Edited version of your written advice

Authorisation Number: 1051234143468

Date of advice: 15 June 2017

Ruling

Subject: Dividend Access Share Arrangement

Question 1

Are the Redeemable Preference Shares (RPSs) to be issued by A Co to B Co as trustee for B Trust and C Co as trustee for C Trust equity interests under Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will A Co have a capital gain from CGT event H2 (section 104-155 of the ITAA 1997) from the issue of the RPSs?

Answer

No.

Question 3

A Co is to pay franked dividends on the RPSs:

a) Will the distributions from A Co to the redeemable preference shareholders (RPS holders) be treated as payments of dividends capable of being franked under section 202-40 of the ITAA 1997?

Answer:

Yes.

b) If so and A Co pays franked dividends to the RPS holders, will the franking credits form part of the assessable income of the RPS holders for inclusion in the calculation of their net income under section 95 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes.

c) In relation to (b), will the RPS holders be entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997?

Answer:

Yes.

d) If the RPS holders distribute the dividends to beneficiary companies (D Co and E Co), will the beneficiary companies be assessable on the franking credits under section 207-35 of the ITAA 1997?

Answer:

Yes.

e) In relation to (d), will the beneficiary companies be entitled to a tax offset equal to the franking credits under section 207-45 of the ITAA 1997?

Answer:

Yes.

Question 4

Will the following anti-avoidance provisions apply to the issue of RPSs by A Co to the RPS holders:

a) The dividend streaming provisions (Subdivision 204-D of the ITAA 1997)?

Answer:

No.

b) The capital streaming provisions (section 45 to section 45D of the ITAA 1936)?

Answer:

No.

This ruling applies for the following periods:

Year ending 30 June 20X1

Year ending 30 June 20X2

Year ending 30 June 20X3

The scheme commences on:

1 July 20X1

Relevant facts and circumstances

1. A Co was incorporated on 1 July 19XX.

2. The share capital of A Co includes 2 ordinary shares each fully paid to $1.00. These ordinary shares are held by Y (1 share) and Z (1 share).

3. Y and Z’s parents (V) and (W) are the current directors of A Co.

4. Y and Z are partners at separate and unrelated law firms.

5. A Co’s assets consist of listed securities, a real property and loans to third parties under arm’s length commercial agreements, all of which were acquired after 20 September 1985.

6. A Co has not undertaken any previous returns of capital, issues of bonus shares, declarations of dividends or payments of share premium to its shareholders.

7. Y and Z currently control separate discretionary family trust structures.

8. Y is the sole shareholder and sole director of B Co, the corporate trustee of B Trust. Beneficiaries of B Trust includes Y and D Co.

9. Z is the sole shareholder and sole director of C Co, the corporate trustee of C Trust. Z is married with two children. The beneficiaries of C Trust includes Z, Z’s spouse, Z’s children and E Co.

Proposal to issue RPSs

10. It is proposed that A Co will issue 1,000 RPSs with a face value of $1.00 to each of the trustees of B Trust and C Trust, as permitted by A Co’s Articles of Association. The terms of the RPS are:

a) The RPS will have no rights in relation to dividends, voting, or any surplus on the winding up of A Co.

b) The RPS will only be redeemable on the winding up of A Co.

c) In the event of a winding up, the RPS holders will rank below debt holders and creditors but above ordinary shareholders for the subscription amount.

11. Subsequent to its issue, directors of A Co will resolve to grant a discretionary dividend right to each RPS. The dividend right will cease by the earlier of a directors’ decision to remove the right or within four years from the issue of the RPS.

12. The directors of A Co will then declare a fully franked dividend in respect of each RPS over a period of time. In this way, current year profits and retained earnings in A Co are distributed to each of Y and Z’s discretionary family trusts.

Proposal to transfer A Co’s listed investments

13. In addition to issuing the RPSs, it is also proposed to transfer all of A Co’s listed investments to the two trusts.

14. As consideration for the transfer, each trust will pay the market value by:

a) assuming A Co’s liabilities associated with the transferred listed investments; and

b) offsetting the dividend receivable from A Co.

