Edited version of private advice

Authorisation Number: 1051645705394

Date of advice: 13 March 2020

Ruling

Subject: Business restructure

Question 1

When the activities of the Original Entities cease and the New Entities commence, will any capital gain or loss arise in respect of any CGT event happening in relation to any goodwill in the Original Entities?

Answer

No

Question 2

Will the redeemable preference shares (RPS) be 'equity interests' under Subdivision 974-C of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes

Question 3

Will the issue of the RPS give rise to a direct value shift (DVS) for the Trust under Division 725 of the ITAA 1997?

Answer

No

Question 4

If the issue of the RPS will give rise to a DVS for the Trust under Division 725 of the ITAA 1997, will that DVS cause CGT event K8 under section 104-250 of the ITAA 1997 to occur?

Answer

Not applicable

Question 5

Will any payment of fully franked dividends to RPS holders be considered dividend streaming under Subdivision 204-D of the ITAA 1997?

Answer

No

Question 6

Will any distribution to RPS holders be considered part of a dividend stripping operation under section 207-155 of the ITAA 1997?

Answer

No

Question 7

Will any distribution to RPS holders be part of 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

No

Question 8

Will section 45A of the ITAA 1936 apply to the issue of the RPS?

Answer

No

Question 9

Will section 45B of the ITAA 1936 apply to the issue of the RPS?

Answer

No

Question 10

Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to RPS holders?

Answer

No

Question 11

Will the Commissioner make a determination pursuant to section 177F of the ITAA 1936 to deny any tax benefit that arises from the scheme/s?

Answer

No

This ruling applies for the following periods:

Year ending 30 June 2020

Year ending 30 June 2021

Year ending 30 June 2022

Year ending 30 June 2023

Relevant facts and circumstances

Background

The Trustee for the Trust (the Trust) trades as the A and the B. The Trust specialises in commercial fitting for properties.

The Trust tenders for new work and holds all existing contracts and relationships with the customers of the business (the business).

The directors of the trustee of the Trust are C and D. C and D are based in an Australian State and have been employed by the Trust since inception. In their capacity as employees of the Trust, C and D have carried out, and do carry out, all of the business development activities.

The Trust owns all of the goodwill and intellectual property associated with the business, including the A and the B trademarks.

All employees, and many of the contractors, are engaged by the trust.

The Trust licences to A Pty Ltd, A2 Pty Ltd and A3 Pty Ltd (collectively the Original Entities) to conduct work and serve the local customers of the business in various Australian States. The Trust provides all services in only three specific Australian States. Each original entity carries on business in one state.

The Original Entities are owned and controlled by C and D equally. Regulatory requirements drove the establishment of the Original Entities.

Licence Agreements

The Trust has granted the Original Entities licence to:

·        operate and manage the business in their respective territories;

·        use the assets of the Trust and employees supplied by the Trust to conduct the business in the relevant territories and premises; and

·        exercise the contractual rights of the Trust under specified agreements with customers to perform the work and be paid under those agreements.

The Original Entities retain the profits from their operation and pay the Trust a licence fee. The Trust uses the fee to cover the fixed and variable costs of running the business. Over time, these arrangements have resulted in the Original Entities having retained earnings.

Recently, C and D became concerned about litigation risks. They are restructuring their business as part of their asset protection and estate planning strategy.

The arrangement

1.     New entities

a.     Each of C and D establishes family trusts - C's Family Trust and D's Family Trust.

                                 i.          Each of C's Family Trust and D's Family Trust subscribes for 50% of the shares in the New Entities - essentially, a group of companies that mirrors the Original Entities.

b.     Each of C and D establishes second family trusts - C's Second Trust and D's Second Trust.

c.      During C or D's 's lifetime, their respective Second Trust:

                                 i.          can only make distributions so that the distributions ultimately flow to C and D, as applicable, as paid distributions.

                               ii.          will not retain the benefit of the distributions arising from the business restructure. The distributions cannot be used by the Second Trusts to fund loans to related entities; reduce debts and liabilities of the trusts; offset unpaid present entitlements of beneficiaries or to form part of trust corpus.

