Edited version of your private ruling

Authorisation Number: 1012626933837

Ruling

Subject: Retirement planning proposal

Question 1

Is the franked distribution from A Pty Ltd (the Company) to the B Superannuation Fund (the Fund) non-arm's length income of the Fund under section 295-550 of the Income Tax Assessment Act (ITAA 1997)?

Answer

Yes

Question 2

Is the franked distribution from the Company to the Fund made as part of a dividend stripping operation within the meaning of paragraph 207-145(1)(d) of the ITAA 1997?

Answer

Yes

Question 3

Is there a scheme to which Part IVA, and therefore section 177F, of the Income Tax Assessment Act 1936 (ITAA 1936) applies?

Answer

Yes

Question 4

Is there a scheme to which section 177EA of the ITAA 1936 applies?

Answer

Yes

This ruling applies for the following periods:

Year of income ended 30 June 2014

The scheme commences on:

1 July 2013

Relevant facts and circumstances

1. Taxpayer 1 and Taxpayer 2 are spouses (together, the Taxpayers).

2. The Taxpayers are the only two members of the Fund (a self managed superannuation fund). The Taxpayers are both currently receiving pension payments from the Fund. The Taxpayers are not able to make further contributions to the Fund as they do not satisfy the "work test".

3. The Company is the trustee of the Fund.

4. The Taxpayers are the only shareholders and directors of the Company. Taxpayer 1 holds one C class share and Taxpayer 2 holds two ordinary shares.

5. The Company's assets broadly comprised of related party debit loans (RPDLs) and cash.

6. The Company has sufficient franking credits available to allow its retained earnings to be paid out as a fully franked dividend.

7. The RPDLs are personal loans between the Company and the Taxpayers. Under the terms of the loan agreements, the loans will take approximately five years to repay in full.

8. Taxpayer 1 is currently unwell. It is said that because of concerns over Taxpayer 1's health, the Taxpayers wish to wind up the Company as soon as possible. The Company no longer trades.

9. It is intended that the following steps will be implemented:

(a) the Fund will pay each of the Taxpayers a lump sum pension payment. The Taxpayers will repay their RPDL to the Company using that sum and other personal funds;

(b) the Company's sole asset will then be cash. At that time, the Fund will have approximately $X in cash and listed securities of approximately $Y;

(c) the Fund will liquidate sufficient of its listed securities to increase its cash to the market value of the Company's shares;

(d) the Fund will then purchase the Taxpayers' shares in the Company for an amount equal to the cash held by the Company;

(e) upon the sale of their shares to the Fund, the Taxpayers will each crystallise a capital gain. The Taxpayers have no carried forward income tax losses or capital losses. It is said that it is expected that the Taxpayers will each have a tax liability resulting from the capital gain on the disposal of the shares;

(f) after the Fund acquires the shares, those shares will be used to support the payment of pensions to each of the Taxpayers with the result that the Fund will only have members whose total account balances are supporting pensions and no other members will be admitted to the Fund;

(g) after the expiry of 45 days, the Company will pay a franked distribution to the Fund equal to its retained earnings, with attached franking credits (the franked distribution);

(h) it is said that a proportion (as worked out under subsection 295-390(3) of the ITAA 1997) of the franked distribution (i.e. including the franking credit) which would otherwise be assessable income of the Fund will be exempt from income tax under subsection 295-390(1) of the ITAA 1997. The relevant proportion is said to be 100%. The Fund is said to be entitled to a refund of the unused franking credit tax offset;

(i) following payment of the franked distribution, the Company will be wound up and deregistered; and

(j) after the Company is deregistered, the Fund will realise a capital loss, (although it is said that the capital loss is of no use while the Fund remains in pension phase).

10. As a net result of the steps in paragraph 9, the Fund is said to increase in value by approximately $Y being a refund of the unused franking credit tax offset of reduced by the lump sum pension payments (as referred to in paragraph 9(a) above).

