Edited version of your written advice

Authorisation Number: 1012883574323

Date of advice: 23 September 2015

Ruling

Subject: Part IVA and dividend access share arrangement

Questions and answers

1. Will section 177E of the Income Tax Assessment Act 1936 apply to the dividend access share arrangement?

Yes.

2. Will section 177D if the Income Tax Assessment Act 1936 apply to the dividend access share arrangement?

Yes.

3. Is there a wider scheme identified in the facts and circumstances of the ruling request?

No.

4. Is there a narrower scheme to obtain a tax benefit other than a scheme to divert potential distributions of profits from the original shareholders to their associated entities as rule in question 2?

No.

This ruling applies for the following period

1 July 2015 to 30 June 2016

1 July 2016 to 30 June 2017

1 July 2017 to 30 June 2018

1 July 2018 to 30 June 2019

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1. The arrangement that is the subject of the private ruling is described below. This is based on the following documents and these documents form part of and are to be read with this description except to the extent that these may be contrary to the description below. The relevant documents are:

• the application for private ruling (Application); and

• the annexures of these applications, including statements by the individual rulees and their accountant lodged with the Application.

The description below incorporates a summary of the factual elements from these documents.

Background

Brief History

2. The individual rulees are all children of the deceased.

3. The deceased's parent died when they were X and the deceased took over the business.

4. From an early time, the deceased invested the business profits made in good years in assets outside of the business for use during bad years.

5. The deceased established the Banking Company.

6. The deceased established the Trust. The trustee is Company X

7. The Trust operated the business.

• The Banking Company is a beneficiary of the Trust.

• Profits from the business were distributed to the Banking Company, which held primarily cash and listed shares.

8. In difficult years, Banking Company was used as a bank to fund the operations.

9. The retained profits from the good years were distributed from the Trust to the Banking Company for the purpose of the Banking Company investing in assets in anticipation of future difficult years.

10. The Banking Company was not in the habit of declaring dividends to either the deceased, or following their death, to the children, the individual rulees. Since the establishment of the Banking Company, dividends have only been declared:

• to the deceased, to resolve a Division 7A issue that had arisen for each of the individual rulees; and

• to the individual rulees to meet minimum loan requirements on Division 7A loans put in place after the individual rulees began to carry out their restructure.

11. The equity of the Banking Company consists of:

• fully paid ordinary shares

• fully paid A class share

• fully paid B class share

• Capital profit reserve

• Retained profits

12. The deceased controlled the investment decisions of the company up until their passing.

13. However, in the last years of the deceased's life, they had deferred more and more of the day to day control of the business to the individual rulees, but the deceased remained involved in this business until death.

Existing Business Structure

14. A diagram of the current business structure has been provided with the application. The Trust continues to carry on the business.

15. The shareholding of the Banking Company is divided equally between the individual rulees. The individual rulees, that is the children of the deceased, will also be referred to in this regard as the Original Shareholders.

16. In addition to the shares, each of the rulees also holds other substantial assets in their own names.

17. The Trust carries on its business through these assets.

Reasons for the Restructure

18. The rulees have stated that the restructure has been motivated by two considerations.

• Following the deceased's death, each individual rulee wanted greater control of the business that involved that rulee's asset.

• As part of considering how a restructure could be implemented, the rulees became aware of poor asset protection in the existing structure, where each individual rulee's shares in Banking Company (which was to provide for difficult years in the future) were exposed to claims made against the individual rulees. The rulees wanted to limit the assets that were exposed to claims in the future.

19. Any restructure would need to achieve both objectives.

Risks of claims made against the individual rulee's personally

20. There are risks of accidents occurring. This is inherent in the individual rulees using their asset to allow the Trust to carry on the business.

21. The rulees have attempted to protect against these risks by taking out insurance in relation to their asset;

a. The Trust has taken out insurance on behalf of the owners for the assets, covering:

i. house insurance;

ii. public liability insurance; and

iii. motor vehicle and truck insurance.

b. One individual rulee has insured a new asset acquired to be used in their own business, once the business has separated. However, it may be used to hold Trust assets prior to the business separation.

