Edited version of private advice

Authorisation Number: 1012652825922

Ruling

Subject: Dividend access share arrangement

Question 1

Is the proposed Redeemable Preference Share ('RPS') to be issued an equity interest under Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997) and not a debt interest under Subdivision 974-B of ITAA 1997?

Answer

Yes.

Question 2

Will any capital gain or capital loss made on the proposed conversion of the RPS to ordinary shares be disregarded under section 130-60(3) of the ITAA 1997?

Answer

Yes.

Question 3

Will any payment of fully franked dividends to the holder of the proposed RPS be considered dividend streaming under Subdivision 204-D of the ITAA 1997?

Answer

No.

Question 4

Will section 45A of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed issue of the RPS?

Answer

No.

Question 5

Will section 45B of the ITAA 1936 apply to the proposed issue of the RPS?

Answer

No.

Question 6

Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to the holder of the proposed RPS?

Answer

No.

This ruling applies for the following periods

Year ending 30 June 2014

Year ending 30 June 2015

The scheme commenced on

1 July 2013

Relevant facts and circumstances

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

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 204-30

Income Tax Assessment Act 1997 Subsection 130-60(3)

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 177EA

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 RPS proposed to be issued is a shareholder interest and therefore meets 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 the company pay a dividend on the RPS, there is no obligation for it to do so. The payment of a dividend on the RPS is still contingent on a decision by the company directors.

Although the company may redeem the RPS at any time at its own discretion by repaying the subscription capital, it does not have to do so. Therefore, there is no ENCO to provide a financial benefit with respect to the possible redemption of the RPS.

If the company does not redeem the RPS by the third anniversary of its issue and it converts to ordinary shares, this does not constitute an ENCO to provide a financial benefit. This is because the issue of an equity interest is specifically excluded from constituting the provision of a financial benefit by subsection 974-30(1) of the ITAA 1997.

Conclusion

The RPS proposed to be issued is an equity interest as it is a shareholder interest (and therefore meets the equity test) and is not characterised as a debt interest.

Convertible interest

A convertible interest in a company includes an interest that may convert into an equity interest in the company (item 4 of the table in subsection 974-75(1) of the ITAA 1997). Therefore, the proposed RPS to be issued is a convertible interest.

CGT event C2 happens on the conversion of a convertible interest. However, subsection 130-60(3) of the ITAA 1997 provides that a capital gain or capital loss made from converting a convertible interest is disregarded.

Therefore, any capital gain or capital loss made on the conversion of the RPS to ordinary shares will be disregarded.

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 member' is a resident individual. It is not considered that they would receive less of a benefit from franking credits than the holder of the RPS.

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

Sections 45A and 45B of the ITAA 1936

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 an RPS. Prior to the issue of the RPS, the RPS holder is not a shareholder of HoldCo.

It is not considered that either section 45A or 45B of the ITAA 1936 applies to the proposed issue of the RPS.

Section 177EA of the ITAA 1936

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies where one of the purposes (other than an incidental purpose) of a scheme is to obtain an imputation benefit. In these circumstances, subsection 177EA(5) enables the Commissioner to make a determination with the effect of either:

• imposing franking debits or exempting debits on the distributing entity's franking account; or

• denying the imputation benefit on the distribution that flowed directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

(i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(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.

The 'imputation benefit' is defined to be simply the availability of a tax offset pursuant to Division 207 of the ITAA 1997. (Subsection 177EA(16) of the ITAA 1936).

The 'relevant circumstances' of the scheme are set out in subsection 177EA(17) of the ITAA 1936 in an inclusive manner.

In the event that a distribution was made on the RPS and franking credits were available, that distribution would be franked and the RPS holder would get the benefit of the franking credits.

Having regard to those relevant circumstances in the context of the specific facts of the particular scheme in question, it has been accepted that the 'imputation benefit' would be no more than an incidental benefit of the scheme and it would not be concluded that any person who proposes to enter into the scheme or carry it out, are doing so for more than an incidental purpose of entitling the RPS shareholder to a tax offset.