Edited version of private advice

Authorisation Number: 1051634223527

Date of advice: 13 February 2020

Ruling

Subject: Subdivision 122-A and Division 124-M rollovers in respect of a commercial business restructure.

Question 1

Will the capital gain on the disposal of Company A shares to Newco be eligible for rollover relief under subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 2

Will the capital gain on the disposal of Company B shares to Newco be eligible for rollover relief under Division 124-M ITAA 1997?

Answer

Yes

Question 3

Will the payment of dividends to Newco after it owns all of the shares in Company A and Company B be transactions to which the Commissioner will seek to apply the provisions of s177E or s177EA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 4

Will the Commissioner seek to deny franking credits pursuant to section 207-145 ITAA 1997 as a distribution made as part of a dividend stripping operation in respect of the payment of dividends to Newco under the proposed restructure?

Answer

No

Question 5

Is the proposed restructure a scheme to which the Commissioner will apply section 177F ITAA 1936?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1. Company A is an Australian tax resident.
2. The shareholders of Company A are as follows
   1. 100 ordinary shares are owned by X.
   2. Each ordinary share carries equal rights to voting, capital and dividends.
   3. E Class share is owned by Trustee Co as trustee of the Trust C discretionary trust. This share has rights to a dividend at the discretion of the directors and dividends can be paid on this share to the exclusion of other share classes. The share carries no rights to votes and only to a return of the amount paid up on the share on winding up.
3. X is the sole director of Company A.
4. X is an Australian tax resident.
5. Trust C is a discretionary trust.
6. Company A trades in commercial operations.
7. Company B is the head entity of a tax consolidated group. This group is made up as follows
   1. Company B
      1. Australian tax resident
      2. Non trading head of the consolidated group
      3. Shareholder is Trustee Co as trustee for Trust C holding YY ordinary shares with a total amount paid up of YY. Each Ordinary share carries equal rights to voting, capital and dividends. Shares were acquired over time from 20XX, with the last parcel of shares that brought the company 100% under the ownership of Trust C occurring in late 20XX.
   2. Company D
      1. Australian tax resident
      2. Wholly owned subsidiary of Company B
      3. 1 ordinary share on issue at a paid up value of $YY
      4. Each ordinary share carries equal rights to voting, capital and dividends
      5. Non trading subsidiary within the group
   3. Company E
      1. Australian tax resident
      2. Wholly owned subsidiary of Company B.
      3. YY ordinary shares on issue with a total paid up value of $YY.
      4. Each ordinary share carries equal rights to voting, capital and dividends.
      5. Trading entity running an operating commercial business.
   4. Company B Group Profit
      1. the year ending 30 June 20XX the Company B Group had profits, prior to the application of carry forward losses, of $YY.
      2. for the year ending 30 June 20XX the Company B Group had profits, prior to the application of carry forward losses, of $YY
      3. for the year ending 30 June 20XX the Company B Group has budgeted for post-tax profits of $YY.
8. Company B was originally formed with ZZ shareholders that started the business around 20XX. Over time Trust C has been acquiring shares in Company B as shareholders exited, with the last external shareholder being bought out in late 20XX. Up until late 20XX the external shareholders had prevented the restructure proposed here being undertaken.
9. X is the sole director of each of the companies within the Company B Group.
10. To facilitate future commercial operations and external investment, the director of Company A and Company B wishes to bring the two different businesses into one group. The business operations have reviewed possible restructure proposals with the intention of:
    1. Improving the overall strength of the group balance sheet.
    2. Utilise management efficiencies.
    3. Allow single branding, group operation efficiencies and facilitate external investment.
    4. Facilitate staff equity incentives.
    5. Asset protection.

The steps proposed for the restructure are:

1. Valuation undertaken of the shares held in Company A. Both the Ordinary shares and the E class share.
2. The E class share owned by Trust C in Company A is transferred to X for consideration equal to its market value.
3. Incorporate a new company, Newco, in Australia to hold all the shares in Company A. Newco would be incorporated initially with one ordinary share owned by X.
4. Newco will not be an exempt entity for tax purposes.
5. Newco acquires the shares in Company A at their market valuation amount from X. As consideration for the disposal of the shares, X will receive ordinary shares in Newco with the same value as the Company A shares.
6. Valuation is undertaken of Company B to determine what the shares in Company B are worth.
7. The subsidiaries in the Company B consolidated group declare dividends up to the head entity, Company B, so all retained earnings and franking credits are within the head entity of that group.
8. To enable the amounts owing to the head entity (i.e. Company B) to be paid, the external party debtors to Company D will be assigned to Company B.
9. Trust C transfers the shares it owns in Company B to Newco. In consideration for these shares Trust C receives ordinary shares in Newco to the same dollar value.
10. Company B Group ceases to be a consolidated group and the ATO are advised within the 14 days required. An exit ACA calculation will be done at this stage. We do not anticipate an L5 CGT event to occur as a result of the assignment of debtors (ie the reduction in liabilities) at point 8.
11. Retained earnings in Company A and Company B will be declared and paid to Newco to allow protection from creditors in the trading companies and to the extent that the dividends cannot be paid in cash they will be treated as amounts owing.

