Edited version of private advice

Authorisation Number: 1052059888636

Date of advice: 24 November 2022

Ruling

Subject: Proposed restructure

Issues

Question 1

Will distributions made by New Holding Company following the Proposed Restructure, and sourced from Retained Earnings initially created out of the Gift, constitute a dividend pursuant to subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) that is a frankable distribution for the purposes of subsection 202-40(1) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

Yes.

Question 2

Will subsection 109R(2) of the ITAA 1936 apply to disregard the repayment of the existing shareholder loans by way of loan advances by New Holding Company to enable the Trustee and each Family member to refinance their existing Division 7A loans with Old Holding Company as new 25-year loans with New Holding Company?

Answer

No.

Question 3

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

Answer

No.

Question 4

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

Answer

No.

Question 5

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936?

Answer

No.

Question 6

Will the Commissioner make a determination under paragraph 177EB(5) of the ITAA 1936 in relation to cancel the franking credits transferred to New Holding Company under section 709-60 of the ITAA 1997?

Answer

No.

This ruling applies for the following period: XXXX

Relevant facts and circumstances

The Family

The Family), for the purposes of this ruling comprises the Individuals.

The Family Trust

The Family Trust is a discretionary trust.

The trustee of the Trust is Company A (the Trustee), being a private company limited by shares, and tax resident in Australia.

The Individuals are beneficiaries of the Family Trust.

The Family controls the Trustee by the virtue of the Individuals jointly holding 100% of the shares on issue in Company A.

New Holding Company

New Holding Company is a private company limited by shares tax resident in Australia.

Shareholdings

The individual each hold 1 Ordinary share.

The Family controls New Holding Company by the virtue of the Individuals holding the only shares in issue (i.e. there are no shareholders other than the Individuals).

Old Holding Company

Old Holding Company is a private company limited by shares, and tax resident in Australia.

Shareholdings

There Individuals hold Class A to F shares.

There have never been any ordinary shares on issue.

The rights attached to the shares

Class A to F shares

•         Entitled to dividends determined by the directors from time-to-time in respect of each class of shares which may be determined to be paid on any one or more class or classes of shares to the exclusion of any other class or classes of shares.

•         In the event of winding-up the company, and subsequent satisfying the wind-up payment to Management shareholders, distribution of assets in excess of liabilities among the members in proportion to the amount paid-up or the amount that ought to have been paid-up on the shares held by each member respectively.

Management shares

•         Collectively, the right to the management of the business and the control of the company and they alone shall be capable of being directors of the company.

•         Right to attend and vote at meetings of members.

•         Right to fixed preferential non-cumulative dividend at the rate of 5 per centum per annum on the capital paid-up thereon payable as regards each year out of the profits for that year without any right in the case of deficiency to resort to profits of prior or subsequent years.

•         In the event of winding-up of the company, right in the first place only to the amount paid-up on the Management shares.

All individuals have voting rights proportionate to their shareholdings and consequently have a say, proportionate to their shareholdings, in determining who will receive distributions of income and capital (whether in the form of dividends or otherwise).

Each individual acts independently in their own best interest and in the interest of the members as a whole.

The pattern of distribution reflects that when dividends are distributed, they are distributed to all shareholders proportionate to their shareholdings.

The Rulees have obtained arm's length market valuation of the shares.

Loans

There are three loans from Old Holding Company to the Trustee. One loan was made prior to 4 December 1997 and is grandfathered from the operation of the existing legislation in Division 7A of ITAA 1936.

The loans have been placed under separate complying Division 7A loan agreements.

The shareholder loans have also been placed under complying Division 7A loan agreements.

Investment properties

There are a number of properties.

Plans

There are plans to develop the properties.

Bank A holds a charge over Old Holding Company in relation to a loan facility. This will have an impact on the options available for obtaining finance specific to the further development of the properties.

Proposed restructure

The Rulees wish to restructure the current group as it relates to the Family, the Family Trust, Old Holding Company and New Holding Company (collectively, the Group).

The Rulees intend that the proposed restructure does not result in a material tax liability for any taxpayer.

The steps of the proposed restructure (Proposed restructure)

•         Each Family member will transfer their Old Holding Company shares to New Holding Company for nil consideration (the Gift).

The shares of Old Holding Company are to be gifted to New Holding Company under a transaction that has been approved for exemption from NSW stamp duty by the NSW Chief Commissioner of State Revenue. The exemption approval specifies that the transaction is to be carried out as a 'gift'.

•         A new company (Company B) will be incorporated with New Holding Company being the sole shareholder.

•         New Holding Company will make an election to form a tax consolidated group: New Holding Company as head company, with Old Holding Company and Company B as subsidiaries

Some properties will be transferred to New Holding Company. Other properties will be retained in Old Holding Company for the foreseeable future.

