Edited version of your written advice

Authorisation Number: 1012962589637

Date of advice: 15 February 2016

Ruling

Subject: Dividend access share arrangement

Question 1

Will the issuing of the proposed A and B Class shares constitute a direct value shift under
section 725-145 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

If the issuing of the proposed A and B Class shares does not constitute a direct value shift under section 725-145 of the ITAA 1997, will the payment of a dividend to the A and B Class shareholders constitute a direct value shift under section 725-145 of the ITAA 1997?

Answer

This question is not applicable as the issuing of the proposed A and B Class shares will constitute a direct value shift under section 725-145 of the ITAA 1997 (as per Question 1)

Question 3

If the issuing of the proposed A and B Class shares constitutes a direct value shift under
section 725-145 of the ITAA 1997, will that direct value shift be of a type that does not have consequences for the taxpayer due to the application of section 725-90 of the ITAA 1997?

Answer

Yes

Question 4

Will the payment of a dividend to the A Class shareholder give rise to a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 5

Will the payment of a dividend to the B Class shareholder give rise to a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of the ITAA 1936?

Answer

Yes

Question 6

Will the proposed scheme described in this ruling constitute a scheme to which section 177D of Part IVA of the ITAA 1936 applies?

Answer

As the more specific integrity provision of section 177E of the ITAA 1936 dealing with dividend stripping is considered to apply to the proposed scheme (as per Question 5), the application of section 177D of the ITAA 1936 has not been considered

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

Year ending 30 June 2018

Year ending 30 June 2019

The scheme commences on:

The scheme is yet to commence

Relevant facts and circumstances

The taxpayer is one of two shareholders in the target company, holding 50% of the shares on issue in his/her own name. The taxpayer is also one of two directors of the target company.

The other 50% of the shares in the target company are held by Family Trust Z. Mr/Mrs Z, a beneficiary of Family Trust Z, is the other director of the target company. Other existing beneficiaries of Family Trust Z are family members of Mr/Mrs Z.

The target company has significant retained earnings and the directors have decided to pay the shareholders fully franked dividends from time to time.

As directors of the target company, both the taxpayer and Mr/Mrs Z are keen to see that payments in the form of franked distributions made to shareholders are treated as equally as possible, meaning they be made to the same entity type and treated equally accordingly.

In light of that intention, the directors propose to issue two new classes of share in the target company, an A Class share and a B Class share. These shares are to be issued at a discount for the purposes of subsection 725-150(1) of the ITAA 1997. The applicant for this ruling advises that there is no purpose for the issue of the A and B Class shares in the target company other than that set out in the paragraph above.

The Constitution of the target company allows for the creation of new classes of shares.

The A and B Class shares will have identical rights attached to them. These will be:

• the right to receive dividends from time to time as declared by the directors in respect of each class of share

• no voting rights at any meeting of the target company, and

• their compulsory redemption by the target company three years from the date of their issue at less than their issue price.

The A Class share is to be issued to Family Trust Z.

The B Class share is to be issued to Family Trust X. Family Trust X:

• is an already settled trust, established to be the operating entity of another venture of the taxpayer's, and therefore not established specifically for the purposes of being issued the B Class share in the target company

• is an Australian resident trust estate as defined in subsection 95(2) of the ITAA 1936

• does not have any carry forward losses, nor does it expect to have any losses during the period covered by this ruling, and

• intends to distribute the franked distributions it receives in respect of its B Class share to its beneficiaries.

The taxpayer and his/her spouse are the only Named Beneficiaries of Family Trust X. The franked distributions received by Family Trust X in respect of its B Class share in the target company are envisaged to be distributed to both Named Beneficiaries only but, at the time of this ruling, it is advised by the applicant for this ruling that the portions to be distributed between each of the Named Beneficiaries is unknown.

A distribution of any portion of the franked distributions received by Family Trust X in respect of its B Class share in the target company to the taxpayer's spouse will result in a reduction in the overall tax liability of the taxpayer's family, as compared to a scenario where all the franked distributions received by Family Trust X had been received by the taxpayer directly from the target company.

Both the taxpayer and his/her spouse are also:

• Australian residents for taxation purposes,

• the only shareholders (in equal portions) in the trustee of Family Trust X, and

• the only directors of that trustee.

