Edited version of your written advice

Authorisation Number: 1012849317397

Date of advice: 31 July 2015

Ruling

Subject: Part IVA and dividend access share arrangement

Questions and answers

1. Will section 177E of the Income Tax Assessment Act 1936 apply to the dividend access share arrangement?

Yes.

2. Will section 177D if the Income Tax Assessment Act 1936 apply to the dividend access share arrangement?

Yes.

3. Is there a narrower scheme identified by the Commissioner to which Part IVA of the 1936 Act applies?

Invalid.

4. Is there a wider scheme identified by the Commissioner to which Part IVA of the 1936 Act applies?

Invalid.

This ruling applies for the following periods:

1 July 2014 to 30 June 2015

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

Relevant facts and circumstances

1. The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description except to the extent that these may be contradictory. The relevant documents are:

• the application for private ruling for the company (being a previous ruling request);

• the application for private ruling for the individual rulees (being a previous ruling request);

• the additional application for private ruling for the individual rulees (being a previous ruling request);

• the Commissioner's private ruling for the individual rulees, (relating to a previous ruling request);

• the application for private ruling for the company and the individual rulees (the rulees) (the current ruling request);

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

• records of conversation with respect to the above applications.

2. Included in the above documents are statements made by the individual rulees, the Original Shareholders, as to the facts and circumstances behind the proposed business restructure. The description below incorporates a summary of the factual elements from those statements.

3. The documents also include references to other ruling requests previously considered in relation to this matter which covered the same proposed business restructure as at issue currently in relation to the application of section 177E of the Income Tax Assessment Act 1936. The description below largely incorporates all the facts considered in the previous ruling plus additional facts provided in the current ruling application.

Background

Brief History

4. The individual rulees are all children of the deceased.

5. The deceased's parent passed away and the deceased took over business.

6. From an early time, the deceased invested profits of the business made in good years in assets for use during bad years.

7. The deceased established a company ('Banking Company').

8. The deceased established a Trust. The trustee is company 2.

9. The Trust operated the business.

a. The Banking Company is a beneficiary of the Trust.

b. Profits from the business were distributed to the Banking Company, which held primarily cash and listed shares.

10 In difficult years, Banking Company was used as a bank to fund the business operations.

11. The retained profits from the good years were distributed from the Trust to the Banking Company for the purpose of the Banking Company investing in assets in anticipation of future difficult years.

12. Banking Company was not in the habit of declaring dividends to either the deceased, or following the deceased's death, to the children, the individual rulees. Dividends have only been declared:

c. to the deceased, in an earlier income year, to resolve a Division 7A issue that had arisen for each of the children; and

d. to the individual rulees in earlier income years to meet minimum loan requirements on Division 7A loans put in place after the individual rulees began to carry out their restructure.

13. The equity of the Banking Company consists of:

• fully paid ordinary shares

• fully paid A class share

• fully paid B class share

• Capital profit reserve

• Retained profits

14. The deceased controlled the investment decisions of the company up until death.

15. However, in the last 10 years of the deceased's life, the deceased had deferred more and more of the day to day control of the business to the children, the individual rulees, but the deceased remained involved in this business until death.

16. A current diagram of the Family tree has been provided with the application.

Existing Business Structure

17. A diagram of the current family business structure has been provided with the application. The Trust continues to carry on the business.

18. The shareholding of the Banking Company is divided equally between the individual rulees.

19. In addition to the shareholdings of the Banking Company, each of the individual rulees also hold other substantial assets in their own names.

20. The Trust carries on its business with the above assets.

21. The extended family is involved in the running of the Trust's business. The family members have worked their own respective businesses for many years.

Reasons for the Restructure

22. The rulees have stated that the restructure has been motivated by two considerations.

a. Following the deceased's death, each individual rulee wanted greater control of the business being carried that involved the individual rulee's asset(s).

b. As part of considering how a restructure could be implemented, the rulees became aware of poor asset protection in the existing structure, where each individual rulee's shares in Banking Company (which was to provide for difficult years in the future) were exposed to claims made against the individual rulees. The rulees wanted to limit the assets that were exposed to claims in the future.

