Private ruling: Part IVA
Published: September 2011

Ruling: Q1: Will a capital loss be incurred on the liquidation of the company under Capital Gains Tax (CGT) event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes | Q2: Will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the transfer of shares to the Fund, the payment of franked dividend to the Fund and the liquidation of the Company? | A2: No | Q3: Will the arrangement involving a transfer of shares to a Fund, the payment of a dividend to the Fund and the liquidation of the Company be a scheme to which section 177E of the ITAA 1936 applies? | A3: No | Q4: Will the transfer of shares to the Fund and the payment of a dividend to the Fund be a scheme to which section 177EA of the ITAA 1936 applies? | A4: No

Relevant facts and circumstances: Person A and Person B are trustees of a Superannuation Fund (Fund). The Fund is a complying superannuation fund at all relevant times. All assets of the Fund are used to support current pension liabilities as from a certain date. Person A and Person B are the only members of the Fund and it is not anticipated that any new members will be admitted. Person A is retiring at the end of the relevant financial year. A pension in the Fund in respect of the entire member account balance has already commenced. Person B is retired. The anticipated ordinary assessable income for the relevant financial years consists of grossed-up listed company dividends which are generally fully franked. Person B has already commenced a pension in the Fund in respect of their entire member account balance. Person A and Person B are the directors of a family company (Company). It has retained earnings represented by cash or investments which are to be liquidated to cash prior to the proposed share transfer. There are no liabilities in the Company. The cost base of the shares is a minimal amount. Person B is the sole beneficial owner of all issued shares in the Company. It is proposed that Person B will transfer the shares to the Fund by way of an in-specie contribution and an in-specie spouse contribution. The market value of the shares immediately prior to the transfer will be determined by a professional valuer to ensure that the transfer is undertaken on an entirely arm-length/commercial basis. Person B will make a gross capital gain on disposal of the shares. Person B will be personally liable for tax on the net capital gain. The fund will then terminate all existing fund pensions. It will commence new account based pensions to the members. After satisfying the requirements of the “45 day rule”, it is proposed that the Company distribute its retained earnings to the Fund by way of a fully franked dividend. As a last step, the Company will be liquidated/deregistered. On liquidation of the Company, the Fund will realise a capital loss equal to the market value of the shares at the time of acquisition. It is expected that this loss will never be used by the Fund. The proposal will be formally documented and all necessary legal requirements will be complied with. Under an alternative proposal, Person B will remain the shareholder of the Company and receive the cash dividends and refund of imputation credits on a yearly basis. These amounts will be contributed to the fund as non-concessional contributions. As Person B will not be subject to capital gains tax liability under the alternative proposal, the additional funds will be contributed to the fund as a non-concessional contribution.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA. | Income Tax Assessment Act 1936 Paragraph 177D(b). | Income Tax Assessment Act 1936 Section 177E. | Income Tax Assessment Act 1936 Section 177EA. | Income Tax Assessment Act 1997 Section 104-25. | Income Tax Assessment Act 1997 Section 104-135. | Income Tax Assessment Act 1997 Section 207-110. | Income Tax Assessment Act 1997 Subparagraph 207-145(1)(a). Question 1 | CGT event C2 in section 104-25 of the ITAA 1997 and CGT event G1 in section 104-135 of the ITAA 1997 deal with payments received by a taxpayer when their ownership of an asset (a share) ends. | CGT event C2 of subsection 104-25(1) of the ITAA 1997 states: | CGT event C2 happens if your ownership of an intangible *CGT asset ends by the asset: | (a) being redeemed or cancelled; or | (b) being released, discharged or satisfied; or | (c) expiring; or | (d) being abandoned, surrendered or forfeited; or | (e) if the asset is an option - being exercised; or | The time of the event is when you enter into the contract that result in the asset ending, or if there is no contract, when the asset ends (subsection 104-25(2) of the ITAA 1997). While according to subsection 104-25(3) of the ITAA 1997, a capital loss is made if the capital proceeds are less than the asset’s reduced cost base. | CGT event G1 in section 104-135 of the ITAA 1997 discusses the capital payment for shares while subsection 104-135(1) of the ITAA 1997 states that: | CGT event G1 happens if: | (a) a company makes a payment to you in respect of a share you own in the company (except for CGT event A1 or C2 happening in relation to the share); and | (b) some or all of the payment (the non-assessable part ) is not a dividend, or an amount that is taken to be a dividend under section 47 of the Income