Edited version of your written advice

Authorisation Number: 1051181251559

Date of advice: 20 January 2017

Ruling

Subject: Refund of franking credits

Question 1

Is the applicant an exempt institution that is eligible for a refund pursuant to subsection 207-115(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Is the applicant entitled to a refund of franking credits attached to a franked distribution received by the applicant from a wholly owned company in the year of income in which the distribution is made pursuant to Division 67 of the ITAA 1997?

Answer

Yes.

Question 3

Will the Commissioner make a determination pursuant to paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

This ruling applies for the following periods:

Year ended 30 June 201Y

Year ended 30 June 201Z

The scheme commences on:

1 July 201X

Relevant facts and circumstances

ABC Pty Ltd (ABC) is an Australian proprietary company limited by shares. It acts as trustee for the ABC Trust (ABC Trust). The ABC Trust is a registered charity with the Australian Charities and not-for-profits Commission (ACNC). It is also endorsed as an income tax exempt entity.

In its role as trustee of the ABC Trust, ABC is the sole shareholder of ABC 2 Pty Ltd (ABC 2).

ABC 2 has a franking account balance based on its income tax return for the 20AA-BB financial year.

ABC 2 proposes to issue fully franked dividends to ABC.

Rather than receiving the distribution by payment of money, ABC has elected to be issued with additional ordinary shares in ABC 2. The value for each new share will be based on its fair market value at the time that the transaction occurs.

The investment will allow you to further the purpose for which you were established. Your investment in ABC 2 is an important part of your passive investment portfolio. You believe that reinvesting your distribution in ABC 2 will assist in increasing your return on your investment in ABC 2.

As a result of this scheme, ABC 2 will be in a better position to obtain debt financing from lenders and you will receive refundable tax offsets. However, this is not your purpose in entering into the scheme.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1997 Subdivision 50-B

Income Tax Assessment Act 1997 section 50-5

Income Tax Assessment Act 1997 section 63-10

Income Tax Assessment Act 1997 Division 67

Income Tax Assessment Act 1997 section 67-25

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 Subdivision 207-A

Income Tax Assessment Act 1997 Subdivision 207-D

Income Tax Assessment Act 1997 Subdivision 207-E

Income Tax Assessment Act 1997 Subdivision 207-F

Income Tax Assessment Act 1997 section 207-115

Income Tax Assessment Act 1997 Subsection 207-115(2)

Income Tax Assessment Act 1997 section 207-117

Income Tax Assessment Act 1997 section 207-119

Income Tax Assessment Act 1997 section 207-120

Income Tax Assessment Act 1997 section 207-122

Income Tax Assessment Act 1997 section 207-124

Income Tax Assessment Act 1997 section 207-128

Income Tax Assessment Act 1997 Subdivision 207-F

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

Reasons for decision

Question 1

Is the applicant an exempt institution that is eligible for a refund pursuant to subsection 207-115(2) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Summary

The applicant is an exempt institution that is eligible for a refund pursuant to subsection 207-115(2) of the ITAA 1997 and none of the anti-avoidance provisions in subdivision 207-E of the ITAA 1997 apply to prevent the applicant from being treated as an exempt institution eligible for a refund.

Detailed reasoning

The general rule in relation to the receipt of franked dividends, as set out in section 207-20 of the ITAA 1997, is that for the income year in which the distribution is made, an entity that receives a franked distribution includes the amount of the franking credit as assessable income (in addition to the amount of the dividend itself under section 44 of the ITAA 1936). Section 207-20 also provides that the entity is entitled to a tax offset equal to the franking credit.

However, there are exceptions to the above general rule. In particular an exception is created where the relevant entity would not have paid tax on the distribution or share of the distribution.

Subdivision 207-E of the ITAA 1997 contains special rules for dividends received by certain exempt institutions that are eligible for a refund so that such entities may be entitled to a tax offset. An entitlement to a tax offset enables an exempt institution to qualify for a refund of franking credit attached to the distribution made.

