Edited version of your written advice

Authorisation Number: 1012992073384

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Date of advice: 1 April 2016

Ruling

Subject: Dividend stripping and general anti-avoidance

Question 1

Is the arrangement a scheme by way of or in the nature of, or has substantially the effect of, dividend stripping pursuant to section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Does section 177EA of the ITAA 1936 apply to the arrangement?

Answer

No

Question 3

Does Part IVA of the ITAA 1936 apply to the arrangement?

Answer

No

Question 4

Is the amount an allowable franking credit offset pursuant to Part 3-6 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

This ruling applies for the following periods

1 July 2015 to 30 June 2016

The scheme commences on

1 July 2015

Relevant facts and circumstances

Background

1. XA and XB Taxpayer were married and together they had three children; A, B and C Taxpayer.

2. A Taxpayer is married to D Taxpayer and together they have three adult children; X, Y and Z Taxpayer. A, D, X, Y and Z are all Australian residents.

3. XA Taxpayer passed away in late 20XX.

L Pty Ltd

4. L Pty Ltd was incorporated in month 19XX, with XA and XB Taxpayer appointed as the company's directors.

5. XA and XB Taxpayer are the sole shareholders of L Pty Ltd, each holding one of the two ordinary shares on issue.

G Pty Ltd

6. G Pty Ltd was incorporated in month 19XX. The directors of the company are A and D Taxpayer.

7. A and D Taxpayer are the sole shareholders of G Pty Ltd, each holding six of the 12 ordinary shares on issue.

Taxpayer Finance Pty Ltd

8. Taxpayer Finance Pty Ltd (was incorporated on dd/mm/yyyy, with XA and XB Taxpayer appointed as the company's directors.

9. XA and XB Taxpayer are the sole shareholders of Taxpayer Finance Pty Ltd, each holding one of the two ordinary shares on issue.

Taxpayer Corporate Pty Ltd

10. Taxpayer Corporate Pty Ltd (Taxpayer Corporate) is an Australian resident company incorporated on dd/mm/yyyy, with XA Taxpayer appointed as the company's director.

11. There are 103 shares issued in Taxpayer Corporate, as follows:

Held by	Class of share	No. of shares held
L Pty Ltd atf the Taxpayer Investment Trust	ordinary	100
XA Taxpayer	E	1
XB Taxpayer	E1	1
Taxpayer Finance Pty Ltd atf Taxpayer Finance Trust	E2	1

12. You state that you do not believe that the E class shares have any voting rights attached to them, that they are dividend access shares.

13. You state that Taxpayer Corporate is an investment company holding cash and a pre-2009 unpaid present entitlement (UPE) from the Taxpayer Investment Trust (the Investment Trust). Taxpayer Corporate has an Interposed Entity Election (IEE) in place, with XA Taxpayer as the Family Trust Election (FTE) specified individual.

14. As at 30 June 2015, Taxpayer Corporate had retained profits of $M million and a franking account balance of $N million. You state that the retained profits of the company are represented by cash on hand and loans. You further explain that the loans are via Taxpayer Finance to the A Taxpayer Family Trust, on terms compliant with Division 7A of the ITAA 1936 where required.

Taxpayer Investment Trust

15. The Taxpayer Investment Trust (the Investment Trust) is an Australian resident discretionary trust. L Pty Ltd is the trustee of the Trust. You state that the potential beneficiaries of the Trust are very broad and include the Taxpayer family members and their associated entities.

16. You explain that the Investment Trust's business activity is to hold ordinary shares. You further state that the Trust has a FTE in place with XA Taxpayer as the specified individual.

Taxpayer Finance Trust

17. The Taxpayer Finance Trust (the Finance Trust) is an Australian Resident discretionary trust. Taxpayer Finance Pty Ltd is the trustee of the Trust. You state that the potential beneficiaries of the Trust are very broad and include the Taxpayer family members and their associated entities.

18. You explain that the business activity of the Finance Trust is to buy and sell publicly listed shares. You state that XA Taxpayer undertook this activity on behalf of the Trust and you believe this share trading activity may cease as a result of XA Taxpayer's death.

19. The Finance Trust has a FTE in place with XA Taxpayer as the specified individual.

A Taxpayer Family Trust

20. The A Taxpayer Family Trust (the Family Trust) is an Australian resident discretionary trust. G Pty Ltd is the trustee of the Trust. You state that A and D Taxpayer are the primary beneficiaries of the Trust and their three children, X, Y and Z Taxpayer, are the secondary beneficiaries.

21. The Family Trust conducts a business activity.

22. In 20CC, the Family Trust put in place a FTE with A Taxpayer as the specified individual. The Family Trust also has an IEE in place, with XA Taxpayer noted as the FTE specified individual.

23. You state that the Family Trust has tax losses of $ million which were incurred in the 20XX and earlier income years.

Existing loans from the Finance Trust to the Family Trust

24. Prior to XA's death, XA and XB Taxpayer were in the process of updating their Wills. The Wills were last updated over 20 years earlier.

25. You state that the reason XA and XB Taxpayer wished to update their Wills was to limit the possibility for dispute between their children as a result of the large disparity in funds that XA and XB Taxpayer have given their children over time.