23. Any restructure would need to achieve both objectives.

Risks of claims made against the individual rulee's personally

24. There are risks of accidents occurring in relation to an individual rulees' asset. This is inherent in the individual rulees using their assets to allow the Trust to carry on the business.

25. The rulees have attempted to protect against these risks by taking out insurance in relation to their assets.

a. The Trust has taken out insurance on behalf of the owners for the assets, covering:

i. house insurance;

ii. public liability insurance; and

iii. motor vehicle and truck insurance.

b. One individual rulee has insured a new asset acquired to be used in their own business once the business has separated. However, it may be used to hold Trust assets prior to the business separation.

26. In relation to these risks, the individual rulees could be joined as a party if any accident occurred. The issue would be whether the insurer accepted liability under the respective insurance contract. The rulees are concerned that accidents may occur that are excluded from the respective insurances contracts.

27. A relevant history of Workcover claims has been provided as part of the application and it shows a number of incidents and accidents have occurred.

28. To date, however, no claim has ever been made against the individual rulees personally in relation to any accidents or injuries that have occurred.

29. The individual rulees' insurance companies have always accepted liability for every claim the individual rulees have made in relation to any injuries or accidents that occurred. The only occasion where a claim was rejected was when an employee lodged a fictitious claim with Workcover.

Proposed Structure

30. A diagram of the proposed structure for each family has been provided with the application.

31. Intending to achieve the objectives of:

a. dividing the assets of the existing business into separate new businesses; and

b. providing asset protection to the families controlling the separate New Banking Companies for the separate new business;

the following steps have/will be taken.

32. Two business trusts have been established for each of the families. One trust will operate the to-be-separated business ('Operating Trust') while the other will hold the business assets ('Investment Trust'). Copies of the respective trust deeds have been provided with the application.

33. Banking Company has issued a redeemable preference shares to each of the Operating Trusts and the Investment Trusts.

a. The redeemable preference shares are redeemable at any time at the direction of the directors for nil value.

b. The redeemable preference shares are automatically redeemed at the end of 47 months after they have been issued.

Terms of the redeemable preference shares have been provided with the application.

34. Each family has established a family trust and company (New Banking Companies). For each New Banking Company, 100% of the ordinary shares are held by the new family trust of the respective family. None of the business owners (or any other individual) holds any shares in the New Banking Companies.

Company constitutions of the New Banking Companies and the family trust deeds for each of the shareholder trusts have been provided with the application.

35. The rulees now propose:

a. for Banking Company to declare and pay partially franked dividends to each of the families' respective Operating Trusts and Investment Trusts under the terms of the redeemable preference shares; and

b. distribute the net income those trusts receive, including all of the franking credits, to the New Banking Companies for each of the respective families.

36. After completion of this restructure the Banking Company will be liquidated and a liquidator's dividend paid to the individual rulees as ordinary shareholders.

37. The rulees have received advice as to the effectiveness of the structure in relation to asset protection. A copy of the advice has not been provided.

Relevant legislative provisions

Income Tax Assessment Act 1936 subparagraph 44(1)(a)(i)

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 paragraph 177C(1)(a)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 subsection 177D(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 paragraph 177D(2)(b)

Income Tax Assessment Act 1936 subsection 177D(3)

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 subsection 177E(1)

Income Tax Assessment Act 1936 paragraph 177E(1)(a)

Income Tax Assessment Act 1936 subparagraph 177E(1)(a)(i)

Income Tax Assessment Act 1936 subparagraph 177E(1)(a)(ii)

Income Tax Assessment Act 1936 paragraph 177E(1)(b)

Income Tax Assessment Act 1936 paragraph 177E(1)(c)

Income Tax Assessment Act 1936 paragraph 177E(1)(d)

Income Tax Assessment Act 1936 paragraph 177E(1)(e)

Income Tax Assessment Act 1936 paragraph 177E(1)(f)

Income Tax Assessment Act 1936 subsection 177E(1)(g)

Income Tax Assessment Act 1936 paragraph 177E(2)(a)

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1936 paragraph 177F(1)(a)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1997 Section 207-20

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 paragraph 207-145(1)(d)

Income Tax Assessment Act 1997 paragraph 207-145(1)(g)

Income Tax Assessment Act 1997 section 207-155

Reasons for decision

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) of the Income Tax Assessment Act 1936 (ITAA 1936)).

