Private ruling: Equity interests - direct value shift - dividend streaming - dividend streaming - capital benefit - Division 7A - cost base - capital proceeds
Date of advice: 30 June 2021
Published: September 2021
Ruling period: 1 July 2020 to 31 July 2021
Date scheme commenced: 1 July 2020

Ruling: Q1: Are the proposed redeemable preference shares (RPS) equity interests under subdivision 974‐C of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the Proposed Transaction give rise to a direct value shift (DVS) under Division 725 of the ITAA 1997 that will result in CGT event K8 happening? | A2: No. | Q3: Will a payment of fully franked dividends to the holder of the proposed RPS, Company B, be considered dividend streaming under Subdivision 204‐D ITAA 1997? | A3: No. | Q4: Will the Proposed Transaction be considered: | A4: No. | Q5: Will section 45A of the ITAA 1936 apply to the proposed issue of the RPS to Company B? | A5: No. | Q6: Will section 45B of the ITAA 1936 apply to the proposed issue of the RPS to Company B? | A6: No. | Q7: Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to the holder of the proposed RPS? | A7: No. | Q8: Will Person B's first element of cost base for the Company A shares that they acquire under the Proposed Transaction be equal to their market value? | A8: Yes. | Q9: Will Person A's capital proceeds for the Company A shares under the Proposed Transaction be equal to their market value? | A9: Yes. | Q10: Will the agreement between Person A and Company B to offset the debt owed by Person A to Company A, so Person A's debt is then owed to Company B instead, be taken to be a dividend under Division 7A of the ITAA 1936 in the 2020-21 income year? | A10: No.

Relevant facts and circumstances: 1. Company A is a private company with a total share capital of xx ordinary shares: • Person A holds X beneficially-owned fully paid ordinary shares. • Person B holds X beneficially-owned fully paid ordinary shares. 2. Person A and Person B are directors of Company A. 3. The shares in Company A were purchased under a contract dated XX and settled on XX for a total acquisition price of $X. 4. The cost base of the shares held by each shareholder is $X. 5. The acquisition was financed by a joint Person B / Person A loan facility established with the X. The current balance of this loan is approximately $X. 6. Company A was valued at XX at $X. 7. Person A and Person B have borrowed funds from Company A to meet the external financing obligations to the X. 8. As at the XX, the total of loans owing by Person A to Company A was $X. 9. Each of these loans are subject to an "umbrella" loan agreement that complies with section 109N of the ITAA 1936. 10. The minimum yearly repayment obligation, as defined in section 109E(5) of the ITAA 1936, on each loan each year has been met with the payment of a dividend from Company A which is offset against the relevant loan amount. 11. Person B and their spouse conduct the day-to-day running of the company. 12. Person A resides in X and is not involved in day-to-day decision making of Company A. 13. Person A wishes to exit their ownership position in Company A. Company B 14. Person A is the sole shareholder of Company B. 15. Company B does not have any assets or liabilities. It has never traded. Proposed Transaction 16. Step 1: 10 RPS are to be issued by Company A to Company B. These shares • will carry rights to dividends, amount to be determined by resolution of Company A's directors at any time. Company B will be the only holder of shares in this class. • will not have any right to vote, nor are capable of being converted to a class of share that can vote. • will not participate in the capital of Company A on winding up. • Are redeemable by Company A at any time for nil consideration; and • If not redeemed earlier, are automatically redeemed at the third anniversary of their date of issue for nil consideration. • will be issued for $1,000. 17. Step 2: A fully franked dividend is to be declared by the directors of Company A on the RPS equal to the loan owed by Person A (approximately $X). Company B be liable to pay income tax on the dividend received from Company A at its corporate tax rate (30%) less the franking credit of (26%), equating to gross tax of $X less a franking credit of $X leaving a net amount of $X payable. 18. Step 3: Payment of the dividend will be satisfied by agreement between Person A and Company B to the offsetting of the loan created in Company A by the declared dividend. The three parties, Company A, Company B and Person A, will sign a document that: • Acknowledges the debt owed by Person A to Company A. • Company B agreeing to have the dividend payable by Company A to Company B offset against Person A's loan. • In return, Person A will agree to repay the loan otherwise owing to Company A, to then be repaid to Company B, on the same terms and conditions as Company A had with Person A for each year's loan. The new loans between Company B and Person A will: o be separate loans for a term equivalent to the period remaining on each of the respective original