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Ruling

Subject: Proposed dividend and transfer of interest.

Question 1

(a) Will the grossed up value of the fully franked dividends be included in the assessable income of Company B pursuant to section 44 of the Income Tax Assessment Act 1936 (ITAA 1936) and 207-20(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

(b) If the response to Question 1(a) is in the affirmative, will Company B be entitled to a tax offset in respect of the franking credits attached to the dividends received pursuant to section 207-20 of the ITAA 1997?

Answer

Yes.

Question 2

Do the proposed dividends trigger the application of Subdivision 204-D of the ITAA 1936 to deny Company B the franking credits attached to the dividends?

Answer

No.

Question 3

Does section 177EA of the ITAA 1936 apply to the proposed dividends such that the Commissioner will make a determination pursuant to paragraph 177EA(5)(b) of the ITAA 1936 to deny Company B from claiming an offset for the franking credits attached to the dividends?

Answer

No.

Question 4

Will the capital proceeds received by Company B, as determined by section 116-20 of the ITAA 1997, from the proposed sale of its 50% interest in Company A Subsidiary be $XXX million for the purposes of determining its capital gain or capital loss from the proposed sale pursuant to section 104-10 of the ITAA 1997?

Answer

Yes, based solely on the figures and information provided by the applicant.

Question 5

Will section 118-20 of the ITAA 1997 apply to reduce the capital gain made by Company B from the proposed sale of its 50% interest in Company A Subsidiary by the amount of dividends received from Company A Subsidiary and that are included in the assessable income of Company B?

Answer

Yes.

Question 6

Will the Commissioner make a determination under section 177F of the ITAA 1936 to apply the general anti-avoidance rules in Part IVA of ITAA 1936 to the proposed transaction?

Answer

No.

This ruling applies for the following period<s>:

The financial year ended 30 June 2011.

The scheme commences on:

1 July 2010.

Relevants facts and circumstances

Company A is an Australian resident company for income tax purposes.

Company B is an Australian resident company for income tax purposes.

Company A and Company B are the ultimate equal shareholders in Company X.

Company X pays two fully franked dividends to its shareholders.

Company A and Company B reinvest the second dividend payment in exchange for the issue of new shares in Company X.

Company B sells its entire shareholding in Company X to Company A.

The price for the sale transaction has been adjusted from the final valuation determined by an independent expert to reflect the distribution of the franking credits.

Relevant legislative provisions

Income Tax Assessment Act 1936 paragraph 44(1)(a).

Income Tax Assessment Act 1936 Part IVA.

Income Tax Assessment Act 1936 section 177EA.

Income Tax Assessment Act 1997 section 104-10.

Income Tax Assessment Act 1997 section 116-20

Income Tax Assessment Act 1997 section 118-20.

Income Tax Assessment Act 1997 subdivision 204-D.

Income Tax Assessment Act 1997 section 207-20.

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Issue 1

Questions 1(a) & (b)

Subsection 44(1) of the ITAA 1936 operates to include in a shareholder's assessable income any dividends, within the meaning of that term in subsection 6(1) of the ITAA 1936, paid to a shareholder out of company profits.

The term 'dividend' is defined in subsection 6(1) of the ITAA 1936 as including:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and

(b) any amount credited by a company to any of its shareholders as shareholders;…

The dividends paid to Company B Subsidiary will be dividends as defined in subsection 6(1) of the ITAA 1936. As the head entity of the group, Company B will include these dividends in its assessable income.

Further, the payment of a franked distribution triggers the operation of Division 207 of the ITAA 1997. Section 207-20 of the ITAA 1997 sets out the general rule in relation to the gross-up and tax offset of franked distributions as follows:

1. If an entity makes a franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the franking credit on the distribution. This is in addition to any other amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act.

2. The receiving entity is entitled to a tax offset for the income year in which the distribution is made. The tax offset is equal to the franking credit on the distribution.

However, recipients of a franked distribution must satisfy a residency requirement as set out in section 207-70 of the ITAA 1997:

If an entity makes a franked distribution to an individual or a corporate tax entity:

(a) no amount is included in the receiving entity's assessable income under subsection 207-20(1); and

(b) the receiving entity is not entitled to a tax offset under subsection 207-20(2);

unless the receiving entity satisfies the residency requirement at the time the distribution is made.

Section 207-75 sets out the residency requirement as follows:

(1) An entity that receives a distribution satisfies the residency requirement at the time the distribution is made if:…

(b) in the case of a company - the company is an Australian resident at that time;…

Accordingly, when an Australian resident shareholder receives a franked distribution, there is a 'gross-up' so that both the cash distribution and the attached franking credits are included in the shareholder's assessable income pursuant to subsection 207-20(1) of the ITAA 1997. In addition, the shareholder will also be entitled to a tax offset equal to the franking credit allocated to the distribution pursuant to subsection 207-20(2) of the ITAA 1997.