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

• Section 177E of the ITAA 1936 - Dividend stripping schemes to which Part IVA applies.

• Section 177D of the ITAA 1936 - Schemes to which Part IVA applies.

Previous private ruling dated 12 September 2015

In the previous private ruling, which concerned the same proposed restructure that is at issue currently, the Commissioner ruled that section 177E of the ITAA 1936 applied to the dividend access share arrangement. The main point of the ruling was that the purpose of dividing the assets of the existing business could be achieved more conveniently, commercially and frugally by an arrangement that does not involve the dividend access share (the DAS). The ruling noted the following, which continues to be relevant to the current considerations.

Section 177E(1) of the ITAA 1936 states:

Where:

(a) as a result of a scheme that is, in relation to a company:


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

(ii) a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

the following provisions have effect:

(e) the scheme shall be taken to be a scheme to which this Part applies;

(f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

(g) the amount of that tax benefit shall be taken to be the notional amount.

177E(1)(a:) as a result of a scheme that is, in relation to a company: (i) a scheme by way of or in the nature of dividend stripping; or (ii)a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping, any property of the company is disposed of

Is there a scheme that satisfies subparagraphs 177E(1)(a)(i) or (ii)?

Scheme is defined in subsection 177A(1) of the ITAA 1936 to mean:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan proposal, action, course of action or course of conduct.

Here, the DAS Arrangement clearly constitutes a scheme as defined in subsection 177A(1) of the ITAA 1936.

In order for the arrangements to be one by way of dividend stripping, the following elements must be established:

(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 target 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 dividends paid to the purchasers (there being no capital gains tax at the relevant times); and

(6) the scheme being carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company.

The first four elements of a dividend stripping are present here because:

(1) The Company carries substantial undistributed profits which, if distributed, would expose the taxpayers (Original Shareholders) to a potential tax liability;

(2) There is an allotment of RPSs to the New Shareholders, that is, the trustees of the Investment Trusts and Z Trusts;

(3) The Company will declare and pay almost fully franked dividends to the New Shareholders out of its accumulated profits;

(4) The Corporate Beneficiaries of the Investment Trusts and Z Trusts to which the dividends will be appointed by those trusts will not incur any tax liability to the extent to which the dividends are franked. As the dividends will be almost fully franked, the Corporate Beneficiaries will incur little additional tax.

The issue is the fifth element that is whether the vendor shareholders (that is, the Original Shareholders) will receive a capital sum in an amount close to the dividend paid to the New Shareholders.

The issue of whether the vendor shareholders receive anything was discussed by Jessup J in the first instance of Lawrence. Jessup J stated:

In the present case an accretion of capital, the same in effect as such a receipt, arose from the increase in the value of the assets held by the Clearmink No. 1 and No. 2 Trusts, to which the applicant and his family were beneficially entitled. 

Here, as the assets of the Corporate Beneficiaries increase, the shares in the Corporate Beneficiaries will become more valuable. As the Family Trusts own the shares to which the Original Shareholders and their family are beneficially entitled, this accretion to the capital of the Family Trusts would constitute a capital sum being received by the Original Shareholders to compensate them for the Company's profits paid to the New Shareholders. As such, applying the above reasoning of Jessup J, the fifth element is present.

This leaves the last element, namely whether the DAS Arrangement has, as its dominant purpose, the avoidance of tax on the distribution of dividends by the Company. In considering this element, it is necessary to examine all of the evidence of the arrangement and to consider the relevant objective features of the arrangement to determine whether the arrangement has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits from the Company. Importantly, an arrangement that has a non-tax purpose may be undertaken for the dominant purpose of avoiding tax.

One objective matter relates to the complexity of the arrangement. The most straightforward manner by which the Original Shareholders can establish their own separate businesses is having the Company pay an in-specie dividend to themselves and transferring the in-specie dividend to their own separate trusts. Given the magnitude of the Company's retained profits, the in-specie dividend would be subject to a rate of tax above the company tax rate, though the Original Shareholders would have the benefit of any available franking credits.

