Edited version of private advice

Authorisation Number: 1051851272382

Date of advice: 18 August 2021

Ruling

Subject: Dividend access share arrangement

Question

Is the arrangement a scheme to which section 177E of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936)applies?

Answer

No

This ruling applies for the following periods

1 July 20xx to 30 June 20xx

The scheme commences on

xx/xx/xx

Relevant facts and circumstances

Background information

Individual A is married to Individual B.

Individual C is the child of Individual A and Individual B.

Individual A is a director of a number of companies.

Company A has a 33% shareholding in Company B which operates a number of entities.

Company A was incorporated after 20 September 1985.

The directors of Company A are Individuals A, B and C.

The shareholdings for Company A are as follows:

• Individual A legally and beneficially owns X ordinary shares,
• Individual B legally and beneficially owns X ordinary shares and Y class shares,
• Individual B legally owns Z shares but is beneficially for Individual A, and
• Individual A legally owns W shares but is beneficially for Individual C.

Company C was incorporated after 20 September 1985.

Company C is governed by its constitution.

The directors of Company C is Individuals A and C.

The sole shareholder of one ordinary share in Company C is Company D as trustee for Trust A.

The Permanent Governing Director (PGD) of Company C is Individual A during their lifetime and then Individual C.

The PGD has special powers to appoint or remove directors, limit or restrict their powers and fix their remuneration and duties and appoint a delegate or proxy to act as the PGD. The PGD has equal voting power as other directors.

The directors are required to convene an advisory board to advise on decisions relating to the proposed implementation and supervision of the investment strategy, payment of dividends and any other matter relating to the management and administration of Company C.

The constitution contains specific restrictions on the directors' ability to declare dividends that would have the effect of reducing the net value of the assets of Company C below the Company A Asset Value.

Company A Assets are defined in Company C's constitution meaning assets which Company C received by way of a dividend from Company A.

Company C's constitution considers the payment of dividends and reserves which includes certain restrictions on these payments.

Trust A was settled in the XXXX income year.

Trust A is a discretionary trust.

Trust A is governed by its trust deed.

The Trustee for Trust A is Company D.

Individual A is 100% shareholder of Company D

The Directors of Company D are Individuals A, B and C.

The PGD of Company D is Individual A during their lifetime and then Individual C.

The PGD has special powers to appoint or remove directors, limit or restrict their powers and fix their remuneration and duties and appoint a delegate or proxy to act as the PGD. The PGD has equal voting power as other Directors.

Beneficiaries of Trust A are defined in its trust deed:

Company A Income is defined in Trust A's trust deed as income of the trust which comprises a dividend from Company C where the dividend from Company C comprises assets (including cash) which were received by Company C by way of dividend from Company A.

Trust A's trust deed provides for accumulation of Company A Income in default of distribution to certain beneficiaries.

The restrictions in the Trust A's trust deed apply following the death or incapacity Individual A.

The trust deed provides that the trustee, in its capacity as the sole shareholder of Company C, cannot change the dividend policy or vary the constitution of Company C or liquidate Company C until after the death of Individual C or the year XXXX, whichever is the earliest.

Proposed transaction

Company A proposes to issue one class x share to Company C.

Company A will declare a dividend in favour of Company C as the class x shareholder. The dividend will be declared as soon as practical following the Commissioner issuing a favourable ruling on the proposed arrangement.

The dividend will be comprised of cash and assets distributed in specie. The dividend is fully franked.

Company C will invest the dividend. It will record the franking credit it receives attached to the Company A dividend in its franking account.

Company C will comply with its constitution in that Company C will not pay a dividend that would cause its net value as recorded in its accounts to be reduced below the Company A Asset Value.

Contentions

The purpose of this arrangement is to:

• separate and protect non-business assets currently owned by Company A from the significant risks related to Company A's business activities and shareholdings in that business. This risk lies with Company A, its directors and shareholders.
• provide a protected pool of assets for the ultimate benefit of Individual A's immediate family and the future lineal descendants of Individual C.

As a result of the current risks and structure holding of Individual A and his family's wealth, it is considered Company A is an inappropriate vehicle for investment.

It is contended that by divesting of a portion of retained earnings (cash, real property and other assets) of Company A outside the business that this would protect the non-business assets from these risks.

A way of protecting the assets is to transfer the assets from Company A to Company C, with 100% of the shares in Company C owned by Trust A.

Family succession planning has also been raised as an objective to ensure the family wealth is preserved for future generations.

The purpose of the restructure is to ensure that the assets and the wealth that the non-business assets generate are available for the decedents of Individual A in the future.

Assumptions

Trust A will not dispose of its share in Company C.

In the event that the Company A dividend is ultimately paid as a dividend from Company C to Trust A it will be subsequently distributed to the Company A Income Beneficiaries in the character of income.

Relevant legislative provisions

Section 177E of the Income Tax Assessment Act 1936

Reasons for decision

Section 177E of Part IVA of the 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.

