Edited version of private ruling

Authorisation Number: 1011829367674

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Subject: Entitlement to franking credits for ultimate beneficiaries

Question

Are the rulees entitled to receive cash dividends and associated franking credits which flow indirectly from Company A through a unit trust with a corporate trustee and then through respective discretionary family trusts under section 207-35 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

This ruling applies for the following period:

Year ended 30 June 2011
Year ended 30 June 2012
Year ended 30 June 2013
Year ended 30 June 2014

The scheme commences on:

1 July 2009

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company A is the family company of the family of persons A and B and the shares in this company are held by Company B as trustee for Trust A.

Units in the shareholder are held equally by Trust B, Trust C, Trust D, Trust E and Trust F.

Beneficiaries of each of these family trusts are the bloodline of persons A and B and/or any other company or trust in which the bloodline have any pecuniary interest.

Company B is a substantial retailer and contractor in a state of Australia. Historically it has adopted a policy of retaining XX% of its after tax profits for further investment to produce further income and security for the family of persons A and B.

World economic affairs being what they are, there is significant concern now that some of the tangible assets, particularly the cash that has been accumulated by this company as after tax profits is exposed to third party claimants in one sort or another. The family are mindful of the need to protect their income flow; to grow the family's assets and to protect the family's assets.

It is proposed to invest some but not all of the cash in further income producing commercial property which will be acquired on the open market if and when a suitable property can be found.

To ensure that as far as practical the acquisition of the property or properties is protected against future claims from third parties it is proposed to declare a fully franked dividend by Company A. That dividend will flow to Company B as trustee for Trust A and the dividend will flow to the unit holders being those discretionary trusts listed above.

Each of the family discretionary trusts has made a family trust election and each company has an interposed entity election. It is proposed to pay cash dividends for Company A through to Trust A and that dividend will then flow to the unit holders $XXX each to Trust B, Trust C, Trust D, Trust E and Trust F.

Those dividends will then flow through as trust distributions to each of Company C, Company D, Company E, Company F and Company G.

The five companies will acquire a commercial property. The acquisition will be by the partnership of the five companies. The five companies will share the rents equally. Some of those rents will be reinvested after tax; some will be paid to shareholders for living and other activities.

Each of the investment companies will pay tax on what are fully franked dividends but will be claiming tax relief for the amount of franking credit that has flowed from historic transactions of Company A.

Applicants view is that the arrangement is purely a commercial arrangement; it is not undertaken for tax minimisation reasons; the arrangement is not undertaken to anyway reduce tax or circumvent any provisions of the tax legislation; the arrangement has the effect of minimising land tax up to an amount of approximately $XXX depending on what property is found and purchased.

The arrangement does have the potential to increase the profit from the venture due to the minimisation of land tax and hence the arrangement does have the consequence of potentially increasing federal income tax from ownership of the property.

The arrangement does take away from potential third party claimants of the business activity entity being Company A.

Those funds which are paid as dividends and which are used in the pursuit of further income derivation and as such does protect the family to some extent from loss of future income and loss of capital.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 207-35,
Income Tax Assessment Act 1997 Section 207-50,
Income Tax Assessment Act 1997 Subsection 207-50(2),
Income Tax Assessment Act 1997 Subsection 207-50(3),
Income Tax Assessment Act 1997 Section 207-55,
Income Tax Assessment Act 1997 Section 207-58,
Income Tax Assessment Act 1997 Section 207-150,
Income Tax Assessment Act 1936 Subsection 160APHG(3),
Income Tax Assessment Act 1936 Section 160APHL,
Income Tax Assessment Act 1936 Subsection 160APHL(5),
Income Tax Assessment Act 1936 Subsection 160APHL(10) and
Income Tax Assessment Act 1936 Subsection 160APHL(14).

Reasons for decision

For trusts and trust beneficiaries, section 207-35 of the ITAA 1997 provides (with certain exceptions) for a gross-up amount to be included in their assessable income. For a trustee that receives a franked distribution, the gross-up amount is equal to the franking credit on the franked distribution. For an ultimate recipient of a franked distribution, such as a trust beneficiary, the gross-up amount is equal to their share of the franking credit on the distribution.

Under section 207-50 of the ITAA 1997, a franked distribution flows indirectly to a beneficiary of a trust in an income year if, and only if:

· during the income year, the distribution is made to the trustee of the trust, or flows indirectly to the trustee as a partner or beneficiary because of the application of section 207-50(2) or 207-50(3) of the ITAA 1997;

· the beneficiary has (for that income year) either a share of the trust's net income that is covered by paragraph 97(1) (a) of the Income Tax Assessment Act 1936 (ITAA 1936) or an individual interest in the trust's net income for that income year that is covered by section 98A or 100 of the ITAA 1936, and;

· the beneficiary's share of the distribution under section 207-55 of the ITAA 1997 is a positive amount.

