Private ruling: Business Restructure
Date of advice: 12 March 2024
Published: 22 April 2024
Ruling period: Year ended 30 June 20YY, and | Year ended 30 June 20YY
Date scheme commenced: 30 June 20YY

Ruling: Q1: Will the issue of the F Class Share to Company A cause a direct value shift under Division 725 of the ITAA 1997 | A1: No | Q2: If the answer to Question 1 is "yes" (or if question 1 cannot be answered), will s725-90 of the ITAA 1997 apply such that there will be no consequences of the direct value shift. | A2: Not applicable | Q3: Will the F Class Share be a non-equity share under Division 974 of the ITAA1997? | A3: No | Q4: Will the issue of the F Class Share attract the operation of s. 45 of the ITAA1936? | A4: No | Q5: Will the issue of the F Class Share result in a deemed dividend under s. 45C of the ITAA1936? | A5: No | Q6: Is the dividend paid on the F Class Share a frankable distribution under s. 202-30 of the ITAA1997? | A6: Yes | Q7: Will Section 177EA of the ITAA1936 apply in relation to the dividend to be paid on the F Class Share? | A7: No | Q8: Will s. 204-30 of the ITAA1997 apply in relation to the dividend to be paid on the F Class Share? | A8: No | Q9: Is the proposed transaction by the way of or in the nature of dividend stripping, or having substantially the effect of a scheme in the nature of dividend stripping? | A9: No | Q10: Will Company A be entitled to a tax offset for the franking credits attached to the dividend paid on the F Class Shares under s. 207-20 of the ITAA1997? | A10: Yes | Q11: Will the Commissioner apply Part IVA to the proposed transaction? | A11: No | Q12: If X Co undertakes an off-market share buy-back of the F Class Share, will s. ss. 159GZZZQ(2) of the ITAA1936 apply to the buy-back? | A12: No

Relevant facts and circumstances: X Co Pty Ltd ("X Co") is an Australian resident private company that was incorporated in July 19XX. X Co runs a business as wholesaler ("the Core Business"). X Co also operates a primary production business ("the PP Business"). Shareholding History X Co Pty Ltd was incorporated on 2 July 19XX with 4 Ordinary $1.00 shares issued to: • Person A 2 ordinary shares fully paid • Person B 1 ordinary share fully paid • Person C 1 ordinary share fully paid. In August 20XY there was a 50% change in shareholding • Person B sold his 1 ordinary share to Y Co as trustee for the Z trust for $X. • Person C sold her 1 ordinary share to Y Co as trustee for the Z Trust for $X. There have been no other changes to shareholding or shares issued / redeemed from incorporation to date, and X Co has the following shareholders: • Person A: 2 Ordinary Shares; • Y Co as trustee for Z Trust ("the Trust"): 2 Ordinary Shares. Proposed future sale of shares X Co has been informed by unrelated parties that they may be interested in acquiring the Core Business in the next few years. It has been indicated that the potential purchasers are likely to proceed with the purchase transaction by acquiring 100% of the shares in X Co. This will enable the purchaser to continue operating the Core Business via the existing company, which will maintain existing and longstanding contracts and customers, leases, intellectual property and other assets that are essential to the ongoing conduct of the Core Business. Having operated a profitable business for many years, X Co has accumulated substantial assets that are surplus to the requirements of the Core Business, collectively referred to as the "Surplus Assets, including: • Cash reserves that are more than the requirements of the Core Business; • Listed shares; • Livestock (cattle) held in operating the PP Business; and • Equipment used in the PP Business. To enable the sale of shares in X Co, it will be firstly necessary for X Co to 'divest' the Surplus Assets. The purchasers will not be willing to purchase the shares in the company while it owns assets that are excess to the requirements of the Core Business. Preferred outcome subsequent to share sale The shareholders of X Co wish to be able to retain their underlying economic ownership of the Surplus Assets in a company structure to allow for the continuing investment and accumulation of wealth into the future. The shareholders and X Co are considering options to allow this to be achieved. Proposed restructure prior to share sale It is proposed that: • A new company will be incorporated ("Company A"). Company A will have exactly the same share structure and shareholders as X Co. That is: o Person A will own 2 Ordinary Shares; and o The Trust will own 2 Ordinary Shares; • X Co will issue 1 F Class Share to Company A for $1. F Class Shares are redeemable preference shares, which have the following rights under the company constitution: o No voting rights; o Rights to dividends as determined at the discretion of the directors; o F Class Shares are redeemable at the option of the directors of X Co for the price at which they are issued (i.e., $1). The terms of the F Class Share issued to Company A will provide X Co with the right to redeem the F Class Share within 2 years of being issued; • X Co will sell its listed share portfolio on the share market. Any net capital gain realised from the sale of the listed share portfolio will be included in X Co' assessable income for the year of the CGT event; • X Co will transfer the Surplus Assets to Company A for full market value. At the time of the transfer to Company A, the listed shares already will have been sold by X Co. As such, in lieu of transferring the listed shares, X Co will transfer an amount of cash that is equal to the sale price for the listed shares (net of the tax liability that will be payable by X Co on the capital gain from the sale of the listed shares); • Any balancing adjustment or assessable amount arising from the transfer of the Surplus Assets to Company A will be included in X Co' assessable income for the year of the transfer; • The transfer of the Surplus Assets to Company A will create a debt owing from Company A back to X Co ("the Debt"); • X Co will pay a fully-franked dividend on the F Class Share (to Company A). The amount of the dividend will be equal to the amount of the Debt; • X Co and Company A will enter into an agreement to set-off their mutual obligations. That is, X Co' obligation to pay the dividend will be satisfied by applying it against the Debt. This will reduce the amount of the Debt to nil; • Company A will own the F Class Share for more than 90 days; • After completing the above steps, X Co will either: o Undertake an off-market selective share buy-back in respect of the F Class Share. The buy-back price will be $1; or o Redeem the F Class Share for $1. It is expected that all the above steps could be completed within 6 months of commencement. After the proposed transaction has been completed the following circumstances will apply to the participants in the arrangement: • Person A and the Trust will be the only shareholders of X Co (equal shareholders); • X Co will no longer be the owner of the Surplus Assets; • X Co will continue operating the Core Business; • Person A and the Trust will be the only shareholders of Company A (equal shareholders); • Company A will be the owner of the Surplus Assets; • Company A will continue operating the PP Business moving forward; and • Company A will continue investing the Surplus Assets moving forward. Assumptions: There are no further steps (including rollovers) to the restructure. The shareholders of X Co will retain the same proportion of legal and beneficial ownership of the shares in Company A (as in X Co) under the restructure scheme.

