Edited version of your written advice

Authorisation Number: 1012859902044

Date of advice: 8 September 2015

Ruling

Subject: Business reorganisation - Part IVA

Question 1

Will the Commissioner exercise his power and make a determination pursuant to paragraph 177F(1)(a) of the Income Tax Assessment Act 1936 to cancel the whole or part of any tax benefits of a kind referred under paragraph 177C(1)(a) obtained, or that would but for paragraph 177F(1)(a) be obtained, by AusCo Ltd in connection with ForeignCo Ltd's export sales of Products X and Y that are manufactured by SubsidiaryCo Ltd?

Answer

No.

The scheme commences on:

Implementation Date

Relevant facts and circumstances

1. AusCo Ltd (AusCo) is an Australian resident head entity of an income tax consolidated group (AusCo TCG) and is also the ultimate holding company of a global group of companies (AusCo group).

2. The AusCo group started an initiative some time ago to improve its global operations and management. Among other things, the initiative involved the establishment of an offshore related entity, ForeignCo Ltd (ForeignCo).

3. Currently, the AusCo TCG manufactures numerous products in Australia including Products X and Y for sale and distribution domestically and overseas. These two products are manufactured in Australia by a member of the AusCo TCG, SubsidiaryCo Ltd (SubsidiaryCo).

4. As part of implementing the initiative in Australia, new manufacturing and distribution models will be introduced for Products X and Y.

5. The new manufacturing and distribution models for Products X and Y will involve entering into the relevant legal framework such as agreements and the transfers of trading stock and finished goods, on or before the proposed Implementation Date.

6. Therefore, under the new manufacturing and distribution models ForeignCo will have ownership of the finished Products X and Y goods which SubsidiaryCo will manufacture on behalf of ForeignCo for a fee.

7. Under the new manufacturing and distribution models for Products X and Y there will be corresponding changes to its supply chain; movement of staff to ForeignCo; expected commercial benefits; forecast export sales; and reduction in Earnings Before Interest and Tax (EBIT) and in Australian income tax payable.

8. ForeignCo will undertake all export sales of Products X and Y outside the Australian market by supplying the products to non-Australian AusCo group entities which will distribute it in their domestic markets.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177CB

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 Part X

Income Tax Assessment Act 1936 section 447

Income Tax Assessment Act 1997 section 6-5

Reasons for decision

All legislative references in the Reasons for decision are to the Income Tax Assessment Act 1936 unless otherwise stated.

Question 1

Summary

The Commissioner will not make a determination under paragraph 177F(1)(a) to cancel the whole or part of any tax benefit of a kind referred under paragraph 177C(1)(a) obtained, or that would but for paragraph 177F(1)(a) be obtained, by AusCo Ltd in connection with ForeignCo's export sales of Products X and Y that are manufactured by SubsidiaryCo?

Detailed reasoning

1. Part IVA applies to a scheme, or any part of a scheme, entered into or carried out by a person for the dominant purpose of enabling a taxpayer to obtain a tax benefit in connection with the scheme. If Part IVA applies to a scheme, the Commissioner can make a determination under section 177F to cancel the tax benefit obtained under the scheme.

The Scheme

2. The relevant identified scheme is the move by SubsidiaryCo, as a member of the AusCo TCG, from the previous manufacturing and distribution models to new manufacturing (on behalf of ForeignCo) and distribution models in respect of Products X and Y.

3. The steps involved in the scheme include entry into the relevant legal framework such as agreements and the transfers of trading stock and finished goods, on or before the proposed Implementation Date.

4. The scheme also includes the expected changes to the supply chain processes relevant for the manufacture and distribution of Products X and Y; anticipated staff movement; achievement of forecast financial benefits and export sales; and corresponding reductions in EBIT and Australian income tax payable.

The Tax Benefit

5. Broadly, subsection 177C(1) provides that a tax benefit exists for the purposes of Part IVA where it would, or might reasonably be expected that, an amount would be included in assessable income; a deduction would not be allowable; a capital loss would not be incurred; or a foreign tax credit would not be allowable; to the taxpayer in a year of income, if the scheme had not been entered into or carried out.

6. Subsection 177D(3) provides that Part IVA only applies to the scheme if the relevant taxpayer has obtained or would obtain a tax benefit in connection with the scheme.

7. The relevant enquiry in determining the tax benefit would therefore be the difference between what would be AusCo Ltd's assessable income under the scheme entered into or carried out and what would be, or might reasonably be expected to be, AusCo Ltd's assessable income if the scheme had not been entered into or carried out.