22. In relation to these risks, the individual rulees could be joined as a party if any accident occurred. The issue would be whether the insurer accepted liability under the respective insurance contract. The rulees are concerned that accidents may occur that are excluded from the respective insurances contracts.

23. A relevant history of Workcover claims has been provided as part of the application and it shows a number of incidents and accidents have occurred.

24. To date, however, no claim has ever been made against the individual rulees personally in relation to any accidents or injuries that have occurred.

25. The individual rulees' insurance companies have always accepted liability for every claim the individual rulees have made in relation to any injuries or accidents that occurred. The only occasion where a claim was rejected was when an employee lodged a fictitious claim with Workcover.

Proposed Structure

26. A diagram of the proposed structure has been provided with the application.

27. Intending to achieve the objectives of:

• dividing the assets of the existing business into new businesses; and

• providing asset protection to the families controlling the New Banking Companies for the new business;

the following steps have/will be taken.

28. Two business trusts have been established for each of the families. One trust will operate the to-be-separated business ('Operating Trust') while the other will hold the assets outside of the business ('Investment Trust'). Copies of the respective trust deeds have been provided with the application.

29. The Banking Company has issued a redeemable preference shares to each of the Operating Trusts and the Investment Trusts.

• The redeemable preference shares are redeemable at any time at the direction of the directors for nil value.

• The redeemable preference shares are automatically redeemed at the end of 47 months after they have been issued.

Terms of the redeemable preference shares have been provided with the application.

30. Each family has established a Family Trust and company (New Banking Companies). For each New Banking Company, 100% of the ordinary shares are held by the new family trust of the respective family. None of the asset owners (or any other individual) holds any shares in the New Banking Companies.

Company constitutions of the New Banking Companies and the family trust deeds for each of the shareholder trusts have been provided with the application.

31. The rulees now propose:

• for the Banking Company to declare and pay partially franked dividends to each of the families' respective Operating Trusts and Investment Trusts under the terms of the redeemable preference shares; and

• distribute the net income those trusts receive, including all of the franking credits, to the New Banking Companies for each of the respective families.

32. After completion of this restructure the Banking Company will be liquidated.

33. The rulees have received advice as to the effectiveness of the structure in relation to asset protection. A copy of the advice has not been provided.

Relevant legislative provisions

Income Tax Assessment Act 1936 subparagraph 44(1)(a)(i)

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 paragraph 177C(1)(a)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 subsection 177D(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 paragraph 177D(2)(b)

Income Tax Assessment Act 1936 subsection 177D(3)

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 subsection 177E(1)

Income Tax Assessment Act 1936 paragraph 177E(1)(a)

Income Tax Assessment Act 1936 subparagraph 177E(1)(a)(i)

Income Tax Assessment Act 1936 subparagraph 177E(1)(a)(ii)

Income Tax Assessment Act 1936 paragraph 177E(1)(b)

Income Tax Assessment Act 1936 paragraph 177E(1)(c)

Income Tax Assessment Act 1936 paragraph 177E(1)(d)

Income Tax Assessment Act 1936 paragraph 177E(1)(e)

Income Tax Assessment Act 1936 paragraph 177E(1)(f)

Income Tax Assessment Act 1936 subsection 177E(1)(g)

Income Tax Assessment Act 1936 paragraph 177E(2)(a)

Income Tax Assessment Act 1936 subsection 177F(1)

Income Tax Assessment Act 1936 paragraph 177F(1)(a)

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Section 207-35

Income Tax Assessment Act 1997 Section 207-45

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 paragraph 207-145(1)(d)

Income Tax Assessment Act 1997 paragraph 207-145(1)(g)

Income Tax Assessment Act 1997 section 207-155

Reasons for decision

Part IVA contains a number of anti-avoidance provisions. It gives the Commissioner the discretion to cancel a 'tax benefit' that, but for the operation of the Part, has been, or would be, obtained by a taxpayer in connection with a scheme to which Part IVA applies (subsection 177F(1) of the Income Tax Assessment Act 1936 (ITAA 1936)).

The Commissioner considers that two anti-avoidance provisions have potential application to the particular facts of this case:

• Section 177E of the ITAA 1936 - Dividend stripping schemes to which Part IVA applies.

• Section 177D of the ITAA 1936 - Schemes to which Part IVA applies.