Subsection 177E(1) of the ITAA 1936 states

Where:

  (a)        as a result of a scheme that is, in relation to a company:

                    (i)        a scheme by way of or in the nature of dividend stripping; or

                  (ii)         a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping;

any property of the company is disposed of;

  (b)        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);

   (c)        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 the property referred to in paragraph (a), an amount (in this subsection referred to as the notional 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; and

  (d)        the scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia;

the following provisions have effect:

  (e)        the scheme shall be taken to be a scheme to which this Part applies;

    (f)        for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and

  (g)        the amount of that tax benefit shall be taken to be the notional amount.

The definition of 'scheme' is contained in section 177A of the ITAA 1936 and includes any plan, proposal, action, course of action or course of conduct. Given the broad definition, it is considered that the proposed restructure will constitute a scheme for the purposes of section 177E.

There are two limbs to consider in the first pre-condition, as expressed in subsection 177E(1)(a). As stated by the Full Federal Court in Lawrence v Commissioner of Taxation [2009] FCAFC 29 ('Lawrence'):

[52] The first limb is concerned with schemes which are by way of or in the nature of dividend stripping; the second limb is concerned with other schemes, that is, schemes that are not by way of or in the nature of dividend stripping but which are schemes having substantially the same effect.

It was noted by the Full Federal Court in Lawrence that:

[48] The reference to 'having substantially the effect of' a dividend stripping scheme is to a scheme that would be within the first limb, except for the fact that the distribution by the target company is not by way of dividend or deemed dividend.

Therefore, in order to determine whether the first pre-condition is satisfied, the common characteristics of a dividend stripping scheme must be identified. If the common characteristics exist, then the manner in which the profits of the target company are distributed requires examination to determine which limb the scheme falls within.

Dividend stripping is further considered in Taxation Determination TD 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? (TD 2014/1) in the context of dividend access share arrangements.

Paragraph 5 of TD 2014/1 states:

'While the application of Part IVA depends on the facts of the particular case the Commissioner considers that a dividend access share arrangement that includes all of the elements described in paragraph 4 of this Determination is a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E where the relevant purpose exists ...'

Paragraph 6 of TD 2014/1 explains:

'In deciding whether there is a scheme 'by way of dividend stripping' or 'in the nature of dividend stripping' within the meaning of section 177E of Part IVA it is necessary to determine if there is an objective purpose of tax avoidance in respect of the scheme. In determining objective purpose, a simple assertion that another non-tax purpose exists will not of itself conclusively determine the issue. Any such assertion must:

·         be supported by the other available evidence; and

·         not be inconsistent with the objective facts of the case having regard to all the other relevant evidence.'

The term 'dividend stripping' has no precise legal meaning. However, it has been the subject of judicial discussion. In Consolidated Press[1], the High Court cited with approval the Full Federal Court's adoption of Gibbs J's list, in Patcorp Investments[2], of the 'common characteristics' of earlier dividend stripping cases. Those characteristics, subsequently adopted in Lawrence[3], include:

      i.        a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders,

     ii.        the sale or allotment of shares in the target company to another party,

    iii.        the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits,

   iv.        the purchaser or allottee escaping Australian income tax on the dividend so declared,

     v.        the vendor shareholders receiving a capital sum for the 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), and

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

Although a plain reading of the words contained in section 177E of the ITAA 1936 do not require determining the purpose for which the scheme was entered, the High Court has held that to constitute dividend stripping the scheme must have as its dominant purpose the avoidance of tax on the distributions of dividends by the target company (see Lawrence v Commissioner of Taxation [2009] FCAFC 29, [33] (Ryan, Stone, Edmonds JJ).

In considering the features of the proposed scheme, the target company (Company A) has substantial undistributed profits which would create a potential tax liability for its shareholders (being Individuals A, B and C), in the event they were paid out as either franked or unfranked dividends. Accordingly, the first characteristic is satisfied.

The scheme involves the sale or allotment of shares in the target company to another party as a special resolution will be made to create a new class of share in Company A. A new class of share will then be issued to Company C. The second characteristic is therefore satisfied.

The scheme provides for a dividend to be declared and subsequently paid on the new class dividend held by Company C. The dividend is paid out of the profits of Company A. Therefore, third characteristic is satisfied.

The new class dividend that is paid to Company C will be a fully franked dividend. Being a corporate entity, Company C will not incur any tax liability in respect of the new class dividend as the benefit of the franking credits will wholly offset any tax liability. Therefore, Company C will escape income tax on the dividend, resulting in the fourth characteristic being satisfied.

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

TD 2014/1 provides an explanation of the features of a dividend access share arrangement for which the Commissioner is of the opinion is within scope of section 177E of Part IVA of the ITAA 1936.

Paragraph 4 explains the features of a 'dividend access share' arrangement that is the subject of TD 2014/1.

