Edited version of your written advice

Authorisation Number: 1051506225091

Date of advice: 15 April 2019

Ruling

Subject: Sale of shares - Division 7A and Part IVA

Question 1

Would any deemed dividend to the Taxpayer pursuant to subsection 109C(1)(a) of the ITAA 1936 not be treated as a dividend as a result of the operation of section 109J of the ITAA 1936?

Answer

Yes

Question 2

Will the loan from Family Member Co 2 to Family Member Co 1 and subsequent payment to the Taxpayer give rise to a deemed dividend to the Taxpayer under section 109T of the ITAA 1936?

Answer

No

Question 3

Will section 109C of the ITAA 1936 apply to treat as dividends a payment made to the Taxpayer under the guarantee provided by Parent Co in the event that Parent Co is called upon to do so?

Answer

No

Question 4

Will the Commissioner confirm that the sale of shares in Parent Co by the Taxpayer is not part of a scheme to which the provisions of section 177E of the ITAA 1936 apply?

Answer

Yes

Question 5

Will the Commissioner confirm that the sale of shares in Parent Co by the Taxpayer is not part of a scheme to which the provisions of section 177F of the ITAA 1936 apply?

Answer

Yes

This ruling applies for the following period:

1 July 2018 to 1 July 2025

The scheme commences on:

1 July 2018

Relevant facts and circumstances

The corporate group consists of Parent Co and its subsidiaries.

Prior to the proposed transaction, the shareholding of Parent Co is as follows:

● The Taxpayer holds a minority shareholding interest; and

● A family member of the Taxpayer (‘Family Member’) holds a majority shareholding interest. The shares are held directly by the Family Member and indirectly through a company that the Family Member controls (‘Family Member Co 1’).

The shareholdings of the Taxpayer and Family Member in Parent Co were acquired prior to 20 September 1985.

The shares in Family Member Co 1 are held by the Trustee Co, as trustee for both the Taxpayer Trust and the Family Member Trust. The Taxpayer is an eligible beneficiary of Taxpayer Trust. Family Member is the sole shareholder and director of Trustee Co.

The assets of Parent Co and its subsidiaries consist of assets that:

● were acquired prior to 20 September 1985;

● were acquired on or after 20 September 1985 which are trading stock; and

● were acquired on or after 20 September 1985 which are not trading stock

A taxable gain will arise when CGT event K6 happens upon the Taxpayer disposing of her shares to Family Member Co.

Parent Co has paid dividends to the Taxpayer in the past, but not in recent years.

The Taxpayer has had minimal involvement in the business to date.

The Taxpayer has granted an option to Family Member to acquire all of the shares held by the Taxpayer in Parent Co, on the Taxpayer’s death. Family Member has granted a put option to the Taxpayer requiring Family Member’s estate to buy all of the Taxpayer’s shares in Parent Co in the event of the Family Member’s death. If the options are exercised, the Deed requires that the price payable for the Taxpayer’s shares is the market value of the shares at the date of death.

Proposed sale of the Taxpayer’s interests in Parent Co to Family Member Co 1

The Taxpayer has now agreed to sell their shares in Parent Co to Family Member Co, rather than waiting for events which will enable the options to acquire the Taxpayer’s shares to be exercised.

Reasons for the proposed sale

The Taxpayer has provided a number of reasons for the proposed sale.

Nature of dealing between the Taxpayer and Family Member in respect of the proposed sale

The Taxpayer has separately engaged advisers who are independent from those advising Family Member. Offers and counteroffers were made over a period of more than 12 months.

Proposed terms of sale

It is proposed that the consideration will be paid by Family Member Co 1 to the Taxpayer as follows:

● upon settlement, a cash sum will be paid. This amount will be funded from an interest bearing loan from another company, Family Member Co 2, that is owned and controlled by Family Member. The Taxpayer has no legal or beneficial interest in Family Member Co 2.

The funds will be borrowed by Family Member Co 2 under existing banking facilities and will be on-lent to Family Member Co 1 with interest charged; and

● the balance of the consideration will be paid by instalments with interest charged over a period of years.

The Taxpayer will have a right to claim on a guarantee provided by Parent Co in respect of the instalment payments.

Effective upon completion, the Taxpayer will have no further rights or obligations in respect of the options granted.

Funding of repayment of loan to Family Member Co 1 and future instalments

The repayment to Family Member Co 2 of the loan to Family Member Co 1 will be funded by dividends from Parent Co.