Tax Assessment Act 1936 The payment can include giving property: see section 103-5 | CGT event G1 happens if: | ● a company makes a payment to a taxpayer in respect of a share the taxpayer owns in the company and | ● some or all of the payment is not a ‘dividend’, is not an amount that is a distribution by a liquidator which is taken to a be a dividend under section 47 of the ITAA 1936 and | ● is not included in the taxpayer’s assessable income. | Subsection 104-135(6) of the ITAA 1997 states that a payment to a taxpayer by a liquidator is disregarded if the company ceases to exist within 18 months of the payment. In such a case, the payment will be included as part of the capital proceeds from CGT event C2 happening to the share when it ends as a result of the company being wound up. | It is noted that the Company is to be liquidated after the shares have been transferred to the Fund and the franked dividend has been paid. | The Fund will therefore incur a capital loss under CGT event C2 in section 104-25 of the ITAA 1997 on the liquidation of the Company equivalent to the market value of the shares less the paid up value, providing the Company ceases to exist within 18 months of the payment by the liquidator. | If the company is not liquidated within 18 months, then a capital loss will not be allowed under section 104-135 of the ITAA 1997 (refer to the note after subsection 104-135(3) of the ITAA 1997). | Question 2 | Part IVA of the ITAA 1936 is a general anti-avoidance provision that can apply in certain circumstances if you obtain a tax benefit in connection with a scheme, and it can be concluded that the scheme, or any part it, was entered into for the dominant purpose of enabling a tax benefit to be obtained. Part IVA is a provision of last resort. | In order for Part IVA to apply, the following requirements must be satisfied: | ● There must be a scheme as defined by section 177A of the ITAA 1936. | ● There must be a tax benefit as defined by section 177C of the ITAA 1936, obtained in connection with the scheme | ● The scheme must be one to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be concluded that the taxpayer (or any other person involved in the scheme) had the sole or dominant purpose of entering into the scheme to obtain the tax benefit. | Scheme | For Part IVA to apply, the identified scheme must fall within the following definition of ‘scheme’. | Subsection 177A(1) of the ITAA 1936 defines ‘scheme’ as any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, by legal proceedings; and any scheme, plan, proposal, action, course of action or course of conduct. | In the current case, the proposed arrangement falls within this definition. It is therefore a scheme in accordance with the definition in subsection 177A(1) of the ITAA 1936. | Tax benefit | Part IVA cannot apply unless a taxpayer has obtained, or would but for section 177F of the ITAA 1936 obtain, a tax benefit in connection with a scheme. | Subsection 177C(1) of the ITAA 1936 defines four kinds of tax benefits, they include:- | ● An amount not being included in the assessable income of a taxpayer of a year of income | ● A deduction being allowable to a taxpayer in relation to a year of income | ● A capital loss being incurred by the taxpayer during the year of income | ● A foreign income tax offset being allowable to the taxpayer where the whole or a part of that foreign income tax offset would not have been allowable. | The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA of the ITAA 1936 to apply, the need for an ‘alternative hypothesis, or an ‘alternative postulate’ must be considered. This is what would have happened or might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. | In FC of T v. Peabody 94 ATC 4663 at 4671; (1994) 181 CLR 359 at 385; 28 ATR 344 at 353, the High Court discussed the meaning of the phrase “might reasonably be expected”. Their Honours held that: | A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable. | It is possible for different conclusions to be reached as to what might reasonably be expected to have happened if the particular scheme had not been entered into or carried out. | In the current case, it is considered that the alternative proposal as outlined in the ruling is what might reasonably be expected to happen if the proposal is not entered into. | Under the alternative proposal, Person B will remain the shareholder of the Company and receive fully franked dividends and imputation credits each year. On the receipt of the dividends and any refunds for excess imputation credits, Person B will each year, contribute the cash dividend and excess imputation credits to the Fund. These contributions will be non-concessional contributions. | Under the proposal, Person B as shareholder of the Company and a member of the Fund, will transfer their entire shareholding to the Fund by way of an in-specie non-concessional contribution and an in-specie non-concessional spouse contribution. The Fund will also receive a fully franked dividend and unused franking credits. The franked dividend and in-specie contributions will be used to support current pension liabilities. | Paragraph 177C(1)(ba) of the ITAA 1936 appears to be the only benefit which may apply and it states that a tax benefit occurs where a