Relevant legislative provisions: Division 725 of the ITAA1997 | Division 974 of the ITAA1997 | Section 45 of the ITAA1936 | Section 45A of the ITAA1936 | Section 45B of the ITAA1936 | Section 45C of the ITAA1936 | Section 202-30 of the ITAA1997 | Section 202-45 of the ITAA1997 | Section 177EA of the ITAA1936 | Section 204-30 of the ITAA1997 | Section 177 of the ITAA1936 | Section 207-20 of the ITAA1997 | Section 207-145 of the ITAA1997 | Section 177D of the ITAA1936 | Subsection 159GZZZQ(2) of the ITAA1936

Reasons for decision: Summary: No. the issue of F Class shares will not be a value shift under s725-50 ITAA 1997. | Detailed Reasoning - Detailed reasoning: The General Value Shifting regime addresses arrangements that shift value out of assets, distorting the relationship between their market values and their values for tax purposes. Without a value shifting regime, these arrangements could encourage the creation of artificial losses and the deferring of gains. Broadly the regime will not apply where: • equity and loan interests in entities are issued at market value • rights over any underlying asset are granted for full market value consideration • entities provide economic benefits to each other at market value or otherwise deal at arm's length. The entity interest direct value shifting rules address the inappropriate tax outcomes that arise where material value is shifted between interests (whether equity or loan) held in a company or trust. Value may be shifted between interests in an entity by, for instance, varying the rights attaching to interests in the entity or issuing new interests at a discount to market value. Division 725 provides: 725-45(1) The main object of this Division is: (a) to prevent inappropriate losses from arising on the realisation of * equity or loan interests from which value has been shifted to other equity or loan interests in the same entity; and (b) to prevent inappropriate gains from arising on the realisation of equity or loan interests in the same entity to which the value has been shifted; so far as those interests are owned by entities involved in the value shift. 725-45(2) This is done by: (a) adjusting the value of those interests for income tax purposes to take account of changes in *market value that are attributable to the value shift; and (b) treating the value shift as a partial realisation to the extent that value is shifted: (i) between interests held by different owners; or (ii) in the case of interests in their character as CGT assets - from post-CGT assets to pre-CGT assets; or (iii) between interests of different characters. 725-50 When a direct value shift has consequences under this Division A * direct value shift under a * scheme involving * equity or loan interests in an entity (the target entity) has consequences for you under this Division if, and only if: (a) the target entity is a company or trust at some time during the * scheme period; and (b) section 725-55 (Controlling entity test) is satisfied; and (c) section 725-65 (Cause of the value shift) is satisfied; and (d) you are an * affected owner of a * down interest, or an * affected owner of an * up interest, or both; and (e) neither of sections 725-90 and 725-95 (about direct value shifts that are reversed) applies. Note: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if section 725-70 (about material decrease in market value) is satisfied Section 725-145 When there is a direct value shift 725-145(1) There is a direct value shift under a * scheme involving * equity or loan interests in an entity (the target entity) if: (a) there is a decrease in the *market value of one or more equity or loan interests in the target entity; and (b) the decrease is reasonably attributable to one or more things done under the scheme, and occurs at or after the time when that thing, or the first of those things, is done; and (c) either or both of subsections (2) and (3) are satisfied. Examples of something done under a scheme are issuing new shares at a * discount, buying back shares or changing the voting rights attached to shares. 725-145(2) One or more *equity or loan interests in the target entity must be issued at a *discount. The issue must be, or must be reasonably attributable to, the thing, or one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. Example: A company runs a family business. There are 2 shares originally issued for $2 each. They are owned by husband and wife. The market value of the shares is much greater (represented by the value of the assets of the company less its liabilities). The company issues one more share for $2 to their son. Caution is needed in such a situation. The example would result in a large CGT liability for the husband and wife under this Division, because they have shifted 1/3 of the value of their own shares to their son. No such liability would arise if the share had been issued for its market value. 725-145(3) Or, there must be an increase in the *market value of one or more * equity or loan interests in the target entity. The increase must be reasonably attributable to the thing, or to one or more of the things, referred to in paragraph (1)(b). It must also occur at or after the time referred to in that paragraph. The F Class share is not issued at a discount under 725-145(2) as the F Class shares are issued for $1 and redeemable for the same amount. The discretionary character of the dividend in this case would most likely limit the market value of F Class shares to the issue price and they will consequently not be issued at a discount under s725-150. In addition, there are no consequences for the direct value shift (refer Q2) under s725-90. . Question 2 If the answer to question 1 is "yes" (or if question 1 cannot be answered), will s. 725-90 of the ITAA1997 apply such that there will be no consequences of the direct value shift. | Summary: Not applicable. However, section 725-145(2) will apply such that there are no consequences should there be a direct value shift. | Detailed Reasoning - Detailed reasoning: Under the reversal exception, there are no consequences for an entity interest direct value shift under a scheme if it is more likely than not that, at the time the first of the things done under the scheme happens, the cause of the value shift will reverse within four years under the terms of the same scheme. The reversal exception applies to both: • the initial entity interest direct value shift that happens under the scheme, and • any entity interest direct value shift that subsequently occurs under that scheme within the four year period because of the reversal of the earlier entity interest direct value shift. Section 725-90 Direct value shift that will be reversed 725-90(1) The *direct value shift does not have consequences for you under this Division if: (a) the one or more things referred to in paragraph 725-145(1)(b) brought about a state of affairs, but for which the direct value shift would not have happened; and (b) as at the time referred to in that paragraph, it is more likely than not that, because of the * scheme, that state of affairs will cease to exist within 4 years after that time. Example: 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. 