The instalment payments of the purchase price payable by Family Member Co 1 to the Taxpayer will be funded by dividends from Parent Co.

Dividends paid by Parent Co will be paid to all shareholders, including Family Member, in proportion to their shareholding.

To the extent that Parent Co is unable to pay dividends to fund the future instalments, Family Member Co 1 will borrow from Family Member Co 2 (or other entities controlled by Family Member from time to time) the amounts due.

Relevant legislative provisions

Income Tax Assessment Act 1936 (ITAA 1936)

Section 109C

Section 109J

Section 109T

Section 109V

Section 109Y

Section 177A

Section 177C

Section 177CB

Section 177D

Section 177E

Section 177F

Section 318

Income Tax Assessment Act 1997 (ITAA 1997)

Section 995-1

Reasons for decision

Question 1

The deemed dividend to the Taxpayer pursuant to subsection 109C(1)(a) of the ITAA 1936 will not be treated as a dividend as a result of the operation of section 109J of the ITAA 1936.

Detailed reasoning

Paragraph 109C(1)(a) in Division 7A of the ITAA 1936 treats an amount paid by a private company to an entity, being a shareholder or shareholder’s associate, as a dividend paid by the company.

Is there a payment for the purposes of subsection 109C(1)?

A payment to an entity for the purposes of Division 7A is defined in subsection 109C(3) as follows:

(a) a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and

(b) a credit of an amount to the extent that it is:

(i) to the entity; or

(ii) on behalf of the entity; or

(iii) for the benefit of the entity; and

(c) a transfer of property to the entity.

The consideration payable by Family Member Co 1 for the shares in Parent Co, comprising both the cash sum upon settlement and the subsequent instalment payments, will be payments to the Taxpayer within the meaning of paragraph 109C(3)(a).

Is the Taxpayer an associate of Trustee Co as trustee for both the Taxpayer and Family Member Trusts?

In order for Division 7A to apply, the payment must be made when the Taxpayer is either a shareholder or an associate of a shareholder of Family Member Co 1, the company making the payment. The shareholder of Family Member Co 1 is Trustee Co as trustee for the Taxpayer and Family Member Trusts. In order for Division 7A to apply, the Taxpayer must be an associate of Trustee Co.

The meaning of ‘associate’ is defined in section 318 of the ITAA 1936. Relevantly, subsection 318(3) provides that associates of a trustee may be:

(3) For the purposes of this Part, the following are associates of a trustee (in this subsection called the primary entity):

(a) any entity that benefits under the trust;

(b) if a natural person benefits under the trust--any entity that, if the natural person were the primary entity, would be an associate of that natural person because of subsection (1) or because of this subsection;

(c) if a company is an associate of the primary entity because of paragraph (a) or (b) of this subsection--any entity that, if the company were the primary entity, would be an associate of the company because of subsection (2) or because of this subsection.

As the Taxpayer is named as a potential beneficiary of the Taxpayer Trust (being one of the trusts of which Trustee Co is a trustee), they will be an entity that benefits under the trust within the meaning of paragraph 318(3)(a). Accordingly, the Taxpayer will be an associate of Trustee Co for the purposes of paragraph 109C(1)(a).

Prima facie, a deemed dividend arises to the Taxpayer pursuant to subsection 109C(1) of the ITAA 1936.

What is the amount taken to be paid, prima facie, as a dividend under section 109C?

Subsection 109C(2) provides that the dividend taken to be paid is equal to the amount paid, subject to the distributable surplus calculated in accordance with section 109Y.

However, the application of subsection 109C(2) is subject to the provisions of Subdivision D which deal with payments and loans that are not treated as dividends.

Are the payments made to the Taxpayer by Family Member Co 1 payments discharging pecuniary obligations and, therefore, not treated as dividends pursuant to section 109J of the ITAA 1936?

Section 109J provides an exception to a deemed dividend arising under Division 7A for payments of genuine debts. To the extent that the payments made to the Taxpayer

● discharge an obligation of Family Member Co 1 to pay money to the Taxpayer: paragraph 109J(a); and

● the payments are not more than would have been required to discharge the obligation had the parties been dealing with each other at arm’s length: paragraph 109J(b)

Family Member Co 1 will not be taken under section 109C to pay dividends to the Taxpayer.

On the facts, it is established that Family Member Co 1 will have an obligation to pay the Taxpayer the total consideration payable in respect of their shares in Parent Co.

