EDITED VERSION OF NOTICE OF PRIVATE RULING
Authorisation Number: 34392
This Ruling is a 'Private Ruling' for the purposes of Part IVAA of the Taxation Administration Act 1953.
YEAR(S) OF INCOME TO WHICH THIS RULING APPLIES:
TAX LAW:
Income Tax Assessment Act 1936 Section 273.
WHAT THIS RULING IS ABOUT:
Will the Commissioner exercise his discretion under section 273 of the Income Tax Assessment Act 1936 (ITAA 1936) to treat dividends paid by a private company to a superannuation fund, as not being special income of the fund?
THE SUBJECT OF THE RULING:
The superannuation fund (the fund) is a complying superannuation fund. The Director of the trustee company of the fund, has submitted the application for ruling on behalf of the fund.
The private company (the company) was formed during the year ended 30 June 2000 for the purpose of purchasing a business enterprise. There are 9 shareholders holding the total of over 2 million ordinary shares issued.
In addition to being the trustee of the fund, the corporate trustee is one of the shareholders in the company.
The director of the corporate trustee and spouse are the only two members of the fund.
The applicant is a director of the company. The other five directors of the company are unrelated to the applicant, the fund or its members.
The fund holds under 30 000 shares in the company having paid $1.00 per share. All shares have been issued at $1 per share.
Shares in the company are held by both the fund and the corporate trustee. The applicant has advised that the fund holds under one per cent of the issued shares of the company and in addition, the trustee company holds slightly over one per cent of total issued shares in its own right, therefore the total percentage of shares held by the fund and related entities is just over 2%. Other shares are held by seven shareholders who are unrelated to the fund or its members.
A dividend was paid during the year ended 30 June 2002. Whilst the company has no formal dividend policy, if there are profits available, the goal of the company is a X% dividend return.
The company made a small operating profit in 2000, an operating loss in 2001 and a larger operating profit in 2002.
No dividends were paid by the company in the 2000 or 2001 financial years.
No shares have been issued by the company to anyone in satisfaction of a part of a dividend.
As only ordinary shares have been issued, all shares in the company have equal voting rights.
Financial statements have been provided by the applicant.
Under the governing rules of the company, the directors may authorise payment of such interim and final dividends as they see fit, however, dividends may only be paid out of the profits of the company. In addition, subject to the rights of shareholders who hold shares with special rights as to dividends (if any) all dividends shall be declared and paid according to the amounts paid up on the shares.
The applicant has advised that the source of the money used to purchase the shares in the company was money held in the fund's bank account.
COMMENCEMENT OF ARRANGEMENT:
1 July 2001
RULING:
Will the Commissioner exercise his discretion under section 273 of the ITAA 1936 to treat dividends paid by a private company to a superannuation fund, as not being special income of the fund?
Yes, the Commissioner will exercise his discretion under section 273 of the ITAA 1936 to treat the dividend as not being special income of the fund.
EXPLANATION: (This does not form part of the Notice of Private Ruling)
Section 273 of the ITAA 1936 identifies income that is being directed to a concessionally taxed superannuation entity, and removes the taxation benefit of directing income to that concessionally taxed entity that would otherwise have been derived by a high rate taxpayer, by treating the income as special income.
The Commissioner of Taxation has issued Draft Taxation Ruling TR 2000/D11 titled Income tax: special income derived by a complying superannuation fund, a complying ADF or a PST in relation to the year of income (TR 2000/D11). Whilst this Draft Ruling represents the preliminary, though considered views of the Commissioner, which may not be relied upon by taxation officers or taxpayers, it provides useful guidance on the interpretation of section 273 of the ITAA 1936.
Subsection 273(2) of the ITAA 1936 has the effect that all private company dividends paid to a superannuation entity are special income unless the Commissioner forms the opinion that it would be reasonable not to treat the dividend as special income of the entity, having regard to:
(a) value of the shares in that company that are assets of the entity;
(b) the cost to the entity of the shares on which the dividend was paid by the company:
(c) the rate of the dividend paid to the entity by the company on the shares in the company
(d) whether the company has paid a dividend on other shares in the company and, if so, the rate of the dividend;
(e) whether any shares have been issued by the company to the entity in satisfaction of, or of a part of, a dividend paid by the company and, if so, the circumstances of the issue of those shares; and
(f) any other matters that the Commissioner considers relevant.
Therefore, in deciding whether to exercise the discretion conferred in subsection 273(2), the Commissioner must have regard to the six matters listed in paragraphs (a) to (f), and all six matters have equal weight.
It is proposed to deal with each of these matters in turn.