Section 207-115 of Subdivision 207-E of the ITAA 1997 sets out the circumstances in which an entity is an 'exempt institution that is eligible for a refund.' Subsection 207-115(2) of the ITAA 1997 provides that an entity that is covered by item 1.1 of the table in section 50-5 of the ITAA 1997 (a registered charity), is endorsed as exempt from income tax under Subdivision 50-B of the ITAA 1997 and that satisfies the residency requirement under section 207-117 of the ITAA 1997 is an 'exempt institution that is eligible for a refund',

You are an exempt institution that is eligible for a refund to a tax offset as you are a registered charity, endorsed as exempt from income tax under Subdivision 50-B of the ITAA 1997 and satisfy the residency requirement under section 207-117 of the ITAA 1997.

Therefore, providing none of the anti-avoidance provisions in subdivision 207-E of the ITAA 1997 you are an exempt institution eligible for a refund.

Anti-avoidance provisions

The applicant will not be treated as an exempt institution that is eligible for a refund in relation to a franked distribution if any of the following anti-avoidance provisions apply to the entity:

(a) Section 207-120 of the ITAA 1997;

(b) Section 207-122 of the ITAA 1997; or

(c) Section 207-124 of the ITAA 1997.

These exceptions are considered below.

Exception 1: section 207-120 of the ITAA 1997

Subject to section 207-128 of the ITAA 1997, the anti-avoidance rule under section 207-119 of the ITAA 1997 will operate if section 207-120 of the ITAA 1997 applies to the applicant. Section 207-120 will apply where the applicant receives a franked distribution and because of a distribution event in relation to the distribution, subsection 207-120(2) of the ITAA 1997 applies.

Distribution event

For present purposes, a distribution event in relation to a franked distribution is an act, transaction or circumstance that has happened, will happen or may reasonably be expected to happen, as part of, in relation to or as a result of the payment or receipt of the distribution or an arrangement entered into in association with the payment or receipt of the distribution.

Where such an act, transaction or circumstance happens, or might happen, as a result of the payment or receipt of the distribution, the anti-avoidance rule under section 207-120 of the ITAA 1997 will apply in certain circumstances. Should this anti-avoidance rule apply, the applicant will not be an exempt institution that is eligible for a refund.

Section 207-120 of the ITAA 1997 will apply (and consequently cause the anti-avoidance rule under section 207-119 of the ITAA 1997 to operate) in any of the following circumstances listed in section 207-120(2) of the ITAA 1997:

(a) where a liability arises for an entity to make a payment or transfer property to any entity because of a distribution event related to the distribution (subparagraphs 207-120(2)(a)(i) and 207-120(2)(a)(ii) of the ITAA 1997)

(b) where a detriment is incurred by an entity because of a distribution event related to the distribution (subparagraph 207-120(2)(a)(iii) of the ITAA 1997)

(c) where the benefit to the entity from the distribution is reduced because of a distribution event (paragraph 207-120(2)(b) of the ITAA 1997)

(d) where a benefit, advantage, right or privilege is to be obtained by the payer of the distribution or an associate of the payer because of a distribution event related to the distribution (subparagraph 207-120(2)(d) of the ITAA 1997).

The proposed dividend distribution and reinvestment strategy will provide a benefit to ABC 2 because it will change ABC 2's debt to equity ratio and will improve its ability to obtain new debt financing. Therefore, subject to the operation of section 207-128 of the ITAA 1997, section 207-120 will apply to the arrangement.

Exception 2: section 207-122 of the ITAA 1997

The anti-avoidance rule under section 207-119 of the ITAA 1997 will operate if section 207-122 of the ITAA 1997 applies to the applicant. Section 207-122 applies where:

(a) Franked distributions are paid in a form of property other than money; and

(b) The terms or conditions on which the franked distribution is made are such that the receiving entity does not receive immediate custody and control of the property, does not have the unconditional right to retain custody and control of the property in perpetuity, or does not obtain an immediate, indefeasible and unencumbered legal and equitable title to the property.

The distribution will be in the form of additional ordinary shares in ABC 2. Although the shares constitute property other than money, section 207-122 of the ITAA 1997 will not apply as the terms and conditions of the scheme do not fall within 207-122(b) of the ITAA 1997.