Specifically, you state that the Finance Trust had made a number of advances to the Family Trust for the purchase of equipment and to fund the mining and primary production business of the Family Trust.

26. You state that the loan to the Family Trust is recorded as an asset in the financial statements of the Investment Trust.

27. You state that the Family Trust has not been able to make the minimum loan repayments on its own without assistance. Instead, the Family Trust has relied upon income distributions from the Finance Trust and monies gifted by XA and XB Taxpayer from which it has made the minimum repayments. Furthermore, you state that the Family Trust is not able to repay the advances without further assistance.

Previous loans to B and C Taxpayer

28. You state that the Finance Trust has previously lent amounts to the other two children of XA and XB Taxpayer; B and C Taxpayer. These amounts were repaid by XA and XB' Taxpayer's credit loan account with the Trust. As a result of this, those amounts were effectively gifted to B and C and have been accounted for when noting the current $J million inequality between the three children.

29. You explain that it is not possible to use XA and XB Taxpayer's credit loan account with the Finance Trust to repay the loans of the Family Trust due to an insufficient balance.

Proposed arrangement

30. You state that XA Taxpayer wished to simplify their estate planning, in particular the loan from the Investment Trust to the Family Trust. You state that if the loan remains outstanding after the passing of both XA and XB Taxpayer, it will likely cause angst and arguments between their three children.

31. In order to deal with the inequality that has arisen as a consequence of A Taxpayer receiving some $J million more from their parents than their siblings, XB Taxpayer's will, currently provides that A's two siblings will inherit $J million each, with the remainder of the Estate to be divided equally between their three children. Consequently, you state that A and their two siblings will gain control of the trustee companies through share bequeaths. Share splits in the relevant companies, Taxpayer Finance Pty Ltd and L Pty Ltd, are being undertaken to ensure A, B and C Taxpayer all receive an equal number of shares in each company.

32. If the loan to A is not repaid prior to XB Taxpayer's passing, it could lead to inequality between the three siblings. The loan of approximately $W million to the Family Trust is an asset held by Taxpayer Corporate and, through the Will bequeathing the shareholding of the company equally between the three children; it will indirectly become part of their inheritance. This will mean that A will indirectly obtain a greater share of their parent's Estate.

33. In the event that the loan to the Family Trust is not repaid prior to the passing of XB Taxpayer, the outstanding balance of the loan will change year to year. As the Family Trust is in a loss position and hasn't previously had the capacity to make the minimum repayments, XB Taxpayer may be required to gift further amounts to the Family Trust in their personal capacity. To achieve equality for the monies received by their children, XB Taxpayer would likely be required to make annual changes to their Will, which you state will be expensive, time consuming and possibly not viable if their health deteriorates.

34. Moreover, you state that XB Taxpayer is unable to make further gifts to the Family Trust (to allow it to repay the loan to the Investment Trust) as they need to maintain their personal assets to enable them to satisfy the equality and gifts they wish to make through their Will. For this, and the abovementioned reasons, XB Taxpayer wishes to resolve these issues before their passing.

35. To eliminate this potential inequality, you claim that an arrangement is being considered which will enable the approximate $W million loan to the Family Trust to be repaid despite the Family Trust not being in a position to repay it. Specifically, it is proposed that Taxpayer Corporate will pay a dividend equalling the outstanding loan to the Investment Trust, being approximately $W million, in the year ending 30 June 2016.

36. You state that in accordance with its trust deed, the Investment Trust will distribute the franked dividend income to the Finance Trust. The Finance Trust will then distribute this amount to the Family Trust. The Family Trust will then use this distribution to repay the outstanding loan balance.

37. Lastly, the Family Trust will have a positive amount of trust income. It is estimated that the Family Trust will have net income of $U million which will be distributed to A, D, X, Y and Z Taxpayer. It is also estimated that each beneficiary will receive a grossed up distribution (including franking credits) from the Family Trust in the year ended 30 June 2016. You claim that any franking credit refunds will be incidental benefits of the arrangement.

38. You claim that 'the sole reason for the dividend is to enable the A Taxpayer Family Trust to repay a loan that otherwise would create difficulty, dispute and consternation generally, if the loan isn't otherwise dealt with when XB Taxpayer passes away'.

39. You confirm that the arrangement will not involve any cash transfers or payments, rather it will solely comprise of paper transactions.

Relevant legislative provisions

Income Tax Assessment Act 1936 paragraph 97(1)(a)

Income Tax Assessment Act 1936 section 98A

Income Tax Assessment Act 1936 section 100

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1997 section 4-10

Income Tax Assessment Act 1997 subsection 63-10(1)

Income Tax Assessment Act 1997 section 67-25

Income Tax Assessment Act 1997 section 207-15

Income Tax Assessment Act 1997 section 207-20

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 section 207-37

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 section 207-50

Income Tax Assessment Act 1997 section 207-55

Income Tax Assessment Act 1997 section 207-70

Income Tax Assessment Act 1997 section 207-75

Income Tax Assessment Act 1997 section 207-150

Income Tax Assessment Act 1997 section 960-115

Income Tax Assessment Act 1997 Division 63

Income Tax Assessment Act 1997 Division 67

Income Tax Assessment Act 1997 Division 200

Income Tax Assessment Act 1997 Division 207

Reasons for decision

Question 1

Is the arrangement a scheme by way of or in the nature of, or has substantially the effect of, dividend stripping pursuant to section 177E of the ITAA 1936?

