Edited version of private advice

Authorisation Number: 1051911855723

Date of advice: 2 November 2021

Ruling

Subject: Anti avoidance

Question 1

Whether section 177D of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to the transaction?

Answer

No

Question 2

Whether section 177E of the ITAA 1936 will apply to the transaction?

Answer

No

Question 3

Whether section 177EA of the ITAA 1936 will apply to the transaction?

Answer

No

This ruling applies for the following period:

I July 2021 to 30 June 2025

Relevant facts and circumstances

The Trustee of Trust A is the sole shareholder of Company A.

Company A is the holding company of a several subsidiaries (Group B).

Entity C, a charitable organisation, is a beneficiary of Trust A.

Group B's charter requires that the group donates approximately 50% of its trading profits to Entity C. This reflects the wishes of the founder of Group B.

Group donates to Entity C by paying franked dividends to Trust A which distributes these to Entity C.

The Transaction will consist of the following steps:

Step 1: Company A will declare a fully franked dividend with franking credits attached (Dividend) to Trust A, being the sole shareholder of Company (Step 1 - Dividend).

Step 2: Trust A will distribute the Dividend to Entity C as a beneficiary of the trust (Step 2 - Trust Distribution).

Step 3: Entity C will enter into a loan facility agreement (loan facility) with Company A (Step 3 - Loan Facility).

In relation to Step 1 - Dividend

The dividends will originate within the Group B, paid to Company A as head company,

then paid to Trust A as shareholder of Company A, then distributed to Entity C. Company A is aware of Trust A's obligations under section 100AA of the ITAA 1936 with respect to distributions to Entity C.

In relation to Step 2 -Family A:

The streaming of the Dividend from the Trust A to Entity C is supported by the trust deed.

a.    Given the status of Entity C as an income tax exempt entity, the Dividend will be exempt income in its hands; and

b.    Given the status of Entity C as an exempt institution that is eligible for a refund, Entity C will be entitled to a tax offset equal to the amount of the franking credits attached to the Dividend. Given Entity C will have no taxable income against which to utilise the tax offset arising from the Dividend, Entity C will receive a refund of the full amount of the franking credits.

Group B will not distribute funds of the proposed quantum unless the loan facility can be

entered into. That is, the distribution will be contingent upon the loan facility being entered into.

In relation to Step 3 - Loan Facility, the loan facility will be provided on commercial terms - i.e. there is a commercial loan arrangement that reflect what would be available at market, including commercial rate of interest:

a.    All amounts of interest expense that will be incurred by Company A under the loan facility

will be deductible pursuant to section 8-1 of the ITAA 1997; and

b.    All amounts of interest income that will be derived by Entity C under the loan facility will be exempt on the basis that Entity C is an income tax exempt entity.

Various individuals, including Individual A and Individual B, control Company B, the corporate trustee of Entity C. Individual A and Individual B also occupy director/officer positions of Company A and its Australian subsidiaries. Individual A and Individual B have fiduciary obligations with respect to each separate legal entity. Entity C has additional officeholders to those of Group B.

Relevant legislative provisions

ITAA 1936 Section 177D

ITAA 1936 Section 177E

ITAA Section 177EA

Reasons for decision

Issue 1

Question

Whether section 177D of the ITAA 1936 will apply to the transaction?

Summary

In these circumstances, it is reasonable to accept that any tax benefits (incidental or otherwise) would not lead to the conclusion that the arrangement was entered into for the sole or dominant purpose of obtaining a tax benefit.

Detailed reasoning

GENERAL ANTI-AVOIDANCE

Part IVA of the ITAA 1936 (Part IVA) is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit.

Scheme

Part IVA requires the consideration of a 'scheme', which is defined in subsection 177A(1) of the ITAA 1936 as:

•         any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable by legal process; and

•         any scheme, plan, proposal, action, course of action or course of conduct.

Guidance of the meaning of the term 'scheme' can be found in case law. In Federal Commissioner of Taxation v. Hart (2004) 55 ATR 712 (Hart), per Gummow and Hayne JJ:

[43] [The] definition is very broad. It encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also (by its reference to "action" in the singular) the taking of but one step.