In the present circumstances, the planned distribution is to flow through a number of entities. The first recipient of the distribution will be the Trust B. It will include the value of the franking credits attached to the distribution in its assessable income pursuant to the operation of section 207-35 of the ITAA 1997.

With respect to the second recipients of the planned distribution (the family trusts), they will be taken to have received the distribution indirectly pursuant to section 207-50 of the ITAA 1997. Accordingly, they will also include the value of the franking credits attached to the distribution in their assessable income.

The trust deeds for the relevant family trusts provide the trustee with the power to apply the income of the trusts to one or more beneficiaries, therefore allowing the trustee to make a beneficiary specifically entitled to the income of the trust under clause 4.2. In addition, the trust deed at clause 9.3 specifically states that any franking credits are to remain attached to the distribution.

In order for the amount to be a specifically entitled distribution, the amount of the net economic benefit that the beneficiary can reasonably be expected to receive is required to be recorded in its character as referable to the franked distribution in the accounts or records of the trust. These records include the trust deed, statements of resolution or distribution statements.

Further, for the companies that are planned to be the ultimate recipient of the franked distribution, the general rule in section 207-20 of the ITAA will apply. This will provide that the companies will include the value of the franking credit attached to the distribution they receive from the family trusts, worked out in accordance with the flow through rules described above, in their assessable income, as well as the amount of the distribution.

However, for a beneficiary of a trust estate to be entitled to a tax offset in respect of a franked distribution that has flowed indirectly to them, subsection 207-150(1) of the ITAA 1997 requires they must be a qualified person in relation to the dividend paid for the purposes of former Division 1A of Part IIIAA of the ITAA 1936.

For a beneficiary of a non-widely held trust to be a qualified person for the purposes of former Division 1A of Part IIIAA of the ITAA 1936 (specifically, former section 160APHO of the ITAA 1936), they must hold their interest at risk for not less than 45 days during the primary qualification period where no related payments have been made. (The trusts in this matter would constitute non-widely held trusts for the purposes of former Division 1A as they would not be a widely held trust as defined in former section 160APHD.)

In circumstances where the franked distribution flows through a number of trusts, the holding period rule must be satisfied at both the trustee and beneficiary level (as former section 160APHP of the ITAA 1936 provides that a beneficiary cannot be a qualified person unless the trustee is also a qualified person).

Thus, at the first instance, the Trust A would need to be a qualified person with respect to its ownership of shares in Company A. If the trust has not previously satisfied former section 160APHO of the ITAA 1936 in respect of a previous dividend for the primary qualification period, it would need to hold its shares in Company A at risk as determined in accordance with former section 160APHM for a period of at least 45 days for the primary qualification period.

With respect to the beneficiaries of the Unit Trust (the family trusts), it is necessary to determine the nature of their interest in the shares in Company A. In the present circumstance, former section 160APHL would allocate a position to the beneficiaries of the Unit Trust in respect to their interest in the shares to the extent that the beneficiaries have a vested and indefeasible interest in the Company A shares. An examination of the Trust Deed would indicate that such an interest does not exist. However, in the circumstances the Commissioner would exercise the discretion available to him in former subsection 160APHL(14) of the ITAA 1936 to determine the interest to be taken to be vested and indefeasible. As such, the beneficiaries (the family trust) would be capable of being qualified persons if they hold their interest for the primary qualification period.

With respect to beneficiaries of the family trusts (the family companies), as there are family trust elections in place, the beneficiaries would be taken to have a position with a delta of +1 with respect to the Company A shares to the operation of the former section 160 APHL of the ITAA 1936 (in particular subsection 160APHL(10)). If this position is held at risk for the relevant qualification period, the family companies are also capable of being qualified persons with respect to the franking credit that flows indirectly to them. As such, paragraph 207-150(1)(a) of the ITAA 1997 would not operate to deny a tax offset entitlement in the circumstances of the planned distribution.

Section 207-150 of the ITAA 1997 also lists other exceptions where an entity is not entitled to a tax offset because of a distribution. These other exceptions are where the Commissioner has made a determination under paragraph 177EA(5)(b) of the ITAA 1936 that no imputation benefit is to arise in respect of the distribution for the entity; where the Commissioner has made a determination under paragraph 204-30(3) of the ITAA 1997 that no imputation benefit is to arise in respect of the distribution for the entity; where a distribution is treated as an interest payment for the entity under section 207-160 of the ITAA 1997; and where the distribution is made as part of a dividend stripping operation.

In this case, the Commissioner considers the corporate beneficiaries of the discretionary family trusts are capable of being qualified persons for the purposes of former Division 1A of Part IIIAAA of the ITAA 1936 and they may include the relevant franking credits in their assessable income under section 207-35 of the ITAA 1997.

Further, the Commissioner is satisfied the other exceptions listed in section 207-150 of the ITAA 1997 do not apply to your case. As such, section 207-150 would not operate to deny a tax offset entitlement in the circumstances of the planned distribution.