Private ruling: retirement planning proposal
Published: April 2014
Ruling period: Year of income ended 30 June 2014 | Year of income ended 30 June 2015
Date scheme commenced: 1 July 2013

Ruling: Q1: Is there a scheme to which Part IVA, and therefore section 177F, of the Income Tax Assessment Act 1936 (ITAA 1936) applies? | A1: Yes

Relevant facts and circumstances: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. Taxpayer 1 and Taxpayer 2 (together, 'the Taxpayers') are the trustees and members of a self managed superannuation fund (the Fund). 2. The Taxpayers are each at or nearing retirement. In 2011 and 2012 they each drew a pension from the Fund. 3. The Taxpayers are concerned that their current superannuation entitlements are insufficient to support the level of retirement income that they desire. 4. Taxpayer 1 is the sole director and shareholder of the Company. The Company has served its purpose and is excess to requirements. 5. The Company has retained earnings of approximately $X fully covered by franking credits, nominal paid up capital and no liabilities. Its retained earnings consist of unpaid present entitlements (UPEs) from a family trust (the Trust) which arose in prior years. 6. It is intended the following steps will be implemented: (a) on or before 30 June 2014, the Trust will satisfy all the UPEs of the Company in full. (b) a share split will be undertaken if necessary to achieve the steps at paragraphs (c) and (d) below. (c) Taxpayer 1 will transfer one third of the shares in the Company to Taxpayer 2 by way of gift, giving rise to a capital gains tax liability to Taxpayer 1. (d) the Taxpayers will each make in-specie contributions of the shares in the Company to the Fund as follows. One parcel to be transferred by each of them on 30 June and another parcel of shares to be transferred by each of them on 1 July: (e) following those contributions, the Fund will hold approximately two-thirds of the shares in the Company. (f) the shares in the Company acquired by the Fund will be recognised in its accounts at market value. It is stated that market value of the shares contributed is $X. (g) the Taxpayers will each commence an account based pension with respect to the contributions so that the total of their respective accounts are supporting pensions. There is no intention to pay a superannuation lump sum to either member in the absence of unforseen major expenses. (h) after the expiry of 45 days, the Company will pay out all its retained earnings by way of fully franked distributions this will result in a fully franked distribution of approximately $X (the Company franked distribution) and a fully franked distribution of approximately $Y paid to Taxpayer 1. (i) the Company franked distribution, including the franking credit on that distribution, is said to be exempt from income tax for the Fund. A proportion (as worked out under subsection 295-390(3) of the Income Tax Assessment Act 1997 (ITAA 1997)) of the franked distribution which would otherwise be assessable income of the Fund, will be exempt from income tax under subsection 295-390(1) of the ITAA 1997. The relevant proportion is expected to be 100%. The Fund is said to be entitled to a refund of the unused franking credit tax offset (which arises from the franking credit of approximately $515,000). (j) the Company will thereafter be placed in voluntary liquidation and the Fund will realise a capital loss (although it is said that this will never be used). 7. As a result of the above scheme, the Fund is said to increase in value, being the dividend amount and the amount of the refund of the unused franking credit tax offset arising from the franking credit. 8. The Taxpayers' purposes in taking these steps are said to be to: a) provide additional retirement benefits in the Fund; b) obtain more wealth in the Fund earlier so that the wealth can grow in the superannuation environment; c) simplify their financial affairs; and d) ability to engage in succession planning earlier. 9. If the Taxpayers do not undertake the above scheme, the Company will pay out its retained earnings to Taxpayer 1 over seven years in which, after tax, Taxpayer 1 will contribute to the Fund. After tax, this will result in a lesser accretion to the Fund than under the proposal.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Section 177A | Income Tax Assessment Act 1936 Section 177E | Income Tax Assessment Act 1936 Section 177F | Income Tax Assessment Act 1997 Section 295-390

