Edited version of your written advice

Authorisation Number: 1013077608366

Date of advice: 25 August 2016

Ruling

Subject: Will the issue of a Redeemable Preference Share give rise to a direct value shift, application of the dividend streaming, dividend stripping provisions, or the application of any other anti-avoidance measures e.g. section 45A or 45B, section 177EA or Part IVA or the ITAA 1936?

Question 1

Is the proposed issue of a Redeemable preference Share ("RPS") an "equity interest" under Subdivision 974-C of the Income Tax Assessment Act 1997 ("ITAA 1997")?

Answer

Yes

Question 2

Will the proposed issue of a RPS give rise to a direct value shift ("DVS") under Division 725 of the ITAA 1997?

Answer

No

Question 3

If the answer to Question 2 is "Yes", will the DVS cause CGT event K8 (section 104-250 of the ITAA 1997) to occur?

Answer

Not applicable

Question 4

Will a payment of fully franked dividends to the holder of the proposed RPS (Company B) be considered dividend streaming under Subdivision 204-D of the ITAA 1997?

Answer

No

Question 5

Will any distribution to the holder of the proposed RPS (Company B) be considered:

(a) Part of a dividend stripping operation under section 207-155 of the ITAA 1997; or

(b) A scheme for the stripping of company profits within the meaning of paragraph 177E(1) of the Income Tax Assessment Act 1936 ("ITAA 1936")?

Answer

No

Question 6

Will section 45A of the ITAA 1936 apply to the proposed issue of the RPS to Company B?

Answer

No

Question 7

Will section 45B of the ITAA 1936 apply to the proposed issue of the RPS to Company B?

Answer

No

Question 8

Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to the holder of the proposed RPS?

Answer

No

Question 9

Will Part IVA of the ITAA 1936 apply to the proposed transaction?

Answer

No

This ruling applies for the following periods:

1 July 20XX to 30 June 20YY

The scheme commences on:

The scheme has not yet commenced

Relevant facts and circumstances

Company Y is a private company incorporated in a particular State. It was established to operate a family business.

Company X, a holding company, is also a private company incorporated in a particular State. Company Y is a 100% subsidiary of Company X. The A and B each hold X ordinary shares in Company X ("Ordinary Shares"). Company X owns all the shares in Company Y and together they form the V Group.

A number of years ago, the A and B's children joined the business and collaboratively worked together with their parents to help the business grow and succeed.

In addition to the children who have been involved in the business, they have other children. Neither of these other children have ever worked in or contributed to the success of the business.

The A and B wish to develop a Business and Personal Asset Succession / Estate plan.

Drivers of the succession plan include both internal and external risks.

Estate Succession Plan

The V Group has been restructured to allow the existing retained profits of the group to be distributed to an entity the A and B control.

For this purpose, a new holding company, Company B was incorporated. The majority of shares in Company B are owned by Company C as Trustee for Trust D. The remaining shares are owned by the A and B respectively. The potential beneficiaries of the Trust D include the A, their children who are involved in the business, and their respective families. Their other children and their respective families have been specifically excluded as eligible beneficiaries of the Trust D.

The Trust D is controlled, both at the trustee level and as Guardians and Appointors with the power to sack the trustee, by the A and B. This control will be maintained during their lifetimes, with control ultimately passing to their children.

This structure will ensure that the business profits are ultimately held for the children and their respective families (and are not held in the A and B's personal names) but remain accessible to the A and B during their lifetime.

Step 1 - Loan arrangements

The first step to achieve the desired Estate Succession Plan involves a series of 'internal' loan/mortgage arrangements. This effectively reduces the size of the A and B's personal estates and moves the value into Trust D. The purpose of the loan arrangements is for asset protection from any challenge to the A and B's Wills, and from third party claims made against them personally.

