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Ruling

Subject: Exempting credits

Question 1

Is Exempting Entity 1 (EE1) (as head company of the EE1 MEC group) an eligible continuing substantial member in relation to dividend 1 and dividend 2 within the meaning of section 208-155 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will EE1 (as head company of the EE1 MEC group) be entitled to franking credits and a tax offset in respect of the exempting credits attaching to dividend 1 and dividend 2?

Answer

Yes

This ruling applies for the following periods:

xx/xx/xxxx to xx/xx/xxxx

The scheme commences on:

xx/xx/xxxx

Relevant facts and circumstances

EE1 is a company incorporated in Australia and is the provisional head company of a multiple entry consolidated (MEC) group (EE1 MEC group). EE1 has a xx/xx/xxxx year end for income tax purposes and is an Australian resident for Australian income tax purposes.

Resident Entity (RE) is a company incorporated in Australia and is a member of the EE1 MEC group. RE is an Australian resident for Australian income tax purposes.

Non-Resident Entity 1 (NRE1) owns 100% of the issued shares in RE. Non-Resident Entity 2 (NRE2) is, and at all relevant times has been, the ultimate 100% parent company of EE1, RE and NRE1.

NRE1 is a non resident for Australian income tax purposes.

Head Company 1 (HC1) is a company incorporated in Australia.

HC1 is the head company of the HC1 income tax consolidated group (the HC1 group) and is an Australian resident company for Australian income tax purposes.

HC1, as head company, elected to form a consolidated group for Australian income tax purposes in mid 2002.

HC1 has a year end of xx/xx/xxxx for financial reporting and income tax purposes.

RE is a shareholder in HC1. Since late 2009 RE's shareholding in HC1 has always exceeded X%.

Former Exempting Entity (FEE) is a company incorporated in Australia. FEE is an Australian resident company for Australian income tax purposes.

Prior to joining the HC1 group, FEE was a former exempting entity. Prior to becoming a former exempting entity, FEE was an exempting entity. At this time NRE2 (through NRE1) indirectly held approximately Y% of the shares in FEE.

In 2009, pursuant to a merger FEE became an indirectly held wholly-owned subsidiary of HC1.

Under that 2009 merger, NRE1 was issued Z% of the shares in HC1.

In late 2009 HC1 undertook a reconstruction of its capital and RE became the owner of approximately W% of the shares in HC1.

In early 2011, FEE and its wholly owned subsidiaries joined the HC1 consolidated group.

At the joining time:

· FEE was a 'former exempting entity' pursuant to section 208-10 of the ITAA 1997. FEE had an exempting account credit balance of $X; and

· HC1 was neither an exempting entity nor a former exempting entity.

Upon FEE joining the HC1 group, HC1 became a former exempting entity pursuant to section 709-165 of the ITAA 1997.

On xx/xx/2011, RE received a dividend distribution from HC1 of approximately $Y (dividend 1) on its shares in HC1. At this time, RE held approximately Z% of the ordinary issued shares in HC1.

On xx/xx/2012, RE received a dividend distribution from HC1 of approximately $W (dividend 2) on its shares in HC1. At this time, RE held approximately Z% of the ordinary issued shares in HC1.

Dividend 1 was X% franked with an exempting credit (but no franking credits) for all HC1 shareholders. RE's share of those exempting credits was approximately $Y.

Dividend 2 was X% franked with an exempting credit (but no franking credits) for all HC1 shareholders. RE's share of those exempting credits was approximately $X.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 208-155 and

Income Tax Assessment Act 1997 Section 709-165.

Does Part IVA apply to this ruling?

Part IVA is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA (other than the application of sections 177E and 177EA when making the ruling on Question 2) to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

Reasons for decision

Question 1

The test to determine whether an entity is an eligible continuing substantial member is contained in subsection 208-155 of Division 208 of the ITAA 1997. In relation to a consolidated group, subdivision 709-B of the ITAA 1997 modifies the way Division 208 operates.