Reasons for decision: Summary: 10. There is a scheme to which Part IVA and therefore section 177F of the ITAA 1936 applies. The Commissioner may make a determination under section 177F of the ITAA 1936 that has the effect of cancelling the tax benefit. | Detailed Reasoning - Section 177E of Part IVA of the ITAA 1936: 11. Where the conditions of subsection 177E(1) of Part IVA of the ITAA 1936 are satisfied, paragraph 177E(1)(e) provides that the relevant scheme "shall be taken to be a scheme to which this Part applies". This has the result that the Commissioner is empowered to issue a determination cancelling a tax benefit under section 177F of the ITAA 1936. 12. The conditions in subsection 177E(1) of the ITAA 1936 are to the following effect: (a) there is a "scheme" of the kind defined in subsection 177A(1) of the ITAA 1936 that is in relation to the company (target co); (b) the scheme is one: (i) by way of or in the nature of dividend stripping; or (ii) having substantially the same effect as dividend stripping; (c) a result of the scheme is that property of the target co is disposed of; (d) the Commissioner forms the opinion that the disposal of property by the target co represents in whole or in part a distribution whether to a shareholder (called the vendor shareholder) or another person of profits of target co; (e) had the target co, immediately before the scheme was entered into, paid a dividend out of profits equal to the amount of profits represented by the target co's disposal of property (the "notional amount"), the notional amount would or might reasonably be expected to have been included by reason of the payment of the dividend in the assessable income of a taxpayer in a year of income; and (f) the scheme was entered into after 27 May 1981. See FCT v. CPH (FFC) at [118] - [123]. 13. As noted above, if those conditions are satisfied, the scheme is taken to be one to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e)), and the taxpayer shall be taken to have obtained a tax benefit referable to the notional amount not being included in the assessable income of the taxpayer in the year of income: FCT v. CPH (FFC) at [124] - [127]. | Detailed Reasoning - Are the conditions of subsection 177E(1) of the ITAA 1936 satisfied in relation to the franked distribution from the Company to the Fund?: 14. For the following reasons, each of the conditions in paragraphs 177E(1)(a) to (d) of the ITAA 1936 referred to in paragraph 12 above are satisfied. 15. First condition : The breadth of the definition of 'scheme' in section 177A of the ITAA 1936 has been judicially noted: British American Tobacco Australia Services Ltd v. Federal Commissioner of Taxation [2010] FCAFC 130; (2010) 189 FCR 151 at [30]. It includes any 'scheme, plan, proposal, action, course of conduct, or course of action'. The matters in paragraph 6 above clearly constitute a scheme within the meaning of subsection 177A(1) of the ITAA 1936. 16. Moreover, the "scheme" described in paragraph 6 above is plainly a "scheme that is in relation to a company. 17. For this reason, the first condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(a) above is satisfied. 18. Second condition : For the reasons given below in paragraphs 29 to 37, the "scheme" is one by way of or in the nature of dividend stripping. For this reason, the second condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(b) above is satisfied. 19. Third condition : Subsection 177E(2) provides as follows: Without limiting the generality of subsection (1), a reference in that subsection to the disposal of property of a company shall be read as including a reference to: (a) the payment of a dividend by the company; (b) the making of a loan by the company (whether or not it is intended or likely that the loan will be repaid); (c) a bailment of property by the company; and (d) any transaction having the effect, directly or indirectly, of diminishing the value of any property of the company. 20. The scheme involves the payment by the Company of the Company franked distribution to the Fund and thus is a scheme the result of which is the disposal of property of the Company within the meaning of paragraph 177E(2)(a) of the ITAA 1936 (see paragraph 6(h) above). 21. Accordingly, the third condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(c) above is satisfied. 22. Fourth condition : As noted above in paragraph 6(h), the Company franked distribution is to be paid represents part of the Company's retained earnings. Therefore, the Commissioner has formed the view that the Company franked distribution will represent, in whole or in part, a distribution of the profits of the Company. For this reason, the fourth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(d) above is satisfied. 