Step 2 - Issue of Redeemable Preference Share

Company X proposes to issue one "A" Class Redeemable Preference Share ("RPS") to Company B at fair market value, being a nominal price. The RPS will be issued on the following principal terms:

a) it will carry rights to dividends (fully franked, partially franked or unfranked) of such amount (if any) as may be determined by a resolution of the Directors of Company X at any time;

b) it will not entitle the holder (Company B) to any voting rights or capital rights upon a winding up of Company Y;

c) the RPS is redeemable by Company X at any time, at the option of Company X, for nil consideration; and

d) if the RPS has not been redeemed by Company X within three years of the date of issue, the RPS is automatically redeemed at the third anniversary of its date of issue, for nil consideration.

Subsequent to the issue of the RPS, it is proposed that a fully franked dividend be declared to the maximum extent possible (subject to any commercial restraints and the need to retain working capital in Company X to fund the business operations). That dividend will be determined by resolution of the Board of Company X. This will be paid to Company B for the ultimate future maintenance and benefit of the children's respective families, in line with the A and B's Estate Succession Plan.

At the date of issue, the fair market value of the one A class RPS is expected to be a nominal amount, as there will be no fixed entitlement to the above proposed dividend.

Other matters

At present, there is only one class of share on issue in Company X, being Ordinary Shares.

No dividend policy or pattern exists in relation to the frequency or quantum of any dividend payments.

All family members and entities within the Group are residents of Australia for tax purposes.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 104-250

Income Tax Assessment Act 1997, section 202-30

Income Tax Assessment Act 1997, Subdivision 204-D

Income Tax Assessment Act 1997, section 204-30

Income Tax Assessment Act 1997, subsection 204-30(8)

Income Tax Assessment Act 1997, paragraph 207-145

Income Tax Assessment Act 1997, paragraph 207-150

Income Tax Assessment Act 1997, section 207-155

Income Tax Assessment Act 1997, Division 725

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

Income Tax Assessment Act 1997, section 725-90

Income Tax Assessment Act 1997, section 725-145

Income Tax Assessment Act 1997, Subdivision 974-C

Income Tax Assessment Act 1997, subsection 974-15(1)

Income Tax Assessment Act 1997, section 974-20

Income Tax Assessment Act 1997, subsection 974-20(1)

Income Tax Assessment Act 1997, subsection 974-20(4)

Income Tax Assessment Act 1997, paragraph 974-20(1)(b)

Income Tax Assessment Act 1997, paragraph 974-20(1)(d)

Income Tax Assessment Act 1997, paragraph 974-20(1)(e)

Income Tax Assessment Act 1997, section 974-70

Income Tax Assessment Act 1997, section 974-75

Income Tax Assessment Act 1997, subsection 974-75(1)

Income Tax Assessment Act 1997, subsection 974-120(1)

Income Tax Assessment Act 1997, section 974-135

Income Tax Assessment Act 1997, subsection 974-135(1)

Income Tax Assessment Act 1997, subsection 974-135(3)

Income Tax Assessment Act 1997, paragraph 974-160(1)(a)

Income Tax Assessment Act 1997, subsection 995-1(1)

Income Tax Assessment Act 1936, section 45A

Income Tax Assessment Act 1936, subsection 45A(1)

Income Tax Assessment Act 1936, subsection 45A(3)

Income Tax Assessment Act 1936, section 45B

Income Tax Assessment Act 1936, subsection 45B(2)

Income Tax Assessment Act 1936, paragraph 45B(2)(a)

Income Tax Assessment Act 1936, paragraph 45B(2)(b)

Income Tax Assessment Act 1936, paragraph 45B(2)(c)

Income Tax Assessment Act 1936, subsection 45B(3)

Income Tax Assessment Act 1936, subsection 45B(8)

Income Tax Assessment Act 1936, section 45C

Income Tax Assessment Act 1936, Part IVA

Income Tax Assessment Act 1936, subsection 177A(1)

Income Tax Assessment Act 1936, subsection 177A(4)

