Edited version of private advice

Authorisation Number: 1051615031489

Date of advice: 11 December 2019

Ruling

Subject: Subdivision 122-A rollover and restructure for beneficiaries of deceased estate

Question 1

Is X and Y eligible to choose a capital gains tax rollover under Subdivision 122-A Income Tax Assessment Act 1997 (ITAA 1997) on the transfer of the shares in Company A to their respective wholly owned companies?

Answer

Yes

Question 2

Does Section 177EA Income Tax Assessment Act 1936 (ITAA 1936) have any application to the payment of the dividend by Company A under the proposed arrangement?

Answer

No

Question 3

Does Section 177E ITAA 1936 have any application to the payment of the dividend by Company A under the proposed arrangement or to the proposed arrangement generally?

Answer

No

Question 4

Is the proposed arrangement a dividend stripping operation for the purposes of Section 207-155 ITAA 1997?

Answer

No

Question 5

Will Part IVA ITAA 1936 apply to the proposed arrangement?

Answer

No

This ruling applies for the following period:

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.     Company A was incorporated in 19XX;

2.     Z passed away in 20XX. Pursuant to Z's will the residuary estate (including the shares in Company A) is to be held on trust absolutely for their two children, as tenants in common (Y and X) until they attain the age of 25. Both beneficiaries are older than 25 and the residuary estate will pass to each child equally upon administration of the estate;

3.     Both shareholders are Australian residents for tax purposes;

4.     The shares in the estate will be split equally between Y and X such that they will hold an equal amount of each of the shares in Company A;

5.     Company A holds a portfolio of investments and cash. It does not trade as a business;

6.     Company A has a significant retained earnings balance. Because of the history of the company the franking credits are not sufficient for all of the earnings to be paid on a fully franked basis;

7.     X and Y do not agree on the future of Company A and in particular the investment strategy to adopt;

8.     X and Y and Company A intend to restructure in accordance with the following steps:

a.     X and Y will each respectively establish separate new companies, wholly owned by each of them;

b.     They will then transfer all of the shares they own in Company A to their respective new companies in exchange for non-redeemable ordinary shares in the new respective companies;

c.      Immediately after the transaction each individual shareholder will each own all of the issued shares in their respective companies;

d.     The shares in Company A will be valued independently;

e.     The market value of the shares that are issued in (b) above will equal the market value of the shares that are transferred;

f.       Each shareholder will choose to disregard any capital gain that would otherwise arise from the transaction pursuant to Division 122-A ITAA 1997;

g.     Shortly after the above steps the Company A will pay a dividend of its retained profits in respect of the shares to the new company shareholders;

h.     The dividend entitlement will be satisfied by a mixture of cash/transfer of assets in specie to each shareholder;

i.       Due to the shortfall in franking credits each company shareholder will incur a significant tax liability upon receipt of the dividend;

j.       After the assets of Company A have been sold/transferred to fund the dividend entitlement, Company A will be liquidated.

9.     There are no further steps in the proposed arrangement and there will be no further rollovers or transactions/loans that would change the actual or beneficial ownership of the membership interests in the respective new companies.

10.  Dividends, where paid by the respective new companies, will be payable directly to the new shareholders, X and Y in their capacity as individuals, as the holders of the membership interests.

11.  Dividends paid by Company A will be paid to the respective new companies only, and for the beneficial interest of the respective new companies.

Relevant legislative provisions

Income Tax Assessment Act 1997 Subdivision 122-A

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1996 Section 177EA

Income Tax Assessment Act 1997 Section 207-155

Income Tax Assessment Act 1936 Part IVA

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company A and others.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

X and Y will each be entitled to obtain a rollover pursuant to subdivision 122-A ITAA 1997 for the proposed share transfers of their membership interest in Company A to their respective wholly owned companies.

Detailed reasoning

Pursuant to s122-15 ITAA 1997, where an individual disposes of a CGT asset to a wholly-owned company(and a CGT event A1 happens to the individual as a result), the individual can choose to obtain a roll-over in the circumstances set out in ss122-20 to 122-35 ITAA 1997.

