Edited version of your written advice

Authorisation Number: 1051428196315

Date of advice: 13 September 2018

Ruling

Subject: Distribution from an Australian subsidiary entity.

Question 1

Will the Commissioner make a determination pursuant to paragraph 204-30(3)(c) of the Income Tax Assessment Act 1997 (ITAA 1997) in respect of the proposed franked distribution from X Co to Y Co on the basis that the conditions in subsection 204-30(1) of the ITAA 1997 are satisfied?

Answer 1

No

Question 2

Will the Commissioner make a determination pursuant to paragraph 177EA (5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) in respect of the franked distribution to be paid from X Co to Y Co on the basis that the conditions in subsection 177EA (3) of the ITAA 1936 are satisfied?

Answer

No

This ruling applies for the following:

A specified period

The scheme commences on:

A specified date

Relevant facts and circumstances

Current structure

X Pty Ltd (‘X Co’):

X Co is an Australian resident for tax purposes.

X Co is directly and wholly-owned by Z Co. Z Co is a Country A resident for tax purposes.

Z Co is directly and wholly-owned by E Inc and forms part of a consolidated Country A federal income tax group.

E Inc is a resident of the Country A for tax purposes.

E Inc is directly and wholly owned by G Co; such that X Co’s ultimate parent is G Co.

G Co was incorporated in the Country A and is a resident of the Country A for tax purposes.

X Co does not own an interest in any other Australian or non-Australian entity, except for its operations in a branch in Country B.

The X Co Country B branch constitutes a permanent establishment in Country B for tax purposes.

X Co conducts retail business across Australia and Country B (via the Country B branch).

“Y Co”:

E Inc wholly-owns Y Co.

Y Co is incorporated in Country C as a private limited liability company which is treated as a corporation for Country A tax purposes.

Y Co currently wholly owns, directly and indirectly all subsidiaries which carry out G Co’s business operations worldwide (i.e. all operations other than the Australian and Country B operations).

X Co and Y Co are members of the same wholly owned group and have been so since Y Co was incorporated.

There are no current plans to restructure the ownership of X Co or Y Co in the future. It is expected that both entities will continue to be members of the same wholly owned corporate group for the foreseeable future.

The group operates a notional cash pooling arrangement eliminates the need to physically transfer funds between accounts in different countries. Under the cash pooling arrangement the actual funds remain in a participant’s account arriving at the positive or negative account balance for each participant.

X Co’s operating activities have historically generated annual cash surpluses which are deposited into the Australian Account.

Cash which is deposited into the Australian Account and the Country B Account is utilised as collateral to offset any overdrafts of other worldwide subsidiaries accounts in the group notional cash pooling arrangement, thereby effectively utilised to assist funding operations in the group’s subsidiaries.

A principal activity of Y Co is that of an investment company providing long-term funding for the activities of G Co.

Transaction:

The transaction consists of three key transaction steps as follows:

1. E Inc transfers all of the shares in X Co to Y Co in exchange for a new issue of financial instruments by Y Co to E Inc;

2. X Co distributes a significant portion of its cash balance to Y Co;

3. X Co’s funds in the cash pooling arrangement are removed and the remaining cash balance in X Co’s Australian Account is transferred to X Co’s local bank account.

The applicant states the key objectives of the restructure are to:

(i) Concentrate all of the group’s foreign activities under the Country C structure;

(ii) Better align the group’s global cash reserves with long term group requirements.

(iii) Strengthen Y Co.’s balance sheet; and

(iv) Distribute excess cash to its shareholder as X Co does not have any current plans to invest such excess cash.

Further detail relevant to each step of the transaction is as follows:

Step 1:

The first step of the proposed transaction is for E Inc to transfer all of the shares in X Co to Y Co in exchange for a new issue of financial instruments by Y Co to E Inc; in line with the group’s objective to concentrate all foreign activities under the existing Country C structure.

The shares in X Co were valued by an independent third party.

The financial instruments have a par value of EUR 1.

The terms and conditions of the new financial instruments were provided by the applicant as part of the private ruling application process.

Upon the transfer of shares X Co will be 100% owned by Y Co.

Step 2: Distribution of cash from X Co to Y Co:

X Co will pay a cash dividend to Y Co as its sole shareholder. It is proposed that this dividend would be paid as a fully franked dividend and/or a portion may be paid as an unfranked dividend declared to be conduit foreign income.

The dividend paid will reduce X Co’s retained earnings.

Step 3: Dismantling of X Co’s funds from the notional cash pooling arrangement and distribution of the remaining cash balance from the Australian Account to a local X Co bank account.

Most, if not all of X Co’s funds in the Australian Account which are linked to the notional cash pooling arrangement are to be transferred to Y Co’s account which is maintained in Euro.

The remaining balance of X Co’s funds in the Australian Account (if any) will be transferred to X Co’s local bank account.

The Australian Account will be completely removed from the notional cash pooling arrangement and subsequently closed.