11. If the above scheme is not implemented, it is intended that the Company will pay yearly franked dividends to the Taxpayers to enable them to meet their minimum yearly repayments on the loans to the Company. It is anticipated that it will take approximately 5 years before the loans will be fully repaid. Once the loans are repaid, the Fund will liquidate listed securities to provide funds for it to be able to purchase the Company's shares, after which the Company can be wound up and deregistered.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Section 177F

Income Tax Assessment Act 1997 Subdivision 207-F

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-155

Income Tax Assessment Act 1997 Section 295-390

Income Tax Assessment Act 1997 Section 295-545

Income Tax Assessment Act 1997 Section 295-550

Reasons for decision

Question 1

Summary

12. Leaving aside considerations of section 207-145 of the ITAA 1997 and Part IVA of the ITAA 1936 as dealt with in the subsequent questions, the franked distribution from the Company to the Fund would be non-arm's length income of the Fund under subsection 295-550(2) of the ITAA 1997. The franked distribution would therefore not be exempt as current pension income under either subsection 295-385(1) or 295-390(1) of the ITAA 1997.

Detailed reasoning

13. In accordance with section 295-545 of the ITAA 1997 the income of a complying superannuation fund is split into a 'non-arm's length component' and a 'low tax component'.

14. The note to subsection 295-545(1) of the ITAA 1997 explains that a concessional rate (15%) of tax applies to the low tax component, while the non-arm's length component is taxed at the highest marginal tax rate (45%). These rates are set out in the Income Tax Rates Act 1986.

15. Subsection 295-545(2) of the ITAA 1997 provides that the non-arm's length component for an income year is the entity's non-arm's length income for that year less any deductions to the extent that they are attributable to that income. The phrase 'non-arm's length income' has the meaning given by section 295-550 of the ITAA 1997.

16. Dividends paid to an entity by a private company, along with ordinary or statutory income reasonably attributable to such a dividend (such as the franking credits), are non-arm's length income of the entity unless the amount is consistent with an arm's length dealing (subsection 295-550(2) of the ITAA 1997).

17. Subsection 295-550(3) of the ITAA 1997 requires consideration of the following matters when deciding whether an amount is consistent with an arm's length dealing:

(a) the value of shares in the company that are assets of the entity; and

(b) the cost to the entity of the shares on which the dividend was paid; and

(c) the rate of that dividend; and

(d) whether the company has paid a dividend on other shares in the company and, if so, the rate of that dividend; and

(e) whether the company has issued any shares to the entity in satisfaction of a dividend paid by the company (or part of it) and, if so, the circumstances of the issue; and

(f) any other relevant matters.

18. The Commissioner has issued Taxation Ruling TR 2006/7 Income tax: special income derived by a complying superannuation fund, a complying approved deposit fund or a pooled superannuation trust in relation to the year of income. This Ruling refers to former section 273 of the ITAA 1936 which concerned 'special income' (now termed non-arm's length income) and continues to provide the ATO view so far as the new provision (section 295-550 of the ITAA 1997) expresses the same ideas as section 273.

19. In the facts of this case it is stated that the shares are to be purchased at market value such that the shares are reflected at market value in the members' accounts. This is a relevant consideration under paragraph 295-550(3)(a) of the ITAA 1997 and the acquisition of shares at market value is consistent with an arm's length dealing.

20. The rate of the dividend (paragraph 295-550(3)(c) of the ITAA 1997) is also relevant and refers to the amount of the dividend (or dividends) paid per share over a period of time (e.g. annually) by a company. In this case the dividend rate reflects the distribution of all of the assets of the company over a short period of time (i.e. potentially soon after the 45 day holding period rule is satisfied).

21. As the Fund is the only shareholder there is no comparison to be made as between the rate of dividends paid to the Fund and the rate of dividends paid to any other shareholder (paragraph 295-550(3)(d) of the ITAA 1997).

22. Other relevant factors (paragraph 295-550(3)(f) of the ITAA 1997) to consider include the market value of the shares as compared with the dividend rate and the rate of return on investment and also the level of investment risk undertaken by the Fund in relation to the dividend rate and the rate of return.

23. It is considered that taking into account the acquisition of the shares at the stated market value, the dividend rate, the rate of return, the lack of risk, the timeframe and the certainty that all of the assets of the Company will be paid to the Fund as a fully franked dividend given all parties are related, the dividend income of the Fund is non-arm's length income. The relevant facts leading to this conclusion are expanded upon below.