15. A Co will not be disposing of the remaining real property.

16. Y and Z are of the view that the objectives of the scheme are:

a) Asset protection – Y and Z wish to hold a minimum of assets in their individual capacity to ensure that, wherever possible, passive investment assets are protected from claims arising due to their role as partners in a commercial partnership. Y holds a small amount in a personal account (for day to day use). Y’s remaining assets are held by B Trust. Z does not have any material investments. Z’s family home is held in Z spouse’s name.

b) Long term succession planning – Y and Z wish to accumulate wealth in a structure that provides them with the flexibility to pass the wealth to their respective families and future generations in the longer term in an efficient manner.

c) Investment strategy and control – Y and Z have and are likely to have, different investment objectives, timeframes, risk profiles and strategies, due to their marital status and family composition. However, the current structure does not allow for flexibility in investment choices.

d) Minimise multiple transaction costs – Y and Z wish to achieve the above objectives without incurring multiple transaction costs, for example, stamp duty.

Assumptions

1. The trustees of B Trust and C Trust will hold the RPSs for at least 90 days.

2. B Trust and C Trust are or will be family trusts within the meaning of Schedule 2F to the ITAA 1936.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Section 45D

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Division 1A of former Part IIIAA

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1997 Section 104-155

Income Tax Assessment Act 1997 Paragraph 104-155(5)(c)

Income Tax Assessment Act 1997 Section 202-40

Income Tax Assessment Act 1997 Section 202-45

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 Division 207

Income Tax Assessment Act 1997 Section 207-20

Income Tax Assessment Act 1997 Subsection 207-20(2)

Income Tax Assessment Act 1997 Section 207-35

Income Tax Assessment Act 1997 Section 207-45

Income Tax Assessment Act 1997 Section 207-145

Income Tax Assessment Act 1997 Section 207-150

Income Tax Assessment Act 1997 Division 974

Income Tax Assessment Act 1997 Subsection 974-20(1)

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

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 Subsection 974-75(1)

Income Tax Assessment Act 1997 Subsection 974-110(1)

Income Tax Assessment Act 1997 Section 974-135

Reasons for decision

Question 1

Summary

1. The RPSs are equity interests for Division 974 of the ITAA 1997 purposes.

Detailed reasoning

2. Division 974 of the ITAA 1997 contains provisions which determine whether a scheme gives rise to a debt interest or an equity interest for taxation purposes.

3. A scheme will give rise to an equity interest in a company if the scheme, when it comes into existence, satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and the interest is not characterised as a debt interest.

Equity test

4. An interest in a company as a member or stockholder meets the equity test (item 1 of the table in subsection 974-75(1) of the ITAA 1997).

5. The RPSs proposed to be issued are shareholder interests.

Debt test

6. A scheme will give rise to a debt interest in an entity if the debt test in subsection 974-20(1) of the ITAA 1997 is satisfied. A scheme satisfies the debt test if all of the following conditions are met:

● the scheme is a financing arrangement for the entity (this condition does not need to be met it the entity is a company and the interest is as a member or stockholder);

● the entity or a connected entity receives or will receive a financial benefit under the scheme;

● the entity has, or the entity and a connected entity of the entity each has, an effectively non-contingent obligation (ENCO) under the scheme to provide a financial benefit;

● it is substantially more likely than not that the value provided will be at least equal to the value received; and

● the value provided and the value received are not both nil.

7. Section 974-135 of the ITAA 1997 specifies that there is an ENCO 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 action. The section also states that an obligation is non-contingent if it is non-contingent on any event, condition or situation, other than the ability or willingness of that entity or connected entity to meet the obligation.

8. It is considered that there is no ENCO to provide a financial benefit with respect to the possible payment of dividends. The RPSs at the time of issue do not have dividend rights.

9. The RPSs are only redeemable on the winding up of A Co. However, an obligation to pay amounts on a redemption date that is not known, and may never arise, would have a value of nil, such that paragraph 974-20(1)(d) is not satisfied.

10. Accordingly, the RPSs do not satisfy the debt test.

Conclusion

11. The RPSs proposed to be issued by A Co are equity interests as they are shareholder interests and are not characterised as debt interests.

12. Subsection 974-110(1) of the ITAA 1997 allows a scheme to give rise to a debt interest where the company subsequently varies a scheme or schemes that constitutes a 'change’ and that would give rise to debt interest.