Were the Taxpayer and Family Member Co 1 dealing at arm’s length for the purposes of paragraph 109J(b)?

The definition of “arm’s length” in section 995-1 of the ITAA 1997 provides that "in determining whether parties deal at arm's length, consider any connection between them and any other relevant circumstance." In the absence of any guidance in the statutory definition on the character and manner of dealings considered to be at arm’s length, it is necessary to have regard to the principles established in the case law with regard to the concept of “arm’s length dealing”.

The meaning of the expression “dealing with each other at arm’s length” was considered by the Federal Court in Trustee for the Estate of the Late A W Furse No 5 Will Trust v. Federal Commissioner of Taxation (1990) 21 ATR 1123 in the context of determining whether an amount was excluded from “excepted trust income” for the purposes of Division 6AA, as a result of being derived from non-arm’s length transactions. Hill J held that the issue of whether parties were dealing at arm’s length was not to be determined by reference to the relationship between the parties, but rather the quality of the dealing between them, observing as follows, at 1132:

The emphasis … is rather upon whether those parties, in relation to the agreement, dealt with each other at arm’s length. The fact that the parties are themselves not at arm’s length does not mean they may not, in respect of a particular dealing, deal with each other at arm’s length. That is not to say that the relationship between the parties is irrelevant to the issue to be determined …

What is required in determining whether parties dealt with each other in respect of a particular dealing at arm’s length is an assessment whether in respect of that dealing they dealt with each other at arm’s length as arm’s length parties would normally do, so that the outcome of their dealing is a matter of real bargaining. [emphasis added]

Similarly, in considering the meaning of the expression in the context of the former paragraph 160ZH(9)(c) that provided for the substitution of the consideration paid in a non-arm’s length transaction with the market value of an asset in calculating the cost base of an asset Lee J in Granby Pty Ltd v. Federal Commissioner of Taxation (1995) 30 ATR 400, at 402-404, was of the view that:

The expression “dealing with each other at arm’s length” involves an analysis of the manner in which the parties to a transaction conducted themselves in forming that transaction. What is asked is whether the parties behaved in the manner in which parties at arm’s length would be expected to behave in conducting their affairs.

… the term “at arm’s length” means, at least, that the parties to a transaction have acted severally and independently in forming their bargain. [emphasis added] Whether parties not at arm’s length have dealt with each other at arm’s length will be a matter of fact.

Whilst the Taxpayer and Family Member may not be parties at arm’s length by reason of their family relationship, the non-arm’s length nature of their relationship is not determinative of the issue of whether the particular dealing was at arm’s length.

The Commissioner considers that that the following circumstances surrounding the transaction support a conclusion that the Taxpayer and Family Member Co 1 acted in their own interests and severally and independently in forming their bargain:

● there has been an ongoing negotiating process between the Taxpayer and Family Member involving various offers and counteroffers over a period of more than 12 months; and

● the Taxpayer and Family Member have each engaged separate advisers to advise them on the legal and tax implications of the transaction.

There are no circumstances surrounding the transaction to indicate that either party exerted personal influence or control over the other party, or that no independent will had been exercised by one of the parties in the formation of the transaction.

As the Commissioner considers that the Taxpayer and Family Member are dealing with each other at arm’s length, it follows that the cash sum and instalment payments agreed upon by the parties as consideration payable for the Parent Co shares represent the consideration payable by parties dealing with each other at arm’s length and the payments are not, therefore, more than the arm’s length amount.

Accordingly, section 109J of the ITAA 1936 will operate to exclude the payments made by Family Member Co 1 to the Taxpayer from being treated as dividends under subsection 109C(1) of the ITAA 1936.

Question 2

The loan from Family Member Co 2 to Family Member Co 1 and subsequent payment to the Taxpayer will not give rise to a deemed dividend to the Taxpayer under section 109T of the ITAA 1936.

Detailed reasoning

Subdivision E in Division 7A of the ITAA 1936 comprises the rules applicable to interposed entities. Those rules treat payments and loans through interposed entities as giving rise to direct payments and loans under Subdivision B from a private company to a shareholder (or their associate) which are then taken to be dividends.