However, after the proposed arrangement is carried out, the accumulated profits of the Company will have been distributed in a complex and contrived manner to entities associated with the Original Shareholders whilst avoiding any additional tax to the Original Shareholders.

In short, the separate business restructures could arguably be achieved more 'conveniently, commercially and frugally' without the creation of the RPSs. Similarly in Federal Commissioner of Taxation v. Hart [2004] HCA 26 2004 at paragraph 94, Callinan J, in the context of 177D(b)(ii) of the ITAA 1936, noted that it was relevant to consider whether the substance of the transaction in question (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction.

There is also a particular feature of the arrangement which appears to have been included to avoid specific provisions within the income tax legislation. The DAS Arrangement contains a requirement that the RPSs must be redeemed within four years, which is a feature inexplicable but for the avoidance of the direct value shifting provisions.

While the private ruling application for the Alternative Arrangement was later withdrawn, the fact that the Original Shareholders put forward the Alternative Arrangement as a substitute proposal also sheds light on the purpose of the DAS Arrangement. Although the Original Shareholders claim that the predominant purpose for the DAS Arrangement is to allow them to operate separate businesses, when it became unclear as to whether a favourable private ruling would be issued on that arrangement, the Original Shareholders did not revert to choosing to implement the most straightforward method discussed above of achieving that goal.

Rather they put forward a second proposed arrangement (being the Alternative Arrangement) that like their first proposal also entailed the payment of the Company's retained profits as dividends to the family trusts of the Original Shareholders rather than directly to the Original Shareholders.

The fact that a second proposed arrangement was developed that like the first, results in the accumulated profits of the Company being distributed in a complex and contrived manner to entities associated with the Original Shareholders whilst avoiding additional tax to the Original Shareholders, points towards tax avoidance being the predominant purpose of both proposed arrangements. If the business restructure itself was the primary overriding motivation, it would be expected that if the most expedient manner to achieve that purpose was not chosen as the first option, at the very least, it would be chosen as the second.

Furthermore, the Alternative Arrangement involved an additional step of borrowing from a bank. When the DAS Arrangement was being proposed, there was no intention that the UPE owed by the Trust would be paid out. It was originally intended under both proposed arrangements that an in-specie dividend including the UPE owed to the Company would be distributed. The borrowing of the funds is considered to be a significant undertaking and would not be necessary if the Original Shareholders chose the most straightforward method of achieving the business restructure. The fact that the Original Shareholders were willing to do this to ensure that the Alternative Arrangement remained an attractive option from a tax perspective rather than simply choosing the most straightforward option also points towards a tax avoidance purpose.

It is also noted that the Original Shareholders have now advised that if a favourable private ruling on the DAS Arrangement is not provided, the Company will continue operating as previously. This contradicts the Original Shareholders' claim that their primary motivation for entering into the arrangement is to separate the business. Their statement shows that this motivation is secondary; they only wish to separate the business if they do not have to pay tax on the Company's remaining accumulated profits at their marginal tax rates.

In other words, the Original Shareholders cannot contend that their overriding objective is to separate the business and they have simply chosen the most tax effective way of doing this as they are now essentially saying that they will not separate the business at all unless they are able to avoid additional tax. This demonstrates that the fact they pay less tax under the DAS Arrangement is not merely a fortunate by-product of them choosing the scheme but the main reason why they chose it.

In light of all of the above, with particular reference to the form chosen for the arrangement, it is considered that the arrangement is one that is entered into for a dominant purpose of avoiding the imposition of any additional tax that the Original Shareholders would be subject to if the accumulated profits were distributed to them. As such, the DAS Arrangement constitutes a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of the ITAA 1936.

As a result of the scheme, is property of the Company disposed of?

The second element of paragraph 177E(1)(a) of the ITAA 1936 is whether as a result of the arrangement (which is a scheme by way of or in the nature of dividend stripping) any assets of the company is disposed of.

Paragraph 177E(2)(a) of the ITAA 1936 states that a reference in subsection 177E(1) of the ITAA 1936 to the disposal of property of a company shall be read as including a payment of a dividend by the company.

As the Company will pay a dividend to the New Shareholders, this second element of paragraph 177E(1)(a) of the ITAA 1936 is satisfied.

It follows that subsection 177E(1) of the ITAA 1936 is satisfied.