No decision as to the amount or frequency of payment of any franked distributions has been made by the directors of the target company, but the total of any franked distributions to be paid in respect of the A & B Class shares will not equal any amount near the total accumulated profits in the target company.

The franked distributions to be made by the target company in respect of the A and B Class shares will be satisfied by cash transfer.

For the purposes of subsection 725-70(1) of the ITAA 1997, the applicant for this ruling advises that the sum of the decreases in the market value of all down interests because of direct value shifts under this proposed scheme will be at least $150,000.

Assumptions

1. The taxpayer and his/her spouse will remain the only Named Beneficiaries of Family Trust X for the duration of the ruling period, such that none of the potential beneficiaries under the trust deed to Family Trust X will be Named Beneficiaries for that period.

2. A percentage of each franked distribution received by Family Trust X will be distributed to the taxpayer's spouse.

3. Mr/Mrs Z and each of the other existing beneficiaries of Family Trust Z will remain the only Named Beneficiaries of Family Trust Z for the duration of the ruling period.

4. For the purposes of subsection 725-90(2) of the ITAA 1997, a realisation event will not happen to an interest of an affected owner prior to the compulsory redemption of the A & B Class shares by the target company.

Relevant legislative provisions

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

Income Tax Assessment Act 1936 subsection 95(2)

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subparagraph 177D(b)(ii)

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 paragraph 177E(1)(g)

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

Income Tax Assessment Act 1936 section 177F

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

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 207-145

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

Income Tax Assessment Act 1997 section 207-150

Income Tax Assessment Act 1997 paragraph 207-150(1)(e)

Income Tax Assessment Act 1997 section 207-155

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 section 725-50

Income Tax Assessment Act 1997 section 725-55

Income Tax Assessment Act 1997 section 725-65

Income Tax Assessment Act 1997 subsection 725-70(1)

Income Tax Assessment Act 1997 section 725-80

Income Tax Assessment Act 1997 section 725-85

Income Tax Assessment Act 1997 section 725-90

Income Tax Assessment Act 1997 paragraph 725-90(1)(a)

Income Tax Assessment Act 1997 subsection 725-90(2)

Income Tax Assessment Act 1997 section 725-95

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 subsection 725-150(1)

Further issues for you to consider

We have limited our ruling to the questions raised in your application. There may be related issues that you should consider, including the application of Division 207 of the ITAA 1997.

Sections 207-145 and 207-150 of the ITAA 1997 modify the normal gross up and tax offset entitlement treatment afforded by Division 207 of the ITAA 1997 in respect of the receipt of a franked distribution in certain circumstances. One of these circumstances, as provided in paragraphs 207-145(1)(d) and 207-150(1)(e) of the ITAA 1997, is when a franked distribution is made as part of a dividend stripping operation. The term 'dividend stripping operation' is defined in section 207-155 of the ITAA 1997 in similar terms to section 177E.

Given the conclusion reached in response to Question 5 of this ruling in respect of the application of section 177E, it is considered that the proposed scheme, insofar as it relates to the B Class share, would constitute a dividend stripping operation for the purposes of
paragraphs 207-145(1)(d) and 207-150(1)(e) of the ITAA 1997.

You may apply for another ruling on this or any other matter.

Reasons for decision

Questions 1 - 3

Pursuant to section 725-145 of the ITAA 1997, there is a direct value shift under a scheme involving equity interests in an entity (the 'target entity') if:

• there is a decrease in the market value of one or more equity interests in the target entity which is reasonably attributable to one or more things done under the scheme, occurring at or after the time when that thing, or the first of those things, is done (a down interest), and

• one or more equity interests in the target entity increases in market value and/or is issued at a discount to market value, and the increase and/or issue, is reasonably attributable to the thing done, or one or more of those things done, and occurs at or after the time the thing, or the first of those things, is done (an up interest).

There will be a direct value shift as per section 725-145 of the ITAA 1997 under the proposed scheme (as described in this ruling) as:

• the market value of the ordinary shares held by both Family Trust Z and the taxpayer in the target company (a target entity for the purposes of section 725-145) will decrease upon the issuing of the A and B Class shares in the target company to Family Trust Z and Family Trust X respectively, at or after the time of that issue, and

• the A and B Class shares proposed to be issued in the target company, which will carry dividend rights at the time of issue (as declared by the directors of the target company), will be issued at a discount.