The stamp duty exemption applications were made on the basis that certain properties would remain in Old Holding Company.

•         Old Holding Company will declare and pay a dividend to New Holding Company equal to the sum of the following Old Holding Company accounts:

Retained Earnings

Post-CGT Capital Profits Reserve

General Reserve

•         New Holding Company will agree to make loans to the Trustee and each Family member (severally) under complying Division 7A loan facility agreements.

These loan advances are intended to enable the Trustee and each Family member to refinance their existing Division 7A loans with Old Holding Company as new 25-year loans with New Holding Company. The maximum terms of each new loan will be set according to the reductions required under s109N(3A) ITAA 1936 in relation to refinancing arrangements.

•         The Trustee and each Family member will repay loans previously advanced to them by Old Holding Company.

•         In order to give legal effect to steps abo:

o   the Trustee and each Family member will direct New Holding Company to pay the proceeds of each loan advance to Old Holding Company;

o   Old Holding Company will agree to accept each directed payment as a repayment in respect of the loans previously advanced to the Trust and each Family member; and

o   Old Holding Company and New Holding Company will agree to set off their mutual obligations to one another in relation to the Old Holding Company dividend and the New Holding Company directed payments.

•         Old Holding Company' share portfolio will be transferred to New Holding Company via the Family's portfolio manager.

Outcomes of the Proposed Restructure

As the A Class to F Class shares in Old Holding Company were acquired by each Family member before 20 September 1985, each Family member will disregard any capital gain made in respect of CGT Event A1 on gifting their Old Holding Company shares to New Holding Company.

It is expected that New Holding Company will not make a capital gain or loss on formation of the tax consolidated group.

The land transfers under the Proposed Restructure will be disregarded for income tax purposes pursuant to the single entity rule. State A revenue has approved exemptions from stamp duty in relation to these transfers.

New Holding Company will prepare its financial statements, in relation to the Old Holding Company shares, in a manner consistent with the measurement and recognition principles described in Australian Accounting Standards Board pronouncements which, pursuant to AASB 127 paragraph 10 allow a choice between (a) cost; (b) in accordance with AASB 9; or (c) the equity method described in AASB 128. New Holding Company will adopt a AASB 9 accounting methodology which will result in it measuring the Old Holding Company shares, initially, at their market value with a corresponding credit to Gift Income in profit or loss.

New Holding Company will present the Gift Income in a separate Gift Reserve in the equity section of its balance sheet and will record the dividend described at Step 5 of the Proposed Restructure directly against the investment in Old Holding Company as a recovery of the initially recorded value. At the same time, New Holding Company will transfer an amount corresponding with the dividend from Gift Reserve to Retained Earnings.

Following these transactions, New Holding Company's balance sheet will reflect:

•         A Gift Reserve equal to the sum of Old Holding Company Share Capital and Pre-CGT Capital Profits Reserve accounts just before the Gift; and

•         Retained Earnings equal to the remainder of Old Holding Company equity just before the Gift.

Although consolidated financial statements will not be prepared for New Holding Company, it is noted that if they were, the transaction would be accounted for in a manner consistent with the Reverse Acquisition rules in AASB 3 which provides that New Holding Company's consolidated balance sheet would reflect:

•         the sum of the share capital accounts of New Holding Company and Old Holding Company before the Gift;

•         the retained earnings and other equity balances of Old Holding Company before the Gift; and

•         the equity structure (i.e. the number and type of shares on issue) of New Holding Company after the Gift.

It is expected that each Family member will obtain a fourth element cost base in respect of their shares in New Holding Company equal to the market value of their Old Holding Company shares on the transfer date.

It is expected that New Holding Company will obtain a first element cost base in respect of its Old Holding Company shares equal to the market value of the Old Holding Company shares on the transfer date pursuant to the market value substitution rule in subsection 112-20(1) ITAA 1997.

State A revenue department has approved an exemption from stamp duty in relation to the share transfer described in the Proposed Restructure.

Taxpayers' reasons for choosing to undertake the proposed restructure as described above

The Restructure is to be undertaken in order to achieve the following commercial objectives:

•         Improve asset protection for the Group by:

o   splitting into two new companies and transferring certain property into its own special purpose company and thereby quarantining the Group's other assets from future property development risks;

o   holding entirely passive assets in a way that largely protects them from any trading risk of its subsidiaries; and

o   quarantining family wealth from the risks associated with the trading history of Old Holding Company.

•         Improve flexibility and simplicity in attracting debt capital by enabling projects to raise new debt without exposing other projects to charges taken by secured lenders and without the need to consider complex debt subordination in lending agreements.

•         Improve flexibility in attracting new equity capital by enabling future projects (e.g. a joint venture with another developer) without giving exposure to other properties/projects of the Group.

