Edited version of your written advice

Authorisation Number: 1051364307790

Date of advice: 26 June 2018

Ruling

Subject: Trust losses, franking credits and dividend access share arrangements

Question 1

Will the payment of a franked distribution (with a franking percentage of 100%) from Company X flowing to:

● Trust X (as shareholder); to

● Trust A and Trust B (eligible beneficiary trusts to Trust X); and then to

● Taxpayer A and Taxpayer B (individual beneficiaries to Trust A and Trust B),

have the result that Taxpayer A and Taxpayer B between them have an entitlement to 100% of the franking credits under Subdivision 207-B of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the entitlement to the franking credits still occur even though the dividend income received by Trust A and Trust B may be offset by losses at the level of the trusts in determining the income available for distribution to Taxpayer A and Taxpayer B?

Answer

Yes

Question 3

If so will Taxpayer A and Taxpayer B be entitled to a tax offset pursuant to section 207-45 of the ITAA 1997?

Answer

Yes

Question 4

If so, are the tax offsets to Taxpayer A and Taxpayer B refundable tax offsets, pursuant to Division 67 of the ITAA 1997?

Answer

Yes

Question 5

If the answers to questions 1 to 4 are all “yes”, would the Commissioner exercise his discretion to make a determination under any of the following provisions to any of the relevant entities under the terms of the proposed scheme:

i.) section 177D of Part IVA of the ITAA 1936;

ii.) section 177E of Part IVA of the ITAA 1936;

iii.) section 177EA of Part IVA of the ITAA 1936;

iv.) Subdivision 204-D of the ITAA 1997;

v.) Subdivision 207-F of the ITAA 1997;

vi.) the 45 day holding period rule in Division 1A of former Part IIIAA of the ITAA 1936; or

vii.) section 100A of the ITAA 1936.

Answer

No

Question 6

Can Trust A and Trust B apply all carried forward prior year tax losses to the distributions Trust X proposes to make to them, for the purposes of determining their respective net income for tax purposes?

Answer

Yes

This ruling applies for the following period:

1 July 2017 to 30 June 2018

The scheme commences on:

During the income year ending 30 June 2018

Relevant facts and circumstances

Company X

Company X has not traded for a number of years but has significant retained profits as the recipient of distributions from trusts from within the family group of Taxpayer A and Taxpayer B. The sole shareholder of Company X is Trust X and Taxpayer A is the sole director.

Trust X

Taxpayer A and Taxpayer B are two of three directors and shareholders in the trustee company for Trust X. The third director and shareholder in the trustee company for Trust X is another family member.

Trust X is an elected family trust for the purposes of Schedule 2F to ITAA 1936.

Trust A and Trust B

The respective directors and shareholders of the trustee companies for Trust A and Trust B are the children of Taxpayer A and Taxpayer B.

Trust A and Trust B are both elected family trust for the purposes of Schedule 2F to ITAA 1936, and have been part of the same family trust group at all times since their inception. The test individual in both trusts is Taxpayer A, who is also the test individual for Trust X.

The trust deeds of Trust A, Trust B and Trust X have been recently amended to modify the definition of income, and give the trustee additional powers to characterise income in the books of account of the trust, allocate losses and distribute different categories of income or capital to nominated beneficiaries.

Trust A and Trust B operate a business by way of X partnership (the Partnership Business) with each of them having a 50% stake in the partnership.

The Partnership Business has generated tax losses over a number of years and as a consequence both Trust A and Trust B will have carried forward trust losses.

Taxpayer A & B

Taxpayer A is the controller of Trust X and has regularly received distributions from Trust X in the past. Taxpayer A has also received distributions from Trust A and Trust B in the past.

Taxpayer B is Taxpayer A’s spouse and has regularly received distributions from Trust X in the past.

Taxpayer A has made loans to each of Trust A and Trust B (the Loans), which they have applied towards the working capital of the Partnership Business. Interest is not charged on the Loans which are currently ‘at call’. There are no written loan agreements in place between the parties.

