Edited version of your written advice

Authorisation Number: 1051234470188

Date of advice: 15 June 2017

Ruling

Subject: Dividend Access Share Arrangement

Question 1

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

Answer

No.

Question 2

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

Answer

Yes.

Question 3

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

Answer

Yes.

Question 4

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

Answer

No.

Question 5

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

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 20X1

Year ending 30 June 20X2

Year ending 30 June 20X3

The scheme commences on:

1 July 20X1

Relevant facts and circumstances

1. A Co was incorporated on 1 July 19XX.

2. The share capital of A Co includes 2 ordinary shares each fully paid to $1.00. These ordinary shares are held by Y (1 share) and Z (1 share).

3. Y and Z’s parents (V) and (W) are the current directors of A Co.

4. Y and Z are partners at separate and unrelated law firms.

5. A Co’s assets consist of listed securities, a real property and loans to third parties under arm’s length commercial agreements, all of which were acquired after 20 September 1985.

6. A Co has not undertaken any previous returns of capital, issues of bonus shares, declarations of dividends or payments of share premium to its shareholders.

7. Y and Z currently control separate discretionary family trust structures.

8. Y is the sole shareholder and sole director of B Co, the corporate trustee of B Trust. Beneficiaries of B Trust includes Y and D Co.

9. Z is the sole shareholder and sole director of C Co, the corporate trustee of C Trust. Z is married with two children. The beneficiaries of C Trust includes Z, Z’s spouse, Z’s children and E Co.

Proposal to issue RPSs

10. It is proposed that A Co will issue 1,000 RPSs with a face value of $1.00 to each of the trustees of B Trust and C Trust, as permitted by A Co’s Articles of Association. The terms of the RPS are:

a) The RPS will have no rights in relation to dividends, voting, or any surplus on the winding up of A Co.

b) The RPS will only be redeemable on the winding up of A Co.

c) In the event of a winding up, the RPS holders will rank below debt holders and creditors but above ordinary shareholders for the subscription amount.

11. Subsequent to its issue, directors of A Co will resolve to grant a discretionary dividend right to each RPS. The dividend right will cease by the earlier of a directors’ decision to remove the right or within four years from the issue of the RPS.

12. The directors of A Co will then declare a fully franked dividend in respect of each RPS over a period of time. In this way, current year profits and retained earnings in A Co are distributed to each of Y and Z’s discretionary family trusts.

Proposal to transfer A Co’s listed investments

13. In addition to issuing the RPSs, it is also proposed to transfer all of A Co’s listed investments to the two trusts.

14. As consideration for the transfer, each trust will pay the market value by:

a) assuming A Co’s liabilities associated with the transferred listed investments; and

b) offsetting the dividend receivable from A Co.

15. A Co will not be disposing of the remaining real property.

16. Y and Z are of the view that the objectives of the scheme are:

a) Asset protection – Y and Z wish to hold a minimum of assets in their individual capacity to ensure that, wherever possible, passive investment assets are protected from claims arising due to their role as partners in a commercial partnership. Y holds a small amount in a personal account (for day to day use). Y’s remaining assets are held by B Trust. Z does not have any material investments in their name. Z’s family home is held in Z spouse’s name.

b) Long term succession planning – Y and Z wish to accumulate wealth in a structure that provides them with the flexibility to pass the wealth to their respective families and future generations in the longer term in an efficient manner.

c) Investment strategy and control – Y and Z have and are likely to have, different investment objectives, timeframes, risk profiles and strategies, due to their marital status and family composition. However, the current structure does not allow for flexibility in investment choices.

d) Minimise multiple transaction costs – Y and Z wish to achieve the above objectives without incurring multiple transaction costs, for example, stamp duty.

Assumptions

1. The trustees of B Trust and C Trust will hold the RPSs for at least 90 days.

B Trust and C Trust are or will be family trusts within the meaning of Schedule 2F to the ITAA 1936.

