Edited version of your written advice

Authorisation Number: 1051228877035

Date of Advice: 24 May 2017

Ruling

Subject: Refund of Franking Credits

XYZ - Ability to obtain a refund of franking credits

Question 1

If ACo Pty Ltd (ACo) were to pay a dividend to XYZ, would section 207-120 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to reduce the amount of refundable franking credits available to XYZ?

Answer

No.

Question 2

Will the Commissioner make a determination under subsection 177EA(5) of the Income Tax Assessment Act 1936 (ITAA 1936) that the payment of a dividend from ACo to XYZ would be a scheme to which section 177EA of Part IVA of the ITAA 1936 applies?

Answer

Yes.

Question 3

3(a) Is the creation of loans between ACo and XYZ as a result of the transfer of property, a scenario to which section 207-155 of the ITAA 1997 applies to reduce the amount of refundable franking credits available to XYZ?

3(b) If ACo were to pay a dividend to XYZ, would this also result in section 207-155 of the ITAA 1997 applying to reduce the amount of refundable franking credits available to XYZ?

Answer

3(a) Yes.

3(b) Yes.

Question 4

If BCo were to pay a dividend to XYZ, would section 207-120 of the ITAA 1997 apply to reduce the amount of refundable franking credits available to XYZ?

Answer

No.

Question 5

If BCo were to pay a dividend to XYZ, would section 207-155 of the ITAA 1997 apply to reduce the amount of refundable franking credits available to XYZ.

Answer

No.

Question 6

Will the Commissioner make a determination under subsection 177EA(5) of the ITAA 1936 that the payment of a dividend from BCo to XYZ would be a scheme to which section 177EA of Part IVA of the ITAA 1936 applies?

Answer

No.

This ruling applies for the following periods:

1 July 2015 to 30 June 2017

The scheme commences during the 2016 income year.

Relevant facts and circumstances

1. XYZ is a registered charity which is exempt from income tax as well as being a deductible gift recipient.

2. The facts below describe the transactions involved in XYZ's purchase of the companies ACo Pty Ltd ('ACo') and BCo Pty Ltd ('BCo').

Transactions and events prior to the sale of ACo and BCo to XYZ

3. ACo operates a business selling various products. BCo, the sister company of ACo, operates various complementary supply and distribution channels. Both ACo and BCo were wholly-owned by the D family until the sale to XYZ.

4. 50% of the shares in ACo (i.e. those shares owned by P ) were pre-CGT interests.

5. ACo held a number of wholly-owned foreign subsidiaries and an investment in an associated company ('Shares').

6. ACo also owned two (2) property units in Sydney ('Real Property').

7. ACo has made various legacy loans to its wholly-owned foreign subsidiaries ('Subsidiary loans receivable') and to members of the D family both directly and indirectly via the D Unit Trust ('D family loans receivable').

8. Just before the sale to XYZ, the Subsidiary loans receivable were written-down in the books of ACo to match the respective debtor company's net asset/liquidity position. The Real Property was also written down by ACo. These write downs were arranged and authorised by the D family directors of ACo.

9. XYZ stated that the write downs of the Subsidiary loans receivable were done because those companies “had a deficit of shareholders' funds and therefore could not repay their loans in full.”

10. XYZ also stated that the write down of the Real Property was to reflect their current market valuation, which was based on two independent sources from which the ACo directors extrapolated the 'mid-point' values as the current market values.

11. The assets recorded in the books of ACo for the Shares, Real Property and Subsidiary loans receivable are collectively called the 'Non-Core Assets'.

12. As at 30 June 2015, ACo and BCo had retained profits and franking credits. ACo had sufficient franking credits to fully frank all of its retained profits at that date.

Sale of ACo and BCo to XYZ

13. In 2015, XYZ approached the shareholders of ACo and BCo (i.e. the D family) to purchase the Australian operations of these entities.

14. Significant synergies were identified between the businesses of XYZ, ACo and BCo, with XYZ seeing the opportunity to vertically integrate the complementary businesses of ACo and BCo with that of XYZ to extend its brand, presence and market share, strengthen its financial capacity and enable it to diversify its distribution channels.

15. XYZ claimed that it bought ACo and BCo's shares (rather than their respective businesses) due to the difficulty and cost in:

(a) re-assigning numerous pieces of intellectual property held by ACo;

(b) re-negotiating customer and supplier contracts; and

(c) novating a number of leases.

16. XYZ asserted that “ACo held a number of 'non-core assets' that XYZ did not wish to purchase” and that the D family wished to keep. These assets refer to the Non-Core Assets and the D family loans receivable.

17. However, XYZ claims that the D family were reluctant to have ACo transfer the Non-Core Assets to themselves before XYZ acquired ACo as:

“There was concern among the D Family that the acquisition of ACo and BCo by XYZ would not complete. They did not wish to incur additional costs (principally stamp duty on the real property assets) by transferring any assets prior to completion, should the acquisition not proceed.

Consequently, as a precaution, it was agreed that the sale of the Non-Core Assets to the D Family would be conditional upon the signing of the Share Sale Agreement. That is, an Asset Sale Agreement was signed between the D Family and ACo, under which the Non-Core Assets would only be sold to the D Family, subject to the sale of the shares in ACo and BCo.”

18. In 2015, XYZ entered into a Share Sale Deed ('SSD') pursuant to which it agreed to buy all the shares in ACo and BCo from the D family for a total consideration of $X (which included consideration being given for the value of the Non-Core Assets and the D Family loans receivable totalling $Q which remained as assets of ACo).

19. The SSD between the D family and XYZ (for the sale of ACo and BCo), had a “Condition Precedent” clause (Clause 2.1(4)) which stated that ACo and ZCo (an entity controlled by the D family that would purchase the Shares and Subsidiary loans receivables which were part of the Non-Core Assets) “must be ready, willing and able to complete the sale of the Completion Restructure Assets in accordance with the Asset Transfer Deed”.

20. The 'Asset Transfer Deed' refers to the contract for the sale of the Non-Core Assets by ACo to the associated D family entities and the 'Completion Restructure Assets' are the Non-Core Assets.

21. At clause 3.2, the SSD states “this Deed is interdependent with the Completion Restructure [the sale of the Non-Core Assets by ACo to the nominated D family entities]. Neither the Sellers [D family shareholders of ACo and BCo] nor the Purchaser [XYZ] is obliged to Complete under this Deed unless the parties to the Completion Restructure are ready, willing and able to complete that transaction.”

22. The total purchase price for the ACo and BCo shares were to be payable in multiple instalments ending in 2016.

23. The D family vendor shareholders obtained a security from XYZ for the payment of the total purchase price in the form of the physical custody over the certificates of title over land owned by XYZ and by lodging caveats on the title to the said land.

Sale of the Non-Core Assets

24. The Non-Core Assets were not sold directly to the D family shareholders of ACo (who held an indirect interest in these assets via their shares in ACo) but to the following associated D family entities:

a) ZCo - which acquired the Shares and the Subsidiary loans receivable;

b) TCo Pty Ltd ('TCo') - which acquired one of the property units and

c) D Unit Trust - which acquired the other property unit.