loans with Company A, and o will be put on loan agreements that comply with section 109N of the ITAA 1936 before the lodgment date for the year of income in which the loan is made. 19. Step 4: Person A will then transfer their shares in Company A to Person B at the market value at that time. 20. Step 5: The consideration for this transfer will be Person B agreeing to assume Person A's obligations under their joint loan with X. 21. The steps in the Proposed Transaction will occur during the XX income year. 22. All parties to the Proposed Transaction are Australian residents for tax purposes. After the Proposed Transaction: 23. Company A will not have any obligation, either in the form of ownership or indebtedness to Person A or any of their associated entities. 24. The net assets of Company A will have reduced from $X to $X. 25. Person A's cost base of their shares is $X. With the market value at the time of disposal being $X, Person A will have a capital loss to carry forward of $X. 26. Given the additional liability taken on by Person B exceeds the market value of the Company A shares they acquire, an amount equal to the difference of $X will be a loan owed by Person A to Person B on the same terms and conditions as X imposes on the loan Person B will continue to owe to the X. 27. Restrictions will be drafted into the dividend policy of Company B to ensure that dividend declarations are mandated in each year to meet the Division 7A obligations that Person A would otherwise have had with Company A. • Person A, as Director of Company B, has committed to ensuring a dividend is declared each year that, at a minimum, will meet the annual loan repayment obligations that exist on each of the Division 7A loans that they will have with Company B, in the same way that would have occurred if the Division 7A loans were still held with Company A. • the minimum declarations will be mandated through amendment of the Constitution of Company B. 28. Person A will in all relevant income years pay any personal tax liability in excess of the franking offset available as a result of the Company B franked dividends received. 29. Company B will not carry on any other activities or earn any other income in the year of the Proposed Transaction and all income years remaining on the Division 7A loans Any tax liability or other expenses of Company B will be funded by a contribution by Person A. 30. Person A does not have any carried forward revenue or capital losses and does not anticipate any in all relevant income years following. 31. Company A is a base rate entity for the XX income year and will have a corporate tax rate of XX%. 32. Company B is not a base rate entity for the XX income year and will have a corporate tax rate of XX%. 33. Person A will not have any capital gain in the XX income year or in the foreseeable future. 34. The only other significant capital asset Person A currently owns is a recently acquired main residence. 35. Person A's net taxable income from sources other than the Company B dividend will be $X. 36. There isn't any material change expected in Person A's taxable income in the foreseeable future.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 104-250 | Income Tax Assessment Act 1936 Subsection 110-25(2) | Income Tax Assessment Act 1936 Subsection 110-55(2) | Income Tax Assessment Act 1936 Subsection 112-20(1) | Income Tax Assessment Act 1936 Subsection 112-30(1) | Income Tax Assessment Act 1936 Subsection 116-20(1) | Income Tax Assessment Act 1936 Paragraph 116-30(2)(b) | Income Tax Assessment Act 1936 Subsection 116-40(2)) | Income Tax Assessment Act 1936 Section 202-45 | Income Tax Assessment Act 1936 Subdivision 204-D | Income Tax Assessment Act 1936 Section 204-30 | Income Tax Assessment Act 1936 Division 207 | Income Tax Assessment Act 1936 Section 207-145 | Income Tax Assessment Act 1936 Section 207-150 | Income Tax Assessment Act 1936 Section 207-155 | Income Tax Assessment Act 1936 Division 725 | Income Tax Assessment Act 1936 Subsection 725-50 | Income Tax Assessment Act 1936 Section 725-90 | Income Tax Assessment Act 1936 Section 725-145 | Income Tax Assessment Act 1936 Subdivision 974-C | Income Tax Assessment Act 1936 Section 974-20 | Income Tax Assessment Act 1936 Section 974-70 | Income Tax Assessment Act 1936 Section 974-75 | Income Tax Assessment Act 1936 Section 974-135 | Income Tax Assessment Act 1936 Subsection 995-1(1) | Income Tax Assessment Act 1936 Section 45A | Income Tax Assessment Act 1936 Section 45B | Income Tax Assessment Act 1936 Section 45C | Income Tax Assessment Act 1936 Division 7A | Income Tax Assessment Act 1936 Subsection 109C(1) | Income Tax Assessment Act 1936 Subsection 109C(3) | Income Tax Assessment Act 1936 Subsection 109C(3A) | Income Tax Assessment Act 1936 Subsection 109D(1) | Income Tax Assessment Act 1936 Subsection 109D(4A) | Income Tax Assessment Act 1936 Subdivision D | Income Tax Assessment Act 1936 Section 1099N | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 Subsection 177A(1) | Income Tax Assessment Act 1936 Section 177C | Income Tax Assessment Act 1936 Section 177D | Income Tax Assessment Act 1936 Subsection 177D(2) | Income Tax Assessment Act 1936 Section 177E | Income Tax Assessment Act 1936 Subsection 177E(1) | Income Tax Assessment Act 1936 Section 177EA | Income Tax Assessment Act 1936 Subsection 177EA(3)