Where a direct value shift that has consequences under Division 725 of the ITAA 1997 occurs, the rules in the Division apply to modify the adjustable values of affected interests to take account of material changes in market value that are attributable to the direct value shift. The rules in
Division 725 may also generate a capital gain on those interests that have decreased in market value as a result of the direct value shift.

Pursuant to section 725-50 of the ITAA 1997, a direct value shift under a scheme involving equity interests in the target entity only has consequences for a taxpayer under Division 725 of the
ITAA 1997 if:

• the target entity is a company or trust at some time during the scheme period (i.e. the period starting when the scheme is entered into and ending when it has been carried out)

• the controlling entity test under section 725-55 of the ITAA 1997 is satisfied

• the cause of the value shift is satisfied as per section 725-65 of the ITAA 1997

• the taxpayer is an affected owner of a down interest (as per section 725-80 of the
ITAA 1997) or an up interest (as per section 725-85 of the ITAA 1997), or both, and

• the value shift is not likely to be reversed as per sections 725-90 or 725-95 of the
ITAA 1997.

For a down interest of which the taxpayer is an affected owner, the direct value shift has consequences under Division 725 of the ITAA 1997 if (in addition to the requirements listed in the above paragraph) the sum of the decreases in the market value of all down interests because of direct value shifts under the same scheme is at least $150,000 (subsection 725-70(1) of the
ITAA 1997).

The reversal exception provided by section 725-90 of the ITAA 1997, such that a direct value shift will not have consequences for a taxpayer under Division 725 of the ITAA 1997, applies where the state of affairs that is brought about by the one or more things done under the scheme:

• will more likely than not cease to exist within four years after the time that that thing, or the first of those things, is done, and

• does not still exist at the earlier of the end of those four years or when a realisation event happens to down or up interests of an affected owner.

The term 'state of affairs' is not defined in the Income Tax Assessment Act, but in the context of section 725-90 of the ITAA 1997 is considered to be used to refer to the factual circumstance(s) that is the trigger or cause for the value shift. The state of affairs is one but for which the direct value shift would not have happened: paragraph 725-90(1)(a) of the ITAA 1997.

With respect to any direct value shift that may happen upon the issue of the A and B Class shares, the relevant state of affairs is that the target company has accumulated significant profits, and there are new classes of shares on issue with discretionary dividend rights.

It is more likely than not that this state of affairs will cease to exist within four years as the terms of issue of the A and B Class shares stipulate that they will be compulsorily redeemed by the target company three years from the date of their issue.

Consequently, the reversal exception under section 725-90 of the ITAA 1997 will apply to any direct value shift on the issue of the A and B Class shares if the scheme is carried out as proposed and, as assumed for the purposes of this ruling, a realisation event doesn't happen to an affected interest prior to their compulsory redemption.

Questions 4 and 5

Generally speaking, Part IVA allows the Commissioner to cancel all or part of a tax benefit that has been obtained, or would, but for section 177F, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

Operating within the framework of Part IVA, section 177E is designed to counter particular 'dividend stripping' schemes and variations of it. Subsection 177E(1) provides the conditions for its operation as follows:

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);

(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.

Paragraph 177E(1)(a)

A 'scheme' for the purposes of section 177E is broadly defined under subsection 177A(1). Here, the proposed arrangement described in this ruling, either in its entirety or to the extent it relates to the B Class share only, constitutes a scheme as defined in subsection 177A(1).

The term 'dividend stripping' has no precise legal meaning, but has been the subject of judicial discussion: see Lawrence v. Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277; (2009) 2009 ATC 20-096; (2009) 75 ATR 306 and FC of T v. Consolidated Press Holdings and Ors; CPH Property Pty Ltd v. FC of T (2001) 207 CLR 235; [2001] HCA 32; 2001 ATC 4343; 47 ATR 229 (Consolidated Press).