• The Fund has minimal or nil investment risk as the only asset of the Company is cash, the Company has no liabilities and there are no trading or investment activities being conducted by the Company.

• There is no risk that the dividend won't be paid given the non-arm's length relationship that exists between all parties involved.

• During the relatively short period of time the shares are held by the Fund it will, for minimal or nil investment risk, realise all of the assets of the Company giving it a return of 100% based on the stated market value of the shares (in total) and an after tax return in excess of 100% (i.e. with the refund of the unused franking credit tax offset).

• The expected market value of the shares takes no account of the statutory right to the franking credit tax offset and the subsequent refund that is conferred on the Fund as a result of the transactions.

24. Therefore, subsection 295-550(2) of the ITAA 1997 would apply to the Fund with respect to its receipt of the franked distribution from the Company. The franked distribution would not be exempt current pension income of the Fund (under subsection 295-385(1) or 295-390(1) of the ITAA 1997).

Question 2

Summary

25. The franked distribution from the Company to the Fund is made as part of a dividend stripping operation within the meaning of paragraph 207-145(1)(d) of the ITAA 1997. As a consequence the amount of the franking credit on the distribution is not included in the assessable income of the Fund under section 207-20 of the ITAA 1997 and the Fund is not entitled to a tax offset under Subdivision 207-F because of the distribution (paragraphs 207-145(e) and (f) of the ITAA 1997).

Detailed reasoning

Subsection 207-145(1) of the ITAA 1997

26. Subsection 207-145(1) of the ITAA 1997 provides, relevantly, that where a franked distribution is made to an entity in circumstances where (in paragraph 207-145(1)(d)) 'the distribution is made as part of a dividend stripping operation', then, relevantly:

(a) (in paragraph 207-145(1)(e)) the amount of the franking credit on the distribution is not included in the assessable income of the entity under section 207-20 or 207-35 of the ITAA 1997; and

(b) (in paragraph 207-145(1)(f)), the entity is not entitled to a tax offset under Subdivision 207-F because of the distribution.

27. Section 207-155 of the ITAA 1997 defines when a distribution is made as part of a 'dividend stripping operation' within the meaning of paragraph 207-145(1)(d) of the ITAA 1997 as follows:

A distribution made to a member of a corporate tax entity is taken to be made as part of a dividend stripping operation if, and only if, the making of the distribution arose out of, or was made in the course of, a scheme that:

(a) was by way of, or in the nature of, dividend stripping; or

(b) had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

28. If the franked distribution from the Company to the Fund would be a distribution made 'as part of a dividend stripping operation' within the meaning of paragraph 207-145(1)(d) of the ITAA 1997, the relevant effect will be that the amount of any franking credit on the distribution will not be included in the assessable income of the Fund and the Fund will not be entitled to a tax offset under Subdivision 207-F of the ITAA 1997.

Dividend stripping operations

29. A 'dividend stripping operation' has been recognised as involving the following characteristics:

(a) a company with substantial undistributed profits (target co);

(b) a sale or allotment of shares in target co to another party;

(c) the payment of a dividend to the purchaser or allottee of shares by target co;

(d) the acquirer escaping Australian income tax on the dividend so declared;

(e) the vendor shareholder receiving a capital sum for their shares in an amount the same as or very close to the dividend paid out; and

(f) the transactions being carefully planned, with the parties acting in concert for the predominant purpose of avoiding tax on the distribution of dividends by target co.

See Commissioner of Taxation v. Consolidated Press Holdings Ltd [1999] FCA 1199; (1999) 91 FCR 524 (FCT v. CPH (FFC)) at [136] - [137] and [157]; Commissioner of Taxation v. Consolidated Press Holdings Ltd [2001] HCA 32; (2001) 207 CLR 235 (FCT v. CPH (HC)) at [126] and [129]; and Lawrence v. Federal Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277 (Lawrence v. FCT) at [42] - [43].

30. A scheme may still be a 'dividend stripping operation' because the making of a distribution was 'by way of or in the nature of dividend stripping' even if it contains features which vary from the paradigm case of dividend stripping, so long as it retains the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45].