Subsection 109T(1) provides that the Division operates as if a private company makes a payment or loan to an entity as described in section 109V if:

(a) the private company makes a payment or loan to another entity (the first interposed entity) that is interposed between the private company and the target entity; and

(b) a reasonable person would conclude (having regard to all the circumstances) that the private company made the payment or loan solely or mainly as part of an arrangement involving a payment or loan to the target entity; and

(c) either:

(i) the first interposed entity makes a payment or loan to the target entity; or

(ii) another entity interposed between the private company and the target entity makes a payment or loan to the target entity.

Is there an amount that Family Member Co 2 is taken to have paid the Taxpayer that was paid through one or more interposed entities for the purposes of section 109V of the ITAA 1936?

Subsection 109V(1) provides that a private company is taken to have paid an amount determined by the Commissioner to a target entity when the target entity has been paid an amount by an interposed entity. In determining the amount of the payment under subsection 109V(2), the Commissioner must take account of:

(a) the amount the interposed entity paid the target entity; and

(b) how much (if any) of that amount the Commissioner believes represented

consideration payable to the target entity by the private company or any of the interposed entities for anything (assuming that the consideration payable equals that for similar transactions at arm’s length).

Under the proposed arrangement, Family Member Co 2 will borrow the cash sum amount under its existing banking facility and an interest bearing loan of that amount will be advanced by Family Member Co 2 to Family Member Co 1. Family Member Co 1 will use those funds to make an initial cash sum payment upon settlement, with the payment representing part of the purchase price for the Taxpayer’s Parent Co shares.

Paragraph 2 of Taxation Determination TD 2011/16 Income tax: Division 7A - payments and loans through interposed entities - factors the Commissioner will take into account in determining the amount of any deemed payment or notional loan arising under section 109T of the Income Tax Assessment Act 1936 sets out the relevant factors that the Commissioner will consider in determining the amount of any deemed payment under section 109T, as follows:

(a) the amount that an interposed entity referred to in subsection 109T(1) (an 'interposed entity') loaned or paid the target entity referred to in that subsection (target entity) under the arrangement described in that subsection (the arrangement);

(b) how much (if any) of the amount loaned or paid to the target entity by an interposed entity under the arrangement the Commissioner believes represented arm's length consideration payable to the target entity by the private company or an interposed entity for anything (other than its right to receive repayment of the loan and any relevant interest);

(c) the extent to which any actual loans made as part of the arrangement have been repaid by that time;

(d) the extent to which any actual payments made as part of the arrangement were converted into loans pursuant to subsection 109D(4A) that have been repaid by that time;

(e) the extent to which any loan made from the private company to an interposed entity as part of the arrangement meets the criteria set out in section 109N (that is, 'a section 109N compliant loan') at that time;

(f) the extent to which any payment made from the private company to an interposed entity as part of the arrangement was converted, pursuant to subsection 109D(4A) into a section 109N compliant loan by that time;

(g) the extent to which any actual loans made as part of the arrangement would be covered by section 109M (loans in the ordinary course of the private company's business made on its usual terms applicable to arm's length parties); and

(h) the extent to which the above factors reflect genuine transactions that are not designed to avoid the application of Subdivision E otherwise than as envisaged within the scheme of Division 7A (such as making a section 109N compliant loan to an entity that has an intention and capacity to repay a loan [in respect of which to the extent expected at the time when the Commissioner is determining the amount of deemed payment or notional loan, appropriate minimum yearly repayments have been made] or genuinely and in substance repaying loans in a manner that would not attract section 109R if it applied).

The Commissioner is of the view that the amount that will be advanced by Family Member Co 2 as a loan to Family Member Co 1 and, in turn, paid by Family Member Co 1 to the Taxpayer represents consideration payable to the target entity (being the Taxpayer) by Family Member Co 1 (being the interposed entity) for the Taxpayer’s shares in Parent Co. Under the proposed arrangement, there will be a genuine disposal of the Taxpayer’s Parent Co shares that will give rise to a capital gain when CGT event K6 happens. In this regard, the Commissioner does not regard the proposed arrangement as being one which properly falls for consideration under Subdivision E of Division 7A.

Further, for the reasons stated above in the detailed reasoning for Question 1, the Commissioner considers that Family Member and the Taxpayer will be dealing with each other at arm’s length, and therefore, the consideration payable agreed upon by the parties will be the arm’s length consideration.

Accordingly, the amount of the payment taken to be made by Family Member Co 2 to the Taxpayer under section 109V will be nil.