Summary

The arrangement is not a scheme by way of or in the nature of, or has substantially the effect of, dividend stripping pursuant to section 177E of the ITAA 1936?

Detailed reasoning

SCHEMES TO REDUCE TAX- STRIPPING OF COMPANY PROFITS

40. Section 177E of the ITAA 1936 is an anti-avoidance provision that is designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme with substantially the same effect as a dividend stripping scheme.

41. Dividend stripping is not a defined term, however its meaning is considered in Taxation Ruling IT 2627 Income Tax: Application of Part IVA to dividend stripping arrangements, which states at paragraphs 8 to 10:

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 year's 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.

Scheme

42. The first requirement of subsection 177E(1) is that there is a scheme by way of or in the nature of dividend stripping or, in the alternative, there must be a scheme having substantially the same effect.

43. Subsection 177A(1) defines a scheme as:

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

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

44. The definition of scheme is broad, however to satisfy subsection 177A(1) and establish that a scheme exists, it is necessary that an agreement, arrangement, understanding, plan, proposal, action, course of action or course of conduct exists.

The first limb of paragraph 177E(1)(a)

45. There are two limbs to subsection 177E(1). Subparagraph 177E(1)(a)(i) (the first limb) requires there to be "a scheme by way of or in the nature of dividend stripping".

46. A dividend stripping operation has been recognised by the courts as involving the following characteristics:

a. a target company, which had substantial undistributed profits creating a potential tax liability either for the company or its shareholders;

b. the sale or allotment of shares in the target company to another party;

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

d. the purchaser or allottee escaping Australian income tax on the dividend so declared; and

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

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

47. "It is … by reference to the presence or absence of those characteristics that the schemes in the present case should be examined for consistency with the broad description contained in para (a)(i) of s 177E(1)" (Lawrence at 395 per Jessup J).

The second limb of paragraph 177E(1)(a)

48. Subparagraph 177E(1)(a)(ii) (the second limb) requires there to be "a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping". In Lawrence, Jessup J explained at 399, [77]:

It seems that the parliament wanted to catch "variations" on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. This is, in my view, a significant indication of parliamentary purpose, since it treats such an effect as distinct from the result of a scheme of the kind contemplated: s 177E does not require that shareholders themselves, as a "result" of the scheme, receive the profits distributed by way of the disposal of property in question.

Dominant purpose

49. For the arrangement to be a scheme to which subsection 177E(1) of the ITAA 1936 applies, a tax avoidance purpose is required. In CPH their Honours said (at 570 [174]):

In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.

50. As Jessup J said in Lawrence, those observations "apply equally to para (a)(ii), in the context of which a tax avoidance purpose is just as necessary" (at 403;[88]).

51. The High Court in Federal Commissioner of Taxation v Spotless Services (1996) 186 CLR 404; 96 ATC 5201; (1996) 34 ATR 183 at CLR 416; ATC 5206; ATR 188; ATR 183 established that where a scheme makes no commercial sense without the tax benefits, there is a greater likelihood of concluding that it is entered into for the sole or dominant purpose of obtaining a tax benefit. Factors which suggest the scheme had been entered into for commercial reasons or as part of ordinary family dealings will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven.

Application to your circumstances

52. In this case the stated estate planning purpose is part of an ordinary family dealing. This is supported by the following objective facts.

a. XA Taxpayer died in the process of updating their will

b. XB Taxpayer, their surviving spouse, is aging and it would be a financial burden to continue to provide on-going assistance to them, A to repay the Division 7A loan payments

c. administering the will would require regular readjustments to the will as the loan balance changes if the loan was not repaid

d. the disparity between the funds that XA and XB Taxpayer had distributed to their three adult children during their lifetime

e. the arrangement involves a family with an existing structure that has been in place long term

f. the franked dividend is distributed to an ordinary shareholder rather than a recently introduced shareholder

g. the company has not previously distributed dividends

h. the franking credits are shared equally among the beneficiaries of the Taxpayer Family Trust

i. the trust losses have existed for a number of years and have not recently been added to the entity structure as part of the scheme.

53. Based on all the relevant facts, section 177E of the ITAA 1936 is not considered to apply to this arrangement.

Question 2

Does section 177EA of the ITAA 1936 apply to the arrangement?

Summary

The arrangement is not a scheme to which section 177EA of the ITAA 1936 will apply.

Detailed reasoning

SCHEMES TO REDUCE TAX - CREATION OF FRANKING CREDIT OR CANCELLATION OF FRANKING CREDITS

54. Section 177EA of the ITAA 1936 is a general anti-avoidance rule that safeguards the operation of the imputation system. It is directed at franking credit trading involving the transfer of franking credits on a dividend from investors who cannot fully use them to investors who can. If the section applies, the Commissioner may debit the company's franking account or deny the franking credit benefit to the recipient of the dividend.

55. In order for section 177EA of the ITAA 1936 to apply, amongst other things, it must be concluded from the circumstances that a purpose of at least one of the participants was to obtain a franking credit benefit. It is not necessary that this purpose is the dominant purpose, but it must be more than incidental.