The portfolio transfer under the Proposed Restructure will be disregarded for income tax purposes pursuant to the single entity rule.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 section 109R

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177EB

Income Tax Assessment Act 1997 section 110-25

Income Tax Assessment Act 1997 section 110-55

Income Tax Assessment Act 1997 section 202-30

Income Tax Assessment Act 1997 section 202-40

Reasons for decision

Question 1

Will distributions made by New Holding Company following the Restructure, and sourced from Retained Earnings initially created out of the Gift, constitute a dividend pursuant to subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) that is a frankable distribution for the purposes of subsection 202-40(1) of the ITAA 1997?

Summary

Detailed reasoning

A dividend includes any distribution made by a company to any of its shareholders, whether in money or other property, and any amount credited by a company to any of its shareholders as shareholders.

Relevantly, subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder of a company (whether resident or non-resident) includes:

• if the shareholder is a resident, dividends paid to the shareholder by the company out of profits derived by it from any source; or
• if the shareholder is a non-resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia.

A dividend does not include moneys paid or credited, or property distributed, by a company to shareholders where the amount of the money or the value of the property is debited against an amount standing to the credit of the company's share capital account (subsection 6(1) of the ITAA 1936).

Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividend, explains when dividends are paid or taken to be paid out of profits; confirming that a distribution that is sourced from the company's share capital account does not fall within the ambit of subsection 44(1) of the ITAA 1936:

Dividends paid out of profits derived by a company

11. Section 44 of the ITAA 1936 includes dividends paid by a company in a taxpayer's assessable income depending on whether they are, or are taken to be, paid out of profits derived by the company. The term 'profits derived' is not defined in the income tax law, nor has it been comprehensively defined by the courts - although there has been judicial consideration of when a dividend is paid out of profits derived by a company. For a discussion of the meaning of profits in the context of section 108 of the ITAA 1936 see paragraphs 24 to 35 of Taxation Ruling IT 2637. This discussion is considered to be equally relevant to subsection 44(1).

12. The following relevant points can be distilled from the case law:

•         'profits' has a wide scope and is not limited to the Corporations Law's conception of the term: MacFarlane v. FCT 86 ATC 4477;

•         'profits' implies a comparison between the states of a business at two specific dates usually separated by an interval of a year. The fundamental meaning is the amount of gain made by the business during the year. This can only be ascertained by a comparison of the assets of the business at the two dates. See Fletcher Moulton LJ in Re Spanish Prospecting Company [1911] 1 Ch 92 at 98. A similar formulation was provided by Enderby J of the Supreme Court of NSW in Masterman v. FCT 85 ATC 4015, at 4029; where it was said that profits constitute 'an increase in the wealth of the business resulting from the conduct of the business'. See also QBE Insurance Group v. ASC (1992) 10 ACLC 1490;

•         the question whether there are profits available for distribution 'is to be answered according to the circumstances of each particular case, the nature of the company, and the evidence of competent witnesses': Bond v Barrow Haematite Steel Company [1902] 1 Ch 353 at 365 to 367 (cited by Gibbs CJ in FCT v. Slater Holdings Ltd 84 ATC 4883 at 4889). See also QBE Insurance Group v. ASC (1992) 10 ACLC 1490;

•         a dividend does not have to be paid out of a profit fund or a dividend fund before it can be said to be paid out of profits for the purpose of subsection 44(1): MacFarlane v. FCT 86 ATC 4477;

•         profits will exist for subsection 44(1) purposes notwithstanding that they might not be considered by accountants as being all available for payment of dividends because of the necessity to make certain provisions: MacFarlane v. FCT 86 ATC 4477; and

•         there is no need for accounts, formal or informal, to be drawn up in respect of an accounting period before a dividend can be paid out of profits: MacFarlane v. FCT 86 ATC 4477.

13. In most cases a company which distributes property to its shareholders and debits part of the value of that property to its share capital account would debit the remaining part to another account or reserve. Where that account or reserve does not represent share capital, it would, for subsection 44(1) purposes, represent profits derived by the company so that the amount debited to it would be included in the shareholder's assessable income under that subsection. This is so irrespective of whether or not the account or reserve is termed a 'profit and loss' account. It could, for example, be an asset revaluation reserve, a reserve to provide for the replacement of wasting assets or, in the context of a demerger, a 'demerger reserve': see QBE Insurance Group 10 ACLC 1490 at 1505. Where a company's assets exceed its liabilities, the excess must represent profits to the extent that it does not represent share capital. This approach is supported by the High Court's approach in Evans v. Deputy Federal Commissioner of Taxation (SA) (1936) 55 CLR 80 at 101. Therefore any account representing the whole or part of such excess, other than the share capital account, is an account of profits. This approach is also generally in accordance with the approach adopted by the Federal Court in the recent case of Sun Alliance Investments Pty Ltd (in liq) v. FC of T 2003 ATC 4171 (2003) FCA 75.