Although RE is the entity which holds the relevant interests for determining eligibility under section 208-155 of the ITAA 1997 for status as an eligible continuing substantial member, by operation of the single entity rule, EE1 as provisional head company of the EE1 MEC group is taken to be the relevant entity for these purposes.

Subdivision 709-B

Section 709-165 of the ITAA 1997 operates where the conditions set out in subsection 709-165(1) of the ITAA 1997 are met. They are:

· the head company of a consolidated group is neither an exempting entity nor a former exempting entity; and

· a corporate tax entity becomes a subsidiary member of the group at a time (also the joining time); and

· the entity is a former exempting entity at the joining time.

Section 709-165 of the ITAA 1997 applies to this scheme as it satisfies these conditions. Specifically, HC1 is the head company of the HC1 consolidated group and was neither an exempting entity nor a former exempting entity; FEE became a subsidiary member of the HC1 consolidated group in early 2011 (the joining time); and, at that time FEE was a former exempting entity.

Consequently, the rules in section 709-165(2) of the ITAA 1997 will apply to the HC1 consolidated group. The rules are;

It is clear that item 1 of the table above operates to deem HC1, as head company of the consolidated group, to have become a former exempting entity at the joining time, that is, on early 2011 when FEE joined the HC1 consolidated group.

Division 208

Subsection 208-155(1) of the ITAA 1997 provides that a member of a former exempting entity is an eligible continuing substantial member in relation to a distribution made by the former exempting entity, if the provisions in section 208-155 of the ITAA 1997 apply.

Where the former exempting entity is a company, subsection 208-155(2) of the ITAA 1997 requires the following test to be satisfied:

At both at the time when the distribution was made and the time immediately before the entity ceased to be an exempting entity, the member was entitled to not less than 5% of

· if the voting shares (as defined in the Corporations Act 2001) in the relevant former exempting entity are not divided into classes - those voting shares; or

· if the voting shares (as so defined) in the relevant former exempting entity are divided into 2 or more classes - the shares in one of those classes...

In relation to the first test time, the relevant distributions are those dividend distributions made by HC1 on xx/xx/2001 (dividend 1) and xx/xx/2012 (dividend 2). At these two times EE1 held X% and X% respectively of the ordinary issued shares in HC1.

The second test time is the time immediately before HC1 "ceased to be an exempting entity". This wording is also found in the definition of former exempting entity contained in subsection 208-50(1) of the ITAA 1997:

…a corporate tax entity is a former exempting entity if it has, at any time, ceased to be an exempting entity…

Although under item 1 of the table in subsection 709-165(2) of the ITAA 1997 HC1 was deemed to become a former exempting entity when FEE joined the HC1 consolidated group, it had never been an exempting entity in its own right. Therefore, the relevant question in regards to the present scheme is whether, for the purposes of subsection 208-155(2) of the ITAA 1997, HC1 could be said to have ceased to be an exempting entity by virtue of its having been deemed a former exempting entity under section 709-165 of the ITAA 1997.

For the purposes of 208-155(2) of the ITAA 1997 it is considered that that the expression 'the head company becomes a former exempting entity at the joining time ' in item 1 of the table in subsection 709-165(2) of the ITAA 1997 necessarily implies that the head company has also 'ceased to be an exempting entity' and that this is taken to have occurred at the joining time.

On this basis, the second test time for the purposes of testing whether EE1 is an eligible continuing substantial member in relation to the dividend distributions made by HC1 is xx, the time at which FEE joined the HC1 consolidated group. At this time EE1 held approximately X% of the ordinary issued shares in HC1.

Consequently subsection 208-155(2) of the ITAA 1997 is satisfied on the basis that EE1 held not less than the prescribed percentage of ordinary shares in HC1 (the former exempting entity) both at the time when the relevant dividend distributions were made and at the time which HC1 is taken to have ceased to be an exempting entity.

Subsection 208-155(3) of the ITAA 1997 is satisfied on the basis that EE1 was an exempting entity (in accordance with paragraph 208-155(3)(c) of the ITAA 1997) at both the time the dividend distributions were made and the time when HC1 is taken to have ceased to be an exempting entity.

