Edited version of your written advice

Authorisation Number: 1051428368704

Date of advice: 19 September 2018

Ruling

Subject: Dividend stripping

Question 1

Will the proposed transaction be considered:

(a) a dividend stripping operation under section 207-155 of the Income Tax Assessment Act 1997 (ITAA 1997); or

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

Answer

(a) No

(b) No

Question 2

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

Answer

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Individual X is the sole director and shareholder of Company X.

Company X has retained profits and substantial franking credits.

The proposed transaction

It is proposed to establish a new company (New Co) with 100% of the shares in New Co held by Individual X.

Individual X intends to transfer 100% of his shares in Company X to New Co in exchange for shares in New Co.

Individual X will choose to obtain rollover relief under Subdivision 122-A of the ITAA 1997 to defer the tax consequences of the share disposal

After the share transfer occurs, a fully franked dividend representing the accumulated profits will be paid to New Co.

Reason for proposed transaction

The intention is to retain the accumulated profits within New Co, from which New Co may at a later time make other investments and/or withdraw funds in the form of dividends.

The reason for undertaking the share transfer is to allow the retained profits to be distributed to New Co so that it can provide loans/investments/cash assets separated from the development entity.

New Co may use those funds to make investments, provide loans, or pay dividends to Individual X.

Individual X will not be paid a dividend under the proposed transaction. Dividends may be paid from New Co to Individual X in future income years.

Company X is considered to be an ‘at-risk’ entity for any potential claims made against it. The accumulated profits have built up over many years and form the basis of Company’s cash reserves. Those assets would be at risk in the event of action taken against the company. By paying a dividend to New Co the cash reserves will now be sitting in New Co which would provide a level of protection against claims made on Company X.

New Co will not be undertaking trading activities.

There are no plans to sell or liquidate Company X.

Other matters

All Division 7A of the ITAA 1936 consequences have been considered and will be maintained and satisfied as a result of the proposed transaction

The shares issued in New Co will be ordinary class shares.

Further dividends will be paid in future years from Company X to New Co.

Company X will be funded going forward through development contracts or loans.

All entities are Australian tax residents for tax purposes

No entity covered by the ruling has any tax losses.

Relevant legislative provisions

Income Tax Assessment Act 1997, section 207-155

Income Tax Assessment Act 1997, section 207-145

Income Tax Assessment Act 1936, section 177A

Income Tax Assessment Act 1936, section 177C

Income Tax Assessment Act 1936, section 177E

Income Tax Assessment Act 1936, section 177F

Income Tax Assessment Act 1936, Part IVA

Reasons for decision

Question 1

Will the proposed transaction be considered:

(a) a dividend stripping operation under section 207-155 of the Income Tax Assessment Act 1997 (ITAA 1997); or

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

Summary

Section 207-155 of the ITAA 1997 or section 177E of the ITAA 1936 will not apply to the proposed scheme.

Detailed reasoning

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.

Section 177E of the ITAA 1936 applies where:

● property of a company is disposed of as a result of:

● a scheme by way of or in the nature of dividend stripping; or

● a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping; and

● in the Commissioner’s opinion, the disposal of property represents, in whole or in part, a distribution of profits of the company; and

● if, immediately before the scheme was entered into, the company had paid a dividend equal to the amount of the disposal of property, an amount (referred to as the notional amount) would have been included in the assessable income of a taxpayer of a year of income; and

● the scheme is entered into after 27 May 1981.

Where all of the above conditions are met, the scheme is taken to be a scheme to which Part IVA of the ITAA 1936 applies, and the taxpayer is taken to have obtained a tax benefit in connection with the scheme equal to the notional amount.

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.

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 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.

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.

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:

● 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.

In this case, the facts do not support a finding that the taxpayers have a predominant purpose of avoiding tax on the distribution of the dividend by Company X.

Conclusion on whether there is a dividend stripping scheme

The proposed transaction is not being carried out with a predominant purpose of avoiding tax. Absent this core feature, there is no scheme by way of or in the nature of dividend stripping, or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping.

Conclusion on application of section 177E

The proposed transaction does not satisfy all the conditions in paragraphs 177E(1)(a)-(d) of the ITAA 1936. Section 177E therefore does not apply to the proposed transaction.

Conclusion on application of section 207-155

It is considered that a ‘scheme…by way of, or in the nature of dividend stripping’ for the purposes of section 207-155 of the ITAA 1997 bears the same meaning as section 177E. For the same reasons set out above, the proposed transaction is not considered part of a dividend stripping operation under section 207-155.

Question 2

Is the proposed transaction a scheme to which Part IVA of the ITAA 1936 will apply?

Summary

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

Detailed reasoning

A scheme will be one to which Part IVA applies if a taxpayer has obtained a tax benefit in connection with the scheme and it would be concluded that the (objective) 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 (subsection 177D(1)).

As discussed above, a dominant purpose of tax avoidance is not present. Consequently, the proposed arrangement is not a scheme to which Part IVA applies.

As section 177D does not apply, the Commissioner would not be empowered to make a determination would not be made under subsection 177F(1) to cancel any tax benefit that may be obtained under the proposed arrangement.