Note:

This private ruling only applies to the arrangement set out above which includes payment of a dividend on the RPSs to the trustees of B Trust and C Trust. No specific details have been provided about any subsequent distributions by the trustees other than distributions may be made to beneficiary companies. Therefore this private ruling has no application to any subsequent distributions by the trustees.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 Subsection 177E(1)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1936 Subsection 177F(1)

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1997 Section 104-250

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 Section 725-90

Income Tax Assessment Act 1997 Subsection 725-90(1)

Income Tax Assessment Act 1936 Paragraph 725-90(1)(a)

Reasons for decision

All legislative references refer to the ITAA 1936 unless otherwise stated.

Question 1

Summary

1. The issue of the RPSs does not give rise to the direct value shifting (DVS) rules under

Division 725 of the ITAA 1997. Therefore CGT event K8 will not happen.

Detailed reasoning

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

3. The RPSs do not have any dividend rights at the time of issue. Consequently, the market value of each RPS is its face value of $1.00, representing capital that is contributed by each trust. The RPSs are therefore not issued at a discount. There will also not be a decrease in the value of A Co’s shares as a result of issuing the RPSs. That is, the issuance of the RPSs have not caused any value to be shifted.

4. Therefore the issue of the RPSs does not give rise to the DVS rules applying under Division 725 of the ITAA 1997 and does not cause CGT event K8 under section 104-250 of the ITAA 1997 to occur.

Question 2

Summary

5. The attachment of a dividend right to the RPSs does not give rise to the DVS rules under Division 725 of the ITAA 1997.

Detailed reasoning

6. Whilst there can be consequences under Division 725 of the ITAA 1997 where there is a direct value shift involving the equity or loan interests in an entity, a reversal exception is provided by section 725-90 of the ITAA 1997 and applies where the state of affairs that is brought about by the things done under the scheme:

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

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

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

8. ITAA 1997. The example that follows subsection 725-90(1) of the ITAA 1997 reads:

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

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

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

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

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

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

Question 3

Summary

12. The declaration and payment of a dividend to the RPS holders does not give rise to the DVS rules under Division 725 of the ITAA 1997.

Detailed reasoning

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

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

Question 4

Summary

15. Section 177E will not apply to the scheme.

Detailed reasoning

Part IVA

16. 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)).

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

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

18. The scheme under consideration involves the following steps:

(1) The earning and retention of profits in A Co.

(2) The issue of 1,000 RPSs at a face value of $1.00 to each of B Co as trustee for B Trust and C Co as trustee for C Trust.

(3) The passing of a resolution to attach dividend rights to each RPS.

(4) The declaration of a fully franked dividend under the RPS in respect of A Co’s current year and retained profits.

(5) The distribution of a dividend by A Co to the respective trusts by offsetting the dividend entitlement as consideration for the transfer of A Co’s listed investments.

19. Taxation Determination TD 2014/1 explains the meaning of the words, 'by way of or in the nature of dividend stripping’ in the context of a dividend access share arrangement.

20. An arrangement falls within the ambit of TD 2014/1 if it exhibits all or most of the features identified at paragraph 4 of the Taxation Determination. These features are discussed below in relation to the scheme.

A private company (the 'target company’) has accumulated significant profits which have been subject to income tax at the company tax rate.

21. A Co, the target company, has substantial undistributed profits arising from investments in Australian listed securities, real property and loans to third parties under arm’s length commercial agreements. These profits have been subject to income tax at the corporate tax rate when they were earned.

The target company’s ordinary shares are held by an individual (the 'original shareholder’) who is also the director of the target company.

22. A Co’s ordinary shares are held by Y (1 share) and Z (1 share).

23. The current directors of A Co are V and W.

24. Although A Co’s ordinary shares are not held by the directors, the directors are associates of both shareholders. This relationship suggests that the directors will – in order to distribute retained earnings in the company to the director’s children – invariably issue a new class of shares as permitted by the company’s Articles of Association and declare a dividend to the shareholders.