Section 177E(1) of the ITAA 1936 states:

Where:

(a) as a result of a scheme that is, in relation to a company:

i. a scheme by way of or in the nature of dividend stripping; or

ii. a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

the following provisions have effect:

(e) the scheme shall be taken to be a scheme to which this Part applies;

(f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

(g) the amount of that tax benefit shall be taken to be the notional amount.

177E(1)(a:) as a result of a scheme that is, in relation to a company: (i) a scheme by way of or in the nature of dividend stripping; or (ii)a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping, any property of the company is disposed of

Is there a scheme that satisfies subparagraphs 177E(1)(a)(i) or (ii)?

Scheme is defined in subsection 177A(1) of the ITAA 1936 to mean:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan proposal, action, course of action or course of conduct.

Here, the arrangement at issue (paragraphs 28-31 of the facts) clearly constitutes a scheme as defined in subsection 177A(1) of the ITAA 1936.

In order for the arrangements to be one by way of dividend stripping, the following elements must be established:

(1) a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders;

(2) the sale or allotment of shares in the target company to another party;

(3) the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits;

(4) the purchaser or allottee escaping Australian income tax on the dividend so declared;

(5) the vendor shareholders receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax at the relevant times); and

(6) the scheme being carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company.

The first four elements of a dividend stripping are present here because:

(1) The Banking Company carries substantial undistributed profits which, if distributed, would expose the taxpayers (Original Shareholders) to a potential tax liability;

(2) There is an allotment of redeemable preference shares (RPSs) to the New Shareholders, that is, the trustees of the Investment Trusts and Operating Trusts;

(3) The Banking Company will declare and pay almost fully franked dividends to the New Shareholders out of its accumulated profits;

(4) The Corporate Beneficiaries of the Investment Trusts and Operating Trusts to which the dividends will be appointed by those trusts will not incur any tax liability to the extent to which the dividends are franked. As the dividends will be almost fully franked, the Corporate Beneficiaries will incur little additional tax.

The issue is the fifth element that is whether the vendor shareholders (that is, the Original Shareholders) will receive a capital sum in an amount close to the dividend paid to the New Shareholders.

The issue of whether the vendor shareholders receive anything was discussed by Jessup J in the first instance of Lawrence. Jessup J stated:

In the present case an accretion of capital, the same in effect as such a receipt, arose from the increase in the value of the assets held by the Clearmink No. 1 and No. 2 Trusts, to which the applicant and his family were beneficially entitled. 

Here, as the assets of the Corporate Beneficiaries increase, the shares in the Corporate Beneficiaries will become more valuable. As the Family Trusts own the shares to which the Original Shareholders and their family are beneficially entitled, this accretion to the capital of the Family Trusts would constitute a capital sum being received by the Original Shareholders to compensate them for the Banking Company's profits paid to the New Shareholders. As such, applying the above reasoning of Jessup J, the fifth element is present.

This leaves the last element, namely whether the scheme has, as its dominant purpose, the avoidance of tax on the distribution of dividends by the Banking Company. In considering this element, it is necessary to examine all of the evidence of the arrangement and to consider the relevant objective features of the arrangement to determine whether the arrangement has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits from the Banking Company. Importantly, an arrangement that has a non-tax purpose may be undertaken for the dominant purpose of avoiding tax.

One objective matter relates to the complexity of the arrangement. The most straightforward manner by which the Original Shareholders can establish their own separate business is having the Banking Company pay an in-specie dividend to themselves and transferring the in-specie dividend to their own separate trusts. Given the magnitude of the Banking Company's retained profits, the in-specie dividend would be subject to a rate of tax above the company tax rate, though the Original Shareholders would have the benefit of any available franking credits.

However, after the proposed arrangement is carried out, the accumulated profits of the Banking Company will have been distributed in a complex and contrived manner to entities associated with the Original Shareholders whilst avoiding any additional tax to the Original Shareholders.

In short, the three separate business restructures could arguably be achieved more 'conveniently, commercially and frugally' without the creation of the RPSs. Similarly in Federal Commissioner of Taxation v. Hart [2004] HCA 26 2004 at paragraph 94, Callinan J, in the context of 177D(b)(ii) of the ITAA 1936, noted that it was relevant to consider whether the substance of the transaction in question (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction.