Income Tax Assessment Act 1936, section 177C

Income Tax Assessment Act 1936, section 177D

Income Tax Assessment Act 1936, subsection 177D(2)

Income Tax Assessment Act 1936, section 177E

Income Tax Assessment Act 1936, section 177E(1)

Income Tax Assessment Act 1936, section 177EA

Income Tax Assessment Act 1936, subsection 177EA(3)

Income Tax Assessment Act 1936, paragraph 177EA(3)(a)

Income Tax Assessment Act 1936, paragraph 177EA(3)(b)

Income Tax Assessment Act 1936, paragraph 177EA(3)(c)

Income Tax Assessment Act 1936, paragraph 177EA(3)(d)

Reasons for decision

Question 1

Summary

1. The RPS is considered to be an equity interest under Subdivision 974-C of the ITAA 1997.

Detailed reasoning

The RPS satisfies the equity test in subsection 974-75(1) of the ITAA 1997. The RPS fails the debt test in subsection 974-20(1) of the ITAA 1997 as it does not meet the effectively non-contingent obligation requirement in paragraph (c) of that subsection.

Equity test

2. Section 974-75 of the ITAA 1997 sets out the requirements for a scheme to satisfy the equity test in relation to a company.

3. The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the RPS would fall within the definition of a scheme.

4. A scheme gives rise to an equity interest in the company under section 974-70 of the ITAA 1997 if the scheme satisfies the equity test in section 974-75 of the ITAA 1997 and the interest is not a debt interest under section 974-20 of the ITAA 1997.

5. A scheme satisfies the equity test in relation to a company if it gives rise to an interest of the kind listed in subsection 974-75(1) of the ITAA 1997 which are:

6. The RPS will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the interest arising from its issue is an interest covered by item 1 of the table listed in subsection 974-75(1) of the ITAA 1997.

7. As item 1 of the table listed in subsection 974-75(1) of the ITAA 1997 is satisfied it is unnecessary, in the present context, to further consider whether any other items in the table are also satisfied for the purposes of passing the equity test.

8. Therefore, the RPS will be an equity interest unless it is characterised as a debt interest under section 974-20 of the ITAA 1997.

Debt test

9. Subsection 974-15(1) of the ITAA 1997 defines the meaning of a 'debt interest' as follows:

A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1).

10. Subsection 974-20(1) of the ITAA 1997 states that a scheme satisfies the debt test if:

(a) the scheme is a financing arrangement for the entity; and

(b) the entity, or a connected entity of the entity, receives, or will receive, a financial benefit or benefits under the scheme; and

(c) the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when:

(i) the financial benefit referred to in paragraph (b) is received if there is only one; or

(ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and

(d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and

(a) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil.

11. The application of the debt test to the RPS is considered below. In order to satisfy the debt test, the scheme must satisfy all five limbs in subsection 974-20(1) of the ITAA 1997.

(a) the scheme is a financing arrangement for the entity.

 As the scheme gives rise to an interest covered by item 1 of the table in subsection 974-75(1) of the ITAA 1997, subsection 974-120(1) of the ITAA 1997 stipulates that this requirement of the debt test does not need to be satisfied.

(b) the entity, or connected entity of the entity, receives or will receive a financial benefit or benefits under the scheme.

12. Subsection 974-20(4) of the ITAA 1997 inter alia provides that a financial benefit to be received is taken into account only if it is one that another entity has an effectively non-contingent obligation to provide. The concept of effectively non-contingent obligation is discussed below under requirement (c).

13. Under the terms of the RPS, the subscription price for the RPS is anticipated to be nominal.

14. Company X will therefore receive a financial benefit under the scheme, namely the subscription price for the RPS, as paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes 'anything of economic value'.

15. Accordingly, paragraph 974-20(1)(b) is satisfied.

(b) the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities.

16. An 'effectively non-contingent obligation' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given in section 974-135 of the ITAA 1997.