25. The Non-Core Assets sale contract (i.e. the Asset Transfer Deed) was entered into on the same date and at the same time as the SSD for the shares in ACo and BCo - though purportedly only having effect after the SSD (i.e. after XYZ acquired ACo inclusive of the Non-Core Assets). The total sale consideration for the Non-Core Assets was $T.

26. Clause 3.5 of the Asset Transfer Deed states:

“This deed is interdependent with the ACo Sale Deed [being the SSD]. Neither the ACo nor the Buyers [of the Non-Core Assets] are obliged to Complete under this deed unless:

(c) the parties to the ACo Sale Deed are ready, willing and able to complete all transactions under the ACo Sale Deed”.

27. The purchase price for the Non-Core Assets was fully payable at the completion date for the Asset Transfer Deed.

28. Accordingly, XYZ's acquisition of ACo and BCo in 20XX was effected through two (2) concurrent and inter-conditional agreements:

1. The SSD, in which all the shares in ACo and BCo (with the Non-Core Assets and D family loans receivable intact) were bought by XYZ for a total consideration of $X. The D family then used part of this sale consideration to repay the D family loans receivables owed to ACo of $Y [$L owed by D Unit Trust and $M owed by JD ]; and

2. The Asset Transfer Deed, in which ACo immediately sold back the Non-Core Assets to the D family controlled entities for a total consideration of $T.

29. ACo then channelled the proceeds from the sale of its Non-Core Assets and the repayment of the D family loans receivable, totalling $Q, back to XYZ via a loan-up.

30. While completion of the SSD and the Asset Transfer Deed occurred simultaneously on the same day as the day both agreements were entered into, repayment of the D family loan receivables occurred on two separate dates in 20XX. Further instalment payments for the purchase of ACo and BCo under the SSD continued until 20XX (when the final instalment payment was paid).

31. As indicated above, the completion of the Non-Core Assets and repayment of the D family loans receivable, and the subsequent loan-up of $Q from ACo to XYZ under loan agreements in 20XX occurred well before the purchase price of ACo was fully paid. This meant that the completion of all the SSD obligations (including all instalments of the sales proceeds) was not in fact and reality a prerequisite to the sale of the Non-Core Assets and the repayment of the D family loans receivable completing.

Flow of funds

32. The payment arrangements for the purchase of the Non-Core Assets by the D family entities was complicated and intertwined with outstanding loans the D family had received from ACo and the consideration paid by XYZ to the D family for the purchase of ACo/BCo. These arrangements involved a series of round-robin transactions between XYZ, the D family and ACo.

33. The diagram below depicts the round-robin transactions that occurred between XYZ, the D family and ACo in connection with the excision of the Non-Core Assets and the extinguishment of the D family loan receivables which immediately followed the sale of ACo to XYZ. The steps involved with these transactions are described in more detail below.

Figure 1: Flow of funds to effect the sale of ACo and BCo to XYZ, the sale of Non-Core Assets to D family, the repayment of D family loans receivable and the loan-up from ACo to XYZ. The steps are described in more detail below.

34. Step 1

XYZ acquires ACo and BCo from the D family for a total consideration of $X.

In actuality, XYZ physically paid a net amount of $C (i.e. $X minus the $L and $M amounts in Steps 2 and 3 below which were effected by way of payment directions and loan-ups and minus the $T amount (for the Non-Core Assets) which was loaned-up in Step 5 below). The amount of $C is the value of the net assets of ACo and BCo (exclusive of the Non-Core Assets and D family loans receivable) plus goodwill, which were the only assets XYZ wished to acquire.

35. Step 2

(a) XYZ owed consideration to P for her shares in ACo/BCo.

(b) As part satisfaction of the consideration XYZ owed to P for her selling her shares in ACo/BCo, P instructed XYZ to “redirect” an amount of $L to ACo in order to discharge the loan D Unit Trust owed to ACo of $L.

(c) ACo then loaned up an amount of $L to XYZ (see Step 5 below).

(d) No actual cash payment was made by any party in this step. ACo ended up with a loan receivable from XYZ of $L and P ended up with a loan receivable from the D Unit Trust of the same amount.

36. Step 3

(a) XYZ owed consideration to JD for shares in ACo/BCo.

(b) As part satisfaction of the consideration XYZ owed to JD for selling shares in ACo/BCo, JD instructed XYZ to “redirect” an amount of $M to ACo in order to discharge the loan JD owed to ACo of $M.

(c) XYZ made a cash payment to ACo of $M in accordance with JD's payment direction.

(d) ACo then loaned up (in cash) the amount of $M to XYZ (see Step 5 below).

(e) The round-robin of this $M resulted in no net cash outflow by XYZ.

(f) ACo ended up with a loan receivable from XYZ of $M.

37. Step 4

D family entities pay $T in cash to ACo for the Non-Core Assets (funded, by part of the proceeds received from XYZ at Step 1 above, through internal family arrangements).

38. Step 5

(a) ACo loans-up to XYZ the “redirected” amounts of $L and $M in Steps 2 and 3 plus the $T cash payment in Step 4 received by ACo [i.e. the entire Non-Core Assets and the D family loans receivable totalling $Q].

(b) Acknowledging the round-robin nature of the above transactions, XYZ stated that these loan “monies were used, in part, to fund the purchase price” of ACo and BCo.

39. The Commissioner and XYZ and its representative attended a meeting of the General Anti-Avoidance Rules Panel (GAAR Panel) for advice as to whether either or both the following provisions apply in relation to the acquisition of ACo by XYZ based on the facts as described above:

a) Paragraph 207-145(1)(d) of the ITAA 1997; or alternatively

b) Section 177EA of the ITAA 1936.

40. In its GAAR Panel submission, XYZ gave another reason why the parties arranged the Non-Core Assets sale after XYZ's purchase of ACo (initially inclusive of these assets):

“It was not possible to make a simple in-specie distribution of the non-core assets as the intended acquirers of all of those assets were not the same as the shareholders. That is, there were different legal entities acquiring the non-core assets but more importantly the proportionality was not equal.

Given the different nature of the purchasers, an in-specie distribution would not have resulted in the assets being held by the correct parties. As such, it would have required a sale of the assets by ACo to the asset purchasers. This would have created a loan from ACo to the asset purchasers which would need to have been settled. The asset purchasers did not have sufficient financing to acquire these assets, absent the share sale. The asset purchasers did not want to be placed in a position of having an obligation owing to ACo which absent the share sale they could not satisfy. As such they required the share sale to be entered into prior to the asset sale.”

41. In its GAAR Panel submission, XYZ also stated that:

The way in which the Acquisition was implemented was purely for commercial reasons and not to create a tax benefit. The dominant purpose of entering into two Transactions in the above manner was to protect both parties (i.e. XYZ and the D Family) from potential adverse outcomes and maintain ACo's business and structural integrity.

Two possible alternate postulates would be to:

A. an asset sale of all core assets of ACo to a new entity controlled by XYZ- this was not a reasonable alternative as the core assets represented a substantial proportion of the total assets held by ACo. It was neither feasible nor commercially viable to transfer each individual assets, given the time, costs, labour and complexities involved with re-negotiating all customer/supplier contracts and re-assigning the leases and intellectual property.

B. A transfer of the non-core assets prior to the share transfer- this was not a reasonable alternative for the reasons set out above [i.e.-the reasons quoted above in paragraph 40].