X and Y will receive consideration for the disposal of their shares in Company A to the respective new wholly owned companies, and that consideration will be only shares in the respective companies.

The shares received as consideration by X and Y are not redeemable shares and are substantially the same market value as those disposed of.In addition, both X and Y will, for their respective companies, own all of the shares in the Company A just after the disposal of the asset.

All parties to the proposed arrangement are Australian residents.

Under s122-40 ITAA 1997, X and Y, upon choosing a rollover under subdivision 122-A can disregard the capital gain or capital loss made from the CGT trigger event.The cost base of the shares in the respective new companies is worked out pursuant to s122-40(2), and s122-70 outlines the consequences for the respective new companies.

Question 2

Summary

The commissioner will not make a determination pursuant to s177EA ITAA 1936 in relation to the dividends paid by Company A under the proposed arrangement.

Detailed reasoning

Section 177EA ITAA 1936 is a general anti-avoidance rule that supports the operation of the imputation system with the purpose of ensuring that the benefits of the imputation system flow to the economic owner of the share which is the source of the franked distribution.The section is directed at schemes involving the transfer of franking credits on a dividend from entities that cannot fully use them to entities that can.If the section applies, the Commissioner may debit the company's franking account or deny the franking credit benefit to the recipient of the dividend.

Specifically, subsection 177EA(3) ITAA 1936 provides that for section 177EA to apply, the following must be present:

a)           there is a scheme for the disposition of shares, or interest in shares, in a company

b)           franked distribution has been paid, or expected to be paid, directly or indirectly

c)           the relevant taxpayer would, or could reasonably be expected to, receive imputation benefits from the distribution, and

d)           having regard to the circumstances of the scheme it would be concluded that the scheme was entered into for the purpose of enabling the relevant taxpayer to obtain imputation benefits.

For the proposed arrangement, the interposition of the respective wholly owned entities and the choice to claim rollover relief under subdivision 122-A would not be considered to be a scheme the purpose of which was to enable Company A, X or Y to obtain imputation benefits.

Question 3

Summary

The proposed arrangement will not constitute either a dividend stripping scheme or a scheme having substantially the same effect for the purposes of section 177E ITAA 1936

Detailed reasoning

Section 177E ITAA 1936 is an anti-avoidance provision designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme with substantially the same effect as a dividend stripping scheme.

Section 177E embraces a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax.Assessing the purpose of the scheme is an objective test having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.

While there is a degree of tax deferral, which can constitute a tax benefit for the purposes of s177E, on the facts there is insufficient tax purpose to engage the application of the dividend stripping provisions in s177E.

Question 4

Summary

The proposed arrangement is not considered a dividend stripping operation for the purposes of Section 207-155 ITAA 1997.

Detailed reasoning

Subdivision 207-F ITAA 1997 has the effect of cancelling the effect of the gross-up and tax offset rules where the imputation system has been manipulated.Under paragraph 207-145(1)(d) ITAA 1997 recipients of a franked distribution can be denied the benefits of the franking credits in various situations including where the distribution is made as part of a dividend stripping operation.

'Dividend stripping operation' in this context is defined in section 207-155 ITAA 1997 which provides:

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.

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.

As the proposed arrangement is not a scheme by way of, or in the nature of, dividend stripping, or a scheme that has substantially the effect of a scheme by way of, or in the nature of, dividend stripping for the purpose of paragraph 177E of the ITAA 1936, it is not a dividend stripping operation for the purpose of paragraph 207-145(1)(d) of the ITAA 1997.

Question 5

Summary

The proposed arrangement will not constitute a scheme to which s177D of Pt IVA ITAA 1936 applies to.

Detailed reasoning

Part IVA is a general anti-avoidance provision.Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit.

A conclusion about a relevant person's purpose for section 177D of the ITAA 1936 is the conclusion of a reasonable person based on all the facts and evidence that are relevant to considering the matters outlined in s177D(2).

While there is a degree of tax deferral, which can constitute a tax benefit for the purposes of s177D, on the facts, and having consideration of the matters outlined in s177D(2) there is insufficient tax purpose to engage the application of the general anti-avoidance provisions in Pt IVA.