There is also a particular feature of the arrangement which appears to have been included to avoid specific provisions within the income tax legislation. The Scheme contains a requirement that the RPSs must be redeemed within four years, which is a feature inexplicable but for the avoidance of the direct value shifting provisions.

In light of all of the above, with particular reference to the form chosen for the arrangement, it is considered that the arrangement is one that is entered into for a dominant purpose of avoiding the imposition of any additional tax that the Original Shareholders would be subject to if the accumulated profits were distributed to them. As such, the Scheme constitutes a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of the ITAA 1936.

As a result of the scheme, is property of the Company disposed of?

The second element of paragraph 177E(1)(a) of the ITAA 1936 is whether as a result of the arrangement (which is a scheme by way of or in the nature of dividend stripping) any property of the company is disposed of.

Paragraph 177E(2)(a) of the ITAA 1936 states that a reference in subsection 177E(1) of the ITAA 1936 to the disposal of property of a company shall be read as including a payment of a dividend by the company.

As the Banking Company will pay a dividend to the New Shareholders, this second element of paragraph 177E(1)(a) of the ITAA 1936 is satisfied.

It follows that subsection 177E(1) of the ITAA 1936 is satisfied.

177E(1)(b) - in the opinion of the Commissioner, the disposal of the property referred to in paragraph 177E(1)(a) of the ITAA 1936 represents, in whole or in part, a distribution (whether to a shareholder or another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period)

The relevant disposal of property under the arrangement is the payment of a dividend by the Banking Company to the New Shareholders. This shows that the disposal represents a distribution of profits of the Banking Company. As such, this condition is met.

177E(1)(c): if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income

Here, if, immediately prior to the execution of the Scheme, the Banking Company paid a dividend out of profits equal to the amount of dividend to be paid to the New Shareholders, that dividend would have been paid to the Original Shareholders, and would have been included in their assessable income by virtue of subparagraph 44(1)(a)(i) of the ITAA 1936. As such, the notional amount for the purpose of subsection 177E(1) of the ITAA 1936 is the amount of the dividend to be paid to the New Shareholders.

Therefore, paragraph 177E(1)(c) of the ITAA 1936 is satisfied.

177E(1)(d): The scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia

The final requirement that the scheme be carried out after 27 May 1981 is clearly satisfied.

The arguments for the taxpayers

The applicant has put forward a number of arguments.

The first is that a need has arisen, following the death of the deceased, to distribute the accumulated profits of the Banking Company among its shareholders (the individual rulees) so that they can establish their own separate businesses. Secondly, it is necessary for the various trusts, not the Original Shareholders, to own the assets to be distributed by the Banking Company for asset protection purposes. It has been claimed these two reasons show the commercial and non-tax driven purpose of the arrangements.

It is true that there has been a triggering event - the deceased's death - that necessitates the commercial reorganisation of the business structure left behind by the deceased. However, as already discussed, these arguments for the individual rulees are not considered persuasive as the reorganisation can be achieved more conveniently, commercially and frugally without the creation of the RPSs.

The individual rulees also state that further tax will be payable on the appointment by the Investment Trusts and Operating Trusts of the dividend to the Corporate Beneficiaries as the dividend will not be completely fully franked. However, further tax is also payable under the more straightforward method of separating the business where a dividend is paid by the Banking Company to the Original Shareholders.

Therefore, it is not accepted that additional tax is payable on choosing the Scheme over the more straightforward method to achieve a restructure.

The main submission provided by the applicant is that the asset protection purposes cannot be achieved by any arrangement that does not involve the use of dividend access shares as any other arrangement would be subject to the claw back provisions under the Bankruptcy Act 1966. Therefore, it is stated that the arrangement is chosen to achieve the two commercial purposes, and thus not for a purpose of avoiding tax.

Before examining whether the arrangement would avoid the application of the clawback provisions, we need to determine whether the litigation risk does exist. If there is no such risk, the clawback provisions would not apply.

The rulees have made an assertion that the business is dangerous and there is a real risk that they can be personally sued for accidents and injuries.