The characteristics found to be common of earlier dividend stripping cases, and adopted in the cases cited above, include:

(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 characteristics of a dividend stripping scheme (as listed above) are satisfied by the proposed scheme, insofar as it relates to the B Class share, because:

• the target company carries substantial undistributed profits which, if paid as a dividend, would expose the taxpayer (an existing shareholder in the target company) to a potential tax liability

• there is an allotment of the B Class share to Family Trust X (an entity which is not an existing shareholder in the target company prior to implementation of the proposed scheme)

• the target company will declare and pay franked dividends out of its accumulated profits to Family Trust X in respect of its B Class share, and

• the Named Beneficiaries of Family Trust X (i.e. the taxpayer and his/her spouse) to whom the dividends on the B Class share are envisaged to be appointed by the trust will collectively incur a tax liability in respect of those dividends which is less than that which would have been incurred by the taxpayer on the payment of a dividend on his/her ordinary shares, thereby having escaped Australian income tax.

In relation to the fifth characteristic and in the context of the B Class share, neither of the existing shareholders in the target company will be vendor shareholders as such because the target company will issue the B Class share, meaning the existing shareholders will not directly receive a capital sum on the allotment of those shares.

In considering the sixth characteristic, namely whether the proposed scheme has, as its dominant purpose, the avoidance of tax on the distribution of dividends by the target company, it is necessary to examine all of the evidence of the scheme and to consider the relevant objective features of the scheme to determine whether the scheme has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits from the target company. Importantly, a scheme that has a non-tax purpose may be undertaken for the dominant purpose of avoiding tax.

As identified at paragraph 24 of Taxation Determination TD 2014/1 about certain 'dividend access share' arrangements described therein, one objective matter relates to the complexity of the scheme. Before carrying out the proposed scheme, the most straightforward manner by which the existing shareholders could arrange for the target company's franked distributions to be treated as equally as possible among them is by having the target company pay the dividends to themselves (as existing shareholders) and then deal with the dividends as they see fit, including (as far as the taxpayer is concerned) their subsequent transfer to other beneficiaries of his/her family trust (Family Trust X). The payment of a dividend to the taxpayer, however, would be subject to a rate of tax above the company tax rate and, although he would have the benefit of any available franking credits, this will not be enough to offset the tax payable on the dividend.

Another means by which the existing shareholders could achieve their stated purpose in a relatively straightforward manner is by way of the transfer of the taxpayer's ordinary shares in the target company to Family Trust X. Such a disposal of the taxpayer's ordinary shares in the target company would, however, give rise to a considerable CGT liability for the taxpayer which wouldn't otherwise arise under the proposed scheme.

By contrast, and in the context of the B Class share, after the proposed scheme is carried out some of the accumulated profits of the target company will have been distributed in a relatively complex and contrived manner to Family Trust X, an entity associated with and controlled by the taxpayer, which will give rise to a reduced tax liability as compared to that which would arise if the proposed scheme is not carried out and those accumulated profits are distributed instead directly to the taxpayer. The liberation of the target company's profits for the benefit of the taxpayer (and family) in a way that would avoid tax ordinarily payable by him/her as an ordinary shareholder of the target company points towards tax avoidance as the predominant purpose of the proposed scheme.

In short, the 'equality' sought to be achieved by the proposed scheme (in all respects that aren't tax-related) could arguably be achieved more 'conveniently, commercially and frugally' by a different transaction without the creation of the new A and B Class shares. The relative complexity of establishing and carrying out the proposed scheme are explicable for tax reasons only.

There is also a particular feature of the proposed scheme which appears to have been included to avoid specific provisions within the income tax legislation. For example, the requirement that the A and B Class shares will be compulsorily redeemed within three years of their issue, is a feature inexplicable but for the avoidance of the direct value shifting provisions (as confirmed by Question 3 of this ruling).

In light of all of the above, it is considered that the proposed scheme, insofar as it relates to the B Class share, is one that is entered into for a dominant purpose of avoiding the imposition of any tax that the taxpayer, as an existing shareholder, would be subject to if the accumulated profits were distributed to him/her in respect of his/her ordinary shares in the target company, over and above the cumulative tax imposed on he and his/her spouse if the accumulated profits were distributed to them indirectly (via Family Trust X).

In assessing the relative presence of the six central characteristics of a dividend stripping scheme to the proposed scheme (as above), it is relevant to refer to Consolidated Press where the Full Federal Court observed that:

The terms of the first limb of s 177E(1)(a) suggests that a scheme may fall within its scope, even though not all the elements of a standard dividend stripping scheme are present. The use of the words 'by way of or in the nature of' suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provided it retains the central characteristics of a dividend stripping scheme.

