Edited version of your written advice

Authorisation Number: 1012958935609

Date of advice: 5 February 2016

Ruling

Subject: Dividend stripping, Part IVA

Question 1

Will the issue of ordinary shares in New Co to you (in return for you disposing of your shares in Company Z), and the subsequent payment of a dividend by Company Z to New Co, constitute a dividend stripping operation for the purposes of section 207-155 of the Income Tax Assessment Act 1997 (ITAA 1997) and section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Is the issue of ordinary shares in New Co to you (in return for you disposing of your shares in Company Z to New Co), and the subsequent payment of a dividend by Company Z to New Co, a scheme to which Part IVA of the ITAA 1936 will apply?

Answer

No

This ruling applies for the following period(s)

1 July 20XX to 30 June 2017

The scheme commenced on

Not yet implemented

Relevant facts and circumstances

This PBR application is based on the following facts, as provided by the Taxpayer:

• You are the sole director and shareholder of Company Z.

• In its financial statement for the year ended 30 June 20XX, Company Z had Retained Profits.

• You propose to admit a number of new shareholders to your company and this will involve issuing new shares in Company Z. You therefore intend to separate your interests in the company (and in particular your interest in the accumulated profits of Company Z) from those of the new shareholders.

• Your intention is to retain the accumulated profits within a corporate tax entity, from which you may at a later time make other investments and/or withdraw funds in the form of dividends.

• It is proposed that a new company (New Co) will be incorporated to acquire the shares owned by you in Company Z. You will receive ordinary shares in New Co in consideration for the disposal of the shares in Company Z and you will be the sole shareholder in New Co.

• You will choose to obtain rollover relief under Subdivision 122-A of the ITAA 1997 to defer the tax consequences of the share disposal.

• After the share transfer occurs, a fully franked dividend representing the accumulated profits will be paid to New Co. Once the dividend has been paid Company Z will issue shares to the new shareholders.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 207-155

Income Tax Assessment Act 1997, section 207-145

Income Tax Assessment Act 1936, section 177A

Income Tax Assessment Act 1936, section 177C

Income Tax Assessment Act 1936, section 177E

Income Tax Assessment Act 1936, section 177F

Income Tax Assessment Act 1936, Part IVA

Reasons for decision

Question 1

Will the issue of ordinary shares in New Co to you (in return for you disposing of your shares in Company Z to New Co), and the subsequent payment of a dividend by Company Z to New Co, constitute a dividend stripping operation for the purposes of section 207-155 of the Income Tax Assessment Act 1997 (ITAA 1997) and section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

The Commissioner does not consider that the scheme involving the issue of the ordinary shares in New Co to you (in return for you disposing of your shares in Company Z to New Co), and the subsequent payment of a dividend by Company Z to New Co, is a dividend stripping scheme for the purposes of section 207-155 of the ITAA 1997 and section 177E of the ITAA 1936.

Detailed reasoning

1. Section 207-155 of the ITAA 1997 states that:

A distribution made to a member of a corporate tax entity 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:

(a) was by way of, or in the nature of, dividend stripping; or

(b) had substantially the effect of a scheme by way of, or in the nature of, dividend stripping.

2. The threshold condition for the application of section 177E of the ITAA 1936, found in paragraph 177E(1)(a) of the ITAA 1936, is in substantially the same terms to section 207-155 of the ITAA 1997.

3. The consequences of a scheme being considered a dividend stripping scheme are found in:

• sections 207-145 and 207-150 of the ITAA 1997, which operate to deny franking credits on distributions from dividend stripping operation; and

• section 177E of the ITAA 1936, which is a general anti-avoidance provision relating specifically to dividend stripping schemes, where the tax benefit associated with a dividend scheme can be cancelled in whole or part, if determined by the Commissioner.

4. Dividend stripping is not a defined term, and it does not have a precise legal meaning. The meaning of dividend stripping is considered in paragraphs 8 to10 of Taxation Ruling IT 2627 Income Tax: Application of Part IVA to Dividend Stripping Arrangements, which state:

8. The term 'dividend stripping' has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression.

9. However, it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current years' profits that are represented by cash or other readily-realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company.

10. No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result.

5. Dividend stripping is further considered in Taxation Determination TD 2014/1 Income tax: is the 'dividend access share' arrangement of the type described in this Taxation Determination a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of Part IVA of the Income Tax Assessment Act 1936? The characteristics of a dividend stripping scheme are listed in paragraph 17 of TD 2014/1, of relevance:

• the vendor shareholders [receive] 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 [is] 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 from the company.

6. In this case, New Co will be subject to tax at the company rate on the dividend to be paid to New Co after the share transfer. Also, the vendor shareholder (i.e. you) will not receive a capital sum for your shares in an amount equivalent to the dividends paid to New Co. Rather, you will receive shares in New Co and in order for you to access the funds in New Co, New Co would need to either pay you a dividend or lend the funds to you. If the funds were paid to you as a dividend by New Co, you would be subject to tax at your marginal rate. Therefore no tax would be avoided.

7. Accordingly, the scheme will not constitute a dividend stripping operation as intended by section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936.

Question 2

Is the issue of ordinary shares in New Co to you (in return for you disposing of your shares in Company Z to New Co), and the subsequent payment of a dividend by Company Z to New Co, a scheme to which Part IVA of the ITAA 1936 will apply?

Summary

There is no tax benefit under the proposed scheme. As there is no tax benefit, Part IVA does not apply.

Detailed reasoning

8. Part IVA of the ITAA 1936 grants the Commissioner discretion to cancel a tax benefit gained by a taxpayer from a scheme that has the sole or dominant purpose on the part of someone participating in it, of enabling the taxpayer to obtain that tax benefit.

9. Before the Commissioner may exercise his discretion the following provisions must be satisfied.

10. There must be a "scheme" (paragraph 177A(1) of the ITAA 1936). The issue of ordinary shares in New Co to you, and the subsequent payment of a dividend on those shares to New Co, would be a scheme for the purposes of Part IVA.

There must be a "tax benefit in connection with a scheme" (section 177C of the ITAA 1936). The most relevant part of the definition in section 177C of the ITAA 1936 is at paragraph 177C(1)(a) of the ITAA 1936:

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 if the scheme had not been entered into or carried out.

11. In this case, the result of the scheme will be a dividend paid to New Co and from there to you as assessable dividends. The corresponding counterfactual to this result is that Company Z would have paid an assessable dividend directly to you.

12. Based on the above there is no identifiable sum of assessable income that would not be included in assessable income for a year of income upon implementation of the scheme. From this it follows that there is no "tax benefit" capable of being cancelled pursuant to section 177F of the ITAA 1936.

Therefore Part IVA of the ITAA 1936 does not apply to the Scheme.