25. There is also suggestion that the original shareholders have influence over the direction of the company, as supported by the fact that it is Y and Z (the shareholders) who have sought advice regarding this scheme, rather than the directors themselves.

The target company’s constitution is amended to allow for the creation of a new class of shares (the 'Z class shares’)

26. New RPSs will be issued to the trustees of B Trust and C Trust as permitted by A Co’s Articles of Association.

The target company issues Z class shares for nominal consideration to either the company controlled by the original shareholder or to a company acting as trustee of a discretionary trust.

27. It is proposed that A Co will issue 1,000 RPSs to each of B Co as trustee for B Trust (discretionary family trust) and C Co as trustee for C Trust (discretionary family trust).

28. The RPS has a face value of $1.00 each.

The target company declares and pays a fully franked dividend on the Z class shares

of an amount approximately equal to the accumulated profits in the target company.

The dividend payment is satisfied by way of a promissory note issued by the target company.

29. It is proposed that A Co will declare and pay fully franked dividends under the RPSs of an amount totalling A Co’s current year profits and retained earnings.

30. The dividend payment is satisfied by way of transferring A Co’s listed investments to the respective trusts, as specified in paragraph 14.

A series of transactions are then carried out to effectively deliver the economic benefit of the target company’s profits to the original shareholder and his or her associates in a tax-free or substantially tax-free form.

31. It is proposed that fully franked dividends will be declared and paid by A Co in respect of the RPSs.

32. The respective trusts currently make distributions to its respective corporate beneficiaries. Given the tax profile of the beneficiaries in the trusts, future distributions are likely to continue to be made to their respective corporate beneficiaries.

33. Thus, all of A Co’s retained earnings will flow indirectly into D Co and E Co. The economic benefit of A Co’s retained earnings is thus represented by the accretion in the value of D Co and E Co.

34. The sole shareholders of D Co and E Co are also trustees of the respective family trusts. Beneficiaries of B Trust are Y and associates. Similarly beneficiaries of C Trust are Z and associates. Thus the original shareholder and their associates are the only entities beneficially entitled to the assets of the respective discretionary family trusts.

35. Accordingly, the accretion in the capital of the ultimate private company beneficiary and by extension the capital of the discretionary family trust (by virtue of its shareholding in the private company beneficiary) would constitute a capital sum being received by the original shareholder and his/her associates.

36. As the dividends are fully franked, there is no tax payable on the dividend by the corporate beneficiaries due to franking credits attached to the dividends.

37. Accordingly, transactions undertaken under the scheme effectively delivers the economic benefit of A Co’s profits to Y and Z and their respective associates in a tax-free form.

Purpose of the scheme

38. TD 2014/1 states:

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

39. Any such assertion must:

● be supported by the other available evidence; and

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

40. In this case the stated asset protection purpose is supported by objective facts. Also, explanations have been provided of why other alternative arrangements are not considered to provide the asset protection afforded by the proposed arrangement. Given all the specific facts of Y’s and Z’s individual circumstances, it has been accepted that the necessary objective purpose of tax avoidance is not present.

41. Consequently, although the proposed arrangement includes all the other necessary elements of a scheme 'by way of or in the nature of dividend stripping’, the absence of the necessary tax avoidance purpose results in the proposed arrangement not being considered such a scheme. Therefore, section 177E is not considered to apply in this particular case.

42. As section 177E does not apply, a determination would not be made under section 177F to cancel any tax benefit that may be obtained under the proposed arrangement due to the operation of section 177E.

Question 5

Summary

43. Section 177D will not apply to the scheme.

Detailed reasoning

Section 177D – Schemes to which Part IVA applies

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

45. As discussed in paragraph 39 above, it has been accepted that on the particular facts of this case, a dominant purpose of tax avoidance is not present. Consequently, the proposed arrangement is not a scheme to which Part IVA applies by operation of section 177D.

46. As section 177D does not apply, a determination would not be made under section 177F to cancel any tax benefit that may be obtained under the proposed arrangement due to the operation of section 177D.

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