Edited version of private advice

Authorisation Number: 1052206003654

Date of advice: 20 December 2023

Ruling

Subject: CGT - rollover relief

Question 1

Will each of the taxpayers be eligible to choose roll-over relief in respect of the transfer of their shares in the Company to a company which will be wholly owned by each respective taxpayer (the interposed company) pursuant to Subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) (the proposed transaction)?

Answer

Yes.

Question 2

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-40(3) of the ITAA 1997 apply to the shares acquired by the taxpayer in the interposed company such that the shares acquired by the taxpayer will be treated as having been acquired before 20 September 1985?

Answer

Yes.

Question 3

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-40(2) of the ITAA 1997 apply to the shares acquired by the taxpayer in the interposed company, such that shares in the Company that had a cost base of approximately $X immediately prior to the transfer, will result in a cost base of approximately $X for the taxpayer's shares in the interposed company?

Answer

Yes.

Question 4

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-70(3) of the ITAA 1997 apply to the shares in the Company acquired by the interposed company from the taxpayer, such that the shares acquired by the interposed company will be treated as having been acquired before 20 September 1985?

Answer

Yes.

Question 5

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-70(2) of the ITAA 1997 apply to the shares in the Company acquired by the interposed company from the taxpayer, such that shares in the Company that had a cost base of approximately $X immediately prior to the transfer, will result in a cost base of approximately $X for the interposed company's shares in the Company?

Answer

Yes.

Question 6

Will section 177D of Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed restructure?

Answer

No.

Question 7

Will section 177E of Part IVA of the ITAA 1936 apply to the proposed restructure?

Answer

No.

Question 8

Will section 177EA of Part IVA of the ITAA 1936 apply to the proposed restructure?

Answer

No.

This ruling applies for the following periods:

1 July 20xx to 30 June 20xx

1 July 20yy to 30 June 20yy

The scheme commenced on:

1 July 20xx

Relevant facts and circumstances

1.    The Company was incorporated prior to 1985.

Shareholding of the Company

2.    Taxpayer A, Taxpayer B, Taxpayer C and Taxpayer D (the taxpayers) each have a 25% legal and beneficial shareholding interest in the Company.

3.    The shareholders each hold a mix of pre-CGT and post-CGT shares in the Company.

The Company's Current Business

4.    The Company is currently a passive investment company.

The Constitution

5.    The constitution for the Company was drafted when the Company conducted a substantial and growing business. The original constitution was developed with restrictive pre-emptive rights to ensure that all shareholders would be confined to lineal descendants of the original shareholders. This was designed to maintain family control of what at the time was an energetic, prosperous, and developing business.

6.    Since the original drafting, the constitution has been changed several times. The changes have allowed some flexibility as to who the current shareholders might leave their shares to.

7.    The current constitution limits the ability to appoint a director to shareholders with a minimum of 25% of the ordinary shares. Shareholders with a less than 25% interest in these shares can combine their interest to together appoint a director for every 25% interest held.

Proposed restructure

8.    The taxpayers consider that the current structure of the constitution is no longer appropriate for the current business profile of the Company as a passive investor. The current shareholders consider that the rigid management structure dictated by the constitution is no longer appropriate for the Company as a passive investment vehicle with independent shareholders.

9.    In addition, the shareholders consider that the differing investment risk profiles, investment styles and strategies of the four shareholders are constricted by the Company's constitution, and the differences are likely become greater when the shares pass to the next generation.

10.    The shareholders propose to each form a new company (the interposed company) in which they will hold 100% of the shares. Each shareholder would then transfer their shares in the Company, in exchange for the same number of shares in the interposed company they wholly own.

11.    Each shareholder would seek to utilise a Subdivision 122-A rollover in respect of the transfer from themselves to the interposed company.