725-90(2) However, this section stops applying if the state of affairs referred to in paragraph (1)(a) still exists: (a) at the end of those 4 years; or (b) when a * realisation event happens to * down interests or * up interests of which you are, or any other entity is, an * affected owner; whichever happens sooner. 725-90(3) If this section stops applying, it is taken never to have applied to the * direct value shift. Note: This may result in an assessment for an earlier income year having to be amended to give effect to the consequences that the direct value shift would have had for you under this Division if this section hadn ' t applied. On the facts in this case, the directors are proposing to buy-back or redeem the F Class shares within 4 years in accordance with s725-90 and even if there was a value shift there would be no consequences. | Detailed Reasoning - Question 3: Will the F Class Share be a non-equity share under Division 974 of the ITAA 1997? | Summary: No. F Class shares will be an equity interest under s974-75(1) ITAA 1997. | Detailed Reasoning - Detailed reasoning: The tests for debt and equity interests determine whether a particular interest is a debt interest or an equity interest. Rules determining what is equity in a company and what is debt in an entity for tax purposes are contained in Division 974 of the Income Tax Assessment Act 1997. The debt or equity classification of an interest is relevant for certain tax purposes, including: • identifying debt for thin capitalisation purposes • identifying debt for the consolidation measure • determining whether certain returns may be subject to interest withholding tax or dividend withholding tax. The debt and equity tests determine whether a return on an interest in an entity may be frankable and non-deductible (like a dividend) or may be deductible to the entity and not frankable (like interest). If an interest passes one or more items of the equity test table, then, subject to the overriding operation of the debt test, it will be an equity interest. Section 974-20 The test for a debt interest, provides: 974-20(1) A *scheme satisfies the debt test in this subsection in relation to an entity if: (a) the scheme is a *financing arrangement for the entity; and (b) the entity, or a *connected entity of the entity, receives, or will receive, a *financial benefit or benefits under the scheme; and (c) the entity has, or the entity and a connected entity of the entity each has, an *effectively non-contingent obligation under the scheme to provide a financial benefit or benefits to one or more entities after the time when: (i) the financial benefit referred to in paragraph (b) is received if there is only one; or (ii) the first of the financial benefits referred to in paragraph (b) is received if there are more than one; and (d) it is substantially more likely than not that the value provided (worked out under subsection (2)) will be at least equal to the value received (worked out under subsection (3)); and (e) the value provided (worked out under subsection (2)) and the value received (worked out under subsection (3)) are not both nil. The scheme does not need to satisfy paragraph (a) if the entity is a company and the interest arising from the scheme is an interest covered by item 1 of the table in subsection 974-75(1) (interest as a member or stockholder of the company). Note: Section 974-30 tells you when a financial benefit is taken to be provided to an entity. 974-20(2) The value provided is: (a) the value of the *financial benefit to be provided under the *scheme by the entity or a *connected entity if there is only one; or (b) the sum of the values of all the financial benefits provided or to be provided under the scheme by the entity or a connected entity of the entity if there are 2 or more. Note: Section 974-35 tells you how to value financial benefits. 974-20(3) The value received is: (a) the value of the *financial benefit received, or to be received, under the *scheme by the entity or a *connected entity of the entity if there is only one; or (b) the sum of the values of all the financial benefits received, or to be received, under the scheme by the entity or a connected entity if there are 2 or more. 974-20(4) For the purposes of paragraph (1)(b) and subsections (2) and (3): (a) a *financial benefit to be provided under the *scheme by the entity or a *connected entity is taken into account only if it is one that the entity or connected entity has an *effectively non-contingent obligation to provide; and (b) a financial benefit to be received under the scheme by the entity or a connected entity is taken into account only if it is one that another entity has an effectively non-contingent obligation to provide. 974-20(5) Paragraphs (1)(b) and (c) apply to 2 or more *financial benefits whether they are provided at the same time or over a period of time. 974-20(6) The regulations: (a) may specify circumstances in which paragraph (1)(d) is satisfied or not satisfied; and may otherwise specify rules to be applied in determining whether or not paragraph (1)(d) is satisfied. ATO ID 2003/873, Debt/Equity Interest: Redeemable Preference Shares - equity interest, provides further guidance on the tax treatment of Redeemable Preference Shares under the debt/equity provisions: The RPS are equity interests as defined in subsection 974-70(1) of the ITAA 1997 because: • the issue of RPS is a scheme (as defined in subsection 995-1(1) of the ITAA 1997); • the scheme falls within one of the items in the equity interest table in subsection 974-75(1) of the ITAA 1997 (principally the RPS give rise to an interest as a member of the issuing company, Item 1 of the equity interest table); • as the RPS satisfy item 1 of the equity interest table, pursuant to subsection 