Profits in this context are not limited to revenue profits or assessable profits - they may be capital profits or exempt profits. Any increase in the company's assets, including an increase resulting from a gift, is a profit (see Slater Holdings (No 2) 84 ATC 4883).

Share capital account' is defined in section 975-300 of the ITAA 1997 as an account in which the company keeps its share capital, or any other amount created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. Subsection 975-300(2) of the ITAA 1997 further provides that where a company has more than one account covered in subsection (1), the accounts are taken, for the purposes of the ITAA 1997, to be a single account.

Share capital contribution

'Share capital' is not defined and its ordinary meaning generally connotes capital contributed to a company in exchange for shares. However, Aurizon Holdings Ltd v FC of T 2022 ATC 20-824 confirms that shareholder contributions without the issuing of further shares can be considered share capital, to the extent it is not a gift.

In Aurizon, the sole shareholder paid an amount to the company expressed to be for nil consideration and not in exchange for further shares.

The Court held that the shareholder contribution was an amount of share capital within the meaning of section 975-300 of the ITAA 1997. The Court noted that the nature of shareholder contribution is to be determined with reference to all of the relevant facts and circumstances and in this case, the background leading to the contribution and documentation relating to the contribution indicated that the contribution was intended to be an equity contribution by the shareholder of the fully paid ordinary shares and the recording of the transaction in a specific account was intended to reflect that the shareholder was making a capital contribution as a shareholder, being a contribution that should be reflected in the accounts of the taxpayer as adjusting the ordinary shares on issue, those ordinary shares comprising the whole of what was then 'the contributed equity': the equity contribution was intended to be share capital and was properly characterised as share capital and there was nothing unusual about recording the transaction in a different account in these circumstances. In making this determination, the Court observed:

89...the judgments in Kellar and Blackburn both accept, by way of obiter dictum, that a shareholder of a company may make a non-loan capital contribution to a company without issuing shares...

90. ... Both cases conclude that a capital contribution, not made in exchange for shares, would form part of " owner ' s equity " (or shareholders ' equity)...

91. ...neither of those cases necessarily deny that a contribution from a shareholder not made in exchange for shares can, in particular circumstances, constitute share capital...The proper characterisation of a non-loan capital contribution, not being a gift, necessarily depends on precisely what occurred. Such a contribution forms part of shareholders ' equity, but whether it does so as share capital is a different question.

The Court found that the contribution was not a gift and concluded the shareholder contribution was a contribution of share capital as the parties dealings reflected the intention the contribution to be treated as share capital:

97. ...paragraph 6 of the November Direction expressly stated that the consideration for the State Contribution was " nil ". Paragraph 6 must, however, be read in the context of the whole document, in particular, with paragraph 7. It must also be read in the context of the known background leading to the November Direction.

98. In providing that " the consideration provided for transfer of the Receivable [the State Contribution] from the State of Queensland to QR National [Aurizon] is nil ", paragraph 6 was making clear that the State Contribution was not a loan and that it was a contribution in respect of which further shares would not be issued.

99. In " designating " the State Contribution to be " a contribution by the State of Queensland and to be adjusted against the contributed equity of QR National [Aurizon] ", paragraph 7 of the November Direction confirms that the State Contribution was intended to augment the existing contributed equity. When the November Direction was made " the contributed equity " of Aurizon comprised only share capital. I infer that the word " designate " was used in paragraph 7 by reason of the terms of Interpretation 1038. This inference is supported by the board resolution of 17 November 2010, which implemented the November Direction, which expressly referred to Interpretation 1038. The " designation " makes clear that the contribution was not intended as a gift; it was intended to be redeemable despite no new equity instruments in fact being issued in exchange for the contribution - see the discussion at [44] to [48] above. The fact that the contribution was to be " adjusted against the contributed equity ", then constituted only by share capital, suggests that the contribution was intended to be to share capital despite no new shares being issued.

100. Assessed objectively, against the known background events and earlier transactions, the State Contribution was intended to be an equity contribution by the sole shareholders of the fully paid ordinary shares on issue, namely by the two Minister shareholders for the State. The contribution was not intended as a gift. By the time the State Contribution was made, the 100 shares had been split into 2,440,000,000 shares. The " designation " made by paragraph 7 of the November Direction was intended to reflect that the State was making a capital contribution as 100% shareholder, being a contribution which should be reflected in the accounts of Aurizon as adjusting the ordinary shares on issue, those ordinary shares comprising the whole of what was then " the contributed equity ". The equity contribution was intended to be share capital and is properly characterised as share capital.

Capital contribution

National Mutual Life Association of Australia Ltd v Commissioner of Taxation 2009 ATC 20-124 considered whether capital expenditure that was incurred by the applicant and added value to the shares that it held in its subsidiary was reflected in the state or nature of those shares upon disposal.