                              iii.          must treat all distributions (including in specie liquidator's distributions) resulting from the business restructure as income of the trust as defined in section 95 of the ITAA 1997. To this end, the trustee must be empowered by its trust deed to treat any distributions (including in specie liquidator's distributions) and/ or any dividends as trust income under section 95.

d.     Each of C and D incorporates separate companies - C's Company and D's Company. C's Second Trust will own all of the shares in C's Company. D's Second Trust will own all of the shares in D's Company.

2. Restructure the business

a.     The licence agreements between the Trust and the Original Entities will be terminated.

b.     The Original Entities will cease to operate.

c.      The Trust and the New Entities will execute a licence agreement on the same terms as the existing licence agreements. The New Entities will commence operating in the same way as the Original Entities.

3. Issue of RPS by the Original Entities

a.     The Original Entities will each issue a RPS to each of C's Company and D's Company. Each of the RPSs will be issued for $1,000 each, on the following terms:

i. the Original Entities may declare and pay a dividend at any time;

ii. the holders will not have voting rights;

iii. the holders will not have capital rights upon a winding up;

iv. the RPSs will be redeemable by the Original Entities at any time, at the option of the Original Entities, for nil consideration;

v. the RPSs will be automatically redeemed at three years after the date of issue if they have not already been redeemed;

vi. the RPSs will not be transferrable.

b.     The Original Entities remain potential beneficiaries of C's Second Trust and D's Second Trust but otherwise carry out no further activities.

Assumption

All distributions of the Original Entities' retained earnings will ultimately flow to C and D and therefore be taxed in their hands.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 subsection 45B(2)

Income Tax Assessment Act 1936 paragraph 45B(2)(a)

Income Tax Assessment Act 1936 paragraph 45B(2)(b)

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

Income Tax Assessment Act 1936 subsection 45B(3)

Income Tax Assessment Act 1936 paragraph 45B(8)(a)

Income Tax Assessment Act 1936 paragraph 45B(8)(b)

Income Tax Assessment Act 1936 paragraph 45B(8)(c)

Income Tax Assessment Act 1936 paragraph 45B(8)(d)

Income Tax Assessment Act 1936 paragraph 45B(8)(e)

Income Tax Assessment Act 1936 paragraph 45B(8)(f)

Income Tax Assessment Act 1936 paragraph 45B(8)(g)

Income Tax Assessment Act 1936 paragraph 45B(8)(h)

Income Tax Assessment Act 1936 paragraph 45B(8)(i)

Income Tax Assessment Act 1936 paragraph 45B(8)(j)

Income Tax Assessment Act 1936 paragraph 45B(8)(k)

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 section 95

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 subsection 177D(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 subsection 177E(1)

Income Tax Assessment Act 1936 paragraph 177E(1)(a)

Income Tax Assessment Act 1936 paragraph 177E(1)(b)

Income Tax Assessment Act 1936 paragraph 177E(1)(c)

Income Tax Assessment Act 1936 paragraph 177E(1)(d)

Income Tax Assessment Act 1936 paragraph 177E(1)(e)

Income Tax Assessment Act 1936 paragraph 177E(1)(f)

Income Tax Assessment Act 1936 paragraph 177E(1)(g)

Income Tax Assessment Act 1936 paragraph 177E(2)(a)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 subsection 177EA(3)

Income Tax Assessment Act 1936 paragraph 177EA(3)(a)

Income Tax Assessment Act 1936 paragraph 177EA(3)(b)

Income Tax Assessment Act 1936 paragraph 177EA(3)(c)

Income Tax Assessment Act 1936 paragraph 177EA(3)(d)

Income Tax Assessment Act 1936 subsection 177EA(5)

Income Tax Assessment Act 1936 paragraph 177EA(14)(a)

Income Tax Assessment Act 1936 subsection 177EA(16)

