Private ruling: Proposed issue of new shares
Date of advice: 9 December 2019
Published: February 2020
Ruling period: Income Year ended 30 June 2020
Date scheme commenced: 1 July 2019

Ruling: Q1: Will Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) apply to deem the provision of the New Shares to be dividends for the purpose of the ITAA 1936? | A1: No. | Q2: Will the proposed issue of the New Shares create a debt interest under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No. | Q3: Will the proposed issue of the New Shares have any consequences Division 725 of the ITAA 1997? | A3: No.

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. Company X currently has the following shares on issue: · A class shares which entitle the holder(s) to vote at members' meetings but with no other rights, and · B class shares which entitle the holder(s) to dividends and to participate in a distribution of capital upon winding up. No shareholders, together with their associates as defined in section 318 of the ITAA 1936, hold more than 40% of the voting, dividend or capital rights in Company X. No entity, either alone or together with its associates as defined by section 318 of the ITAA 1936, controls Company X. The directors of Company X propose to create a new class of shares (New Shares) with the following rights: · No voting rights or right to attend shareholder meetings. · No right to a distribution of capital upon winding up. · A right to a dividend at the discretion of the directors to be paid to all shareholders. · The New Shares will also have the following features: · They will not be redeemable. · They will not be preference shares. · The shareholders will have no ability to reassign their dividends. · They cannot be converted to either A Class or B Class shares at any time. The New Shares will be issued to the existing B Class shareholders for $1.00 each. The market value of the shares is either nil or a nominal amount, not exceeding $1.00 each. Each of the B Class shareholders will provide $1.00 consideration for the issue of the New Shares. Each B Class shareholder will receive one share. In future incoming members will be issued A class shares, B class shares and the new class of shares. Dividends will continue to be paid to holders of B class shares in accordance with the number of shares held by each shareholder. The holders of the B class shares and the holders of the New Shares will be identical. It is not proposed that any other transactions such as loans or other amounts will be distributed to its B class shareholders.