56. Paragraph 177EA(3)(e) of the ITAA 1936 sets out the relevant circumstances that must be considered in determining whether a person has the requisite purpose and includes, but is not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

57. These relevant circumstances cover a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposal and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose to obtain an imputation benefit.

58. The requisite purpose is further explained in paragraph 8.124 of the Explanatory Memorandum (EM) to the Taxation Laws Amendment Bill (no. 3) 1998 that accompanied the introduction of section 177EA as follows:

One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (ie. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings.

59. Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the scheme seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders.

Application to your circumstances

60. In your case the stated estate planning purpose is supported by the following objective facts:

a) the parent, XA Taxpayer died in the process of updating their will.

b) XB Taxpayer, their surviving spouse is aging and it would be a financial burden to continue to provide on-going assistance to their child A to repay the Division 7A loan payments

c) administering the will would require regular readjustments to the will as the loan balance changes if the loan was not repaid

d) the disparity between the funds that XA and XB Taxpayer distributed to their three adult children during their lifetime

e) the arrangement involves a family with an existing structure that has been in place long term

f) the franked dividend is distributed to an ordinary shareholder rather than a recently introduced shareholder

g) the company has not previously distributed dividends

h) the franking credits are shared equally among the beneficiaries of the Taxpayer Family Trust

i) the trust losses have existed for a number of years and have not recently been added to the entity structure as part of the scheme.

61. In the circumstances, the access to the refundable tax credits is considered merely incidental to achieving the overall estate planning goals.

62. As a result, having regard to the relevant circumstances of the scheme, the requirements of section 177EA of the ITAA 1936 have not been satisfied. Therefore, it is not considered that section 177EA of the ITAA 1936 has any application in relation to the scheme.

Question 3

Does Part IVA of the ITAA 1936 apply to the arrangement?

Summary

Part IVA of the ITAA 1936 does not apply to the arrangement.

Detailed Reasoning

SCHEMES TO REDUCE TAX

63. Part IVA of the ITAA 1936 (Part IVA) is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit.

Scheme

64. Part IVA requires the consideration of a 'scheme', which, as discussed in question 1 above is defined in subsection 177A(1) of the ITAA 1936 as:

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

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

65. Subsection 177A(4) of the ITAA 1936 further states that carrying out a scheme by a person also includes the carrying out of a scheme by a person together with another person or persons.

66. Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart [2004] (Hart); per Gummow and Hayne JJ:

[The] definition is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.

Tax Benefit

67. There must be a tax benefit obtained by the taxpayer in order for Part IVA to potentially apply. Section 177C of the ITAA 1936 broadly provides that a tax benefit in relation to a scheme relates to:

a. amounts not being included in assessable income that would otherwise have been included in assessable income

b. amounts included as an allowable deductions that would otherwise not have been included as allowable deductions

c. capital losses incurred that would otherwise not have been incurred

d. foreign income tax offsets being allowable that would otherwise not have been allowable, and

e. no liability to withholding tax on an amount that would otherwise have had a liability.

68. Part 2-5 of the ITAA 1997 provides a number of rules regarding the deductibility of certain amounts. Section 36-15 broadly provides that entities that are not corporate tax entities are entitled to deduct earlier year tax losses from a current year's assessable income.

Can the availability to a 'tax offset' generate a tax benefit?

69. As discussed above, for Part IVA to potentially apply to a scheme there must be a tax benefit so that section 177C of the ITAA 1936 can be satisfied. Consequently, in considering whether Part IVA could apply to a scheme which results in refundable tax offsets becoming available, it is necessary to first establish whether these tax offsets are tax benefits.

70. Tax offsets are referred to in section 4-10 of the Income Tax Assessment Act 1997 (ITAA 1997) in explaining how to calculate income tax. The provision explains the income tax equation, stating that a tax offset reduces the amount of tax that is required to be paid. That is, tax offsets are subtracted from a taxpayer's income tax liability after it has been calculated.

71. Not all tax offsets are refundable. That is, where the tax offset is greater than a taxpayer's income tax liability, the excess may not be refunded. Section 67-25 of the ITAA 1997 outlines which tax offsets are refundable, and include offsets that occur as a result of receiving a franked distribution from a corporate tax entity.

72. However, a tax offset is not a tax benefit for Part IVA purposes as it does not satisfy section 177C of the ITAA 1936. That is, a tax offset does not involve:

a. amounts not being included in assessable income that would otherwise have been included in assessable income

b. amounts included as allowable deductions that would otherwise not have been included as allowable deductions

c. capital losses incurred that would otherwise not have been incurred

d. foreign income tax offsets being allowable that would otherwise not have been allowable, and

e. no liability to withholding tax on an amount that would otherwise have had a liability.