Income Tax Assessment Act 1936 paragraph 177EA(17)(a)

Income Tax Assessment Act 1936 paragraph 177EA(17)(b)

Income Tax Assessment Act 1936 paragraph 177EA(17)(c)

Income Tax Assessment Act 1936 paragraph 177EA(17)(d)

Income Tax Assessment Act 1936 paragraph 177EA(17)(e)

Income Tax Assessment Act 1936 paragraph 177EA(17)(f)

Income Tax Assessment Act 1936 paragraph 177EA(17)(g)

Income Tax Assessment Act 1936 paragraph 177EA(17)(h)

Income Tax Assessment Act 1936 paragraph 177EA(17)(i)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

Income Tax Assessment Act 1936 paragraph 177EA(17)(j)

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 section 104-250

Income Tax Assessment Act 1997 subsection 104-250(1)

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 subsection 204-30(8)

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1936 paragraph 207-145(1)(d)

Income Tax Assessment Act 1936 paragraph 207-150(1)(e)

Income Tax Assessment Act 1997 section 207-155

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 section 725-50

Income Tax Assessment Act 1997 section 725-90

Income Tax Assessment Act 1997 section 725-145

Income Tax Assessment Act 1997 subsection 725-145(1)

Income Tax Assessment Act 1936 paragraph 725-145(1)(b)

Income Tax Assessment Act 1997 subsection 725-145(2)

Income Tax Assessment Act 1997 subsection 725-145(3)

Income Tax Assessment Act 1997 section 725-245

Income Tax Assessment Act 1997 Subdivision 974-C

Income Tax Assessment Act 1997 subsection 974-20(1)

Income Tax Assessment Act 1936 paragraph 974-20(1)(b)

Income Tax Assessment Act 1936 paragraph 974-20(1)(c)

Income Tax Assessment Act 1936 paragraph 974-20(1)(d)

Income Tax Assessment Act 1936 paragraph 974-20(1)(e)

Income Tax Assessment Act 1997 subsection 974-70(1)

Income Tax Assessment Act 1997 subsection 974-75(1)

Reasons for Decision

All legislative references are to the ITAA 1997 unless otherwise stated.

Question 1

Summary

The goodwill of the business is owned by the Trust. As the Trust does not dispose of its goodwill as part of the restructure, there is no CGT event to trigger a gain or loss.

Detailed reasoning

Taxation Ruling TR 1999/16 Income tax: capital gains: goodwill of a business (TR 1999/16) explains the Commissioner's views about the meaning of 'goodwill' - in particular, the Commissioner 'adopts' the definition of goodwill as expressed by the High Court in Federal Commissioner of Taxation v Murray [1998] HCA 42

When used in the CGT context, 'goodwill' takes its legal meaning, rather than a business or accounting meaning. Under this approach, 'goodwill' has three aspects: property, sources, and value. These aspects of goodwill cannot be separated and treated as separate CGT assets for the purposes of the CGT law (paragraphs 9 to 11 of TR 1999/16).

Goodwill is the combination of tangible, intangible and human parts of a business in a way that draws custom. Goodwill derives from the use of a business's other assets. It is therefore appropriate to refer to goodwill as having sources rather than being composed of elements.

Goodwill has elements that form one asset. Goodwill is indivisible and distinct from its sources. It attaches to a business and cannot be separated from the conduct of the business. Goodwill is therefore one CGT asset (paragraphs 12 to 14 of TR 1999/16). A business's goodwill can therefore only be owned by one entity within a group, where that group conducts just one business.

The key issue here is whether all of the entities involved are carrying on one business - in which case there is only one asset that we can describe as being goodwill - or multiple businesses - in which case we can describe each discrete business as having its own goodwill.

The following facts demonstrate that there is only one business and that the Trust owns the associated goodwill:

1.           The Trust is the entity that commenced the business.

2.           The business grew its operations into other parts of Australia, and regulatory requirements necessitated the incorporation of the Original Entities in those other parts of Australia.

