Edited version of your written advice

Authorisation Number: 1051478166067

Date of advice: 31 January 2019

Ruling

Subject: Dividend access share arrangement

Question 1: Are A Class shares in Company A treated as equity interest under Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer: Yes

Question 2: Are there any tax consequences triggered as a result of the direct value shifting rules under Division 725 of the ITAA 1997 in respect of the A Class shares?

Answer: No

Question 3: Will payments of future dividends on the A Class shares be frankable distributions as defined in section 202-40 of the ITAA 1997?

Answer: Yes

Question 4: Will the dividend streaming provisions contained in Subdivision 204-D of the ITAA 1997 apply to the payment of future dividends on the A Class shares?

Answer: No

Question 5: Will Person A be entitled to a tax offset equal to the franking credits on the future dividends under subsection 207-20(2) of the ITAA 1997?

Answer: Yes

Question 6: Will the dividend stripping rules contained in Subdivision 207-F of the ITAA 1997 and section 177E of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the payment of future dividends on the A Class shares?

Answer: No

Question 7: Will the franking credit benefit trading rules in section 177EA of the ITAA 1936 applies to the payment of future dividends on the A Class shares?

Answer: No

Question 8: Will the payments of future dividends on the A Class shares constitute a scheme to which section 177D of the ITAA 1936 will apply such that the Commissioner will make a determination under section 177F of the ITAA 1936?

Answer: No

This ruling applies for the following period:

1 July 2018 – 30 June 2019

The scheme commences on:

1 July 2018

Relevant facts and circumstances

1. Company A is an Australian resident company.

2. The issued share capital of Company A consists of:

● Ordinary shares: held by other individuals, and

● A Class shares: held by Person A.

3. All shareholders are Australian residents for income tax purposes.

4. The A Class shares were issued upon incorporation together with the ordinary shares. No new classes of shares have been created and no new shares have been issued since incorporation.

5. A Class shares have the right to receive dividends at the discretion of the directors but no voting right, no right to participate in surplus profits or assets on the winding up of the company.

6. There have been no variations or changes to the rights attached to all the shares on issue since incorporation.

7. Dividend distributions have been made to Person A and other shareholders in approximately equal amounts.

8. All dividends paid have been fully franked and have not carried a variable franking credit percentage between particular classes.

9. Company A proposes to continue to make dividend distributions to Person A as the holder of the A Class shares together with other shareholders in equal proportions.

10. These dividends will be paid out of retained profits, be fully franked and not be funded from the share capital account.

Relevant legislative provisions

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 section 207-20

Income Tax Assessment Act 1997 Subdivision 204-F

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 subsection 725-50

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 section 974-20

Income Tax Assessment Act 1997 section 974-70

Income Tax Assessment Act 1997 section 974-75

Income Tax Assessment Act 1997 section 974-135

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

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177C

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Reasons for decision

Question 1

Summary: The A Class shares are treated as equity interest under Subdivision 974-C of the ITAA 1997

Detailed reasoning:

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.

A scheme will give rise to an equity interest in a company if the scheme 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

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).

The A Class shares are shareholder interests and therefore meet the equity test.

Debt test

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

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

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 not contingent on any event, condition or situation, other than the ability or willingness of that entity or connected entity to meet the obligation.

It is considered that there is no ENCO to provide a financial benefit with respect to the future dividends on A Class shares as they are paid at the discretion of the directors.

The A Class shares are, therefore, equity interest as they satisfy the equity test and do not satisfy the debt test.

Question 2

Summary: There are no tax consequences triggered as a result of the direct value shifting rules under Division 725 of the ITAA 1997 in respect of the A Class shares.

Detailed reasoning:

Pursuant to section 725-145 of the ITAA 1997, there is a direct value shift under a scheme involving equity interests in an entity (the target entity) if:

● there is a decrease in the market value of one or more equity interests in the target entity which is reasonably attributable to one or more things done under the scheme, occurring at or after the time when that thing, or the first of those things, is done (a down interest), and

● one or more equity interests in the target entity increases in market value and/or is issued at a discount to market value, and the increase and/or issue, is reasonably attributable to the thing done, or one or more of those things done, and occurs at or after the time the thing, or the first of those things, is done (an up interest).

The A Class shares were issued upon Company A’s incorporation and the voting, dividend and capital rights have never been changed. Therefore, a direct value shift under Division 725 does not occur.

Question 3

Summary: Future dividends on A Class shares are frankable distributions as defined in section 202-40 of the ITAA 1997.

Detailed reasoning:

Subsection 202-40(1) of the ITAA 1997 states that a distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45 of the ITAA 1997.

The future dividends will not fall into any of the categories of unfrankable distributions under section 202-45 of the ITAA 1997. Therefore, they are considered to be dividends capable of being franked under section 202-40 of the ITAA 1997.

Question 4

Summary: The dividend streaming provisions contained in Subdivision 204-D of the ITAA 1997 does not apply to the payment of future dividends on A Class shares.

Detailed reasoning:

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.

