Private ruling: Dividend access share arrangement
Published: June 2014
Ruling period: Year ended 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q1: Will the arrangement result in any consequences under the direct value shifting provisions of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Is the arrangement a scheme by way of, or in the nature or, or having substantially the effect of, dividend stripping for the purposes of section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: Yes. | Q3: Is the arrangement a scheme to which section 177D of the ITAA 1936 applies? | A3: As the more specific integrity provision of section 177E of the ITAA 1936 dealing with dividend stripping is considered to apply in this case, the Commissioner has not considered the application of section 177D of the ITAA 1936.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 725-90. | Income Tax Assessment Act 1936 Section 177A. | Income Tax Assessment Act 1936 Section 177C. | Income Tax Assessment Act 1936 Section 177CB. | Income Tax Assessment Act 1936 Section 177D. | Income Tax Assessment Act 1936 Section 177E. | Income Tax Assessment Act 1936 Section 177F.

Reasons for decision: Summary: 19. All subsequent legislative references are to the ITAA 1936 unless otherwise stated. | Detailed Reasoning - Direct value shifts: 20. There can be consequences under Division 725 of the ITAA 1997 where there is a direct value shift involving the equity or loan interests in an entity. 21. However, a reversal exception is provided by section 725-90 of the ITAA 1997. It applies where the state of affairs that is brought about by the things done under the scheme: • will more likely than not cease to exist within four years after the time that the first of those things is done; and • does not still exist at the earlier of the end of those four years or when a realisation event happens to an affected interest for the direct value shift. 22. The legislative context shows that the term 'state of affairs' is used to refer to the factual circumstance that is the trigger or cause for the value shift. The state of affairs is one but for which the direct value shift would not have happened: paragraph 725-90(1)(a) of the ITAA 1997. The example that follows subsection 725-90(1) of the ITAA 1997 reads: Under a scheme, the voting rights attached to a class of shares in a company are changed. As a result, the market value of shares in that class decreases, and the market value of other classes of shares in the company increases. The company's constitution provides that the change is to last for only 3 years. Issue of the DAS 23. With respect to any direct value shift that may happen upon the issue of the DAS, the relevant state of affairs is that the company has accumulated profits, and there is a further class of shares on issue with discretionary dividend rights. 24. It is more likely than not that this state of affairs will cease to exist within four years, as the proposed arrangement involves the payment of a dividend shortly after the DAS is issued and then the cancellation of the DAS once the payment has been made. Declaration and payment of a dividend to the holder of the DAS 25. With respect to any direct value shift that may happen upon the declaration of a dividend to the holder of the DAS, the relevant state of affairs is that a dividend is payable to the holder. This state of affairs will cease to exist when the dividend is paid, an event that will happen within the four year period. 26. Consequently, the reversal exception will apply to any direct value shift upon the declaration of a dividend with respect to the DAS. | Detailed Reasoning - Part IVA: 27. Part IVA contains a number of anti-avoidance provisions. It gives the Commissioner the discretion to cancel a 'tax benefit' that, but for the operation of the Part, has been, or would be, obtained by a taxpayer in connection with a scheme to which Part IVA applies (subsection 177F(1)). 28. The Commissioner considers that two anti-avoidance provisions have potential application to the particular facts of this case: • Section 177D - Schemes to which Part IVA applies • Section 177E - Dividend stripping schemes to which Part IVA applies 29. As section 177E is the more specific provision, it will be considered first. | Detailed Reasoning - The relevant law: 30. Section 177E(1) states: 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 following provisions have effect: (e) the scheme shall be taken to be a scheme to which this Part applies; (f) for the purposes of section 177F, the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme that is referable to the notional amount not being included in the assessable income of the taxpayer of the year of income; and (g) the amount of that tax benefit shall be taken to be the notional amount. 177E(1)(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 Is there a scheme that satisfies subparagraphs 177E(1)(a)(i) or (ii)? 31. Scheme is defined in subsection 177A(1) to mean: (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. 32. Here, the proposed arrangement clearly constitutes a scheme as defined in subsection 177A(1). 33. In order for the arrangement to be one by way of dividend stripping, the following elements must be established: (1) a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders; (2) the sale or allotment of shares in the target company to another party; (3) the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits; (4) the purchaser or allottee escaping Australian income tax on the dividend so declared; (5) 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 (6) 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. 34. The first four elements of a dividend stripping are present here because: • Firstly, Company A carries substantial undistributed profits which, if distributed, would expose the original shareholder to a potential tax liability; • Secondly, a DAS will be issued by Company A to Company E; • Thirdly, a dividend will be paid to Company E; • Fourthly, Company E will not incur any additional liability to taxation in respect of the payment of the dividend as the dividend will be fully franked. 35. The issue is the fifth element, that is, whether the vendor shareholder (Individual B) will receive a capital sum in an amount close to the dividend to be paid to Company E. 36. The issue whether the vendor shareholders receive anything was discussed by Jessup J in the first instance of Lawrence . Jessup J stated: In the present case an accretion of capital, the same in effect as such a receipt, arose from the increase in the value of the assets held by the Clearmink No. 1 and No. 2 Trusts, to which the applicant and his family were beneficially entitled. 