Reasons for decision: Summary: No. | Detailed Reasoning - Detailed reasoning: 37. For the RPS to be an equity interest: • it must satisfy the equity test in subsection 974-75(1); and • must not pass the debt test in subsection 974-20(1). 38. A share is an interest in a company as a member or stockholder of that company. Therefore, item 1 of subsection 974-75(1) is satisfied and the RPS pass the test for an equity interest. 39. Subsection 974-20(1) provides the test for a debt interest. The conditions which must be met for a scheme to satisfy the debt test are: • there must be a scheme (subsection 974-20(1)); • 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)). 40. In the present case, the obligation to pay dividends will be entirely at the discretion of the directors of Company A. 41. Company A may redeem the RPS at any time at its own discretion up to the third anniversary of the issue date of the RPS. If the RPS remain on issue as at the third anniversary, they will be automatically redeemed with effect from that day. Importantly, whether Company A redeems the RPS at some time during the first three years or otherwise at the third anniversary of their issue, it is not obligated to pay Company B any consideration for that redemption. 42. In summary, there is no obligation on Company A to pay dividends to the holder of the RPS or to pay all or part of the subscription amount (or a greater amount) upon redemption of the RPS to the holder. There is thus no effectively non-contingent obligation for Company A to provide a financial benefit under the scheme. On that basis, the proposed RPS do not meet all the conditions to be a debt interest, and would therefore be an equity interest in Company A. | Detailed Reasoning - Question 2: Will the Proposed Transaction give rise to a direct value shift (DVS) under Division 725 of the ITAA 1997 that will cause CGT event K8 to happen? | Summary: No. | Detailed Reasoning - Detailed reasoning: 43. Subsection 725-145(1) explains that a DVS occurs when: • there is a decrease in the market value of one or more equity or loan interests in the target entity; and • the decrease is reasonably attributable to one or more things done under a scheme, and occurs at or after the time when the thing, or the first of those things is done; and • either or both of subsections (2) and (3) of section 725-145 are satisfied. 44. Subsections 725-145(2) and (3) relevantly require: • one or more equity or loan interests in the target entity must be issued at a discount. The decrease in the interest must occur at or after the time of the issue and be reasonably attributable to it. • 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 decrease in the other interest. 45. However, section 725-50 relevantly provides that a DVS will only have consequences under Division 725 if section 725-90 does not apply. 46. Section 725-90 applies if: • 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 • 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. 47. The 'one or more things referred to in section 725-145 that might have brought about a state of affairs but for which the value shift would not have happened' is the issue of the RPS to Company B. 48. The relevant 'state of affairs' is that the proposed RPS has specific characteristics in the form of discretionary dividend rights which give rise to the potential shift in value. 49. The RPS are redeemable by Company A at any time for nil consideration and if not redeemed earlier, are automatically redeemed at the third anniversary of the date of issue for nil consideration. 50. The removal of these specific characteristics when the RPS are redeemed (which must happen within 3 years of the issue of the RPS by virtue of its terms of issue) will satisfy the requirements of section 725-90 and hence enliven its operation. 51. For the above reasons it is not necessary to determine if there is a DVS pursuant to section 725-145 as section 725-90 will apply such that any DVS will not have any consequences under Division 725. 52. CGT event K8 happens if there is a 'taxing event generating a gain' for a down interest under section 725-245 (subsection 104-250(1)). As there is no DVS that has consequences under Division 725, CGT event K8 will not happen as a result of the Proposed Transaction. | Detailed Reasoning - Question 3: Will a payment of fully franked dividends to the holder of the proposed RPS, Company B, be considered dividend streaming under Subdivision 204‐D ITAA 1997? | Summary: No. | Detailed Reasoning - Detailed reasoning: 53. Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another. 54. Section 204-30 of the ITAA 1997 applies where an entity streams one or more distributions in such a way that the franking credits attaching to the distribution are received by those members of the entity who derive a greater benefit from them, and other members receive lesser imputation or no imputation benefits. 