177E(1)(b) - in the opinion of the Commissioner, the disposal of the property referred to in paragraph 177E(1)(a) of the ITAA 1936 represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period)

The relevant disposal of assets under the arrangement is the payment of a dividend by the Company to the New Shareholders. This shows that the disposal represents a distribution of profits of the Company. As such, this condition is met.

177E(1)(c): if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income

Here, if, immediately prior to the execution of the DAS Arrangement, the Company paid a dividend out of profits equal to the amount of dividend to be paid to the New Shareholders, that dividend would have been paid to the Original Shareholders, and would have been included in their assessable income by virtue of subparagraph 44(1)(a)(i) of the ITAA 1936. As such, the notional amount for the purpose of subsection 177E(1) of the ITAA 1936 is the amount of the dividend to be paid to the RPS holder.

Therefore, paragraph 177E(1)(c) of the ITAA 1936 is satisfied.

177E(1)(d): The scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia

The final requirement that the scheme be carried out after 27 May 1981 is clearly satisfied.

The arguments for the taxpayers

The Original Shareholders have put forward a number of arguments.

The first is that a need has arisen, following the death of the deceased, to distribute the accumulated profits of the Company among its shareholders (the children of the deceased) so that they can establish their own separate businesses. Secondly, it is necessary for the various trusts, not the Original Shareholders, to own the assets to be distributed by the Company for asset protection purposes. It has been claimed these two reasons show the commercial and non-tax driven purpose of the arrangements.

It is true that there has been a triggering event - the deceased's death - that necessitates the commercial reorganisation of the business structure left behind by the deceased. However, as already discussed, these arguments for the individual rulees are not considered persuasive as the reorganisation can be achieved more conveniently, commercially and frugally without the creation of the RPSs.

Also, it is clear that asset protection was only a consideration with respect to deciding what type of structure the business should be operated under once it was separated; it was not the reason for the restructure. This is supported by the fact that we have been advised that if not for the desired separation of the business, the Original Shareholders would be content for the Company to continue operating as it always has.

The individual rulees also contend that there is no tax avoidance purpose as additional tax will be paid under the proposed arrangement in the form of capital gains tax payable by the Company on the in-specie distribution of the listed shares to the Investment Trusts. However, if instead of the proposed arrangement, the more straightforward method to distribute the assets to the Original Shareholders took place by paying a dividend to them by way of in-specie distribution then the Company would still have to pay capital gains tax on the transfer of the listed shares.

The individual rulees also state that further tax will be payable on the appointment by the Investment Trusts and Z Trusts of the dividend to the Corporate Beneficiaries as the dividend will not be completely fully franked. However, further tax is also payable under the more straightforward method of separating the business where a dividend is paid by the Company to the Original Shareholders.

Therefore, it is not accepted that additional tax is payable on choosing the DAS Arrangement over the more straightforward method to achieve a restructure.

By now stating that if a favourable ruling is not given, that the Company will essentially continue operating as previously, it appears that the Original Shareholders are attempting to avail themselves of the 'do nothing' counterfactual to show there is no tax benefit. The 'do nothing' counterfactual may have been available under the previous wording of section 177C of the ITAA 1936 in determining whether there would be a tax benefit for the purposes of section 177D of the ITAA 1936 and section 177F of the ITAA 1936.

Section 177C of the ITAA 1936 has now been amended to remove the 'do nothing' counterfactual as an argument for taxpayers. It is noted that the new section 177C of the ITAA 1936 only applies to schemes entered into after 12 November 2012 which is not the case here.

However, this is of no consequence in this case as section 177C of the ITAA 1936 is not relevant in considering section 177E of the ITAA 1936. This is confirmed by the following statement in the Explanatory Memorandum to the Income Tax Laws Amendment Bill (No 2) 1981 (Cth) which introduced Part IVA:

Section 177F…will come into play once section 177D, together with section 177C (for the general run of cases), or section 177E (for dividend stripping and similar schemes) has done its work

For the purposes of section 177E of the ITAA 1936, 'tax benefit' is determined according to paragraphs 177E(1)(f) and (g) of the ITAA 1936. The 'do nothing' counterfactual is not available under these paragraphs.

