Edited version of your written advice

Authorisation Number: 1012925395384

Date of advice: 17 December 2015

Ruling

Subject: Proposed transaction involving the sale of shares in a private company

Question 1

Is the Taxpayer considered to be a CGT concession stakeholder as described in section 152-60 of the Income Tax Assessment Act 1997 (ITAA 97)?

Answer

Yes

Question 2

If the Taxpayer is not considered to be a CGT concession stakeholder as per Question 1, will the Taxpayer be considered to be a CGT concession stakeholder as described in section 152-60 of the ITAA 97 if his Dividend E class shares in the Company are cancelled before the disposal of his ordinary shares in the Company?

Answer

This Question is not applicable as the taxpayer is considered to be a CGT concession stakeholder pursuant to section 152-60 of the ITAA 97 (as per Question 1)

Question 3

Is the scheme, as proposed to be implemented, a scheme to which section 177D of Part IVA of the Income Tax Assessment Act 1936 (ITAA 36) applies?

Answer

No

Question 4

Is the scheme, as proposed to be implemented, considered to be a dividend stripping scheme to which section 177E of the ITAA 36 applies?

Answer

No

Question 5

Is the scheme, as proposed to be implemented, considered to constitute a dividend stripping operation for the purposes of section 207-145 of the ITAA 97?

Answer

No

Question 6

If the answer to either Question 3, 4 or 5 is yes, would the answer to each Question be the same if, prior to implementing the proposed scheme, the Company declared and paid a dividend to the Taxpayer of an amount at least equal to the Company's loan to the trustee for an associated Family Trust?

Answer

This Question is not applicable as the answer to Questions 3, 4 and 5 is 'no'

This ruling applies for the following period:

1 July 2015 to 30 June 2016

The scheme commences on:

The scheme is yet to commence

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.

The Taxpayer is the sole director and shareholder of the Company which operates an advertising agency and employs five people (including the Taxpayer).

The Company was incorporated in 19XX and the share capital comprises ordinary shares and Dividend E class shares. The Taxpayer owns Z% of the shares, the cost base of which is $X,XXX for the ordinary shares and $X,XXX for the Dividend E class shares.

The Dividend E class shares have no right to vote and no entitlement to income or capital of the Company. The Dividend E class shares were initially held by the Taxpayer's ex-spouse before being transferred to the Taxpayer after the couple divorced. The Dividend E class shares have no current purpose and can (according to the Taxpayer) be cancelled if necessary.

The Company paid dividends in respect of the ordinary shares to the Taxpayer in the 20UU, 20VV and 20WW financial years.

In addition to the Company, the Taxpayer also controls the following entities:

• a trustee company which acts as the trustee for an associated family trust (the Family Trust) and an associated unit trust (the Unit Trust). The Taxpayer is the sole director and shareholder of this company.

• the Family Trust. The Taxpayer is the principal beneficiary of this trust which owns Z% of the units in the Unit Trust and Z% of the shares in company A. The Family Trust does not have tax losses available and does not expect to have losses in the future.

• the Unit Trust which owns the commercial property from which the Company operates.

• company A. The Taxpayer is the sole director of this company which previously operated an unrelated business before ceasing. There are no assets or liabilities in this company.

The potential beneficiaries of the Family Trust per the trust deed of that trust are quite wide ranging. However, the actual beneficiaries are the Taxpayer (as primary beneficiary) and his/her children (as secondary beneficiaries). In each of the 20UU, 20VV and 20WW financial years, the taxpayer's children each received a $XXX distribution while the Taxpayer received the balance. The trust deed to the Family Trust also cites the Taxpayer's spouse as a primary beneficiary. The Taxpayer's ex-spouse will not receive distributions from the Family Trust.

The actual beneficiaries of the Family Trust are all Australian residents for tax purposes.

Other matters

The Taxpayer has advised that the Company has maintained a Y% active asset to total asset ratio for over 7.5 years.

The Taxpayer has also advised that they have estimated a maximum total net asset value of less than $6,000,000 for the Taxpayer and entities related to the Taxpayer.