Reasons for decision: Summary: Division 7A of the ITAA 1936 will not apply to deem the provision of the New Shares to be dividends for the purpose of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Subsection 109C(1) of ITAA 1936 provides where a private company makes a payment or transfers property to an entity that is a shareholder or an associate of a shareholder of that company, the private company is taken to have paid a dividend to the shareholder or associate. A payment or other benefit provided by a private company to a shareholder or their associate can be treated as a dividend for income tax purposes under Division 7A of the ITAA 1936. A payment is defined in subsection 109C(3) of the ITAA 1936 and includes a transfer of property. Shares are property and the issue of the New Shares to the Class B shareholders will be a transfer of property. However, pursuant to subsection 109C(4) of the ITAA 1936, the amount of a payment consisting of a transfer of property is the amount that would have been paid for the transfer by parties dealing at arm's length less any consideration given by the transferee for the transfer. The amount of a payment is nil if the consideration given by the transferee equals or exceeds the amount that would have been paid at arm's length for the transfer. It is been provided that the market value of the New Shares is either nil or a nominal amount not exceeding $1.00 each. The Class B shareholders will provide $1.00 consideration for the issue of the New Shares. As the $1.00 consideration provided by the shareholders for the shares is either equal to or exceeds the amount that would have been paid at arm's length for the transfer of the shares, subsection 109(C)(4) of the ITAA 1936 will apply and the amount of the payment will be nil. Accordingly, Division 7A of the ITAA 1936 will not apply to deem the provision of the New Shares to be dividends for the purpose of the ITAA 1936. | Summary: The proposed issue of the New Shares will be an equity interest in Company X pursuant to subsection 974-70(1) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Division 974 of the ITAA 1997 contains provisions which determine whether a scheme gives rise to a debt interest or an equity interest for taxation purposes. A scheme will give rise to an equity interest in a company if the scheme satisfies the equity test in subsection 974-75(1) of the ITAA 1997 and the interest is not characterised as a debt interest. An interest in a company as a member or stockholder meets the equity test under item 1 of the table in subsection 974-75(1) of the ITAA 1997. Therefore as the New Shares are shareholder interests they meet the equity test. A scheme will give rise to a debt interest in an entity if the debt test in subsection 974-20(1) of the ITAA 1997 is satisfied. A scheme satisfies the debt test if all of the following conditions are met: · the scheme must be a financing arrangement (paragraph 974-20(1)(a)). However, this condition is not required to be met where the interest is as a member or stockholder of a company · there must be a financial benefit received (paragraph 974-20(1)(b)) · the issuing entity must have an 'effectively non-contingent obligation' to provide a future financial benefit (paragraph 974-20(1)(c)), and · it must be substantially more likely than not that the value of the financial benefit to be provided will be at least equal to, or exceed the financial benefit received and will not equal nil (paragraphs 974-20(1)(d) and 974-20(1)(e)). Section 974-135 of the ITAA 1997 specifies that there is an 'effectively non-contingent obligation' to take action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take action. The section also states that an obligation is non-contingent if it is not contingent on any event, condition or situation, other than the ability or willingness of that entity or connected entity to meet the obligation. In the present case, the obligation to pay dividends on the New Shares will be entirely at the discretion of the board of Company X. Additionally, the New Shares are not redeemable. There is no effectively non-contingent obligation for Company X to provide a financial benefit under the scheme. On that basis, the proposed New Shares do not meet all the conditions to be a debt interest, and would therefore be an equity interest in Company X under subsection 974-70(1) of the ITAA 1997. | Summary: The proposed issue of the New Shares will not have any consequences under Division 725 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Pursuant to section 725-50 of the ITAA 1997, a direct value shift under a scheme involving equity interests in the target entity only has consequences for a taxpayer under Division 725 of the ITAA 1997 if: · the target entity is a company or trust at some time during the scheme period (i.e. the period starting when the scheme is entered into and ending when it has been carried out) · the controlling entity test under section 725-55 of the ITAA 1997 is satisfied · the cause of the value shift is satisfied as per section 725-65 of the ITAA 1997 · the taxpayer is an affected owner of a down interest (as per section 725-80 of the · ITAA 1997) or an up interest (as per section 725-85 of the ITAA 1997), or both, and · the value shift is not likely to be reversed as per sections 725-90 or 725-95 of the · ITAA 1997. Pursuant to section 725-55 of the ITAA 1997, the 'controlling entity test' is satisfied where an entity (the controller) controls (for value shifting purposes) the target entity at some time starting when the scheme is entered into and ending when the scheme has been carried out. Section 727-355 of the ITAA 1997 provides that an entity controls a company for value shifting purposes if it satisfies one of the following three tests: · 50% stake test · 40% stake test, or · actual control test. The 50% stake test in subsection 727-355(1) of the ITAA 1997 provides that an entity controls (for value shifting purposes) a company if the entity, or the entity and its associates between them: (a) can exercise, or can control the exercise of, at least 50% of the voting power in the company, or (b) have the right to receive at least 50% of any dividends that the company may pay, or (c) have the right to receive at least 50% of any distribution of capital of the company. These rights can be held either directly, or indirectly through one or more interposed entities. The 40% stake test in subsection 727-355(2) of the ITAA 1997 is the same as the first test except that the relevant percentage is 40% rather than 50%. However the 40% control test will not apply if another entity together with their associates actually controls the company. Again, these rights can be held either directly, or indirectly through one or more interposed entities. The actual control test in subsection 727-355(3) of the ITAA 1997 provides that an entity controls (for value shifting purposes) a company if the entity, either alone or together with its associates, in fact controls the company without satisfying either the 50% or 40% thresholds. In applying these tests, where the entity, or an entity and its associates, has an indirect control interest and a direct control interest relating to rights to voting, dividends, income or capital of the company that would be counted twice, only the direct control interest is counted (section 727-370 of the ITAA 1997). It is has been provided that none of the shareholders of Company X, together with their associates as defined in section 318 of the ITAA 1936, hold more than 40% of the voting, dividend or capital rights in Company X. Further, it has also been provided that none of Company X's shareholders actually control Company X. Accordingly, none of the shareholders of Company X control Company X for value shifting purposes as defined in section 727-355 of the ITAA 1997, and the controlling entity test in section 725-55 is not satisfied. Consequently, paragraph 725-50(b) of the ITAA 1997 is not satisfied and there will be no consequences under Division 727 of the ITAA 1997 if a direct value shift does occur upon the issuing of the New Shares in Company X. CGT event K8 happens if there is a 'taxing event generating a gain' for a down interest under section 725-245 of the ITAA 1997 (subsection 104-250(1)). As there are no consequences under Division 725 upon the issue of the New Shares, CGT event K8 will not happen.