(a) value of the shares in that company that are assets of the entity
The company has issued over two million ordinary shares, of which the fund owns under 30 000, just under one per cent. The fund paid $1 per each share. The shares are fully paid.
The company was formed solely to purchase the business enterprise.
All shares have been issued at $1.00 per share. All shares in the company are fully paid.
This factor supports the exercise of the Commissioner's discretion under subsection 273(2) of the ITAA 1936.
(b) the cost to the entity of the shares on which the dividend was paid
The fund paid $1.00 for each ordinary share. The applicant has stated that all the shares were original issues by the company. Hence they were not valued in the usual sense of the word. The trustee's decision to invest was based upon a detailed analysis of future cash flows and profitability undertaken by the trustees themselves, who also subsequently invested in the company.
The cost of the ordinary shares was based on the cost of purchasing the business enterprise and meeting cash flow requirements. In view of this, it is accepted that the shares were purchased at a reasonable market value.
Paragraph 27 of TR 2000/D11 states:
The issue of new shares in the private company to the superannuation entity is by itself a neutral matter. If the new shares are being issued as a means by which the superannuation entity can increase its equity in the company and entitlement to dividends, this will raise concerns for the Commissioner.
The facts for this matter support the Commissioner exercising his discretion under subsection 273(2) of the ITAA 1936.
(c) the rate of the dividend paid to the entity on the shares that are assets of the entity
Dividends were paid during the year ended 30 June 2002. The unfranked dividends were paid solely from profit earned during the year. It is the goal of the company, if there are profits available, to pay dividends at the rate of X% return.
Prima facie, this appears to be a fairly high rate of return. The applicant has advised that there are no public companies in Australia which own and operate the same business enterprise. However, the applicant states that given the risks, a X% dividend appears reasonable.
The financial statements of the company indicate a significant improvement in financial performance in the 2002 financial year compared with the 2000 and 2001 financial years.
As the improved financial performance allowed the payment of the dividend, it is accepted that the rate of the dividend does not suggest that the income should be treated as special income.
The facts for this matter support the Commissioner exercising his discretion under subsection 273(2) of the ITAA 1936.
(d) whether the company has paid a dividend on other shares in the company, and if so, the rate of that dividend
There is only one class of share in the company. The same rate of dividend will be paid on all shares, which are all fully paid. It appears that there is no preferential treatment being given in the declaration of dividends.
The facts for this matter support the Commissioner exercising his discretion under subsection 273(2) of the ITAA 1936.
(e) whether any shares have been issued in satisfaction of, or a part of, a dividend paid by the company
There have been no shares issued by the company in satisfaction of a dividend, or part of a dividend, paid by the company.
The facts for this matter support the Commissioner exercising his discretion under subsection 273(2) of the ITAA 1936.
(f) any other matters the Commissioner considers relevant
This paragraph recognises that in assessing whether dividends from private companies are to be considered special income, there may be other relevant matters in addition to the matters specified in paragraphs (a) to (e) of the subsection.
Section 273 of the ITAA 1936 was inserted by Taxation Laws Amendment Act (No 2) 1989. Superannuation entities generally qualified for an exemption from income tax under taxation law as it applied prior to 1 July 1988. They were, however, taxable in full on income of a type that would now be special income because of the operation of subsection 273(2). Subsection 273(2) is in the same terms as former subsections 23FC(2)-(5) and the earlier provisions of former subsections 23F(16)-(18) of the ITAA 1936.
A number of cases concerning the reasonableness or otherwise of excluding private company dividends under the equivalent provisions of the former subsections 23F(16)-(18) of the ITAA 1936 were decided by the Board of Review (see Case A38 69 ATC 225, Case A39 69 ATC 227, Case A40 69 ATC 229, Case A41 69 ATC 233, Case B15 70 ATC 61, Case B40 70 ATC 202, Case M63 80 ATC 440). As subsection 273(2) of the ITAA 1936 is in the same terms as former ITAA 1936 provisions regarding special income, the principles to be drawn from these cases remain relevant.
The following factors were considered by the Board of Review to be relevant in determining whether the Commissioner's discretion should be exercised:
Other factors which emerge from the case law as relevant considerations are:
These factors are illustrative and not exhaustive.
In Case A38, the facts that the company was the only contributor to the fund, that the members of the fund were the only other shareholders in the company and that the fund's shareholding entitled it to one-fifth of all the distributed profits of the company went against the claim for exemption from tax under subsection 23F(16) of the ITAA 1936.
In Case A40, eighty-eight per cent of the dividends received by the fund were credited to members who were also the shareholders of the private company. Taking into account the proportion of dividends paid by the private company to the fund and the level of shareholding of the fund in the private company, the Board of Review upheld the Commissioner's opinion that it would not be reasonable in terms of subsection 23F(16) of the ITAA 1936 to exempt the dividends received by the fund from income tax.
