Edited version of private advice

Authorisation Number: 1052198000525

Date of advice: 4 January 2024

Ruling

Subject: Post-death distributions

Question 1

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

Answer

No

Question 2

Is the arrangement a scheme to which section 177EA of Part IVA of the ITAA 1936 applies?

Answer

No

This ruling applies for the following periods:

Year ended 30 June 2023

Year ending 30 June 2024

Year ending 30 June 2025

Year ending 30 June 2026

Year ending 30 June 2027

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

The company (first company) carries on a business. It has accumulated substantial funds from the success of its business.

Individual A is the company's founder and sole shareholder.

Individual A has updated their will and bequeathed in their will the shares of the company to their partner, Individual B. This will provide future dividend amounts to be paid to Individual B. If Individual B does not take possession of the gift, the company will be liquidated and the proceeds will be distributed to Individual A's family members.

Individual A wishes for part of the accumulated funds in the company to be bequeathed to their family. To give effect to this, another company (second company) was incorporated which Individual A is the sole shareholder of.

The first company has issued the second company with dividend access shares for the purpose of allowing part of the accumulated profits of the first to be paid to the second company. Under the updated will, the trustees will appoint themselves as directors of the second company and liquidate it. The net proceeds of the liquidation after payment of expenses and any taxation liability will be distributed the Individual A's family members and her partner.

When these amounts are paid subsequent to Individual A's death, they will be assessable income of the recipients and subject to income tax.

Individual A is not compensated in the operation of this scheme which was entered into solely to benefit Individual B by leaving them the operating company and the family members by leaving them funds to help them in their lives.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177E

Income Tax Assessment Act 1936 section 177EA

Question 1

Is the arrangement a scheme to which section 177E of Part IVA of the ITAA 1936applies?

Summary

Section 177E of the ITAA 1936does not apply to the scheme described in this private binding ruling.

Detailed reasoning

For the arrangement to be a scheme to which Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies, it must be shown that, having regard to all the matters listed in subsection 177D(2) of the ITAA 1936, the sole or dominant purpose of the taxpayer or of some other party, in entering the arrangement was to obtain a tax benefit. The sole or dominant purpose of a taxpayer in entering into a scheme is 'their most influential and prevailing or ruling purpose' per the High Court in Federal Commissioner of Taxation v Spotless Services (1996) 186 CLR 404 (Spotless Services).

In Spotless Services, it is established that there is a greater likelihood of concluding that a scheme is entered for the sole or dominant purpose of obtaining a tax benefit if it makes no commercial sense without the tax benefits. Where there are factors which suggest the scheme has been entered into for commercial reasons, it will generally lead to the opposite conclusion, even if the arrangement is to some extent tax driven.

The relevant question in applying Part IVA of the ITAA 1936 is not whether the taxpayer or another person would not have entered the scheme 'but for' the tax benefit, but what was the taxpayer's dominant purpose in entering the scheme.

Section 177E of the ITAA 1936 is an anti-avoidance provision that is designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme with substantially the same effect as a dividend stripping scheme.

Paragraph 5 of Taxation Determination TD 2014/1 Income tax: is the 'dividend access share' arrangement of the type described in this Taxation Determination a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of Part IVA of the Income Tax Assessment Act 1936? states:

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

Paragraph 6 of TD 2014/1 explains:

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

•         be supported by the other available evidence; and

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

The term 'dividend stripping' has no precise legal meaning; however it has been the subject of judicial discussion. Lawrence v Commissioner of Taxation [2008] FCA 1497 adopted the following characteristics from cases such as FC of T v Consolidated Press Holdings and Ors; CPH Property Pty Ltd v. FC of T (2001) 207 CLR 235 (Consolidated Press) and Federal Commissioner of Taxation v Patcorp Investments Ltd (1976) 140 CLR 247:

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

•         the sale or allotment of shares in the target company to another party;

•         the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits;

•         the purchaser or allottee escaping Australian income tax on the dividend so declared;

•         the vendor shareholders receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax at the relevant times); and

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

In Consolidated Press, it was held that the placement of section 177E of the ITAA 1936 is important when interpreting the meaning of dividend stripping. The legislature had used the language of tax avoidance in section 177E of the ITAA 1936 to supplement the general anti-avoidance provisions. The dominant purpose of the scheme is determinative of whether there is a scheme by way of or in nature of dividend stripping.

Based on the above relevant facts and circumstances, a reasonable person would conclude that the taxpayer's sole or dominant purpose in entering the scheme was for a reason other than obtaining a tax benefit. It is also not considered that this arrangement has the characteristics of a dividend stripping scheme.

The dominant purpose of the entities entering into the arrangement is to benefit the family members subsequent to Individual A's death, rather than to obtain a tax benefit.

It is not considered that section 177E of the ITAA 1936 has any application in relation to the arrangement so described in this ruling.

Question 2

Is the arrangement a scheme to which section 177EA of Part IVA of the ITAA 1936applies?

Summary

Section 177EA of the ITAA 1936 does not apply to the scheme described in this private ruling.

Detailed reasoning

The circumstances which are relevant in determining whether a person has the requisite purpose as referred to in paragraph 177EA(3)(e) of the ITAA 1936 include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936.

These relevant circumstances encompass a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposition and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose of enabling the relevant taxpayer to obtain an imputation benefit.

The requisite purpose is further clarified when read in conjunction with the objective of section 177EA of the ITAA 1936 which is set out in paragraph 8.124 of the Explanatory Memorandum ('EM') to the Taxation Laws Amendment Bill No.3 (1998):

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

In determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the arrangement seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders as envisaged in the preceding extract of the EM.

Having regard to the terms and circumstances of the scheme, the requirements of section 177EA of the ITAA 1936 have not been satisfied, and it is not considered that section 177EA of the ITAA 1936 has any application in relation to this arrangement.