The majority of the Full Federal Court concluded that the added 'value' of a share, in this case reflected by way of an increase in shareholders' equity, could not be separated from the rights that made up that share, and the 'state' of those rights reflected the enhanced value at the time of disposal of the share. Therefore, for the purposes of paragraph 160ZH(3)(c) of the ITAA 1936, the non-scrip capital contribution by the Applicant was reflected in the 'state or nature' of the shares at the time of disposal and consequentially included in the reduced cost base.

In Decision Impact Statement DIS VID 1082 of 2008, the Commissioner accepts that the decision will also apply to the calculation of cost base under former paragraphs 160ZH(1)(c) and 160ZH(2)(c) of the ITAA 1936.

However, for CGT events occurring on or after 1 July 2005, the amendments made to subsections 110-25(5) (cost base) and 110-55(2) (reduced cost base) of the ITAA 1997 no longer require that expenditure be reflected in the 'state or nature' of the asset at the time of the CGT event in order for the expenditure to be included in the cost base or reduced cost base.

In Aurizon, the Court referred to the decision in National Mutual Contrary and observed that 'none of this involves a conclusion that the contribution was capital contribution that was share capital.

Application in these circumstances

The shares of Old Holding Company are to be transferred to New Holding Company under a transaction that has been approved for exemption from State A stamp duty. The exemption approval specifies that the transaction is to be carried out as a gift.

New Holding Company will prepare its financial statements, in relation to the Old Holding Company shares, in a manner consistent with the measurement and recognition principles described in Australian Accounting Standards Board pronouncements which, pursuant to AASB 127 para 10 allow a choice between (a) cost; (b) in accordance with AASB 9; or (c) the equity method described in AASB 128. New Holding Company will adopt a AASB 9 accounting methodology which will result in it measuring the Old Holding Company shares, initially, at their market value with a corresponding credit to Gift Income in profit or loss. New Holding Company will present the Gift Income in a separate Gift Reserve in the equity section of its balance sheet and will record the dividend described below directly against the investment in Old Holding Company as a recovery of the initially recorded value. At the same time, New Holding Company will transfer an amount corresponding with the dividend from Gift Reserve to Retained Earnings. Following these transactions, New Holding Company's balance sheet will reflect:

• a Gift Reserve equal to the sum of Old Holding Company Share Capital and Pre-CGT Capital Profits Reserve accounts just before the Gift; and
• Retained Earnings equal to the remainder of Old Holding Company equity just before the Gift.

Each Family member will obtain a fourth element cost base in respect of their shares in New Holding Company equal to the market value of their Old Holding Company shares on the transfer date.

Notwithstanding the description of the transaction for state stamp duty exemption purposes, the Commissioner would not accept that it is a gift for income tax purposes. Rather, there is a capital contribution that is not intended to be reflected in the share capital account.

Consequently, distributions by New Holding Company to its shareholders, which are sourced from New Holding Company's Retained Earnings or Gift Reserve accounts, will be 'dividends' within the meaning of section 6(1) ITAA 1936 and, hence, such distributions will be 'distributions' for the purposes of Subdivision 202-C of the ITAA 1997.

Section 202-30 of the ITAA 1997 provides that a distribution is frankable unless specified otherwise.

A 'frankable distribution' means a distribution under section 202-40 of the ITAA 1997 that is not an unfrankable distribution under section 202-45 of the ITAA 1997

Section 202-45 of the ITAA 1997 sets out the instances in which distributions are unfrankable distributions. Relevantly, under paragraphs 202-45(e) of the ITAA 1997, a distribution that is sourced, directly or indirectly, from a company's share capital account.

The exception does not apply in this instance as the franking is limited to the distribution that is sourced from accounts other than the share capital account.

As explained above, an amount paid out of sources other than the share capital account constitute a dividend as defined in subsection 6(1) of the ITAA 1936 and for the purposes of subsection 44(1) of the ITAA 1936.

That is, a distribution will be a dividend for tax purposes to the extent that it is not debited to share capital account (paragraphs (a) and (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936). Consequently, any distribution that is not debited to the share capital account constitutes a dividend.

In this case the amount that debited to New Holding Company's Retained Earnings and Gift Reserves accounts, is a dividend. As a result, the entire dividend is a frankable distribution.

Question 2

Will subsection 109R(2) of the ITAA 1936 apply to disregard the repayment of the existing shareholder loans by way of loan advances by New Holding Company to enable the Trustee and each Family member to refinance their existing Division 7A loans with Old Holding Company as new 25-year loans with New Holding Company?

Summary

Section 109R of the ITAA 1936 would not apply with respect to this re-financing arrangement.

Detailed reasoning

Section 109R of the ITAA 1936 is an anti-avoidance mechanism designed to prevent repayments and re-borrowings from undermining the intended operation of Division 7A of the ITAA 1936.