Exception 3: section 207-124 of the ITAA 1997

Subject to section 207-128 of the ITAA 1997, the anti-avoidance rule under section 207-119 of the ITAA 1997 will operate if section 207-124 of the ITAA 1997 applies. Section 207-124 of the ITAA 1997 will apply if:

(a) The ABC, ABC 2 or another entity has entered into an arrangement as part of, or in association with the distribution; and

(b) because of the arrangement, ABC or ABC 2 or another entity has acquired or will acquire (whether directly or indirectly) money or property, other than money or property comprising the distribution from the entity making the distribution or an associate of that entity.

The term 'arrangement' is broadly defined in subsection 995-1(1) of the ITAA 1997 as:

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

You have advised that the arrangement comprises ABC2 issuing the franked distribution to ABC as additional ordinary shares. As the additional shares are the property that comprise the distribution section 207-124 will not apply.

Application of section 207-128 of the ITAA 1997.

Section 207-128 of the ITAA 1997 operates to ensure that a mere reinvestment of a franked distribution by an exempt institution under a bona fide dividend reinvestment plan would not make it ineligible to benefit from refundable tax offsets in relation to the distribution. In particular, section 207-128 provides that section 207-120(2)(d) is taken not to apply to an entity (referred to as the "receiving entity") to which a franked distribution is made if all of the following conditions are met:

1. Instead of receiving the distribution by payment of money, the receiving entity chooses to be issued with shares in the corporate tax entity making the distribution.

In the present case, you have chosen to be issued with additional ordinary shares in ABC 2 rather than receive a payment of money from ABC 2.

2. The choice is genuine and furthers the purpose for which the entity was established.

This arrangement is part of your overall investment strategy and furthers the purpose to which the charity was established.

3. The choice is not made for the purpose of benefiting the corporate tax entity or any of their associates (other than the receiving entity) - or for purposes that include that purpose.

Your investment in ABC 2 is an important part of your passive investment portfolio. The reinvestment will assist with increasing your return on your investment in ABC 2 and will allow you to further your purpose as a charity. The reinvestment choice is not made for the purpose of benefitting ABC 2.

4. Any benefit derived by the corporate tax entity or their associates (other than the receiving entity) because of that choice is one that is an ordinary incident of issuing the shares or interests to the receiving entity or of the receiving entity's holding of those shares or interests.

The scheme allows ABC 2 to restructure their balance sheet and places them in a better position to obtain debt financing from lenders in the future. However, this benefit is an ordinary incident of issuing new equity shares to ABC.

5. The parties that were involved in the distribution event or arrangement concerned deal with one another on an arm's length basis in relation to the event or arrangement.

The value for each new ordinary share issued by ABC 2 to ABC will be based on the fair market value of the share at the time that the transaction occurs. This indicates that the parties are dealing with each other on an arm's length basis.

As the proposed distribution of shares is a reinvestment choice, section 207-128 of the ITAA operates to prevent the application of sections 207-119 and 207-120 of the ITAA 1997. Therefore, based on the facts provided, the 'anti-avoidance' provisions in subdivision 207-E of the ITAA 1997 will not apply to prevent the applicant from being treated as an exempt institution entitled to a refundable tax offset.

Conclusion

You are an exempt institution that is eligible for a refund as you are a registered charity, endorsed as exempt from income tax under Subdivision 50-B of the ITAA 1997 and satisfy the residency requirement under section 207-117 of the ITAA 1997. None of the 'anti-avoidance' provisions in subdivision 207-E of the ITAA 1997 apply to prevent you from being treated as an exempt institution entitled to a refundable tax offset.

Question 2

Is the applicant entitled to a refund of franking credits attached to a franked distribution received by the applicant from a wholly owned company in the year of income in which the distribution is made pursuant to Division 67 of the ITAA 1997?

Detailed reasoning

Subsection 67-25(1) of the ITAA 1997 provides that the tax offsets available under Division 207 are subject to the refundable tax offset rules, unless the operation of the rules is excluded by section 67-25 of the ITAA 1997.

Section 67-25(1C) of the ITAA 1997 provides that a where a corporate tax entity is entitled to a tax offset under Division 207 because a franked distribution is made to the entity, the tax offset is not subject to the refundable tax offset rules unless the entity is an exempt institution that is eligible for a refund.