23. Fifth condition : If, before the scheme described in paragraph 6 is entered into, the Company paid a dividend of the same amount to its then shareholder, being Taxpayer 1, it is reasonable to expect that an amount would have been included in the assessable income of Taxpayer 1. For this reason, the fifth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(e) above is satisfied. 24. Sixth condition : The scheme is to be entered into after 27 May 1981. Therefore, the sixth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 12(f) above is satisfied. 25. For those reasons, if the scheme in paragraph 6 is entered into, it will be taken to be a scheme to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e)) and Taxpayer 1 will be taken to have obtained a tax benefit in connection with the scheme, being the amount which, had the Company paid a franked distribution prior to entering into the scheme, would have formed part of his assessable income (paragraphs 177E(1)(f) and (g)). | Detailed Reasoning - Dividend stripping scheme: 26. Similar to a dividend stripping operation, a dividend stripping scheme has been recognised as involving the following characteristics: (a) a company with substantial undistributed profits (target co); (b) a sale or allotment of shares in target co to another party; (c) the payment of a dividend to the purchaser or allottee of shares by target co; (d) the acquirer escaping Australian income tax on the dividend so declared; (e) the vendor shareholder receiving a capital sum for their shares in an amount the same as or very close to the dividend paid out; and (f) the transactions being carefully planned, with the parties acting in concert for the predominant purpose of avoiding tax on the distribution of dividends by target co. Commissioner of Taxation v. Consolidated Press Holdings Ltd [1999] FCA 1199; (1999) 91 FCR 524 ( FCT v. CPH (FFC) ) at [136] - [137] and [157], Commissioner of Taxation v. Consolidated Press Holdings Ltd [2001] HCA 32; (2001) 207 CLR 235 ( FCT v. CPH (HC) ) at [126] and [129]; Lawrence v. Federal Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277 ( Lawrence v. FCT ) at [42] - [43]. 27. A scheme may still be a dividend stripping scheme because the making of a distribution was "by way of or in the nature of dividend stripping" even if it contains features which vary from the paradigm case of dividend stripping, so long as it retains the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45]. 28. A difference between a scheme "by way of or in the nature of dividend stripping" and a scheme which has "substantially the effect" of a scheme "by way of or in the nature of dividend stripping" lies in the means adopted to distribute the profits of the target company. Where the means adopted do not involve a distribution, but some other step (such as the purchase by the target company of near worthless assets or assets later rendered near worthless by the target company) this involves a scheme having "substantially the effect" of a scheme "by way of or in the nature of dividend stripping": Lawrence v. FCT at [47] - [52]. | Detailed Reasoning - Will the franked distribution from the Company to the Fund be a distribution made as part of a dividend stripping scheme?: 29. The payment of the Company franked distribution from the Company to the Fund will be made as part of a dividend stripping scheme thus satisfying paragraph 177E(1)(a) of the ITAA 1936 because each of the elements of a scheme "by way of or in the nature of dividend stripping" will be present. For the reasons below, each of the central characteristics of a scheme by way of or in the nature of dividend stripping identified in paragraph 26 above are satisfied. 30. First element : The Company has substantial undistributed profits. The Company's sole asset is cash or cash assets from settled UPEs represented by retained earnings of the same amount. Accordingly, the element of a dividend stripping scheme identified in paragraph 26(a) above is satisfied. 31. Second element : The Taxpayers will transfer approximately $X worth of shares in the Company to the Fund. The transfer of the shares in the Company to the Fund will result in an accretion to the value of each member's interest in the Fund. It is not significant that this takes place by way of contribution rather than sale, because this is merely a variation from the paradigm case and does not remove the scheme from having the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45] (see paragraph 27 above). Alternatively, the scheme will have "substantially the effect" of a scheme "by way of or in the nature of dividend stripping". Accordingly, the element of a dividend stripping scheme identified in paragraph 26(b) above is satisfied. 