Having regard to the substance of the Acquisition and the result that XYZ and the D Family intended to achieve, we believe that no alternative postulate provides the same commercially viable outcome as the Transactions actually undertaken.

42. A copy of the minutes of the GAAR Panel was provided to the Applicant. The result was that the Chair of the GAAR Panel agreed that a favourable private binding ruling should not be issued to the taxpayer in relation to the acquisition of ACo. This was on the basis that section 177EA of the ITAA 1936 (which should be applied in preference to section 207-145 of the ITAA 1997) was attracted in relation to the acquisition of ACo by XYZ based on these facts.

43. In an email XYZ's agent advised certain amounts of fully franked dividends which were proposed to be paid by ACo and BCo to XYZ before 30 June 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1997 (ITAA 1997)

Subsection 204-30(6)

Section 207-120

Section 207-145

Section 207-155

Income Tax Assessment Act 1936 (ITAA 1936)

Section 177D

Section 177E

Section 177EA

Reasons for decision

Question 1

Summary

1. Section 207-120 of the ITAA 1997 would not apply to any dividend paid by ACo to XYZ in the Relevant Period.

Detailed reasoning

2. After considering the facts of the scheme, the Commissioner is of the view that section 207-120 of the ITAA 1997 would not apply to any future dividend paid by ACo to XYZ in the Relevant Period.

Question 2

Summary

3. The Commissioner would make a determination under subparagraph 177EA(5)(a) of the Income Tax Assessment Act 1936 (ITAA 1936) to impose a franking debit of $H on ACo's franking account, for any dividend payments in the Relevant Period up to $Q from ACo to XYZ. This is a result of XYZ, the D family, ACo and/or their advisers entering into a scheme to which section 177EA of Part IVA would apply.

Detailed reasoning

Franking credit trading scheme under section 177EA of the ITAA 1936

4. The Commissioner is of the view that XYZ, the D family, ACo and/or their advisers engaged in a scheme for a more than incidental purpose to allow XYZ to obtain more imputation credits in accordance with section 177EA of the ITAA 1936.

5. Section 177EA of the ITAA 1936 is a general anti-avoidance rule that safeguards the operation of the imputation system. The purpose of that section is to protect the imputation system from abuse and ensure that the benefits of the imputation system flow to the economic owner of the share which is the source of the franked distribution. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1998 that introduced section 177EA of the ITAA 1936 states:

8.5 Two of the underlying principles of the imputation system are, firstly, that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves and, secondly, that tax paid at the company level is in broad terms imputed to shareholders proportionately to their shareholdings.

6. The conditions required for the application of section 177EA is stated in subsection 177EA(3):

This section applies if:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(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.

The relevant scheme

7. It should be noted that the Commissioner does not, in these circumstances, consider that XYZ's purchase of ACo and BCo per se as being the offending scheme. The Commissioner accepts that, on the facts, the purchase of the two companies (leaving aside the Non-Core Assets and D family loans receivable transactions) was made for legitimate commercial reasons by XYZ that was not motivated by a predominant or sole reason of stripping ACo/BCo of their profits in a tax preferred manner.

8. On the evidence, the Commissioner is satisfied that there were genuine commercial reasons to vertically integrate the businesses of ACo/BCo with that of XYZ. There is no evidence to suggest XYZ will not continue to carry on the ACo/BCo businesses well into the future. The Commissioner also accepts the reasons put forward by XYZ for the acquisition of the shares in ACo/BCo rather than their underlying businesses and assets.

9. The relevant scheme is the scheme described at paragraphs 32 to 38 in the Facts section of this Ruling, summarised as having the following effect:

(a) the sale of ACo inclusive of the value of its Non-Core Assets and the D family loan receivables to XYZ and the inflation of the sale price of ACo by $Q for the value of assets which XYZ never wanted to buy nor did it end up owning nor did it in effect pay for; and

(b) the concurrent excision of the Non-Core Assets by ACo, which was paid for using the inflated sales proceeds for ACo and then lent-back to XYZ in a round-robin manner so that XYZ was not out-of-pocket for the amount of $T (representing the value of the Non-Core Assets which in substance it never acquired); and

(c) the concurrent repayment of the D family loan receivables using the inflated sales proceeds for ACo and then lent-back to XYZ in a round-robin manner so that XYZ was not out-of-pocket for the amount of $Y (representing the value of the D family loans receivable which in substance it never acquired).

10. The scheme identified in paragraphs 32 to 38 in the Facts section of this Ruling satisfies all the conditions set out in paragraphs 177EA(3)(a) - (d) of the ITAA 1936 (inclusive) on the basis of the following:

(a) There was a scheme for the disposition of membership interests in ACo (a corporate tax entity) by the D family vendor shareholders to XYZ under the SSD (paragraph 177EA(3)(a) is satisfied);

(b) A frankable distribution is expected to be payable to XYZ in respect of its membership interests in ACo (paragraph 177EA(3)(b) is satisfied);

(c) The distribution is expected to be a franked distribution (paragraph 177EA(3)(c) is satisfied);

(d) Except for section 177EA of the ITAA 1936, XYZ being the relevant taxpayer would receive, or could reasonably be expected to receive, imputation benefits (relevantly defined in subsection 204-30(6) of the ITAA 1997) as a result of the distribution in the form of refundable tax offsets (paragraph 177EA(3)(d) is satisfied).

11. The determinative question is whether, having regard to the relevant circumstances of the scheme, it would be concluded that XYZ or some other person entered into or carried out the scheme or any part of the scheme for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling XYZ to obtain an imputation benefit (paragraph 177EA(3)(e) of the ITAA 1936). The Commissioner has concluded that there is such a purpose.

Wide ambit of “relevant circumstances” re the purpose test in 177EA

12. In relation to the purpose test in paragraph 177EA(3)(e) of the ITAA 1936, the Supplementary Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1998 stated at paragraph 2.6 that:

… while new section 177EA does not require the purpose of obtaining the franking benefit to be the ruling, most influential or prevailing purpose, neither does it include any purpose which is not a significant purpose.

13. It should also be noted that the consideration of purpose required under paragraph 177EA(3)(e) of the ITAA 1936 is the consideration of the objective purpose of any of the parties to the scheme (including advisers) rather than the subjective intentions of the parties concerned. This is supported by the Full High Court case of Mills v Commissioner of Taxation 250 CLR 171 ('Mills') where the Full Court stated at paragraphs 44 and 60 in that case:

44. In relation to s177EA(3)(e) of the ITAA 1936, it was also uncontroversial that:…the words “would be concluded” required an undertaking of an objective assessment from the perspective of a reasonable person in the same way as do the identical words in s177D(b) of the ITAA 1936.

60.The conclusion of a reasonable person would draw in answer to the question statutorily posed by s177EA(3)(e) will therefore, for most capital raisings, be the jurisdictional fact on which the application of s177EA will turn.

14. The purpose is also to be determined by having regard to all the 'relevant circumstances' of the scheme.

15. The relevant circumstances to be considered include all the factors stated in subsection 177EA(17) of the ITAA 1936, including the eight factors in subsection 177D(2) of the ITAA 1936 (paragraph 177EA(17)(j) of the ITAA 1936). However, the relevant circumstances are not limited to the factors set out in subsection 177EA(17) of the ITAA 1936. This was confirmed in the Full High Court case of Mills, where the Court stated at paragraph 61:

Two uncontroversial features of “the relevant circumstances” to which s177EA(3)(e) refers can usefully be noted. The first is that the relevance of the relevant circumstances lies to the extent to which they are probative of the ultimate question as to purpose. The second is that the circumstances referred to in s177EA(17) are not exhaustive of the circumstances that might be probative of that ultimate question. [Emphasis added.]