In other words (and as confirmed in paragraph 20 of TD 2014/1), variations from 'the paradigm' that, in effect, at least retain the substance of the listed central characteristics of a dividend stripping scheme, could nevertheless fall within the scope of section 177E.

With that in mind, whilst every one of the six central characteristics are not present in the proposed scheme insofar as it relates to the B Class share, the substance of a dividend striping scheme (i.e. a reduction or elimination of the ordinary shareholder's tax liability) is present such that the payment of a dividend in respect of the B Class share is considered to constitute a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E.

Against the possibility that the views expressed above on the application of subparagraph 177E(1)(a)(i) are found to be incorrect, it is considered in the alternative, that the payment of a dividend in respect of the B Class share would amount to a scheme 'having substantially the effect of a scheme by way of, or in the nature of, a dividend stripping', such that subparagraph 177E(1)(a)(ii) applies.

The second element of paragraph 177E(1)(a) is whether any property of the company is disposed of as a result of a scheme by way of or in the nature of dividend stripping. Paragraph 177E(2)(a) states that a reference in subsection 177E(1) to the disposal of property of a company shall be read as including the payment of a dividend by the company.

As the target company will pay a dividend to the holder of the B Class share, this second element of paragraph 177E(1)(a) is also satisfied.

Paragraph 177E(1)(b)

The relevant disposal of property under the proposed scheme, i.e. the payment of a dividend by the target company to the holder of the B Class share, will represent a distribution of profits of the target company, thereby satisfying the requirement of paragraph 177E(1)(b).

Paragraph 177E(1)(c)

If, immediately prior to the execution of the proposed scheme (and in the context of the B Class share), the target company paid a dividend out of profits equal to the portion of the dividend paid to Family Trust X which was then distributed by the trust to the taxpayer's spouse, an amount (referred to as the 'notional amount' for the purposes of subsection 177E(1)) would have been included, by reason of the payment of that portion of the dividend to the taxpayer (as the existing shareholder), in the assessable income of the taxpayer by virtue of subparagraph 44(1)(a)(i), thereby satisfying the requirement of paragraph 177E(1)(c).

Paragraph 177E(1)(d)

The proposed scheme will be entered into after 27 May 1981, thereby satisfying the requirement of paragraph 177E(1)(d).

Conclusion

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

• the proposed scheme is taken to be a scheme to which Part IVA applies

• for the purposes of section 177F, the taxpayer (as the existing shareholder) will be taken to have obtained a tax benefit in connection with the proposed scheme that is referable to the notional amount not being included in his/her assessable income by virtue of having entered into and carried out the proposed scheme, and

• the amount of that tax benefit is taken to be the notional amount.

Accordingly, where a dividend is paid out of the accumulated profits of the target company to Family Trust X in respect of the B Class share, the Commissioner would exercise his/her discretion to make a determination under paragraph 177F(1)(a) to include that tax benefit in the taxpayer's assessable income.

The Commissioner will not, on the other hand, make such a determination in relation to any dividend paid out of the accumulated profits of the target company to Family Trust Z in respect of the A Class share. The critical feature which distinguishes a dividend paid in respect of the A Class share from a dividend paid in respect of the B Class share, the latter of which comprises a scheme by way of or in the nature of dividend stripping, or having the same effect thereof, is the fact that the A Class share will be issued to an existing shareholder of the target company. There is therefore no prospect of the target company's accumulated profits being diverted in a manner which achieves a reduction or elimination of the taxation liabilities of Family Trust Z (or that of its beneficiaries) upon the payment of dividends by the target company to Family Trust Z in respect of its A Class share, as compared to its ordinary shares.

Question 6

A scheme will be one to which Part IVA applies by operation of section 177D if a taxpayer has obtained a tax benefit in connection with a scheme and it would be concluded that the dominant purpose of a person who entered into or carried out the scheme (or part of the scheme) was to obtain a tax benefit.

Where, however, section 177E operates to deem a scheme to be one to which Part IVA applies, it is unnecessary to consider the operation of section 177D and whether an entrant into the scheme did so for the purposes of obtaining a tax benefit.