Company B Subsidiary will receive two franked distributions from Company X under the scheme. The amount of the franking credits on these distributions will be included in the assessable income of Company B for the purposes of calculating its taxable income. This will be in addition to the two dividend payments that were included in Company B's assessable income in relation to the distribution under section 44 of the ITAA 1936.

For the purposes of determining Company B's taxable income, Company B will also be entitled to a tax offset equal to the franking credits allocated to the two distributions pursuant to subsection 207-20(2) of the ITAA 1997.

Question 2

Subdivision 204-D of the ITAA 1997 is an integrity provision that, if applied, will either deem a franking debit to arise in the franking account of Company X or deny Company B Subsidiary the imputation benefit in respect of the scheme.

Section 204-30 of the ITAA 1997 is the operative provision of Subdivision 204-D of the ITAA 1997 and applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members 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 (paragraph 204-30(1)(a) of the ITAA 1997);

(b) the member would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997); 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 (paragraph 204-30(1)(c) of the ITAA 1997).

Relevantly, if section 204-30 of the ITAA 1997 applies the Commissioner is vested with discretion under subsection 204-30(3) to make a determination in writing either:

(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 (paragraph 204-30(3)(a) of the ITAA 1997); or

(b) that no imputation benefit is to arise in respect of any streamed distributions made to a favoured member and specified in the determination (paragraph 204-30(3)(c) of the ITAA 1997).

Further guidance is provided by considering the underlying principles of the dividend imputation system which is set out in paragraph 8.124 of the Explanatory Memorandum to Taxation Laws Amendment Bill (No.3) 1998):

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.…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.

Accordingly, for section 204-30 of the ITAA 1997 to apply, members to whom distributions are streamed must receive imputation benefits that are disproportionate to their shareholdings with the result that at least one member will receive lesser imputation benefits, or will not receive any imputation benefits.

Company X will make two distributions in the following manner:

· Payment of a cash dividend by Company X to its shareholders in proportion to their shareholding; and then

· Payment of a dividend by Company X to its shareholders in proportion to their shareholding.

The franking credits that are distributed are consistent with the Company X ownership percentages. In this regard, both Company A Subsidiary and Company B will only receive their 50% share of the Company X franking credits consistent with their ownership percentage in Company X.

Under the scheme, Company X will make distributions to both of its equal shareholders and in proportion to their equal shareholding in Company X. As the distributions to both shareholders will be fully franked, the tax paid by Company X at the company level will be imputed to its shareholders proportionately to their shareholdings. Therefore, no one shareholder of Company X will receive lesser imputation benefit than the other.

Thus, the conditions in subsection 204-30(1) of the ITAA 1997 for the provision to apply are not met. The Commissioner will not make a determination under section 204-30 of the ITAA 1997 to apply Subdivision 204-D of the ITAA 1997 to deny Company B the franking credit attached to the dividends.

Question 3

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes to obtain a tax advantage in relation to imputation benefits. In essence, it applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares. This would include a selective off-market share buy-back with a franked dividend component.

Specifically, subsection 177EA(3) of the ITAA 1936 provides that 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:

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

ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of 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, a person (the 'relevant taxpayer') would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

The requisite criteria are tested against the scheme as explained below.

Scheme

The first criterion is contained in paragraph 177EA(3)(a) of the ITAA 1936 and requires the existence of a 'scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity'.

A scheme, for the purposes of Part IVA of the ITAA 1936, is broadly defined in section 177A of the ITAA 1936. In the present circumstances, the scheme forms a 'scheme' as defined in subsection 177A(1) of the ITAA 1936.

Subsection 177EA(14) of the ITAA 1936 defines the words 'scheme for a disposition' to include a scheme that involves the entering into any contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests.

The divestment of its shares in Company X by Company B Subsidiary under the structure constitutes a scheme for a disposition of membership interests in Company X. Therefore, this criterion is satisfied.

Franked distribution

The next two criteria are contained in paragraphs 177EA(3)(b) and (c) of the ITAA 1936.

Under the scheme, Company X will distribute fully franked dividends to both of its shareholders, being Company B Subsidiary and Company A Subsidiary.

Also, the fully franked distributions under the scheme are frankable distributions according to section 202-30 of the ITAA 1997.

Accordingly, these two criteria are satisfied.