31. A difference between a scheme 'by way of or in the nature of dividend stripping' and a scheme which has 'substantially the effect' of a scheme 'by way of or in the nature of dividend stripping' lies in the means adopted to distribute the profits of the target company. Where the means adopted do not involve a distribution, but some other step (such as the purchase by the target company of near worthless assets or assets later rendered near worthless by the target company) this involves a scheme having 'substantially the effect' of a scheme 'by way of or in the nature of dividend stripping': Lawrence v. FCT at [47] - [52].

Will the franked distribution from the Company to the Fund be a distribution made as part of a dividend stripping operation?

32. The payment of the franked distribution from the Company to the Fund will be made as part of a 'dividend stripping operation' within the meaning of paragraph 207-145(1)(d) of the ITAA 1997 because each of the elements of a scheme 'by way of or in the nature of dividend stripping' will be present. For the reasons below, each of the central characteristics of a scheme by way of or in the nature of dividend stripping identified in paragraph 29 above are satisfied.

33. First element: The Company has substantial undistributed profits. Following the repayment of the RPDLs referred to in paragraph 9(a) above the Company will have retained earnings represented by only cash assets with no liabilities. Accordingly, the element of a 'dividend stripping operation' identified in paragraph 29(a) above is satisfied.

34. Second element: The Taxpayers will transfer their shares in the Company to the Fund by way of sale. Accordingly, the element of a 'dividend stripping operation' in paragraph 29(b) above is satisfied.

35. Third element: The Company will pay the franked distribution to the Fund which is equal or substantially equal to the value of its retained earnings. Accordingly, the element of a 'dividend stripping operation' in paragraph 29(c) above is satisfied.

36. Fourth element: On the assumption that the franked distribution is 'consistent with an arm's length dealing' within the meaning of subsection 295-550(2) of the ITAA 1997, and therefore is not 'non-arm's length income' of the Fund within the meaning of paragraph 295-390(2)(a) of the ITAA 1997, the franked distribution is said to be exempt from income tax under subsection 295-390(1) of the ITAA 1997. In the result, absent the application of subsection 207-145(1) of the ITAA 1997, the Fund will obtain a refund of the unused franking credit tax offset in relation to the franked distribution (see paragraph 9(h) above). Accordingly, the element of a 'dividend stripping operation' in paragraph 29(d) above is satisfied.

37. Fifth element: The Taxpayers will receive a capital sum for their shares in the Company. That amount equals the amount of the franked. Accordingly, the element of a 'dividend stripping operation' in paragraph 29(e) above is satisfied.

38. Sixth element: The sixth element of a dividend stripping operation identified in paragraph 29 above is satisfied for the following reasons:

(a) The arrangement proposed and described at paragraph 9 above is carefully planned. It involves all the parties acting in concert. The parties are all related, being the Taxpayers or entities controlled by the Taxpayers.

(b) From the point of view of the Fund the principal or pre-dominant economic effect of the arrangement proposed and described at paragraph 9 above is obtaining a tax benefit; namely the attraction of the exemption in subsection 295-390(1) of the ITAA 1997 as it applies to the franked distribution. The increase in the value of the Fund as a result of the arrangement is attributable solely to the refund of the unused franking credit tax offset after taking into account the tax free lump sum paid to the Taxpayers and used by the Taxpayers to settle, in part, their outstanding RPDLs with the Company (see paragraph 9(a) above). It is therefore the franking credit tax offset refund amount that is available for subsequent tax free distribution as superannuation benefits to the Taxpayers;

(c) A further tax effect for the Fund (although of lesser significance while it remains entirely in 'pension phase') is the generation of a capital loss which might be used if the Fund ceases to be entirely in pension phase (see paragraph 9(j) above).

(d) From the point of view of the Taxpayers, the principal or predominant effect of the arrangement proposed and described at paragraph 9 above is the substitution of a capital amount for the disposal of the shares instead of a franked distribution with a resultant lower incidence of tax (under the applicable capital gains tax provisions) for the Taxpayers: see Lawrence v. FCT at [44]. It also ensures that there is a refund of a franking credit tax offset amount paid to the Fund which effectively recompenses the Fund for the withdrawal of the amount from the Fund by the Taxpayers used to settled the RPDL and is therefore available to be paid as a tax free superannuation benefit to the Taxpayers.