Section 109T(1) will not treat the payment made by Family Member Co 2 to the Taxpayer through an interposed entity (being Family Member Co 1) as giving rise to a payment under Subdivision B from Family Member Co 2 to the Taxpayer which is then deemed to be a dividend, for the following reasons:

● there is no amount that is taken to be paid by Family Member Co 2 to the Taxpayer under section 109V; and

● a reasonable person would not conclude (having regard to all the circumstances) that Family Member Co 2 (the private company) made the loan solely or mainly as part of an arrangement involving a payment by Family Member Co 1 (the interposed entity) to the Taxpayer (the target entity).

Question 3

Section 109C of the ITAA 1936 will not apply to treat a payment made to the Taxpayer under the guarantee provided by Parent Co in the event that Parent Co is called upon to do so, as a result of the operation of section 109J of the ITAA 1936.

Detailed reasoning

The Taxpayer will have a right to claim on a guarantee provided by Parent Co in respect of the performance by Family Member Co 1 of its obligations to pay the instalment payments. In the event that Parent Co is called upon to make payments of those amounts to the Taxpayer, those amounts will be payments to the Taxpayer within the meaning of paragraph 109C(3)(a).

The Taxpayer will cease to be a shareholder of Parent Co upon completion. However, the Taxpayer will be an associate of both of Parent Co’s shareholders post-completion (Family Member and Family Member Co 1) based on the following:

● the Taxpayer is a relative of Family Member, a natural person and the primary entity, for the purposes of paragraph 318(1)(a); and

● the directors of Family Member Co 1, the primary entity for the purposes of subsection 318(2), might reasonably be expected to act in accordance with the directions, instructions or wishes of Family Member who is the sole director and shareholder of Trustee Co (being the trustee of both the Taxpayer and Family Member Trusts). Thus, the requirements of paragraph 318(6)(b) are satisfied and Family Member Co 1 is sufficiently influenced by Family Member within the meaning of sub-paragraph 318(2)(d)(i), such that they are the controlling entity of Family Member Co 1.

Thus, the Taxpayer is an associate of Family Member by virtue of paragraph 318(1)(a) and Family Member is an associate of Family Member Co 1 by virtue of sub-paragraph 318(2)(d)(i). It, therefore, follows that under paragraph 318(2)(f), the Taxpayer is an associate of Family Member Co 1.

Prima facie, a deemed dividend arises to the Taxpayer pursuant to subsection 109C(1) of the ITAA 1936 when a payment is made by Parent Co to the Taxpayer under the guarantee because they are an associate of both of the shareholders in Parent Co. Under subsection 109C(2), the dividend taken to be paid is equal to the amount paid, subject to the distributable surplus of Parent Co calculated in accordance with section 109Y of the ITAA 1936.

Are the payments made to the Taxpayer payments discharging pecuniary obligations and, therefore, not treated as dividends pursuant to section 109J of the ITAA 1936?

Section 109J provides an exception to a deemed dividend arising under Division 7A for payments of genuine debts. To the extent that the payments made to the Taxpayer

● discharge an obligation of Parent Co to make payments to the Taxpayer, upon the Taxpayer exercising the right to claim on a guarantee provided by Parent Co: paragraph 109J(a); and

● the payments are not more than would have been required to discharge the obligation had the parties been dealing with each other at arm’s length: paragraph 109J(b)

Parent Co will not be taken under section 109C to pay dividends to the Taxpayer.

On the facts, it is established that Family Member Co 1 will have an obligation to pay the Taxpayer the total consideration amount in respect of their shares in Parent Co. Parent Co has provided to the Taxpayer a guarantee in respect of Family Member Co 1’s obligations to make the deferred instalment payments.

The guarantee involves rights of subrogation which enable Parent Co to be reimbursed by Family Member Co 1 in the event that Parent Co is called upon to make payments owed by Family Member Co. Insofar as Parent Co’s liability under the guarantee is as a principal debtor, any payment that Parent Co makes pursuant to the guarantee will be a payment to discharge an obligation of Parent Co to pay money to the Taxpayer.

Based on the reasons stated in the detailed reasoning in relation to Question 1, the Commissioner considers that the total consideration for the sale was negotiated at arm’s length. Therefore, payments made pursuant to the guarantee provided by Parent Co will represent an arm’s length amount.

Accordingly, section 109J of the ITAA 1936 will operate to exclude the payments made by Parent Co to the Taxpayer from being treated as dividends under subsection 109C(1) of the ITAA 1936.