3.           The business has operated through the Original Entities, and the value of the goodwill owned by the Trust grew in value as a result, but this business growth did not create goodwill in the Original Entities as such because the:

a.           the Trust developed all of the know-how;

b.           the Trust undertakes all marketing and promotional activities;

c.           key personnel responsible for building and maintaining relationships and custom are employed by the Trust; and

d.           Original Entities' capacity to operate is entirely dependent on their relationship with the Trust.

On the basis that the Trust owns the goodwill associated with the conduct of the business, and that the Original Entities do not conduct separate businesses, no CGT event can happen in relation to the Original Entities ceasing their involvement in the operation of the business.

Question 2

Summary

The RPS will be equity interests under subsection 974-70(1).

Detailed reasoning

For the RPS to be equity interests they must:

·        satisfy the equity test in subsection 974-75(1); and

·        not pass the debt test in subsection 974-20(1).

A share is an interest in a company as a member or stockholder of that company. Therefore, item 1 of subsection 974-75(1) is satisfied and the RPS pass the test for an equity interest.

Subsection 974-20(1) provides the test for determining debt interests. The conditions which must be met for a scheme to satisfy the debt test in this case are:

·        there must be a financial benefit received (paragraph 974-20(1)(b));

·        the issuing entity must have an "effectively non-contingent obligation" to provide a future financial benefit (paragraph 974-20(1)(c)); and

·        it must be substantially more likely than not that the value of the financial benefit to be provided will be at least equal to, or exceed the financial benefit received and will not equal nil

·        (paragraphs 974-20(1)(d) and 974-20(1)(e)).

Here, the obligation to pay dividends will be entirely at the discretion of the boards of the Original Entities. The Original Entities may redeem the RPS at any time at their own discretion up to the third anniversary of the issue date of the RPS. If the RPS remain on issue at the third anniversary, they will be redeemed. Importantly, the Original Entities are not obligated to pay C's Company or D's Company any consideration if the RPS are redeemed within three years.

There is therefore no effectively non-contingent obligation for the Original Entities to provide financial benefits under the scheme. As such, the proposed RPS do not meet all the conditions to be classified as debt interests, and so are equity interests.

Questions 3 and 4

Summary

The issue of the RPS will not give rise to any DVS under Division 725 and therefore CGT event K8 under section 104-250 will not occur.

Detailed reasoning

Subsection 725-145(1) explains that a DVS occurs when:

·        there is a decrease in the market value of one or more equity or loan interests in the target entity; and

·        the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when the thing, or the first of those things is done; and

·        either or both of subsections (2) and (3) of section 725-145 are satisfied.

Subsections 725-145(2) and (3) relevantly require:

·        one or more equity or loan interests in the target entity to be issued at a discount. The decrease in the interest must occur at or after the time of the issue and be reasonably attributable to it; and

·        that there be an increase in the market value of one or more equity or loan interests in the target entity. The increase must be reasonably attributable to the decrease in the other interest.

Do the proposed transactions involve the issue of equity or loan interests at a discount or is there an increase in value of any shares in any of the Original Entities?

The proposed transaction involves issuing the RPS at market value of $1,000 each. There are therefore no equity or loan interests in the Original Entities being issued at a discount. It follows that subsection 725-145(2) is not satisfied.

Whether subsection 725-145(3) is satisfied is less clear on the present facts. However, section 725-50 relevantly provides that a DVS will only have consequences under Division 725 if section 725-90 does not apply. Section 725-90 applies if:

·        the one or more things referred to in paragraph 725-145(1)(b) brought about a state of affairs, but for which the DVS would not have happened; and

·        as at the time referred to in that paragraph, it is more likely than not that, because of the scheme, that state of affairs will cease to exist within 4 years after that time.

The one or more things referred to in section 725-145 that might have brought about a state of affairs but for which the value shift would not have happened is the issue of the RPS to C's Company and D's Company.

