Edited version of private advice

Authorisation Number: 1051562936515

Date of advice: 12 August 2019

Ruling

Subject: Succession plan and section 177E of the Income Tax Assessment Act 1936 (ITAA 1936).

Question

Will the Commissioner confirm that the Scheme is not a scheme to which the provisions of section 177E of the ITAA 1936 would apply?

Answer

Yes

This ruling applies for the following period:

Year ended 30 June 2020.

The scheme commences on:

Year ended 30 June 2020.

Relevant facts and circumstances

The key entities in the proposed arrangement are as follows:

The family

A1 is the patriarch of the family. The immediate family is their spouse A2, their child B and their child C.

B Trust

The B Trust is a discretionary trust. The appointor of the trust is A2.

The primary beneficiaries are named as B; their children, grandchildren and great grandchildren; all the spouses of all the children of B; and any spouse of B.

The only trust property it has is ordinary shares in X Co Pty Ltd.

C Trust

The C Trust is a discretionary trust. The appointor of the trust is A2.

The primary beneficiaries are C; their children, grandchildren and great grandchildren; all the spouses of all the children of C; and any spouse of C.

The only trust property it has is ordinary shares in X Co.

X Co

X Co is an Australian resident company.

It is a passive holding company with various interests including a majority shareholding in Group co.

It has two classes of shares on issue, being management shares and ordinary shares. The shareholders of X Co, and the number of shares they own, are as follows:

·        A1acquired:

-   Pre-CGT management shares

-   Ordinary shares

·        A2 acquired:

-   1 Post CGT management share

-   Ordinary shares

·        B Trust acquired ordinary shares.

·        C Trust acquired ordinary shares.

The management shares of X Co have a greater value than the ordinary shares, as amongst other things they have twice the votes of all ordinary shares on issue. Most of the value of the company is attributable to the management shares.

Group Co

General

Group Co is an Australian resident company.

Group Co has only issued ordinary shares. The shareholding of Group Co is as follows:

·        X Co holds approximately X% of the ordinary shares in Group Co.

·        A1 holds approximately Y% of the ordinary shares in Group Co.

Group Co has a history of paying dividends with the practice of transferring to X Co retained profits from a subsidiary trading entity which is regarded as 'at-risk'.

Group Co is presently the head company of a consolidated group comprising XZ active trading entities and ZY dormant non-trading entities.

B2 Trust

This trust was established recently.

The trustee of the trust is a corporate trustee. B and A1 are directors of the company.

The assets in this trust are held, in general, for the benefit of B and their descendants, and will be a Family trust.

X Investment Co

The director and secretary of X Investment Co is B.

The holding entity and only shareholder for this company is the B2 Trust.

Proposed Family Trust

This trust has not yet been established.

The trustee of the trust is proposed to be a corporate trustee.

The assets in this trust are to be held in general for the benefit of A1, B, and the descendants of B. It will be a Family trust.

The objective of the proposed arrangement

The purpose of the proposed arrangement expressed is to achieve succession for future generations of the family as well to mentor and educate the next generation within the family in managing its wealth.

The proposed arrangement

The abovementioned entities will enter into the arrangement outlined below ('the Scheme'):

1.     A1will sell their pre-CGT ordinary shares in Group Co to X Co. These shares will be transferred for market value consideration

2.     X Investment Co will acquire Z% of A1's management shares and ordinary shares in X Co, represented by:

a)     pre-CGT management shares. These shares will be transferred for market value consideration with the consideration left outstanding.

b)     ordinary shares. These shares will be transferred for market value consideration with the consideration left outstanding.

3.     In return for the transfer of the shares specified in paragraph (2) above, A1will be issued convertible loan notes pursuant to a Convertible Loan Note Deed.

The loan notes issued pursuant to the Deed are non-share equity interests under the terms of the ITAA 1936 and the ITAA 1997.

With the exception of the transfer specified in Step 6, the Scheme does not include any dealing with the loan notes. For example, it does not include any form of repayment of the loan; or the redemption, sale, further assignment or other dealing with the loan notes.

4.     X Investment Co will acquire the balance of the ordinary shares in X Co as follows:

·        ordinary shares will be acquired from A2 for market value consideration with the consideration left outstanding.

·        ordinary shares will be acquired from B Trust for market value consideration with the consideration left outstanding.

·        ordinary shares will be acquired from C Trust for market value consideration with the consideration left outstanding.

5.     In return for the transfer of shares specified in paragraph (4) above, loans will be established in respect of each vendor as lender and X Investment Co as borrower. The loans will be non-repayable for at least 10 years with no ability to be called at the discretion of the vendor-lender for 10 years.

The loans will not carry interest.