12.    The shares in each interposed company will not be redeemable preference shares.

13.    There are no liabilities attached to the share in the Company.

14.    Each interposed company will not be an exempt entity in the income year in which the proposed transaction will occur.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 177D

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1936 section 177F

Income Tax Assessment Act 1997 section 122-15

Income Tax Assessment Act 1997 section 122-20

Income Tax Assessment Act 1997 section 122-25

Income Tax Assessment Act 1997 section 122-35

Income Tax Assessment Act 1997 section 122-40

Income Tax Assessment Act 1997 section 122-70

Issue 1

Subdivision 122-A rollover

Question 1

Will each of the taxpayers be eligible to choose roll-over relief in respect of the transfer of their shares in the Company to a company which will be wholly owned by each respective taxpayer (the interposed company) pursuant to Subdivision 122-A (the proposed transaction)?

Summary

Yes, each taxpayer can elect to obtain roll-over relief under Subdivision 122-A.

Reasons for decision

Disposal or creation of assets - wholly owned company

15.    Section 122-15 states:

If you are an individual or a trustee, you can choose to obtain a roll-over if one of the *CGT events (the trigger event) specified in this table happens involving you and a company in the circumstances set out in sections 122-20 to 122-35.

Table 1 relevant CGT events

Application in these circumstances

16.    As each shareholder is an individual proposing to dispose of their shares in the Company, a CGT asset, to their own respective interposed company.

17.    The disposal of the shares will be an A1 event, and if the conditions in section 122-20 to 122-35 are satisfied, each shareholder will be able to choose to obtain a roll-over.

Section 122-20 - What you receive for the trigger event?

18.    Subsection 122-20(1) provides:

The consideration you receive for the trigger event happening must be only:

(a) *shares in the company; or

(b) for a *disposal of a *CGT asset, or all the assets of a business, to the company (a disposal case) - shares in the company and the company undertaking to discharge one or more liabilities in respect of the asset or assets of the *business (as appropriate).

Note: There are rules for working out what are the liabilities in respect of an asset: see section 122-37.

19.    Subsection 122-20(2) provides:

The *shares cannot be *redeemable shares.

20.    The term 'redeemable shares' is defined in subsection 995-1(1) as:

redeemable shares means:

(a)  *shares that are liable to be redeemed; or

(b)  shares that, at the option of the company that issued them, are liable to be redeemed.

21.    Subsection 122-20(3) states

The *market value of the *shares you receive for the trigger event happening must be substantially the same as:

(a) for a disposal case - the market value of the asset or assets you disposed of, less any liabilities the company undertakes to discharge in respect of the asset or assets (as appropriate); or

(b) for another trigger event (a creation case) - the market value of the CGT asset created in the company (the created asset).

22.    In respect of paragraph 122-20(3)(a), subsection 122-20(4) states:

In working out if the requirement in paragraph (3)(a) is satisfied, if the *market value of the *shares is different to what it would otherwise be only because of the possibility of liabilities attaching to the asset or assets, disregard the difference.

Application in these circumstances

23.    Each shareholder will receive shares in each of their respective interposed companies, as consideration for their shares in the Company such that paragraph 122-20(1)(a) is satisfied.

24.    Subsection 122-20(2) will also be satisfied as the shares in the interposed company received as consideration for the share in the Company will be ordinary shares and will not be redeemable preference shares.

25.    The proposed transaction will be a disposal case, as each shareholder will dispose of their shares in the Company.

26.    The market value of the shares in each interposed company will be substantially the same as the market value of each shareholder's shares in the Company, as each interposed company will be incorporated by each shareholder and after the proposed transaction, each interposed company will hold only shares in the Company. Consequently, subsection 122-20(3) will also be satisfied.

27.    As there are no liabilities attached to the shares in the Company, subsection 122-20(4), will not be relevant.

28.    Therefore, subsection 122-20 will be satisfied for the proposed transaction.

Section 122-25 Other requirements to be satisfied

29.    Subsection 122-25(1) provides

You must own all the *shares in the company just after the time of the trigger event.

Note: You must own the shares in the same capacity as you owned or created the assets that the company now owns.

30.    Subsection 122-25(2) provides

This Subdivision does not apply to the *disposal or creation of any of the assets specified in this table:

Table 2 Assets to which Subdivision does not apply

31.    In respect of item 1(c) a precluded asset is defined in subsection 122-25(3) as:

A precluded asset is:

(a) a *depreciating asset; or

(b) *trading stock; or

(c) an interest in the copyright in a *film referred to in section 118-30; or

(d) a *registered emissions unit.