The features described in paragraphs 4(a) - 4(f) are very similar to the first four of the 'common characteristics' cited in judicial discussion as explained previously. Paragraph 4(g) states:

A series of transactions are then carried out that have the effect of ensuring that the original shareholder(s) and/or associates receive the economic benefit of the target company's profits in a tax-free or substantially tax-free form. Examples of this include:

·         where the Z class shares are issued to a company, the company need not pay tax on the fully franked dividend as it gets enough franking credits to offset any tax liability. In many of these arrangements, the company is wholly owned by a discretionary trust. This allows the original shareholder to direct any subsequent dividend distributions by the company to tax-preferred entities such as non-resident associates of the original shareholder, other related individuals exposed to a lower marginal tax rate or entities with carried forward tax losses.

Whilst the proposed arrangement has similarities with the structure described in the first dot point in paragraph 4(g), there are some features that differentiate the proposed arrangement from that described in TD 2014/1.

The structure described in the first dot point is in the context of the features described in paragraph 4(g). However, the proposed arrangement does not envisage the series of transactions described in paragraph 4(g), and does not contemplate any further transactions beyond that described in paragraph 4(f), being the company declaring and paying a fully franked dividend on the dividend access share.

That is, whilst the dividend is paid to Company C, and Trust A is the sole shareholder in Company C, the proposed scheme does not involve a series of transactions that have the effect of ensuring the original shareholders and/or their associates receive the economic benefit of the target company's profits in a tax-free or substantially tax-free form, being the feature described in paragraph 4(g).

Rather, Company C's dividend policy as per the Constitution is such that it may only pay a dividend if the net value of the company would not reduce below the value of the dividend paid to it by Company A. This has the effect of quarantining the Company A dividend within Company C. The Trust Deed includes a restriction on the Trustee's power to exercise its rights as the majority shareholder in Company C to effect any change to the dividend policy of Company C. This restriction comes into effect on the death of Individual A, and applies until the earlier of the death of Individual C or xxxx. Further, the restriction states that the Trustee may not exercise its rights as a majority shareholder in Company C to cause the winding up of Company C unless or until there are no lineal descendants of Individual A who are then living. Individual A, is also the PGD of the corporate Trustee of the Trust.

Under the Trust Deed, the class of beneficiaries that may receive the Company A dividend ('Company A Income Beneficiaries') are limited to the three original Company A shareholders, the lineal descendants of Individual C, and any company in existence in which the only beneficial owners of shares are Individuals A, B and C, or lineal descendants of Individual C. Given one of the stated purposes of the arrangement is to provide for succession planning, it would not be practical to limit the Company A Income Beneficiaries to Individuals A, B and C (being the Company A shareholders) as the structure would become extremely limited upon their death. This feature does not create any tax benefit that could not be achieved by way of a shareholder's shareholding in Company A being transferred to a beneficiary of a will upon death.

For these reasons, the proposed arrangement cannot be said to 'have the effect of ensuring that the original shareholder(s) and/or associates receive the economic benefit of the target company's profits in a tax-free or substantially tax-free form'. Rather, the beneficiaries are denied the economic benefit of dividend for up to xx years, and the assets that represent the Company A dividend will ultimately be taxed as a dividend distributed by Company C. This deferral of the economic benefit is particularly restrictive such that it is a significant factor in considering the predominant or sole purpose of the arrangement, and concluding that this purpose is not to avoid tax.

Whilst Trust A will have the ability to pay dividends consisting of the income derived by the trust, the constitution of Company C ensures that it preserves the original Company A dividend, prohibits Company C from borrowing, and limits Company C to holding only low risk assets. The Trust Deed further ensures that these restrictions are maintained and prevents any amendments to the Trust Deed which may enable the amending of the Company C Constitution to change this dividend policy, alter its investment strategy or allow it to borrow. The constitution of Company C also requires the appointment of an independent advisory board to advise on the administration of the company.

If the taxpayer wished to merely defer both the economic benefit and tax liability of the dividend, then the existing structure could achieve this by Company C simply delaying the payment of a dividend to the shareholders. However, maintaining the current structure would not achieve the objective of separating the non business assets. Further, it would not ensure the assets are protected for future generations after the death of Individual A in such a controlled environment. In considering the sixth characteristic of a dividend strip, whilst the scheme has been carefully planned, it cannot be concluded that it was for the predominant if not the sole purpose of the vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company.

The taxpayer's decision to quarantine the dividend is particularly unique and restrictive such that it is indicative of a dominant purpose which is unrelated to tax, being the asset protection achieved by separating the non-business assets from Company A and by establishing a protected pool of these assets for the ultimate benefit of Individual A's immediate family and the future lineal descendants of Individual C. As the proposed scheme lacks a predominant if not sole purpose of avoiding tax on the distribution of dividends, it does not contain all the necessary characteristics of a dividend strip. Accordingly, the Commissioner is unable to conclude that the proposed scheme is a scheme by way of or in the nature of a dividend strip, or has substantially the effect of a scheme by way of or in the nature of dividend stripping.

Therefore, it is not considered that section 177E of the ITAA 1936 has application to the arrangement so described in this ruling.