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Ruling

Subject: Part IVA: Donation of art works and trust distribution

Question 1

Will the Commissioner confirm that the general anti-avoidance provisions in Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) will not apply to the arrangement?

Answer

Yes

Relevant facts

Donation

· The Taxpayer has a history of making charitable donations.

· The Taxpayer has a personal art collection which is not held as trading stock.

· The Taxpayer purchased each piece of art in the collection for more than $500 and they are the sole beneficial and legal owner of the pieces.

· The Taxpayer purchased the art for private use.

· The Taxpayer donated a number of pieces of art from their collection to the Recipient.

· The Taxpayer did not receive any naming rights, tickets or any other benefit apart from an acknowledgement in return.

· The Recipient obtained immediate and unconditional full title, unconditional right of custody and control of the property transferred.

· The Recipient accepted the works of art in keeping with their collecting interests and the pieces will be installed in prominent positions within the Recipient's premises.

· The Taxpayer has obtained two GST inclusive independent valuations by approved valuers in accordance with section 30-200 of the Income Tax Assessment Act 1997 (ITAA 1997) within 90 days of the Taxpayer's donation being accepted.

· The works of art were purchased before 20 September 1985 and have been held by the Taxpayer for more than 12 months.

Franked Distribution

· Company A is the head company of the Taxpayer's group of consolidated companies. All shares in Company A are held by Company C as trustee for Trust X.

· Company C has held the shares in Company A since its date of incorporation.

· The Taxpayer has been a director and shareholder of Company C since its incorporation.

· Since incorporation, the shares in Company A have been held by Company C. Company C has not purchased or sold any shares nor has Company A changed its share structure in any way since its incorporation.

· Company A has no current intention or expectation of issuing new shares to any other entity. There is also no intention to either reduce the capital in respect of the existing shareholding or vary the rights attached to the shares held by the existing shareholder.

· Company C currently has no intention or expectation of disposing, redeeming or changing its interests in Company A.

· Trust X is a discretionary family trust.

· The beneficiaries of Trust X include the Taxpayer, who by virtue of Trust X's trust deed is a primary and general beneficiary.

· Under the trust deed, Company C, as trustee of Trust X, can by 'majority decision'…..pay, apply, allocate or set aside all or any part of the income or net income of the trust.

· The expressions income and net income are defined in the trust deed and include franked dividend income received from Company A.

· The beneficiaries entitled to receive an income distribution under the power of appointment contained in the amended and rectified trust deed are general beneficiaries.

· Company A proposes to pay a cash dividend with attached imputation credits (franking credits) to Trust X.

· The dividend will be sourced from accumulated retained earnings of Company A. The company has sufficient retained earnings available to make the distribution.

· Trust X has no prior year or current year losses to recoup in the income year in which the distribution is to be made to the Taxpayer.

· Company A will not debit the dividend amount to its share capital account.
The dividend will be the only dividend declared or paid in the proposed year of the transaction.

· The dividend will be 100% franked. There are sufficient franking credits available in the franking account of Company A.

· During the year in question, Trust X will distribute all of its income to the Taxpayer.

· Trust X will not have any income from any other sources in the relevant income year.
Company C, as trustee of Trust X, has made a family trust election.

· The total of the franking credits that the Taxpayer will receive from all sources in the income year in question will be more than $5,000.

· The Taxpayer's net taxable income and tax payable in the year of income, before credits and tax offsets, will be a positive amount.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1997 Subsection 30-15(1)

Income Tax Assessment Act 1997 Section 30-215

Income Tax Assessment Act 1997 Section 30-248

Reasons for decision

All references are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

Question 1

Summary

The general anti-avoidance provisions in Part IVA will not apply to the arrangement.

Detailed reasoning

Part IVA contains a number of general anti-avoidance provisions that give the Commissioner the discretion to cancel a tax benefit that has been obtained, or would, but for the operation of section 177F, be obtained by the taxpayer in connection with a scheme to which Part IVA applies. This discretion is found in subsection 177F(1).

Before the Commissioner can exercise the discretion in subsection 177F(1), the requirements of Part IVA must be satisfied. These requirements are that:

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

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

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

Scheme

A scheme is broadly defined in subsection 177A(1) to be:

(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 or course of conduct.

In Federal Commissioner of Taxation v Hart [2004] HCA 26, it was noted that the definition of scheme encompasses not only a series of steps which together can be said to constitute a 'scheme' or a 'plan' but also the taking of but one step. The residing judges further stated that in a given case, a wider or narrower approach may be taken to the identification of a scheme.

In the present case it is considered that the narrow scheme involves the deduction received for the donation whilst the wider scheme incorporates both the donation and the proposed distribution of income by Company A to the Taxpayer by way of Trust X.

As such there is a scheme for the purposes of 177A.