32.    Subsection 122-25(4) provides

If:

(a) the *CGT asset or any of the assets of the *business is a right, option, *convertible interest or *exchangeable interest; and

(b) the company *acquires another CGT asset by exercising the right or option or by converting the convertible interest or in exchange for the disposal or redemption of the exchangeable interest;

the other asset cannot become *trading stock of the company just after the company acquired it.

33.    Subsection 122-25(5) provides

The *ordinary income and *statutory income of the company must not be exempt from income tax because it is an *exempt entity for the income year of the trigger event.

34.    Subsection 122-25(6) provides:

If you are an individual at the time of the trigger event, either:

(a)  you and the company must both be Australian residents at that time; or

(b)  both of the following requirements must be satisfied:

(i)    each asset must be *taxable Australian property at that time;

(ii)   the shares in the company mentioned in subsection 122-20(1) must be taxable Australian property just after that time.

Application in these circumstances

35.    Each of the shareholders will own 100% of the shares in each of their respective interposed company just after the proposed transaction such that subsection 122-25(1) will be satisfied.

36.    Each shareholder will own the shares in their interposed company in the same capacity, ie as individuals, as they owned their shares in the Company.

37.    The shares in the Company disposed of are not assets of the type listed in the table at subsection 122-25(2) or 122-25(3).

38.    The interest disposed of by the shareholders is not a right, option, convertible interest of exchangeable interest. Therefore, subsection 122-25(4) does not apply.

39.    As each interposed company will not be an exempt entity, subsection 122-25(5) does not apply.

40.    Therefore, all the relevant subsections of section 122-25 will be satisfied for the proposed transaction.

Company undertakes to discharge a liability

41.    Section 122-35 of the ITAA 1997 provides additional requirements if a CGT asset has been disposed of and the company has undertaken to discharge a liability in respect of it.

Application in these circumstances

42.    Section 122-35 of the ITAA 1997 does not apply in these circumstances as New Company is not discharging a liability in respect of the Company shares.

Conclusion

43.    As the requirements of sections 122-15, 122-20, 122-25 are satisfied and 122-35 does not have application, the taxpayers may choose to obtain a 122-A rollover on the transfer of their shares in the Company to each of their interposed entities.

44.    The choice to obtain roll-over relief under Subdivision 122-A of the ITAA 1997 does not require a specific election. The way in which the income tax return is prepared for the taxpayer is sufficient evidence of making the choice, pursuant to subsection 103-25(2).

Question 2

If the answer to Question 1 is yes, where a taxpayer elects roll-over relief, will section 122-40(3) apply to the shares acquired by the taxpayer in the interposed company such that the shares acquired by the taxpayer will be treated as having been acquired before 20 September 1985?

Summary

Yes, the shares in the interposed company acquired by the taxpayer will be treated as having been acquired before 20 September 1985.

Detailed reasoning

45.    Subsection 122-40(1) provides

If you choose a roll-over, a *capital gain or *capital loss you make from the trigger event is disregarded.

46.    Subsection 122-40(2) provides

If you *acquired the asset on or after 20 September 1985:

(a)  the first element of each *share's *cost base is the asset's cost base when you *disposed of it (less any liabilities the company undertakes to discharge in respect of it) divided by the number of shares; and

(b)  the first element of each share's *reduced cost base is worked out similarly.

Note 1: There are rules for working out what are the liabilities in respect of an asset: see section 122-37.

Note 2: There are special indexation rules for roll-overs: see Division 114.

47.    Subsection 122-40(3)

If you *acquired the asset before 20 September 1985, you are taken to have acquired the *shares before that day.

Application in these circumstances

48.    Where a taxpayer chooses roll-over relief under Subdivision 122-A of the ITAA 1997, the shares acquired in the interposed company will be taken to be acquired before 20 September 1985 (pre-CGT) where the disposed assets were acquired before 20 September 1985.