37. Here, as the assets of Company E increase, its shares will become more valuable. As Individual B and their associates own the shares in Company E, this accretion to the value of Company E would constitute a capital sum being received by Individual B to compensate them for the profits of Company A paid to Company E. As such, applying the above reasoning of Jessup J, the fifth element is present. 38. This leaves the last element, namely whether the arrangement has, as its dominant purpose, the avoidance of tax on the distribution of dividends by Company A. In considering the element, it is necessary to examine all of the evidence of the arrangement and to consider the relevant objective features of the arrangement to determine whether the arrangement has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits from Company A. Importantly, an arrangement that has a non-tax purpose may be undertaken for the dominant purpose of avoiding tax. 39. One objective matter relates to the complexity of the arrangement. The most straightforward manner by which Individual B can separate the funds of Company A is by having that company pay a dividend to themselves and then deal with the dividend as they then see fit, including using the proceeds to subscribe for shares in a new company such as Company E or dealing with the proceeds as personal property in their will. However, given the amount that Individual B wishes to extract from Company A, the dividend would be subject to marginal tax rates that are higher than the company tax rate. Although Individual B would have the benefit of the attached franking credits, this would not be enough to offset the tax payable and consequently they would be liable for a considerable amount of additional tax. By way of contrast, the proposed arrangement would result in the transfer of substantial funds with the preservation of the current company tax regime, assuming no dividend payments are made by Company E or would allow the payment of dividends to the new shareholders of Company E. 40. After the proposed arrangement is carried out, accumulated profits of Company A will have been distributed in a complex and contrived manner to entities associated with Individual B whilst avoiding any additional tax. 41. In short, the estate planning mechanism offered by the proposed arrangement could arguably be achieved more 'conveniently, commercially and frugally' without the creation of the new DAS in Company A. Similarly in Federal Commissioner of Taxation v. Hart [2004] HCA 26 2004 at paragraph 94, Callinan J, in the context of 177D(b)(ii) of the ITAA 1936, noted that it was relevant to consider whether the substance of the transaction in question (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction. 42. It is also noted that the arrangement does not fully achieve Individual B's stated objective. This is because the ownership of Company E does not replicate the ownership of Company A. That is, Individual B is not the sole shareholder of Company E. Instead Company E also has Individual B's spouse and a trust as shareholders. To fully achieve Individual B's stated objective, Individual B would have had to make themselves the sole shareholder of Company E. Then they could bestow the funds separated from Company A by bequesting their Company E shareholding as they wished in their will. By including additional entities as shareholders of Company E, Individual B has lost their ability to bequeath the full amount of the separated funds. However, the inclusion of the additional shareholders provides the capability to reduce tax through income splitting. 43. Individual B states that their spouse was included as a shareholder of Company E because they believe it is appropriate to own assets together as they are married and Individual B's spouse was not a shareholder of Company A because this company was registered prior to their marriage. However, a taxpayer who transfers an asset, or part of an asset, they own to their spouse would ordinarily become liable to capital gains tax. If instead of an asset, they wish to transfer funds from their company to their spouse then they would ordinarily have to pay themselves a dividend on which they would be subject to tax, then they could gift those funds to their spouse. 44. That is, although it is understandable that Individual B wishes to share with their spouse part of the assets they fully own or part of the accumulated profits they are fully entitled to, any transfer would ordinarily result in a tax liability for themselves. The proposed arrangement achieves such a transfer while avoiding any tax liability. 45. In light of all of the above, with particular reference to the form chosen for the arrangement, it is considered that the arrangement is one that is entered into for a dominant purpose of avoiding the imposition of any additional tax that Individual B would be subject to if the accumulated profits were distributed to them. As such, the arrangement constitutes a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E. As a result of the scheme, is property of the company disposed of? 46. The second element of paragraph 177E(1)(a) is whether as a result of the arrangement (which is a scheme by way of or in the nature of dividend stripping) any property of the company is disposed of. 47. Paragraph 177E(2)(a) states that a reference in subsection 177E(1) to the disposal of property of a company shall be read as including a payment of a dividend by the company. 48. As Company A will pay a dividend to the new DAS holder, this second element of paragraph 177E(1)(a) is satisfied. 49. It follows that subsection 177E(1) is satisfied. 