Tax Benefit

There must be a tax benefit obtained by the taxpayer in order for Part IVA to potentially apply. Section 177C of the ITAA 1936 broadly provides that a tax benefit in relation to a scheme relates to:

•         amounts not being included in assessable income that would otherwise have been included in assessable income

•         amounts included as an allowable deduction that would otherwise not have been included as an allowable deduction

•         capital losses incurred that would otherwise not have been incurred

•         foreign income tax offsets being allowable that would otherwise not have been allowable, and

•         no liability to withholding tax on an amount that would otherwise have had a liability.

Dominant purpose

Part IVA also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D of the ITAA 1936 refers to the purpose of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer.

The meaning of the purpose is clarified by subsection 177A(5) of the ITAA 1936, which explains that, where there are two or more purposes, the purpose includes the dominant purpose:

A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose.

When determining whether the purpose of the scheme was to enable a tax benefit, the Commissioner must also have regard to the following eight factors specified in subsection 177D(2) of the ITAA 1936:

(a)  the manner in which the scheme was entered into or carried out

(b)  the form and substance of the scheme

(c)   the time the scheme was entered into and the length of time during which the scheme was carried out

(d)  the result that, but for the operation of Part IVA, would be achieved by the scheme

(e)  any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme). in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme

(f)    any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme) in the financial position of any person who has, or has had, any connection with the relevant taxpayer

(g)  any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f) of the scheme having been entered into or carried out, and

(h)  the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph(f).

Focussing on the various elements of Part IVA should not obscure the way in which the Part as a whole is intended to operate. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person in entering into or carrying out the scheme, and the existence of the tax benefit, must be considered against a comparison with reasonable alternative schemes capable of carrying out the commercial objectives of the arrangement.

In summary, section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, after having regard to the eight specified factors, it would be concluded that any person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the relevant taxpayer to obtain the tax benefit.

The identification of a tax benefit requires consideration of the tax consequences of a 'counterfactual', or alternative hypothesis, that would have resulted had the scheme not been entered into. As stated by Gummow and Hayne JJ Hart:

[66] When [section 177C(1)] is read in conjunction with [former] s177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in [former] s177D(b) will require consideration of what other possibilities existed.

Guidance for identifying the counterfactuals of the scheme can be found in Practice Statement PS LA 2005/24: Application of the General Anti-Avoidance Rules (PS LA 2005/24). In particular, paragraph 74 lists the following considerations for determining the counterfactuals:

a)    the most straightforward way of achieving the commercial and practical outcomes

b)    commercial norms, such as standard industry behaviour

c)    social norms, such as family obligations

d)    behaviour of the parties around the time of the scheme compared with the period of the scheme's operation, and

e)    actual cash flow.

PSLA 2005/24 further explains that if:

a)    the scheme had no effect other than obtaining the tax benefit, it is reasonable to assume that nothing would have happened if it was not carried out (paragraph 75), and

b)    a tax benefit is obtained in connection with the scheme which also achieves a wider commercial objective, then it would be reasonable to expect that in absence of the scheme the wider commercial objectives would have been pursued by an alternative arrangement (paragraph 76).

In Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531 the Court explained that although the Commissioner has to consider each of the factors provided by former subsection 177D(b), this doesn't mean that each of the factors must point to the dominant purpose, stating that:

Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against that [former] s177D requires in order to reach the conclusion to which 177D refers.

The Commissioner's support of this view is provided in PS LA 2005/24 which states at paragraph 88 that all factors of subsection 177D(2) of the ITAA 1936 need to be taken into account with regard to the relevant evidence, and weighed together, to identify the dominant purpose of the scheme.

Cancellation of tax benefit

Where the Commissioner has made a determination under paragraph 177F(1)(a) of the ITAA 1936 that an amount is to be included in a taxpayer's assessable income, subsection 177F(2) provides that this amount shall be deemed to be included in the taxpayer's assessable income.

Application to your circumstances

The proposed arrangement (i.e. the transaction) would satisfy the requirements for a scheme pursuant to subsection 177A(1) of the ITAA 1936.

Tax benefit

To establish whether there is a tax benefit associated with the proposed arrangement, it is necessary to consider what is reasonably expected to occur, including the tax outcomes, if the scheme is not entered into. Taking into account the factors listed in paragraph 74 of PS LA 2005/24, a counterfactual to your proposed scheme, would be to donate the amount directly to Entity C.