Proposed Distribution

The proposed scheme involves the following:

i.) Company X will declare a dividend (most of its retained profits), to Trust X in the 2018 financial year.

ii.) Trust X will distribute all of its net income for the 2018 year (containing the above franked distribution) 50% to Trust A; and 50% to Trust B.

iii.) Trust A proposes to recoup most, but not all of its trust losses from the franked distribution it receives from Trust X, leaving net trust income for distribution purposes. Trust A would make Taxpayer A entitled to 100% of the net trust income.

iv.) Trust B proposes to recoup most, but not all of its trust losses from the franked distribution it receives from Trust X, leaving net trust income for distribution purposes. Trust B would make Taxpayer B entitled to 100% of the net trust income.

Subsequently:

● the franked distribution will initially create a debt owed by Company X to Trust X (Company X Receivable);

● Company X and Trust X will set-off most of the Company X Receivable, against the UPE owed by Trust X to Company X. That will eliminate the pre 2009 UPE owed by Trust X to Company X;

● Trust X will assign 50% of the remaining Company X Receivable, to Trust A. Trust A and Company X will set this off directly against part of the UPE owed by Trust A to Company X. (Thus reducing part of Trust A’s pre 2009 UPE to Company X); and

● Trust X will assign the remaining Company X Receivable, to Trust B. Trust B and Company X will set this off directly against part of the UPE owed by Trust B to Company X. (Thus reducing part of Trust B’s pre 2009 UPE to Company X).

Relevant legislative provisions

Income Tax Assessment Act 1997 section 8-1

Income Tax Assessment Act 1997 section 36-15

Income Tax Assessment Act 1997 Division 67

Income Tax Assessment Act 1997 section 67-25

Income Tax Assessment Act 1997 subsection 67-25(1)

Income Tax Assessment Act 1997 subsection 67-25(1A)

Income Tax Assessment Act 1997 subsection 67-25(1E)

Income Tax Assessment Act 1997 Division 204

Income Tax Assessment Act 1997 Subdivision 204-D

Income Tax Assessment Act 1997 subsection 204-30(1)

Income Tax Assessment Act 1997 subsection 204-30(3)

Income Tax Assessment Act 1997 paragraph 204-30(6)(a)

Income Tax Assessment Act 1997 paragraph 204-30(6)(b)

Income Tax Assessment Act 1997 paragraph 204-30(6)(e)

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

Income Tax Assessment Act 1997 paragraph 204-30(8)(a)

Income Tax Assessment Act 1997 paragraph 204-30(8)(b)

Income Tax Assessment Act 1997 paragraph 204-30(8)(c)

Income Tax Assessment Act 1997 paragraph 204-30(8)(d)

Income Tax Assessment Act 1997 paragraph 204-30(8)(f)

Income Tax Assessment Act 1997 subsection 204-30(7)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 Subdivision 207-F

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 paragraph 207-50(1)(a)

Income Tax Assessment Act 1997 paragraph 207-50(1)(b)

Income Tax Assessment Act 1997 subsection 207-50(3)

Income Tax Assessment Act 1997 paragraph 207-50(3)(a)

Income Tax Assessment Act 1997 paragraph 207-50(3)(b)

Income Tax Assessment Act 1997 paragraph 207-50(3)(c)

Income Tax Assessment Act 1997 subsection 207-50(5)

Income Tax Assessment Act 1997 section 207-55

Income Tax Assessment Act 1997 subsection 207-55(2)

Income Tax Assessment Act 1997 subsection 207-55(3)

Income Tax Assessment Act 1997 subsection 207-57(1)

Income Tax Assessment Act 1997 subsection 207-57(2)

Income Tax Assessment Act 1997 section 207-70

Income Tax Assessment Act 1997 subsection 207-70(1)

Income Tax Assessment Act 1997 subsection 207-70(2)

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

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

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

Income Tax Assessment Act 1997 section 207-150

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

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

Income Tax Assessment Act 1997 Subdivision 210-H

Income Tax Assessment Act 1997 subsection 960-120(1)

Income Tax Assessment Act 1936 subsection 92(2)(a)

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

Income Tax Assessment Act 1997 section 100A

Income Tax Assessment Act 1997 subsection 100A(1)

Income Tax Assessment Act 1997 subsection 100A(7)

Income Tax Assessment Act 1997 subsection 100A(8)

Income Tax Assessment Act 1997 subsection 100A(9)

Income Tax Assessment Act 1997 subsection 100A(13)