Conclusion on section 177E of the ITAA 1936

Because all the criteria in paragraphs 177E(1)(a) to (d) of the ITAA 1936 are satisfied, in accordance with paragraphs 177E(1)(e), (f) and (g) of the ITAA 1936:

• the arrangement is a scheme to which Part IVA applies;

• for the purposes of section 177F of the ITAA 1936, the taxpayer (that is, the Original Shareholders) is taken to have obtained a tax benefit in connection with the arrangement; and

• the amount of that tax benefit is taken to be the notional amount referred to in paragraph 177E(1)(c) of the ITAA 1936.

In this case, where a dividend is paid out of the accumulated profits of the Company to the New Shareholders, the Commissioner would exercise his discretion to make a determination under paragraph 177F(1)(a) of the ITAA 1936 to include in each of the Original Shareholders' assessable income the 'tax benefit' being their share of the dividend.

This conclusion is consistent with Taxation Determination TD 2014/1 which provides the Commissioner's view as to the application of section 177E of the ITAA 1936 to 'dividend access share' arrangements.

As the more specific integrity provision of section 177E dealing with dividend stripping is considered to apply in this case, the Commissioner has not considered the application of section 177D.

Further issues for you to consider

It should be noted that section 207-145 of the ITAA 1997 modifies the normal gross up and tax offset entitlement treatment afforded by sections 207-20, 207-35 and 207-45 of the ITAA 1997 in respect of the receipt of a franked distribution in certain circumstances. One of these circumstances, as provided in paragraph 207-145(1)(d) of the ITAA 1997, is when a franked distribution is made as part of a 'dividend stripping operation'. This term is defined in section 207-155 of the ITAA 1997 in similar terms to section 177E of the ITAA 1936. Given the conclusion reached in respect of the application of 177E of the ITAA 1936, it is considered that the above arrangement would constitute a dividend stripping operation for the purposes of paragraph 207-145(1)(d) of the ITAA 1997. This would have the effect of the non-inclusion of any franking credit amount attached to the franked distribution made as part of the arrangement in the assessable income of the corporate beneficiaries of the New Shareholders, as well as the denial of any tax offset entitlement to those corporate beneficiaries in respect to the distribution which flows indirectly through the New Shareholders to them, per the operation of paragraph 207-145(1)(g) of the ITAA 1997.

Current ruling application and additional facts for consideration under section 177E of the ITAA 1936

The main submission provided by the applicant, in the current ruling, is that the asset protection purposes cannot be achieved by any arrangement that does not involve the use of dividend access shares as any other arrangement would be subject to the claw back provisions under the Bankruptcy Act 1966. Therefore, it is stated that the arrangement is chosen to achieve the two commercial purposes, and thus not for a purpose of avoiding tax.

Before examining whether the arrangement would avoid the application of the clawback provisions, we need to determine whether the litigation risk does exist. If there is no such risk, the clawback provisions would not apply.

The rulees have made an assertion that this is a dangerous business and there is a real risk that they can be personally sued for accidents and injuries occurring in the business.

It is accepted that the history of Workcover claims does show a number of incidents and injuries have occurred. However, that does not necessary mean that the individual rulees are personally exposed to the litigation risks.

What the history of Workcover claims shows is that the individual rulees are adequately protected from the litigation risks.

There is no evidence of the individual rulees ever having been sued or threatened with proceedings in relation to the accidents or injuries.

The litigation risk by the rulees is perceived and not real. In the absence of any personal proceedings brought against the individual rulees or claims being rejected by Workcover, it cannot be said that a real risk exists.

Therefore, the applicant has not provided an evidential basis to substantiate their claim. This conclusion is consistent with the conclusion reached in recent decisions dealing with 'asset protection' claims. As was stated in Track, in rejecting an asset protection claim, there was no satisfactory explanation of the nature of any potential risk, but more importantly 'any satisfactory reason why insurance against such a risk was not available or adequate'.

Accordingly, as the applicant has not established the existence of the risk, there is no need to consider the clawback provisions of the Bankruptcy Act 1966.

As concluded in the previous ruling, the purpose of dividing the assets of the business can be achieved more conveniently, commercially and frugally by an arrangement that does not involve the dividend access shares. Furthermore, as discussed, the applicant has not substantiated the existence of the litigation risk.