The loan interests will be non-share equity interests under the terms of the ITAA 1936 and the ITAA 1997.

6.     A1will transfer some or all of the loan notes issued to them in step (3) to a Family trust as trust corpus. Apart from this step, the Scheme does not include any further dealing with any of the loans. For example, for the purposes of this Ruling, the Scheme does not include any repayment or assignment of the loans, or any application of the loan notes to offset any advance or loan made by an entity in the Group Co tax consolidated group (or proposed consolidated group as outlined in step 7 below).

7.     The Group Co consolidated group will deconsolidate. X Co will elect to form a new tax consolidated group (as A2 will still retain 1 management share in X Co).

Relevant legislative provisions

Section 177E of the ITAA 1936.

Where:

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

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

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

any property of the company is disposed of;

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

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

the following provisions have effect:

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

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

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

Under paragraph 177E(1)(a), the scheme in question must be 'by way of or in the nature of dividend stripping', or one that has substantially the same effect.

The High Court's judgment in FC of T v Consolidated Press Holdings 2001 ATC 4343, agreed with the definition of dividend stripping adopted by the Full Federal Court, which identified common characteristics of dividend stripping as follows:

'a target company, with substantial undistributed profits creating a potential tax liability; the sale or allotment of shares to another party; the payment of a dividend to the purchaser or allottee; the purchaser escaping Australian tax on the dividends so declared; and the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers. A further common characteristic of each case was that the scheme was carefully planned for the predominant if not sole purpose of the vendor shareholders avoiding tax on a distribution of dividends.'

Subparagraph 177E(1)(a)(ii) expands the scope of the provision to capture cases which may not have all the elements of a traditional dividend stripping case, but have 'substantially the same effect' of one. In this regard it was held by the court that:

What sub-par (ii) was aimed at was a scheme that would be within sub-par (i) except for the fact that the distribution by the target company was not by way of a dividend or deemed dividend. Dividend stripping does not lose its connotation of tax avoidance purpose. But a scheme may have substantially the effect of a scheme by way of or in the nature of dividend stripping even though some means other than a dividend or deemed dividend is employed to make the distribution.

The court in Lawrence v FC of T 2009 ATC ¶ 20-096 applied subparagraph 177E(1)(a)(ii) notwithstanding that the scheme which it concerned did not involve a sale or allotment of shares in the target company, and did not involve the distribution of the target company's profits to the allottee (instead involving the diminution in the value of the relevant company's property).

The relevant section 177E 'scheme' in this case comprises the Scheme - that is, steps 1 to 7 in the facts in this Ruling. In essence, the Scheme provides 3 general outcomes:

·        Except for the management share held by A2, all the shares currently held by the various shareholders in X Co will be transferred to a new holding company, X Investment Co.

·        In return, X Investment Co will owe the following debts:

˗        A1, who currently has the shareholding of the largest value, will be issued the loan notes to the value of the shares transferred.

˗        The other shareholders (A2, B Trust and C Trust) will have non-repayable loans owing to them by X Investment Co to the value of the shares transferred.

·        A1will transfer some or all of the loan notes issued to them to a Family bloodline trust as trust corpus.

Importantly the Scheme as strictly defined does not:

·        (apart from the transfer under Step 6), contemplate any further dealing with A1's loan notes. This includes, for example, the repayment, redemption, further assignment, and sale of the loan notes; as well as the use of the loan notes as a set-off against any advance or loan made by an entity in the relevant tax consolidated group to a Family trust to which the loan notes were transferred;

·        include any dealing with the loans owing by X Investment Co to the other shareholders.

It is noted that the Convertible Loan Note Deed allows for both the redemption as well as the conversion of the loan notes. It is also noted that the loan notes issued pursuant to the Deed are non-share equity interests under the terms of the ITAA 1936 and the ITAA 1997 and would be capable of falling within the scope of section 45B of the ITAA 1936.

The sale of shares by way of a vendor financing arrangement broadly effects a change in ownership of the company and the creation of a liability from the new owner to the vendor.

There is no payment of a dividend or deemed dividend, or any other form of distribution, that arises at this point. Nor can it be said the sale and vendor financing arrangement would result in the diminution in the value of X Co or its property (including its subsidiaries) as per the arrangement contemplated in Lawrence.

The further step in the Scheme - in which A1will transfer his loan notes to a Family trust as trust corpus - does not, similarly, itself result in an effective distribution or diminution in the value of the shares of X Co.

For the reasons stated above, the latter requirement of paragraph 177E(1)(a) - that 'property of the company is disposed of' - as well as the requirements in paragraph 177E(1)(b) will not be satisfied under the terms of the Scheme.

Consequently section 177E will have no application to the Scheme.

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