Income Tax Assessment Act 1936 subsection 92(2)(a)

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

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 subsection 177E(1)

Income Tax Assessment Act 1936 subparagraph 177E(1)(a)(j)

Income Tax Assessment Act 1936 paragraph 177E(1)(f)

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

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 subsection 177EA(14)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 Schedule 2F

Income Tax Assessment Act 1936 Subdivision 207-B

Income Tax Assessment Act 1936 Division 270

Reasons for decision

Question 1

Summary

The payment of the franked dividend from Company X with those dividends then flowing indirectly to the relevant beneficiaries of Trust A and Trust B will have the result that each of Taxpayer A and Taxpayer B will have a share of the franking credits and a corresponding entitlements to a franking credit offset.

Detailed reasoning

Subdivision 207-B of the ITAA 1997 sets out the effect of an entity receiving a franked distribution through one or more interposed partnerships or trusts. In certain circumstances, a franked distribution to a trust is treated as flowing indirectly to a beneficiary of the trust (or through the trust as an interposed entity).

Paragraph 207-50(1)(a) of the ITAA 1997 directs attention to (relevantly) subsection 207-50(3) of the ITAA 1997 to determine when a franked distribution flows indirectly to beneficiaries.

Flows indirectly to trustees of Trust A and Trust B

Subsection 207-50(3) of the ITAA 1997 prescribes that a franked distribution will be taken to flow indirectly to a beneficiary of a trust in a particular income year if:

(a) a franked distribution was made to the trustee of the trust; and

(b) during that income year, the beneficiary has a share of the trust’s net income under subsection 97(1)(a) of the ITAA 1936 (whether or not the share amount becomes assessable income in the hands of the beneficiary); and

(c) the beneficiary’s share of the franked distribution under section 207-55 of the ITAA 1997 is a positive amount (whether or not the beneficiary actually receives any of that share).

Distribution made to trustee of Trust X

Under the proposed scheme, paragraph 207-50(3)(a) of the ITAA 1997 is satisfied.

Beneficiaries of that trust (trustees of Trust A and Trust B) have share amounts

Under the proposed scheme, paragraph 207-50(3)(b) of the ITAA 1997 is satisfied as a share (half) of the net income of Trust X is included in the assessable income of Trust A and Trust B in working out the net incomes of those trusts.

The beneficiaries' shares of the distribution is a positive amount

The trustee beneficiaries’ shares of the distribution are calculated under section 207-55(4) per item 3 of the table in subsection 207-55(3) of the ITAA 1997. Each beneficiary has a share of the distribution of 50%.

Flows indirectly through Trust A and Trust B to Taxpayer A and Taxpayer B

Applying subsection 207-50(3) of the ITAA 1997 a second time allows one to conclude that the franked distribution also flows indirectly to Taxpayer A and Taxpayer B.

Paragraph 207-50(3)(a) is satisfied as the franked distribution flowed indirectly to the trustee of Trust X because of a previous application of subsection 3.

Paragraph 207-50(3)(b) is satisfied as a share (all) of the net income of the Trust A is included in the assessable income of Taxpayer A and similarly all of the net income of the Trust B is included in the assessable income of Taxpayer B.

As to paragraph 207-50(3)(c), applying item 4 to the table in subsection 207-55(3), Taxpayer A and Taxpayer B, each have a positive share of the distribution. In particular, each have a share of 50% (being 100% of the share of the respective shares of Trust A and Trust B).

By way of further explanation, in the context of Item 4, the trustees for Trust A and Trust B are the intermediary entities and Taxpayer A and Taxpayer B are the focal entities. The shares of Taxpayer A and Taxpayer B in the franked distribution are based on the respective shares of the trustee of Trust A and Trust B already calculated. As regards Taxpayer A, the question is how much of Trust A’s share of the distribution is attributable to Taxpayer A having regard to the trust deed and any other relevant circumstances.

In this case, while Trust A and Trust B have deductions and prior year losses which would be set off against the portion of the franked distribution flowing through the trusts, both Trust A and Trust B will still have distributable net trust income and net taxable income for the year. As all of the distributable income of the Trust A goes to Taxpayer A, all of Trust A’s share of the distribution is attributable to Taxpayer A. As a result Taxpayer A’s share of the distribution is 50%. Likewise, Taxpayer B’s share of the distribution is 50%.