Consequently, the arrangement is entered into for a dominant purpose of avoiding tax and therefore section 177E of the ITAA 1936 applies.

Section 177D of the ITAA 1936

Subsection 177D(1) of the ITAA 1936 states;

This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) 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 the purpose of:

(a) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in

connection with the scheme; or

(b) enabling the relevant taxpayer and another taxpayer (or other taxpayers)

each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or

any part of the scheme is the relevant taxpayer or is the other taxpayer or

one of the other taxpayers.

Subsection 177D(2) of the ITAA 1936 provides;

For the purpose of subsection (1), have regard to the following matters:

(a) the manner in which the scheme was entered into or carried out;

(b) the form and substance of the scheme;

(c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Subsection 177D(3) of the ITAA 1936 states;

Despite subsection (1), this Part applies to the scheme only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme.

The arrangement as described above constitutes a scheme for the purposes of 177D of the ITAA 1936.

As shown in subsection 177D(1) of the ITAA 1936, the first question to be answered when determining whether section 177D of the ITAA 1936 applies to an arrangement is to ask whether a participant in the arrangement had the requisite purpose of securing a tax benefit for the taxpayer in connection with the scheme. Therefore, it is necessary to decide whether the rulees entered into or carried out the arrangement for the purpose (or the dominant purpose) of enabling themselves to obtain a tax benefit in connection with the arrangement. The purpose is to be ascertained by having regard to the eight matters listed in subsection 177D(2) of the ITAA 1936.

The rulees stated that the sole or dominant purpose of entering into the arrangement was to achieve the commercial objectives of: dividing the assets of the existing business into separate businesses; and providing asset protection to the rulees.

However, as already discussed in relation to section 177E of the ITAA 1936, the rulees did not establish the existence of the litigation risk and therefore it cannot be accepted that there is a need to protect the assets. Therefore, the only commercial objective that can be achieved by the arrangement is dividing the assets of the existing business.

It is accepted that the arrangement does achieve the commercial purpose of dividing the assets of the existing business. However, it is possible for an arrangement to be both tax-driven and commercial. As such, the presence of a discernible commercial end does not determine the answer to the question posed by section 177D of the ITAA 1936 and, therefore, 'it becomes apparent that the inquiry directed by Pt IVA requires comparison between the arrangement in question and an alternative postulate'. In other words, 'to draw a conclusion about purpose from the eight matters identified in subsection 177D(2)(b) of the ITAA 1936 will require consideration of what other possibilities existed'.

Therefore, it is necessary to determine whether there exists an alternative postulate that achieves the commercial objective in a more convenient, commercial and frugal way. In the present case, if the arrangement is not entered into, it might be reasonably expected that the rulees, to achieve the commercial purpose, would personally receive dividends from the Banking Company and transfer the dividends to their associated entities. This would result in the dividend being included in the assessable income of the individual rulees.

This alternative postulate, having particular regard to the substance of the arrangement and its results and consequences for the rulees, is a reasonable alternative to entering into the arrangement. Furthermore, the fact that this alternative postulate incurs a tax liability (i.e. the dividend being included in the assessable income of the individual rulees) is not a relevant consideration in assessing the reasonableness of the alternative postulate.

The eight matters in subsection 177D(2) of the ITAA 1936 are considered against the background of this alternative postulate.

Eight matters in subsection 177D(2)

(a) the manner in which the scheme was entered into or carried out

The most straightforward and commercial manner by which the individual rulees can establish their own separate businesses is having the Banking Company pay an dividend to themselves and transferring the dividend to their own separate trusts. Given the magnitude of the Company's retained profits, the dividend would be subject to a rate of tax above the company tax rate, though the individual rulees would have the benefit of any available franking credits.

However, under the arrangement, the rulees will have the Banking Company issue the redeemable preference shares to entities associated with them for a nominal consideration. These associated entities will receive a large amount of dividend notwithstanding that the only consideration they provided for the redeemable preference shares is nominal. This is highly artificial and contrived, and would not normally be present in a commercial transaction. Because of this highly artificial and contrived part of the arrangement, the accumulated profits of the Banking Company will have been distributed in a complex and contrived manner to entities associated with the rulees whilst avoiding any additional tax to the individual rulees. In short, the separate business restructures could arguably be achieved more conveniently, commercially and frugally without the creation of the redeemable preference shares.