Relevant legislative provisions

Income Tax Assessment Act 1997, subsection 6(1)

Income Tax Assessment Act 1997, section 152-125

Income Tax Assessment Act 1997, section 202-40

Income Tax Assessment Act 1997, section 202-45

Income Tax Assessment Act 1997, section 204-30

Income Tax Assessment Act 1997, paragraph 204-30(1)(a)

Income Tax Assessment Act 1997, paragraph 204-30(1)(b)

Income Tax Assessment Act 1997, paragraph 204-30(1)(c)

Income Tax Assessment Act 1997, subsection 204-30(3)

Income Tax Assessment Act 1997, subsection 204-30(6)

Income Tax Assessment Act 1997, subsection 204-30(7)

Income Tax Assessment Act 1997, subsection 204-30(8)

Income Tax Assessment Act 1997, section 207-35

Income Tax Assessment Act 1997, section 208-5

Income Tax Assessment Act 1997, section 215-10

Income Tax Assessment Act 1997, section 215-15

Income Tax Assessment Act 1997, section 220-105

Income Tax Assessment Act 1997, paragraph 960-115(a)

Income Tax Assessment Act 1997, subsection 960-120(1)

Income Tax Assessment Act 1997, section 960-130

Income Tax Assessment Act 1997, section 960-140

Income Tax Assessment Act 1997, section 995-1

Income Tax Assessment Act 1936, paragraph 128B(3)(ga)

Income Tax Assessment Act 1936, section 177EA

Income Tax Assessment Act 1936, subsection 177EA(2).

Income Tax Assessment Act 1936, subsection 177EA (3)

Income Tax Assessment Act 1936, paragraph 177EA(3)(a)

Income Tax Assessment Act 1936, paragraph 177EA(3)(b)

Income Tax Assessment Act 1936, subparagraph 177EA(3)(b)(i)

Income Tax Assessment Act 1936, subparagraph 177EA(3)(b)(ii)

Income Tax Assessment Act 1936, paragraph 177EA(3)(c)

Income Tax Assessment Act 1936, paragraph 177EA(3)(d)

Income Tax Assessment Act 1936, paragraph 177EA(3)(e).

Income Tax Assessment Act 1936, paragraph 177EA (5)(b)

Income Tax Assessment Act 1936, paragraph 177EA(14)(b)

Income Tax Assessment Act 1936, subsection 177EA(17)

Income Tax Assessment Act 1936, paragraph 177EA(17)(a)

Income Tax Assessment Act 1936, subsection 177EA(14)

Income Tax Assessment Act 1936, paragraph 177EA(17)(b)

Income Tax Assessment Act 1936, paragraph 177EA(17)(c)

Income Tax Assessment Act 1936, paragraph 177EA(17)(d)

Income Tax Assessment Act 1936, paragraph 177EA(17)(e)

Income Tax Assessment Act 1936, paragraph 177EA(17)(f)

Income Tax Assessment Act 1936, paragraph 177EA(17)(g)

Income Tax Assessment Act 1936, paragraph 177EA(17)(ga)

Income Tax Assessment Act 1936, paragraph 177EA(17)(h)

Income Tax Assessment Act 1936, paragraph 177EA(17)(i)

Income Tax Assessment Act 1936, paragraph 177EA(17)(j)

Income Tax Assessment Act 1936, subsection 177EA(18)

Income Tax Assessment Act 1936, subsection 177EA(19)

Reasons for decision

Question 1

Summary

The Commissioner will not make a determination pursuant to paragraph 204-30(3)(c) in respect of the proposed franked distribution from X Co to Y Co. Such a determination will not be made as, while Y Co will receive an imputation benefit as a result of the distribution, it will not receive a greater benefit from franking credits than another member of the entity as a result of the distribution. Accordingly the subsection 204-30(1) will not be satisfied and thus paragraph 204-30(3)(c) is not applicable.

Detailed reasoning

All legislative references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.

Subdivision 204-D was introduced as a specific anti-avoidance provision. The broad provision is intended to apply where a company streams dividends in a particular way in order to provide franking credit benefits to shareholders who benefit most from these credits, in preference over shareholders who would gain either nil or lesser benefit from such franking credits.

As stated in paragraph 3.2 of the Explanatory Memorandum (EM) to New Business Tax System (Imputation) Bill 2002, the anti-streaming provisions are intended to ensure that

‘…over time, the benefit of franking credits is spread more or less evenly across members in proportion to their ownership interest in the entity.’ The general intent ‘…is that credits for tax paid on behalf of all members should flow to all members and not to only some of them.’

By encouraging the distribution of franked dividends to shareholders who might not be able to take full advantage of imputation credits, it was expected that the ‘intended wastage’ envisaged at the time of introduction of the imputation credit regime would be achieved.

Section 204-30 contains the specific anti streaming rule which applies in circumstances where a corporate entity streams distributions in a manner that gives those members who would benefit most from franking credits a greater imputation benefit than those who benefit less. Subsection 204-30(1) states that:

This section empowers the Commissioner to make determinations if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, in such a way that:

(a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions; and

(b) the member would derive a greater benefit from franking credits than another member of the entity; and

(c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

The member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member.