By reason of each having a 50% share of the franked distribution, Taxpayer A and Taxpayer B likewise have a 50% share of the franking credit calculated under subsection 207-57(2) of the ITAA 1997.

Question 2

The rules in Subdivision 207-B of the ITAA 1997 have the effect that Taxpayer A and Taxpayer B each have a 50% share of the distribution made by Company X to Trust X albeit a portion of the distribution was offset by losses at the levels of Trust A and Trust B. As regards Taxpayer A, this is because Trust A has a positive net income (all of which is included in the assessable income of Taxpayer A) and all of Trust A’s share of the distribution is attributable to Taxpayer A as a matter of fact. Similar reasoning applies to Taxpayer B.

Question 3

Summary

Taxpayer A and Taxpayer B will be entitled to a tax offset pursuant to section 207-45 of the ITAA 1997. The trustee of neither Trust A and Trust B is entitled to an offset.

Detailed reasoning

Section 207-45 of the ITAA 1997 provides (relevantly):

An entity to whom a *franked distribution *flows indirectly in an income year is entitled to a *tax offset for that income year that is equal to its *share of the *franking credit on the distribution, if it is:

(a) an individual; or

(b) ….

Under the proposed scheme, each of the relevant beneficiaries are resident individuals to whom a franked distribution flows indirectly and are therefore entitled to a tax offset that is equal to their respective share of the franking credit on the distribution.

The trustee of neither Trust A nor Trust B is entitled to an offset. While the franked distribution flows to each of the trustees indirectly in certain shares, a trustee can only be entitled to an offset under section 207-45 of the ITAA 1997 if the trustee is liable to be assessed on a share of, or all or a part of, the trust's net income under section 98, 99 or 99A of the ITAA 1936, which is not the case for either the trustee of the Trust A or Trust B.

Question 4

Summary

The tax offsets for Taxpayer A and Taxpayer B will be refundable tax offsets pursuant to Division 67 of the ITAA 1997.

Detailed reasoning

Division 67 of the ITAA 1997 deals with refundable tax offsets and section 67-25 deals specifically with franked distributions.

Subsection 67-25(1) of the ITAA 1997 states that tax offsets available under Division 207 of the ITAA 1997 are subject to the refundable tax offset rules, unless otherwise stated in this section.

Pursuant to section 67-25 of the ITAA 1997, and Item 40 of the table in subsection 63-10(1), to the extent that Taxpayer A and Taxpayer B have tax offsets which exceed their respective income tax liability, Taxpayer A and Taxpayer B would be entitled to a refund, as none of the exclusions in subsections 67-25(1A) to 67-25(1E) of the ITAA 1997 inclusive are applicable under the proposed scheme.

Question 5

Summary

The proposed scheme is not by way of or in the nature of dividend stripping (or has substantially the effect of such a scheme) and is not otherwise a scheme to manipulate the imputation system. The tax consequences associated with dividend stripping arrangements, or imputation system manipulation arrangements, will not arise in this case.

Section 100A of the ITAA 1936 also will not apply to the proposed arrangement.

Detailed reasoning

Section 177E of Part IVA of the ITAA 1936

Subsection 177E(1) of the ITAA 1936 states:

Where:

(a) as a result of a scheme that is, in relation to a company:

(i) a scheme by way of or in the nature of dividend stripping; or

(ii) a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping;

any property of the company is disposed of;

(b) in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder of another person) of profits of the company (whether of the accounting period in which the disposal occurred or of any earlier or later accounting period);

(c) if, immediately before the scheme was entered into, the company had paid a dividend out of profits of an amount equal to the amount determined by the Commissioner to be the amount of profits the distribution of which is, in his or her opinion, represented by the disposal of the property referred to in paragraph (a), an amount (in this subsection referred to as the notional amount) would have been included, or might reasonably be expected to have been included, by reason of the payment of that dividend, in the assessable income of a taxpayer of a year of income; and

(d) the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

the following provisions have effect:

(e) the scheme shall be taken to be a scheme to which this Part applies;

(f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

(g) the amount of that tax benefit shall be taken to be the notional amount.

Relevantly, the payment of a dividend constitutes a disposal of property as provided in paragraph 177E(2)(a) of the ITAA 1936.

