Edited version of private advice

Authorisation Number: 1012652676263

Ruling

Subject: Redeemable preference shares

Question 1

Will the issue of the Redeemable Preference Shares (RPSs) give rise to the direct value shifting (DVS) rules applying under Division 725 of the Income Tax Assessment Act 1997 (ITAA 1997) and as such cause CGT event K8 to occur?

Answer

No.

Question 2

Will section 725-90 of the ITAA 1997 (about direct shifts that are reversed) apply to prevent any consequences under Division 725 of the ITAA 1997 for any direct value shift that happens upon the variation of rights to dividends attached to the RPSs where those rights cease within four years and no realisation event has happened to an affected interest in the company before that cessation?

Answer

Yes.

Question 3

Will section 725-90 of the ITAA 1997 (about direct shifts that are reversed) apply to prevent any consequences under Division 725 of the ITAA 1997 for any direct value shift that happens upon the declaration and payment of a dividend to the holder of the RPSs?

Answer

Yes.

Question 4

Will the dividend stripping provisions in section 177E of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the issue of the RPSs?

Answer

No.

Question 5

Having regard to the factors in section 177D of the ITAA 1936, would the Commissioner make a determination under section 177F of the ITAA 1936 to cancel any tax benefits that may be obtained under the proposal?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2013

Relevant facts and circumstances

The arrangement that is the subject of the private ruling involves a redeemable preference share.

The arrangement is set out in the following documents:

• the application for private ruling

• further documentation, including emails, received in relation to the application; and

• records of conversation with respect to the application.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 725-90.

Income Tax Assessment Act 1936 Section 177E.

Income Tax Assessment Act 1936 Section 177D.

Income Tax Assessment Act 1936 Section 177F.

Reasons for decision

All subsequent legislative references are to the ITAA 1936 unless otherwise stated.

Direct value shifts

There can be consequences under Division 725 of the ITAA 1997 where there is a direct value shift involving the equity or loan interests in an entity.

However, a reversal exception is provided by section 725-90 of the ITAA 1997. It applies where the state of affairs that is brought about by the things done under the scheme:

• will more likely than not cease to exist within four years after the time that the first of those things is done; and

• does not still exist at the earlier of the end of those four years or when a realisation event happens to an affected interest for the direct value shift.

The legislative context shows that the term 'state of affairs' is used to refer to the factual circumstance that is the trigger or cause for the value shift. The state of affairs is one but for which the direct value shift would not have happened: paragraph 725-90(1)(a) of the ITAA 1997. The example that follows subsection 725-90(1) of the ITAA 1997 reads:

Under a scheme, the voting rights attached to a class of shares in a company are changed. As a result, the market value of shares in that class decreases, and the market value of other classes of shares in the company increases. The company's constitution provides that the change is to last for only 3 years.

Issue of the RPSs

The RPSs do not have any dividend rights at the time of issue. Consequently, the market value of each RPS is its face value, representing capital that is contributed by each new shareholder. The RPSs are therefore not issued at a discount. There will also not be a decrease in the value of Company X's shares as a result of issuing the RPSs. That is, the issuance of the RPSs has not caused any value to be shifted.

Therefore the issue of the RPSs does not give rise to the DVS rules applying under Division 725 of the Income Tax Assessment Act 1997 (ITAA 1997) and does not cause CGT event K8 to occur.

Attachment of dividend right

With respect to any direct value shift that may happen upon the attachment of a dividend right to each RPS, the relevant state of affairs is that Company X has accumulated profits, and there is a further class of shares on issue with discretionary dividend rights.

It is more likely than not that this state of affairs will cease to exist within four years, as the terms of the attachment of the dividend right stipulate that the right will cease by the earlier of the directors' decision or within four years from the issue of the RPS.

Consequently, the reversal exception will apply to any direct value shift on the attachment of the dividend right as long as:

• the dividend right in fact ceases to exist within four years; and

• a realisation event doesn't happen to an affected interest for the direct value shift while the dividend right is still is still in existence (for example, no shares in Company X are sold while the dividend right is still in existence).

Declaration and payment of a dividend to the holder of the RPSs

With respect to any direct value shift that may happen upon the declaration of a dividend to the holder of the RPSs, the relevant state of affairs is that a dividend is payable to the holder. This state of affairs will cease to exist when the dividend is paid, an event that will happen within the four year period.

Consequently, the reversal exception will apply to any direct value shift upon the declaration of a dividend with respect to the RPSs.

Part IVA

Part IVA contains a number of anti-avoidance provisions. It gives the Commissioner the discretion to cancel a 'tax benefit' that, but for the operation of the Part, has been, or would be, obtained by a taxpayer in connection with a scheme to which Part IVA applies (subsection 177F(1)).

The Commissioner considers that two anti-avoidance provisions have potential application to the particular facts of this case:

• Section 177D - Schemes to which Part IVA applies

• Section 177E - Dividend stripping schemes to which Part IVA applies

As section 177E is the more specific provision, it will be considered first.

Section 177E - Dividend stripping schemes to which Part IVA applies

The first requirement of subsection 177E(1) is that there is a scheme by way of or in the nature of dividend stripping or, in the alternative, there must be a scheme having substantially the effect of the aforementioned scheme.

TD 2014/1 states:

In deciding whether there is a scheme 'by way of dividend stripping' or 'in the nature of dividend stripping' within the meaning of section 177E of Part IVA it is necessary to determine if there is an objective purpose of tax avoidance in respect of the scheme. In determining objective purpose, a simple assertion that another non-tax purpose exists will not of itself conclusively determine the issue.

Any such assertion must:

• be supported by the other available evidence; and

• not be inconsistent with the objective facts of the case having regard to all the other relevant evidence.

In examining this point, particular note has been taken of the fact that there is objective evidence of a non-tax purpose for the scheme and that explanations have been provided of why other arrangements cannot achieve that non-tax purpose. Given all the specific facts of the taxpayer's individual circumstances, it has been accepted that the necessary objective purpose of tax avoidance is not present.

Consequently, the proposed arrangement is not considered to be a scheme 'by way of or in the nature of dividend stripping'. Therefore, section 177E is not considered to apply in this particular case.

Section 177D - Schemes to which Part IVA applies

A scheme will be one to which Part IVA applies by operation of section 177D if a taxpayer has obtained a tax benefit in connection with the scheme and it would be concluded that the dominant purpose of a person who entered into or carried out the scheme (or a part of the scheme) was to obtain a tax benefit.

As discussed further above, it has been accepted that in the particular facts of this case, a dominant purpose of tax avoidance is not present. Consequently, the proposed arrangement is not a scheme to which Part IVA applies by operation of section 177D.

As neither section 177E or 177D apply, a determination would not be made under section 177F to cancel any tax benefit that may be obtained under the proposed arrangement.

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