Relevantly, subsection 109R(2) of the ITAA 1997 provides:

A payment [repayment] must not be taken into account if:

(a) a reasonable person would conclude (having regard to all the circumstances) that, when the payment was made, the entity intended to obtain a loan or loans from the private company of a total amount similar to, or larger than, the payment; or

(b) both of the following subparagraphs apply:

(i) the entity obtained, before the payment was made, a loan or loans from the private company of a total amount similar to, or larger than, the amount of the payment;

(ii) a reasonable person would conclude (having regard to all the circumstances) that the entity obtained the loan or loans in order to make the payment.

Application in these circumstances

In this case, New Holding Company will agree to make loans to the shareholder under complying Division 7A loan facility agreements.

These loan advances are intended to enable the shareholders to refinance their existing Division 7A loans with Old Holding Company as new 25-year loans with New Holding Company. The maximum terms of each new loan will be set according to the reductions required under subsection109N(3A) ITAA 1936 in relation to refinancing arrangements.

Under the proposed arrangement:

• the Trustee and each Family member will direct New Holding Company to pay the proceeds of each loan advance to Old Holding Company;
• Old Holding Company will agree to accept each directed payment as a repayment in respect of the loans previously advanced to the Trust and each Family member; and
• Old Holding Company and New Holding Company will agree to set off their mutual obligations to one another in relation to the Old Holding Company dividend and the New Holding Company directed payments.

As a consequence of this, the former shareholders of Old Holding Company (now shareholders of New Holding Company) will now owe New Holding Company the outstanding amount instead of Old Holding Company.

Neither section 109R of the ITAA 1936, nor section 109T, would not apply in these circumstances.

The shareholders (and their associates) already had use of the monies in question. The mere replacement of Division 7A compliant loans from Old Holding Company with new Division 7A compliant loans from New Holding Company will not put more money in their hands.

This refinancing will meet Division 7A of the ITAA 1936 requirements and the maximum terms of each new loan will be set according to the reductions required under s109N(3A) ITAA 1936 in relation to the refinancing arrangements.

Question 3

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

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), 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):

•         the manner in which the scheme was entered into or carried out

•         the form and substance of the scheme

•         the time the scheme was entered into and the length of time during which the scheme was carried out

•         the result that, but for the operation of Part IVA, would be achieved by the scheme

•         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

•         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

•         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

•         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:

•         the most straightforward way of achieving the commercial and practical outcomes

•         commercial norms, such as standard industry behaviour

•         social norms, such as family obligations

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

•         actual cash flow.

PSLA 2005/24 further explains that if:

•         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

•         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) 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 in these

The proposed arrangement 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, there are no counterfactuals to your proposed scheme - having regard to NSW Revenue's requirement to transfer the Old Holding Company shares to New Holding Company for nil consideration. Relevantly, the proposed restructure cannot be an arrangement which would satisfy the relevant rollover relief provisions as they are premised on transfer for market value.

The potential tax benefits are:

•         The uplift in the tax cost which would have the effect of reducing future assessable income on the eventual disposal of subdivided units.

•         The uplift in the tax cost of the post CGT component which would have the effect of reducing future assessable income on the eventual disposal of assets.

Arguably, a potential benefit is the operation of the market value substitution rule to give New Holding Company a market value cost base for the Old Holding Company shares it receives for nil consideration under the proposed restructure.

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:

•         The manner in which the scheme is entered into or carried out

•         The form and substance of the scheme

•         The time at which the scheme was entered into and the length of the period during which the scheme will be carried out

•         The result in relation to the operation of this Act, but for this part, would be achieved by the scheme

•         Any change in the financial position of the relevant taxpayer that has resulted, will result, or may be reasonably expected to result, from the scheme

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

•         Any other consequences for the relevant taxpayer or person connected

•         The nature of any connection between the relevant taxpayer and any person referred to in subparagraph (vi)

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 'benefits' in entering into this scheme - for example, the favourable outcome from the operation of the market value substitution rules.

Arguably, a potential mischief is the better outcome that New Holding Company may obtain from the uplift in tax costs and the market value cost base as a result of the market value substitution rule.

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 proposed arrangement would be entered into for the sole or dominant purpose of obtaining a tax benefit. These considerations include that:

•         No cash is flowing to the original shareholders in a manner that escapes tax - any refinancing will result in loans that will be Division 7A compliant loans, such that the shareholders and the trustee/beneficiaries of the Family Trust will be no better or worse off. The refinancing of the Division 7A loans are a one-off arrangement - there is no pattern of refinancing in this manner, the term of the refinanced loans have not been extended, there is no debt forgiveness and there is no intention to re-borrow from Old Holding Company.