The relevant state of affairs is that the proposed RPS has specific characteristics in the form of discretionary dividend rights which give rise to the potential shift in value. The removal of these specific characteristics when the RPS are redeemed (which must happen within 4 years of the issue of the RPS by virtue of its terms of issue), will satisfy the requirements of section 725-90 and hence enliven its operation.

For the above reasons, the proposed transactions do not cause any DVS. Alternatively, if there is a DVS, its reversal within 4 years of the issue of the RPS means section 725-90 will apply such that the DVS will not have any consequences under Division 725.

CGT event K8 happens if there is a 'taxing event generating a gain' for a down interest under section 725-245 (subsection 104-250(1)). As there is no DVS that has consequences under Division 725, CGT event K8 will not happen as a result of the proposed transaction.

Question 5

Summary

The payment of fully franked dividends to RPS holders will not be considered dividend streaming under Subdivision 204-D.

Detailed reasoning

Subdivision 204-D contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another.

Section 204-30 applies 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 them; and other members receive lesser imputation or no imputation benefits.

For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members.

Subsection 204-30(8) details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member:

(a)         is not an Australian resident;

(b)         is not entitled to use the tax offset under Division 207;

(c)         incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions;

(d)         is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution;

(e)         is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; or

(f)           is an exempting entity.

In the current circumstances, C's Company, D's Company, C, D, and all other relevant entities are all residents of Australia for tax purposes. Therefore from a residency perspective no entity will derive a greater benefit from franking credits than another entity.

Furthermore, provided only assessable dividends are paid to C's Company and D's Company, none of the other factors listed in subsection 204-30(8) are applicable, nor do the proposed RPS holders derive a greater benefit from franking credits than other Original Entities' shareholders in some other way. Therefore the Commissioner is not empowered to make a determination under Subdivision 204-D.

Questions 6 and 7

Summary

Neither section 207-155 nor section 177E of the ITAA 1936 will apply to any distribution to RPS holders.

Detailed reasoning

Direct or indirect recipients of a franked distribution can be denied the benefits of attached franking credits in various situations including if the distribution is made as part of a dividend stripping operation (paragraphs 207-145(1)(d) and 207-150(1)(e)).

The notion of dividend stripping operation in this context is defined in section 207-155 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 same 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 (set out in paragraphs 177E(1)(a)-(d) of the ITAA 1936) are met, the effect of paragraphs 177E(1)(e)-(g) of the ITAA 1936 is that 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 scheme

'Scheme' is defined broadly in subsection 177A(1) of the ITAA 1936. In this case, the relevant scheme comprises the following proposed steps:

·        the issue of the RPS by the Original Entities to C's Company and D's Company respectively; and

·        the declaration by the Original Entities of dividends on the RPS;

·        the declaration by C's Company and D's Company of dividends.

Will property of a company be disposed of as a result of the scheme?

For the purposes of section 177E of the ITAA 1936, disposal of property of a company includes the payment of a dividend by the company (paragraph 177E(2)(a)).

The Original Entities' dividend payments on its RPS will constitute disposals of property as a result of the scheme.

Does that disposed property represent a distribution of profits of the company?

The proposed dividend payments will be sourced from the accumulated profits of the Original Entities. Accordingly, those payments will be a disposal of property representing a distribution of the profits of the company.

Would an amount have been included in the assessable income of a taxpayer if the company had paid a dividend equal to the disposal of property immediately before the scheme was entered into?

An amount would be included in the assessable income of each of C and D if the Original Entities had paid dividends of an equivalent amount to its ordinary shareholders immediately before the scheme is entered into.

Is the scheme by way of or in the nature of dividend stripping?

'Dividend stripping' is not defined in the ITAA 1936. We refer to the decisions in Patcorp Investments Ltd v. FCT [1976] HCA 67; (1976) 140 CLR 247; FCT v. Consolidated Press Holdings Ltd [2001] HCA 32; (2001) 207 CLR 235 at [126-133] (Consolidated Press (HC)); Lawrence v. FCT [2009] FCAFC 29; (2009) 175 FCR 277 at [42-43].