In Case A41, the Board of Review confirmed the Commissioner's opinion not to exempt the dividends received from tax within the terms of subsection 23F(16) of the ITAA 1936 in view of the fund's substantial shareholding in the private company (virtually 100%) and the limitation of the membership of the fund to the shareholders/directors of the trading group.
In Case B15, the facts that the dividend received by the fund was one-quarter of the dividends paid by the private company and that the whole of such a dividend was credited only to the benefit of the two directors/shareholders who were the members of the fund led the majority of the Board of Review to conclude that it would not be reasonable to exempt from tax the dividends from the private company.
In Case M63, the Board confirmed the decision not to exempt private company dividends paid to a superannuation fund on the basis of, amongst other factors, the level of the fund's shareholding in the private company (26.63%) and the fact that the sole members of the fund were the directors/shareholders of the private company.
The broad pattern to emerge from all these cases is that of a family company setting up a fund primarily for the benefit of its directors/shareholders, in some cases to the exclusion or virtual exclusion of non-shareholder employees. In other words, the superannuation funds in the cases were being maintained to provide benefits wholly or almost wholly for members who were not at arm's length from the directors/shareholders of the private company. This fact, combined with the level of the fund's shareholding in the private company in question and the large amount of dividends received by the fund mitigated against the Commissioner forming an opinion not to exempt the dividends from income tax.
In considering the facts and circumstances of this case, the following issues arise:
(i) The company was formed to purchase the business enterprise.
(ii) The proportion of dividends paid by the company to the fund during the year is commensurate with the fund's shareholding. There are 9 shareholders in the company and each shareholder receives an equal and proportionate distribution of the dividends received.
(iii) The fund owns just under one per cent of the issued shares of the company and the combined shareholding of the fund and its related entities amounts to approximately 2%. This situation is clearly distinguishable from the cases quoted above, and it is considered that the shareholding of the fund and its related entities does not allow it to exert any significant influence over the decisions of the private company regarding the declaration and payment of dividends.
(iv) The only members of the fund are the applicant and spouse. In line with the decided cases, limited membership of the superannuation fund is an unfavourable factor in the exercise of the Commissioner's discretion. At paragraph 29 of TR 2000/D11, the Commissioner states that the more members of a superannuation entity who are at arm's length to the private company, the more likely it is that the Commissioner will conclude that it is reasonable to treat the dividends from the company as not being special income.
(v) One of the members of the fund is also one of six directors of the company. None of the other directors are related to the members or trustees of the fund. It is considered that, as a director of the company, the member is in a position to influence the decisions of the company, including the timing and amount of the payment of dividends. Therefore the relationship between the member of the fund and the company is a factor unfavourable to the exercise of the Commissioner's discretion.
(vi) The fund did not borrow any money to acquire the shares in the company. The source of the money used to purchase shares was existing monies in the fund's bank account. This is a factor favourable to the exercise of the Commissioner's discretion.
(vii) The history of dividend payment by the company, both prior to the fund becoming a shareholder and afterwards, is also a relevant consideration. In this case, the company was incorporated during the year ended 30 June 2000. A small operating profit was made in the year ended 30 June 2000, an operating loss was made in the year ended 30 June 2001 and an operating profit was made in the year ended 30 June 2002, the year for which the ruling is requested. It is considered that the Commissioner's discretion should be exercised favourably in view of the company's history of profits.
Overall, it is considered that there is nothing in paragraph 273(2)(f) of the ITAA 1936 that would lead the Commissioner not to exercise his discretion.
Conclusion
All of the matters in paragraphs (a) to (f) of subsection 273(2) of the ITAA 1936 as evidenced by facts support the exercise of the Commissioner's discretion for the year ended 30 June 2002.
Accordingly, the private company dividend paid to the fund from the company for the year ended 30 June 2002 is not to be treated as special income.
Disclaimer
The Register of Private Binding Advice is published as a public record of the binding advice issued by the ATO. Each piece of advice is based on a specific set of circumstances advised to the ATO and the law in force at the time of the advice, and is considered binding only in respect of the person/s or entity/ies on whose behalf the advice was sought. The Register is a historical record of advice provided, and is not updated to reflect changes in the law, withdrawal of advice or any other change in circumstance. Each piece of advice has been edited to avoid disclosing the identity of the person or entity on whose behalf advice was sought and published advice may therefore not disclose all the relevant facts or circumstances on which the advice was based. For these reasons, advice published in this Register cannot be relied upon as precedent for any other person or entity.