Private ruling: Retirement planning
Published: May 2014
Ruling period: Year of income ended 30 June 2014
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. Factual arrangement 1. Taxpayer 1 is semi-retired. 2. Taxpayer 1 is employed part time and satisfies the 'work-test' for superannuation contribution purposes. 3. Taxpayer 1 is the sole director of A Pty Ltd (the Company). Prior to his/her semi-retirement, Taxpayer 1 accumulated substantial wealth in the Company. 4. The Company's shares are wholly owned by Taxpayer 1, as trustee of the B Trust (the Trust). 5. The Company's sole asset is cash, attributable to retained earnings and which can be paid out as a franked dividend. The Company has franking credits available. Taxpayer 1 considers that the Company is of no further use. 6. Taxpayer 1 has a superannuation account with M (the M Fund). 7. It is intended that the following steps will be implemented: (a) Taxpayer 1 will transfer the amount standing to the credit of the M Fund into a self-managed superannuation fund (the Fund); (b) Taxpayer 1 will make a concessional contribution and a non-concessional contribution to the Fund (together, 'the contributions'); (c) the Fund will purchase the shares in the Company from the Trust. This will be achieved in part by the Fund entering into a limited recourse borrowing arrangement (LRBA) and in part by the Fund applying the contributions to the purchase of the shares; (d) the shares in the Company will be purchased at market value, which is said to be equal to the cash asset of the Company; (e) the loan amount under the LRBA will be an amount approximately equal to the stated market value of the shares in the Company less the contributions applied to the purchase of the shares; (f) the shares will be held on trust (the LRBA holding trust) with the trustee of the LRBA holding trust acquiring the legal title and the trustee of the Fund acquiring a 'beneficial interest' in the shares (as referred to in paragraph 67A(1)(b) of the Superannuation Industry (Supervision) Act 1993 (SISA)). (g) the key features of the LRBA will be as follows: (i) the interest rate will be pegged to the interest rate offered by the major Australian banks for a similar product; (ii) repayments will be due and payable on a monthly basis; (iii) the repayments will comprise both principal and interest as would apply between arms-length parties; (iv) the LRBA will be fully repaid within 12 months; (v) the Fund will be required to repay the loan in such a way as to maintain an agreed loan to value ratio at a certain percentage; there will not be an amount outstanding under the LRBA at a time when the value of the shares in the Company is nil. The terms of the LRBA will require the Fund to repay the loan sufficiently to maintain the agreed loan to value ratio at a certain level being equivalent to that of a similar product offered by a major Australian bank; (vi) there will be no forgiveness of the loan amount; (h) the Trust will make a capital gain as a result of the disposal of the shares to the Fund which is to be reflected as a capital gain for Taxpayer 1, who is a beneficiary of the Trust and who also has no carried forward income or capital losses; (i) the shares received by the Fund will be recorded in its accounts at the stated market value; (j) on receipt the shares will be used by the Fund to support the commencement of the payment of a pension to Taxpayer 1; (k) once the pension is commenced, the Fund will have only one member whose total account balance is supporting a pension. No other members will be admitted to the Fund; (l) at least 45 days after the purchase of the shares the Company will pay a fully franked dividend to the Fund equal to the value of its retained earnings (the franked distribution); (m) the franked distribution, including the franking credit, is said to be exempt from income tax on the basis that a proportion (as worked out under subsection 295-390(3) of the 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%); (n) the Fund is also said to be entitled to a refund of the unused franking credit tax offset; (o) part of the franked distribution and refunded franking credit tax offset will be used to pay a pension to Taxpayer 1. The balance of the franked distribution amount will be used to repay the LRBA; (p) following repayment of the LBRA, the Fund will have assets principally attributable to the value of the amount rolled over from the M Fund, the value of the non-concessional contributions and the refund of the unused franking credit tax offset; (q) once the loan under the LRBA is repaid in full, the Company will be deregistered; (r) upon deregistration of the Company, the Fund will realise a capital loss but this loss will not be used while the Fund is entirely in pension phase; (s) following the payment of the franked distribution to the Fund, the Fund will not pay Taxpayer 1 any lump sum amounts. It will pay a pension over a number of years; (t) it is expected that these steps will be completed within a 12 month period. 8. Taxpayer 1 asserts that his/her purposes in taking these steps are to: (a) simplify his/her tax affairs, to ease the passing of his/her eventual estate to his/her beneficiaries; and (b) increase the amount of superannuation benefits available to him; (c) eliminate the ongoing payment of accounting and ASIC fees; (d) protect his/her/ wealth by keeping it in the hands of other entities rather than in his/her own name. 9. As an alternative to these steps, it is proposed that: (a) the current balance of the M Fund will be rolled over into the Fund; (b) each income year until Taxpayer 1 turns 75, the Company will pay a fully-franked dividend to the Trust per annum, with attached franking credits; (c) the Trust will distribute the dividend to Taxpayer 1 and/or his/her family members who are beneficiaries of the Trust; (d) Taxpayer 1 will use his/her distribution of the dividends and any refund of the unused franking credit tax offset to contribute to the Fund each year up to his/her concessional and non-concessional contribution limits. The Fund will pay tax on the concessional contributions equal to 15% of those contributions; and (e) the Company will be deregistered once retained profits have been fully paid out. Assumptions 10. There is a borrowing of money that would otherwise be prohibited under subsection 67(1) of the SISA but for the LRBA that complies with the requirements of section 67A of the SISA. (Note: Not all forms of financial accommodation give rise to a borrowing of money. See Self Managed Superannuation Funds Ruling SMSFR 2009/2 Self Managed Superannuation Funds: the meaning of 'borrow money' or 'maintain an existing borrowing of money' for the purposes of section 67 of the Superannuation Industry (Supervision) Act 1993.) 11. There will be no default on the loan under the LRBA.