Subsection 208-155(4) of the ITAA 1997 is satisfied if, when the assumptions set out in subsection 208-155(5) of the ITAA 1997 are made, the member (being a person referred to in any of paragraphs under subsection 208-155(3) of the ITAA 1997) would (if a foreign resident) be exempt from withholding tax on the distribution or (if an Australia resident) be entitled to a franking credit or a tax offset in relation to the distribution.

The assumptions relevant to this scheme under subsection 208-155(5) of the ITAA 1997 referred to in subsection 208-155(4) are that:

· the relevant former exempting entity was an exempting entity at the time it made the distribution; and

· the distribution was a franked distribution made to the member.

In this case you would assume that HC1 was an exempting entity at the time it made the dividend distributions and the dividend distributions were franked distributions to EE1.

Subsection 208-155(4) of the ITAA 1997 is satisfied as EE1, being the relevant member, is an Australia resident as referred to in paragraph 208-155(3)(c) of the ITAA 1997 and would be entitled to a franking credit or tax offset in respect of the dividend distributions.

As demonstrated above, the provisions in section 208-155 of the ITAA 1997, as modified by section 709-165 of the ITAA 1997, are satisfied by EE1 and therefore EE1 is an eligible continuing substantial member in relation to the relevant dividend distributions made by HC1.

Although, prior to FEE joining the HC1 group, any application of section 208-155 of the ITAA 1997 would have focused on FEE as being the relevant former exempting entity, the dividend distributions which are the subject of this ruling were paid after FEE joined the HC1 group. At consolidation section 709-165 of the ITAA 1997 deemed HC1 to become a former exempting entity and as consequence it is considered that HC1 will thereafter be the relevant former exempting entity for the purpose of applying the provisions of Division 208 of the ITAA 1997. Pursuant to subsection 709-155(4) of the ITAA 1997, Division 208 has no separate application to a subsidiary member of a consolidated group.

Question 2

The table in section 208-130 of the ITAA 1997 sets out when a franking credit arises in the franking account of an entity because of its status as an exempting entity.

A franking credit will arise in the account of EE1 under item 2 of the table in section 208-130 on the basis that:

· EE1 received a distribution franked with an exempting credit from HC1;

· At the time the distribution was made EE1 was an exempting entity within the meaning of section 208-20 of the ITAA 1997 on the basis that 100% of the issued shares in EE1 were held by NRE2 at the relevant times. NRE2 is a prescribed person as defined by paragraph 208-40(1)(a) of the ITAA 1997 as it is a foreign resident company;

· EE1 satisfies the residency requirement in section 205-25 of the ITAA 1997 as required by item 2 of the table in section 208-130 of the ITAA 1997 for the income year in which the distributions were made and at the time the distributions were made on the basis that it was at all relevant times an Australian resident company;

· The distributions are neither exempt income nor non-assessable non exempt income for EE1;

· EE1 is an eligible continuing substantial member in relation to both dividend 1 and dividend 2;

· The distribution is not affected by a manipulation of the imputation system mentioned in section 208-160 of the ITAA 1997.

As EE1 meets the requirements of item 2 of the table in section 208-130 of the ITAA 1997 the amount of the franking credit on each distribution is worked out under paragraph 208-165(1)(b) of the ITAA 1997.

By virtue of paragraph 208-230(b) of the ITAA 1997, Division 207 will apply to the dividend distributions made by HC1, being a former exempting entity, as if they were franked distributions on the basis that EE1 was an exempting entity and the dividend distributions gave rise to a franking credit for EE1.

As Division 207 will apply to dividend 1 and dividend 2 received by EE1, the assessable income of EE1 is grossed up for the amount of the franking credit attaching to the dividend distribution pursuant to subsection 207-20(1) of the ITAA 1997

In addition, under subsection 207-20(2) of the ITAA 1997, EE1 is entitled to a "tax offset" equal to the franking credit on each distribution.