It is accepted that the history of Workcover claims does show a number of incidents and injuries have occurred at the business. However, that does not necessary mean that the individual rulees are personally exposed to the litigation risks.

What the history of Workcover claims shows is that the rulees are adequately protected from the litigation risks. The rulees state:

'[o]ur insurance has accepted liability for each claim to date'.

There is no evidence of the individual rulees ever having been sued or threatened with proceedings in relation to the accidents or injuries. On the contrary, the individual rulees state:

'[w]e have been fortunate not to have a claim made against us personally'.

An individual rulee states:

'I am concerned that, with increasing litigation, and gaps and exclusion in our insurance policies, the chance of a claim being made against us personally will increase'.

The other individual rulees have made an identical statement. The litigation risk by the rulees is perceived and not real. In the absence of any personal proceedings brought against the rulees or claims being rejected by Workcover, it cannot be said that a real risk exists.

Therefore, it is not accepted that the applicant has provided a sufficient evidential basis to substantiate their claim. This conclusion is consistent with the conclusion reached in recent decisions dealing with 'asset protection' claims. As was stated in Track, in rejecting an asset protection claim, there was no satisfactory explanation of the nature of any potential risk, but more importantly 'any satisfactory reason why insurance against such a risk was not available or adequate'.

Accordingly, as the applicant has not established the existence of the risk, there is no need to consider the clawback provisions of the Bankruptcy Act 1966. Had it been necessary to do so, however, this would have been difficult to consider based on the lack of detailed submissions put forward on the matter.

The purpose of dividing the assets of the business can be achieved more conveniently, commercially and frugally by an arrangement that does not involve the dividend access shares. Furthermore, as discussed, the applicant has not substantiated the existence of the litigation risk.

Consequently, the arrangement is entered into for a dominant purpose of avoiding tax and therefore section 177E of the ITAA 1936 applies.

Conclusion on section 177E of the ITAA 1936

Because all the criteria in paragraphs 177E(1)(a) to (d) of the ITAA 1936 are satisfied, in accordance with paragraphs 177E(1)(e), (f) and (g) of the ITAA 1936:

• the arrangement is a scheme to which Part IVA applies;

• for the purposes of section 177F of the ITAA 1936, the taxpayer (that is, the Original Shareholders) is taken to have obtained a tax benefit in connection with the arrangement; and

• the amount of that tax benefit is taken to be the notional amount referred to in paragraph 177E(1)(c) of the ITAA 1936.

In this case, where a dividend is paid out of the accumulated profits of the Banking Company to the New Shareholders, the Commissioner would exercise his discretion to make a determination under paragraph 177F(1)(a) of the ITAA 1936 to include in each of the Original Shareholders' assessable income the 'tax benefit' being their share of the dividend.

This conclusion is consistent with Taxation Determination TD 2014/1 which provides the Commissioner's view as to the application of section 177E of the ITAA 1936 to 'dividend access share' arrangements.

Further issues for you to consider

It should be noted that section 207-145 of the ITAA 1997 modifies the normal gross up and tax offset entitlement treatment afforded by sections 207-20, 207-35 and 207-45 of the ITAA 1997 in respect of the receipt of a franked distribution in certain circumstances. One of these circumstances, as provided in paragraph 207-145(1)(d) of the ITAA 1997, is when a franked distribution is made as part of a 'dividend stripping operation'. This term is defined in section 207-155 of the ITAA 1997 in similar terms to section 177E of the ITAA 1936. Given the conclusion reached in respect of the application of 177E of the ITAA 1936, it is considered that the above arrangement would constitute a dividend stripping operation for the purposes of paragraph 207-145(1)(d) of the ITAA 1997. This would have the effect of the non-inclusion of any franking credit amount attached to the franked distribution made as part of the arrangement in the assessable income of the corporate beneficiaries of the New Shareholders, as well as the denial of any tax offset entitlement to those corporate beneficiaries in respect to the distribution which flows indirectly through the New Shareholders to them, per the operation of paragraph 207-145(1)(g) of the ITAA 1997.

Section 177D of the ITAA 1936

Subsection 177D(1) of the ITAA 1936 states;

This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) 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 the purpose of:

(a) enabling a taxpayer (a relevant taxpayer) to obtain a tax benefit in connection with the scheme; or

(b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme;

whether or not that person who entered into or carried out the scheme or

any part of the scheme is the relevant taxpayer or is the other taxpayer or

one of the other taxpayers.