Subsection 204-30(3) then sets out the determinations the Commissioner may make, being:

a) that a specified franking debit arises in the franking account of the entity for a specified distribution or other benefit to a disadvantaged member;

b) that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member;

c) that no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination.

In considering whether subsection 204-30(1) will apply to the facts presented, such that the Commissioner may make a determination under paragraph 204-30(3)(c), it is necessary to consider each paragraph at subsection in 204-30(1) as follows:

An imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions:

Subsection 204-30(6) provides that a member of an entity receives an imputation benefit as a result of a distribution if:

(a) the member is entitled to a tax offset under Division 207 as a result of the distribution; or

(b) an amount would be included in the member’s assessable income as a result of the distribution because of the operation of section 207-35; or

(c) a franking credit would arise in the franking account of the member as a result of the distribution; or

(d) an exempting credit would arise in the exempting account of the member as a result of the distribution; or

(e) the member would not be liable to pay withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f) the member is entitled to a tax offset under section 210-170 as a result of the distribution.

At step 2 of the proposed transaction, X Co will pay a cash dividend to Y Co. Y Co at that time will be X Co’s sole shareholder. It is proposed this dividend will be paid as a fully franked dividend and a portion may be paid as an unfranked dividend declared to be conduit foreign income. This cash dividend is a distribution for the purposes of section 204-30. Y Co as a shareholder is a member of the entity.

Accordingly, the factors listed in subsection 204-30(6) have been applied as follows in order to establish if Y Co receives an imputation benefit as a result of the distribution:

● Y Co is a non-resident entity and is therefore not entitled to a tax offset under Division 207 as a result of the distribution.

● Section 207-35 does not apply as Y Co is not a partnership or the trustee of a trust and is a corporate entity.

● Y Co is a non-resident and does not maintain a franking account; hence no franking credit will arise.

● Y Co is a non-resident and is not an exempting entity (noting that X Co is an exempting entity for the purposes of section 208-5).

● Y Co would not be liable to pay withholding tax on the distribution because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936 (ITAA 1936). Paragraph 128B(3)(ga) applies such that withholding tax will not be payable in these circumstances on the franked part of a dividend.

● Y Co will not be entitled to a tax offset under section 210-170.

As paragraph 128B(3)(ga) will apply such that Y Co will not be liable for withholding tax on the franked part of a dividend, Y Co will receive an imputation benefit as a result of the distribution.

Accordingly, paragraph 204-30(1)(a) will apply.

The member would derive a greater benefit from franking credits than another member of the entity:

For paragraph 204-30(1)(b) to apply, the member (being Y Co) needs to derive a greater benefit from franking credits than another member of the entity. In this case, at the point in time the distribution is made from X Co to Y Co, Y Co is the only member as they will hold 100% of the ordinary shares in X Co.

Accordingly, as at the time of the distribution there is no other member of the entity, paragraph 204-30(1)(b) will have no application and will not be satisfied.

That no imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination:

As paragraph 204-30(1)(b) is not satisfied, it is not necessary to consider paragraph 204-30(1)(c).

Conclusion

As Y Co will not be liable to pay withholding tax on the distribution because of the operation of paragraph 128B(3)(ga); paragraph 204-30(1)(a) will be satisfied and an imputation benefit is, or apart from this section would be, received by as a result of the distribution.

However, at the time the distribution is made to X Co, there will be no other member for the purposes of paragraph 204-30(1)(b) as Y Co will hold 100% of the ordinary shares in X Co. It follows then that subsection 204-30(1)(b) will not be satisfied. It follows that it is not necessary to consider paragraph 204-30(1)(c). As all three paragraphs at subsection 204-30(1) are not satisfied, section 204-30 will not apply.

Accordingly, the Commissioner will not make a determination under paragraph 204-30(3)(c); as while an imputation benefit is received by a member of the entity as a result of the distribution; the member would not derive a greater benefit from franking credits than another member of the entity.

Question 2

Summary

The Commissioner will not make a determination pursuant to paragraph 177EA (5)(b) in respect of the franked distribution to be paid from X Co to Y Co; as the conditions in subsection 177EA (3) of the ITAA 1936 are not satisfied. The scheme was not entered into with a purpose of enabling Y Co to obtain an imputation benefit. Accordingly subsection 177EA(3) will not be satisfied and paragraph 177EA(5)(b) is not applicable.

Detailed reasoning

All legislative references are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936) unless specified otherwise.

Section 177EA broadly concerns the creation of a franking debit or the cancellation of franking credits. The section applies if a scheme involving a disposition of shares is entered into with a purpose of enabling the taxpayer to obtain franking credit benefits. In these circumstances, it enables the Commissioner to deny the franking credit benefits arising from the scheme or, if the company is a party to the scheme, to post a debit to the company’s franking account.

Pursuant to subsection 177EA(3), section 177EA 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:

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

(i) 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.

Where the provision applies, the Commissioner may make a determination that no imputation benefit arises for the relevant (recipient) taxpayer pursuant to paragraph 177EA(5)(b).