16. Paragraph 8.79 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No. 3) 1998 also supported the above view when it commented on subsection 177EA(17) of the ITAA 1936 (when it was previously referred to as subsection 177EA(19) of the ITAA 1936):

Circumstances which are relevant in determining whether any person has the requisite purpose include, but are not limited to, the factors listed in new subsection 177EA(19) . These factors include the eight factors which are used to determine purpose under the existing section 177D in relation to schemes which omit assessable income or create allowable deductions. [Emphasis added.]

17. The wide ambit of what are considered 'relevant circumstances' was also reiterated in paragraph 114 in PSLA 2007/9 and also paragraph 60 of TR 2009/3 (Application of s177EA to non-share distributions on certain 'dollar value' convertible notes) which stated:

Because there is not an exhaustive definition of the meaning of 'relevant circumstances', the necessary conclusion of purpose could be supported by some circumstance that is not specifically listed in subsection 177E(17).

18. It is further noted that while paragraph 177EA(17)(b) of the ITAA 1936 requires an evaluation of whether a more than incidental purpose exists by reference to whether the relevant taxpayer derives a 'greater benefit from franking credits' than others, the condition in paragraph 177EA(3)(d) of the ITAA 1936 only requires that the relevant taxpayer derives imputation benefits - this is sufficient of itself to prima facie invoke section 177EA of the ITAA 1936, subject to satisfying the purpose test.

19. The relevant factors the Commissioner has taken into consideration in respect of the present scheme are described below.

Paragraph 177EA(17)(a) of the ITAA 1936 - extent and duration of the risks and opportunities borne by parties to the scheme.

20. In its ruling application XYZ provided the following argument against the possible application of paragraph 177EA(17)(a):

As a result of the Transaction, XYZ holds 100% of the shares in ACo. There are no arrangements (e.g. options, swaps, etc.) in the Share Sale Agreement that would deem all or part of the shares not to be held fully at risk such that XYZ does not bear all the ongoing risks and rewards of holding the shares in ACo. In the present case, it is submitted that all the risks and opportunities associated with ACo (bar the Non-Core Assets) were transferred to XYZ and none were retained by the D Family upon disposal of the shares in ACo to XYZ. As discussed above at Section C, XYZ was only ever interested in ACo's active Australian operations and the transfer of the passive Non-Core Assets does not substantially alter the risks and opportunities associated with ACo.

21. The Commissioner rejects the above quoted statement by XYZ. Based on the facts, XYZ clearly did not have to “bear all the risks and opportunities” of its purchase of ACo as the scheme guaranteed it (via the round-robin transactions) a loan of $Q in relation to the Non-Core Assets and the D family loans receivable. Clause 2.1(4) of the Share Sale Agreement had a Condition Precedent Clause which obliged ACo and ZCo to complete the Non-Core Asset sale, while the Asset Transfer Deed also obliged the D purchaser entities to buy ACo's assets. XYZ also admitted that the $Q loan monies it received from ACo “were used, in part, to fund the purchase price” of ACo.

22. The Commissioner also considers that XYZ's own statement supports the Commissioner's argument that XYZ did not bear all risks and opportunities in relation to the scheme. This is indicated in XYZ's comment that “…all the risks and opportunities associated with ACo (bar the Non-Core Assets) were transferred to XYZ [emphasis added]…” XYZ's caveat wording “bar the Non- Core Assets”, is a clear admission that it did not bear all risks and opportunities relating to these assets and the D family loans receivable when it bought ACo.

23. The Commissioner disagrees with XYZ that the Non-Core Assets and D family loans receivable round-robin transactions did not “substantially alter the risks and opportunities” of the ACo purchase. The Non-Core Assets and D family loans receivable represented a significant part of the agreed purchase price for ACo.

24. Based on the above the Commissioner considers that paragraph 177EA(17)(a) of the ITAA 1936 is a relevant circumstance, as the scheme clearly limited XYZ's risks of purchase of ACo due to the arrangements involving the Non-Core Assets and the D family loans receivable.

Paragraph 177EA(17)(f) of the ITAA 1936 - whether any consideration paid or given, in connection with the scheme, was calculated by reference to imputation benefits to be received.

25. The SSD labels franking credits as “Tax Assets” and Clause 17.1 of the SSD has a condition that the D family are obliged to refund part of the purchase price equivalent to any franking credits that XYZ is not able to access.

26. Despite ACo and BCo having aggregate franking credits of $R at the time of their acquisition by XYZ, and the fact that XYZ being a registered charity could normally obtain a full refund of these franking credits in the form of fully refundable tax offsets, XYZ stated that:

“No value was attributed to these franking credits as part of the purchase price under the Share Sale Agreement.”

27. Despite the above assertion by XYZ that no value was attributed to the franking credits in the purchase price, as noted above, Clause 1 of the SSD describes the franking credits in ACo and BCo as “Tax Assets” and Clause 17.1 of the SSD (under the title “Tax Indemnity”) obliged the D family to pay XYZ the amount of any Tax Asset in ACo and BCo if these were lost, denied, cancelled or otherwise became unavailable. Clause 17.1 states:

Each Responsible Shareholder…will pay the Purchaser, such Responsible Shareholder's Respective Proportion of:

The amount of any Tax Asset which is lost, denied, cancelled or otherwise is or becomes unavailable as a result of any act, event, or transaction occurring before Completion (including without limitation the Completion Restructure [the sale of the Non-Core Assets by ACo to specified D family entities] (except where such loss, denial, cancellation or otherwise is the result of any subsequent act or omission of the Purchaser or a Company).

28. XYZ has stated that:

“It is standard commercial practice for the tax attributes of a target entity to be warranted by a vendor to give a purchaser certainty as to what are the attributes of the entity being acquired. In some cases this would include tax losses, franking credits, foreign tax offsets, and other tax statuses…. In the current circumstances, the only relevant tax attribute was the franking credits.

The clause does not prescribe value to the franking credits, it merely confirms that they exist and in the event that the vendors have misrepresented this fact, a possible consequence for the vendor (if a loss can be shown). This clause does not warrant any benefit of value for XYZ merely the existence of the credits.”

29. While it may be arguable whether Clauses 1 and 17.1 of the SSD proves consideration was paid by XYZ in connection with the scheme by reference to the imputation benefits it received, it certainly was part of the total economic value equation for the overall transaction.

Paragraph 177EA(17)(j) of the ITAA 1936 - the eight factors in subsection 177D(2) of the ITAA 1936.

30. The analysis of the eight (8) factors in subsection 177D(2) of the ITAA 1936 indicate the scheme had a more than an incidental purpose of allowing XYZ to inappropriately obtain imputation benefits.