Subsection 177D(2) of the ITAA 1936 provides;

For the purpose of subsection (1), have regard to the following matters:

(a) the manner in which the scheme was entered into or carried out;

(b) the form and substance of the scheme;

(c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Subsection 177D(3) of the ITAA 1936 states;

Despite subsection (1), this Part applies to the scheme only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme.

The arrangement as described above, at paragraph 28 to 31 of the facts constitutes a scheme for the purposes of 177D of the ITAA 1936.

As shown in subsection 177D(1) of the ITAA 1936, the first question to be answered when determining whether section 177D of the ITAA 1936 applies to an arrangement is to ask whether a participant in the arrangement had the requisite purpose of securing a tax benefit for the taxpayer in connection with the scheme. Therefore, it is necessary to decide whether the rulees entered into or carried out the arrangement for the purpose (or the dominant purpose) of enabling themselves to obtain a tax benefit in connection with the arrangement. The purpose is to be ascertained by having regard to the eight matters listed in subsection 177D(2) of the ITAA 1936.

The rulees stated that the sole or dominant purpose of entering into the arrangement was to achieve the commercial objectives of: dividing the assets of the existing business into separate businesses; and providing asset protection to the rulees.

However, as already discussed in relation to section 177E of the ITAA 1936, it is not accepted that the rulees have established the existence of the litigation risk and therefore it cannot be accepted that there is a need to protect the assets. Therefore, the only commercial objective that can be achieved by the arrangement is dividing the assets of the existing business.

It is accepted that the arrangement does achieve the commercial purpose of dividing the assets of the existing business. However, it is possible for an arrangement to be both tax-driven and commercial. As such, the presence of a discernible commercial end does not determine the answer to the question posed by section 177D of the ITAA 1936 and, therefore, 'it becomes apparent that the inquiry directed by Pt IVA requires comparison between the arrangement in question and an alternative postulate'. In other words, 'to draw a conclusion about purpose from the eight matters identified in subsection 177D(2)(b) of the ITAA 1936 will require consideration of what other possibilities existed'.

Therefore, it is necessary to determine whether there exists an alternative postulate that achieves the commercial objective in a more convenient, commercial and frugal way. In the present case, if the arrangement is not entered into, it might be reasonably expected that the rulees, to achieve the commercial purpose, would personally receive dividends from the Banking Company and transfer the assets represented by the dividends to their associated entities. This would result in the dividends being included in the assessable income of the individual rulees.

This alternative postulate, having particular regard to the substance of the arrangement and its results and consequences for the rulees, is a reasonable alternative to entering into the arrangement despite the incurrence of tax liability on the basis that the commercial need to separate the control of each business means that is not feasible to continue with existing corporate structure.

The eight matters in subsection 177D(2) of the ITAA 1936 are considered against the background of this alternative postulate.

Eight matters in subsection 177D(2)

(a) the manner in which the scheme was entered into or carried out

The most straightforward and commercial manner by which the individual rulees can establish their own separate business is having the Banking Company pay a dividend to themselves and transferring the dividend to their own separate trusts. Given the magnitude of the Company's retained profits, the dividend would be subject to a rate of tax above the company tax rate, though the individual rulees would have the benefit of any available franking credits.

However, under the arrangement, the rulees will have the Banking Company issue the redeemable preference shares to entities associated with them for a nominal consideration. These associated entities will receive a large amount of dividend notwithstanding that the only consideration they provided for the redeemable preference shares is nominal. This is highly artificial and contrived, and would not normally be present in a commercial transaction. Because of this highly artificial and contrived part of the arrangement, the accumulated profits of the Banking Company will have been distributed in a complex and contrived manner to entities associated with the rulees whilst avoiding any additional tax to the individual rulees. In short, the separate business restructures could arguably be achieved more conveniently, commercially and frugally without the creation of the redeemable preference shares.

There is also a particular feature of the arrangement which appears to have been included to avoid specific provisions within the income tax legislation. The arrangement contains a condition that the redeemable preference shares will be automatically redeemed at the end of 47 months after they have been issued, which is a feature inexplicable but for the avoidance of the direct value shifting provisions.