Scheme

A scheme 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 proceedings; and

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

In this case, there is a scheme for the purposes of subsection 177A(1) of the ITAA 1936.

By way of or in the nature of dividend stripping (subparagraph 177E(1)(a)(i) of the ITAA 1936

The first limb requires that there be a scheme by way of or in the nature of dividend under which property of the company is disposed of.

The franked dividend proposed to be made by under this scheme would constitute a disposal of property by Company X in favour of Trust X for the purposes of section 177E of the ITAA 1936.

The term 'dividend stripping' is not defined in the legislation. The Courts have identified a number of common characteristics that indicate a traditional dividend strip. These common characteristics were surmmarised in the Full Federal Court in FC of T v Consolidated Press Holdings Limited (No 1) [1999] FCA 1199 (CPH Case) and confirmed in Lawrence v FC of T [2009] FCAFC 29 (Lawrence Case) to include:

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

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

● the payment of a dividend to the purchaser or allottee of the shares out of the target company’s profits;

● the purchaser escaping Australian income tax on the dividend; and

● the vendor shareholders receiving a capital sum for their share in an amount the same as or very close to the dividends paid to the purchasers.

A further common characteristic identified by the Courts was that the scheme was carefully planned with all parties acting in concert for the predominant or sole purpose of the vendor shareholders avoiding tax on a distribution of dividends.

Taxation Ruling IT 2627 Income Tax: Application of Part IVA to dividend stripping arrangements (IT 2627) sets out the Commissioner's view on what constitutes dividend stripping. The Commissioner sets out the typical elements of a traditional dividend strip at paragraph 9 of IT 2627 is reflective of those identified by the Courts.

While the Commissioner states at paragraph 10 of IT 2627 that no exhaustive list can be given of what constitutes a dividend strip for the purposes of section 177E of the ITAA 1936, the ruling expresses the view that a key element is the release of profits of a company to shareholders in a non-taxable form.

In the circumstances of this case, the common characteristics of a dividend strip identified by the Courts are not present. Relevantly, there is no sale or allotment of shares in the target company to another party and subsequent dividend payment on those shares. Rather, Company X will be paying a dividend to its only ordinary shareholder with no new shareholders being introduced. The income attributable to that dividend will then be distributed through existing entities in the family group in a manner consistent with past patterns of distributions. There will be no accompanying alteration to the trust deeds and no introduction of additional beneficiaries to the pre-existing trusts.

Objectively, the apparent purpose for distributing the retained earnings from Company X now is that put forward by the taxpayer: to strengthen the balance sheet of Trust A and Trust B for commercial purposes by reducing its intragroup debt, and reducing the risk of future Division 7A implications by eliminating UPEs between Trust X and Company X.

It therefore may be concluded that, objectively, the scheme is not being carried out with a sole or dominant purpose of avoiding tax on a distribution of dividends.

The proposed scheme is therefore not a scheme by way of or in the nature of dividend stripping.

Scheme having substantially the effect of a scheme by way of or in the nature of a dividend strip

The second limb requires property of the company to be disposed of under a scheme having substantially the effect of a scheme by way of or in the nature of a dividend strip. A sole or dominant purpose of tax avoidance remains needed.

As explained above, in the particular facts of this case, a sole or dominant purpose of tax avoidance is not present.

Therefore, the proposed scheme is not a scheme having substantially the effect of a scheme by way of or in the nature of a dividend strip.

Conclusion

Neither the first or second limb of paragraph 177E(1)(a) of the ITAA 1936 is satisfied. As such, the proposed scheme is not considered to constitute a dividend strip or to have the effect of a dividend strip.

Section 177EA of Part IVA of the ITAA 1936

Section 177EA of the ITAA 1936 is a general anti-avoidance rule that is intended 'to prevent abuse of the imputation system through franking credit trading schemes which circumvent the basic rules for the franking of dividends’.

Subsection 177EA(3) of the ITAA 1936 states:

This section applies if:

(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.

Where these conditions are satisfied, the Commissioner has a discretion to either cancel the imputation benefits that would otherwise arise for the relevant taxpayer that receives a franked distribution, or (in certain circumstances) to make a franking debit determination for a corporate tax entity that makes a franked distribution.