Paragraph 177EA(3)(a) scheme for disposition of membership interests:

An expression used in section 177EA has the same meaning as in the ITAA 1997, except to the extent that its meaning is extended by subsection (16), (18) or (19), or affected by subsection (15); subsection 177EA(2).

X Co is a company and therefore constitutes a ‘corporate tax entity’; as per the definitions in subsection 6(1), and in section 995-1 of the ITAA 1997, and paragraph 960-115(a) of the ITAA 1997.

E Inc holds ordinary shares in X Co. Therefore, E Inc holds ‘ordinary membership interests’ in X Co, a corporate tax entity; as provided by sections 960-130, 960-135 and 960-140 of the ITAA 1997.

As per subsection 177EA(14), a scheme for a disposition of membership interests or an interest in membership interests includes, but is not limited to, a scheme that involves any of the following:

a) issuing the membership interests or creating the interest in membership interests;

b) entering into any contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests;

c) creating, varying or revoking a trust in relation to the membership interests or interest in membership interests;

d) creating, altering or extinguishing a right, power or liability attaching to, or otherwise relating to, the membership interests or interest in membership interests;

e) substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding or owning the membership interests or having the interest in membership interests;

f) the membership interests or interest in membership interests beginning to be included, or ceasing to be included, in any of the insurance funds of a life assurance company.

The subsection 177EA(14) requirements are disjunctive (only one requirement needs to be present).

The proposed reorganisation of X Co consists of three key transaction steps:

1. E Inc transfers all of the shares in X Co to Y Co in exchange for a new issue of financial instruments by Y Co to E Inc;

2. X Co distributes a significant portion of its cash balance to Y Co;

3. X Co’s funds in the cash pooling arrangement are removed and the remaining cash balance in X Co’s Australian Account is transferred to X Co’s local bank account.

At step 1 of the transaction, Y Co will acquire 100% of the ordinary shares in X Co from E Inc. The transaction will result in a change to E Inc’s ownership of the relevant number of shares (ordinary membership interests) it holds in X Co. There will be no change in the ultimate ownership of X Co by G Co; it will continue to hold the shares indirectly through its existing wholly owned entity Y Co. As a result, the requirement at paragraph 177EA(14)(b) is satisfied.

As one of the disjunctive requirements of subsection 177EA(14) is present in the circumstances of the restructure, the paragraph 177EA(3)(a) scheme for disposition of membership interests requirement is met.

Paragraph 177EA(3)(b) frankable distribution has been paid or is expected to be payable:

The requirement at paragraph 177EA(3)(b) is satisfied if either subparagraph 177EA(3)(b)(i) or 177EA(3)(b)(ii) is present.

Both subparagraphs 177EA(3)(b)(i) and 177EA(3)(b)(ii) require a ‘person’. The term ‘person in subsection 6(1), and as defined in section 995-1 of the ITAA 1997, includes a company. Relevantly, Y Co, E Inc and G Co are companies and therefore each entity is a ‘person’ for the purposes of both subparagraphs 177EA(3)(b)(i) and 177EA(3)(b)(ii).

Both subparagraphs require a ‘frankable distribution’. The term ‘frankable distribution’ in subsection 6(1), and in section 995-1 of the ITAA 1997, refers to section 202-40 of the ITAA 1997. The term ‘distribution’ in subsection 6(1), and in section 995-1 of the ITAA 1997, refers to section 960-120 of the ITAA 1997.

As per Item 1 in the table in subsection 960-120(1) of the ITAA 1997, a dividend or something that is taken to be a dividend by a company constitutes a distribution. A distribution is a frankable distribution to the extent it is not unfrankable. Section 202-45 of the ITAA 1997 provides that the following are unfrankable:

(a) … [Repealed] …

(b) a distribution to which paragraph 24J(2)(a) … applies that is taken under section 24J … to be *derived from sources in a prescribed Territory, as defined in subsection 24B(1) … (distributions by certain *corporate tax entities from sources in Norfolk Island);

where the purchase price on the buy-back of a *share by a *company from one of its *members is taken to be a dividend under section 159GZZZP … - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place;

a distribution in respect of a *non-equity share;

a distribution that is sourced, directly or indirectly, from a company's *share capital account;

an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15;

an amount that is taken to be a dividend for any purpose under any of the following provisions:

iv.

(h) an amount that is taken to be an unfranked dividend for any purpose:

i. under section 45 … (streaming bonus shares and unfranked dividends);

ii. because of a determination of the Commissioner under section 45C …(streaming dividends and capital benefits);

(i) a *demerger dividend;

(j) a distribution that section 152-125 or 220-105 says is unfrankable.

As part of the proposed transaction, X Co will pay a franked distribution to Y Co. In applying section 202-45 to the proposed transaction, the paragraphs at 202-45 of the ITAA 1997 do not apply as follows:

● Paragraphs (a) and (b) are not applicable to the transaction.