8. Section 177CB refers to two bases upon which the existence of tax benefits can be established, the 'would have' and the 'might reasonably be expected to have' approaches.

9. The first approach, otherwise known as the annihilation or 'would have' approach, is that if the scheme had not been entered into or carried out what 'would have' been the tax outcome for AusCo Ltd.

10. Under this approach, the postulate is not to proceed with the implementation of the initiative in Australia that relates specifically to the move to the new manufacturing and distribution models for Products X and Y.

11. Annihilating the scheme identifies tax benefits for AusCo Ltd (as head company of the AusCo TCG) in relation to ForeignCo's export sales to non-Australian markets of Products X and Y that will be manufactured by SubsidiaryCo for a fee under the scheme.

12. Specifically, the tax benefits for the relevant income years will arise from a reduction in AusCo Ltd's assessable income as a result of the scheme, being:

• amounts of export sales that would, if the scheme was not entered into or carried out, be assessable to AusCo Ltd under section 6-5 of Income Tax Assessment Act 1997 (ITAA 1997) as AusCo Ltd, or a member of the AusCo TCG, would have held the title to these finished products and accordingly, AusCo Ltd would have treated these as its assessable export sales,

less:

• amounts of manufacturing fees that would be assessable to AusCo Ltd under section 6-5 of the ITAA 1997 because SubsidiaryCo will receive fees from ForeignCo for manufacturing the Products X and Y for export by ForeignCo.

13. Therefore, under the annihilation approach the tax benefits in connection with the scheme for the relevant income years will be the estimated overall reduction in AusCo Ltd's Australian assessable income.

14. The export sales are considered not assessable by AusCo Ltd under the scheme based on the application of the Controlled Foreign Companies (CFC) rules in Part X.

15. A decision that a tax effect 'might reasonably be expected to have' occurred if a scheme had not been entered into or carried out must be made on the basis of a postulate that is a reasonable alternative to the scheme, having particular regard to the substance of the scheme and its results and consequences for the taxpayer, and disregarding any potential tax results and consequences.

16. Given there are substantial commercial benefits expected under the scheme, it would be reasonable to expect these commercial benefits would also be sought under an alternative scheme. An alternative approach might be that SubsidiaryCo would transition into different manufacturing or distribution models for Products X and Y. However, it is difficult to predict what each of these might be.

17. In this case, a reconstruction approach is more difficult to speculate with reasonable certainty.

18. Therefore for the relevant income years the estimated tax benefits that would be obtained by AusCo Ltd in connection with the scheme is determined by comparing the change in assessable income for AusCo Ltd under the alternative postulate of annihilating the scheme.

The applicable purpose test

19. In determining objectively whether the sole or dominant purpose in entering into the scheme is to obtain (or would but for section 177(F)) a tax benefit, regard must be had to the eight matters outlined in subsection 177D(2).

Manner, substance & timing of the scheme and nature of connection of entities in the scheme

20. The first three matters in paragraphs 177D(2) (a), (b) and (c) direct us to examine how the scheme is to be carried out; to focus our attention on the commercial and economic substance of the scheme; and to consider whether timing aspects of the scheme achieve a beneficial tax outcome.

21. Paragraph 177D(2)(h) enquires into the nature of the connection of the relevant taxpayer or any other person in connection with the scheme, and along with the above three matters, consider how the scheme achieves its effect to determine whether the taxpayer had the requisite purpose.

22. The relevant scheme involves the move by SubsidiaryCo from the current manufacturing and distribution models to new manufacturing and distribution models for Products X and Y operations. The move forms part of the broader implementation of an initiative in Australia involving other products which also follow the rollout in other regions.

23. The scheme requires entry into the relevant legal framework such agreements and the transfers of trading stock and finished goods, on or before the proposed Implementation Date.

24. The legal framework is necessary to facilitate transactional and operational efficiency and has implications for related AusCo group companies such as SubsidiaryCo, ForeignCo and foreign AusCo group entities which then affect numerous aspects of the supply chain of Products X and Y.

25. The title and ownership to all manufacturing input and output of Products X and Y operations will now be held by ForeignCo instead of SubsidiaryCo as a result of the legal framework. As a consequence of the above, inventory and capacity risks are moved away from SubsidiaryCo.

26. The scheme also includes relocating a number of employees offshore, in addition to the substantial number already employed there. This reflects the shift away from Australia of certain functions, risks and assets as a result of the new manufacturing and distribution models for products currently manufactured in Australia, inclusive of Products X and Y.