974-75(2) of the ITAA 1997, it does not have to satisfy the financing arrangement definition; and • the RPS are not characterised as, and do not form part of a larger interest that is characterised as, a debt interest (as defined in subsection 974-15(1) of the ITAA 1997) in the issuing company. It is necessary to consider the 'tie-breaker' provision outlined at subsection 974-5(4) of the ITAA 1997 to ascertain if the nature of the interest is also a debt interest, in which case the character of the interest will be taken as being a debt interest despite the fact that it is also an equity interest. An essential element (inter alia) in the debt test outlined in subsection 974-20(1) of the ITAA 1997 is that the effectively non-contingent obligations to provide a financial benefit by the entity (or entity and connected entity) under the scheme is equal to, or greater than, the financial benefit received by the (interest issuing) entity (or connected entity). The RPS will not be characterised as a debt interest because they fail to satisfy two elements of the debt test as set out in subsection 974-20(1) of the ITAA 1997. That is: 1.there is no effectively non contingent obligation on the part of the (issuer) entity (or the entity and a connected entity) to repay the investment amount (provide a financial benefit as defined in section 974-160 of the ITAA 1997) under the RPS (as required by paragraph 974-20(1)(c) of the ITAA 1997); and, as a result, 2.it cannot be said that the requirements of paragraph 974-20(1)(d) of the ITAA 1997 will be met (that is, it is not substantially more likely than not that the value of the financial benefit provided will equal or exceed the value of the financial benefit received)." On the facts in this case, the F Class shares will not satisfy the debt test under s974-20 ITAA 1997, and will be an equity interest under s974-75(1). | Detailed Reasoning - Question4: Will the issue of the F Class Share attract the operation of s. 45 of the ITAA1936? | Summary: No. The dividend streaming provisions in s 45 ITAA 1936 will not apply. | Detailed Reasoning - Detailed reasoning: Any strategy that aims to avoid wastage of imputation benefits, by directing franked distributions to members who can most benefit from them to the exclusion of other members, may amount to dividend streaming. This might happen where, for example, some members are non-residents or tax exempt bodies that can't fully use franking credits, and the franking entity seeks to divert franking credits from these members to others who can fully use the credits. Section 45 ITAA 1936 applies to capital streaming arrangements in which bonus shares are provided to some shareholders and unfranked or minimally franked dividends are paid to other shareholders. Section 45 ITAA 1936 provides: 45(1) This section applies in respect of a company that, whether in the same year of income or in different years of income, streams the provision of shares (other than shares to which subsection 6BA(5) applies) and the payment of minimally franked dividends to its shareholders in such a way that: (a) the shares are received by some shareholders but not all shareholders; and (b) some or all of the shareholders who do not receive the shares receive or will receive minimally franked dividends. 45(2) The value of the share at the time that the shareholder is provided with the share is taken, for the purposes of this Act, to be a dividend that is unfrankable (within the meaning of subsection 995-1(1) of the Income Tax Assessment Act 1997 ) and that is paid by the company, out of profits of the company, to the shareholder at that time. 45(3) A dividend is minimally franked if it is not franked, or is franked to less than 10%, in accordance with section 202-5 or 208-60 of the Income Tax Assessment Act 1997 On the facts the issue of the shares would not be part of a streaming arrangement. In addition, there is no proposal for minimally franked dividends to be paid, and it is intended to frank all future dividends. | Detailed Reasoning - Question 5: Will the issue of the F Class Share result in a deemed dividend under s. 45C of the ITAA1936? | Summary: No. The Commissioner will not make a determination under s45A or s45B ITAA 1936 in respect of the scheme. | Detailed Reasoning - Detailed reasoning: Section 45C applies to treat a capital benefit for which there is a determination under s45A or s45B as an unfranked dividend paid out of company profits. In addition, where the Commissioner has made a determination under s 45B, it provides for the Commissioner to make a further determination that the relevant capital benefit was provided under a scheme to avoid franking debits, with the result that a franking debit of the company arises. 45C(1) If the Commissioner makes a determination under subsection 45A(2) or 45B(3), the amount of the capital benefit, or the part of the benefit, is taken, for the purposes of this Act, to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time that the shareholder or relevant taxpayer is provided with the capital benefit. 45C(2) The dividend is taken to have been paid out of profits of the company. 45C(3) If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or the part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company: (a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and (b) the amount of the franking debit is the amount that, if the company had: (i) paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and (ii) fully franked the dividend; would have been the amount of the franking credit of the company that would have arisen as a result of the dividend. 45C(4) The amount of the capital benefit is: (a) if the benefit is the provision of an ownership interest - the market value of the interest at the time that it is provided; or (b) if the benefit is an increase in the market value of an ownership interest - the increase in the market value of the interest as a result of the change; or (c) if the benefit is a distribution to the shareholder of share capital or share premium - the amount debited to the share capital account or share premium account of the company in connection with the provision of the benefit. 