Question 4

The sale of shares in Parent Co by the Taxpayer is not part of a scheme to which the provisions of section 177E of the ITAA 1936 apply.

Detailed reasoning

Section 177E was enacted as a General Anti-Avoidance Rule in Part IVA that applies specifically to dividend stripping arrangements. Where section 177E operates, it deems the scheme to be one to which Part IVA applies (paragraph 177E(1)(e)) and deems the taxpayer to have obtained a tax benefit, being the non-inclusion in assessable income of the amount that would have been included if the company had paid the dividend described by paragraph 177E(1)(c) (paragraphs 177E(1)(f) and (g)).

In order for section 177E to apply, the following requirements must be satisfied:

● there must be a scheme, in relation to a company, that is either a scheme by way of or in the nature of dividend stripping (sub-paragraph 177E(1)(a)(i)) or a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping (sub-paragraph 177E(1)(a)(ii));

● as a result of the abovementioned scheme, any property of the company is disposed of: paragraph 177E(1)(a);

● in the opinion of the Commissioner, the disposal of that property represents, in whole or in part, a distribution (whether to a shareholder or 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): paragraph 177E(1)(b);

● 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 property referred to in paragraph (a), an 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: paragraph 177E(1)(c); and

● the scheme was entered into after 27 May 1981: paragraph 177E(1)(d).

The Commissioner is of the view that there was no scheme by way of or in the nature of dividend stripping or having substantially the effect of a scheme by way of or in the nature of a dividend stripping for the purposes of paragraph 177E(1)(a).

The leading case concerning the meaning of ‘scheme by way of or in the nature of dividend stripping’ in sub-paragraph 177E(1)(a)(i) is FCT v. Consolidated Press Holdings (2001) 207 CLR 235 (‘Consolidated Press Holdings’). The Full Federal Court in Commissioner of Taxation v. Consolidated Press Holdings Ltd (1999) 91 FCR 524 (‘Consolidated Press Holdings FFC’), at 561, referred to Gibbs J’s summation of the central characteristics of a dividend stripping scheme in Commissioner of Taxation (Cth) v. Patcorp Investments Ltd (1976) 140 CLR 247 as follows:

What is helpful for present purposes is that Gibbs J identified four cases as involving dividend stripping operations: Bell v Federal Commissioner of Taxation (1953) 87 CLR 548; Newton v Federal Commissioner of Taxation (1958) 98 CLR 1 (PC); Hancock v Federal Commissioner of Taxation (1961) 108 CLR 258; Federal Commissioner of Taxation v Ellers Motor Sales Pty Ltd (1972) 128 CLR 602. These four cases had the following characteristics in common:

● 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 (a company in three cases and individuals resident in the then Territory of New Guinea in Bell);

● 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 (whether by reason of a s46 rebate, an offsetting loss on the sale of the shares, or the fact that the shareholders were resident outside Australia); and

● 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 at the relevant times).

The characteristics that may be present in the proposed arrangement include:

● the target company, Parent Co, having substantial undistributed profits which would create a potential tax liability for the shareholders if they were to be distributed as dividends;

● the sale of shares in Parent Co to Family Member Co 1 by the Taxpayer;

● the payment of dividends to Family Member Co 1 out of the existing and future profits of Parent Co to fund payments to the Taxpayer of the purchase price for the Taxpayer’s shares in Parent Co;

● Family Member Co 1 will potentially be entitled to a franking credit tax offset that matches the tax liability of the dividend income, and will, therefore, not be required to pay Australian income tax on the dividends declared ; and

● the Taxpayer, the vendor shareholder, will receive a capital sum for their shares in an amount the same as or very close to the dividends paid to Family Member Co 1. The Taxpayer’s shares are pre-CGT assets, although there will be a capital gain arising to the Taxpayer when CGT event K6 happens.

In addition to the central characteristics identified in the case law, the Full Federal Court in Consolidated Press Holdings also considered, at 570, that only a scheme which has the requisite tax avoidance purpose will be a scheme by way of or in the nature of dividend stripping:

In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.

The Commissioner considers that the proposed arrangement will not be entered into for the dominant purpose of avoiding tax.

In the absence of a dominant purpose of avoiding tax, the proposed scheme will not be 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 dividend stripping for the purposes of paragraph 177E(1)(a). Accordingly, the proposed arrangement will not give rise to a scheme to which section 177E applies.