39. It is no answer to say that the arrangement is undertaken for the purposes of retirement planning rather than for the purposes of avoiding tax. This is because that poses a false dichotomy of the kind referred to in Commissioner of Taxation v. Spotless Services Limited (1996) 186 CLR 404 (FCT v. Spotless) at 415 - 416. This is because, on an objective assessment, the substantial aspect of the arrangement that makes it desirable retirement planning for the Taxpayers and gives rise to the enhanced value is the tax benefits obtained through the channelling of the franked distribution through the Fund, namely, refund of the franking credit tax offset (see paragraphs 9(g) and (h) and 10 above).

40. Furthermore, the fact that the Taxpayers may have been assessed on a net capital gain made in respect of the disposal of the shares in the Company to the Fund does not mean that a 'dividend stripping operation' cannot arise. In Lawrence v. FCT, the Full Court of the Federal Court observed at [44] that 'notwithstanding the advent of comprehensive taxation of capital gains, this characteristic remains relevant because the methods of calculating capital gains invariably lead to a lower amount of tax'.

Question 3

Summary

41. There is a scheme to which Part IVA and therefore section 177F of the ITAA 1936 applies. The Commissioner may make a determination under section 177F of the ITAA 1936 that has the effect of cancelling the tax benefit.

Detailed reasoning

Section 177E of Part IVA of the ITAA 1936

42. Where the conditions of subsection 177E(1) of Part IVA of the ITAA 1936 are satisfied, paragraph 177E(1)(e) provides that the relevant scheme 'shall be taken to be a scheme to which this Part applies'. This has the result that the Commissioner is empowered to issue a determination cancelling a tax benefit under section 177F of the ITAA 1936.

43. The conditions in subsection 177E(1) of the ITAA 1936 are to the following effect:

(a) there is a 'scheme' of the kind defined in subsection 177A(1) of the ITAA 1936 that is in relation to the company (target co);

(b) the scheme is one:

(i) by way of or in the nature of dividend stripping; or

(ii) having substantially the same effect as dividend stripping;

(c) a result of the scheme is that property of the target co is disposed of;

(d) the Commissioner forms the opinion that the disposal of property by the target co represents in whole or in part a distribution whether to a shareholder (called the vendor shareholder) or another person of profits of target co;

(e) had the target co, immediately before the scheme was entered into, paid a dividend out of profits equal to the amount of profits represented by the target co's disposal of property (the 'notional amount'), the notional amount would or might reasonably be expected to have been included by reason of the payment of the dividend in the assessable income of a taxpayer in a year of income; and

(f) the scheme was entered into after 27 May 1981.

See FCT v. CPH (FFC) at [118] - [123].

44. As noted above, if those conditions are satisfied, the scheme is taken to be one to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e)), and the taxpayer shall be taken to have obtained a tax benefit referable to the notional amount not being included in the assessable income of the taxpayer in the year of income: FCT v. CPH (FFC) at [124] - [127].

Are the conditions of subsection 177E(1) of the ITAA 1936 satisfied in relation to the franked distribution from the Company to the Fund?

45. For the following reasons, each of the conditions in paragraphs 177E(1)(a) to (d) of the ITAA 1936 referred to in paragraph 43 above are satisfied.

46. First condition: The breadth of the definition of 'scheme' in section 177A of the ITAA 1936 has been judicially noted: British American Tobacco Australia Services Ltd v. Federal Commissioner of Taxation [2010] FCAFC 130; (2010) 189 FCR 151 at [30]. It includes any 'scheme, plan, proposal, action, course of conduct, or course of action'. The steps in paragraph 9 above clearly constitute a scheme within the meaning of subsection 177A(1) of the ITAA 1936.

47. Moreover, the 'scheme' described in paragraph 9 above is plainly a 'scheme that is in relation to a company';.

48. For this reason, the first condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(a) above is satisfied.

49. Second condition: For the reasons given above in paragraphs 32 to 40, the 'scheme' is one by way of or in the nature of dividend stripping. For this reason, the second condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(b) above is satisfied.

50. Third condition: Subsection 177E(2) of the ITAA 1936 provides as follows:

Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to:

(a) the payment of a dividend by the company;

(b) the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid);

(c) a bailment of property by the company; and

(d) any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company.