•         The original shareholders will still ultimately benefit if and when dividends are paid by the subsidiary (Old Holding Company) to the head company (New Holding Company) to those shareholders: the same shareholders will own all the shares in the parent company such that when the subsidiary pays out dividends they flow to the parent and then if the parent pays dividends they flow to precisely the same shareholders (as assessable income in their hands). In these circumstances, the Commissioner accepts that there is no effective change in their rights as the individuals have treated the Old Holding Company shares as ordinary shares. Relevantly, all individuals have voting rights proportionate to their shareholdings and consequently have a say, proportionate to their shareholdings, in determining who will receive distributions of income and capital (whether in the form of dividends or otherwise), each individual acts independently in their own best interest and in the interest of the members as a whole, and the pattern of distribution reflects that when dividends are distributed, they are distributed to all shareholders proportionate to their shareholdings. The management shares held on behalf of all shareholders in Old Holding Company equally, are only eligible for dividends to a maximum of 5% of issued capital, and each individual has equal decision making power in relation to those shares. Likewise, with respect to the New Holding Company shares, all individuals will have voting rights proportionate to their shareholdings and consequently have a say, proportionate to their shareholdings, in determining who will receive distributions of income and capital (whether in the form of dividends or otherwise), each individual will act independently in their own best interest and in the interest of the members as a whole, and when dividends are distributed, they must be distributed proportionate to shareholdings. It is also noted that under the proposed arrangement, the shareholders are losing the benefits that come with the potential to stream dividends.

•         The disposal of the Old Holding Company shares in any form will not give rise to CGT consequences for the Old Holding Company shareholders as they are pre-CGT shares.

•         The Old Holding Company shareholders lose the benefit of the pre-CGT status of their Old Holding Company shares under the proposed arrangement - that may otherwise have been retained under a relevant CGT rollover relief provision (including the potential tax free treatment of pre-CGT profits in the event of liquidation).

•         The loss of any pre-CGT benefits of the assets the subject of the tax cost uplift.

•         The arrangement is driven, in part, by stamp duty requirements - stamp duty exemption was provided on the basis that the Old Holding Company shares will be transferred to New Holding Company for nil consideration (which will trigger the market value substitution rules).

•         There are legitimate commercial reasons for the proposed restructure:

o   Improve asset protection for the Group by spreading the current risks.

o   Improve flexibility and simplicity in attracting debt capital by enabling projects to raise new debt without exposing other projects to charges taken by secured lenders and without the need to consider complex debt subordination in lending agreements.

o   Improve flexibility in attracting new equity capital by enabling future projects to attract equity investments (e.g. a joint venture with another developer) without giving exposure to other properties/projects of the Group.

Consequently, the Commissioner does not consider that Part IVA of the ITAA 1936 will apply to the scheme.

Question 4

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

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, the subsidiary, distributes profits in the form of dividends to its sole shareholder, the head company of the consolidated group, and if and when the head company distributes profits it will flow to entities that were the same shareholders of the subsidiary prior to the restructure (encompassing the creation of the consolidated group).

Detailed reasoning

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 restructure 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) of the ITAA 1936 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 (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 Commissioners 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 in these 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 (i.e. New Holding Company as head company) by way of dividends by the subsidiary (i.e. Old Holding Company). The same shareholders in Old Holding Company will own all the shares in New Holding Company. As such, if and when New Holding Company makes any dividend payments they flow to precisely the same entities.

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.

Question 5

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936?

Summary

The Commissioner will not exercise his discretion to make a determination pursuant to paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in the company's (i.e. New Holding Company's) franking account in respect of the whole or part of the franked dividend component of the distribution.

Detailed Reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits. In essence, it 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.

This would include a distribution with a franked dividend component.

Subsection 177EA(3) sets out when section 177EA applies.

Where section 177EA of the ITAA 1936 applies, the Commissioner has the discretion to make a determination to debit a company's franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

The conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 would be satisfied in respect of the distributions. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that there was more than a merely incidental purpose of conferring an imputation benefit under the scheme. In respect of the distribution, the relevant taxpayers are Old Holding Company, New Holding Company and the shareholders and the scheme comprises the circumstances surrounding the proposed restructure.

In making the determination, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The relevant circumstances listed in subsection 177EA(17) of the ITAA 1936 encompass a range of circumstances which, taken individually or collectively, could indicate the requisite purpose.

Based on the information provided and the qualifications set out in this Ruling, the Commissioner's consideration of all of the relevant circumstances of the scheme would not, on balance, lead to a conclusion that the purpose of enabling participating shareholders to obtain imputation benefits is more than incidental. Relevantly, the same shareholders in Old Holding Company will own all the shares in New Holding Company on a proportionate basis. Those shares carry the same rights to income and capital. As such, when Old Holding Company makes any dividend payments they flow to precisely the same entities: there will be no streaming of dividends to certain entities. No shareholder will be receiving an imputation benefit that would not have otherwise been available to them.

