)(c) is satisfied:

(c) except for section 177EA, the Fund could reasonably be expected to receive an imputation benefit as a result of the franked distributions. Accordingly, the jurisdictional fact in paragraph 177EA(3)(d) is satisfied.

63. Accordingly, the question as to whether the Commissioner has the power to make a determination under subsection 177EA(5) of the ITAA 1936 then 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 imputation benefits?

64. 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]).

65. Some of the 'relevant circumstances' in subsection 177EA(17) of the ITAA 1936 can be put aside as irrelevant. Because the Fund 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 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].

66. 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:

(a) the consideration paid by the Fund for the shares in the Company does not appear to have been calculated by reference to any imputation benefits (cf., paragraph 177EA(17)(f)). However, given the close relationship of all parties to the scheme, the fact that the scheme involves circular payments as between those related parties and the fact that the tax effect of the scheme is not dependent on the dividend being calculated by reference to the franking credits, the weight of this factor is slight;

(b) the franked distributions do not appear to be equivalent to receipts of amounts in the nature of interest (cf., paragraph 177EA(17)(h));

(c) the franked distributions appear 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.

67. The following matter in subsection 177EA(17) of the ITAA 1936 points to the existence of the relevant purpose:

(a) the period of time the Fund will hold the shares in the Company prior to the payment of the first franked distribution is short. The Company will conduct no trading activities in the period the Fund holds the shares and its asset is wholly cash. The extent and duration of the risk of loss the Fund will bear as a result of its holding of the shares in the Company will be minimal. After payment of each franked distribution, the Company's value will be diminished until it will be worthless. The Fund was not the economic owner of the shares when the Company generated the franking credits and will not bear any significant risk in the period of its holding of the shares in the Company. This undermines the principles of the imputation system: Explanatory Memorandum to the Taxation Laws (Amendment) Bill (No 3) at [8.5] (cf., paragraphs 177EA(17)(a) and (i));

(b) if the Company is subsequently deregistered or the shares are otherwise disposed of by the Fund once all retained earnings are paid out, this will give rise to a capital loss for the Fund thus incurring a capital loss in connection with the distributions being made (cf., paragraph 177EA(17)(g)). However, as any such capital loss cannot be utilised while the Fund is entirely in pension phase, this factor would be of limited weight.

68. 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:

(a) the scheme involves a carefully orchestrated and interlinked series of transactions (cf., paragraph 177D(2)(a)) between persons who are, or who are all connected with, taxpayer 1 (cf., paragraph 177D(2)(h));

(b) the scheme's form involves a sale of the shares in the Company to the Fund and payment of franked distributions to it. The substance of the scheme (that is, 'what in fact [the relevant person] may achieve by carrying it out': Mills v. FCT at [71]) is the channelling of the distribution of the profits and the franking credits of the Company to its ultimate economic owner (taxpayer 1) through the Fund in order to generate a refund of the franking credits (cf., paragraph 177D(2)(b));

(c) the scheme is to be implemented over number of years, which is determined by the period necessary to pay the retained earnings of the Company as dividends (cf., paragraph 177D(2)(c));

(d) the effects of the scheme (that is, the financial position of the relevant persons with and without the scheme: Mills v. FCT at [70]) will be as follows (cf., paragraphs 177D(2)(d) - (f)):

(i) the Fund will receive the franked distributions ($X per annum; in total $X) as well as a refund of the franking credit tax offsets ($X per annum; in total $X) on the basis that the franked distributions are exempt income pursuant to section 295-390 of the ITAA 1997. The Fund at any time may also choose to deregister the Company or to dispose of the shares to generate a capital loss. The Fund will utilize an amount of cash to purchase the shares which will be recouped as payment of the franked distributions occurs. The difference in the economic position of the Fund with and without the scheme is overwhelmingly due to the effect of the refund of the franking credit tax offsets. (cf., paragraph 177D(2)(d));

(ii) taxpayer 1will receive a capital amount for the sale of the shares and thus will have an amount, referable to the net capital gain made upon disposal of the shares in the Company included in his assessable income and, because of the method of calculating net capital gains, this will be a lesser amount than would be included if the franked distributions were paid directly to him. (cf., paragraph 177D(2)(d)); and

(iii) taxpayer 1 and taxpayer 1's spouse will each receive the benefit of superannuation benefits being a pension or lump sums in a tax free form from the Fund - supported by the franked distributions and the refunds of the franking credit tax offsets received by the Fund. In the absence of the scheme taxpayer 1would otherwise reasonably expect to receive franked distributions from the Company and he could reasonably expect to incur a taxation liability in respect of that income. (cf., paragraph 177D(2)(e)).

69. 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 an imputation benefit each year. The critical factor in an assessment of purpose is the absence of any substantial explanation for the implementation of the scheme other than to ensure that the Company's franking credits are channeled, to their ultimate economic owner (Taxpayer 1) through the Fund with the benefit of the exemption in section 295-390 of the ITAA 1997. This has the effect of converting the franking account of the Company to cash which is then used to support taxpayer 1 and spouse's retirement income. A further taxation benefit is the conversion of the Company's funds on which taxpayer 1could reasonably expect to incur a taxation liability to a capital sum with a lower taxation liability.

70. It is no answer to say that the main purpose of the scheme is to provide cash flow for taxpayer 1's and spouse's retirement. 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 additional cash flow than that which would otherwise be achieved.

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