Relevant legislative provisions: Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Section 177E | Income Tax Assessment Act 1936 Section 177F | Income Tax Assessment Act 1997 Section 295-390 | Superannuation Industry (Supervision) Act 1993 subsection 67(1) | Superannuation Industry (Supervision) Act 1993 section 67A

Reasons for decision: Summary: 12. 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: 13. 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'; and paragraph 177E(1)(f) provides that 'the taxpayer shall be taken to have obtained a tax benefit in connection with the scheme' with the result that the Commissioner is empowered to issue a determination cancelling the tax benefit under section 177F of the ITAA 1936. 14. 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 Commissioner of Taxation v. Consolidated Press Holdings Ltd [1999] FCA 1199; (1999) 91 FCR 524 ( FCT v. CPH (FFC) ) at [118] - [123]. 15. 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 that flows from the Company to the Fund?: 16. For the following reasons, each of the conditions in paragraphs 177E(1)(a) to (d) of the ITAA 1936 referred to in paragraph 14 above are satisfied. 17. 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'. 18. The steps in paragraph 7 above clearly constitute a scheme within the meaning of subsection 177A(1) of the ITAA 1936. 19. Moreover, the 'scheme' described in paragraph 7 above is plainly a 'scheme that is in relation to a company'. 20. For this reason, the first condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 14(a) above is satisfied. 21. Second condition: For the reasons given below in paragraphs 31 to 38, the steps set out in paragraph 7 above involve a 'scheme' by way of or in the nature of dividend stripping. Therefore, the second condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 14(b) above is satisfied. 22. Third condition: Subsection 177E(2) of the ITAA 1936 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. 23. The scheme involves the payment by the Company of the 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 7(l) above). 24. Accordingly, the third condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 14(c) above is satisfied. 25. Fourth condition: As noted above in paragraph 7(l), the franked distribution represents all of the Company's retained earnings. Therefore, the Commissioner has formed the view that the 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 14(d) above is satisfied. 26. Fifth condition: If, before the scheme described in paragraph 7 above was entered into, the Company paid a franked distribution to its then shareholder, being Taxpayer 1, as trustee of the Trust, it is reasonable to expect either Taxpayer 1 as trustee of the Trust and/or a beneficiary, or beneficiaries of that Trust (which may include Taxpayer 1) would be assessed on an amount reflecting the franked distribution. For this reason, the fifth condition in subsection 177E(1) of the ITAA 1936 referred to in paragraph 14(e) above is satisfied 27. 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 14(f) above is satisfied. 28. For those reasons, if the steps in paragraph 7 above are entered into, there will be taken to be a scheme to which Part IVA of the ITAA 1936 applies (paragraph 177E(1)(e) of the ITAA 1936). Further, Taxpayer 1 as trustee of the Trust and/or a beneficiary, or beneficiaries of that Trust (which may include Taxpayer 1) will be taken to have obtained a tax benefit in connection with the scheme (paragraph 177E(1)(f)) being the amount which, had the Company paid a franked distribution prior to entering into the scheme, would have been assessed to Taxpayer 1 as trustee of the Trust or an amount reflecting the franked distribution would have been assessed to a beneficiary, or beneficiaries of the Trust. | Detailed Reasoning - Dividend stripping scheme: 29. 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. See 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]; and Lawrence v. Federal Commissioner of Taxation [2009] FCAFC 29; (2009) 175 FCR 277 ( Lawrence v. FCT ) at [42] - [43]. 30. 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]. 31. 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 be a distribution made as part of a dividend stripping scheme?: 32. The payment of the franked distribution that flows 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 (identified in paragraph 29 above) of a scheme 'by way of or in the nature of dividend stripping' will be present. 33. First element: The Company has substantial undistributed profits as its sole asset is cash attributable to retained earnings. This creates a potential tax liability for either Taxpayer 1 as trustee of the Trust and/or a beneficiary, or beneficiaries, of the Trust. If the franked distribution were paid to Taxpayer 1 as trustee of the Trust under subparagraph 44(1)(a)(i) of the ITAA 1936, either Taxpayer 1 as trustee of the Trust and/or a beneficiary, or beneficiaries, of the Trust would be assessed on an amount reflecting the retained earnings. Accordingly, the element of a 'dividend stripping scheme' identified in paragraph 29(a) above is satisfied. 34. Second element: Taxpayer 1 as trustee of the Trust will sell the shares in the Company to the Fund, and as trustee of the Trust will receive a capital sum for those shares. There is nothing in the concept of a scheme by way of or in the nature of a dividend stripping operation which would require that the sale involve a share trader or be a company-to-company transaction attracting an inter-company dividend rebate. In FCT v. CPH (FFC) at [136], the Full Court referred to a dividend stripping operation involving a sale and allotment to individuals. Accordingly, the element of a 'dividend stripping operation' in paragraph 29(b) above is satisfied. 