In the present case, it is not the corporate tax entity ABC that is entitled to the tax offset, but rather ABC Pty Ltd as trustee for the ABC Trust. In addition, it is not ABC, the corporate tax entity that is an exempt institution eligible for a refund, but rather it is the trustee for the ABCTrust that is an exempt institution eligible for a refund. Therefore, section 67-25(1C) of the ITAA 1997 does not apply to exclude the operation of the refundable tax offset rules. None of the other subsections in section 67-25 are applicable to exclude you from the refundable tax offset rules. Therefore, you are subject to the application of the refundable tax offset rules.

Item 40 of the table in section 63-10 of the ITAA 1997 provides that where a taxpayer is subject to the refundable tax offset rules in Division 67 of the ITAA 1997, any offset that remains after being applied to your basic tax liability, will be refunded.

In your case, the tax offsets that are available under Division 207 are subject to the operation of the refundable tax offset rules. As you are an income tax exempt entity, you are entitled to a full refund of the franking credits attached to the distribution.

Conclusion

You are entitled to a refund of franking credits attached to the franked distribution you will receive from ABC 2 pursuant to Division 67 of the ITAA 1997.

Question 3

Will the Commissioner make a determination pursuant to paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

The Commissioner will not issue a determination pursuant to paragraph 177EA(5)(b) ITAA 1936 as there is no more than an incidental purpose of entering into the scheme to obtain a tax benefit.

Detailed reasoning

The effect of the general rule entitling you to a refundable tax offset as an exempt institution can be nullified by the operation of section 207-145 of subdivision 207-F of the ITAA 1997. If a franked distribution is made to an entity in one or more of the circumstances outlined in that section, then that entity will not include the franking credit on distribution in its assessable income and is not entitled to a tax offset because of the distribution.

Pursuant to paragraph 207-145(1)(b) of the ITAA 1997, one of the circumstances in which this can happen is if the Commissioner has made a determination under paragraph 177EA(5)(b) of the ITAA 1936 that no imputation benefit is to arise in respect of a franked distribution.

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 a scheme is to obtain an imputation benefit. In these circumstances, subsection 177EA(5) enables the Commissioner to make a determination with the effect of either:

● imposing franking debits or exempting debits on the distributing entity's franking account; or

● denying the imputation benefit on the distribution that flowed directly or indirectly to the relevant taxpayer.

Pursuant to subsection 177EA(3) of the ITAA 1936, the provision applies if the following conditions 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:

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

(ii) 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.

The “imputation benefit” is defined to be simply the availability of a tax off-set pursuant to subsection 204-30(6) of the ITAA 1997.

Subsection 177EA(17) of the ITAA 1936 provide that the relevant circumstances of the scheme are set out in in an inclusive manner and include the following:

(a) the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity);

(b) whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

(c) whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

(d) whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b);

(e) if the scheme involves the issue of a non-share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies - whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity:

(i) that are similar, from a commercial point of view, to the non-share equity interest; and

(ii) distributions in respect of which are frankable;

(f) whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer;

(g) whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

(ga) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits;

(h) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest;

(i) the period for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity;

(j) any of the matters referred to in subsection 177D(2) (of the ITAA 1936).

Subsection 177D(2) of the ITAA 1936 provides that the following matters be taken into consideration:

(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;

(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).

In the current situation, the applicant proposes that ABC 2 will make a fully franked distribution to the applicant by way of the issue of additional ordinary shares to the applicant under a reinvestment strategy. The applicant will remain the sole shareholder of ABC 2, albeit with a more substantial investment.

The increased investment will assist the applicant to increase its return on its investment in ABC 2. Once the strategy is implemented, the debt to equity ratio in ABC 2 will be more favourable to debt financing.

Having regard to the relevant circumstances outlined in subsection 177EA(17) of the ITAA 1936 and subsection 177D(2) of the ITAA 1936 in the context of the facts of this proposal, it cannot be concluded that any person who proposes to enter into the scheme or carry it out, are doing so for the more than an incidental purpose of obtaining a tax benefit.