The 8 factors in subsection 177D(2) of the ITAA 1936 for the purposes of paragraph 177EA(17)(j) of the ITAA 1936

1^st factor - the manner in which the scheme was entered into or carried out (paragraph 177(D)(2)(a) of the ITAA 1936)

31. The Commissioner's view is that the manner in which the acquisition of ACo was effected, initially inclusive of assets which XYZ had no intention to acquire, and which could have been distributed to the D family vendor shareholders by way of an in-specie dividend distribution (but were retained in ACo only to be immediately sold back to the vendor shareholders' associate entities), suggests objectively the presence of a more than incidental purpose of preserving franking credits in ACo, so that these could be distributed to XYZ, to which franking tax offsets would be fully refundable.

2nd factor - the form and substance of the scheme (paragraph 177D(2)(b) of the ITAA 1936)

32. When viewed objectively, the Commissioner considers that the form and substance of the scheme in which the Non-Core Assets were excised and the D family loans receivable were extinguished, points to a more than incidental purpose to allow XYZ to obtain imputation benefits. This is supported by the reasoning below.

33. XYZ argues that the dominant purpose why the parties (XYZ, the D family, ACo and their advisers) entered into the scheme were their stated reasons in the Facts section in the Ruling. In the Commissioner's view these alleged reasons lack both legal and practical credibility. The Commissioner considers that the parties could have achieved their commercial objectives (which also met their concerns) in a simpler and less complex alternate postulate position.

ATO alternate postulate position

34. The alternative postulate is that ACo could have rid itself of the value of the Non-Core Assets and the D family loans receivable prior to the acquisition of ACo by XYZ.

35. ACo could have done this by way of the following steps:

Step 1 ACo agrees to sell the Non-Core Assets to TCo, D Unit Trust and ZCo (Non-Core Assets Buyers) (prior to XYZ's purchase of ACo) for $T in return for a loan receivable.

Step 2 ACo declares a pre-sale fully franked dividend to the D family of $Q.

Step 3 D family sells ACo to XYZ. The market value of ACo would be $C (taking into account the Step 2 dividend liability of $Q).

Step 4 ACo completes the sale of the Non-Core Assets and satisfies the dividend to former D family shareholders by an in-specie distribution of the $T loan receivable owed by the Non-Core Asset Buyers and the $Y D family loans receivable.

36. Under the alternate postulate, the Asset Transfer Deed (in respect of the Non-Core Assets sale to the Non-Core Assets Buyers) and dividend of $Q would have been subject to a contingent condition precedent to completion, that XYZ sign and complete the sale contract of ACo and BCo (all being inter-conditional on each other). On this proviso, if XYZ did not complete the ACo/BCo contract, then ACo would not be legally obliged to complete the inter-related Asset Transfer Deed contract or to satisfy the dividend declared of $Q to the D family shareholders.

37. Under this alternate postulate:

(i) the purchase price of ACo would not have been inappropriately inflated;

(ii) XYZ would have acquired ACo only with the assets which XYZ intended to acquire instead of having to procure that ACo will, post completion of acquisition by XYZ, rid itself of assets which XYZ did not want;

(iii) the value of the Non-Core Assets and the D family loans receivable would remain with the D family entities; and

(iv) $H amount of franking credits in ACo would have been used up.

38. In the Commissioner's view the above alternative postulate is consistent with the design feature of the imputation system, whereby the shareholders who owned the company when it made the profits on which it paid tax, should obtain the benefit of the franking credits.

39. The parties (XYZ, D family and ACo) not conducting the simpler, less complex alternate postulate above, indicates that the scheme was done for a dominant (or at least more than incidental) purpose to obtain a tax benefit for the parties.

Lack of credibility of XYZ's formal reasons for the scheme

40. The Commissioner's conclusion that the parties conducted the scheme for a dominant (or at least more than incidental) tax purpose is supported by the lack of credibility of XYZ's stated reasons why the parties arranged the Non-Core Assets sale to occur ostensibly only after XYZ's purchase of ACo. These reasons are as follows:

a) The D family wanted certainty that XYZ would complete the ACo acquisition before it excised the Non-Core Assets, to avoid unnecessary stamp duty costs to the Non-Core Assets Buyers if XYZ failed to complete the purchase. This would also allow ACo's business and structural integrity to be preserved;

b) The Non-Core Assets Buyers were not the same entities that held the same proportion of shares in ACo. Therefore, a pre-sale in-specie dividend distribution would not have delivered the assets to the intended entity. Furthermore, the entities that acquired the Non-Core Assets did not have sufficient financing to acquire these assets absent the share sale. The asset purchasers did not want to be placed in a position of having obligations owing to ACo, which absent the share sale, they could not satisfy. As such they required the share sale to be entered into prior to the asset sale;

c) A possible alternate postulate was an asset sale of all core assets of ACo to a new entity controlled by XYZ - this was rejected as it was neither feasible nor commercially viable to transfer each individual ACo asset to the new entity; and

d) No alternative postulate provided the same commercially viable outcome.

41. The Commissioner's view why XYZ's stated reasons for the scheme lack credibility is explained below.

Applicant's contention 1: The D family wanted certainty that XYZ would complete the ACo acquisition before it excised the Non-Core Assets, to avoid unnecessary stamp duty costs to the Non-Core Assets Buyers, if XYZ failed to complete the purchase and to protect ACo's business/structural integrity

42. The Commissioner is of the view that there were no credible commercial reasons that the arrangement needed to be structured in the way it was. As demonstrated in the alternate postulate in paragraphs 34 to 37 above, the transaction documents could have been drafted with the reversed order such that the excision of the value of the Non-Core Assets and the D family loans receivable were effected before the sale of ACo/BCo to XYZ, with the completion of the two transactions being inter-conditional on each other (which the actual contracts already required) thereby achieving the same results.

43. In reality, the two transactions occurred concurrently on the same day and the obligations to complete them were already inter-conditional and inter-dependent. There was no practical commercial difference whether one transaction preceded the other. This is clearly indicated in the Asset Transfer Deed (to transfer the Non-Core Assets from ACo to the Non-Core Assets Buyers) which already had a contingent condition in clause 3.5(c) which stated that:

This deed is interdependent with the ACo Sale Deed [the SSD]. Neither the ACo Books nor the Buyers are obliged to Complete under this deed unless:

(c) the parties to the ACo Sale Deed are ready, willing and able to complete all transactions under the ACo Sale Deed.

44. Accordingly, under Clause 3.5(c) of the Asset Transfer Deed, both ACo and the Non-Core Assets Buyers could have withdrawn from this agreement if XYZ failed to complete the ACo purchase. As mentioned above, this same clause could have been used with equal efficacy and effect if the parties conducted the scheme in the reverse order, under the simpler, less complex alternate postulate.

45. If inter-conditional contracts had been entered into as per the alternate postulate, and if XYZ did not complete the contact to purchase ACo/BCo, then ACo would not have been legally obliged to complete the inter-related Asset Transfer Deed (to sell the Non-Core Assets to the Non-Core Assets Buyers) or to satisfy the dividend of $Q. On this basis, any stamp duty payable upon ACo entering the Asset Transfer Deed to transfer the Non-Core Assets would not become payable if the Real Property is not transferred to the D entities (due to the cancellation or rescission of the Asset Transfer Deed agreement). This would have adequately addressed any alleged “concern” the D family had relating to potential stamp duty liabilities if XYZ failed to complete the ACo/BCo purchase.