A scheme for a disposition of membership interests includes a scheme under which membership interests are issued as per paragraph 177EA(14)(a) of the ITAA 1936.

Paragraph 177EA(14)(a) states:

A scheme for a disposition of membership interests or an interest in membership interests includes, but is not limited to, a scheme that involves any of the following:

(a) issuing the membership interests or creating the interest in membership interests;

(b) entering into any contract, arrangement, transaction or dealing that changes or otherwise affects the legal or equitable ownership of the membership interests or interest in membership interests;

(c) creating, varying or revoking a trust in relation to the membership interests or interest in membership interests;

(d) creating, altering or extinguishing a right, power or liability attaching to, or otherwise relating to, the membership interests or interest in membership interests;

(e) substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding or owning the membership interests or having the interest in membership interests;

(f) the membership interests or interest in membership interests beginning to be included, or ceasing to be included, in any of the insurance funds of a life assurance company.

Under the proposed scheme, there will be dividends which are capable of being franked and will be franked. Trust A and Trust B will then distribute the franked distributions to the relevant beneficiaries.

However, at no time before or after the proposed distributions has there been a disposition of membership interests or interests in membership interests in Company X as required under subsection 177EA(14) of the ITAA 1936.

The only changes that have been recently made are in relation to the powers of the trustee in each of the Deeds of Variation executed for Trust X, Trust A and Trust B.

The changes to the Trust X, Trust A and Trust B deeds modify the definition of trust income and provide the relevant trustees with a greater ability to characterise income and deal with income according to its character. They do not have any effect on the underlying membership interests in Company X.

Accordingly, the proposed scheme does not involve a disposition of membership interests and paragraph 177EA(3)(a) of the ITAA 1936 is not satisfied. Therefore section 177EA of the ITAA 1936 does not apply.

Section 177D of Part IVA of the ITAA 1936

A scheme will be one to which Part IVA applies by operation of section 177D of the ITAA 1936 if a taxpayer has obtained a tax benefit in connection with the scheme and it would be concluded that the dominant purpose of a person who entered into or carried out the scheme (or a part of the scheme) was to obtain a tax benefit.

Section 177D of Part IVA of the ITAA 1936 states:

This Part applies to any scheme that has been or is entered into after 27 May 1981, and to any scheme that has been or is carried out or commenced to be carried out after that date (other than a scheme that was entered into on or before that), whether the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia, where:

(a) a taxpayer (in this section referred to as the ‘relevant taxpayer’ has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme; and

(b) having regard to:

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

(ii) the form and substance of the scheme;

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

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

(v) 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;

(vi) any change in the financial position of any other 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;

(vii) any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and

(viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

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 the purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme or of enabling the relevant taxpayer and another taxpayer or other taxpayers each to obtain a tax benefit in connection with the scheme (whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers).

In the circumstances of this case, the proposed scheme does not involve:

● the establishment of any new entities;

● the introduction of any new shareholders; or

● the creation of any new class or type of shares.

As discussed above, the form and nature of the proposed scheme is consistent with the objective dominant purpose of the parties to the scheme being to:

● significantly reduce the indebtedness of Trust A and Trust B;

● recoup most of the carried trust losses for Trust A and Trust B;

● strengthen the balance sheet of Trust A and Trust B for commercial reasons as well as to improve the financial position of the Partnership Business;

● eliminate all unpaid present entitlements (UPE) between Trust X and Company X; and

● eliminate the pre-2009 UPE and allow Trust X to make any future loans without any Division 7A implications.

Therefore an objective dominant purpose of tax avoidance is not present in the case of the proposed scheme. Consequently, the proposed arrangement is not a scheme to which Part IVA applies by operation of section 177D.

Subdivision 204-D of the ITAA 1997

Subdivision 204-D of the ITAA 1997 aims to prevent the inappropriate streaming of imputation benefits to one member of a corporate tax entity in preference to another. Subsection 204-30(1) of the ITAA 1997 states:

This section empowers the Commissioner to make determinations if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, in such a way that:

(a) an imputation benefit is, or apart from this section would be, received by a *member of the entity as a result of the distribution or distributions; and

(b) the member would *derive a *greater benefit from franking credits than another member of the entity; and

(c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits.