The Commissioner has the power to make a determination under section 204-30 of the ITAA 1997 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 franking credits; and other members receive lesser imputation or no imputation benefits. For the determination to be made, members to whom distributions are streamed must be in a position to derive a greater benefit from franking credits than other members.

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. The payments of dividends will not result in Person A’s deriving a greater benefit from franking credits than the holders of ordinary shares and do not meet any of the (non-exhaustive) examples listed in subsection 204-30(8) of situations where a member derive a greater benefit from franking credits than another member.

The payments of future dividends on A Class shares, therefore, will not constitute streaming for the purposes of Subdivision 204-D of the ITAA 1997.

Question 5

Summary: Person A will be entitled to a tax offset equal to the franking credits in respect of the future dividends under subsection 207-20(2) of the ITAA 1997.

Detailed reasoning:

As the future dividends will not fall into any of the categories of unfrankable distributions under section 202-45 of the ITAA 1997, they are considered to be dividends capable of being franked under section 202-40 of the ITAA 1997.

The franking credits attached to the distributions will form part of the assessable income of Person A under subsection 207-20(1) of the ITAA 1997.

Person A will be entitled to a tax offset equal to the franking credits under subsection 207-20(2) of the ITAA 1997.

Question 6

Summary: The dividend stripping rules contained in Subdivision 207-F of the ITAA 1997 and Section 177E of the ITAA 1936 do not apply to the payment of future dividends on A Class shares.

Detailed reasoning:

Subdivision 207-F of the ITAA 1997 creates the appropriate adjustment to cancel the effect of the gross-up and tax offset rules where the entity concerned has manipulated the imputation system in a manner that is not permitted under the income tax law.

Direct or indirect recipients of a franked distribution can be denied the benefits of franking credits in various situations, one of which is when the distribution is made as part of a dividend stripping operation (paragraphs 207-145(1)(d), 207-150(1)(e) of the ITAA 1997).

Dividend stripping operation in this context is defined in section 207-155 of the ITAA 1997 as:

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 same effect of a scheme by way of, or in the nature of, dividend stripping.

Section 177E of the ITAA 1936 operates to counter particular kinds of scheme which would otherwise effectively place company profits in the hands of shareholders in a tax-free form. 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 (paragraphs 177E(1)(e)-(g) of the ITAA 1936).

‘Dividend stripping’ is not defined in the ITAA 1936 and has been recognised by the courts as involving the following six characteristics:

● a target company, which has 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 so declared;

● the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax liability at the relevant time); and

● the scheme being carefully planned, with all the parties acting in concert, for the predominant if not sole purpose of the vendor shareholders avoiding tax on a distribution of dividends by the target company.¹

In the context of dividend access shares the Commissioner has expressed the view in Taxation Determination TD 2014/1² that section 177E of the ITAA 1936 applies to an arrangement with features of the type described in paragraph 4 of the Determination:

● A private company (the 'target company') has accumulated significant profits which have been subject to income tax at the company tax rate;

● The target company's ordinary shares are held by an individual, or individuals;

● The target company creates a new class of shares with rights to dividend distribution at the discretion of the directors and no voting rights or capital rights;

● The newly created shares are issued to a related entity;

● Profits are distributed as a dividend to the new shareholder;

● A series of transactions are entered into that have the effect of placing the accumulated profits in the hands of the original shareholders and/or their associates in a substantially tax-free or entirely tax-free form.

The application of section 177E of the ITAA 1936 depends on the facts of the particular case, and in particular whether there is an objective purpose of tax avoidance in respect of the scheme.

The payments of future dividends on A Class shares do not exhibit the above features. Accordingly, 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. Section 177E of the ITAA 1936, therefore, does not apply.

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 of the ITAA 1936. For the same reasons set out above, the payment of future dividends on A Class shares is not considered part of a dividend stripping operation under section 207-155 of the ITAA 1997.

Question 7

Summary: The franking credit benefit trading rules contained in section 177EA of the ITAA 1936 do not apply to the payments of future dividends on A Class shares.

Detailed reasoning:

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 person entering into a scheme is to enable a taxpayer to obtain an imputation benefit.

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

(a) There is a scheme for the 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 is expected to be payable, to a person in respect of membership interests…;

ii. …; 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… who entered into… 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.

Although frankable distributions are expected to be paid by Company A the arrangement to make payments of future dividends on A Class shares does not involve a disposition of membership interest nor is it implemented for a more than incidental purpose of enabling taxpayers to obtain an imputation benefit. Accordingly, section 177EA of the ITAA 1936 does not apply.

Question 8

Summary: The Commissioner will not make a determination under Section 177F of the ITAA 1936 in respect of the payments of future dividends on A Class shares.

Detailed reasoning:

A scheme will be one to which Part IVA of the ITAA 1936 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) of the ITAA 1936).

As discussed above, a dominant purpose of tax avoidance is not present. As section 177D of the ITAA 1936 does not apply, the Commissioner will not make a determination under subsection 177F(1) of the ITAA 1936 to cancel any tax benefit.