Edited version of private advice

Authorisation Number: 1051876224024

Date of advice: 28 July 2021

Ruling

Subject: CGT rollover

Question 1

Is A eligible for the capital gains tax rollover under subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) on the transfer of shares in the Company to a wholly owned company, Company A?

Answer

Yes

Question 2

Is B eligible for the capital gains tax rollover under subdivision 122-A of the ITAA 1997 on the transfer of shares in the Company to a wholly owned company, Company B?

Answer

Yes

Question 3

Should the Company declare a fully franked dividend to Company A and Company B, will section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) have any application to the proposed arrangement?

Answer

No

Note: the Commissioner has not considered the potential application of section 177E of the ITAA 1936 to the proposed arrangement.

This ruling applies for the following period:

Income year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

1.       A and B equally own shares in the Company.

2.       A is sole director of the Company.

3.       The Company has retained earnings and a franking account balance.

4.       A and B were living in a de facto relationship but have now separated and are looking to separate their financial affairs.

5.       There is no Family Court order or other formal binding agreement between A and B relating to the division of assets from their relationship.

6.       A and B do not want to remain joint owners of the Company.

7.       As part of the separation, it is proposed that the Company will pay fully franked dividend distributions to its shareholders.

8.       The dividends will only be paid from retained taxed earnings.

9.       The Company will be wound-up.

10.    Prior to the fully franked dividend distributions, A and B will transfer their shareholdings in the Company to respective wholly owned companies.

11.    The dividend distributions by the Company will be retained in the wholly owned companies for future investment activities.

12.    A and B have no financial need to receive the dividends personally.

13.    A has established Company A, of which A is the sole shareholder and director.

14.    It is proposed that A will transfer shares in the Company to Company A. A will receive no consideration for the transfer, other than ordinary shares in Company A.

15.    Company A has no other assets or liabilities.

16.    Following payment of the proposed dividends by the Company, the market value of the shares in Company A will be equal to the total of the dividends paid by the Company.

17.    Company A is not an exempt entity and has no exempt income.

18.    Company A will pay dividends to A when required by A.

19.    B has established Company B, of which B is the sole shareholder and director.

20.    It is proposed that B will transfer shares in the Company to Company B. B will receive no consideration for the transfer, other than ordinary shares in Company B.

21.    Company B has no other assets or liabilities.

22.    Following payment of the proposed dividends by the Company, the market value of the shares in Company B will be equal to the total of the dividends paid by the Company.

23.    Company B is not an exempt entity and has no exempt income.

24.    Company B will pay dividends to B when required by B.

25.    Both A and B want to keep the value of their interests in the Company in a corporate structure for reinvestment, but also want the assets in separate companies that they control, so they can pursue their investment activities without the involvement of their ex-spouse.

26.    All parties to the scheme are Australian residents for tax purposes.

Relevant legislative provisions

Section 104-10 of the Income Tax Assessment Act 1997

Section 108-5 of the Income Tax Assessment Act 1997

Subdivision 122-A of the Income Tax Assessment Act 1997

Section 122-15 of the Income Tax Assessment Act 1997

Section 122-20 of the Income Tax Assessment Act 1997

Section 122-25 of the Income Tax Assessment Act 1997

Section 122-35 of the Income Tax Assessment Act 1997

Section 122-40 of the Income Tax Assessment Act 1997

Section 177EA of the Income Tax Assessment Act 1936

Reasons for decision

Section 122-15 of the Income Tax Assessment Act 1997 (ITAA 1997) provides that an individual can choose to obtain a roll-over if a specified CGT event (including CGT event A1) occurs involving the individual and a company in the circumstances set out in sections 122-20 to 122-35 of the ITAA 1997. It should be noted that section 122-35 relates to the discharge of a liability, and is not relevant to the current scheme.

Where there is a disposal of a CGT asset, or all the assets of a business, to a company by an individual (event A1), subsection 122-20(1) of the ITAA 1997 requires that the consideration received by the individual for the CGT event must only be shares in the company, or shares in the company and the company undertaking to discharge liabilities in respect of the asset or assets (the current scheme does not include the discharge of a liability).

The shares received by the individual cannot be redeemable (subsection 122-20(2) of the ITAA 1997), and the market value of the shares received from the disposal of the CGT asset must be substantially the same as the market value of the CGT asset disposed of (subsection 122-20(3)).

Section 122-25 of the ITAA 1997 also requires:

• the individual must own all the shares in the company just after the disposal of the CGT asset (subsection 122-25(1)),
• the CGT asset disposed of cannot be an excluded CGT asset under subsections 122-25(2) to (4) - such as collectables, personal use assets, bravery or valour awards, trading stock, registered emissions units, rights, options, convertible interests or exchange interests,
• the company must not be an exempt entity (subsection 122-25(5)), and
• relevantly, the individual and the company must both be Australian residents at the time of the disposal of the CGT asset (subsection 122-25(6)).

Under the proposed scheme, A will transfer shares in the Company to Company A for no consideration, other than shares in A Company.

Shares in a company are CGT assets for the purposes of section 108-5 of the ITAA 1997, and the transfer of shares from A to Company A will be a disposal of a CGT asset (CGT event A1) for the purposes of section 104-10 of the ITAA 1997.