The member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member.

A distribution is defined in subsection 960-120(1) of the ITAA 1997 as a dividend or something taken to be a dividend under the Act.

Where the above is present, the Commissioner can make a determination to either debit the franking account of the entity or that no imputation benefit is to arise in relation to the distribution made to the favoured member under subsection 204-30(3) of the ITAA 1997.

● An imputation benefit is (relevantly) received as a result of a distribution where a member:• is entitled to a tax offset under Division 207 of the ITAA 1997 (paragraph 204-30(6)(a) of the ITAA 1997); or

● • includes an amount in assessable income as a result of the distribution by virtue of section 207-35 of the ITAA 1936 (paragraph 204-30(6)(b) of the ITAA 1997);

● • or the member is not liable to pay withholding tax on the distribution because of paragraph 128B(3ga) of the ITAA 1936 (paragraph 204-30(6)(e) of the ITAA 1997).

A favoured member receives a greater benefit from franking credits than another member pursuant to subsection 204-30(8) of the ITAA 1997 where:

● the other member is a foreign resident (paragraph 204-30(8)(a) of the ITAA 1997);

● the other member is not entitled to a tax offset under Division 207 because of the distribution (paragraph 204-30(8)(b) of the ITAA 1997);

● the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled (paragraph 204-30(8)(c) of the ITAA 1997);

● is a corporate tax entity but no franking credit arises as a result of the distribution (paragraph 204-30(8)(d) of the ITAA 1997);

● is a corporate tax entity that cannot utilise franking credits because it is not a franking entity or is unable to make frankable distributions (paragraph 204-30(8)(e) of the ITAA 1997); or

● is an exempting entity (paragraph 204-30(8)(f) of the ITAA 1997).

However, subsection 204-30(7) of the ITAA 1997 states the above list should not be considered as exhaustive of the circumstances in which one member receives a greater benefit from franking credits than another.

Under the proposed scheme, Trust A and Trust B have the authority to direct the franked dividend from Company X to Taxpayer A and Taxpayer B respectively and in equal proportion and the ultimate beneficiaries who may derive a benefit from the dividend income passed through Trust X, Trust A and Trust B are all resident individuals. The scheme does not involve one member deriving a greater benefit from franking credits by way of an inappropriate streaming.

Accordingly, Subdivision 204-D of the ITAA 1997 has no application to the proposed scheme.

Subdivision 207-F of the ITAA 1997 and the 45 day holding period rule

Subdivision 207-F of the ITAA 1997 applies where the imputation system has been manipulated in a manner not permitted under the income tax law.

Relevantly, where a franked distribution is made to an entity and that entity is not a qualified person (for the purposes of Division 1A of former Part IIIA of the ITAA 1936) in relation to the distribution as stated at paragraph 207-145(1)(a) of the ITAA 1997, the following consequences arise:

● the franking credit is not included in the entity's assessable income (paragraph 207-145(1)(f) of the ITAA 1997);

● the entity is not entitled to a tax offset (paragraph 207-145(1)(g) of the ITAA 1997); and

● where the distribution flows indirectly through the entity to another entity, that entity also will not include the franking credits in assessable income or be entitled to the tax offset (paragraph 207-145(1)(h) of the ITAA 1997).

Section 207-150 of the ITAA 1997 is couched in similar terms and applies to a distribution that flows indirectly to an entity. Relevantly, where a franked distribution flows indirectly to an entity that is not a qualified person (for the purposes of Division 1A of former Part IIIA of the ITAA 1936) as stated at paragraph 207-150(1)(a) of the ITAA 1997, the following consequences arise:

● in the case of a beneficiary of a trust, an amount equal to the lesser of the share of the distribution or the share of the franking credits on the distribution will be deducted (subsection 107-150(3) of the ITAA 1997);

● the entity is not entitled to a tax offset (paragraph 207-150(1)(g) of the ITAA 1997); and

● where the distribution flows indirectly through the entity to another entity, that entity will also not include the franking credits in assessable income or be entitled to a tax offset (paragraph 207-150(1)(h) of the ITAA 1997.