capital loss is incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been incurred, by the taxpayer during the year of income if the scheme had not been entered into or carried out. | As noted previously, capital losses will be incurred on the liquidation of the Company. As the Company would not be liquidated under the alternative proposal, the Fund will not incur a capital loss under the alternative proposal. | As capital losses will be incurred under the proposal, the capital losses will be a tax benefit to the Fund in accordance with paragraph 177C(1)(ba) of the ITAA 1936. This is despite the fact the Fund may never use the losses. | Objective purpose test | Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to the eight specified factors in paragraph 177D(b) of the ITAA 1936, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain a tax benefit. | The consideration of purpose or dominant purpose under paragraph 177D(b) of the ITAA 1936 requires an objective conclusion to be drawn. The conclusion required by section 177D of the ITAA 1936 is not about a person’s actual, that is, subjective, dominant purpose or motive. It is possible for Part IVA to apply notwithstanding that the dominant purpose of obtaining the tax benefit was consistent with the pursuit of commercial gain. | A conclusion about a relevant person’s purpose for section 177D of the ITAA 1936 is the conclusion a reasonable person would make based on all the facts and evidence that are relevant to considering the eight factors for the scheme. | Conclusion | Having regard to the eight matters in paragraph 177D(b) of the ITAA 1936, it is concluded that the dominant purpose for entering into or carrying out the scheme will be not to obtain a tax benefit. Accordingly, Part IVA will not apply to the scheme. | Question 3 | Dividend stripping – section 177E | Section 177E of the ITAA 1936 is a specific provision within the general anti-avoidance provisions found in Part IVA of the ITAA 1936. Section 177E specifically brings within the ambit of Part IVA dividend stripping, including schemes having substantially the effect of dividend stripping, as a circumstance under which section 177F of the ITAA 1936 can operate to cause the vendor of the shares involved in the transaction to be subject to tax on the property disposed of by the company after the sale of the shares. | Section 177E of the ITAA 1936 operates where four pre-conditions are satisfied. These are set out in paragraphs 177E(1)(a) to 177E(1)(d) of the ITAA 1936. | Paragraph 177E(1)(a) | Paragraph 177E(1)(a) of the ITAA 1936 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 one having substantially the effect of such a scheme. | Subparagraph 177E(1)(a)(ii) of the ITAA 1936 includes ‘a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping’. By its express terms, section 177E can apply where there is a scheme having substantially the effect of a scheme by way of, or in the nature of, a dividend stripping. | Taxation Ruling IT 2627 provides the Tax Office’s view on the application of section 177E of the ITAA 1936 to dividend stripping arrangements. As paragraph 8 of IT 2627 states the term ‘dividend stripping’ does not have a precise legal meaning. | However, as paragraph 9 of 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. | Paragraph 10 of IT 2627 states further that: | …. 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 | While paragraph 20 of IT 2627 states: | The disposal of property must be as a result of the scheme. Therefore, as mentioned above, it is important to identify accurately the point at which the scheme commenced and the transactions that formed part of it. Disposals that occurred before the scheme was entered into, and contemporaneous but unrelated disposals would not be disposals of the kind contemplated by section 177E. | To determine if the conditions of paragraph 177E(1)(a) of the ITAA 1936 are satisfied it is necessary to initially determine if there is a scheme. As stated earlier the definition of a scheme is very wide and such will apply in this instance. It is necessary to determine the time of the commencement of the scheme and the transactions that are part of that scheme. The time of the commencement will occur when Person B transfers their shares to the Fund. The transactions of the scheme will be the steps involved in the transfer of the wealth of the Company to the Fund. | For paragraph 177E(1)(a) of the ITAA 1936 to apply, the scheme must involve the disposal of assets as a result of the scheme, or by way of a dividend strip, or one having substantially the effect of a such a scheme. | The term ‘dividend stripping’ is not defined in the ITAA 1936. The Explanatory Memorandum (EM) to the introduction of repealed section 46A of the ITAA 1936 referred to subsection 46A(3) of the ITAA 1936 as stating matters which the Commissioner is obliged to consider in determining whether there has been a dividend strip ‘in a case potentially within the scope of the section’. The EM continues as follows: | The subsection thus directs the Commissioner to consider features common to dividend stripping as the term is ordinarily understood. These features do not exist in normal commercial transactions, eg, in the purchase in the ordinary way of shares cum div. and the subsequent sale of those shares. | In effect, the subsection requires the Commissioner to consider those features which are common to most dividend stripping operations. The EM states: | In its simplest form, a dividend-stripping operation involves the purchase by a share-trading company of shares in another company which has accumulated profits. A payment of a dividend is then made to the share-trading company which, in effect, wholly or substantially recoups its outlay on purchase of the shares that are then resold for a reduced price or are retained at a reduced value for income tax purposes.’ | Dividend stripping in its classical form is a set of facts where somebody buys the controlling shares in a company which has a considerable balance on profit and loss account and appreciable liquid assets. The new controller arranges for the company to declare a large dividend payment. The value of the shares would be reduced as a result of the dividend payment, and they would be sold at a loss. The loss on their sale may be a trading loss if the purchaser is a share trader or the loss might be used to shield other income. If the purchaser is another company, the dividends are rebatable. | FC of T v. Consolidated Press Holdings Ltd (No1 ) (1999) 91 FCR 524; 99 ATC 4945; 42 ATR 575 (the CPH case), which dealt with the stripping of company profits under section 177E of the ITAA 1936, it can also provide guidance in identifying a dividend stripping scheme. In the CPH case, the Full Federal Court stated that the central characteristics of a dividend stripping scheme, as identified by reference to established case law decisions, were: | (a) A target company with substantial accumulated profits. | (b) The sale of the shares in the target company to another party; | (c) The payment of dividends to the purchaser out of the target company’s profits; | (d) The purchase escaping Australian tax on the dividends so declared; | (e) The vendor shareholders receiving a capital sum approximating the dividend paid by the target; and | (f) A scheme carefully planned and carried through by the stripper and a number of other persons acting in concert. | The High Court determined that CPH had not engaged in dividend stripping. The High Court agreed with the lower Courts that CPH had merely engaged in a corporate reorganisation rather than a scheme with the sole or dominant purpose of avoiding taxation upon any anticipated profit distribution. Further, the High Court noted that in CPH, the shareholders of the ‘target’ companies had incurred Australian income tax liability with respect to capital gains triggered as a result of the corporate reorganisation. | These general elements of dividend stripping were recently re-affirmed by the Federal Court in Lawrence v. FC of T 2008 ATC 20-052; 70 ATR 376; 2008 FCA 1497. The Federal Court considered that a dividend stripping scheme should at least exhibit all six characteristics as discussed above. The Court also held that where all or some of the characteristics are not present, it may nonetheless have substantially the effect of a dividend stripping scheme. From a reading of the explanatory memorandum, the Court held that the second limb of paragraph 177E(1)(a) of the ITAA 1936 was designed to capture variations on dividend stripping which had the effect of placing company profits in the hands of the shareholders in a tax free form in substitution for taxable dividends. This approach was consistent with the High Court's decision in the CPH case. | In the current case, under the proposal, the shares will be transferred by the vendor shareholder as an in-specie contribution. Therefore, Person B will not receive a capital sum for the shares and the Fund will not pay any consideration for the shares. In addition, Person B will incur a significant capital gain on the transfer. These factors indicate that the scheme is not a dividend stripping scheme. As stated above, in the CPH case, the capital gains tax incurred by the vendor shareholders was one of the factors considered in determining that the scheme was not a dividend strip. | In addition, the Company only has unrealised profits relating to the value of the investments. | On liquidation, the Fund will incur a significant capital loss equivalent to the market value of the shares less the cost base of the shares. However, as the Fund pays minimal or no tax, the capital loss will most likely not be utilised. | The reorganisation is to be undertaken for the purpose of retirement planning rather than for the purpose of avoiding taxation upon any anticipated profit distribution. | It is concluded, based on the above factors that the scheme is not in the nature of a dividend strip. | As the scheme is not in the nature of a dividend stripping scheme, it is not necessary to consider the remaining paragraphs 177E(b),177E(c) and 177E(d) of the ITAA 1936. | Question 4 | Franking Credit Benefits –section 177EA | Section 177EA of the ITAA 1936 targets franking credit trading and dividend streaming schemes where one of the purposes (other than an incidental purpose) of the scheme is to obtain a franking credit benefit (or imputation benefit under the Simplified Imputation System applicable from 1 July 2002). The reason for its introduction was explained in the Explanatory