Arguably, one of the tax benefits to be obtained may be from streaming franked dividends to beneficiaries in a tax effective manner.

It is noted the fact that a taxpayer pays less tax if one form of the transaction rather than another is adopted, does not by itself demonstrate that Part IVA applies (paragraph 109 of PS LA 2005/24).

Dominant purpose

Whether your purpose in entering into the arrangement is to obtain a tax benefit, is determined with reference to the eight factors specified in subsection 177D(2) of the ITAA 1936:

(a)  the manner in which the scheme was entered into or carried out

(b)  the form and substance of the scheme

(c)   the time the scheme was entered into and the length of time during which the scheme was carried out

(d)  the result that, but for the operation of Part IVA, would be achieved by the scheme

(e)  any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme). in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme

(f)    any change (being a change that has resulted from, will result of or may reasonably be expected to result from, the scheme) in the financial position of any person who has, or has had, any connection with the relevant taxpayer

(g)  any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f) of the scheme having been entered into or carried out, and

(h)  the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph(f).

Conclusion

Based on the available information and having regard to the eight factors in section 177D of the ITAA 1936, a reasonable person would more likely than not conclude that there are 'tax benefits' in entering into this scheme - that profits under the proposed arrangement can be distributed to beneficiaries of the trust in a tax effective manner.

Arguably, the potential mischief is the release of franking credits as a refund through the circular movement of the dividends through the related entities.

Taking into account the various considerations, it is reasonable to accept that any tax benefits (incidental or otherwise) would not lead to the conclusion that the arrangement was entered into for the sole or dominant purpose of obtaining a tax benefit. These considerations include that:

•         Group B effectively has to ensure that Entity C benefits from investment of at least 50% of its profits each year, having regard to its founder's wishes.

•         Various individuals, including Individual A and Individual B, control the trustee of Entity C. The fact that Entity C has additional officeholders to those of the Group B indicates a degree of independence from Group B. Furthermore, Individual A and Individual B also occupy director/officer positions of Company A and its Australian subsidiaries. Individual A and Individual B have fiduciary obligations in respect to each separate legal entity.

•         Entity C's history and status - in addition to the terms of its trust deed, its conduct is bound by strict rules and regulations.

•         There is an assumption that the loan is on commercial terms.

•         There are legitimate commercial reasons for the loan - having regard to the nature of Group B, it offers a safe and reasonable return to Entity C on their excess funds.

•         The loan will provide investment and working capital finance to Group B - there will be no private or domestic use of the funds.

Consequently, Part IVA of the ITAA 1936 will not apply to the scheme.

Issue 2

Question

Whether section 177E of the ITAA 1936 will apply to the transaction?

Summary

The transaction will not constitute a 'dividend stripping scheme' (or a scheme having substantially that effect) for the purposes of section 177E of the ITAA 1936 because the ordinary characteristics of a 'dividend stripping' scheme will not be apparent if the company distributes profits in the form of franked dividends to its sole shareholder.

Detailed reasoning

DIVIDEND STRIPPING

Section 177E of the ITAA 1936contains an anti-avoidance provision regarding a scheme to reduce income tax through stripping of company profits.

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 transaction will constitute a scheme for the purposes of the anti-avoidance provisions.

The pre-conditions to the operation of the dividend stripping rules are contained in paragraphs 177E(1)(a)-(d), which state the provisions have effect 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 four pre-conditions

The Commissioner's view on the nature of dividend stripping schemes is contained in Taxation Ruling IT 2627. The Commissioner identified four pre-conditions that must be satisfied in paragraphs 177E(1)(a)-(d) above, which are:

•         As a result of a dividend stripping scheme or scheme having substantially the same effect, any property of the company is disposed of (paragraphs 6 to 21).

•         The disposal of property represents, in whole or in part, a distribution of profits of the company, regardless of whether the profits existed at the time the property was disposed of (paragraph 22).

•         If the profits had been paid as a dividend immediately before the scheme was entered into an amount would, or might reasonably be expected to, have been included in the taxpayer's assessable income (paragraph 24 to 25).

•         The scheme was entered into after 27 May 1981, whether inside or outside Australia.

Two limbs of the first pre-Condition

There are two limbs to the application of this the first pre-condition, the difference between them being the method by which profits of the target company are distributed. 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.