32. Third element : The Company will pay dividends which are equal to the value of its retained earnings. It is not significant that only two-thirds of the dividends will be paid to the transferee of the shares in the Company (i.e. the Fund) and not the whole value of the dividends. This is because it is, again, merely a variation from the paradigm case which does not affect the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45] (see paragraph 27 above). Accordingly, the element of a dividend stripping scheme identified in paragraph 26(c) above is satisfied. 33. Fourth element : On the assumption that the Company franked distribution is "consistent with an arm's length dealing" within the meaning of subsection 295-550(2) of the ITAA 1997, and therefore is not "non-arm's length income" of the Fund within the meaning of paragraph 295-390(2)(a) of the ITAA 1997, a proportion (as worked out under subsection 295-390(3) of the ITAA 1997) of that income and which would otherwise be assessable income of the Fund will be exempt from income tax under subsection 295-390(1) of the ITAA 1997. The relevant proportion of the Fund income that is to be exempt is 100%. The Fund will obtain a refund of the unused franking credit tax offset in relation to the Company franked distribution. Accordingly, the element of a dividend stripping scheme identified in paragraph 26(d) above is satisfied. 34. Fifth element : The Taxpayers will benefit from an accretion to the value of their interests in the Fund as a result of the transfer of the Company shares to the Fund. Although this accretion to the value of the members' interests is less than the entire amount of the dividend payment it is equal to the amount of the dividend paid to the Fund (i.e. the Company franked distribution). The remainder of the dividend paid to Taxpayer 1 equates with his retention of one-third of the shares in the Company. Although the Taxpayers will not receive a direct payment for the shares in the Company this is (again) only a "variation on the paradigm" which will not remove the scheme from one which has the central characteristics of a dividend stripping scheme: FCT v. CPH (FFC) at [156], Lawrence v. FCT at [45] (see paragraph 27 above). Alternatively, the scheme will have "substantially the effect" of a scheme "by way of or in the nature of dividend stripping". Accordingly, the element of a dividend stripping scheme identified in paragraph 26(e) above is satisfied. 35. Sixth element : The arrangement proposed and described at paragraph 6 above is carefully planned. It involves all the parties acting in concert for a predominant purpose. The objective purpose of the parties is to obtain: (a) the exemption in subsection 295-390(1) of the ITAA 1997 as it applies to the Company franked distribution, and the refund of the unused franking credit tax offset (that arises from a franking credit of approximately $515,000) thus increasing the amount available for subsequent tax free distribution as superannuation benefits to the members of the Fund; (b) (to a lesser extent) the generation of a capital loss in the Fund on the liquidation of the Company; and (c) the substitution of a capital amount for the disposal of the shares instead of dividend income with a resultant lower incidence of tax (under the applicable capital gains tax provisions) for Taxpayer 1: see Lawrence v. FCT at [44]. There are no other rational explanations for the implementation of the arrangement. 36. It is no answer to say that the arrangement is undertaken for the purposes of retirement planning and simplification of the Taxpayers' affairs rather than for the purposes of avoiding tax. This is because that poses a false dichotomy of the kind referred to in Commissioner of Taxation v. Spotless Services Limited (1996) 186 CLR 404 ( FCT v. Spotless ) at 415 - 416. This is because, on an objective assessment, the substantial aspect of the arrangement that makes it desirable retirement planning for the Taxpayers and gives rise to the enhanced value and simplification of affairs is the tax benefits obtained through the channelling of the Company franked distribution through the Fund; namely, refund of the unused franking credit tax (see paragraph 7 above). 37. Furthermore, the fact that Taxpayer 1 may have an assessable net capital gain in relation to the transfer of the Company shares to Taxpayer 2 and to the Fund does not mean that a dividend stripping scheme cannot arise. In Lawrence v. FCT , the Full Court of the Federal Court observed at [44] that "notwithstanding the advent of comprehensive taxation of capital gains, this characteristic remains relevant because the methods of calculating capital gains invariably lead to a lower amount of tax".