Dividend stripping has been recognised by the courts (in the above decisions) 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 CGT 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.

The Full Federal Court in Consolidated Press observed that the use of the words 'by way of or in the nature of' in paragraph 177E(1)(a) of the ITAA 1936 suggests that variations from these paradigmatic six characteristics will not necessarily result in the scheme being excluded, provided it retains the central characteristics of a dividend stripping scheme: Commissioner of Taxation v. Consolidated Press Holdings Ltd (No 1) (1999) 91 FCR 524; [1999] FCA 1199 at 156 (Consolidated Press (FFC).

Application to the Original Entities

Target company with substantial undistributed profits creating a potential tax liability for the company or its shareholders

The Original Entities have significant retained earnings.

Tax has already been paid on these accumulated profits at the company rate, but there is a potential further tax liability to shareholders C and D if that amount were paid to them as dividends that are included in their assessable income and taxed at their marginal rates.

Sale or allotment of shares in the target company to another party

The scheme involves the issue of RPS shares in the Original Entities to C's Company and D's Company.

Payment of a dividend to the purchaser or allottee of shares out of the target company's profits

The Original Entities will pay dividends to C's Company and D's Company.

The purchaser or allottee escapes Australian income tax on the dividend declared

No additional tax liability will be incurred by C's Company and D's Company in respect of the fully franked dividend payments, as the franking credits attached to the dividends will offset any tax liability. This does not amount to escaping tax because C's Company and D's Company will still pay the correct amount of tax.

The ultimate shareholders and beneficiaries of those two entities may have a relevant tax liability if they are paid a dividend or made presently entitled to income which is attributable to a dividend paid by the Original Entities. This liability may be deferred for as long as that amount is retained in C's Company and D's Company without them declaring a dividend to their shareholders. However, this is no different to the amounts being retained by the Original Entities. Ultimately, C and D will not escape tax on the dividends.

The vendor shareholder receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the purchaser

C and D will not receive any capital sum in respect of the proposed transaction.

The scheme being carefully planned, with all parties acting in concert, for the predominant purpose of the vendor shareholder avoiding tax on a distribution of dividends by the target company

As noted above, there is no immediate avoidance of tax on the payment of dividends on the RPS by the Original Entities. However, a deviation from the paradigm dividend strip, such as by reason of a postponement of tax by a shareholder or their associate on a distribution of dividends by a target company, could still be an operation in the nature of dividend stripping or a scheme having substantially the effect of dividend stripping: Consolidated Press (FFC) at [156].

This is reflected in the language of section 177E of the ITAA 1936 itself, that is it is concerned with schemes 'by way of or in the nature of' dividend stripping.

The purpose of the scheme is to be determined objectively, having regard to the characteristics of the scheme and the circumstances in which it is designed and operated: Consolidated Press (FFC) at [174].

One of the factors that the Commissioner takes into account in determining whether there is a dominant purpose of avoiding tax in a case like this is the complexity of the arrangement: paragraph 24 of Taxation Determination 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?.

Viewed objectively by reference to the surrounding circumstances, there can be no dominant purpose of tax avoidance where the possibility of tax deferral is the same after the scheme as it was before. That the retained earnings will ultimately be taxed in the same way as they will be if the restructure does not proceed, demonstrates that the true motivation for the transaction is asset protection as asserted.

While the ownership of C's Company and D's Company differs from the ownership of the Original Entities, in the sense that these companies will be owned by C's Second Trust and D's Second Trust, the scheme has been constructed so that dividends can only flow to C and D. This fact is critical to the assessment that the scheme is not being carried out for the purpose of avoiding tax, and that the scheme is driven by a desire to protect assets.

Conclusion on whether there is a dividend stripping scheme

The proposed transaction is not being carried out with the dominant 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 of the ITAA 1936

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 bears the same meaning as section 177E of the ITAA 1936. For the same reasons set out above, the proposed transaction is not considered part of a dividend stripping operation under section 207-155.