Imputation benefit

For section 177EA of the ITAA 1936 to apply, there needs to be an imputation benefit arising from the scheme. Subsection 177EA(16) of the ITAA 1936 refers to subsection 204-30(6) of the ITAA 1997 which outlines the circumstances for when an imputation benefit arises for a relevant taxpayer who receives a direct distribution from a corporate tax entity.

It is clear from the facts that Company B, as the head entity of the Company B tax consolidated group, will receive an imputation benefit under the scheme in accordance with subsection 204-30(6) of the ITAA 1997.

Purpose

The key criterion for section 177EA of the ITAA 1936 to apply is contained in paragraph 177EA(3)(e) of the ITAA 1936 which provides:

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.

This statement is qualified by subsection 177EA(4) of the ITAA 1936 which provides that if a person entered into or carried out a scheme for a purpose of merely acquiring membership interests, or an interest in membership interests, in an entity, this in itself will not satisfy the criterion under paragraph 177EA(3)(e) of the ITAA 1936.

In relation to the meaning of the phrase 'incidental purpose' in paragraph 177EA(3)(e) of the ITAA 1936, paragraph 8.76 of the Explanatory Memorandum to the Bill which led to the enactment of section 177EA (Taxation Laws Amendment Bill (No.3) 1998) (EM) stated that:

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.

The Supplementary Explanatory Memorandum to the same Bill (Supplementary EM) added at paragraph 2.6:

New section 177EA requires a "purpose (whether or not the dominant purpose, but not including an incidental purpose)" of enabling a taxpayer to obtain a franking credit benefit…the reference to 'a purpose' of a scheme, is usually understood to include any main or substantial purpose of the scheme, and the words in parentheses clarify that this is the intended meaning here. Thus, while new section 177EA does not require the purpose of obtaining the franking benefit to be the ruling, most influential or prevailing purpose, neither does it include any purpose which is not a significant purpose of a scheme.

Further, the EM and relevant judicial authority makes it clear that the requisite purpose contained in paragraph 177EA(3)(e) of the ITAA 1936 may co-exist with other commercial purposes that the parties to the scheme may also objectively be found to have.

For instance, in Electricity Supply Industry (Superannuation) (Qld) Ltd v. Deputy Commissioner of Taxation (2002) ATC 4888 (ESI), Cooper J in the Federal Court drew on authority dealing with the operation of section 177D of the ITAA 1936 to find as follows (at 4906):

The fact the trustee of the QT, and the Trustee on behalf of ESI Super, as parties to the scheme, made investment and trust decisions on a proper commercial basis, for a proper commercial purpose and to achieve the long term commercial objectives of the QT and ESI Super, does not mean that they, or either of them, did not also have, as a not incidental purpose, a purpose that in carrying into effect the scheme ESI Super would obtain franking credit benefit: Spotless Services Ltd at ATC 5206; CLR 415-416.

The circumstances which are relevant in determining whether a person has the requisite purpose as referred to in paragraph 177EA(3)(e) of the ITAA 1936 include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

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.

The requisite purpose is further clarified when read in conjunction with the objective of section 177EA of the ITAA 1936 which is set out in paragraph 8.124 of the EM:

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.

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 streaming franking credits to select shareholders as envisaged in the preceding extract of the EM.

Having regard to the relevant circumstances contained in subsection 177EA(17) of the ITAA 1936 it is concluded that none of the entities involved in the scheme entered into or carried out the scheme or any part of the scheme for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Conclusion

Having regard to the terms and circumstances of the scheme, the requirements of section 177EA of the ITAA 1936 have not been satisfied. Therefore, the Commissioner will not make a determination to apply section 177EA of the ITAA 1936 to the proposed dividends.

Question 4

CGT event A1 occurs when Company B Subsidiary disposes of its shares in Company X to Company A pursuant to section 104-10 of the ITAA 1997. Company B, as the head entity of the Company B tax consolidated group, will make a capital gain from the disposal if the capital proceeds from the disposal are more than the share's cost base (subsection 104-10(4) of the ITAA 1997).

Section 116 of the ITAA 1997 sets out how to determine the capital proceeds from a CGT event for the purposes of calculating the capital gain or capital loss from the CGT event. Generally, the capital proceeds from a CGT event are the total of (subsection 116-20(1) of the ITAA 1997):

(a) the money you have received, or are entitled to receive, in respect of the event happening; and

(b) the market value of any other property you have received, or are entitled to receive, in respect of the event happening (worked out as at the time of the event).