35. Third element: The Company will pay a franked distribution which flows to the Fund equal to the value of the Company's retained earnings. Accordingly, the element of a 'dividend stripping scheme' in paragraph 29(c) above is satisfied. 36. Fourth element: On the assumption that the franked distribution is not non-arm's length income of the Fund within the meaning of section 295-550 of the ITAA 1997, the franked distribution is said to be exempt income of the Fund under section 295-390 of the ITAA 1997. Leaving aside the potential application of section 207-145 of the ITAA 1997, or section 177EA of the ITAA 1936 to the Fund, the Fund will obtain a refund of all, or substantially all, of the unused franking credit tax offset in relation to the franked distribution. It does not detract from this conclusion that the shares are held under the LRBA. This is because the Fund holds the beneficial interest in the shares under the LRBA and the franked distribution flows to the Fund with the consequence that neither the LRBA holding trust nor the Fund is subject to tax on the franked distribution. 37. The reference in FCT v. CPH (FFC) at [136] to various different means by which tax can be escaped (including application of an inter-company dividend rebate) was not an exhaustive description of the means by which tax can relevantly be escaped on the dividend by a dividend stripping scheme. Accordingly, the element of a 'dividend stripping scheme' in paragraph 29(d) above is satisfied. 38. Fifth element: Taxpayer 1 as trustee of the Trust will receive a capital sum for the sale of the shares in the Company to the Fund. This amount equals the sum of the dividend. Accordingly, the element of a 'dividend stripping scheme' in paragraph 29(e) above is satisfied. It does not detract from this conclusion that the capital sum is, in part, initially recognised as a loan amount due to Taxpayer 1 as trustee of the Trust by the Fund, and that the loaned amount will not be paid to Taxpayer 1 as trustee of the Trust until the franked distribution has been paid by the Company. 39. Sixth element: The sixth element is satisfied for the following reasons: (a) The arrangement proposed and described at paragraph 7 above is carefully planned. It involves all the parties acting in concert. The parties are all related, being Taxpayer 1 or the Company or Trust controlled by him. (b) From the point of view of the Fund, the principal or predominant economic effect of the arrangement proposed and described at paragraph 7 above is obtaining a tax benefit; namely, the attraction of the exemption in subsection 295-390(1) of the ITAA 1997 to the franked distribution and generating a refund of the unused franking credit tax offset. That tax benefit overwhelmingly provides the explanation for the increase in the value of the Fund as a result of the arrangement (see paragraph 7(n) above). The balance of the franked distribution (other than what is met from contributions) is used to repay the loan under the LRBA to the Trust (from whom the shares in the Company were purchased) and thus has no other economic effect. (c) A further tax effect for the Fund (although of lesser significance while it remains entirely in 'pension phase') is the generation of a capital loss which might be used if the Fund ceases to be entirely in pension phase. (d) From the point of view of the vendor shareholder Taxpayer 1 as trustee of the Trust the principal or predominant effect of the arrangement proposed and described at paragraph 7 above is 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). The fact that Taxpayer 1 as trustee of the Trust and/or a beneficiary, or beneficiaries, of the Trust (which may include Taxpayer 1) may have an assessable net capital gain in relation to the sale of the shares in the Company 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 a comprehensive taxation of capital gains, this characteristic remains relevant because the methods of calculating capital gains invariably lead to a lower amount of tax'. (e) It is no answer to say that the arrangement is undertaken for the purposes of retirement planning and to provide for Taxpayer 1's better retirement 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. On an objective assessment, the aspect of the arrangement that makes it desirable retirement planning for Taxpayer 1 is the tax benefit obtained through the channeling of the franked distribution through the Fund; namely refund of the unused franking credit tax offset arising from a franking credit. (g) It is also no answer to say that the arrangement is undertaken for the purpose of simplifying Taxpayer 1's wealth structure; or for the purpose of keeping Taxpayer 1's wealth in the hands of other entities rather than in his own name as an aspect of wealth protection; or to avoid accounting or ASIC fees. If those were the objectives, they could be more simply achieved by the Company distributing its assets to the Trust and then being deregistered. The relevant difference would be the tax effects achieved by the arrangement proposed and described at paragraph 7 above would not be achieved. 40. For these reasons, the arrangement proposed and described at paragraph 7 above is a dividend stripping scheme.