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Ruling

Subject: Consolidations

Question 1

Does section 177EB of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deny any credit to X's franking account which will result from the Restructure?

Answer: No

This ruling applies for the following period:

Year ending 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

A & B are ultimate Owners of the group

The current business structure divides a number of the business assets into separate associated entities.

The Owners have stated that they wish to consolidate these assets under one holding structure.

The Owners have also stated a wish to open up the future control and ownership of the group to their children to meet their business succession requirements and move valuable assets from their own names.

The Owners would like to dispose of their shareholding in Y to X in order to consolidate the related businesses within the group under their discretionary family trust.

Proposed Restructure Steps

The Owners will lend funds to X.

With the loaned funds X will buy the shares in Y from the Owners for a price determined by reference to the indicative valuation to be performed by an independent valuer.

The Ruling application states that the owners' shares in Y are pre-capital gains tax ("CGT").

Summary

As all the relevant provisions of section 177EB ITAA 1936 are not satisfied in this case, it will not be applied to enable the Commissioner to deny the franking credit to the company's franking account.

Detailed reasoning

While a group is consolidated, the head company maintains a single franking account for the group as a whole, and the franking accounts of subsidiary members are inoperative. When a subsidiary member joins a consolidated group, any surplus in its franking account is transferred to the head company's franking account. The franking credit resulting from the transferred surplus remains with the head company even if the subsidiary member subsequently leaves the group.

Section 177EB of the ITAA 1936 applies where (paraphrased):

· There is a scheme for disposition of membership interests in an entity (the joining entity) and as a result of the disposition, the joining entity becomes a subsidiary member of a consolidated group;

· A credit arises in the franking account of the head company of the group because of the joining entity becoming a subsidiary member of the group; and

· 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 credit to arise in the head company's franking account.

The consequence of s177EB applying is that the Commissioner may make a determination that no credit is to arise in the head company's franking account because of the joining entity becoming a subsidiary member of the consolidated group (177EB(5) ITAA 1936).

Part IVA Reasoning

Law Administration Practice Statement PS LA 2005/24 Application of General Anti-Avoidance Rules (PS LA 2005/24), states at Para 44 that "while this practice statement does not contain specific guidance on the operation of 177EB (cancellation of franking credits for head company of consolidated group) nevertheless it can be used as a background reference for officers exercising powers in respect of those provisions.

"Scheme" is defined broadly and as such, the actions described in this ruling application would constitute a scheme for the purpose of Part IVA.

For the purposes of section 177EB we are looking to see if the scheme has enabled a franking credit to arise in the head company's accounts. In this case this will definitely occur as a result of the scheme.

PS LA 2005/24 states that the identification of a tax benefit requires consideration of the income tax consequences of an alternative hypothesis (i.e. the "counterfactual"), i.e. what the current owners might reasonably be expected to have done, but for undertaking this scheme.

In this case if they wish to consolidate their group then X has to obtain the shares in Y company. The only way to avoid the franking credit arising in the head company's account would be to pay the current shareholders a dividend and utilise the franking credits. If the franking credits go to the consolidated group then the current owners may receive the benefit of the franking credits but as the relevant trust is a discretionary trust they may not. Thus there is no benefit to them of conducting this scheme it actually may not benefit them at all.

This referral concerns in particular subsection 177EB(3) ITAA 1936 which states that the section applies if there is a scheme for the disposition of membership interests' in an entity (the joining entity) and as a result of the disposition the joining entity becomes a subsidiary member of a consolidated group and a credit arises in the franking account of the head company as a result and having regard to the relevant circumstances it would be concluded that the person entered into the scheme for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the franking credit to arise in the head company's account.

However, subsection 177EB(4) states that it is not to be concluded that the person entered into the scheme for the purposes described above merely because the person acquired membership interests in the joining entity

When Y company joins the existing Consolidated Group the tax cost for each asset brought into the group will need to be set at the Assets Tax Cost setting amount - section 701-10. of the Income Tax Assessment Act 1997 (ITAA 97). Goodwill and other reset cost base assets (including land, and depreciable assets) in Y company will be identified as separate assets and as a reset cost base asset. It is noted that the reset cost base (uplift) of assets is a normal mechanism of the consolidation regime.

CGT Event L1 - section 705-57 of the ITAA 1997- If there is a reduction under this section in the tax cost setting amounts of assets of C company then the head company will be allowed a capital loss equal to the deduction.

Paragraph177EB (10)(b) Head Company or person holding interest derive a greater benefit from the franking credits than other persons who held membership interest before it became a subsidiary of the group.

Once Y company joins the Consolidated group the Head Company will receive the franking credits and they will remain locked in the Head Company. On the facts provided the head company will not derive a greater benefit than the current owners.

Paragraph177EB (10) (c) of the ITAA 1936. Extent to which the joining entity was able to pay a franked dividend or distribution immediately before it became a subsidiary member of the group

The ruling request provides information on Y company's dividend pattern and the ruling request stated that Y company is not restricted from paying franked dividends immediately prior to joining the consolidated group. However on the facts provided, they would not be able to fully utilize the franking credit balance prior to joining the consolidated group.

Paragraph 177EB (10) (d) of the ITAA 1936. Consideration paid or given on behalf of the head company in connection with the scheme (e.g. interest on a loan) was calculated by reference to the franking credit to be received by the head company

The ruling request states the loan provided to the Head Company by the Owners was to be determined based on an independent valuation of Y company's business (hence arms length market value amount). The ruling indicates that the consideration will not factor in the value of Y company's franking Credits as at 30 June 2011 as required by this section.