The Commissioner's view in IT 2627 is that in order for a scheme to fall within the second limb 'it would require at a minimum that company profits are effectively distributed to shareholders.' The profits do not need to be distributed specifically to the shareholder, as long as it can be determined that the payment has been made for the benefit of the shareholder or their associate.

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 required examination to determine which limb the scheme falls within.

Common characteristics of a dividend stripping scheme

The High Court in Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32 ('Consolidation Press') applied the following common characteristics of dividend stripping that had been identified by the Full Court of the Federal Court:

A target company with substantial undistributed profits

The sale or allotment of share to another party

The payment of a dividend to the purchaser or allottee

The purchaser escapes Australian tax on the dividends declared

The vendor receives a capital sum for their shares in an amount the same or very close to the dividends paid to the purchasers; and

The scheme was carefully planned for the predominant if not sole purpose of the vendor shareholders avoiding tax.

It is noted that many of these characteristics are consistent with the description of a dividend stripping scheme provided in Taxation Ruling IT 2627.

In the Federal Court, Hill J held that:

[A] scheme will only be a dividend stripping scheme if it would be predicated of it that it would only have taken place to avoid the shareholders in the target company becoming liable to pay tax on dividends out of the accumulated profits of the target company. It is that matter which distinguishes a dividend stripping scheme from a mere reorganisation.

Therefore, in order to determine whether a scheme will possess the ordinary characteristics of a dividend stripping scheme, it must be determined whether it would only have taken place to avoid the shareholders becoming liable to tax on dividends that they otherwise would have. This requires a consideration of the amount of tax, and the quantum of dividends, that would ordinarily have resulted.

Dominant purpose

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).

The tax avoidance purpose is ordinarily that of enabling the shareholders to receive profits of the company in a substantially tax-free form(see Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32, [129] (Gleeson CJ, Gaudron, Gummow, Hayne, Callinan JJ). Determining the purpose of an arrangement depends upon objective facts and is not concerned with the subjective motivation of the taxpayer. It is the dominant purpose of a person who entered into or carried out the scheme that must be determined in this manner(see Commissioner of Taxation v Consolidated Press Holdings & Anor [2001] HCA 32, [129] (Gleeson CJ, Gaudron, Gummow, Hayne, Callinan JJ)).

Application to your circumstances

The Commissioner accepts that the transaction is unlikely to constitute a scheme that demonstrates the common characteristics of a dividend stripping scheme as profits are distributed to the sole shareholder by way of franked dividends. Furthermore, in broad terms, streaming of franked dividends to beneficiaries is accepted where the streaming is permitted by the trust deed and appropriately reflected in a trust resolution (and it is assumed that the trust deed for the Trust A empowers the trustee to stream the dividend to Entity C and that it will have in place the necessary trust resolution).

As discussed, the Commissioner considers that in these circumstances it is reasonable to accept that any tax benefits (incidental or otherwise) would not lead to the conclusion that the arrangement was entered into for the sole or dominant purpose of obtaining a tax benefit.

Issue 3

Question

Whether section 177EA of the ITAA 1936 will apply to the transaction?

Summary

The transaction will not constitute a 'dividend stripping scheme' (or a scheme having substantially that effect) for the purposes of section 177E of the ITAA 1936 because the ordinary characteristics of a 'dividend stripping' scheme will not be apparent if the company distributes profits in the form of franked dividends to its sole shareholder.

Detailed reasoning

GENERAL IMPUTATIONS BENEFITS ANTI-AVOIDANCE

Section 177EA of the ITAA 1936 deals with the disposition of shares to obtain a franking credit benefit.

In broad terms, it is a general anti-avoidance provision that applies to franking credit trading schemes where one of the purposes (other than an incidental purpose) of the schemes is to obtain a franking credit benefit. The provision applies to schemes for the disposition of shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares which includes an off-market share buy-back with a franked dividend component.

Relevantly, subsection 177EA(3) of the ITAA 1936, provides that the following conditions must exist for the operation of the provision:

(a) there is scheme for the 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 the 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 section 177EA of the ITAA 1936, 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 taxpayer to obtain an imputation benefit.

Application to your circumstances

As there will be no disposition of shares, there will be no imputation benefit for the purposes of section 177EA of the ITAA 1936 to allow the Commissioner to make a determination to cancel a benefit.