17. Subsection 974-135(1) of the ITAA 1997 states that there is an effectively non-contingent obligation to take action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action.

18. Subsection 974-135(3) of the ITAA 1997 provides inter alia that an effectively non-contingent obligation is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or connected entity to meet the obligation.

19. The relevant obligations that fall for consideration under section 974-135 of the ITAA 1997 are Company X obligations to:

(i) pay dividends on the RPS, and

(ii) return any amount of the issue price of the RPS

20. In relation to the obligation to pay dividends, it is evident that under the terms of the RPS the obligation to pay dividends will be entirely at the discretion of the Board of Company X.

21. Company X may redeem the RPS at any time at its own discretion up to the third anniversary of the issue date of the RPS. If the RPS remains on issue as at the third anniversary, it will be redeemed. There is no obligation at any time for Company X to pay Company B any consideration for that redemption.

22. Given there is no obligation on Company X to pay dividends to the holder of the RPS or to pay all or part of the subscription amount (or a greater amount) upon redemption of the RPS, Company X does not have an effectively non-contingent obligation to provide a financial benefit in relation to the RPS.

23. The RPS will not satisfy the debt test in subsection 974-20(1) of the ITAA 1997 and accordingly we have not considered the application of paragraphs 974-20(1)(d) and 974-20(1)(e) of the ITAA 1997 to the present situation.

24. Therefore in accordance with section 974-70 of the ITAA 1997, as the RPS fails the debt test, it will constitute an equity interest in Company X.

Question 2

Summary

25. The proposed issue of a RPS will not give rise to a direct value shift ("DVS") under Division 725 of the ITAA 1997?

Detailed reasoning

26. There is a direct value shift under section 725-145 of the ITAA 1997 if, as a result of things done under a scheme, there is a decrease in the market value of one or more equity or loan interests in a company (the down interests) and either:

• equity or loan interests in the company are issued at a discount (the up interests); or

• there is an increase in the market value of one or more equity or loan interests in the company (the up interests).

27. A direct value shift may result in consequences under Division 725 of the ITAA 1997 which would include a realignment of the value of the equity or loan interests for tax purposes to reflect changes in market value attributable to the direct value shift and, in some cases, a capital gain being generated on the down interests (see CGT event K8 in section 104-250 of the ITAA 1997).

28. The market value of the RPS is based on the rights and benefits attached to the RPS. At the time of issue, the RPS will carry no voting rights or rights to receive capital. The RPS is only eligible for discretionary dividends, determined from time to time by the board of Company X. At the time of issue, the RPS is entirely inferior to the Ordinary Shares in terms of voting and capital rights, and is only on par with the Ordinary Shares in respect of dividend rights (and only to the extent dividends are declared by the Board on the RPS).

29. The payment of dividends to the holder of the RPS will be at the sole and absolute discretion of the directors of Company X. Furthermore, any such rights are limited to a three year period at most, but potentially a lesser period if Company X determines to redeem the RPS before the end of that term.

30. The RPS therefore appears to have nominal value, and would not be issued at a discount under the proposed transaction.

31. A direct value shift will not have consequences under Division 725 of the ITAA 1997 if the sum of the decreases in market value of all the down interests under the same scheme does not exceed $150,000: subsection 725-70(1) of the ITAA 1997.

32. In this regard, subsection 725-70(1) of the ITAA 1997 specifically states:

For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if the sum of the decreases in the market value of all down interests because of direct value shifts under the same scheme as the direct value shift is at least $150,000.

33. In the current circumstances, Company X intends to issue the RPS for a nominal amount. The applicant has submitted that the issue price reflects the market value of this interest taking into consideration the entitlements attaching to the RPS. Even if there is any material value in the RPS, where that value is less than $150,000 the de minimis rule in section 725-70 of the ITAA 1997 would apply to prevent the proposed transaction having any DVS tax consequences.