49.    Of the total shares held by each taxpayer in the Company, Z, shares have a deemed acquisition date that is pre-CGT. Therefore, where a taxpayer choses roll-over relief for the proposed transfer, that taxpayer will acquire XXXX shares in their interposed company which are taken to be acquired before 20 September 1985 in accordance with section 122-40.

Question 3

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-40(2) apply to the shares acquired by the taxpayer in the interposed company, such that shares in the Company that had a cost base of approximately $X immediately prior to the transfer, will result in a cost base of approximately $X for the taxpayer's shares in the interposed company?

Summary

Yes, the shares in the interposed company acquired by the taxpayer will have a cost base of approximately $X.

Detailed reasoning

Application in these circumstances

50.    As explained in Question 2, where a shareholder chooses roll-over relief under Subdivision 122-A and the shares disposed were acquired on or after 20 September 1985 (post-CGT), the first element of the cost base of each share in the interposed entity received by the taxpayer in consideration for the disposal of the shares, will be the cost base of the shares disposed of divided by the number of shares.

51.    Therefore, where a taxpayer choses roll-over relief for the proposed transfer, the Z, post-CGT shares disposed of by the taxpayer with cost base of approximately $X,, will result in the taxpayer acquiring Z shares in their interposed entity with a cost base of $X.

Question 4

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-70(3) apply to the shares in the Company acquired by the interposed company from the taxpayer, such that the shares acquired by the interposed company will be treated as having been acquired before 20 September 1985?

Summary

Yes, the shares in the Company acquired by the interposed company will be treated as having been acquired before 20 September 1985.

Detailed reasoning

52.    Subsection 122-70(3)

If you *acquired the asset before 20 September 1985, the company is taken to have acquired the *shares before that day.

Application in these circumstances

53.    Each taxpayer holds Y, ordinary shares in the Company that have a deemed acquisition date that is pre-CGT. Where a taxpayer choses roll-over relief for the proposed transfer, the interposed company will acquire Y shares in the Company which will be taken to be acquired before 20 September 1985 in accordance with section 122-70(3).

Question 5

If the answer to Question 1 is yes, where the taxpayer elects roll-over relief, will section 122-70(2) apply to the shares in the Company acquired by the interposed company from the taxpayer, such that shares in the Company that had a cost base of approximately $X immediately prior to the transfer, will result in a cost base of approximately $X for the interposed company's shares in the Company?

Summary

Yes, the shares in the Company acquired by the interposed company will have a cost base of approximately $X.

Detailed reasoning

54.    Subsection 122-70(2) provides

If you *acquired the asset on or after 20 September 1985:

(a)  the first element of each *share's *cost base (in the hands of the company) is the asset's cost base when you *disposed; and

(b)  the first element of each share's *reduced cost base (in the hands of the company) is the asset's reduced cost base when you disposed of it.

Application in these circumstances

55.    Where the taxpayer chooses roll-over relief under Subdivision 122-A, the shares acquired in the interposed company will be taken to be acquired before 20 September 1985 where the disposed assets were acquired before 20 September 1985.

56.    Where a taxpayer choses roll-over relief for the proposed transfer, the Z post-CGT shares disposed of by the taxpayer with cost base of approximately $X, will result in the interposed entity acquiring Z, shares in the Company with a cost base of $X,.

Issue 2

Part IVA

Question 6

Will section 177D of Part IVA of the ITAA 1936 apply to the proposed restructure?

Summary

No, 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

57.    Part IVA of the ITAA 1936 is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion under section 177F 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

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

(a)    the *CGT asset or any of the assets of the *business is a right, option, *convertible interest or *exchangeable interest; and

(b)    any scheme, plan, proposal, action, course of action or course of conduct.

59.    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

60.    There must be a tax benefit obtained by the taxpayer in order for Part IVA of the ITAA 1936 to potentially apply. Section 177C 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;

•         loss carry back offsets being allowable that would otherwise not have been allowable;

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

•         an innovation tax offset being allowable that would otherwise not have been allowable;

•         an exploration credit being issued that would otherwise not have been issued;

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

•         a refundable R&D tax offset being allowable that would otherwise not have been allowable.