51. The scheme involves the payment by the Company of the franked distribution to the Fund and thus is a scheme the result of which is the disposal of property of the Company within the meaning of paragraph 177E(2)(a) of the ITAA 1936 (see paragraph 9(g) above).

52. Accordingly, the third condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(c) above is satisfied.

53. Fourth condition: As noted above in paragraph 9(g), the franked distribution is to be paid which represents all or substantially all of the Company's retained earnings. Therefore, the Commissioner has formed the view that the franked distribution will represent, in whole or in part, a distribution of the profits of the Company. For this reason, the fourth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(d) above is satisfied.

54. Fifth condition: If, before the scheme described in paragraph 9 above was entered into, the Company paid a franked distribution to its then shareholders, being the Taxpayers, it is reasonable to expect that an additional amount would have been included in each of their assessable incomes equal to the value of the franked distribution. For this reason, the fifth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(e) above is satisfied.

55. Sixth condition: The scheme is to be entered into after 27 May 1981. Therefore, the sixth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 43(f) above is satisfied.

56. For those reasons, if the scheme in paragraph 9 above is entered into, it will be taken to be a scheme to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e) of the ITAA 1936) and the Taxpayers will be taken to have obtained a tax benefit in connection with the scheme, being the amount which, had the Company paid franked distributions prior to entering into the scheme, would have formed part of their assessable incomes (paragraphs 177E(1)(f) and (g)).

Question 4

Summary

57. There is a scheme to which section 177EA of the ITAA 1936 applies. The Commissioner may therefore determine (under paragraph 177EA(5)(b)) that no imputation benefit arises for the Fund in respect of that distribution.

Detailed reasoning

Section 177EA of the ITAA 1936

58. Subsection 177EA(5) of the ITAA 1936 gives the Commissioner the power (relevantly, in paragraph 177EA(5)(b)) to determine that no imputation benefit is to arise in respect of a distribution or specified part of a distribution that is made or flows indirectly to a relevant taxpayer.

59. In Mills v. Federal Commissioner of Taxation [2012] HCA 51; (2012) 87 ALJR 53 (Mills v. FCT) at [59], it was pointed out that subsection 177EA(3) of the ITAA 1936 'is an exhaustive statement of the jurisdictional facts that are necessary and sufficient for s177EA to apply so as to found an exercise of power by the Commissioner to deny a franking credit under s177EA(5)(b)'.

60. The 'jurisdictional facts' can be relevantly identified as follows:

(a) there is a scheme for the distribution of membership interests, or interests in membership interests, in a corporate tax entity (paragraph 177EA(3)(a) of the ITAA 1936). This includes entering into a contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interests in membership interests (paragraph 177EA(14)(b));

(b) a frankable distribution has been paid, or is payable, or expected to be payable in respect of the membership interest (subparagraph 177EA(3)(b)(i); subparagraph 177EA(3)(b)(ii) being presently irrelevant);

(c) the distribution was, or is expected to be, a franked distribution (paragraph 177EA(3)(c));

(d) except for section 177EA, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, an imputation benefit as a result of the distribution (paragraph 177EA(3)(d)). An 'imputation benefit' includes receipt by the taxpayer of a tax offset under Division 207 of the ITAA 1997 or, in the case of a corporate taxpayer, a franking credit arising in the franking account of the taxpayer (subsection 177EA(16));

(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' (paragraph 177EA(3)(e)).

61. The 'relevant circumstances' are defined in subsection 177EA(17) of the ITAA 1936 to include 11 matters, the last of which (in paragraph 177EA(17)(j)) includes the eight matters in paragraphs 177D(2)(a) to (h) of the ITAA 1936.

62. Section 177EA of the ITAA 1936 was considered by the High Court in Mills v. FCT. The following propositions emerge from the judgment of Gageler J (with whom the other members of the Court agreed):

(a) the relevance of the 'relevant circumstances' in subsection 177EA(17) lies in the extent to which they are probative of the ultimate question of purpose (at [61]);

(b) the circumstances referred to in subsection 177EA(17) are not exhaustive of the circumstances that might be probative of that ultimate question. They are nevertheless mandatory relevant considerations. Where they exist, they must be taken into account and their degree of relevance will vary according to the extent to which they are probative of the ultimate question (at [61]);