Therefore, this factor highly suggests there is a dominant purpose of obtaining tax benefit.

(b) the form and substance of the scheme

The form of the Scheme is an arrangement that divides the assets of the Banking Company into separate businesses. However, the substance of the Scheme is an arrangement to achieve the commercial purpose in a manner that avoids tax. The part of the arrangement that involves the issuance of the redeemable preference share has no explanation other than the purpose of obtaining a tax benefit.

This artificial manner in which the accumulated profits of the Banking Company are distributed is a feature that separates form from substance. Therefore, this factor also highly suggests there is a dominant purpose of obtaining a tax benefit.

(c) the time at which the scheme is entered into, and the length of the period during which it is carried out

The arrangement is to be entered into because of the death of the deceased. Since their death, a need has arisen to separate the business structure they created so that each business will be separately owned by the individual rulees. Therefore, there clearly exists a non-tax related event that triggers the arrangement.

However, the arrangement contains a condition that the RPS must be redeemed within four years, which is a feature inexplicable but for the avoidance of the direct value shifting provisions. Therefore, this part of the arrangement suggests there is a purpose of obtaining a tax benefit.

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

The arrangement allows the Banking Company to distribute its accumulated profits to the individual rulees' associated entities, instead of its shareholders (i.e. the individual rulees), in a complex and contrived manner whilst avoiding any additional tax to the individual rulees. As the individual rulees would be required to pay tax if the accumulated profits are distributed in a most conventional and commercial manner, this factor also shows there is a dominant purpose of avoiding tax.

(e) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

The arrangement will achieve the commercial purpose, which is that the accumulated profits of the Banking Company will be relocated to the separate family trusts of the individual rulees. As this non-tax related result is achieved, this factor indicates there is no dominant purpose of avoiding a tax benefit.

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has result, will result or may reasonably be expected to result, from the scheme

As a result of the arrangement, the individual rulees' family trusts will own shares in the New Banking Companies to which the accumulated profits of the Banking Company will be relocated. This does achieve the commercial purpose and therefore shows the dominant purpose of entering into the arrangement is not tax-related.

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out

There is no other consequence.

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred in in paragraph (f)

Each individual rulee will be a director of the New Banking Company, which will be owned by each of the family trusts. Each individual rulee will be a discretionary beneficiary of the family trust. These connections show the desire of the rulees to relocate the accumulated profits of the Banking Company into three separate entities, each of which is respectively associated with each of the individual rulees. Therefore, this nature of connection shows the desire of the rulees to liberate the accumulated profits in the Banking Company into the associated entities without paying any additional tax. This shows there is a dominant purpose of obtaining a tax benefit.

Conclusion as to the dominant purpose

Having regard to the eight matters, it can be concluded that the dominant purpose of the arrangement is to obtain a tax benefit.

Tax benefit

The term 'tax benefit' is explained in section 177C of the ITAA 1936, which includes;

an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out.

In the present case, if the arrangement is not entered into, it might be reasonably expected that the rulees, to achieve the commercial purpose, would personally receive dividends from the Banking Company and transfer the dividends to their associated entities. This would result in the dividend being included in the assessable income of the individual rulees. As already discussed, this alternative postulate, having particular regard to the substance of the arrangement and its results and consequences for the individual rulees, is a reasonable alternative to entering into the arrangement.

As such, if the arrangement is not entered into, an amount not being included in the assessable income of the individual rulees might reasonably be expected to be included in their assessable income. This satisfies the definition of a tax benefit in paragraph 177C(1)(a) of the ITAA 1936.

Conclusion

Part IVA applies to the arrangement under section 177D of the ITAA 1936.

Is there a wider scheme identified in the facts and circumstances of the ruling request?

No. The Commissioner has not identified a wider scheme on the relevant fact and circumstances set out in the ruling request

Is there a narrower scheme to obtain a tax benefit other than a scheme to divert potential distributions of profits from the original shareholders to their associated entities as ruled in question 2?

No. The Commissioner has not identified a narrower scheme to obtain a tax benefit other than the scheme to direct potential distributions of profits from the original shareholders to their associated entities as ruled in question 2.