● Paragraph (c) does not apply as the transaction is not a share buyback; rather E Inc is transferring its shares in X Co to Y Co.

● Paragraph (d) does not apply as the distribution is not in respect of a non-equity share. A non-equity share means a share that is not an equity interest in the company. The shares transferred are ordinary shares and constitute an equity interest in X Co.

● Paragraph (e) does not apply as the distribution is not sourced, directly or indirectly, from X Co’s share capital account.

● Paragraph (f) does not apply as the distribution is not taken to be an unfrankable distribution under section 215-10 (as X Co is not an authorised deposit-taking institution for the purposes of the Banking Act 1959). Section 215-15 does not apply as immediately before the payment, the amount of the available frankable profits of the entity was greater than nil.

● None of the subparagraphs at Paragraph (g) will apply.

● The subparagraphs at Paragraph (h) will not apply. Subparagraph (i) will not apply as the proposed distribution is a franked dividend paid to the sole shareholder. There are no bonus shares or unfranked dividends other than a portion of the distribution which may be paid as conduit foreign income. Subparagraph (ii) will not apply as a determination under 45C may be made where under section 45A a capital benefit has been received by certain shareholders (the advantaged shareholders). The provision of a capital benefit for the purposes of section 45A is a reference to the provision of shares in the company; the distribution of share capital or share premium; or something that is done in relation to a share that has the effect of increasing the value of a share held by a shareholder. There is no provision of a capital benefit as a result of the proposed transaction; rather a distribution from profit. Accordingly, section 45A will not apply and there can be no determination under section 45C.

● Paragraph (i) will not apply as the transaction is not a demerger transaction and the distribution is not a demerger dividend.

● Paragraph (j) will not apply as the distribution is not unfrankable because of the application of section 152-125 or section 220-105.

Accordingly, paragraph 177EA(3)(b) will be satisfied.

It is noted that a portion of the distribution may be paid as conduit foreign income. Any such portion would be an unfranked distribution, and would not be subject to the operation of Section 177EA.

Paragraph 177EA(3)(c) Dividend or distribution was, is expected to be franked:

The third condition for section 177EA(3) to apply is that the dividend or distribution was or is expected to be a franked distribution.

At step 2 of the proposed transaction X Co will pay a franked distribution to Y Co. This is a franked distribution for the purposes of section 200-20 of the ITAA 1997.

Accordingly paragraph 177EA(3)(c) will be satisfied.

Paragraph 177EA(3)(d) Imputation benefits:

The fourth condition for section 177EA(3) to apply is that, as provided by paragraph 177EA(3)(d), a person would, but for the operation of 177EA, have received imputation benefits as a result of the distributions, or could reasonably be expected to receive such benefits as a result of the distribution.

‘Imputation benefit’ has the meaning given by subsection 204-30(6) as the distribution is being made to Y Co directly. Subsection 204-30(6) provides that a member of an entity receives an imputation benefit as a result of a distribution if:

(a) the member is entitled to a tax offset under Division 207 as a result of the distribution; or

(b) an amount would be included in the member’s assessable income as a result of the distribution because of the operation of Section 207-35; or

(c) a franking credit would arise in the franking account of the member as a result of the distribution; or

(d) an exempting credit would arise in the exempting account of the member as a result of the distribution; or

(e) the member would not be liable to pay withholding tax on the distribution, because of the operation of paragraph 128B(3)(ga) of the Income Tax Assessment Act 1936; or

(f) the member is entitled to a tax offset under Section 210-170 as a result of the distribution.

As per the analysis at Question 1, the factors listed in subsection 204-30(6) have been applied as follows in order to establish if Y Co, as the sole shareholder and member of the entity, will receive an imputation benefit as a result of the distribution:

● Y Co is a non-resident entity and is therefore not entitled to a tax offset under Division 207 as a result of the distribution.

● Section 207-35 of the ITAA 1997 does not apply as Y Co is not a partnership or the trustee of a trust and is a corporate entity.

● Y Co is a non-resident and does not maintain a franking account hence no franking credit will arise.

● Y Co is a non-resident and is not an exempting entity (noting that X Co is an exempting entity for the purposes of section 208-5 of the ITAA 1997).

● Y Co would not be liable to pay withholding tax on the distribution because of the operation of paragraph 128B(3)(ga). Paragraph 128B(3)(ga) applies such that withholding tax will not be payable in these circumstances on the franked part of a dividend.

● Y Co will not be entitled to a tax offset under section 210-170.

As paragraph 128B(3)(ga) will apply such that Y Co will not be liable for withholding tax on the franked part of a dividend; Y Co will receive an imputation benefit as a result of the distribution. Therefore paragraph 177EA(3)(d) will be satisfied.