34. For completeness, even if a DVS was identified, the exception in section 725-90 will apply so that there are no consequences under the DVS rules.

35. Section 725-90 applies if:

(a) The one or more things referred to in paragraph 725-145(1)(b) brought about a state of affairs, but for which the direct value shift would not have happened; and

(a) As at the time referred to in that paragraph, it is more likely than not that, because of the scheme, that state of affairs will cease to exist within 4 years after that time.

36. The relevant 'state of affairs' is that the proposed RPS has specific characteristics in the form of discretionary dividend rights which give rise to the potential shift in value. The removal of these specific characteristics when the RPS is redeemed (which must happen within 4 years of the issue of the RPS by virtue of its terms of issue) will satisfy the requirements of the reversal exception (section 725-90 of the ITAA 1997).

Question 3

Summary

37. CGT event K8 will not arise on the issue of the RPS.

Detailed reasoning

38. As concluded in Question 2, the issue of the RPS will not trigger a direct value shift. Alternatively, if a direct value shift is triggered, it has no consequences because of the de minimis threshold in section 725-70 of the ITAA 1997 or because of the reversal of any such DVS in accordance with section 725-90 of the ITAA 1997. Accordingly, CGT event K8 will not arise on the issue of the RPS.

Question 4

Summary

39. The Commissioner will not make a determination under Subdivision 204-D of the ITAA 1997 that the imputation benefits attaching to dividends paid on the RPS are being streamed.

Detailed reasoning

40. Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another.

41. Section 204-30 of the ITAA 1997 applies where an entity streams one or more distributions in such a way that the franking credits attaching to the distribution are received by those members of the entity who derive a greater benefit from them; and other members receive lesser imputation or no imputation benefits.

42. For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members.

43. Subsection 204-30(8) of the ITAA 1997 details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member:

(a) is not an Australian resident;

(b) is not entitled to use the tax offset under Division 207 of the ITAA 1997;

(c) incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions;

(d) is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e) is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; and

(f) is an exempting entity.

44. In the current circumstances, the potential beneficiaries of the Trust D include the A and B, their children who are involved in the business, and their respective families. It has been confirmed that the A and B, all entities they control and their children are all residents of Australia for tax purposes. Therefore from a residency perspective no beneficiary will derive a greater benefit from franking credits than another beneficiary.

45. Provided only assessable dividends are paid to the beneficiaries of the Trust D none of the factors listed in subsection 204-30(8) of the ITAA 1997 are applicable. Therefore the Commissioner will not make a determination under Subdivision 204-D of the ITAA 1997 that the imputation benefits attaching to dividends paid on the RPS are being streamed.

Question 5

Summary

46. The Commissioner does not consider that the scheme involving the issue of the RPS is a dividend stripping scheme, as intended by section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936 and therefore the frankability of any dividends paid on the RPS will not be affected by these provisions.

Detailed reasoning

47. 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.

48. 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.

49. 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 a 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.

50. 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.

51. 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 is:

• 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.

52. In both IT 2627 and the High Court's statement in the case FCT v Consolidated Press Holdings Ltd (2001), a core factor is that the scheme is designed to enable a shareholder(s) to be paid or receive the profits of the company, or an equivalent amount, in a tax-free or substantially tax-free manner.

53. 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.

54. Where the circumstances of a scheme suggest the scheme had been entered into for commercial reasons or as part of ordinary family dealings it will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven.

Application to your circumstances

55. In the current case, the scheme is required to implement the A and B's Estate Succession Plan. The issue of the RPS to Company B and the potential payment of dividends to Company B in respect of that RPS is designed to:

(a) protect the retained earnings of the V Group from external creditors, in the event of a personal liability claim against A and/or B (i.e. as the Ordinary Shares in Company X are held in their personal names); and

(b) to ensure that the respective families of their children who are involved in the business are able to ultimately benefit from the current retained profits of the V Group, in light of their concerns that a TFM claim(s) may be made against their estate, particularly in respect of their Group V shares.