Assumptions

1. Dividends paid out of Newco as part of, or subsequent to, the restructure will be ultimately received by X (either directly or indirectly through the discretionary trust).
2. Dividends paid out of Newco will be consistent with the historical calculation methodology for dividend amounts paid out of Company A to X prior to the restructure, for the purposes of living expenses and Division 7A loan payments.
3. Dividends paid out of Newco may exceed historical dividend amounts determined in accordance with assumption 2 above to the extent they reflect increased profits (above historical profit levels) in Company A, or dividends attributable to Company B. In this case dividends may be distributed to any beneficiaries of Trust C as appropriate under the trust deed.
4. With the exception of the dividends listed in 2 and 3, dividends paid up to Newco as part of the restructure will be retained in Newco for operating capital. The intention of these assumptions is that retained earnings held in Company A prior to the restructure will be held in Newco for operating capital or paid out as taxable income to X.
5. There are no further steps (including rollovers) to the restructure and X will retain the legal and beneficial ownership of the shares in Newco held subsequent to the restructure.
6. There will be no reconsolidation of the group either as part of, or subsequent to, the restructure.
7. Valuations undertaken as part of the restructure will be consistent with ATO guidance and processes (https://www.ato.gov.au/General/Capital-gains-tax/In-detail/Market-valuations/Market-valuation-for-tax-purposes/) for establishing market value for tax purposes.

Relevant legislative provisions

Subdivision 122-A Income Tax Assessment Act 1997
>Division 124-M Income Tax Assessment Act 1997
>Section 177E Income Tax Assessment Act 1936
>Section 177EA Income Tax Assessment Act 1936
>Section 207-155 Income Tax Assessment Act 1997
>Part IVA Income Tax Assessment Act 1936

Question 1

Summary

The capital gain on the disposal of Company A shares to Newco will be eligible for rollover relief under subdivision 122-A ITAA 1997.

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 s122-20 to s122-35 ITAA 1997.

X will receive consideration for the disposal of his shares in Company A to the new wholly owned company (Newco), and that consideration will be only shares in the new company.

The shares in Newco received as consideration by X are not redeemable shares and are substantially the same market value as those disposed of.

X will own all of the shares in Newco just after the disposal of the asset. Both X and Company A are Australian residents.

Under s122-40 ITAA 1997, X, upon choosing a rollover under subdivision 122-A can disregard the capital gain or capital loss made from the CGT trigger event.

Question 2

Summary

The capital gain on the disposal of Company B shares to Newco will be eligible for rollover relief under Subdivision 124-M ITAA 1997.

Detailed reasoning

Division 124 ITAA 1997 provides for replacement asset rollovers, allowing in certain cases, for a taxpayer to defer the making of a capital gain or loss from one CGT event until a later CGT event happens. Subdivision 124-M scrip for scrip rollover allows a taxpayer to choose a roll-over where post-CGT shares are replaced with other shares.

Pursuant to s124-780 ITAA 1997, there is a rollover if an entity exchanges a share in a company for a share in another company and the conditions outlined in s124-780 are satisfied.

Trust C will exchange shares in Company B for shares in Newco. Under the disposal:

• The exchange will be part of a single arrangement;
• Newco becomes the owner of 80% or more of Company B shares;
• The arrangement is one in which participation was available on the same terms for all shareholders.

The conditions for the rollover outlined in s124-780(3) ITAA 1997 are met:

• Company B shares held by Trust C were acquired post-GST;
• Apart from the rollover, Trust C would make a capital gain;
• The replacement interest is in Newco;
• Both Trust C and Newco choose to rollover under the provisions, and Trust C will inform Newco of its cost base;
• As part of the arrangement no member of the same wholly owned group as Newco issues equity or owes a new debt to an entity that is not a member of the group.

The scrip will be exchanged at market value, and the replacement interest carries the same rights and obligations as the original interest.

Under s124-20 ITAA 1997 and subdivision 124-M the capital gain made from the original asset is disregarded and the cost base of the new asset is determined in accordance with those provisions.

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. The Commissioner will not make a determination pursuant to s177EA ITAA 1936 in relation to the dividends paid by up to Newco as part of the proposed restructure.

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 and assumptions in this case there is insufficient tax purpose to engage the application of the dividend stripping provisions in s177E. Dividends from retained earnings paid up to Newco as part of the restructure, with the exception of those consistent with historical dividends, are retained in Newco for operating capital.

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:

1. there is a scheme for the disposition of shares, or interest in shares, in a company
2. franked distribution has been paid, or expected to be paid, directly or indirectly
3. the relevant taxpayer would, or could reasonably be expected to, receive imputation benefits from the distribution, and
4. 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.

The proposed restructure results in dividends from retained earnings paid up to Newco, but held in Newco for operating capital and would not be considered to be a scheme the purpose of which was to enable Company A, Company B or Newco to obtain imputation benefits.

Question 4

Summary

The payment of dividends to Newco, after it owns all of the shares in Company A and Company B, will not be transactions in regard to which the Commissioner will seek to deny the franking credits as part of a dividend stripping operation for the purposes of section 207-145 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:

1. was by way of, or in the nature of, dividend stripping; or
2. 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 ITAA 1936, it is not a dividend stripping operation for the purpose of paragraph 207-145(1)(d) ITAA 1997.

Question 5

Summary

The proposed arrangement will not constitute a scheme to which s177D of Pt IVA ITAA 1936 applies to, and accordingly is not a scheme to which the Commissioner will apply section 177F ITAA 1936.

Detailed reasoning

Part IVA is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion under s177F ITAA 1936 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.