In the present circumstances, Company B will receive consideration in respect of the disposal of Company B Subsidiary's shares in Company X. As discussed earlier, Company B Subsidiary will also receive, or will be entitled to receive, in respect of the disposal, two dividend payments from Company X prior to the disposal happening. Taxation Ruling TR 2010/4 (TR 2010/4) lends guidance on whether or not these dividend payments form part of the capital proceeds received for the purposes of working out the capital gain or loss from the disposal. Paragraph 9 of TR 2010/4 provides:

A dividend declared or paid by the target company to the vendor shareholder will be money or property that the vendor shareholder has received, or is entitled to receive, under the contract or the scheme of arrangement, in respect of the transfer of the shares, if the vendor shareholder has bargained for the receipt of the dividend (whether or not in addition to other consideration) in return for giving up the shares. That is to say, if the dividend forms the whole or part of that sum of money or property in return for which the vendor shareholder is willing, and under the contract has promised or under the scheme of arrangement is bound, to transfer the shares in the target company, it will be capital proceeds in respect of the CGT event A1 happening.

The applicant states that the dividends received by Company B prior to the sale of shares will satisfy the criteria as listed in paragraph 10 of TR 2010/4. Therefore, the dividends are included in the capital proceeds.

The capital proceeds determined under the general rules contained in section 116-20 of the ITAA 1997 are subject to modifications contained in section 116-10 of the ITAA 1997. The relevant modification is a market value substitution rule which applies if, amongst other circumstances, the capital proceeds are more or less than the market value of the asset and you and the entity that acquired the asset from you did not deal with each other at arm's length in connection with the event.

The capital proceeds from the disposal of Company B Subsidiary's 50% interest in Company X is higher than the market value.

As to whether Company B Subsidiary and Company A did not deal with each other at arm's length in connection with the event, the expression 'did not deal with each other at arm's length' is not defined in the ITAA 1997. However, subsection 995-1(1) of the ITAA 1997 provides a definition of 'arm's length' as follows:

in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance.

Further guidance on the expression is found in case law. Generally, dealing at arm's length is a question of fact to be decided with reference to the manner in which the parties to a transaction conducted themselves in forming that transaction, and whether the parties have acted severally and independently in forming their bargain (Re Hains (dec'd); Barnsdall v FCT (1988) 19 ATR 1352; 88 ATC 4565).

The courts have recognised a distinction between two uses of the term 'arm's length'. One refers to the relationship of the parties to a transaction and the other refers to the terms of a transaction between the parties (Pontifex Jewellers (Wholesale) Pty Ltd v FCT (1999) 43 ATR 643 at 646-47). Thus, the arm's length test also requires consideration of the terms of the transaction to determine whether these terms are such as would be entered into between independent parties.

Company A and Company B are independent parties. Although they both have an equal stake, through wholly owned companies, in a joint venture company, namely Company X, the commercial rationale behind the scheme as provided by the applicant indicates that Company B and Company A have acted independently from each other. The terms of the scheme were formed on the basis of each party acting severally and independently.

In the present case, the terms of the scheme and the surrounding circumstances of the scheme indicate that the parties have acted at arm's length with each other. The manner in which Company B and Company A conducted themselves in the transaction corresponds with the manner in which independent parties to a similar transaction would conduct themselves in forming their bargain. Accordingly, the payment of the dividends and the subsequent sale of shares by Company B will constitute an arm's length transaction for the purposes of subsection 116-10 of the ITAA 1997.

Therefore, the capital proceeds received by Company B from the sale of Company A's 50% interest in Company X for the purposes of determining its capital gain or capital loss from the sale, pursuant to section 104-10 of the ITAA 1997 will be the sum of the consideration received and the two dividend payments received.

Question 5

Section 118-20 of the ITAA 1997 is a so-called 'anti-overlap' provision that if applied, reduces a capital gain made from a CGT event by an amount that has been inter alia included in the taxpayer's assessable income by another provision of the ITAA 1936 or ITAA 1997.

In relation to circumstances where a dividend forms part of the capital proceeds from the sale of shares and is also assessable income of the vendor shareholder, by reason of the so-called 'anti-overlap' rule in section 118-20 of the ITAA 1997, any capital gain of the vendor shareholder is reduced by the amount of the dividend or to zero, whichever is greater, unless one of the exceptions in section 118-20 of the ITAA 1997 applies.

However, the 'anti-overlap' provision will not apply to an amount included in assessable income under subsection 207-20(1) of the ITAA 1997 (which relate to franked distributions).

As discussed in Question 1 above, the terms of the scheme provide for the payment of two dividend payments to Company B Subsidiary prior to the sale of shares in Company X. These dividend payments will form part of Company B's assessable income. Further, in Question 4 above, the dividends also form part of the capital proceeds deemed to be received by Company B in respect of Company B Subsidiary's sale of shares in Company X for the purposes of working out Company B's capital gain or capital loss under section 104-10 of the ITAA 1997.