45C(4A) For the purposes of this section: (a) a non-share distribution to an equity holder is taken to be the distribution to the equity holder of share capital to the extent to which it is a non-share capital return; and (b) the debit to the company's non-share capital account, in respect of the non-share distribution, is taken to be a debit to the company's share capital account. Section 45A ITAA 1936 Section 45A of the ITAA 1936 applies in a situation where capital benefits are received by shareholders (advantaged shareholders) who would, in the same year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders and it is reasonable to assume that the other shareholders (disadvantaged shareholders) have received or will receive dividends. Implicit in the section's operation is the 'streaming' of benefits, that is, the provision of different benefits to different shareholders. The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed return of capital In the present case, the arrangement does not change the ultimate shareholders of NewCo and there is no streaming of capital benefits and dividends among different shareholders of the company. Section 45B ITAA 1936 In so far as it relates to the provision of a capital benefit, subsection 45B(2) of the ITAA 1936 provides that section 45B applies where: • there is a scheme under which a person is provided with a capital benefit by a company; • under the scheme, a taxpayer (the 'relevant taxpayer'), who may or may not be the person provided with the capital benefit, obtains a tax benefit; and • 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 a taxpayer (the 'relevant taxpayer') to obtain a tax benefit. Section 45B(2) ITAA 1936 provides: Schemes to provide certain benefits Purpose of section (1) The purpose of this section is to ensure that relevant amounts are treated as dividends for taxation purposes if: (a) components of a demerger allocation as between capital and profit do not reflect the circumstances of a demerger; or (b) certain payments, allocations and distributions are made in substitution for dividends. Application of section (2) This section applies if: (a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and (b) under the scheme, a taxpayer (the relevant taxpayer ), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and (c) 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit. Having regard to the facts in this case, the Commissioner does not view the proposed scheme as one for a purpose of enabling a taxpayer to obtain a tax benefit and the Commissioner will not make a determination under s45A or s45B ITAA 1936 in respect of the scheme. | Detailed Reasoning - Question 6: Is the dividend paid on the F Class Share a frankable distribution under s. 202-30 of the ITAA1997? | Summary: Yes. The proposed dividend on the F Class share will be frankable. | Detailed Reasoning - Detailed reasoning: To frank a distribution, the distribution must be frankable and the entity making the distribution must be a franking entity. Generally, only distributions from profits can be franked. For imputation purposes, a distribution includes: • a dividend, or something taken to be a dividend, made by a company • a distribution made by a corporate limited partnership, other than a distribution from profits or gains arising during an income year in which the partnership was not a corporate limited partnership • something taken to be a dividend, made by a corporate limited partnership • a unit trust dividend made by a public trading trust. A distribution is frankable unless the law specifies that it is unfrankable. Unfrankable distributions include: • distributions made in respect of shares treated as debt interest under the debt test (non-equity shares) • distributions made in relation to an instrument characterised as an equity interest under the equity test (non-share equity) where the distribution exceeds available frankable profits • distributions made by approved deposit institutions in respect of certain capital instruments issued overseas that are characterised as non-share equity under the equity test • distributions that are treated as demerger dividends for taxation purposes • distributions sourced from a company's share capital account • excessive payments by private companies to shareholders, directors and associates that are deemed to be dividends • payments or loans made by private companies to their members (or their associates) deemed as dividends under Division 7A (except in some circumstances - see Private company benefits - Division 7A dividends) • distributions to controlled foreign companies that are deemed to be dividends under section 47A of the Income Tax Assessment Act 1936 • distributions relating to off-market buy-backs of shares where the amount paid for the buy-back exceeds the market value of the share (ignoring the buy-back) • payments to CGT concession stakeholders of exempt amounts (where the small business 15-year exemption is available) • payments to CGT concession stakeholders of exempt amounts (where the small business retirement exemption is available) • deemed dividends relating to the streaming of bonus shares to some members and minimally franked (franked to less than 10%) dividends to other members • deemed dividends relating to capital streaming and dividend substitution arrangements • certain payments made by NZ franking companies • distributions from profits sourced in Norfolk Island before 1 July 2016 from companies resident there. A distribution can only be franked by: • a company or corporate limited partnership that is an Australian resident at the time of making the distribution • a public trading trust that is a resident unit trust for the income year in which the distribution is made • a New Zealand resident company that chooses to enter the Australian imputation system (Trans-Tasman imputation) Specifically, section 202-30 ITAA 1997 provides that: Distributions and non-share dividends are frankable unless it is specified that they are unfrankable. On the facts and circumstances in this case the ATO accepts the dividend will not be unfrankable. X Co will pay the dividend from retained profits and the share will not be a non-equity share and the arrangement will not be considered a streaming arrangement | Detailed Reasoning - Question 7: Will Section 177EA of the ITAA1936 apply in relation to the dividend to be paid on the F Class Share? | Summary: No. Having regard to the relevant circumstances of the scheme, it is not concluded that there is a purpose of enabling an imputation benefit. | Detailed Reasoning - Detailed reasoning: Section 177EA is a general anti-avoidance rule that is intended 'to prevent abuse of the imputation system through schemes which circumvent the basic rules for the franking of dividends'. Imputation benefits represent the tax paid by a company on its profits for the benefit of all its owners. Two of the basic principles of the imputation system are that imputation benefits are only to be available to the true economic owners of the company to the extent that those owners are personally able to use those franking credits, and that those true economic owners of the company are to have the tax paid at the company level imputed to them in proportion to their ownership of the company. A consequence of these principles is that an element of 'wastage' of franking credits is an intended feature of the tax system. 