46. Furthermore, stamp duty would only have applied to the transfer of Real Property, which comprised (in number and value) the minority of the Non-Core Assets. The vast majority of the Non-Core Assets consisted of receivables and foreign company shares which did not attract stamp duty when transferred.

47. The Commissioner considers that the actual facts also do not support the reason put by XYZ that the transaction was done in the order it was, due to the D family's alleged “concern” about incurring undue stamp duty liability, if XYZ did not complete the ACo/BCo contract. In reality, the excision of the Non-Core Assets and the extinguishment of the D family loans receivable were completed well before the final three tranches of the ACo/BCo sales proceeds were received by the D family from XYZ.

48. If there was any concern about ensuring that XYZ could and did indeed perform all of its obligations in relation to the purchase by XYZ of the ACo shares, it would be expected that as a matter of practice, the Non-Core Assets and the D family loans receivable would only be excised out of ACo and extinguished respectively once XYZ has paid for the acquisition of shares in ACo in full. This did not occur in reality.

49. Another fact that does not support the reasoning put forward by XYZ is the way the actual SSD between XYZ and the D family for the sale and purchase of ACo/BCo was drafted. Clause 2.1(4) of the SSD had a Condition Precedent which obliged ACo and ZCo to “be ready willing and able to complete the sale of the Completion Restructure Assets [the Non-Core Assets] in accordance with the Asset Transfer Deed”. However, the two D family entities (TCo Pty Ltd and D Unit Trust) that were required under the Asset Transfer Deed to purchase the Real Property were neither named nor bound by this Condition Precedent clause in the SSD.

Applicant's contention 2: The D family entities that acquired the Non-Core Assets were not the same entities that held the same proportion of shares in ACo. Therefore, a pre-sale in-specie dividend distribution would not have delivered the assets to the intended entity. Furthermore, the entities that acquired the Non-Core Assets did not have sufficient financing to acquire these assets absent the share sale.

50. Under the Commissioner's alternate postulate, ACo still sells the Non-Core Assets directly to the same D family purchaser entities who acquired them in actuality (i.e. ZCo, TCo and D Unit Trust also referred to as the Non-Core Assets Buyers), in return for a loan receivable owing to ACo from these entities in the amount of $T. Accordingly, under the alternate postulate, there is no pre-sale in-specie dividend distribution of these assets to the D family shareholders (who were not the intended recipients of these assets).

51. In the Commissioner's view, XYZ's argument that the scheme had to be carried out the way it was (that is, the D purchaser entities lacked the funding to acquire the Non-Core Assets absent the share sale) lacks credibility. This is especially so, when what actually transpired were internal D family financial arrangements summarised as follows:

● P loaned part of their ACo sales proceeds to the D Unit Trust to repay the loan it owed to ACo;

● JD used part of their ACo sales proceeds to repay the loan receivable they owed ACo; and

● All vendor shareholders (in combination) loaned or contributed a total of $T to ZCo, TCo and D Unit Trust to enable these entities to acquire the Non-Core Assets from ACo.

52. The Commissioner considers that the same internal family arrangements where the D family loaned or funded the Non-Core Assets Buyers would have resulted under the alternative postulate to achieve exactly the same result in delivering the Non-Core Assets to the Non-Core Assets Buyers who could be funded by the D family vendor shareholders.

Applicant's contention 3: Another possible alternate postulate was an asset sale of all core assets of ACo to a new entity controlled by XYZ.

53. XYZ argued that the other possible alternate postulate was for ACo to sell all its core assets to a new entity controlled by XYZ. XYZ advised this was rejected by the parties as:

It was neither feasible nor commercially viable to transfer each individual asset, given the time, costs, labour and complexities involved with re-negotiating all customer/supplier contracts and re-assigning the leases and intellectual property.

54. The Commissioner agrees that the alternate postulate of ACo selling all its core assets to a new entity controlled by XYZ would not have been a commercially viable postulate. However, this was not the only alternate postulate as shown in the Commissioner's own alternate postulate.

Applicant's contention 4: No other alternate postulate provides the same commercially viable outcome as the transactions actually undertaken

55. Having mentioned the problems of the two alternate postulates, XYZ then argued that:

Having regard to the substance of the Acquisition and the result that XYZ and the D Family intended to achieve, we believe that no alternate postulate provides the same commercially viable outcome as the Transactions actually undertaken [emphasis added].

56. The Commissioner rejects XYZ's view “that no alternate postulate provides the same commercially viable outcome as the Transactions actually undertaken.”

57. As mentioned above, the Commissioner's alternate postulate provides the same commercially viable outcome for all the parties, while also addressing the D family's alleged “concern” if XYZ did not complete the purchase of ACo/BCo.

58. The importance of counterfactual analysis in determining the purpose requirement in paragraph 177EA(3)(e) was mentioned in the Full High Court case of Mills v FCT by Gageler J (whose judgement was endorsed by the rest of the Court) who stated at paragraph 66 in that case:

Secondly, counterfactual analysis is not antithetical to the statutory inquiry mandated by s177EA(3)(e). Purpose is a matter of inference and incidentality is a matter of degree. Consideration of possible alternatives may well assist the drawing of a conclusion in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if such a purpose exists, that the purpose is or is not incidental to some other purpose.

59. The Commissioner considers that the parties (XYZ, the D family and ACo) effectively ignored the simpler, less complex, commercially viable alternate postulate put by the Commissioner, for the dominant purpose (or at least a more than incidental purpose) of obtaining the following tax benefits:

a) allowing the D family to avoid paying top-up tax on an in-specie dividend of $Q by selling their shares in ACo while it owned the Non-Core Assets and the D family loans receivable (only to separately but concurrently excise the Non-Core Assets and extinguish the D family loans receivable as part of the same broader arrangement).This resulted in a larger amount of concessionally-taxed (or even exempt) capital proceeds (P's 50% shareholding in ACo was pre-CGT); and

b) preserving $H amount of ACo's franking credits (i.e. $Q x 30/70) available to frank dividends to XYZ (which would, apart from the imputation integrity measures, obtain a fully refundable tax offset). These franking credits would otherwise have been used up if ACo had paid an in-specie fully franked dividend to the D family under the alternate postulate.

60. The Commissioner considers that the High Court case of FCT v Hart [2004] 217 CLR 216 ('Hart'), provides support for the above view. In Hart, Callinan J stated the following factor was relevant in determining the substance of a transaction (in the context of s177D(b)(ii)):

… whether the substance of the transaction (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction.

61. The ATO alternative postulate indicates that XYZ and the D family could have chosen a more convenient, or commercially frugal, method of excising the value of the Non-Core Assets and the D family loans receivable, after which XYZ could have purchased ACo “clean” of these assets. The alternate postulate would also have addressed the alleged “concern” by the D family about the Non-Core Assets Buyers incurring undue stamp duty if XYZ did not complete the purchase and the Non-Core Assets not being transferred to the appropriate D purchaser entities.

62. Instead, the parties chose a far more complex, contrived and convoluted set of round-robin transactions (involving XYZ momentarily purchasing assets it did not want and immediately thereafter disposing of these assets), based on alleged reasons that lack both legal and practical credibility. The Commissioner considers that the dominant purpose (or at least a more than incidental purpose) whereby the parties agreed to dispose of the Non-Core Assets and D family loan receivable under the scheme, was because it achieved tax advantages for both parties that would not have occurred otherwise.

