Edited version of private advice

Authorisation Number: 1012652549198

Ruling

Subject: Dividend access share arrangement

Question 1

Are the Redeemable Preference Shares (RPSs) to be issued, equity interests under Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will Company X have a capital gain from CGT event H2 (section 104-155 of the ITAA 1997) from the issue of the RPSs?

Answer

No.

Question 3

Company X is to pay franked dividends on the redeemable preference shares:

a) Will the distributions from Company X to the redeemable preference shareholders (RPS holders) be treated as payments of dividends capable of being franked under section 202-40 of the ITAA 1997?

Answer: Yes.

b) If so and Company X pays franked dividends to the RPS holders, will the RPS holders be assessable on the franking credits under subsection 207-20(1) of the ITAA 1997?

Answer: Yes.

c) In relation to (b), will the RPS holders be entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997?

Answer: Yes.

d) If the RPS holders distribute the dividends to beneficiary companies, will the beneficiary companies be assessable on the franking credits under section 207-35 of the ITAA 1997?

Answer: Yes.

e) In relation to (d), will the beneficiary companies be entitled to a tax offset equal to the franking credits under section 207-45 of the ITAA 1997

Answer: Yes.

Question 4

Will the following anti-avoidance provisions apply to the issue of the RPSs?:

a) The dividend streaming provisions (Subdivision 204-D of the ITAA 1997)

Answer: No.

b) The capital streaming provisions (section 45 to section 45D of the Income Tax Assessment Act 1936 (ITAA 1936)

Answer: No.

This ruling applies for the following periods

Year ending 30 June 2014

Year ending 30 June 2015

Year ending 30 June 2016

The scheme commenced on

1 July 2013

Relevant facts and circumstances

The arrangement that is the subject of the private ruling involves redeemable preference shares.

The arrangement is set out in the following documents:

• the application for private ruling

• further documentation, including emails, received in relation to the application; and

• records of conversation with respect to the application.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subsection 974-20(1)

Income Tax Assessment Act 1997 Section 974-135

Income Tax Assessment Act 1997 Section 104-155

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Section 202-45

Income Tax Assessment Act 1997 Section 204-30

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Section 207-35

Income Tax Assessment Act 1997 Section 207-150

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Reasons for decision

Debt/Equity

Division 974 of the ITAA 1997 contains provisions which determine whether a scheme gives rise to a debt interest or an equity interest for taxation purposes.

A scheme will give rise to an equity interest in a company if the scheme satisfies the equity test in subsection 974-20(1) of the ITAA 1997 and the interest is not characterised as a debt interest.

Equity test

An interest in a company as a member or stockholder meets the equity test (item 1 of the table in subsection 974-20(1) of the ITAA 1997).

The RPSs proposed to be issued are shareholder interests and therefore meet the equity test.

Debt test

A scheme will give rise to a debt interest in an entity if the debt test in subsection 974-20(1) of the ITAA 1997 is satisfied. A scheme satisfies the debt test if all of the following conditions are met:

• the scheme is a financing arrangement for the entity (this condition does not need to be met it the entity is a company and the interest is as a member or stockholder)

• the entity or a connected entity receives or will receive a financial benefit under the scheme

• the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation (ENCO) under the scheme to provide a financial benefit

• it is substantially more likely than not that the value provided will be at least equal to the value received

• the value provided and the value received are not both nil.

Section 974-135 of the ITAA 1997 specifies that there is an ENCO to take action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take action. The section also states that an obligation is non-contingent if it is non-contingent on any event, condition or situation, other than the ability or willingness of that entity or connected entity to meet the obligation.

It is considered that there is no ENCO to provide a financial benefit with respect to the possible payment of dividends. Although it is intended that Company X pay a dividend on the RPSs, there is no obligation for it to do so. The payment of a dividend on the RPSs is still contingent on a decision by the board of the company.

The RPSs are only redeemable on the winding up of the company. There is no term of the RPSs that specify that an amount is payable on redemption. Therefore, there is no ENCO to provide a financial benefit with respect to any future redemption of the RPSs on the winding up of the company.

Conclusion

The RPSs proposed to be issued by the company are equity interests as they are shareholder interests (and therefore meet the equity test) and are not characterised as debt interests.

CGT event H2

CGT event H2 will not happen if a company issues or allots equity interests in the company (paragraph 104-155(5)(c) of the ITAA 1997).

As the issue of the RPSs represents the issue of equity interests in Company X, CGT event H2 will not happen.

Franking credits

As discussed previously, the RPSs will be equity interests. The proposed distributions on the RPSs will not fall into any of the categories of unfrankable distributions under section 202-45 of the ITAA 1997. Therefore, the proposed distributions are considered to be dividends capable of being franked under section 202-40 of the ITAA 1997.

The franking credits attached to the distributions will form part of the assessable income of the RPS holders under subsection 207-20(1) of the ITAA 1997.

The RPS holders will be entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997.

Where the RPS holders distribute the dividends to individual beneficiaries or beneficiary companies, these beneficiaries will be assessable on the franking credits under section 207-35 of the ITAA 1997.

Due to the operation of section 207-150 of the ITAA 1997, for a trust beneficiary to be entitled to use the franking credits attached to the dividend component of a trust distribution it is necessary that the beneficiary is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

Given the facts provided that the RPS holders will hold the RPS for at least 45 days and that the beneficiary companies form part of the family groups of Individual A and Individual B, the beneficiary companies will be qualified persons for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Consequently, the beneficiary companies will be entitled under section 207-45 of the ITAA 1997 to a tax offset equal to its share of the franking credits.

Dividend streaming

Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another.

Section 204-30 of the ITAA 1997 applies where an entity streams one or more distributions in such a way that the franking credits attaching to the distribution are received by those members of the entity who derive a greater benefit from them; and other members receive lesser imputation or no imputation benefits.

For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members.

Subsection 204-30(8) of the ITAA 1997 details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member:

(a) is not an Australian resident;

(b) is not entitled to use the tax offset under Division 207;

(c) incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions;

(d) is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e) is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; and

(f) is an exempting entity.

Streaming is not a defined term but the Explanatory Memorandum, to the New Business Tax (Imputation) 2002 at Chapter 3, Paragraph 28 described streaming as 'selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.'

In this case the 'other members' are resident individuals. It is not considered that they would receive less of a benefit from franking credits than the holders of the RPSs.

Therefore, it is not considered that the arrangement in question is dividend streaming to which Division 204-D of the ITAA 1997 applies.

Capital streaming

Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Section 45B of the ITAA 1936 applies where certain capital payments are made to shareholders in substitution for dividends.

The proposed arrangement in question involves the issue of RPSs by Company X. Prior to the issue of the RPSs, the RPS holders were not shareholders of Company X.

It is not considered that either section 45A or 45B of the ITAA 1936 applies to the proposed issue of the RPSs. Section 45 of the ITAA 1936 is also not applicable in this case. Consequently, there are no implications under section 45C or section 45D of the ITAA 1936