Edited version of private advice

Authorisation Number: 1052249522521

Date of advice: 20 May 2024

Ruling

Subject: Section 177E - proposed transaction and payment of dividends

Question

Does section 177E of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the scheme comprising the proposed Transaction and the payment of dividends by the Company following its implementation?

Answer

No.

This ruling applies for the following period:

1 July 2023 to 30 June 2028

The scheme will commence on or before:

30 June 2024

Relevant facts and circumstances

The Company is an Australian private company.

The Company has ordinary shares on issue. The ordinary shares entitle the shareholders to the right to vote, the right to dividends and surplus capital upon winding up. The Company does not have a formal dividend policy.

The shareholders of the Company are X and Y, who each hold a 50% shareholding in the Company. The shares held by X and Y are pre-CGT shares.

The Company operates in the construction industry.

X and Y's children, A, B and C, are employed in the business.

Relevant legislative provisions

Section 177E of the Income Tax Assessment Act 1936

Reasons for decision

Section 177E of the ITAA 1936 is an anti-avoidance provision 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.

Where section 177E applies, the scheme is deemed to be one to which Part IVA applies.

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

Paragraph 177E(1)(a)

The first step in the determination of whether section 177E applies to the proposal in this case is to consider the first requirement in paragraph 177E(1)(a), which provides:

"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;"

Paragraph 177E(1)(a) sets out the initial and key test that there must be a scheme that is either one by way of, or in the nature of, dividend stripping, or is one having substantially the effect of such a scheme.

Definition of a scheme

Section 177A defines a 'scheme' as follows:

(a)  any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

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

Taxation Ruling IT 2627 states the definition of 'scheme' as set out above is very broad, and further that:

"..it may be that in a given case there will be several possible schemes. It is important to identify the point at which a scheme commences and the transactions that are parts of it. The time of commencement will affect which taxpayer is targeted by Part IVA and the transactions included will determine which disposals of property occurred as a result of the scheme."

The scheme for the purposes of section 177E must be one that falls within the scope of paragraph 177E(1)(a).

Dividend Stripping

The term 'dividend stripping' has no precise legal meaning. However, Taxation Ruling IT 2627 states:

"...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 years' 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."

The meaning of sub-paragraphs 177E(a)(i) and (ii) was considered by the High Court in FC of T v Consolidated Press Holdings 2001 ATC 4343 (Consolidated Press Holdings). In that case, the High Court noted that there was no statutory or technical legal meaning of 'dividend stripping', but agreed with the definition of dividend stripping adopted by the Full Federal Court. The Full Federal Court referred to earlier dividend stripping cases in concluding that dividend stripping entailed the following characteristics:

(1)  A target company has substantial undistributed profits which will generate a potential tax liability for the existing shareholder(s) if distributed as dividends.

(2)  There is a sale or allotment of shares in the company to new shareholders.

(3)  The payment of dividends to the new shareholder.

(4)  The new shareholder escapes Australian tax upon the dividends.

(5)  The vendor(s) of the shares receives a capital sum which is substantially the same as the total of the dividends received by the new shareholder(s).

(6)  The scheme is carefully planned for the sole or predominant purpose of enabling the original shareholders to escape taxation with respect to any distribution of dividends.

The Commissioner's view

It is determined that the proposal is largely driven by commercial objectives and, in particular, is not orchestrated with the sole or dominant purpose of enabling the original shareholders to escape taxation with respect to any distribution of profits.

Consequently, it is our view that the scheme is not one 'by way of or in the nature of dividend stripping; or...having substantially the effect of a scheme by way of or in the nature of a dividend stripping' such as to fall within the scope of section 177E of the ITAA 1936.