Application to your circumstances

73. You state that an arrangement is being considered which will enable the Family Trust to repay the approximate $W million loan from the Finance Trust. This arrangement consists of the following steps:

a. Taxpayer Corporate declaring and paying a dividend equalling the outstanding loan to the Investment Trust, being approximately $W million, in the year ending 30 June 2016

b. the Investment Trust will distribute the whole of the franked dividend income to the Finance Trust

c. the Finance Trust will then distribute this amount to the Family Trust

d. the Family Trust will then use this distribution to repay the outstanding loan balance owed to Taxpayer Corporate, and

e. the Family Trust will have a positive amount of trust income. It is estimated that the Family Trust will have net income of $U million which will be distributed to A, D, X, Y and Z Taxpayer. It is also estimated that each beneficiary will receive an approximate $ grossed up distribution (including franking credits) from the Family Trust in the year ended 30 June 2016.

74. If implemented, these steps are clearly agreements, arrangements, plans, course of actions and the like and as such, constitute a scheme for the purposes of subsection 177A(1) of the ITAA 1936.

75. The scheme will have the following key results:

a. a reduction in the retained profits of Taxpayer Corporate of approximately $W million and a proportionate reduction in its franking account balance,

b. the repayment by the Family Trust of an amount owing to Taxpayer Corporate, and

c. the distribution of amounts by the Family Trust to A, D, X, Y and Z Taxpayer which will entitle them to refundable franking credits.

76. None of these outcomes meet the definition of a tax benefit pursuant to section 177C of the ITAA 1936.

77. However, the scheme also involves the utilisation of carried forward losses currently accumulated by the Family Trust. As the Family Trust is not a corporate tax entity, pursuant to section 36-15 of the ITAA 1997 it is able to deduct earlier year tax losses from a current year of assessable income.

78. The Family Trust will therefore be entitled to a deduction in relation to its carried forward losses that, but for the scheme, it would not be entitled to. Paragraph 177C(1)(b) of the ITAA 1936 is thereby satisfied and the deduction is a tax benefit to which Part IVA may apply.

Dominant purpose

79. Part IVA also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D of the ITAA 1936 refers to the purpose of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer.

80. The meaning of the purpose is clarified by subsection 177A(5), which explains that, where there are two or more purposes, the purpose includes the dominant purpose:

A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.

81. When determining whether the purpose of the scheme was to enable a tax benefit, the Commissioner must also have regard to the following eight factors specified in subsection 177D(2):

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

b. the form and substance of the scheme

c. the time the scheme was entered into and the length of time during which the scheme was carried out

d. the result that, but for the operation of Part IVA, would be achieved by the scheme

e. any change in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme

f. any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer

g. any other consequence for the relevant taxpayer, or for any person referred to in paragraph 178.f of the scheme having been entered into or carried out, and

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 178.e.

82. Focussing on the various elements of Part IVA should not obscure the way in which the Part as a whole is intended to operate. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person in entering into or carrying out the scheme, and the existence of the tax benefit, must be considered against a comparison with an alternative.

83. In summary, section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, after having regard to the eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the relevant taxpayer to obtain the tax benefit.

84. The identification of a tax benefit requires consideration of the tax consequences of a 'counterfactual', or alternative hypothesis, that would have resulted had the scheme not been entered into. As stated by Gummow and Hayne JJ in Federal Commissioner of Taxation v Hart [2004] HCA 26; 217 CLR 216; 206 ALR 207; 2004 ATC 4599, 55 ATR 712 at [66]:

When [section 177C(1)] is read in conjunction with [former] s177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in [former] s177D(b) will require consideration of what other possibilities existed.

85. In Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531 the Court explained that although the Commissioner has to consider each of the factors provided by former subsection 177D(b), this doesn't mean that each of the factors must point to the dominant purpose, stating that:

Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against that [former] s177D requires in order to reach the conclusion to which 177D refers.

86. The Commissioner's support of this view is provided in Practice Statement PS LA 2005/24: Application of the General Anti-Avoidance Rules (PS LA 2005/24). PS LA 2005/24 states at paragraph 88 that all factors of subsection 177D(2) need to be taken into account with regard to the relevant evidence, and weighed together, to identify the dominant purpose of the scheme.

(a) manner in which the scheme was entered into or carried out - paragraph 177D(2)(a) of the ITAA 1936

87. Consistent with the Explanatory Memorandum to Income Tax Laws Amendment Bill (No. 2) 1981, paragraph 93 of PS LA 2005/24 states that the first factor, being the manner in which the scheme was entered into or carried out, enables the identification of artificiality or contrivance when compared to the manner in which the scheme would have been carried out pursuant to the counterfactual. Paragraph 93 further states that if a scheme was carried out in a manner consistent with ordinary business or family dealings, this would not indicate a purpose of obtaining a tax benefit.

(b) form and substance of the scheme - paragraph 177D(2)(b) of the ITAA 1936

88. Paragraph 95 of PS LA 2005/24 states that this factor requires the consideration of the substance rather than the form of the scheme. That is, if there is a discrepancy between the legal form and its economic and practical substance, this may indicate that the scheme was implemented as a means of obtaining a tax benefit.

(c) timing of the scheme - paragraph 177D(2)(c) of the ITAA 1936

89. PS LA 2005/24 discusses the timing factor at paragraph 101, stating that this involves consideration of the time the scheme was entered into and the length of the period in which the scheme will be carried out. It also states that this factor examines whether the scheme was entered into shortly before the end of a financial year, or a tax sensitive date such as a change in tax rates, and whether the scheme was entered into for a short period.