(c) the reference to purpose in paragraph 177EA(3)(e) may, but need not, be that of the issuer. A purpose is a consequence intended by a person to result from some action and, in this context, refers to a consequence intended by the person in entering into or carrying out a scheme for the disposition of relevant interests. A person will often intend a single action to have multiple consequences (at [63]);

(d) a purpose is an 'incidental purpose' within the meaning of paragraph 177EA(3)(e) if it does no more than follow from some other purpose. A purpose can be incidental even when it is central to the design of a scheme if the design is directed to the achievement of another purpose (at [64] and [66]);

(e) the reference to 'enabling' in paragraph 177EA(3)(e) refers to 'supplying with the requisite means or opportunities' to the end of obtaining an imputation benefit (at [65]);

(f) a relevant purpose within the scope of paragraph 177EA(3)(e) need not be a 'dominant purpose'; a 'dominant purpose' is sufficient but not necessary to supply the relevant jurisdictional fact. It does not follow that 'a purpose which does no more than further or follow from some dominant purpose is incidental' (at [66]);

(g) counterfactual analysis is not antithetical to the assessment of purpose in paragraph 177EA(3)(e). Consideration of alternatives may assist the drawing of conclusions in a particular case that a purpose of enabling a holder to obtain a franking credit does or does not exist and, if it does exist, whether it is incidental to some other purpose (at [66]);

(h) in the case of a capital raising, if the franking of distributions serves no purpose other than to facilitate the capital raising, then the purpose is an incidental purpose within the meaning of paragraph 177EA(3)(e) (at [67]); and

(i) in the assessment of purpose in subsection 177EA(3), each of the factors in subsection 177EA(17) need not be analysed individually, so long as they are all taken into account, where probative, in a global assessment of purpose (at [73]).

Application of paragraphs 177EA(3)(a) - (d) of the ITAA 1936

63. It is clear that the 'jurisdictional facts' in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 and described in paragraphs 60(a) to (d) above are satisfied. This is because:

(a) there is a 'scheme for the disposition of membership interests' because the relevant scheme involves the sale of shares in the Company from the Taxpayers to the Fund (see paragraph 9 above). Accordingly, the jurisdictional fact in paragraph 177EA(3)(a) is satisfied;

(b) it is expected that the distribution to the Fund will be a frankable distribution and it is expected to be a franked distribution. Accordingly, the jurisdictional facts in subparagraph 177EA(3)(b)(i) and paragraph 177EA(3)(c) are satisfied;

(c) except for section 177EA, the Fund could reasonably be expected to receive an imputation benefit as a result of the franked distribution. Accordingly, the jurisdictional fact in paragraph 177EA(3)(d) is satisfied.

64. Accordingly, the question as to whether the power to make a determination under subsection 177EA(5) of the ITAA 1936 will arise turns on whether the relevant purpose in paragraph 177EA(3)(e) is present.

Is it more than an incidental purpose of the scheme to enable the Fund to obtain an imputation benefit?

65. As was observed in Mills v. FCT, the relevance of each of the factors in subsection 177EA(17) of the ITAA 1936 and the probative weight they bear will differ in each case (at [61]).

66. Some of the 'relevant circumstances' in subsection 177EA(17) of the ITAA 1936 can be put aside as irrelevant. Because the Fund will be the sole shareholder in the Company, there is no question of it deriving a 'greater benefit' than other persons who hold membership interests. Thus, the circumstances in paragraphs 177EA(17)(b), (c) and (d) can be put to one side. Equally, the scheme does not involve the issue of non-share equity and so the matter in paragraphs 177EA(17)(e) can be put to one side. These matters are generally concerned with 'dividend streaming' arrangements: see Mills v. Federal Commissioner of Taxation [2011] FCAFC 158; 198 FCR 89 at [43].

67. Some of the 'relevant circumstances' in subsection 177EA(17) of the ITAA 1936 point, at least to some extent, against the existence of the relevant purpose. The consideration paid by the Fund for the shares in the Company does not appear to have been calculated by reference to any imputation benefits (cf., paragraph 177EA(17)(f)). The franked distribution does not appear to be equivalent to receipt of an amount in the nature of interest (cf., paragraph 177EA(17)(h)). The franked distribution appears to be paid from taxed and not untaxed profits (cf., paragraph 177EA(17)(ga)). These matters, to the extent that they bear probative weight, point against the relevant conclusion.