61.  However, sections 177C(2), 177C(2A) and 177(3) of the ITAA 1936 stipulate that benefits arising from the exercise of a statutory choice would be excluded from the definition of 'tax benefit', provided the scheme was not entered into or carried out for the purposes of creating the conditions necessary for the choice to be made.

Dominant Purpose

62.    Part IVA of the ITAA 1936 also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D 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.

63.    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.

64.    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 in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme;

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

(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).

65.    Focussing on the various elements of Part IVA of the ITAA 1936 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.

66.    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.

67.    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 in 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.

68.    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 109 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.

69.    PSLA 2005/4 further explains that:

•         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 110), 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 111).

70.    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) of the ITAA 1936, 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.

71.    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

72.    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 circumstances

Scheme

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

Tax benefit

74.    Prima facie, the non-inclusion of an amount in the assessable income of the shareholders (i.e. the capital gain made from the transfer of the Company's shares to each shareholders interposed company) cannot be a tax benefit in connection with the scheme (pursuant to subparagraph 177C(2)(a)(i) of the ITAA 1936) on the basis that the non-inclusion is attributable to the making of a choice by the shareholders which is expressly provided to them by subsection 122-40(1) of the ITAA 1997.

75.    However, 177C(2)(a)(i) of the ITAA 1936 is subject to the scheme not having been entered into or carried out by any person for the dominant purpose of creating any circumstance or affairs necessary to enable the shareholders to make the choice to obtain the roll-over relief expressly provided to them by subsection 122-40(1) of the ITAA 1997, refer subparagraph 177C(2)(a)(ii) of the ITAA 1936.

76.    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 109 of PS LA 2005/24, the counterfactuals to your proposed scheme - having regard to the intergenerational and wealth extraction objectives of the shareholders of the Company, include:

a.    Liquidating the Company;

b.    Leaving the structure as is ie not interposing the companies, and the shares passing to the children of the shareholders upon their death;

c.     Choosing not to obtain 122-A rollover relief; or

d.    Changing in the constitution to allow broader transfers of shares in the Company and less restrictive control of the Company.

77.    The potential tax benefits are:

•         Deferral of capital gains tax paid via 122-A rollover relief.

•         Deferral of personal tax to the shareholders on any distributions made by the Company.

78.    It is noted the fact that a taxpayer pays less tax in 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

79.    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 - for example the transfer of shares in the Company without capital gains tax consequences.

80.    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:

•         The disposal of a significant proportion of the Company's shares in any form will not give rise to CGT consequences for the shareholders as they are pre-CGT shares.

•         The proposed restructure is not artificial or contrived, it will be implemented to achieve the following objectives:

o   Improved flexibility in relation to management of the Company without the need to change the company's constitution.

o   Improved flexibility in relation to succession planning for the shareholders' individual family groups.

Application in these circumstances

81.    The Commissioner does not consider that section 177D of the ITAA 1936 will apply to the scheme.

Question 7

Will section 177E of Part IVA of the ITAA 1936 apply to the proposed restructure?

Summary

No, 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

82.    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.

83.    Section 177E applies to a scheme which can be said objectively to have the dominant (although not necessarily exclusive) purpose of avoiding tax. Assessing the purpose of the scheme is an objective test having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated.

The first limb - paragraph 177E(1)(a)(ii)

84.    There are two limbs to paragraph 177E(1)(a) of the ITAA 1997. Subparagraph 177E(1)(a)(i) (the first limb) requires there to be "a scheme by way of or in the nature of dividend stripping".

85.    Dividend stripping is not a defined term, however its meaning is considered in Taxation Ruling IT 2627 Income Tax: Application of Part IVA to dividend stripping arrangements, which states at paragraphs 8 to 10:

8.            The term 'dividend stripping' has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression.

9.            However it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current year's profits that are represented by cash or other readily-realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company.

10.         No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result.

86.    A dividend stripping operation has been recognised by the courts as involving the following characteristics:[1]

a.    a target company, which had substantial undistributed profits creating a potential tax liability either for the company or its shareholders;

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

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

d.    the purchaser or allottee escaping Australian income tax on the dividend so declared; and

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

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

87.    "It is ... by reference to the presence or absence of those characteristics that the schemes in the present case should be examined for consistency with the broad description contained in para (a)(i) of s 177E(1)" (Lawrence at 395 per Jessup J).