Paragraph 177EB(10)(f) of the ITAA 1936 provides that when considering the relevant circumstances of a scheme this includes any of the matters referred to in subparagraphs 177D(b)(i) to (viii). These are considered below:

The manner in which the scheme was entered into or carried out:

This scheme is second in a series of transactions undertaken in order to form a consolidated group for ease of administration, planning etc. Part of the scheme involves provision of a loan from the current owners to X and they have stated that this will be following an independent valuation and will be on commercial terms.

The counterfactual of the current owners receiving a dividend and utilising the franking credit would not negate the need for the loan as the ultimate plan is to consolidate the group. It would only mean that the franking credit would no longer arise in the head company but there is no tax benefit in this for either Y or the current owners. There is a benefit to the head company but as per subsection 177EB(4) of the ITAA 1936 it is not to be concluded that the person entered into the scheme to obtain the tax benefit merely because the person acquired membership interests in the joining entity.

The form and substance of the scheme:

On the facts provided there is no discrepancy here between the form and substance of the scheme and there is no more straightforward way of obtaining the objective of moving Y into the consolidated group that what is planned.

PS LA 2005/24 states that the first three factors are very important because they examine exactly how a scheme achieves its effects. The first factor which examines 'the manner in which the scheme was entered into or carried out' enables contrivance and artificiality to be identified by comparing the manner in which the scheme was entered into or carried out with the manner in which the counterfactual would have been implemented, for example, by the presence of a step or steps in a relevant transaction or arrangement that would not be expected to be present in a more straightforward or ordinary method of achieving the outcome of the transaction or arrangement. Conversely, if a scheme is entered into and carried out in the manner in which ordinary business or family dealings are conducted, the manner of the scheme will not indicate the purpose of obtaining the tax benefit.

Paragraph 94 of PS LA 2005/24 states that the identification of any step or aspect of the scheme that is apparently explicable for no purpose but a tax purpose will go to the manner in which the scheme was entered into or carried out. In this case considering both the scheme and the counterfactual there does not appear to be any steps outside normal commercial planning in order to consolidate.

The second factor, which examines 'the form and substance of the scheme', directs attention to whether there is a discrepancy between the form of the scheme and its substance, meaning its commercial and economic substance. A discrepancy between the business and practical effect of a scheme on the one hand, and its legal form on the other, may well indicate the scheme has been implemented in a particular form as the means to obtain a tax benefit if the substance of the scheme may be achieved or available by some other more straightforward or commercial transaction or dealing.

The first two factors require consideration of any elements or aspects of how the particular scheme is implemented that make the scheme more complicated than a straightforward or ordinary commercial or family arrangement that achieves the same overall effect, disregarding the tax effects. Again in this case the stated purpose of forming a consolidated group can only be achieved by X buying the shares in Y from the Owners and they require a loan to do this.

The time at which the scheme was entered into and the length of the period during which the scheme was carried out:

This factor will enable consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements. For example, this factor will identify whether the scheme is entered into shortly before the end of a financial year (or other tax sensitive date such as the date of a change in the rate of tax), or carried out for only a brief period.

The second set of factors focuses on the tax, financial and any other consequences or effect of carrying out the scheme. These factors require consideration of the tax result, financial change and any other consequences of the scheme for the taxpayer and for related parties. The absence of any practical change in the overall financial, legal or economic position of a taxpayer and connected parties that are affected by the scheme is likely to add weight to the dominance of the tax purpose when all the paragraph 177D(b) factors are weighed together.

In considering the second set of factors it should be kept in mind that the application of Part IVA turns on an objective determination of the purpose of a person entering into a scheme, not the effect or purpose of the scheme. The fourth to seventh factors cannot simply be compared and weighed to determine purpose for to do so is to ignore the other factors. The bare fact that a taxpayer pays less tax if one form of the transaction rather than another is adopted, does not by itself demonstrate that Part IVA applies. Nevertheless, the effect of the scheme can contribute to a conclusion about the objective purpose of a person in entering into the scheme.

The result in relation to the operation of this Act that but for Part IVA would be achieved

A franking credit will arise in the account of the head company.

Any change in the financial position of connected entities

The current Owners will sell their shares to X; will loan them the money to pay for the shares and will lose entitlement to the dividends and relevant franking credits unless distributed by the family trust in the future.

The nature of the connection referred to above

The connections are that the current owners are currently the only shareholders of Y company and following it joining the consolidated group will still be connected via the family trust.

Relevant purpose

Paragraph 177EB(3)(d) of the ITAA 1936 states that the section applies if having regard to the relevant circumstances of the scheme it would be concluded that the person who carried out the scheme did so for a purposes (whether or not the dominant purpose but not including an incidental purpose) of enabling the franking credit to arise in the head company's franking account. For this section then it is not necessary to establish a dominant purpose but subsection 177EB(4) does state that it is not to be concluded for the purposes of paragraph (3)(d) that a person entered into the scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests in the joining entity.

Therefore if consolidation is the purpose and the franking credit is incidental to this purpose then the Commissioner should not deny the franking credit.

On the evidence provided there is nothing to support a decision that the dominant purpose of this scheme is to cause the franking credit to arise in the head company's accounts.

Therefore the Commissioner will not exercise his discretion under subsection 177EB(5) to make a determination that no credit arise in the head company's franking account.