Tax benefit

Part IVA only applies to a scheme where a taxpayer has obtained a tax benefit in connection with the scheme. Paragraph 61 of Practice Statement Law Administration 2005/24 (Application of General Anti-Avoidance Rules) provides that the scheme ultimately matters only in the context of whether there is a tax benefit obtained by the taxpayer in connection with the scheme.

Subsection 177C(1) defines four kinds of tax benefit, relating broadly to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income; or

(b) a deduction being allowable to the taxpayer in relation to a year of income; or

(c) a capital loss being incurred by the taxpayer during a year of income; or

(d) a foreign tax credit being allowable to the taxpayer.

In the present case, the Taxpayer made a donation of art works to the Recipient under the Cultural Gifts Program. By virtue of section 30-215 of the ITAA 1997, the Taxpayer is entitled to receive a tax deduction equal to the GST inclusive market value of the art works rather than its cost. Further, under section 30-246 of the ITAA 1997, deductions for gifts made under the Cultural Gifts Program may be spread over a period of up to five income years at the election of the taxpayer.

Under the arrangement it is also proposed that on, or around year end, Company A will distribute a franked dividend to Trust X and the trustee will subsequently exercise their discretion and distribute all of the Trust's net income (with attached franking credits) for that year to the Taxpayer.

It is considered that the tax benefit in this case could be regarded as the ability for the Taxpayer to offset future assessable income, including the current proposed distribution from Trust X, by making the donation.

Purpose

Section 177D applies to a scheme where it would be concluded that the scheme was entered into or carried out for the purpose of enabling a relevant taxpayer to obtain a tax benefit in connection with the scheme.

The eight factors in paragraph 177D(b), considered below, look at the purpose of the scheme and are to be considered objectively. A conclusion to be reached should be that of a reasonable person (Federal Commissioner of Taxation v Spotless Services Ltd (1996) ATC 4674).

The manner in which the scheme was entered into or carried out: 177D(b)(i)

This factor examines the manner in which the scheme was entered into or carried out and looks to determine whether there is any contrivance or artificiality present in the scheme by comparing the manner in which the scheme was entered into or carried out with the manner in which an alternative transaction would have been implemented.

The wider scheme undertaken by the Taxpayer is structured in a way that potentially allows them to offset future assessable income given the deduction received for the donation can be spread over a period of up to five income years (as per subdivision 30-DB of the ITAA 1997). Further, under section 30-248 of the ITAA 1997, the taxpayer can specify the percentage to be deducted in each income year.

Under the scheme it is also proposed that on or around year end, Company A will make a distribution of profits to Trust X by way of a dividend distribution with attached franking credits (pursuant to Division 207 of the ITAA 1997). It is then proposed that the trustee will exercise their discretion and distribute the Trust's net income for that year to the Taxpayer with attached franking credits.

Given the deduction can be spread over the next five income years, it is considered that the scheme provides the Taxpayer with the potential to offset future assessable income, including the current distribution proposed by Trust X.

However, it is also acknowledged that the Taxpayer has a long history of making charitable donations. As such it would be difficult to conclude that the donation of art works made to the Recipient is out of character for the Taxpayer. Further, the Applicant has asserted that if the donation had not been made to the Recipient it would have been made to another charitable foundation as this was always the Taxpayer's intention.

It is also considered that the franked dividends to be distributed to the Taxpayer are not generated by the scheme, rather they are dividends already available for distribution by Company A and the Taxpayer receives the distribution as a beneficiary of Trust X. Being a discretionary trust, the Taxpayer only becomes presently entitled to the income of Trust X at the trustee's discretion. In this regard the Corporate Trustee consists of a number of directors, the Taxpayer being but one of these.

When determined objectively, it is considered that there are no unusual steps to indicate any contrivance or artificiality in the scheme.

The form and substance of the scheme 177D(b)(ii)

This factor 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 the scheme on the one hand and its legal form on the other may indicate the scheme is being implemented in a particular form as a means to obtain a tax benefit.

The form of the scheme is to distribute franked dividends through Company A by way of Trust X to the Taxpayer. These entities currently exist within the group and no new entities will be created as part of the scheme. The trustee of Trust X has the discretion to distribute the income of the Trust to the beneficiaries, of which the Taxpayer is both a primary and general beneficiary. Given the Corporate Trustee has a number of directors, it can not be concluded that the Taxpayer has the ability to influence the trustee in exercising this discretion.

In terms of the donation, the Taxpayer donated a large portion of their art collection to the Recipient and unconditional title has since passed.

The substance of the scheme therefore consists of the Taxpayer receiving a tax deduction for the donation of the art works and the receipt of a franked distribution from Trust X.

The timing and duration of the scheme 177D(b)(iii)

The third factor draws attention to particular aspects related to the timing of the manner in which the scheme is entered into or carried out.