A will receive ordinary shares from Company A in consideration for the Company shares. The market value of the shares in Company A will substantially be the same as the shares transferred from the Company as Company A will have no assets or liabilities other than the shares in the Company.

As such, the roll-over in Subdivision 122-A will be available to A provided that the other requirements for the roll-over are satisfied.

Company A is not an exempt entity, and the shares in the Company are not excluded CGT assets for the purposes of subsections 122-25(2) to (4).

Following the transfer of shares, A will be sole shareholder in Company A, and both A and Company A will be Australian residents.

Conclusion

If A transfers shares in the Company to Company A as described, A will be able to choose the roll-over in Subdivision 122-A of the ITAA 1997. Under subsection 122-40(1) any capital gain or loss from the disposal of the Company shares to Company A will be disregarded.

Question 2

Detailed reasoning

Under the scheme, the circumstances of A and B are similar, and the reasoning in question 1 will also apply to B. As such, B will also be able to choose the roll-over in Subdivision 122-A of the ITAA 1997, and any capital gain or loss from the disposal of the Company shares to Company B will be disregarded under subsection 122-40(1) of the ITAA 1997.

Question 3

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance rule that safeguards the operation of the imputation system. The purpose of the section is to protect the imputation system from abuse and ensure that the benefits of the imputation system flow to the economic owners of the share which is the source of the franked distribution.

Subsection 177EA(3) of the ITAA 1936 sets out the circumstances in which 177EA will apply:

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

(b)     either

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

(ii)         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

(c)     the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and

(d)     except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and

(e)     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 tax payer to obtain an imputation benefit.

Under the proposed scheme, A and B will transfer their ownership interests in the Company to companies that they control (A to Company A, and B to Company B). The Company will then pay fully franked shares to Company A and Company B, causing all the assets in the Company to pass to those companies, and the Company will be wound up.

A person has an interest in membership interests if they have a legal interest in a membership interest (subsection 177EA(13) of the ITAA 1936). A scheme for the disposition of membership interests includes entering into any arrangement, transaction or dealing that changes the legal ownership of the membership interest (subsection 177EA(14) of the ITAA 1936).

Subsection 204-30(6) of the ITAA 1997 sets out the meaning of 'imputation benefit', and relevantly provides that a 'imputation benefit' is received from a distribution where a franking credit would arise in the franking account of the member as a result of the distribution (paragraph 204-30(6)(c)).

Under the scheme there is a disposition of membership interests (ownership in the shares of the Company pass from A and B to Company A and Company B), franked distributions will be paid from the Company to the new shareholders, and the franking account of Company A and Company B will be credited with the franking credit received from the Company (subsection 205-5(2) of the ITAA 1997 provides that the receipt of a franked distribution by an entity from another corporate tax entitywill generate a franking credit).

The relevant circumstances of a scheme referred to in paragraph 177EA(3)(e) of the ITAA 1936 are set out in subsection 177EA(17) of the ITAA 1936, which states:

The relevant circumstances of a scheme include the following:

(a)         the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity);

(b)         whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity;

(c)         whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b);

(d)         whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b);

(e)         if the scheme involves the issue of a non-share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies--whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity:

(i)       that are similar, from a commercial point of view, to the non-share equity interest; and

(ii)      distributions in respect of which are frankable;

(f)          whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer;

(g)         whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme;

(ga) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits;

(h)         whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest;

(i)           the period for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity;

(j)           any of the matters referred to in subsection 177D(2).

The circumstances giving rise to the proposed scheme is the separation of A and B from a de-facto relationship. The Company is currently an investment vehicle for A and B who both own shares in the Company, but control of the Company sits with A.

Both A and B want to separate their financial affairs so that they individually manage their investments without input from their former spouse. Both want to maintain their investments in a corporate structure. To achieve this, both A and B have set up separate companies which they control as sole owners. Following payment of the fully franked dividend by the Company, it will be wound up and A and B will continue with their investment activities from their respective new companies.

The Explanatory Memorandum to the Taxation Law Amendment Bill (No.3) 1998 which inserted section 177EA states the following explanation about the dividend imputation system:

One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process transferring the franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax exempts) to others who can fully use them undermines the principle. Similarly, dividend streaming (ie. the streaming of franking credits to select shareholders undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings (paragraph 8.124).

Under the proposed scheme, there is no change in the ultimate economic owners of shares. The transfer of shares in the Company to Company A and Company B facilitate the separation of the assets of A and B, and the ongoing investment of the assets in a corporate structure. The scheme will cause franking credits to transfer between corporate entities but ultimately the same individuals (A and B) control the corporate entities and will be required to pay top-up tax on any franked distribution from the new companies. The arrangement defers the entitlement of A and B to franking credits but does not change their ultimate entitlement to the franking credits (as sole shareholders the franking credits of their respective companies will pass through to them). The proposed scheme does not cause the risk owners (A and B) to receive a greater or lesser imputation benefit.

The circumstances of the scheme show that while the scheme will give rise to imputation benefits, in the form of franking credits for the two companies that will receive dividends from the Company (Company A and Company B), it is considered that obtaining those imputation benefits will merely be an incidental purpose of each of the entities that will enter into or carry out the scheme.

As such, section 177EA of the ITAA 1936 will not apply to the proposed scheme.

Note: the Commissioner has not considered the potential application of section 177E of the ITAA 1936 to the proposed arrangement.