55. For this section to apply, members to whom distributions are streamed must be in a position to derive a greater benefit from the franking credits than other members. 56. Subsection 204-30(8) of the ITAA 1997 details examples of when a member of an entity will be taken to have derived a greater benefit from franking credits than another member. These are where the other member: • is not an Australian resident; • is not entitled to use the tax offset under Division 207 of the ITAA 1997; • incurs a tax liability as a result of the distribution that is less than the benefit associated with the tax offset attributable to the distributions; • 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; • is a corporate tax entity at the time the distribution is made, but cannot use the franking credits to frank a distribution to its own members because it is not a franking entity or is unable to make a frankable distribution; or • is an exempting entity. 57. In the current circumstances, Company B, Person A and Person B are all residents of Australia for tax purposes. Therefore, from a residency perspective no entity will derive a greater benefit from franking credits than another entity. 58. Furthermore, provided only assessable dividends are paid to Company B, none of the other factors listed in subsection 204-30(8) of the ITAA 1997 are applicable, nor does the proposed RPS holder derive a greater benefit from franking credits than other Company A shareholders in some other way. Therefore, the Commissioner is not empowered to make a determination under Subdivision 204-D of the ITAA 1997. | Detailed Reasoning - Question 4: Will the Proposed Transaction be considered: b. a scheme for the stripping of company profits within the meaning of subsection 177E(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | Summary: No. | Detailed Reasoning - Detailed reasoning: 59. Direct or indirect recipients of a franked distribution can be denied the benefits of attached franking credits in various situations including if the distribution is made as part of a dividend stripping operation (paragraphs 207-145(1)(d), 207-150(1)(e)). 60. The notion of dividend stripping operation in this context is defined in section 207-155: A distribution made to a member of a corporate tax entity is taken to be made as part of a dividend stripping operation if, and only if, the making of the distribution arose out of, or was made in the course of a scheme that: a. was by way of, or in the nature of dividend stripping; or b. had substantially the same effect of a scheme by way of, or in the nature of, dividend stripping. 61. Section 177E of the ITAA 1936 applies where: • property of a company is disposed of as a result of: o a scheme by way of or in the nature of dividend stripping; or o a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping; and • in the Commissioner's opinion, the disposal of property represents, in whole or in part, a distribution of profits of the company; and • if, immediately before the scheme was entered into, the company had paid a dividend equal to the amount of the disposal of property, an amount (referred to as the notional amount) would have been included in the assessable income of a taxpayer of a year of income; and • the scheme is entered into after 27 May 1981. 62. Where all of the above conditions (set out in paragraphs 177E(1)(a)-(d)) are met, the effect of paragraphs 177E(1)(e)-(g) is that the scheme is taken to be a scheme to which Part IVA of the ITAA 1936 applies, and the taxpayer is taken to have obtained a tax benefit in connection with the scheme equal to the notional amount. The scheme 63. 'Scheme' is defined broadly in subsection 177A(1) of the ITAA 1936. In this case, the relevant scheme comprises of the steps of the Proposed Transaction. 64. The scheme will be carried out after 27 May 1981. Has property of a Company B been disposed of as a result of the scheme? 65. For the purposes of section 177E of the ITAA 1936, disposal of property of a company includes the payment of a dividend by the company (paragraph 177E(2)(a)). 66. Dividends paid on the RPS to Company B will constitute a disposal of property as a result of the scheme. Does that disposed property represent a distribution of profits of the company? 67. The proposed dividend payments will be sourced from the retained profits of Company A. Accordingly, those payments will be a disposal of property representing a distribution of the profits of the company. Would an amount have been included in the assessable income of a taxpayer if the company had paid a dividend equal to the disposal of property immediately before the scheme was entered into? 68. An amount would be included in the assessable income of each of Person A and Person B if Company A had paid dividends of an equivalent amount to its ordinary shareholders immediately before the scheme is entered into. Is the scheme by way of or in the nature of dividend stripping? 69. 