As none of the exceptions in section 118-20 of the ITAA 1997 apply to the present circumstances, section 118-20 of the ITAA 1997 will apply to reduce the capital gain made by Company B on the disposal of Company B Subsidiary's shares in Company X by an amount equal to the sum of the two dividend payments.

Question 6

Part IVA of the ITAA 1936 (Part IVA) is a general anti-avoidance provision. Its role is to ensure that the purpose of the primary operative provisions is not defeated in circumstances where the other provisions should, but have not, operated.

Part IVA gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. This discretion is found in subsection 177F(1) of the ITAA 1936.

Before the Commissioner can exercise the discretion in subsection 177F(1) of the ITAA 1936, the requirements of Part IVA must be satisfied. These requirements are contained in section 177D of the ITAA 1936 which provides that Part IVA applies where there is:

i) a 'tax benefit', as identified in section 177C, was or would, but for subsection 177F(1), have been obtained;

ii) the tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A; and

iii) having regard to section 177D, the scheme is one to which Part IVA applies.

The requirements are further discussed below.

Scheme

A scheme, for the purposes of Part IVA, is broadly defined in section 177A of the ITAA 1936 and includes:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action nor course of conduct.

In the present circumstances, the payment of the two dividends followed by the sale by Company B of Company B Subsidiary's shares in Company X form a scheme within the meaning of Part IVA.

Tax benefit

For Part IVA to apply a taxpayer must have obtained, or would but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with a scheme.

Subsection 177C(1) of the ITAA 1936 provides that a reference to the obtaining of a tax benefit by a taxpayer in connection with a scheme shall be read as a reference to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or …

The reference in paragraph 177C(1)(a) of the ITAA 1936 to 'an amount not being included in the assessable income of the taxpayer' is a reference to an amount not being included that would be or might reasonably be expected to be included in the taxpayer's assessable income under the counterfactual scenario(s) (Australia & New Zealand Banking Group Ltd v. Federal Commissioner of Taxation [2003] FCA 1410; 137 FCR 1; 203 ALR 644; 2003 ATC 5041; 54 ATR 449 at [54]; Federal Commissioner of Taxation v. Spotless Services Ltd (1996) 186 CLR 404 at 423 to 424; 141 ALR 92 at 103 to 104; 96 ATC 5201 at 5211; 34 ATR 183 at 193).

The identification of a tax benefit for the operation of Part IVA of the ITAA 1936 necessarily requires consideration of the income tax consequences of an 'alternative hypothesis' or an 'alternative postulate' (referred to as counterfactual). This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out (Federal Commissioner of Taxation v. Hart [2004] HCA 26; 217 CLR 216; 206 ALR 207; 2004 ATC 4599; 55 ATR 712 at [6] per Gleeson CJ and McHugh, and at [66] per Gummow and Hayne JJ).

A reasonable expectation requires more than a possibility (Federal Commissioner of Taxation v. Peabody (1994) 181 CLR 359 at 385; 123 ALR 451 at 461; 94 ATC 4663 at 4671; 28 ATR 344 at 353):

A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable.

It is possible for different conclusions to be reached as to what might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. In that event, the Commissioner may rely on both or all the reasonable expectations, and therefore on more than one counterfactual, to support a determination made under subsection 177F(1) of the ITAA 1936.

In this case, a counterfactual should accord with Company B's commercial objective of divesting Company B Subsidiary's shareholding in Company X to Company A as envisaged under the Agreement.

As the requirement for there to be a tax benefit within the meaning of section 177C of the ITAA 1936 is not satisfied, it is unnecessary to address the dominant purpose criteria of Part IVA of the ITAA 1936.

Conclusion

Having regard to the terms and circumstances of the scheme, the requirements of Part IVA of the ITAA 1936 have not been satisfied. Therefore, the Commissioner will not make a determination to apply the general anti-avoidance rules in Part IVA to the transaction.

CGT reduction arrangements

For completeness, consideration needs to be given to whether or not the scheme is a CGT reduction arrangement of the type described in Taxation Determination TD 2003/3 (TD 2003/3). Arrangements of the type described in paragraph 3 of TD 2003/3, and arrangements having similar economic and tax effects, are considered likely to attract the operation of Part IVA of the ITAA 1936.

Having regard to the features of the scheme, there are clear distinguishing features that do not accord with the features of a CGT reduction arrangement or an arrangement having similar economic and tax effects as described in paragraph 3 of TD 2003/3. Therefore, the scheme is distinguishable from the type of CGT reduction arrangements as described in TD 2003/3.