Paragraph 177EA(3)(e) Relevant purpose:

As the threshold requirements of section 177EA have been met (see paragraphs 177EA(3)(a) to (d)), it is necessary to consider the ‘relevant circumstances’ of the scheme in determining whether it could 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 test of purpose under section 177EA(3)(e) is an objective test. It is necessary to determine whether, objectively, it would be concluded that a person who entered into or carried out the ‘scheme for a disposition’ did so for the purpose but not an incidental purpose of obtaining a tax advantage relating to franking credits. “Incidental purpose’ is not a defined term and therefore takes its ordinary meaning. The Explanatory Memorandum to the Taxation Laws Amendment Bill (No.3) 1998 at Paragraph 8.76 states the following in this regard:

A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident. For example, when a taxpayer holds shares in the ordinary way to obtain the benefit of any increase in their share price and the dividend income flowing from the shares, a franking credit benefit is generally no more than a natural incident of holding the shares, and generally the purpose of obtaining the benefit simply follows incidentally a purpose of obtaining the shares: it is therefore merely an incidental purpose.

In ascertaining purpose under section 177EA, it is pertinent to consider the reason for its introduction; as explained in the Explanatory Memorandum to Act No 47 of 1998 (paragraph 8.124) as follows:

…One of the underlying principles of the dividend imputation system is 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. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (i.e. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings…

Further, the High Court decision in Mills v Commissioner of Taxation (2012) 250 CLR 171 has clarified some aspects of the basis for ascertaining purpose under section 177EA:

● The relevant circumstances referred to in subsection 177EA(17) are only relevant to the extent that they are probative of the ultimate question as to purpose.

● The relevant circumstances referred to in subsection 177EA(17) are mandatory considerations but are not exhaustive of the circumstances that might be probative of the ultimate question.

● A purpose will be incidental if it does no more than further or follow as a consequence of some other purpose.

● A purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose.

● Purpose is a matter for inference, incidentality is a matter of degree, and counterfactual analysis may be relevant to the ascertainment of both franking purpose and whether that purpose is or is not incidental to some other purpose.

These relevant circumstances encompass a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposition and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose of enabling the relevant taxpayer to obtain an imputation benefit.

Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the scheme seeks to undermine the principles of the dividend imputation system by franking credit trading or streaming franking credits to select shareholders as envisaged in the preceding extract of the EM or some other abuse of the imputation system.

To establish the requisite purpose, it is necessary to consider the relevant circumstances as outlined in subsection 177EA(17) against the facts as provided. Consideration of the relevant circumstances with regards to the proposed transaction is as follows:

Paragraph 177EA(17)(a):

Paragraph 177EA(17)(a) refers to the extent and the duration of the risks of loss and the opportunities for profit from holding the relevant shares which are respectively borne by or accrue to the parties to the scheme.

● Upon transfer of the shares from E Inc to Y Co, the same rights will be attached to the shares, such that Y Co will be subject to the same risks and rewards associated with the X Co shares as E Inc did.

● As a result of the proposed distribution, the franking credits will flow to Y Co in direct proportion to its 100% ownership interest in X Co.

● It is expected that Y Co will remain the long-term holder of X Co, such that it will be exposed to the full risks and rewards of ownership. There is no plan that Y Co will divest X Co, and no arrangements are contemplated whereby E Inc would reacquire a direct interest in X Co. E Inc will still indirectly benefit from the distributions as E Inc wholly owns Y Co. Therefore, the economic owner of the shares is still within the corporate group.

Accordingly, this circumstance does not support a finding of the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(b):

Paragraph 177EA(17)(b) is directed to whether a taxpayer receiving the franked distribution would derive a greater franking benefit from franking credits than other entities who hold membership interests in the corporate tax entity. Subsection 177EA(19) describes circumstances in which a taxpayer receives a greater benefit than another entity.

In the explanatory memorandum to the Taxation Laws Amendment Act (No. 3) 1998, the matters for consideration referred to in paragraph 177EA(17)(b) are described as the tax profiles of the parties to the scheme. If maximum value is derived from the franking credits and wastage is avoided (for instance, because the franking credits end up in the hands of taxpayers who can make relatively more use of them), then this may point to the existence of the requisite purpose.

Subsections 177EA(18) and (19) set out a non-exhaustive list of some of the cases in which a taxpayer to whom a distribution flows indirectly receives a ‘greater benefit from franking credits’ than other entities who hold membership interests in the corporate tax entity. In relation to taxpayers to whom a distribution flows directly (as is the case here), subsections 204 30(7), (8), (9) and (10) of the ITAA 1997 provide a list of circumstances in which the taxpayer will be treated as deriving a greater benefit from franking credits than another entity.

Relevantly, subsections 204-30(7) and (8) provide as follows:

204-30(7)

The following subsection lists some of the cases in which a member of an entity derives a greater benefit from franking credits than another member of the entity. It is not an exhaustive list.

204-30(8)

A member of an entity derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution is giving rise to the benefit is made, and not in relation to the first member:

(a) the other member is a foreign resident;

(b) the other member would not be entitled to any tax offset under Division 207 because of the distribution;

(c) the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled;

(d) the other member is a corporate entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e) the other member is a corporate tax entity at the time the distribution is made, but cannot use the franking credits received on the distribution to frank distributions to its own members because:

(i) It is not a franking entity; or

(ii) It is unable to make frankable distributions;

(f) the other member is an exempting entity.