There is also a particular feature of the arrangement which appears to have been included to avoid specific provisions within the income tax legislation. The arrangement contains a condition that the redeemable preference shares will be automatically redeemed at the end of 47 months after they have been issued, which is a feature inexplicable but for the avoidance of the direct value shifting provisions.

Therefore, this factor highly suggests there is a dominant purpose of obtaining tax benefit.

(b) the form and substance of the scheme

The form of the Scheme is an arrangement that divides the assets of the Banking Company into separate businesses. However, the substance of the Scheme is an arrangement to achieve the commercial purpose in a manner that avoids tax. The part of the arrangement that involves the issuance of the redeemable preference share has no explanation other than the purpose of obtaining a tax benefit.

This artificial manner in which the accumulated profits of the Banking Company are distributed is a feature that separates form from substance. Therefore, this factor also highly suggests there is a dominant purpose of obtaining a tax benefit.

(c) the time at which the scheme is entered into, and the length of the period during which it is carried out

The arrangement is to be entered into because of the death of the deceased. Since the deceased's death, a need has arisen to separate the business structure he created so they will be separately owned by the individual rulees. Therefore, there clearly exists a non-tax related event that triggers the arrangement.

However, the arrangement contains a condition that the redeemable preference shares must be redeemed within four years, which is a feature inexplicable but for the avoidance of the direct value shifting provisions. Therefore, this part of the arrangement suggests there is a purpose of obtaining a tax benefit.

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

The arrangement allows the Banking Company to distribute its accumulated profits to the individual rulees' associated entities, instead of its shareholders (i.e. the individual rulees), in a complex and contrived manner whilst avoiding any additional tax to the individual rulees. As the individual rulees would be required to pay tax if the accumulated profits are distributed in a most conventional and commercial manner, this factor also shows there is a dominant purpose of avoiding tax.

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

The arrangement will achieve the commercial purpose, which is that the accumulated profits of the Banking Company will be relocated to the separate family trusts of the individual rulees. As this non-tax related result is achieved, this factor indicates there is no dominant purpose of avoiding a tax benefit.

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has result, will result or may reasonably be expected to result, from the scheme

As a result of the arrangement, the individual rulees' family trusts will own shares in the New Banking Companies to which the accumulated profits of the Banking Company will be relocated. This does achieve the commercial purpose and therefore shows the dominant purpose of entering into the arrangement is not tax-related.

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out

There is no other consequence.

(h) the nature of nay connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred in in paragraph (f)

Each individual rulee will be a director of the New Banking Company, which will be owned by each of the family trusts. Each individual rulee will be a discretionary beneficiary of the family trust. These connections show the desire of the rulees to relocate the accumulated profits of the Banking Company into separate entities, each of which is respectively associated with each of the individual rulees. Therefore, this nature of connection shows the desire of the rulees to liberate the accumulated profits in the Banking Company into the associated entities without paying any additional tax. This shows there is a dominant purpose of obtaining a tax benefit.

Conclusion as to the dominant purpose

Having regard to the eight matters, it can be concluded that the dominant purpose of the arrangement is to obtain a tax benefit.

Tax benefit

The term 'tax benefit' is explained in section 177C of the ITAA 1936, which includes;

an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.

In the present case, if the arrangement is not entered into, it might be reasonably expected that the rulees, to achieve the commercial purpose, would personally receive dividends from the Banking Company and transfer the dividends to their associated entities. This would result in the dividend being included in the assessable income of the individual rulees. As already discussed, this alternative postulate, having particular regard to the substance of the arrangement and its results and consequences for the individual rulees, is a reasonable alternative to entering into the arrangement.

As such, if the arrangement is not entered into, an amount not being included in the assessable income of the individual rulees might reasonably expected to be included in their assessable income. This satisfies the definition of a tax benefit in paragraph 177C(1)(a) of the ITAA 1936.

Conclusion

Part IVA applies to the arrangement under section 177D of the ITAA 1936.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).