(d) the tax consequences resulting from the scheme - paragraph 177D(2)(d) of the ITAA 1936

90. This factor requires the examination of the tax benefit and other tax consequences that result from the scheme, as explained by paragraph 105 of PS LA 2005/24.

(e) the change in financial position of the relevant taxpayer and connected parties resulting from the scheme - paragraphs 177D(2)(e) to (g) of the ITAA 1936

91. These three factors require the examination of the change in the financial position of the relevant taxpayer and connected entities. As explained by paragraph 106 of PS LA 2005/24, it may not be the financial position of the relevant taxpayer that has a material change, but that of his or her spouse or wholly-owned company.

(f) the nature of any connection between the taxpayer and any person who has connection with the relevant taxpayer - paragraph 177D(2)(h) of the ITAA 1936

92. This factor requires consideration of the nature of the relationship between the taxpayer and any other entity that will experience a change in financial position as a result of the scheme. PS LA 2005/24 explains at paragraph 111 that examination of any family relationship between the taxpayer and others affected by the scheme is necessary and that transactions that may appear odd between strangers may be entirely appropriate between family members.

Cancellation of tax benefit

93. Where the Commissioner has made a determination under paragraph 177F(1)(a) of the ITAA 1936 that an amount is to be included in a taxpayer's assessable income, subsection 177F(2) provides that this amount shall be deemed to be included in the taxpayer's assessable income.

Application to your circumstances

94. The Commissioner considers that the counterfactual to the proposed scheme is that the XB Taxpayer would leave their Will unamended such that they would be required to make further gifts to the Family Trust to enable it to make its minimum yearly repayments. Consequently, there would be no tax consequences should the scheme not be implemented.

(a) manner in which the scheme was entered into or carried out - paragraph 177D(2)(a) of the ITAA 1936

95. The proposed scheme involves a number of transactions within a family group. Namely, Taxpayer Corporate will declare a franked dividend to the Investment Trust, which will then distribute this income to the Finance Trust. The Finance Trust will then distribute this amount to the Family Trust, which will then use this distribution to repay its outstanding loan balance. As the Family Trust will have a positive amount of trust income, it will distribute an estimated grossed up amount of $ each to A, D, X, Y and Z Taxpayer.

96. The proposed scheme does not involve the creation of any new entities or changes to existing shareholdings or trust deeds. Nor does it involve any new elections or restructuring of the entities already in existence. The transactions are not complex they involve a group of entities that have been owned and controlled by the same family group for at least 9 years.

97. Further, the proposed scheme does not create any new income or expenses. Rather, it accesses the carried forward losses that have been held by the Family Trust for some years. The franking credits that are associated with the proposed dividends are not generated by the implementation of the scheme.

98. Consequently it is not considered that the proposed scheme involves any degree of artificiality or contrivance, as described by paragraph 93 of PS LA 2005/24. Rather, the transactions are consistent with ordinary business or family dealings.

(b) form and substance of the scheme - paragraph 177D(2)(b) of the ITAA 1936

99. The form of the scheme is the distribution of fully franked dividends through entities that have been in existence for a number of years. There will be no change in the shareholding of the companies or trust deeds of the trusts involved.

(c) timing of the scheme - paragraph 177D(2)(c) of the ITAA 1936

100. Although the proposed scheme is intended to be implemented prior to 30 June 2016, this is part of the ordinary business transactions of the group of entities. That is, the Trustees are required to make distributions of the Trusts income prior to the end of the financial year.

(d) tax consequences resulting from the scheme - paragraph 177D(2)(d) of the ITAA 1936

101. The proposed scheme will result in the retained earnings of Taxpayer Corporate being reduced and franking credits being utilised. The accumulated tax losses of the Family Trust will be recouped such that the financial position of the Trust will be improved. Additionally A, D, X, Y and Z Taxpayer will be entitled to a refund for the excess tax offsets available as a result of the franking credits.

(e) change in financial position of the relevant taxpayer and connected parties resulting from the scheme - paragraphs 177D(2)(e) to (g) of the ITAA 1936

102. There are no additional changes to the financial position of any other related entities to those already explained.

(f) the nature of any connection between the taxpayer and any person who has connection with the relevant taxpayer - paragraph 177D(2)(h) of the ITAA 1936

103. The entities involved in the proposed arrangement are all part of the same family group.

Conclusion

104. Consideration of the 8 factors contained in subsection 177D(2) of the ITAA 1936 indicates that the proposed scheme would be entered into for the purpose of obtaining a tax benefit. However, given that it does not involve any convoluted steps, newly formed entities, changes to group structure or has any other elements of artificiality or contrivance, the Commissioner is satisfied that the proposed arrangement is one of ordinary business or family dealings. Consequently, the Commissioner will not exercise his discretion to cancel the tax benefit arising from the scheme pursuant to section 177F.

Question 4

Is the amount an allowable franking credit offset pursuant to Part 3-6 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The amount is an allowable franking credit offset.

Detailed Reasoning

IMPUTATION SYSTEM

105. Division 200 of the ITAA 1997 provides for an imputation system to avoid double taxation at the shareholder level. Broadly, this is achieved by allowing members who receive assessable income from a corporate tax entity to claim a tax offset for tax already paid by the corporate entity. The tax credit paid by the corporate tax entity is known as a franking credit.