The Taxpayer has also advised that he/she intends to expand the Company's business in the near future and that may involve:

• the acquisition of one or more similar advertising agencies, and/or

• bringing in a general manager who would take over much of the Taxpayer's current workload to allow the Taxpayer to focus on expanding the client base.

It is considered that a new general manager would more than likely be required to buy into the business and become a part shareholder.

The Taxpayer has advised that the Company would not issue any new class of shares to any potential new shareholders. Similarly, company A will not issue any new class of shares to any potential new shareholders.

Overview of the scheme

The steps to implement the proposed scheme are as follows:

1. The Taxpayer will obtain an independent valuation of his/hers shares in the Company.

2. The Taxpayer will transfer Z% of his/hers shares in the Company to company A.

3. Company A will fund the purchase of the Taxpayer's shares via a combination of external finance and a loan from the Taxpayer on commercial terms.

4. The Taxpayer will apply the general 50% capital gains tax discount to his/hers resulting capital gain (as the shares are held for over 12 months).

5. The Taxpayer will apply the small business 50% reduction to reduce the remaining capital gain by a further 50%.

6. With the remaining capital gain (25% of the gross capital), the Taxpayer (who is over 55 years of age) will contribute the equivalent amount into his/hers superannuation and apply the small business retirement exemption.

It is not expected that any franked distributions from the Company to company A would be satisfied by any means other than a cash transfer.

The Family Trust intends to continue making distributions as it has in the past with the Taxpayer's children being paid a small sum (up to $XXX each) and the Taxpayer being paid the balance. The Taxpayer's children may receive more substantial distributions in the future once they reach a suitable age and depending on other factors such as their involvement in the business, their relationship status, their costs of education and how responsible they are with money.

Objective of the scheme

The Taxpayer's primary objective is to ensure that the shares in the Company are held for the ultimate benefit of his/hers two children. A succession plan has been established for his/hers two children (aged 15 and 14 years of age) to take control of the Family Trust upon the Taxpayer's death.

As company A is fully owned by the Family Trust, the transfer of the Taxpayer's shares in the Company to company A will ultimately be effectively owned by the Family Trust and therefore preserved for the benefit of the Taxpayer's children.

As a secondary objective, company A would be utilised as a holding company whereby it would hold significant assets of the Company's business. These assets would be protected in the event the Company is ever involved in a legal dispute. Further, the proposed structure is considered to be more attractive to any potential future investor.

Relevant legislative provisions

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177D

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1997 Section 152-55

Income Tax Assessment Act 1997 Section 152-60

Income Tax Assessment Act 1997 Section 152-65

Income Tax Assessment Act 1997 Section 152-70

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-155

Reasons for decision

Question 1

An individual is a CGT concession stakeholder of a company or trust at a time if they are a significant individual in the company or trust (paragraph 152-60(a) of the ITAA 97).

An individual is a significant individual in a company or trust at a time if they have a small business participation percentage in the company or trust of at least 20% (section 152-55 of the ITAA 97).

An entity's small business participation percentage in another entity at a time is the percentage that is the sum of:

i. the entity's direct small business participation percentage in the other entity at that time, and

ii. the entity's indirect small business participation percentage in the other entity at that time (section 152-65 of the ITAA 97).

The Taxpayer has advised that they are the sole director and shareholder of the Company. As such, the Taxpayer's direct small business participation percentage in the Company is Z% (pursuant to subsection 152-70(1) of the ITAA 97), and they are a significant individual in the Company.

Question 3

Part IVA of ITAA 36 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded (pursuant to section 177D of the ITAA 36) that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA of the ITAA 36 applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable or by including an amount in assessable income that was otherwise not included.

In this case, the scheme (as proposed) is not being implemented for the dominant purpose of obtaining a tax benefit. Therefore, section 177D of Part IVA of the ITAA 36 will not apply.