'Wastage' for this purpose includes prolonged deferment of use of franking credits (including cases where distribution of profits to economic owners is deferred because profits are reinvested). The ATO has provided guidance on Section 177EA in TR2009/3: Income tax: application of section 177EA of the Income Tax Assessment Act 1936 to non-share distributions on certain 'dollar value' convertible notes. TR2009/3 provides at paragraph 13: The application of section 177EA to a particular scheme depends upon a careful weighing of all the relevant facts and surrounding circumstances. In the absence of all relevant information, it is not possible to state definitively whether a particular scheme will attract section 177EA. 177EA(3) provides: This section applies if: (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 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. Bare acquisition of membership interests or interest in membership interests 177EA(4) It is not to be concluded for the purposes of paragraph (3)(e) that a person entered into or carried out a scheme for a purpose mentioned in that paragraph merely because the person acquired membership interests, or an interest in membership interests, in the entity. In the particular facts and circumstances of this case there will be an insufficient tax avoidance purpose to enliven the provisions of s177EA. The shareholders of NewCo will remain the same and in the same proportion before and subsequent to the payment of a dividend under the F class shares. | Detailed Reasoning - Question 8: Will s. 204-30 of the ITAA1997 apply in relation to the dividend to be paid on the F Class Share? | Summary: No. The dividend paid on the F Class shares under the proposed arrangement will not amount to streaming under s204-30 ITAA 1997. | Detailed Reasoning - Detailed reasoning: Any strategy that aims to avoid wastage of imputation benefits, by directing franked distributions to members who can most benefit from them to the exclusion of other members, may amount to dividend streaming. Section 204-30 on streaming distributions provides: Commissioner's power to make a determination when distributions or distributions and other benefits are streamed 204-30(1) This section empowers the Commissioner to make determinations if an entity streams one or more *distributions (or one or more distributions and the giving of other benefits), whether in a single *franking period or in a number of franking periods, in such a way that: (a) an *imputation benefit is, or apart from this section would be, received by a *member of the entity as a result of the distribution or distributions; and (b) the member would *derive a *greater benefit from franking credits than another member of the entity; and (c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits. The member that derives the greater benefit from franking credits is the favoured member. The member that receives the lesser imputation benefits is the disadvantaged member. Examples of other benefits 204-30(2) These are examples of the giving of other benefits: (a) issuing bonus *shares; (b) returning *paid-up share capital; (c) *forgiving a debt; (d) the entity or another entity making a payment of any kind, or giving any property, to a *member or to another person on a member's behalf. Nature of the determination that the Commissioner may make 204-30(3) The Commissioner may make one or more of these determinations: (a) that a specified *franking debit arises in the *franking account of the entity, for a specified *distribution or other benefit to a disadvantaged member; (b) that a specified *exempting debit arises in the *exempting account of the entity, for a specified *distribution or other benefit to a disadvantaged member; (c) that no *imputation benefit is to arise in respect of a distribution that is made to a favoured member and specified in the determination. A determination must be in writing. When does a favoured member derive greater benefit from franking credits? 204-30(7) The following subsection lists some of the cases in which a *member of an entity *derives a greater benefit from franking credits than another member of the entity. It is not an exhaustive list. 204-30(8) A *member of an entity *derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution giving rise to the benefit is made, and not in relation to the first member: (a) the other member is a foreign resident; View history reference (b) the other member would not be entitled to any *tax offset under Division 207 because of the distribution; (c) the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled; (d) the other member is a *corporate tax entity at the time the distribution is made, but no *franking credit arises for the entity as a result of the distribution; (e) the other member is a *corporate tax entity at the time the distribution is made, but cannot use *franking credits received on the distribution to *frank distributions to its own members because: (i) it is not a *franking entity; or (ii) it is unable to make *frankable distributions; (f) the other member is an *exempting entity. View history reference 204-30(9) A *member of an entity *derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the first member in the income year in which the *distribution giving rise to the benefit is made, and not in relation to the other member: (a) a *franking credit arises for the first member under item 5, 6 or 7 of the table in section 208-130 (distributions by *exempting entities to exempting entities); (b) a franking credit or *exempting credit arises for the first member because the distribution is *franked with an exempting credit; (c) the first member is entitled to a *tax offset because: (i) the distribution is a *franked distribution made by an exempting entity; or (ii) the distribution is *franked with an exempting credit. 