Effect of receiving a franked distribution

106. In general, sections 207-15 and 207-20 of the ITAA 1997 set out the tax effect of receiving a franked distribution for entities that are not partnerships or trustees - known as the general rule. It provides that a franked distribution is included in the assessable income of the receiving entity, including the franking credit.

107. Where the receiving entity is a trustee of a trust, the tax effect of receiving a franked distribution is provided in Subdivision 207-B of the ITAA 1997.

108. Section 207-45 of the ITAA 1997 provides for the tax treatment of the franked distribution in the hands of the ultimate recipients, that is the ultimate taxpayers in respect to the income. As the distribution does not flow through them to any further entities, section 207-45 provides that corporate tax entities and individuals, amongst others, to which a franked distribution has indirectly flowed are entitled to a tax offset in the same year equal to their share of the franking credit on the distribution. Applied together with section 207-50 of the ITAA 1997 (explained below), this means that an entity whom a distribution flows through will not be entitled to an offset equal to the franking credit.

Application to your circumstances

109. You state that Taxpayer Corporate will pay a dividend equal to the outstanding loan to the Investment Trust, being approximately $W million in the year ending 30 June 2016.

110. After receiving the fully franked dividend from Taxpayer Corporate, the Investment Trust will distribute the franked dividend income to the Finance Trust. As the franked dividend received by the Investment Trust will be distributed to a further entity, it will not be entitled to a franking credit pursuant to section 207-45 of the ITAA 1997.

111. The Finance Trust will then distribute this amount to the Family Trust. As the franked dividend received by the Finance Trust will be distributed to a further entity, it will not be entitled to a franking credit pursuant to section 207-45 of the ITAA 1997.

112. The Family Trust will use this distribution to repay the outstanding loan balance. The Family Trust will make a franked distribution to each of its five beneficiaries; A, D, X, Y and Z Taxpayer. As the franked dividend received by the Family Trust will be distributed to a further entity, it will not be entitled to a franking credit pursuant to section 207-45 of the ITAA 1997.

Gross up - distribution made to, or flows indirectly through, a trustee

113. Section 207-35 of the ITAA 1997 provides for the circumstances where a franked distribution is made to, or flows indirectly through, a partnership or a trust. Specifically, subsection 207-35(1) provides that if the franked distribution is made to a trustee of a trust, the assessable income of the trust for that year includes the amount of franking credit on the distribution if the following conditions are met at the time the distribution is made:

a. the entity is not a corporate tax entity, and

b. in the case of a trustee of a trust, the trust is not a complying superannuation entity or FHSA trust.

114. Section 960-115 of the ITAA 1997 defines the term 'corporate tax entity' as an entity that is:

a. a company

b. a corporate limited partnership

c. a corporate unit trust, or

d. a public trading trust.

115. The amount is included in assessable income in addition to any other income in relation to the distribution, pursuant to subsection 207-35(2) of the ITAA 1997.

116. Subsections 207-35(3) and (4) of the ITAA 1997 provide that, in relation to a trust, the beneficiary's assessable income includes their share of the franking credit on the distribution and the amount referred to in section 207-37 where:

a. the franked distribution is made, or flows indirectly, to a trustee of a trust

b. the assessable income of the trust for that year includes the franking credit amount that is all or part of the additional amounts of assessable income included in subsection 207-35(1)

c. the distribution flows indirectly to a beneficiary of the trust, and

d. the beneficiary has an amount of assessable income for that year that is attributable to all or part of the distribution.

When a franked distribution flows indirectly to or through an entity

117. Pursuant to subsection 207-50(3) of the ITAA 1997, a franked distribution flows indirectly to a beneficiary if:

a. during that income year, the distribution is made to the trustee, and

b. the beneficiary receives the following during that income year:

(i) a share of the trust's net income for that income year that is covered by paragraph 97(1)(a) of the Income Tax Assessment Act 1936; or

(ii) an individual interest in the trust's net income for that income year that is covered by section 98A or 100 of that Act;

(whether or not the share amount becomes assessable income in the hands of the beneficiary); and

c. the beneficiary's share of the distribution pursuant to section 207-55 is a positive amount.

118. Broadly, paragraph 97(1)(a) of the ITAA 1936 provides that a beneficiary of a trust that is not under a legal disability is presently entitled to a share of the trust's income must include in their assessable income that share of the trust income.

Residency requirements

119. Section 207-70 of the ITAA 1997 broadly provides that an individual or corporate tax entity must meet the residency requirement in order to be entitled to a tax offset associated with a franked distribution it received.

120. The residency requirement is provided by section 207-75 of the ITAA 1997. Pursuant to subsection 207-75(1), the residency requirement is satisfied at the time the distribution is made if:

a. in the case of an individual - he or she is an Australian resident

b. in the case of a company - it is an Australian resident, and

c. in the case of a corporate unit trust - the trust is a resident unit trust for the income year in which the distribution occurred.

Application to your circumstances

121. Taxpayer Corporate will pay to the Investment Trust a dividend equal to the outstanding loan (approximately $W million). As the Investment Trust is not a corporate unit trust or a public trading trust, section 207-35 of the ITAA 1997 is satisfied and the distribution from Taxpayer Corporate will carry the associated franking credits.