Question 5

The sale of shares in Parent Co by the Taxpayer will not be part of a scheme to which the provisions of section 177F of the ITAA 1936 apply.

Detailed reasoning

Part IVA gives the Commissioner the power to cancel a 'tax benefit' that has been obtained, or would, but for section 177F, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies.

The Commissioner may only exercise the power in subsection 177F(1) if the requirements of Part IVA are satisfied. Part IVA requires that

● a 'tax benefit', as identified in section 177C of the ITAA 1936, was or would, but for subsection 177F(1) of the ITAA 1936, have been obtained;

● the tax benefit was or would have been obtained in connection with a 'scheme' as defined in section 177A of the ITAA 1936; and

● having regard to section 177D of the ITAA 1936, the scheme is one to which Part IVA applies.

Each of the requirements of Part IVA are considered in further detail in the following paragraphs.

Will there be a scheme within the meaning of section 177A of the ITAA 1936 in connection with which a tax benefit would have been obtained?

“Scheme” is defined broadly in section 177A to mean

(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.

It is considered that the transactions under the proposed sale of the Taxpayer’s interests in Parent Co to Family Member Co 1 (being the sale of the Taxpayer’s interests in Parent Co, the on-lending of part of the purchase price by Family Member Co 2 to Family Member Co 1 to pay the Taxpayer and the funding of the subsequent instalment payments from the profits of Parent Co) comprise a scheme within the meaning of section 177A.

Will there be a tax benefit within the meaning of section 177C that was or would, but for subsection 177F(1), have been obtained?

Broadly, subsection 177C(1) of the ITAA 1936 defines six kinds of tax benefit:

(i) an amount not being included in the assessable income of the taxpayer of a year of income;

(ii) a deduction being allowable to the taxpayer in relation to a year of income;

(iii) a capital loss being incurred by the taxpayer during a year of income;

(iv) a loss carry back offset being allowable to the taxpayer in relation to a year of income;

(v) a foreign income tax offset being allowable to the taxpayer;

(vi) an amount of withholding tax not being incurred by the taxpayer in a year of income.

In determining whether a tax benefit within the meaning of subsection 177C(1) has been obtained in connection with a scheme, it is necessary to refer to section 177CB of the ITAA 1936.

In deciding whether a tax effect (being one of the tax benefits identified in subsection 177C(1)) would have occurred, or might reasonably be expected to have occurred, if the scheme had not been entered into or carried out, section 177CB provides two different bases for identifying tax benefits.

Subsection 177CB(2) requires that

a decision that a tax effect would have occurred if the scheme had not been entered into or carried out must be based on a postulate that comprises only the events or circumstances that actually happened or existed (other than those that form part of the scheme)

Insofar as the scheme comprises the sale of the Taxpayer’s shares (amongst other steps), there would be no tax effect for the purposes of subsection 177CB(2) if the Taxpayer continued to hold their shares. Accordingly, no tax benefit would arise for the purposes of section 177C under this approach.

The alternative approach to determining tax benefit is contained in subsections 177CB(3) and (4).

Subsection 177CB(3) requires that

A decision that a tax effect might reasonably be expected to have occurred if the scheme had not been entered into or carried out must be based on a postulate that is a reasonable alternative to entering into or carrying out the scheme.

In determining for the purposes of subsection (3) whether a postulate is a reasonable alternative to entering into or carrying out a scheme, subsection 177CB(4) requires that

● particular regard be had to the substance of the scheme and any result or consequence for the taxpayer that is or would be achieved by the scheme (other than a result in relation to the operation of the Act): paragraph 177CB(3)(a); and

● any result in relation to the operation of the Act that would be achieved by the postulate for any person (whether or not a party to the scheme) be disregarded: paragraph 177CB(3)(b).

The Commissioner considers the substance of the scheme to be the transfer of the Taxpayer’s shareholding in Parent Co to Family Member Co 1, being an entity controlled by Family Member. The Commissioner does not consider there to be any reasonable alternative to entering into or carrying out the scheme.

In the absence of any postulate that is a reasonable alternative to entering into or carrying out the scheme, no tax benefit would arise for the purposes of section 177C under this approach.

As the Taxpayer will not obtain, or will not but for section 177F obtain, a tax benefit within the meaning of subsection 177C(1) in connection with the scheme, the proposed arrangement will not be part of a scheme to which the provisions of section 177F of the ITAA 1936 apply.