The proposed restructure involving the distributions 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 of the ITAA 1936 will not apply to any fully franked distribution under the proposed restructure.

Where section 177EA of the ITAA 1936 does not apply, the Commissioner does not have discretion to make a determination to debit a corporate tax entities franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

Therefore, in this case, the Commissioner will not be empowered to use his discretion in such a way as to debit the company's (i.e. New Holding Company's) franking account pursuant to paragraph 177EA(5)(a) of the ITAA 1936.

Question 6

Will the Commissioner make a determination under paragraph 177EB(5) of the ITAA 1936 in relation to cancel the franking credits transferred to New Holding Company under section 709-60 of the ITAA 1997?

Summary

The Commissioner will not make a determination under subsection 177EB(5) of the ITAA 1936 to cancel the franking credits transferred to New Holding Company under section 709-60 of the ITAA 1997.

Detailed reasoning

Section 177EB of the ITAA 1936 is a consolidation related integrity measure to prevent a head entity from acquiring a subsidiary to circumvent the franking credit trading scheme rules in section 177EA of the ITAA 1997.

The general anti-avoidance provision in section 177EA of the ITAA 1936 is primarily directed at schemes involving franking credit trading and dividend streaming. Section 177EA is designed to secure the integrity of the underlying principles of the dividend imputation system. That is, to ensure that the benefits of imputation are restricted to the true economic owners of the shares in proportion to their interest in the corporate tax entity, and only to the extent that they are able to use those franking credits themselves. Section 177EA also backs-up the specific anti-streaming rules and associated provisions.

Section 177EB of the ITAA 1936 applies where there is a scheme to dispose of a membership interest in an entity (the joining entity) and as a result of that disposition, the joining entity becomes a subsidiary of a consolidated group and a franking credit arises in the account of the head entity. Where, having regard to the relevant circumstances of the scheme, it would be concluded that a person entered into or carried out the scheme for a purpose of enabling the head entity to access the credit, the Commissioner may disallow the credit.

Subsection 177EB(3) of the ITAA 1936 states that the section applies if:

(a) there is a scheme for a disposition of membership interests in an entity and

(b) as a result of the disposition the joining entity becomes a subsidiary member of a consolidated group; and

(c) a credit arises in the franking account of the head company of the group because of the joining entity becoming a subsidiary member of the group; and

(d) 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 credit referred to in paragraph (c) to arise in the head company's franking account.

Subsection 177EB(4) of the ITAA 1936 states that it is not to be concluded for the purpose of paragraph (3)(d) that a person entered into or carried out a scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests in the joining entity.

The relevant circumstances of a scheme are provided for in subsection 177EB(10) as:

(a) the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests in the joining 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 head company 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 in the joining entity);

(b) whether the head company, or a person holding membership interests in the head company, would, in the year of income in which the joining entity became a subsidiary member of the group or any later year of income, derive a greater benefit from franking credits than other persons who held membership interests in the joining entity immediately before it became a subsidiary member of the group;

(c) the extent (if any) to which the joining entity was able to pay a franked dividend or distribution immediately before it became a subsidiary member of the group;

(d) whether any consideration paid or given by or on behalf of, or received by or on behalf of, the head company in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the franking credit benefits to be received by the head company;

(e) the period for which the head company held membership interests in the joining entity;

(f) any of the matters referred to in subparagraphs 177D(b)(i) to (viii).

The matters referred to in subparagraphs 177D(b)(i) to (viii) are discussed above.

Application to your circumstances

In this case, the first three pre-conditions contained in paragraphs 177EB(3)(a), (b) and (c) would be satisfied as there is a scheme for the disposition of membership interests in Old Holding Company and it will become a subsidiary member of a consolidated group. A credit will arise in the franking account of the head company, i.e. New Holding Company, under section 709-60 of the ITAA 1997 with respect to Old Holding Company's franking credits balance.

In determining whether the fourth condition in paragraph 177EB(3)(d) is satisfied, it is necessary to consider whether, 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 credit to arise in the account of New Holding Company.

Taking into account the various considerations set out in to subsections 177EB(10) of the ITAA 1936, it is reasonable to conclude that the transfer of franking credits to the head company would be merely incidental. These considerations include that:

•         There are commercial reasons for the proposed restructure, including the proposed consolidation, i.e. asset protection, quarantining risk, attracting investment and obtaining financing (as discussed above).

•         The scheme will benefit essentially the same shareholders as those who were the shareholders in Old Holding Company with respect to the imputation credits. Therefore, the benefits of the franking credits are essentially restricted to the true economic owners of the shares in proportion to their interest in the original corporate tax entity after the scheme is implemented.

Therefore the Commissioner will not make a determination under subsection 177EB(5) to cancel the franking credits transferred to New Holding Company.