Paragraph 101 of PS LA 2005/24 provides that this factor enables consideration of the extent to which the timing and duration of the scheme goes towards delivering the relevant tax benefit and is aimed at transactions entered into shortly before the end of the tax year or transactions that last for an artificially brief period.

In the present case the Taxpayer made a donation of art works and in the same year it is proposed that a dividend will be paid to the Taxpayer, as a beneficiary of Trust X, on or around year end.

The Applicant claims that the timing difference between the date the Taxpayer decided to make the donation and the proposed distribution of income to the Taxpayer via Trust X indicates that the decision to donate was made irrespective of the possible distribution of income.

However it is considered that the timing of the scheme indicates that the scheme is being undertaken for the purpose of obtaining a tax benefit.

When comparing the pattern of distributions made by Trust X over the last number of years, it is evident that the proposed distribution to be made to the Taxpayer in the current year (consisting of the Trust's entire net income) is extraordinary in comparison to past distributions.

Therefore it is considered that the timing of the proposed distribution, this being at year end, and the fact that the Taxpayer will be the only beneficiary receiving a trust distribution for that year suggests that the distribution of profits from Company A to the Taxpayer is being undertaken to coincide with the receipt of the tax deduction. It is therefore considered that the scheme is a means of releasing the profits held in Company A to the Taxpayer in a tax effective manner.

Upon receipt of the distribution the Taxpayer, as a result of the scheme, will be able to reduce their assessable income arising from the distribution by applying the tax deduction received for the donation. Further as the tax deduction can be spread over five income years, the Taxpayer also has the potential to offset future assessable income in a tax effective manner.

Given the Taxpayer's tax payable for the year of income will be positive, as advised by the Applicant, the Taxpayer will also be entitled to refundable tax offsets arising from the distribution (due to the franking credits attached).

The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme 177D(b)(iv)

If the dividend is distributed by Company A to Trust X and subsequently to the Taxpayer, as proposed, the following will result:

1) The retained earnings and franking account balance of Company A will be reduced;

2) In accordance with subsection 207-35(1) of the ITAA 1997, Trust X will include in its assessable income for that year, the amount of the franking credit on the distribution and the amount of the franked distribution received; and

3) The Taxpayer will include in their assessable income by virtue of subsection 207-35(3) of the ITAA 1997, their share of the franking credit on the distribution and the amount of the distribution received from Trust X.

With respect to the donation, the Taxpayer would be entitled to a deduction under subsection 30-15(1) of the ITAA 1997, the amount of which would be the GST inclusive market value of the art works in accordance with section 30-215 of the ITAA 1997. Further, by virtue of subdivision 30-DB of the ITAA 1997, the Taxpayer may elect to spread the deduction over five income years.

Change in financial position of the relevant taxpayers 177D(b)(v); any change in the financial position of any persons other than the relevant taxpayers (177D(b)(vi); and any other consequence for the relevant taxpayers or any other person 177D(b)(vii)

Under the scheme the Taxpayer receives a tax deduction for the donation and in the same year, a distribution of income from Trust X (amounting to retained profits held in Company A). As the deduction for the donation can be spread over the next five income years, the Taxpayer now has the ability to reduce any future assessable income by the amount of the deduction.

Further, the Taxpayer will also be eligible to receive a refund of excess franking credits in the current year as their tax payable, as advised by the Applicant, will be positive.

There is no change in the financial position, or any other consequence, for the relevant taxpayers or other persons.

Connection between the relevant taxpayers and any person referred to in 177D(b)(vi)

The nature of the connection between the relevant taxpayer and any person referred to in subparagraph 177D(b)(vi) is that of a family group.

Company A is a wholly owned subsidiary of Trust X (a discretionary family trust) and has been since its incorporation in 1995. The Applicant has advised that Trust X was established for the benefit of the Taxpayer, their partner and lineal descendants.

Conclusion

From an objective analysis of the factors referred to in paragraph 177D(b), it is considered that it can not be concluded that the scheme was entered into or carried out for the dominant purpose of enabling the taxpayer to obtain a tax benefit in connection with the scheme.

The dominant purpose has been held to mean the ruling, prevailing or most influential purpose (Federal Commissioner of Taxation v Spotless Services Pty Ltd (1996) ATC 4674) and is directed at blatant, artificial and contrived arrangements.

In the present case although the timing of the scheme and the change in the pattern of distributions for Trust X suggests that the scheme was entered into to obtain a tax benefit, it is also acknowledged that the Taxpayer has a long history of making charitable donations.

It is also considered that the franked dividends proposed to be distributed to the Taxpayer under the scheme are not generated by the scheme itself, rather they are dividends available for distribution by Company A. Given Trust X is a discretionary trust, the Taxpayer only becomes presently entitled to the distribution at the time the trustee exercises this discretion, as the trustee has six directors it can not be concluded that the Taxpayer can influence the trustee in exercising this discretion.

Accordingly Part IVA will not apply to the scheme.