Question 8

Summary

Section 45A of the ITAA 1936 will not apply to the issue of RPS.

Detailed reasoning

Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

The proposed arrangement in question involves the issue of RPS to C's Company and D's Company. Prior to the issue of the RPS these entities are not shareholders of the Original Entities.

As such, section 45A of the ITAA 1936 does not apply to the proposed issue of the RPS.

Question 9

Summary

Section 45B of the ITAA 1936 will not apply to the issue of RPS.

Detailed reasoning

Section 45B of the ITAA 1936 applies where certain payments are made to shareholders in substitution of dividends. Subsection 45B(2) of the ITAA 1936 sets out the conditions under which the Commissioner may make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies with the effect that the payment is taken to be an unfranked dividend. These conditions are that:

·        there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);

·        under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and

·        having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of 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 a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). The relevant circumstances of the scheme include the various matters listed in paragraphs 45B(8)(a)-(k) of the ITAA 1936 (paragraph (k) bringing into the various circumstances the eight matters referred to in subsection 177D(2) of Part IVA).

In this case, the issue of RPS would constitute a scheme under which a person is provided with a capital benefit by a company.

However, as explained above, the scheme is not being carried out with the dominant purpose of avoiding tax.

Accordingly, the Commissioner is not empowered to make a determination under subsection 45B(3) of the ITAA 1936.

Question 10

Summary

Section 177EA of the ITAA 1936 will not apply to any distribution of fully franked dividends to RPS holders.

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:

·        there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and

·        either:

ii. a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or

iii. a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

·        the distribution was, or is expected to be, a franked distribution; and

·        except for section 177EA, the person would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

·        having regard to the 'relevant circumstances of the scheme', it would be concluded that one of those who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling that person to obtain an 'imputation benefit'.

It is considered that the first four conditions in subsection 177EA(3) of the ITAA 1936 are satisfied in respect of the issue of the RPS because:

(a)   the issue of the RPS constitutes a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936). Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, a 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves the issuing of membership interests;

(b)   frankable distributions are expected to be payable to the holders of the RPS

(c)   (paragraph 177EA(3)(b) of the ITAA 1936). Dividends payable on the RPS will be frankable distributions to the extent that the dividends on the RPS do not fall within the list of unfrankable distributions in section 202-45;

(d)   distributions are expected to be paid to the holder of the RPS (paragraph 177EA(3)(c) of the ITAA 1936). It is expected that these distributions will be franked; and

(e)   it is reasonable to expect that an imputation benefit will be received by the relevant taxpayers as a result of distributions made on the RPS given that the Original Entities expect to frank the distributions on the RPS: paragraph 177EA(3)(d) and

(f)     subsection 177EA(16) of the ITAA 1936.

As these threshold requirements of section 177EA of the ITAA 1936 have been met, it is necessary to consider the 'relevant circumstances' of the scheme in determining whether it could be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

The relevant circumstances include the matters listed in paragraphs 177EA(17)(a)-(j) of the

ITAA 1936 (paragraph (j) bringing into the various circumstances the eight matters referred to in subsection 177D(2) of Part IVA)).

As discussed above, the RPS will issue to implement the estate planning and asset protection objectives of C and D. The proposed transaction involving the issue of the RPS is not being carried out for a more than incidental purpose of enabling taxpayers to obtain an imputation benefit.

As a result, and having regard to the relevant circumstances of the scheme, the five conditions in 177EA(3) of the ITAA 1936 have not been satisfied and section 177EA will not apply to any fully franked distribution under the proposed transaction: specifically the Commissioner will not be empowered to make a determination under subsection 177EA(5).

Question 11

Summary

Part IVA of the ITAA 1936 will not apply to the scheme/s.

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) of the ITAA 1936).

There is no tax benefit in this case, for the reasons explained above.

As section 177D of the ITAA 1936 does not apply, the Commissioner would not be empowered to make a determination under subsection 177F(1) to cancel any tax benefit that may be obtained under the proposed arrangement.