204-30(10) A *member of an entity *derives a greater benefit from franking credits than another member if the first member is entitled to a *tax offset under section 210-170 as a result of the *distribution, and the other member is not. In this case, the payment of a franked dividend under the F Class shares will not amount to selectively directing the flow of franked distributions to those members who can most benefit from imputation credits. The deferral of itself would be insufficient intention to stream and the shareholders in NewCo are the same and in the same proportion as the entity making the distribution. | Detailed Reasoning - Question 9: Is the proposed transaction by the way of or in the nature of dividend stripping, or having substantially the effect of a scheme in the nature of dividend stripping? | Summary: No. The proposed scheme is not considered a scheme by way of or in the nature of dividend stripping, or having the substantially such effect. | Detailed Reasoning - Detailed reasoning: Section 177E brings dividend stripping within Pt IVA to cancel any tax benefit that arises under a dividend stripping arrangement. Per S177E: (1) 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. Taxation Ruling IT 2627 "Income Tax: application of Part IVA to dividend stripping arrangements, provides further guidance by the ATO". Taxation Determination TD 2014/1, "Income tax: is the 'dividend access share' arrangement of the type described in this Taxation Determination a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E of Part IVA of the Income Tax Assessment Act 1936?" provides specific ATO guidance with respect to dividend access share arrangements. Per IT 2627: The term 'dividend stripping' has no precise legal meaning; however it has been the subject of judicial discussion, including recently by the Full Federal Court in Lawrence and the High Court in Consolidated Press. In Consolidated Press, the High Court cited with approval the Full Federal Court's15 adoption of Gibbs J's list, in Patcorp Investments,16 of the 'common characteristics' of earlier dividend stripping cases. Those characteristics, subsequently adopted in Lawrence, include: i. a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders; ii. the sale or allotment of shares in the target company to another party; iii the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits; iv. the purchaser or allottee escaping Australian income tax on the dividend so declared; v. 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);17 and vi. 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. Per TD 2014/1, a key aspect of the arrangement that caused concern was a scheme involving "a series of transactions are then carried out that have the effect of ensuring that the original shareholder(s) and/or associates receive the economic benefit of the target company's profits in a tax-free or substantially tax-free form" In the arrangement as proposed, the same shareholders hold shares in NewCo in the same proportions as the original entity. Whilst there is an aspect of deferral to the distribution, the arrangement does not provide a mechanism for the original shareholders to receive the company profits in a tax-free form and lacks the necessary tax avoidance purpose required for dividend stripping. | Detailed Reasoning - Question 10: Will NewCo be entitled to a tax offset for the franking credits attached to the dividend paid on the F Class Shares under s. 207-20 of the ITAA1997? | Summary: Yes. Subdivision 207 F will not apply to the proposed dividend by the Class F shares | Detailed Reasoning - Detailed reasoning: Subdivision 207-F creates the appropriate adjustment to cancel the effect of the gross-up and tax offset rules where the entity concerned has manipulated the imputation system in a manner that is not permitted under the income tax law. Where: • The entity is not a "qualified person" for the purposes of holding period rules under the ITAA 1936 imputation regime (s 207-145(1)(a)), • the ATO has made a franking credit benefit determination under s177EA(5)(b); • the ATO has made a determination under s204-30(3)(c) that, as a result of the streaming of distributions, the recipient is not entitled to an imputation benefit; • the distribution is part of a dividend stripping scheme or a scheme that substantially operates as a dividend stripping scheme; • the distribution is one to which section 207-157 (which is about distribution washing) applies; or • the distribution is one to which s207-158 applies (which is about foreign income tax deductions). The effect of Subdivision 207-F is that the distribution will not be grossed up and the entity will not be entitled to a tax offset. Section 207-20 ITAA 97 provides: General rule--gross-up and tax offset (1) If an entity makes a * franked distribution to another entity, the assessable income of the receiving entity, for the income year in which the distribution is made, includes the amount of the * franking credit on the distribution. This is in addition to any other amount included in the receiving entity's assessable income in relation to the distribution under any other provision of this Act. (2) The receiving entity is entitled to a * tax offset for the income year in which the distribution is made. The tax offset is equal to the * franking credit on the distribution. Subdivision 207 F will not apply to the proposed dividend by the Class F share in this case. | Detailed Reasoning - Question 11: Will the Commissioner apply Part IVA to the proposed transaction? | Summary: No. The proposed scheme, as outlined in the facts and assumptions, does not exhibit the necessary tax avoidance purpose for the application of Part IVA. | Detailed Reasoning - Detailed reasoning: The general anti-avoidance rules are contained in Pt IVA of ITAA 1936. These rules apply to deny a tax benefit to a taxpayer in connection with a scheme to which Part IVA applies. Section 177 D of Pt IVA provides: Scheme for purpose of obtaining a tax benefit 177D(1) This Part applies to a scheme if it would be concluded (having regard to the matters in subsection (2)) 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 the purpose of: (a) enabling a taxpayer (a relevant taxpayer ) to obtain a tax benefit in connection with the scheme; or (b) enabling the relevant taxpayer and another taxpayer (or other taxpayers) each to obtain a tax benefit in connection with the scheme; whether or not that person who entered into or carried out the scheme or any part of the scheme is the relevant taxpayer or is the