63. As per the above analysis, the lack of credibility of XYZ's stated reasons for entering into the scheme and their claim that there was no commercially viable alternate postulate, supports the Commissioner's view that the parties entered into the scheme for the dominant (or at least more than incidental) purpose to obtain tax benefits.

64. It is considered that examining the form and substance of the scheme objectively indicates a dominant (or at least more than incidental) purpose by either XYZ, the D family, ACo and/or their legal/accounting advisers to allow XYZ to inappropriately obtain an imputation benefit from ACo in respect of the value of the Non-Core Assets and the D family loans receivable of $Q.

3rd factor - the timing and duration of the scheme (paragraph 177D(2)(c) of the ITAA 1936)

65. The Commissioner considers the timing (that is, the sale of the Non-Core Assets following the sale of ACo and BCo) and duration of the scheme (being entered into, effected and completed on the same day) again supports the Commissioner's view that the parties entered into these transactions for a more than incidental purpose to obtain a tax benefit for XYZ.

4th factor - the result achieved by the scheme under tax legislation but for Part IVA of the ITAA 1936 (paragraph 177D(2)(d) of the ITAA 1936)

66. The result of this scheme under the tax legislation (but for Part IVA) would be that XYZ would be entitled to $H amount of franking credits that would otherwise have been used up in paying a $Q fully franked in-specie dividend to the D family in relation to the Non-Core Assets and the D family loans receivable. In addition, the D family avoided paying any top-up tax on an in-specie dividend comprising of the Non-Core Assets and the D family loans receivable. Further, the scheme would have resulted in no capital gains tax being assessed on P's pre-CGT interests in ACo and possibly capital gains tax concessions afforded to other D family shareholders.

5th, 6th and 7th factors - any change in the financial position of the relevant taxpayer and any connected person (paragraphs 177D(2)(e), 177D(2)(f) and 177D(2)(g) of the ITAA 1936)

67. Any franking credits preserved in ACo would, when franked dividends are made to XYZ, result in dividends not being assessable to XYZ (as a tax exempt entity) and the franking credits being fully refunded in the form of franking tax offsets. The way in which Non-Core Assets and the D family loans receivable were dealt with as part of the sale and purchase of ACo by XYZ enabled $H amount of franking credits to be unduly retained in ACo and subsequently liberated in the hands of XYZ as refundable tax offsets.

68. The scheme also changed the financial position of the D family by:

● artificially inflating the sale price of ACo and BCo by including the value of the Non-Core Assets and the D family loans receivable in the sales proceeds which were concessionally-taxed under CGT provisions; and

● avoiding paying any top-up tax on a dividend representing the value of the Non-Core Assets and the D family loans receivable.

8th factor - the nature of any connection between the relevant taxpayer and any person (paragraph 177D(2)(h) of the ITAA 1936)

69. The scheme indicates a close collaboration between XYZ, ACo and the D family in executing the complex scheme and round-robin transactions involved with the scheme.

Conclusion

70. The Commissioner considers the above factors in subparagraphs 177EA(17)(a) and (j) of the ITAA 1936 (particularly the factors in paragraphs 177D(2)(a), (b), (c), (d) and (h)) as strong factors that objectively indicate a more than incidental purpose of allowing XYZ to inappropriately obtain an imputation credit as a result of the scheme.

71. It should be noted that not all the factors in section 177D of the ITAA 1936 are necessary to determine the requisite purpose. This was supported by Callinan J in the High Court case of FCT v Hart where his Honour stated:

The Act requires that questions raised by s177D be answered by reference to the indicia stated in the section. It is not necessary of course that every one of them be relevant to every scheme. Indeed the presence or overwhelming weight of one factor alone may of itself in an appropriate case be of such significance as to expose a relevant dominant purpose [emphasis added].

72. In conclusion, the Commissioner considers the way the transactions comprising the scheme have been ordered have resulted in the preservation of franking credits in ACo so that XYZ would be entitled to a refund of them. The scheme involves artificial or contrived features whereby XYZ would participate as a 'conduit' for what is, in substance, the internal affairs of the D family with respect to the excision of the Non-Core Assets and the D family loans receivable from ACo. The Commissioner considers that in this circumstance, it would be appropriate that franking credits associated with the amount of $Q (being the value of the Non-Core Assets and the D family loans receivable which XYZ never acquired and for which XYZ was merely acting as a conduit with regards to the fund flows involved with excising and extinguishing them) ought to be wasted or attributed to the D family members, consistent with the fundamental tenet of the imputation system.

Question 3

Summary

73. Section 207-155 of the ITAA 1997 would apply to the creation of loans between ACo and XYZ as a result of the transfer of property. The Commissioner is also of the view that section 207-155 would apply to dividends (up to $Q) paid by ACo to XYZ, so as to reduce the amount of refundable franking credits available to XYZ.

Detailed reasoning

Dividend stripping scheme under paragraph 207-145(1)(d) and section 207-155 of the ITAA 1997 and franking credit trading scheme under section 177EA of the ITAA 1936

74. The Commissioner considers that a dividend stripping scheme has occurred in accordance with paragraph 207-145(1)(d) and section 207-155 of the ITAA 1997.

75. Paragraph 207-145(1)(d) states:

If a franked distribution is made to an entity in one or more of the following circumstances:

(d) the distribution is made as part of a dividend stripping operation;

then, for the purposes of this Act:

(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; and

(f) the entity is not entitled to a tax offset under this Division because of the distribution;

Section 207-155 of the ITAA 1997 states:

A distribution made to a member of a corporate tax entity is taken to be made as part of a dividend stripping operation if, an 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.

76. It should be noted that the definition in section 207-155 invokes the same concept of dividend stripping as found in section 177E of the ITAA 1936.

77. The term “dividend stripping” has no precise legal meaning, however it has been the subject of judicial consideration. In Federal Commissioner of Taxation v Consolidated Press Holdings Ltd the High Court cited with approval the Full Federal Court's adoption of Gibbs J list in Patcorp Investments, of the “common characteristics” of earlier dividend stripping cases. Those characteristics, subsequently adopted in Lawrence v Commissioner of Taxation (2009) 175 FCR 277 include:

(a) a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders;

(b) the sale or allotment of shares in the target company to another party;

(c) the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits;

(d) the purchaser or allottee escaping Australian income tax on the dividend so declared;

(e) 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

(f) 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.

78. It is concluded that the scheme entered into by XYZ, the D family and ACo demonstrates all the dividend stripping characteristics stated above for the following reasons:

a) At time of its acquisition by XYZ, ACo (the target company) had substantial undistributed profits;

b) All the shares in ACo (as target company) were sold to XYZ (a third party);

c) ACo intends to pay XYZ a fully franked dividend before 30 June 2017. It is assumed XYZ will use part of this proposed dividend to satisfy the loan it owes ACo as a result of Step 5 of the scheme as described at paragraph 38 of the Facts section of this Ruling.