122. The Investment Trust will then distribute the franked dividend income to the Finance Trust. As the Finance Trust is not a corporate unit trust or public trading trust, section 207-35 of the ITAA1997 is satisfied and the distribution will carry the associated franking credits.

123. The Finance Trust will distribute the franked dividend income to the Family Trust. As the Family Trust is not a corporate unit trust or public trading trust, section 207-35 of the ITAA is satisfied and the distribution will carry the associated franking credits.

124. Each of the five beneficiaries will be presently entitled and will receive a portion of the distribution from the Family Trust, consistent with paragraph 97(1)(a) of the ITAA 1936. Pursuant to subsection 207-50(3) of the ITAA 1997, the franked distribution will flow indirectly to the five beneficiaries. As they and all the other entities in the proposed arrangement are Australian residents, the residency requirements of section 207-70 of the ITAA 1997 will be met. The beneficiaries, (A, D, X, Y and Z) will be entitled to a tax offset associated with the franked distribution pursuant to section 207-45.

Tax offset - distribution flows indirectly to an entity

125. As explained above, section 207-45 of the ITAA 1997 provides for the tax treatment of the franked distribution in the hands of the ultimate recipients, that is, the ultimate taxpayers in respect to the income. As the distribution does not flow through them to any further entities, section 207-45 provides that individuals, amongst others, to which a franked distribution has indirectly flowed are entitled to a tax offset in the same year equal to their share of the franking credit on the distribution.

126. Section 207-55 of the ITAA 1997 broadly provides that, in relation to a distribution that has flowed indirectly to a beneficiary of a trust, the franking credits will be allocated notionally to the entities that benefit from the distribution.

Application to your circumstances

127. Under the proposed arrangement, the beneficiaries of the Family Trust (A, D, X, Y and Z) will indirectly receive a distribution from the Family Trust. The distributions will have franking credits attached. As the distributions will not flow to any subsequent entities, section 207-45 of the ITAA 1997 will be satisfied and the beneficiaries will be entitled to a tax offset equal to the franking credits.

Refund of tax offsets

128. A common set of rules applicable for all tax offsets is provided for in Division 63 of the ITAA 1997. Read together with Division 67, item 40 of the table in subsection 63-10(1) states that tax offsets obtained as a result of receiving a franked distribution, that is, those offsets available pursuant to Division 207, are subject to the refundable tax offset rules. Where an entity's tax offsets are greater than its income tax liability, it is entitled to a refund.

Application to your circumstances

129. You have stated that none of the beneficiaries of the Family Trust have any losses and that they all have income from other sources. According to subsection 63-10(1) and Division 67 of the ITAA 1997, if the beneficiaries have a tax offset that is greater than their income tax liabilities they will be entitled to a refund of the excess amount.

Integrity measures

130. A number of integrity measures have been put in place to ensure that the imputation system is not manipulated.

131. As discussed above, the beneficiaries of the Family Trust will be entitled to a franking credit offset if they are entitled to a share of the trust income. However, if any of the following circumstances as set out in paragraphs 207-150(1)(a) to 207-150(1)(ea) of the ITAA 1997 apply, then the entity that the franked dividend indirectly flows to is not entitled to a tax offset:

a. the entity is not a qualified person in relation to the distribution for the purposes of Division IA of former Part IIIVA of the ITAA 1936

b. the Commissioner has made a determination under paragraph 177EA(5)(b) of the ITAA 1936

c. the Commissioner has made a determination under paragraph 204-30(3)(c) of the ITAA 1997

d. the distribution is treated as an interest payment for the entity under section 207-160 of the ITAA 1997

e. the distribution is part of a dividend stripping operation

ea. section 207-157 (about distribution washing) applies to the distribution

132. Paragraph 207-150(1)(a) sets out that the tax offset will not be available where the recipient is not a 'qualified person' in relation to the distribution for the purposes of Division 1A of the former Part IIIA ITAA 1936, that is, because the holding period rule and /or related payments rules have not been satisfied.

133. Broadly, the holding period rule requires taxpayers to hold shares at risk for more than 45 days (90 days for preference shares) in order to qualify for a franking benefit and the related payments rule requires taxpayers who are under an obligation to make a related payment in relation to a dividend to hold the relevant shares at risk for more than 45 days (90 days for preference shares) during the relevant qualification period in order to qualify for the franking benefit.

134. You have provided that the Investment Trust, being the ordinary shareholder of Taxpayer Corporate has held the shares for 10 years. You have provided that the Investment Trust, the Finance Trust and the Family Trust are family trusts with Family Trust Elections in place. We agree that paragraph 207-150(1)(a) will not act to disallow the tax offset in this case.

135. Questions 1 and 2 of this ruling explain why the Commissioner has not made a determination pursuant to paragraph 177EA(5)(b) or concluded that the distribution is part of a dividend stripping operation. As such, the circumstances in paragraphs 207-150(1)(b) and 207-150(1)(e) do not exist to disallow the tax offset.

136. Based on the information provided to the Commissioner in this ruling application there is no evidence to suggest that the necessary circumstances described in paragraphs 207-150(1)(c), 207-150(1)(d) and 207-150(ea) exist to disallow the tax offset.