other taxpayer or one of the other taxpayers. Have regard to certain matters 177D(2) For the purpose of subsection (1), have regard to the following matters: (a) the manner in which the scheme was entered into or carried out; (b) the form and substance of the scheme; (c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (d) the result in relation to the operation of this Act that, but for this Part, 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; (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). Note: Section 960-255 of the Income Tax Assessment Act 1997 may be relevant to determining family relationships for the purposes of paragraphs (f) and (h). Tax benefit 177D(3) Despite subsection (1), this Part applies to the scheme only if the relevant taxpayer has obtained, or would but for section 177F obtain, a tax benefit in connection with the scheme. When schemes entered into etc. 177D(4) Despite subsection (1), this Part applies to the scheme only if: (a) the scheme has been or is entered into after 27 May 1981; or (b) the scheme has been or is carried out or commenced to be carried out after that day (and is not a scheme that was entered into on or before that day). Schemes outside Australia 177D(5) This section applies whether or not the scheme has been or is entered into or carried out in Australia or outside Australia or partly in Australia and partly outside Australia. Section 177D provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. The objective test in subsection 177D(2) is the core of Part IVA and has been described by the High Court as the 'pivot' or 'fulcrum' on which Part IVA turns. It is frequently referred to as the 'statutory predication test'. 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. Subsection 177A(5) clarifies that the 'purpose' includes the dominant purpose where there are two or more purposes. The dominant of two or more purposes is the ruling, prevailing or most influential purpose. The proposed scheme, as outlined in the facts and assumptions, does not exhibit the necessary tax avoidance purpose. Of relevance in reaching this conclusion is that: • The same shareholders, including the same family trust, are present in both shareholdings, • The restructure, as described, provides a deferral but does not change the ultimate entities that may benefit from the distributions, or that hold the interest in the retained profits accruing to the original entity. • The proposed scheme does not provide a mechanism for the original shareholders to ultimately receive the company profits in a tax-free, or reduced tax, form. | Detailed Reasoning - Question 12: If X Co undertakes an off-market share buy-back of the F Class Share, will s. ss. 159GZZZQ(2) of the ITAA1936 apply to the buy-back? | Summary: No. s159GZZZQ will not operate to increase the buy-back price if the F Class share is the subject of a buy-back under the proposed arrangement. | Detailed Reasoning - Detailed reasoning: Share buy-backs are mainly governed, for taxation purposes, by Division 16K of Part III of the ITAA 1936 (Division 16K). Division 16K was enacted in 1990 to deal with changes to the Corporations Law that permitted companies to buy-back their own shares. The Division applies where a company buys a share (or a non-share equity) in itself from a shareholder and cancels the share. On-market and off-market share buy-backs are defined in section 159GZZZK of the ITAA 1936. If the share is listed on a stock exchange and the purchase is made in the ordinary course of business of that stock exchange, the buy-back will be an on-market purchase. All other buy-backs are treated as off-market purchases for taxation purposes. The purchase price paid by the company to the shareholder is the amount of money and/or the market value of any property the shareholder receives as consideration for the buy-back: section 159GZZZM of the ITAA 1936. The special rule in subsection 159GZZZQ(2) of the ITAA 1936 applies where the purchase price of a share in an off-market share buy-back is less than its market value. The rule requires that the amount of consideration that a seller is taken to have received is the amount that would have been the market value of the share at the time of the buy-back if the buy-back did not occur and was never proposed to occur. In effect, the amount of any deemed increase pursuant to the special rule is taken to be a capital receipt and alters the CGT position of the seller (usually decreasing any capital loss otherwise available). Likewise, the amount of any assessable revenue gain would be increased, and any deductible loss decreased, by the difference between the actual consideration and the substituted market value amount. Per s159GZZZQ ITAA 1936 Consideration in respect of off-market purchase (1) Subject to this section, if a buy-back of a share is an off-market purchase, then: (a) in determining, for the purposes of this Act: (i) whether an amount is included in the assessable income of the seller under a provision of this Act other than Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (about CGT); or (ii) whether an amount is allowable as a deduction to the seller; or (b) whether the seller makes a capital gain or capital loss; in respect of the buy-back, the seller is taken to have received or to be entitled to receive, as consideration in respect of the sale of the share, an amount equal to the purchase price in respect of the buy-back. Deemed consideration increased to market value (2) If apart from this section: (a) the purchase price in respect of the buy-back; is less than: (b) the amount that would have been the market value of the share at the time of the buy-back if the buy-back did not occur and was never proposed to occur; then, subject to subsection (3), in making the determinations mentioned in paragraphs (1)(a) and (b), the amount of consideration that the seller is taken to have received or to be entitled to receive in respect of the sale of the share is equal to the market value mentioned in paragraph (b) of this subsection. For procedural simplicity under the Corporations Act 2001, X Co may choose to undertake an off-market selective share buy-back in relation to the Class F share, rather than a redemption. The full $1 buy-back price will be debited against the paid-up capital account for X Co in its accounting records. The buy-back will be equal to the F Class share market value and s159QZZZQ(2) ITAA 1936 will not apply should there be a buy-back under the arrangement as proposed.