The second limb - subparagraph 177E(1)(a)(ii)

88.    Subparagraph 177E(1)(a)(ii) (the second limb) of the ITAA 1936 requires there to be "a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping". In Lawrence, Jessup J explained at 399, [77]:

It seems that the parliament wanted to catch "variations" on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. This is, in my view, a significant indication of parliamentary purpose, since it treats such an effect as distinct from the result of a scheme of the kind contemplated: s 177E does not require that shareholders themselves, as a "result" of the scheme, receive the profits distributed by way of the disposal of property in question.

89.    In Lawrence[2], Jessup J also referred to the Full Court decision in Commissioner of Taxation of the Commonwealth of Australia v Patcorp Investments Limited (1976) 140 CLR 247 which stated that:

The terms of the first limb of s 177E(1)(a) suggest that a scheme may fall within its scope, even though not all the elements of a dividend stripping scheme are present. The use of the words "by the way of or in the nature of" suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provide it retains the central characteristics of a dividend stripping scheme.

Dominant purpose

90.    For the arrangement to be a scheme to which subsection 177E(1) of the ITAA 1936 applies, despite the fact that the provision does not expressly use the term "purpose" or "dominant purpose". The High Court has held that a dominant purpose of tax avoidance is required, as objectively determined, in the same way that the general provisions of Pt IVA require such a "dominant" purpose FCT v Consolidated Press Holdings Ltd (2001) 47 ATR 229.

91.    The High Court in Federal Commissioner of Taxation v Spotless Services (1996)[3] established that where a scheme makes no commercial sense without the tax benefits, there is a greater likelihood of concluding that it is entered into for the sole or dominant purpose of obtaining a tax benefit. Factors which suggest the scheme had been entered into for commercial reasons or as part of ordinary family dealings will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven.

Application in these circumstances

92.    Although the Company has significant undistributed retained profits, the proposed arrangement does not involve the payment of dividends from the Company to the relevant Interposed Companies. Nor does the proposed arrangement include the payment of a capital sum to the Taxpayers in an amount the similar, or very close to, the dividends paid from the Company to their relevant Interposed Companies.

93.    Rather, the proposed arrangement is to be implemented to allow a more flexible corporate structure between the family members which is more appropriate for the passive investment activities that the Company now undertakes. It also allows for the differing investment risk profits of the Taxpayers.

94.    Without additional steps to the proposed arrangement than that described in this Ruling, the Commissioner accepts that the transaction is unlikely to constitute a scheme that demonstrates the common characteristics of a dividend stripping scheme and section 177E of Part IVA of the ITAA 1936 would not be satisfied.

Question 8

Will section 177EA of Part IVA of the ITAA 1936 apply to the proposed restructure?

Summary

No, 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

95.    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.

96.    Subsection 177EA(3) of the ITAA 1936 sets out when section 177EA applies.

97.    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.

98.    Section 177EA of the ITAA 1936 is a general anti-avoidance rule that supports the operation of the imputation system with the purpose of ensuring that the benefits of the imputation system flow to the economic owner of the share which is the source of the franked distribution. The section is directed at schemes involving the transfer of franking credits on a dividend from entities that cannot fully use them to entities that can. If the section applies, the Commissioner may debit the company's franking account or deny the franking credit benefit to the recipient of the dividend.

99.    Specifically, subsection 177EA(3) of the ITAA 1936 provides that for section 177EA to apply, the following must be present:

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

(b)  either

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

                          (ii)        a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and

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

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

(e)  having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.

Application in these circumstances

100.    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 an imputation tax benefit.

[1] The Commissioner of Taxation of the Commonwealth of Australia v Patcorp Investments Limited (1976) 140 CLR 247; Commissioner of Taxation v Consolidated Press Holdings Ltd and Others (No 1) (1999) 91 FCR 524; Lawrence v Federal Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277

[2] at [62].

[3] 186 CLR 404; 96 ATC 5201; (1996) 34 ATR 183 at CLR 416; ATC 5206; ATR 188; ATR 183