68. The following matters in subsection 177EA(17) of the ITAA 1936 point towards the existence of the relevant purpose:

(a) the period of time the Fund will hold the shares in the Company prior to the payment of the franked distribution is short and the Company will be thereafter deregistered. The Company will conduct no trading activities in that period and its assets are substantially cash assets. The extent and duration of the risk of loss the Fund will bear as a result of its holding of the shares in the Company will be minimal. After payment of the franked distribution the Company will be worthless. The Fund was not the economic owner of the shares when the Company generated the franking credits and will not bear any significant risk in the short period of its holding of the shares in the Company. This undermines the principles of the imputation system: Explanatory Memorandum to the Taxation Laws (Amendment) Bill (No 3) at [8.5] (cf., paragraphs 177EA(17)(a) and (i));

(b) the subsequent deregistration of the Company will give rise to a capital loss for the Fund (cf., paragraph 177EA(17)(g)). However, the weight of this matter is limited while ever the Fund remains entirely in pension phase.

69. Turning to the matters in paragraphs 177D(2)(a) to (h) of the ITAA 1936 which are picked up by paragraph 177EA(17)(j) of the ITAA 1936, the following are relevant:

(a) the scheme involves a carefully orchestrated and interlinked series of transactions (cf., paragraph 177D(2)(a)) between persons who are all connected with the Taxpayers, being either themselves or the entities which one or both of them control and are interested in (cf., paragraph 177D(2)(h));

(b) the scheme's form involves a sale of the shares in the Company to the Fund and payment of a franked distribution to it. The substance of the scheme (that is, 'what in fact [the relevant person] may achieve by carrying it out': Mills v. FCT at [71]) is the channelling of the distribution of the profits and the franking credits of the Company to its ultimate economic owner (the Taxpayers) through the Fund (cf., paragraph 177D(2)(b));

(c) the scheme is to be implemented over a short period of time (cf., paragraph 177D(2)(c));

(d) the effects of the scheme (that is, the financial position of the relevant persons with and without the scheme: Mills v. FCT at [70]) will be as follows:

(i) the Fund will receive the franked distribution together with a refund of the unused franking credit tax offset on the basis that the franked distribution is exempt income pursuant to section 295-390 of the ITAA 1997 and the Fund will make a capital loss when the Company is deregistered (cf., paragraph 177D(2)(d)). Therefore, the net effect will be an increase in the value of the Fund arising from the franking credit tax offset. Further, the franking credit tax offset recompenses the Fund for the amount withdrawn to settle, in part, the RPDLs. (cf., paragraph 177D(2)(d));

(ii) the Taxpayers will have an amount, referrable to the net capital gain made upon disposal of the shares in the Company, included in their assessable incomes and, because of the method of calculating net capital gains, this will be a lesser amount than would be included if the franked distribution had been paid directly to them: see FCT v. Lawrence at [44] (cf., paragraph 177D(2)(e)); and

(iii) the Taxpayers will each receive the benefit of pensions from the Fund supported by the franked distribution and the refund of the unused franking credit tax offset whereas without the scheme they would not have the benefit of the full value of the franked distribution and a franking credit. Instead the Taxpayers would have the benefit of a lesser amount. That is, the franked distribution amount reduced by tax payable (top up tax) to the extent that their marginal tax rate exceeds the company tax rate. (cf., paragraph 177D(2)(f)).

70. Overall, the balance of matters points towards a conclusion that a more than incidental purpose of the scheme is to enable the Fund to gain an imputation benefit. The critical factor in an assessment of purpose is the absence of any explanation for the implementation of the scheme other than to ensure that the profits of the Company and the attached franking credits are channelled to their ultimate economic owner (the Taxpayers) through the Fund and thus with the benefit of the exemption in section 295-390 of the ITAA 1997.

71. It is no answer to say that the main purpose of the scheme is the maximising of the Taxpayers' wealth in retirement. That draws the same false dichotomy as was rejected in FCT v. Spotless. This is because it is the tax effect referred to above which achieves the maximisation of wealth in retirement over that which would otherwise be achieved.