'Dividend stripping' is not defined in the ITAA 1936. 70. As set out in TD 2014/1 [1] , dividend stripping has been recognised by the courts as involving the following six common characteristics: i. a target company which has 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 escaping Australian income tax on the dividend so declared; v. the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax liability at the relevant time); and vi. the scheme being carefully planned, with all the parties acting in concert, for the predominant if not sole purpose of the vendor shareholders avoiding tax on a distribution of dividends by the target company. 71. The Full Federal Court in Consolidated Press [2] observed that the use of the words 'by way of or in the nature of' in paragraph 177E(1)(a) suggests that variations from these six characteristics will not necessarily result in the scheme being excluded, provided it retains the central characteristics of a dividend stripping scheme. 72. The Proposed Transaction meets the following characteristics of dividend stripping schemes: i. a target company with substantially undistributed profits creating a potential tax liability, either in the company or its shareholders • Company A's retained earnings as at 30 June 2020 totals $X. Any payment of these profits as dividends to the ordinary shareholders, Person A and Person B, would be subject to 'top-up tax' (i.e. the difference between the top marginal tax rate for individuals and the corporate tax rate) ii. the sale or allotment of shares in the target company to another party • Company A will issue ten RPS in Company A Company B iii. the payment of a dividend to the purchaser or allottee of the share out of the target company's profits • Company A will pay a fully franked dividend on the RPS equal to the loan owed by Person A iv. the purchaser or allottee escaping Australian income tax on the dividend declared • Company B, an entity controlled by Person A, will be liable to income tax in the XX income on the dividend received from Company A at its corporate tax rate (30%) less the franking credit of (26%). While, Company B will have some tax liability on the dividend, the tax liability is largely offset by the franking offset arising from the franking credits attached to dividend on the RPS. 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 • Person A will not directly receive a capital sum corresponding to the dividend to be paid on the RPS by Company A. However, as the sole shareholder of Company B, the value of their shareholding in that company will increase by a corresponding amount. As discussed in paragraph 22 of TD 2014/1, this accretion of capital in Company B will indirectly benefit Person A as the sole shareholder of Company B and would constitute a capital sum being received by them to compensate them for Company A's profits paid on the RPS to Company B. • It is noted, however, that during the remaining term of the loans owed by Person A to Company B (i.e. a maximum term of seven years), they will be paid dividends by the company to fund their minimum yearly repayment obligations on those loans. Correspondingly, they will be subject to top up tax on these dividends (i.e. the difference between the corporate tax rate and the top marginal tax rate for individuals). The profits of Company B referable to the RPS dividend will, accordingly, be included in the assessable income of Person A within seven years. For that reason, it could be argued that Person A will effectively receive and bear tax on the relevant profits, as opposed to compensation for such profits in a 'substantially tax-free form'. 73. The sixth characteristic is the scheme being carefully planned, with all parties acting in concert, for the predominant purpose of the vendor shareholder avoiding tax on a distribution of dividends by the target company. 74. The purpose of the scheme is the cessation of Person A's interest in Company A while dealing with their Division 7A loan obligations. 75. The scheme achieves this without minimising Person A's tax obligations. 76. In particular, in addition to Person A paying income tax on the dividends paid by Company B to fund their minimum yearly repayments on the Division 7A loans, Person A will also pay income tax on any additional dividends that Company B may pay in relation to the interest income Company B earns from the Division 7A loans. 77. Person A's taxable income for the XX and future years from sources other than the Company B dividends is expected to exceed the top tax threshold ($180,000). Therefore, any tax on the Company B dividends will be paid at the top marginal tax rates plus Medicare levy. 78. While Person A's objective may have been achieved more simply by having Company A issue the RPS and paying a dividend directly to Person A, when the Proposed Transaction is compared to this counterfactual, it does not avoid tax but incurs additional income tax. 79. For this reason, it cannot be concluded that the scheme has the dominant purpose of tax avoidance. 