The Commissioner also considers the fact XYZ received the value of the Non-Core Assets and D family loan receivable, by way of a loan rather than dividend from ACo, is only a variance of the paradigm which does not negate this scheme still being a scheme by way of or in the nature of a dividend stripping. This is supported by the Full Federal Court case of Federal Commissioner of Taxation v Consolidated Press Holdings Ltd (No 1) (1999) 91 FCR 524 where the Court in analysing the first limb of section 177E(1)(a)(i) (re a scheme by way of or in the nature of dividend stripping) stated at 566:

The terms of the first limb of s177E(1)(a) suggests that a scheme may fall within its scope, even though not all the elements of a standard dividend stripping scheme are present. The use of the words 'by way of or in the nature of' suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provided it retains the central characteristics of a dividend stripping scheme.

a) As purchaser of ACo, XYZ is a tax exempt entity, and no tax would be payable on any dividend it receives from ACo;

b) The sale consideration received by the D family vendor shareholders for the sale of their shares in ACo was inflated by an amount of $Q reflecting the value of the Non-Core Assets and the D family loans receivable. This amount would have been concessionally-taxed or not taxed (for pre-CGT interests) and this is the amount to which the Commissioner considers is able to be distributed to XYZ for which no franking credit tax offset should be available; and

c) The above scheme was carefully planned by all parties (XYZ, the D family, ACo and their advisers) acting in concert together. This is evident by the highly sophisticated and complex legal agreements and transactions the parties entered into for the sale of ACo/BCo, ACo's subsequent sale of the Non-Core Assets, and the complex set of contrived round-robin transactions where the sale consideration ACo received from the Non-Core Assets sale (along with the value of the D family loans receivable) was loaned up to XYZ (who then used this loan to partly satisfy the consideration for the purchase ACo/BCo). In the Commissioner's view the parties entered into this scheme for the dominant purpose of:

● allowing the D family to avoid paying top-up tax on a dividend of $Q by selling their shares in ACo while it owned the Non-Core Assets and the D family loans receivable (only to separately but concurrently excise the Non-Core Assets and extinguish the D family loans receivable as part of the same broader arrangement). This resulted in a larger amount of concessionally-taxed (or even exempt) capital proceeds (P's 50% shareholding in ACo was pre-CGT); and

● preserving $H amount of ACo's franking credits (i.e. $Q x 30/70) available to frank dividends to XYZ (which would, apart from the imputation integrity measures, obtain a fully refundable tax offset). These franking credits would otherwise have been used up if ACo had declared a fully franked dividend to the D family in respect of the value of the Non-Core Assets and the D family loans receivable prior to entering into the agreement to sell ACo to XYZ.

79. It should be noted that the Commissioner does not, in these circumstances, consider that XYZ's purchase of ACo and BCo per se as being the offending scheme. The Commissioner accepts that, on the facts, the purchase of the two companies (leaving aside the Non-Core Assets and D family loans receivable transactions) was made for legitimate commercial reasons by XYZ that was not motivated by a predominant or sole reason of stripping ACo/BCo of their profits in a tax preferred manner.

80. The relevant scheme is the scheme described at paragraphs 31 to 37 in the Facts section of this Ruling above, summarised as having the following effect:

a) the sale of ACo inclusive of the value of its Non-Core Assets and the D family loan receivables to XYZ and the inflation of the sale price of ACo by $Q for the value of assets which XYZ never wanted to buy nor did it end up owning nor did it in effect pay for; and

b) the concurrent excision of the Non-Core Assets by ACo, which was paid for using the inflated sales proceeds for ACo and then lent-back to XYZ in a round-robin manner so that XYZ was not out-of-pocket for the amount of $T (representing the value of the Non-Core Assets which in substance it never acquired); and

c) the concurrent repayment of the D family loan receivables using the inflated sales proceeds for ACo and then lent-back to XYZ in a round-robin manner so that XYZ was not out-of-pocket for the amount of $Y (representing the D family loans receivable which in substance it never acquired).

The Dominant Purpose of the scheme

81. When viewed objectively, the manner, timing and ordering in which the Non-Core Assets were excised and the D family loans receivable were extinguished under the scheme, points to a dominant purpose of securing the tax benefits described above. For the reasons stated in paragraphs 19 to 72, the arguments put forward by XYZ concerning securing performance of XYZ's obligations to complete the acquisition of ACo, and the mitigation of additional stamp duty costs, have been rejected as the dominant purpose of the scheme. The analysis in these paragraphs also demonstrates that the parties could have achieved their commercial objectives (while also addressing the D family's alleged “concern” over XYZ completing the SSD) equally under the simpler alternate postulate.

82. Accordingly, for the reasons stated in paragraphs 19 to 72, the Commissioner is of the view that the above scheme clearly comes within the ambit of paragraph 207-155(a) of the ITAA 1997 as a scheme by way of, or in the nature of dividend stripping. The Commissioner considers that the scheme is an orthodox dividend stripping operation.

83. For completeness, the Commissioner is also of the view that the above scheme comes within the ambit of paragraph 207-155(b) of the ITAA 1997 as well. The scheme had “substantially the effect of a scheme by way of, or in the nature of, dividend stripping.” This is supported by the fact that the D family vendor shareholders received consideration as capital proceeds for the value of the undistributed profits represented by the Non-Core Assets and the D family loans receivable and that these profits were later able to be stripped out of ACo by XYZ to access the franking credits via the refundable tax offset available to XYZ as a tax exempt entity.

84. It is also considered that the Federal Court case of Lawrence v FCT supports the Commissioner's view. In Lawrence, the Full Federal Court gave paragraph 177E(1)(b) of the ITAA 1936 (which uses the same words as paragraph 207-155(b) of the ITAA 1997) a wide ambit and ruled that the scheme had the effect of a dividend stripping scheme as it distributed profits by way of loans. In the current scheme, the loans provided by ACo to XYZ in 2015 can readily be used as a means to channel the profits of ACo as dividends to XYZ (without requiring any cash payment).

85. Based on the above, the Commissioner is of the view that the above scheme clearly comes within one or both limbs of the dividend stripping arrangement expressed in section 207-155 of the ITAA 1997. The effect is that section 207-145(1)(d) is engaged with the result that XYZ is not entitled to a tax offset under Division 207 in respect of the amount of $H.

Question 4

Summary

86. Section 207-120 of the ITAA 1997 would not apply to any dividend paid by BCo to XYZ in the Relevant Period.

Detailed reasoning

87. After considering the facts of the scheme, the Commissioner is of the view that section 207-120 of the ITAA 1997 would not apply to any future dividend paid by BCo to XYZ in the Relevant Period.

Question 5

Summary

88. Section 207-155 of the ITAA 1997 would not apply to reduce the amount of refundable franking credits available to XYZ on any dividend paid by BCo in the Relevant Period.

Detailed reasoning

89. As the assets of BCo were not involved in the relevant scheme described in the Facts section of the Ruling, the Commissioner is of the view that subsection 177EA(5) of the ITAA 1997 would not apply to any future dividend paid by BCo to XYZ in the Relevant Period.

Question 6

Summary

90. The Commissioner will not make a determination under subsection 177EA(5) of the ITAA 1936 that the payment of a dividend from BCo to XYZ, in the Relevant Period, would be a scheme to which section 177EA of Part IVA of the ITAA 1936 applies.

Detailed reasoning

91. As the assets of BCo were not involved in the relevant scheme described in the Facts section of the Ruling, the Commissioner is of the view that subsection 177EA(5) of the ITAA 1997 would not apply to any future dividend paid by BCo to XYZ in the Relevant Period.

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