With regard to the application of subsection 204-30(8) of the ITAA 1997:

● As both Y Co and E Inc are non-resident entities, neither entity would derive a greater benefit from franking credits received on a distribution from X Co.

● As non-residents, both entities are equally exempt from withholding tax on the franked distribution because of the operation of paragraph 128B(3)(ga).

● Y Co will hold the same membership interest (100%) in XCo post transaction as is currently held by X Co; thus each entity would be entitled to the same proportion of the distribution and franking credits when each entity holds the interest in X Co.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(c):

Paragraph 177EA(17)(c) is concerned with, whether, apart from the scheme, a corporate tax entity would have retained the franking credits or would have used the franking credits to pay a franked distribution to another entity referred to in paragraph 177EA(17)(b).

The applicant contends that the key commercial drivers for the transaction are to:

● Concentrate all of the group’s foreign activities under the Country C structure.

● Better align the group’s global cash reserves with long term group requirements. The reorganisation of funding arrangements reflects the low likelihood that X Co will draw on funds in the future and the long term funding needs of various foreign operations.

● Strengthen Y Co’s balance sheet; and

● Distribute excess cash to its shareholder as X Co does not have any current plans to invest such excess cash.

Given the commercial objective of restructuring for ownership and funding purposes, the counterfactual transaction in these circumstances can be identified as:

● Step 1: X Co would pay a fully franked dividend to E Inc pre transfer;

● Step 2: The transfer of ownership from E Inc to Y Co would still occur;

● Step 3: E Inc would contribute the cash repatriated by way of dividend (from X Co) to Y Co in return for the financial instruments.

The counterfactual transaction would:

● Ultimately achieve the same ownership and funding structure as that in the proposed transaction; as the transfer of ownership from E Inc to Y Co would still occur.

● By distributing the dividend to E Inc pre transfer, X Co will still not retain its franking credits.

● E Inc will not be liable for withholding tax on the franked distribution as they are a non-resident entity; thus it would benefit to the same extent from the distribution as Y Co in the proposed transaction.

● For Country A income tax purposes, the distribution to E Inc would be tax free up to the amount of previously taxed income (Australian earnings previously taxed in the Country A).

● For Country C tax purposes, the contribution of cash from E Inc to Y Co in exchange for the financial instruments would be tax free in Country C.

The counterfactual transaction supports the contention that, apart from the scheme, the franking credits would not be retained by X Co and further; that E Inc would benefit to the same extent as Y Co if the distribution was paid to E Inc pre transfer.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(d):

Paragraph 177EA(17)(d) is concerned with whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity who would have received less benefit from the franking credits.

The franking credits attached to the proposed distribution will not flow through to any higher order entities as the recipient, Y Co, is a non-resident of Australia. This is also the outcome in the counterfactual transaction if E Inc were to receive the franking credits.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(e)

Paragraph 177EA(17)(e) is concerned with the issue of non-share equity interests. This factor is not relevant as there will be no issue of non-share equity interests as part of the distribution.

Paragraph 177EA(17)(f)

Paragraph 177EA(17)(f) is concerned with whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme was calculated by reference to the imputation benefits to be received by the relevant taxpayer. Where consideration paid by or to, or provided by, the relevant taxpayer is calculated wholly or in part, by reference to the franking credit benefit, that may indicate the presence of the requisite purpose.

The consideration paid by Y Co to E Inc for the shares in X Co has not been calculated by reference to the franking credit benefit. Rather, as per the facts, the shares in X Co were valued by an independent third party.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(g)

Paragraph 177EA(17)(g) considers whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme.

Y Co will not receive any deduction or capital loss as a result of the distribution. X Co will also not receive an allowable deduction or a capital loss in connection with the distribution.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(ga)

Paragraph 177EA(17)(ga) considers whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits.

It is accepted that no distribution under the scheme will be sourced, directly or indirectly, from unrealised or untaxed profits. The distribution will be sourced from X Co’s retained earnings account.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(h)

Paragraph 177EA(17)(h) considers whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or an amount in the nature of, or similar to, interest.

The distribution paid from X Co to Y Co under the proposed transaction will be ordinary dividends. It is accepted that the distribution does not represent an equivalent amount of interest or any amount similar to interest.

Accordingly, this circumstance does not support a conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(i)

Paragraph 177EA(17)(i) considers the period for which the relevant taxpayer held membership interests or had an interest in membership interests, in the corporate tax entity in the relevant circumstances.

At the time of the transaction, Y Co will only have held the shares in X Co for a relatively short amount of time in comparison to that of E Inc.

The applicant contends that it is intended Y Co will be a long term holder of the shares in X Co and therefore, in the long term this should not be indicative of a short term franking credit trading arrangement.

In considering this circumstance, in itself it does not support a broader conclusion as to the requisite purpose under paragraph 177EA(3)(e).