80. The dominant purpose of the scheme is the cessation of Person A's interest in Company A while dealing with their Division 7A loan obligations. Conclusion on whether there is a dividend stripping scheme 81. The Proposed Transaction is not being carried out with a predominant purpose of avoiding tax. Absent this core feature, there is no scheme by way of or in the nature of dividend stripping, or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. | Detailed Reasoning - Question 5: Will section 45A of the ITAA 1936 apply to the proposed issue of the RPS to Company B? | Summary: No | Detailed Reasoning - Detailed reasoning: 82. Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends. 83. Subsection 45A(4) of the ITAA 1936 lists circumstances in which a shareholder may derive a greater benefit from a capital benefit than another shareholder, including • some or all of the shares in the company held by the shareholder were acquired, or are taken to have been acquired, before 20 September 1985; • the shareholder is a non-resident; • the cost base (for the purposes of Part IIIA ) of the relevant share is not substantially less than the value of the applicable capital benefit; • the shareholder has a net capital loss for the year of income in which this capital benefit is provided; • the shareholder is a private company who would not have been entitled to a rebate under former section 46F if the shareholder had received the dividend that was paid to the disadvantaged shareholder • the shareholder has income tax losses. 84. The proposed arrangement in question involves the issue of RPS to Company B. Prior to the issue of the RPS Company B is not a shareholder of Company A. 85. All shares were acquired after 1985 and are held by Australian residents for tax purposes. Company B has no capital or income tax losses. 86. Accordingly, Company B will not derive a greater benefit from capital benefits than the existing shareholders as set out in subsection 45(4) as none of the circumstances are applicable in this case. 87. It is not considered that section 45A of the ITAA 1936 applies to the proposed issue of the RPS. | Detailed Reasoning - Question 6: Will section 45B of the ITAA 1936 apply to the proposed issue of the RPS to Company B? | Summary: No. | Detailed Reasoning - Detailed reasoning: 88. Section 45B of the ITAA 1936 applies where certain payments are made to shareholders in substitution of dividends. Subsection 45B(2) of the ITAA 1936 sets out the conditions under which the Commissioner may make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies with the effect that the payment is taken to be an unfranked dividend. These conditions are that: • there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); • 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 (paragraph 45B(2)(b) of the ITAA 1936); 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). The relevant circumstances of the scheme include the various matters listed in paragraphs 45B(8)(a)-(k) of the ITAA 1936 (paragraph (k) bringing into the various circumstances the eight matters referred to in subsection 177D(2) of Part IVA). 89. In this case, the issue of RPS would constitute a scheme under which a person is provided with a capital benefit by a company. 90. As discussed above, the facts do not support a finding that the taxpayers have a purpose of obtaining a tax benefit. 91. Having regard to the relevant circumstances of the scheme, it cannot be concluded that any of the parties to the scheme entered into or carried out the scheme for a more than incidental purpose of to obtain a tax benefit. 92. Accordingly, the Commissioner is not empowered to make a determination under subsection 45B(3) of the ITAA 1936. | Detailed Reasoning - Question 7: Will section 177EA of the ITAA 1936 apply to any distribution of fully franked dividends to the holder of the proposed RPS? | Summary: No. | Detailed Reasoning - Detailed reasoning: 93. Section 177EA of the ITAA 1936 is a general anti avoidance provision that applies where a scheme involving the disposition of shares is entered into with a purpose of enabling a taxpayer to obtain a franking credit benefit. It applies where: • There is a disposal of shares or interests in shares (s.177EA (3)(a)); and • A franked dividend is paid or is payable (s.177EA(3)(b) and (c)); and • The shareholder would, or could reasonably be expected to, receive franking credit benefits from the dividend (s.177EA(3)(d)); and • Having regard to specified circumstances, it would be concluded that a purpose of at least one of the participants was to obtain a franking credit benefit. It is not necessary that this purpose is the dominant purpose but it is not sufficient that it is merely incidental (s.177EA(3)(e)). 94. Section 177EA(3)(e) of ITAA 1936 requires the taxpayer to have carried out the scheme (or any part of the scheme) for the purpose of obtaining an imputation benefit and defines this purpose to exclude 'an incidental purpose': '...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'. 