Memorandum (EM) to the Taxation Laws Amendment Bill (No. 3) 1998 in paragraphs 8.5 to 8.7 as follows: | 8.5. Two of the underlying principles of the imputation system are, firstly, 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 and, secondly, that tax paid at the company level is imputed to the shareholders proportionately to their shareholdings. | 8.6. Franking credit trading schemes allow franking credits to be inappropriately transferred by, for example, allowing the full value of franking credits to be accessed without bearing the economic risk of holding the share. These schemes undermine the first principle. | 8.7. Companies can also engage in dividend streaming (that is, the distribution of franking credits to select shareholders), which undermines the second principle by attributing tax paid on behalf of all shareholders to only some of them. Generally this entails the streaming of franking credits to taxable residents and away from non-residents and tax-exempts. | The preconditions for the application of section 177EA of the ITAA 1936 are listed in subsection 177EA(3) of the ITAA 1936 and applies if: | (a) there is a scheme for a disposition of shares or an interest in shares in a company; and | (b) either: | i. a frankable distribution 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. | As previously discussed, the proposed transaction represents an arrangement, proposal, plan course of action or course of conduct. It therefore constitutes a scheme for the purposes of section 177EA of the ITAA 1936. Paragraph 177EA (3)(a) of the ITAA 1936 is satisfied. | Subparagraph 177EA(3)(b)(i) of the ITAA 1936 states that a frankable distribution is to be paid to a ‘person’. | Paragraph 207-145(1)(a) refers to persons who are qualified to receive franking credits and refers to the definition under former Part IIIAA of the ITAA 1936. Former paragraph 160APHR(1)(g) in Part IIAA of the ITAA 1936 states that the trustee of a complying superannuation fund is a ‘person’ qualified to receive a frankable distribution. As the arrangement involves the payment of a frankable distribution to the Fund which is a complying superannuation fund, it is considered that the proposal is a scheme where a frankable distribution has been paid to (the trustee of) the Fund in respect of its membership interests. Subparagraph 177EA(3)(b)(i) of the ITAA 1936 is satisfied. | Paragraph 177EA(3)(c) of the ITAA 1936 is satisfied as a frankable distribution is to be paid to the Fund. Paragraph 177EA(3)(d) of the ITAA 1936 is also satisfied as (the trustee of) the Fund could reasonably be expected to receive imputation benefits as a result of the distribution. | Determining purpose: paragraph 177EA(3)(e) of the ITAA 1936 | The test of purpose under section 177EA of the ITAA 1936 is a test of objective purpose. The question posed by the test is whether, objectively, it would be concluded that a person who entered into or carried out the scheme under which the disposition of shares occurs, did so for the purpose of obtaining a tax advantage relating to franking credits. | A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident. | In the current case, the purpose as detailed in the facts of this case is to assist in the retirement planning of the individuals and to do so by transferring the property from the Company to (the trustee of) the Fund. | In determining whether it would be concluded that a person entered into or carried out a scheme involving the disposition of shares or an interest in shares for a purpose, not being merely an incidental purpose, of enabling a taxpayer to obtain a tax advantage in relation to franking credits, regard must be had to the terms of the disposition and the relevant circumstances. | Under subsection 177EA(17) of the ITAA 1936, the relevant circumstances of a scheme include listed factors and the last factor includes any of the eight matters listed in paragraph 177D(b) of the ITAA 1936 used in connection with the general provisions of Part IVA of the ITAA 1936. | Taxation Ruling TR 2009/3 discusses the relevant circumstances outlined in subsection 177EA(17) of the ITAA 1936. | Paragraph 51 of TR 2009/3 states that the requirements of paragraph 177EA(3)(e) will be satisfied if: | … 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. | In arriving at a conclusion, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The listed circumstances there encompass a range of circumstances which, taken individually or collectively, indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. | Conclusion | Having regard to the above circumstances and factors as outlined in section 177EA of the ITAA 1936, it is concluded that the trustees of the Fund did not enter into the scheme or any part of the scheme for a purpose (whether or not the dominant purpose, but not including an incidental purpose) of enabling the Fund to obtain an imputation benefit. Therefore, the Commissioner will not make a determination under subsection 177EA(5) of the ITAA 1936 that no imputation benefit is to arise to the Fund in relation to the distribution of the franked dividend.


This notice must not be taken to imply anything about: | ● the binding nature of the private advice issued to the applicant | ● the correctness of other edited versions.