Question 4

Section 177E of the ITAA 36 applies to dividend stripping schemes, or schemes with substantially the same effect as a dividend stripping scheme. It applies where:

• as a result of a dividend stripping scheme, any property of the company is disposed of

• the Commissioner is of the opinion that the disposal of the property represents, wholly or in part, a distribution of profits (whether of the current, a past or a future accounting period) of the company, and

• if the profits represented by the disposal of the property had been paid as a dividend immediately before the scheme was entered into, it would be reasonable to expect that this would result in an amount (the 'notional amount') being included in a taxpayer's assessable income.

For these purposes, subsection 177E(2) of the ITAA 36 provides that a disposal of property of a company includes the payment of a dividend or the making of a loan by the company (whether or not it is intended that the loan will be repaid).

Where these conditions are met, the scheme is taken to be a scheme to which Part IVA of the ITAA 36 applies. The taxpayer who would have been assessed is taken to have obtained a tax benefit that is referable to the notional amount not being included in their assessable income.

In FCT v Consolidated Press Holdings Ltd & Anor; CPH Property Pty Ltd v FCT 2001 ATC 4343, the High Court considered the common characteristics of a dividend stripping scheme for the purposes of section 177E of the ITAA 36. At page 4365, the High Court referred, with approval, to the decision by the Full Federal Court which identified the main characteristics of a dividend stripping scheme, as identified by reference to established case law, as being:

• a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders

• the sale or allotment of shares in the target company to another party

• the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits

• the purchaser or allottee escaping Australian income tax on the dividend so declared

• 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, and

• the scheme being carefully planned for the predominant, if not the sole purpose of the vendor shareholders avoiding tax on a distribution of dividends by the target company.

Generally, section 177E of the ITAA 36 will not apply if the dominant purpose was; for example, to carry out a corporate reorganisation, or where the sale of the shares was otherwise only incidental and significant assessable gains were received.

Taxation Determination TD 2014/1 describes 'dividend access share' arrangements by way of or in the nature of dividend stripping within the meaning of section 177E of the ITAA 36. The proposed scheme is not considered to be a 'dividend access share' arrangement as contemplated in TD 2014/1 for a number of reasons. Significantly, this includes the fact that -

• the shares in respect of which future dividend payments will be made to company A will be acquired by company A at full market value (and not as a result of a single share created, issued and/or allotted for nominal consideration), and

• the Family Trust (as the ultimate recipient of any future dividend payments made by the Company) will continue to distribute the vast majority of its income to the Taxpayer, such that the accumulated profits of the Company will not, by virtue of the proposed scheme, be distributed in a substantially tax-free form.

Company A's purchase of Z% of the shares in the Company is not considered to be a scheme (or part thereof) by way of or in the nature of dividend stripping, or substantially having the effect of dividend stripping as -

• no income tax on any dividend to be declared by the Company is to be avoided by company A

• there will be little to no correlation between the amount of the capital sum to be received by the Taxpayer from the sale of their shares to company A and the amount of any dividend to be paid by the Company to company A, and

• for reasons mentioned in the previous paragraph, the proposed scheme is not entered into by the Taxpayer for the dominant purpose of ensuring that an assessable dividend is not received by them (as the vendor shareholder), thereby avoiding tax on the distribution of any dividend by the Company.

Therefore, section 177E of the ITAA 36 has no application to the proposed scheme.

Question 5

Subsection 207-145(1) of the ITAA 97, amongst other things, will not include the amount of the franking credit on a franked distribution in the assessable income of the recipient of the franked distribution pursuant to Division 207 of the ITAA 97, and will deny a tax offset otherwise provided under that Division because of the franked distribution, if the distribution made to the recipient is made as part of a dividend stripping operation.

Pursuant to section 207-155 of the ITAA 97, a franked distribution 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 was by way of, or in the nature of, dividend stripping, or had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

As explained in response to Question 4 of this ruling, the proposed scheme is not considered to be a scheme by way of or in the nature of dividend stripping, or substantially having the effect of dividend stripping. As such, a franked distribution made by the Company as part of the proposed scheme will not be taken to be made as part of a dividend stripping operation pursuant to section 207-155 of the ITAA 97, or for the purposes of section 207-145 of the ITAA 97.