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

a. The A and B's advancing age , and a desire to see their children rewarded for their lifelong contribution to growing and expanding the family business;

b. Upon their deaths, a concern their wishes as outlined in their Wills may not be respected, and a TFM claim may be made against their estate by one of their other children;

c. The arrangement involves a family with an existing structure that has been in place long term;

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

e. The only way the beneficiaries of the Trust D receive money in respect to the dividends paid to Company B on the RPS is by way of assessable dividends (franked or otherwise).

f. There is no corporate value being released to shareholders or associates in a tax free form. Only assessable dividends are paid to the beneficiaries of the Trust D.

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

Question 6

Summary

58. Section 45A of the ITAA 1936 will not apply to the proposed issue of the RPS to the Trust D.

Detailed reasoning

59. Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

60. Subsection 45A(1) of the ITAA 1936 states:

This section applies in respect of a company that, whether in the same year of

income or in different years of income, streams the provision of capital benefits and

the payment of dividends to its shareholders in such a way that:

(a) the capital benefits are, or apart from this section would be, received by

shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

(b) it is reasonable to assume that the other shareholders (the disadvantaged

shareholders) have received, or will receive, dividends.

61. Subsection 45A(3) of the ITAA 1936 states:

A reference to the provision of a capital benefit to a shareholder in a company is a

reference to any of the following:

(a) the provision to the shareholder of shares in the company;

(b) the distribution to the shareholder of share capital or share premium;

(c) something that is done in relation to a share that has the effect of

increasing the value of a share (which may or may not be the same share)

held by the shareholder.

Provision of capital benefits

62. The definition requires that in order for a company to stream capital benefits, the recipient (i.e. the shareholder) must already hold shares in the company (so as to qualify as a shareholder) before they can be provided with a capital benefit.

63. Prior to the issue of the RPS to Company B, it will not hold any shares in Company X so is not a shareholder of the company. The issue of the RPS to Company B does not therefore constitute the provision of shares or distribution of share capital to, or the increase in value of shares held by, a shareholder in Company X.

64. On the facts of this matter, the Commissioner cannot be satisfied that a capital benefit will be provided in accordance with the definition at subsection 45A(3) of the ITAA 1936.

65. For completeness, considering the circumstances of the scheme, there is no 'streaming' of capital benefits and dividends in the present case. It cannot be said that a shareholder would derive a greater benefit in accordance with the proposed arrangement than other shareholders of the company within the terms of section 45A of the ITAA 1936.

66. In the Commissioner's view, section 45A of the ITAA 1936 will not apply to the proposed arrangement.

Question 7

Summary

67. Section 45B of the ITAA 1936 will not apply to the proposed issue of the RPS to Company B.

Detailed reasoning

68. Section 45B of the ITAA 1936 is aimed at preventing companies from providing 'capital benefits' to shareholders in substitution for the payment of dividends, and having regard to the relevant circumstances of the scheme, it would be concluded that a person who entered into the scheme did so for a purpose (whether or not the dominant purpose, but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit.

69. In this way, the section is designed to ensure that certain payments that are paid in substitution for dividends are treated as assessable dividends for tax purposes. The operative provision appears at subsection 45B(2) of the ITAA 1936.

70. In broad terms, section 45B applies where:

(a) there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a))

(b) under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)), and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose), of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

71. Where these conditions are met, the Commissioner is authorised to make a determination under subsection 45B(3) of the ITAA 1936. The effect of this determination is that the capital benefit that is provided to the shareholder is taken to be an unfranked dividend (section 45C of the ITAA 1936).

72. Based on the facts of the case, although the conditions of paragraphs 45B(2)(a) and 45B(2)(b) appear to have been met, the requisite purpose of enabling the participating Company X shareholder to obtain a tax benefit - by way of a capital distribution - is not present.