13. The Commissioner is satisfied that the inclusion of a dividend right on the RPS subsequent to its initial issue, does not create an ENCO to pay dividends on the RPS, as dividends will be contingent on A Co’s board approval. Therefore subsection 974-110(1) of the ITAA 1997 will not apply.

Question 2

Summary

14. On issue of the RPSs, CGT event H2 will not happen.

Detailed reasoning

15. CGT event H2 will not happen if a company issues or allots equity interests in the company (paragraph 104-155(5)(c) of the ITAA 1997).

16. As the issue of the RPSs represents the issue of equity interests in A Co, CGT event H2 will not happen.

Question 3

Summary

17. Distributions from A Co to RPS holders are frankable under section 202-40 of the ITAA 1997.

18. RPS holders’ calculation of their net income under section 95 of the ITAA 1936 will include the franking credits on any franked distribution.

19. RPS holders are entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997.

20. If the RPS holders distribute the dividends to beneficiary companies, the beneficiary companies will be assessed on the franking credits under section 207-35 of the ITAA 1997.

21. The beneficiary companies will be entitled to a tax offset equal to the franking credits under section 207-45 of the ITAA 1997.

Detailed reasoning

22. As discussed previously, the RPSs will be equity interests. The proposed distributions on the RPSs will not fall into any of the categories of unfrankable distributions under section 202-45 of the ITAA 1997. Therefore, the proposed distributions are considered to be dividends capable of being franked under section 202-40 of the ITAA 1997.

23. The franking credits attached to the distributions will form part of the RPS holders’ calculation of their net income under section 95 of the ITAA 1936.

24. Section 207-145 of the ITAA 1997 provides for an entity to be entitled to use the franking credits attached to a dividend distributed to that entity it is necessary that the entity is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

25. Given the facts provided that the RPS holders will hold the RPSs for at least 90 days, they will be qualified persons for the purposes of Division 1A of former Part IIIAA of the

26. ITAA 1936. Consequently, the RPS holders will be entitled to a tax offset equal to the franking credits, pursuant to section 207-145, under subsection 207-20(2) of the ITAA 1997.

27. Where the RPS holders distribute the dividends to individual beneficiaries or beneficiary companies, these beneficiaries will be assessable on the franking credits under section 207-35 of the ITAA 1997.

28. Due to the operation of section 207-150 of the ITAA 1997, for a trust beneficiary to be entitled to use the franking credits attached to the dividend component of a trust distribution it is necessary that the beneficiary is a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936.

29. Given the facts provided that the trustees of B Trust and C Trust will hold the RPS for at least 90 days and that the beneficiary companies form part of the family groups of Y and Z, the beneficiary companies will be qualified persons for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Consequently, the beneficiary companies will be entitled under section 207-45 of the ITAA 1997 to a tax offset equal to their share of the franking credits.

Question 4

Summary

30. The dividend and capital streaming provisions will not apply to the issue of RPSs by A Co to B Co and C Co as trustee for B Trust and C Trust respectively.

Detailed reasoning

Dividend streaming

31. 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.

32. 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.

33. 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.

34. 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; or

(f) is an exempting entity.

35. Streaming is not a defined term but the Explanatory Memorandum to the New Business Tax (Imputation) Act 2002 at Chapter 3, paragraph 28 described streaming as 'selectively directing the flow of franked distributions to those members who can most benefit from imputation credits.'

36. In this case the 'other members' are Y and Z who are resident individuals. It is not considered that they would receive less of a benefit from franking credits than the holders of the RPSs, being the trustees of B Trust and C Trust.

37. Therefore, it is not considered that the arrangement in question is dividend streaming to which Subdivision 204-D of the ITAA 1997 applies.

Capital streaming

38. 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.

39. Section 45B of the ITAA 1936 applies where certain capital payments are made to shareholders in substitution for dividends.

40. The proposed arrangement in question involves the issue of RPSs by A Co to the trustees of B Trust and C Trust. Prior to the issue of the RPSs, these entities are not shareholders of A Co.

41. It is not considered that either section 45A or 45B of the ITAA 1936 applies to the proposed issue of the RPSs. Section 45 of the ITAA 1936 is also not applicable in this case. Consequently, there are no implications under section 45C or section 45D of the ITAA 1936.