177E(1)(b) - in the opinion of the Commissioner, the disposal of the property referred to in paragraph 177E(1)(a) of the ITAA 1936 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) 50. The relevant disposal of property under the arrangement is the payment of a dividend by Company A to Company E. This shows that the disposal represents a distribution of profits of Company A. As such, this condition is met. 177E(1)(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 51. Here, if immediately prior to the execution of the proposed arrangement, Company A paid a dividend out of profits equal to the amount of the dividend proposed to be paid to Company E, that dividend would have been paid to Individual B, and would have been included in their assessable income by virtue of subparagraph 44(1)(a)(i). As such, the notional amount for the purpose of subsection 177E(1) is the amount of the dividend proposed to be paid to Company E. 52. Therefore, paragraph 177E(1)(c) is satisfied. | Detailed Reasoning - 177E(1)(d): The scheme has been or is entered into after 27 May 1981, whether in Australia or outside Australia: 53. The final requirement that the scheme be carried out after 27 May 1981 is clearly satisfied. | Detailed Reasoning - The argument for the taxpayer: 54. It has been stated by Individual B that the purpose of the arrangement is to separate assets so that they can be distributed to different beneficiaries in their will. However, as stated previously, this outcome could be achieved in a more straightforward manner without the creation of a DAS. Also, the arrangement is structured in such a way that it does not fully achieve its stated purpose but instead allows for income splitting. | Detailed Reasoning - Conclusion on section 177E: 55. Because all the criteria in paragraphs 177E(1)(a) to (d) are satisfied, in accordance with paragraphs 177E(1)(e), (f) and (g): • the arrangement is a scheme to which Part IVA applies; • for the purposes of section 177F, the taxpayer (that is, Individual B) is taken to have obtained a tax benefit in connection with the arrangement; and • the amount of that tax benefit is taken to be the notional amount referred to in paragraph 177E(1)(c). 56. In this case, where a dividend is paid out of the accumulated profits of Company A to Company E, the Commissioner would exercise his discretion to make a determination under paragraph 177F(1)(a) to include in Individual B's assessable income the 'tax benefit' being the dividend. 57. This conclusion is consistent with Taxation Determination TD 2014/1 which provides the Commissioner's view as to the application of section 177E to 'dividend access share' arrangements. 58. As the more specific integrity provision of section 177E dealing with dividend stripping is considered to apply in this case, the Commissioner has not considered the application of section 177D. | Detailed Reasoning - Further issues for you to consider: 59. It should be noted that section 207-145 of the ITAA 1997 modifies the normal gross up and tax offset entitlement treatment afforded by section 207-20 of the ITAA 1997 in respect of the receipt of a franked distribution in certain circumstances. One of these circumstances, as provided in paragraph 207-145(d) of the ITAA 1997, is when a franked distribution is made as part of a 'dividend stripping operation'. This term is defined on 207-155 of the ITAA in similar terms to section 177E. Given the conclusion reached in respect of the application of 177E, it is considered that the above arrangement would constitute a dividend stripping operation for the purposes of paragraph 207-145(d) of the ITAA 1997. This would have the effect of the non- inclusion of any franking credit amount attached to franked distribution made as part of the arrangement in the assessable income of Company E, as well as the denial of any tax offset entitlement to Company E in respect to the distribution, per the combined operation of paragraphs 207-145(e) and (f) of the ITAA 1997.

Relevant facts: 1. Company A has substantial undistributed profits. | 2. Currently, Company A's sole shareholder is Individual B. | 3. Company A receives trust distributions from two discretionary trusts, the C Trust and D Trust. | 4. Company A earns interest income on deposits sourced from the trust distributions which is its only source of income apart from the trust distributions. | 5. The trust distributions from each trust are deposited into separate term deposits. | 6. A new company (Company E) was registered. | 7. It is proposed that Company A will issue a share to Company E that will entitle the shareholder to receive dividends, but does not entitle the shareholder to any voting rights or rights to capital (that is, a dividend access share or DAS). | 8. The original proposal, as outlined in the application, was to pay a fully franked dividend to Company E equal to the amount invested in term deposits that have resulted from distributions from the D Trust. | 9. However, the applicant now states that due to the smaller amount involved, it is proposed to pay a fully franked dividend to Company E equal to the amount invested in term deposits that have resulted from distributions from the C Trust (not the D Trust). | 10. The income from the C Trust for the year ended 30 June 2013 will be distributed to Company E. | 11. The shareholders for Company E are: | • Individual B - 1 fully paid ordinary share | • Individual B as trustee for the F Trust - 1 fully paid C class share | • Individual B's spouse) - 1 fully paid ordinary share and 1 fully paid D class share. | 12. Company E's C and D class shares have dividend rights but no voting rights or rights to capital. | 13. The director of Company E is Individual B. | 14. The beneficiaries of the F Trust include: Individual B; Individual B's spouse; their children; and any companies and trusts in which Individual B or Individual B's spouse have an interest. | 15. Company A will pay the proposed dividend shortly after the DAS is issued and will then cancel the DAS once the payment has been made, so that the only shareholder in Company A will be Individual B, as is currently the case. | 16. Company E has no intention of paying a dividend to the shareholders. | 17. As a result of the above amended arrangement: | • Company A will only hold term deposits invested from distributions from the D Trust, and not the C Trust. | • Company E will only hold term deposits invested from distributions received from the C Trust. | 18. The stated purpose of the proposal is to separate the assets held as a result of trust distributions received to facilitate estate planning to avoid any complications and disputes arising from the Last Will and Testament of Individual B, under which it is intended to bequeath the shareholdings in Company A and Company E to separate groups of beneficiaries. In this way, the proceeds from the distributions of the different trusts can be treated separately for estate planning purposes.