For a beneficiary of a non-widely held trust to be a qualified person for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 (specifically, former section 160APHO of the ITAA 1936), they must hold their interest in shares on which a dividend has been paid at risk for not less than 45 days during the primary qualification period where no related payments have been made. (Trust X, Trust A and Trust B are non-widely held trusts for the purposes of Division 1A as they do not meet the definition of widely held trust in former section 160APHD.)

In circumstances where the franked distribution flows through a number of trusts, the holding period rule must be satisfied at both the trustee and beneficiary level (as former section 160APHU of the ITAA 1936 provides that a beneficiary cannot be a qualified person unless the trustee is also a qualified person).

Shares are held ‘at risk’ if the taxpayer’s net position on that day in relation to the shares has at least 30% of the risks and opportunities associated with holding the shares (i.e. a delta of at least +0.3: former subsection 160APHM(2) of the ITAA 1936).

The shares in Company X have been held for longer than 45 days. In this case, Trust X, Trust A and Trust B have all made family trust elections. The result is that the trustees of Trust X, Trust A and Trust B will be qualified persons in respect of the dividend paid by Company X, as will Taxpayer A and Taxpayer B (Taxpayer A and Taxpayer B being treated under section 160APHL as having a net position of delta +1 in relation to their interest in the shares held by Trust X via their interests in Trust A and Trust B).

‘Dividend stripping operation’

Section 207-155 of the ITAA 1997 defines ‘dividend stripping operation’ in similar terms to section 177E of the ITAA 1936. As the proposed arrangement is not considered to be a scheme ‘by way of or in the nature of dividend stripping’ for the purposes of section 177E, it follows that it is also not a ‘dividend stripping operation’ for the purposes of section 207-155 of the ITAA 1997.

Section 100A of the ITAA 1936

Subsection 100A(1) of the ITAA 1936 states that where a beneficiary of a trust (who is not under a legal disability), is presently entitled to income of the trust and the present entitlement is linked either directly or indirectly to a reimbursement agreement, the beneficiary shall be deemed not to be, and never to have been, presently entitled to the trust income.

Under subsections 100A(7) and 100A(13) of the ITAA 1936, a reimbursement agreement is an arrangement entered into otherwise than in the course of ordinary family or commercial dealings that provides for the payment of money (including the payment of money by way of loan) or the transfer of property to a person or persons other than the beneficiary.

To be a reimbursement agreement, it must also be the case that the agreement was entered into with a purpose to secure that someone had a lesser income tax liability.

Section 100A does not apply in the present case as there is no evident relevant tax-avoidance purpose and the lack of artificiality and contrivance in the arrangement is consistent with it being an arrangement entered into in the course of ordinary family or commercial dealings.

Question 6

Summary

Trust A and Trust B can apply all carried forward prior year tax losses to the distribution Trust X proposes to distribute to them for the purposes of determining their respective net income for tax purposes.

Detailed reasoning

Schedule 2F of the ITAA 1936

Schedule 2F of the ITAA 1936 deals with trust losses and other deductions.

Division 270 of Schedule 2F provides that a trust will be unable to deduct a loss or other allowable deduction, if:

● a deduction is allowable to the trust for the income year

● there is a 'scheme' under which:

● the trust derives assessable income

● a person not connected with the trust (an outsider) provides a 'benefit' (directly or indirectly) to the trustee or a beneficiary (or an associate), and

● the trustee or a beneficiary (or an associate) provides a benefit to the outsider, and

● it is reasonable to conclude that the any of the three aspects of the scheme was carried out wholly or partly, but not merely incidentally, because the deduction would be allowable.

In this case, the dividend will be distributed through existing entities in the family group to beneficiaries who have received distributions from those entities in the past. There will be no introduction of new entities or additional beneficiaries to the pre-existing trusts, and therefore there will not be any benefit provided by or to an outsider. Accordingly, Division 270 of Schedule 2F to the ITAA 1936 will not apply, and will not prevent Trust A and Trust B from applying their carried forward prior year tax losses.

Trust A and Trust B have at all relevant times since incurring the tax losses, been part of a family group and are excepted trusts for the purposes of Schedule 2F of the ITAA 1936, under a FTE with Taxpayer A as the test individual. Accordingly, no other provision in Schedule 2F will deny Trust A and Trust B a deduction in respect of their carried forward tax losses, including losses arising as a result of their partnership interests in the Partnership Business.