Paragraph 177EA(17)(j)

Paragraph 177EA(17)(j) requires an examination of any matters referred to in former subparagraphs 177D(b)(i) to (viii), namely:

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

(ii) the form and substance of the scheme;

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

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

(v) 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;

(vi) 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;

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

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

Not all the factors in Section 177D are necessary to determine the requisite purpose. This was supported by Callinan J in the High Court case of Federal Commissioner of Taxation v Hart [2004] HCA 26 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.”

Further, the above needs to be considered in line with the original intent of the law. The EM to Taxation Laws Amendment Bill (No. 3) 1998 states as follows at paragraph 8.2:

The purpose of the amendments is to protect the revenue by introducing a general anti-avoidance rule and anti-streaming measures to curb the unintended usage of franking credits through dividend streaming and franking credit trading schemes.

And further:

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.

8.6 Franking credit trading schemes allow franking credits to be inappropriately transferred by, for example, allowing the full value of franking credits to be accessed without bearing the economic risk of holding the shares. These schemes undermine the first principle.

8.7 Companies can also engage in dividend streaming (i.e. the distribution of franking credits to select shareholders), which undermines the second principle by attributing tax paid on behalf of all shareholders to only some of them. Generally this entails the streaming of franking credits to taxable residents and away from non-residents and tax-exempts.

8.64: The mere acquisition of shares or units in a unit trust where the shares or units are to be held at risk in the ordinary way, will not, in the absence of further features, attract the rule, [meet the definition of a scheme for a disposition of membership intest or an interest in such interests], even though the shares or units are expected to pay franked dividends or distributions.

In considering the application of paragraph 177EA(17)(j), the following subparagraphs are relevant:

(ii) Form and substance of the scheme

In respect of former Subparagraph 177D(b)(ii), Callinan J stated in Federal Commissioner of Taxation v. Hart (2004) ATC 4599 at 2004 ATC 4625:

The reference in s177D(b)(ii) to the 'substance of the scheme' invites attention to what in fact the taxpayer may achieve by carrying it out, that is to matters whether forming part of, or not to be found within the four corners of an agreement or an arrangement. They also require that substance rather than form be the focus.

The applicant has submitted the proposed transaction is motivated by the commercial objective of long term structural change to the group’s ownership and funding structures. In this case, the form and substance of the scheme can be aligned with those commercial objectives. Specifically:

● All non-Country A resident entities within the group are held via Country C. The legal form of the proposed arrangement is to transfer 100% of the shares in X Co to Y Co from E Inc to align the Australian and Country B holding structure with all other non-US resident entities within the same global group.

● Y Co became the holding company of all other non-Country A resident entities as a result of a series of acquisitions. The proposed transaction completes the global group holding structure strategy.

● Y Co is 100% owned by E Inc such that E Inc would still indirectly benefit from the distribution.

● Both E Inc and Y Co (the pre- and post-transaction shareholders) have and will hold the shares as long term investors and have and will be exposed to the full risks and benefits of ownership.

● The ultimate owner of the group, G Co, will not change.

● The relevant dividend distribution will effect (in form and substance) a distribution of profits and cash to the same entity, being Y Co.

● At the time the distribution is to be made there are no other entities which hold membership interests in X Co apart from Y Co.

● The shares in X Co will have the same rights when transferred to Y Co from E Inc as when held directly by E Inc.

Accordingly, there is no disparity as between the form and substance of the scheme. This factor is favourable to the conclusion that the relevant purpose does not exist.

(iii) Timing of the scheme

On the facts provided, there is no aspect of the timing of this scheme that would indicate the arrangement was entered into for a purpose which is more than an incidental purpose of obtaining an imputation benefit.

(v) Financial position

This consideration requires a comparison of the financial/economic outcomes for a taxpayer as compared to the tax outcomes. For example, a scheme resulting in a tax deduction for a taxpayer with no corresponding economic or financial loss would indicate a purpose of obtaining a tax benefit.

Under the proposed transaction Y Co will pay market value consideration to E Inc to acquire the shares in X Co. The applicant also contends that while the payment of the franked distribution by X Co to Y Co will result in Y Co effectively converting a portion of its underlying investment value into a more liquid form; the nature of the payment of a dividend, in the absence of any other transaction features (derivatives or other contractual arrangements such as buy back arrangements, share loans, etc) is a common commercial transaction and should not be seen as indicative of a tax avoidance purpose.

This factor supports the conclusion that the relevant purpose does not exist.

Conclusion

In examining the relevant circumstances of the scheme and the commercial drivers against the factors listed in subsection 177EA(17) as a whole, the Commissioner concludes the relevant purpose requirement at paragraph 177EA(3)(e) is not satisfied. It is not concluded that the proposed transaction is entered into with a purpose of enabling Y Co to obtain franking credit benefits; and the imputation benefit received by Y Co as a recipient of the distribution is considered to be an incidental benefit. Accordingly, as paragraph 177EA(3)(e) is not satisfied; the conditions in Section 177EA(3) are not satisfied. The Commissioner will not make a determination under Subsection 177EA(5) with respect to the distribution X Co will make to Y Co under the proposed transaction.

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