73. Having regard to the relevant circumstances of the scheme, as listed under subsection 45B(8), it cannot be concluded that Company X entered into or carried out the scheme for a more than incidental purpose of enabling the Company X shareholders to obtain a tax benefit.

74. Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies.

Question 8

Summary

75. Section 177EA of the ITAA 1936 will not apply to any distribution of fully franked dividends to the holder of the proposed RPS.

Detailed reasoning

76. Section 177EA of the ITAA 1936 is a general anti avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain an imputation benefit.

77. Specifically, section 177EA of the ITAA 1936 applies if the following conditions, set-out in subsection 177EA(3) of the ITAA 1936 are satisfied:

(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

(b) either:

ii. a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

iii. a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

(c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

78. It is considered that the conditions in paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied in respect of the issue of the RPS because:

(a) the issue of the RPS constitutes a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936). Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, a 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves the issuing of membership interests;

(b) frankable distributions are expected to be payable to the holder of the RPS (paragraph 177EA(3)(b) of the ITAA 1936). The Commissioner accepts that dividends payable on the RPS will be frankable distributions to the extent that the dividends on the RPS do not fall within the list of unfrankable distributions in section 202-45 of the ITAA 1997;

(c) distributions are expected to be paid to the holder of the RPS (paragraph 177EA(3)(c) of the ITAA 1936). It is expected that these distributions will be franked; and

(d) it is reasonable to expect that an imputation benefit will be received by the relevant taxpayers as a result of distributions made on the RPS given that Company X expects to frank the distributions on the RPS: paragraph 177EA(3)(d) of the ITAA 1936.

79. As the threshold requirements of section 177EA of the ITAA 1936 have been met, it is necessary to consider the 'relevant circumstances' of the scheme in determining whether it could be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

80. In the current circumstances, it is evident that the RPS was issued to implement the Estate Succession Plan of the A and B. Therefore, the new trust and company structure and issue of the RPS is being implemented for the purpose of achieving these estate planning goals, rather than to deliver a tax benefit by way of franking credit and dividend streaming.

81. As a result, having regard to the relevant circumstances of the scheme, the requirements of 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 9

Summary

82. Part IVA of the ITAA 1936 will not apply to the proposed transaction.

Detailed reasoning

83. 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

84. 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.

85. 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.

86. Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart [2004] (Hart)¹; 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

87. 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.

88. Whether a scheme has been carried out for the dominant purpose of enabling a taxpayer to obtain a tax benefit is determined according to the provisions of section 177D of the ITAA 1936. Under section 177D of the ITAA 1936, it would be concluded that the person who entered into or carried out the scheme did so for the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme, whether or not that person who entered the scheme is the relevant taxpayer or one of the other taxpayers. Additionally, subsection 177D(2) of the ITAA 1936 sets out a number of tests to be applied in determining the purpose of a scheme.

89. The eight factors required to be considered in connection with the broader scheme are:

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

(b) the form and substance of the scheme;

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

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

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

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

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

90. For Part IVA of the ITAA 1936 to apply it is necessary that based on an analysis of the above factors, it would be concluded that the scheme was entered into for the sole or dominant purpose of obtaining a tax benefit. Our analysis of the above factors leads to the conclusion that Part IVA of the ITAA 1936 would not apply to the scheme.

91. From the facts provided the proposed scheme is being entered into to implement the A and B's Estate Succession Plan. The new company and trust structure, the issue of the RPS and associated dividend payments are required to guarantee that the family wealth is safeguarded from TFM claims and able to be directed for the benefit of their children who are involved in the business and their families in acknowledgement of their lifelong commitment and investment in the family business.

92. This indicates the dominant purpose of the scheme is for estate planning and asset protection purposes and not to obtain a tax benefit. 

¹ HCA 26; 217 CLR 216; 206 ALR 207; 2004 ATC 4599; 55 ATR 712 at [43].