27. The timing of the scheme is consistent with the wider planned implementation of an initiative in Australia involving other products. This is also aligned with a long period of transition of the AusCo group into a more centralised and co-located hub for regional activities offshore.

28. Together, all these factors do not indicate any contrivance or artificiality in respect of the scheme. Furthermore, there is no discrepancy when comparing the intended manner in which the scheme is to be implemented and the desired practical outcome expected from the scheme.

29. Rather, the matters discussed reflect the commercial narrative taking place within the AusCo group concerning the proposed centralisation and co-location offshore of numerous aspects of the supply chain of products currently manufactured in Australia, inclusive of, but not limited to, Products X and Y.

Non-tax consequences as a result of the scheme

30. The other three matters in paragraphs 177D(2)(e), (f) and (g) focus on the legal, financial and other non-tax consequences for AusCo Ltd and related entities as a result of the scheme. These factors direct an inquiry into the practical non-tax outcomes to assess whether the sole or dominant purpose of AusCo Ltd in entering into the scheme is to obtain a tax benefit.

31. The changes to the ownership of assets, functions performed and risks borne by SubsidiaryCo, ForeignCo and relevant foreign AusCo group entities, reflect the legal framework of the scheme which involves, among other things, entry into long term agreements; assignment & novation of relevant contracts; the issuing of legal notices; and title transfers of trading stock, input and finished products.

32. These changes are necessary features of the scheme in order to achieve the expected economic and financial gains for the AusCo group not only in respect of the move to new manufacturing and distribution models for the Products X and Y in Australia but also from the broader implementation of an initiative in Australia and other regions.

33. Specifically, the gains are expected to arise from improvements in four key areas - customer, supply chain, manufacture and inventory level - which are also anticipated to enhance the AusCo group's profit and loss and working capital.

34. Whilst the non-tax outcomes specific to AusCo Ltd or the AusCo TCG in relation the scheme cannot yet be ascertained by AusCo Ltd, the AusCo group anticipates that there will be financial benefits from the global implementation of the initiative.

35. The AusCo group also anticipates that a part of the financial benefits from the global implementation of the initiative will be attributable to the worldwide manufacturing model itself. Furthermore, it is estimated that there will also be financial benefits attributable to the manufacturing model aspect of the initiative's implementation in Australia. This financial benefit is inclusive of, but not limited to, the Products X and Y operations under the scheme, that is, it also relates to the other manufactured operations as part of the initiative in Australia.

36. There are also global annual benefits attributable to operating efficiency achieved from the new manufacturing model; a portion of which will be attributable to the Australian operations.

37. Together these anticipated non-tax consequences and the previous matters in subsection 177D(2) discussed earlier indicate that the scheme is reasonably expected to result in practical changes in the overall financial, legal and economic position of AusCo Ltd, the AusCo TCG and members of the AusCo group.

Tax consequences as a result of the scheme

38. The final matter to be discussed in subsection 177D(2) requires consideration of the tax consequences that would be achieved by the scheme in evaluating whether AusCo Ltd has the sole or dominant purpose in entering into scheme of obtaining the tax benefits (paragraph 177D(2)(d)).

39. The estimated tax benefits for AusCo Ltd in entering into the scheme represent the amount not included in assessable income in each income year as a result of entering into or carrying out the scheme.

40. There will also be a net tax result under the scheme that would be obtained by AusCo Ltd, representing the overall reduction in its Australian income tax payable in contrast with its Australian income tax payable absent the scheme.

41. Finally, there will be financial benefits worldwide from the initiative, including the new manufacturing and distribution models for the relevant income years.

42. The estimated global financial benefits of the initiative are quite significant when compared with the estimated reduction in Australian income tax payable for the relevant income years under the scheme. Whilst the reduction will exceed the estimated annual financial benefits from the new manufacturing model from the implementation of the initiative in Australia (which the scheme is part of), the difference is not excessive and the claimed qualitative benefits of the scheme are not insubstantial.

Conclusion

43. Having regard to the eight matters in subsection 177D(2), we conclude that AusCo Ltd does not have a sole or dominant purpose in entering into the scheme of obtaining a tax benefit. Rather, the scheme is proposed to be entered into as part of the global reorganisation taking place within the AusCo group in order to achieve practical outcomes which have a commercial basis.

44. Accordingly, the Commissioner will not exercise his power to make a determination pursuant to paragraph 177F(1)(a).