95. The High Court considered what amounts to an ' incidental purpose ' in Mills v Commissioner of Taxation [3] and noted that even though a purpose can be central to a scheme it may nevertheless still be an incidental purpose to another purpose: '... a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality [4] '. 96. The issue of the RPS is a disposal of shares resulting in the payment of a franked dividend to Company B and satisfies paragraphs 177EA(3) (a) to (d) of ITAA 1936. 97. As detailed above, the dominate purpose of the Proposed Transaction is the cessation of Person A's ownership interest in Company A and extricating themself from the Division 7A loans owed to Company A by effectively transferring those obligations to Company B. 98. The franking credit benefits are merely incidental to this primary purpose and follow from the issue of RPS which are primarily motivated to transfer the Division 7A loan obligations from Company A to Company B. The purpose requirement in paragraph 177EA(3)(e) of ITAA 1936 is not satisfied. Conclusion 99. As a result, and having regard to the relevant circumstances of the scheme, the conditions in subsection 177EA(3) of the ITAA 1936 have not been satisfied and section 177EA will not apply to any fully franked distribution under the proposed transaction: specifically the Commissioner will not be empowered to make a determination under subsection 177EA(5). | Detailed Reasoning - Question 8: Will Person B's first element of cost base for the Company A shares that they acquire under the Proposed Transaction be equal to their market value? | Summary: Yes. | Detailed Reasoning - Detailed reasoning: 100. Under the general cost base and reduced cost base rules covered under subsections 110-25(2) and 110-55(2), the first element of the cost base and reduced cost base of an asset is the sum of the amount paid (or required to be paid) and the market value of the property given (or required to be given) in respect of acquiring it. 101. Subsection 112-20(1) deems the first element of your cost base and reduced cost base of the CGT asset to be its market value if you did not deal at arm's length with the other entity in connection with the acquisition. 102. There are apportionment rules if only part of the expenditure you incur relates to the acquisition of the CGT asset. The first element of your cost base and reduced cost base is that part of the expenditure that is reasonably attributable to the acquisition of the asset (subsection 112-30(1)). 103. Person A will transfer their shares in Company A to Person B at market value. 104. The consideration for this transfer will be Person B agreeing to remove Person A from their obligations under their joint loan with XX by refinancing the loan with Person B as the sole debtor of the outstanding loan balance. 105. Given the liability assumed by Person B on the X loan exceeds the market value of the shares acquired, the balance will be for a loan owed by Person A to Person B on the same terms and conditions as X imposes on the loan Person B will owe to the X. 106. As the consideration relates to the Company A shares and something else, the apportionment rules in subsection 112-30(1) will apply to Person B's cost base for the Company A shares. 107. A reasonable apportionment of the consideration would be to attribute the market value of the shares as Person B's first element of cost base. | Detailed Reasoning - Question 9: Will Person A's capital proceeds for the Company A shares under the Proposed Transaction be equal to their market value? | Summary: Yes. | Detailed Reasoning - Detailed reasoning: 108. Under subsection 116-20(1) your capital proceeds from a CGT event is the money and the market value of any other property you have received or are entitled to receive in respect of the CGT event. 109. Under paragraph 116-30(2)(b), the capital proceeds you received from the CGT event are replaced with the market value of the CGT asset that is the subject to the event if those capital proceeds are more or less than the market value of the asset. 110. There are apportionment rules if you receive a payment in connection with a transaction that relates to a CGT event and something else. The capital proceeds from the event is so much of the payment that is reasonable attributable to the event (subsection 116-40(2)). 111. As the consideration relates to the shares and something else, i.e. an undertaking from Person B to loan you $X, the apportionment rules in subsection 116-40(2) will apply. 112. A reasonable apportionment of the consideration for the disposal of the shares would be to attribute the market value of the shares as Person A's capital proceeds and the balance as relating to the loan between Person A and Person B. | Detailed Reasoning - Question 10: Will the agreement between Person A and Company B to offset the debt owed by Person A to Company A, so Person A's debt is then owed to Company B instead, be taken to be a dividend under Division 7A of the ITAA 1936 in the 2020-21 income year? | Summary: No. | Detailed Reasoning - Detailed reasoning: 113. Subsection 109C(1) of ITAA 1936 provides that a private company is taken to pay a dividend to a shareholder (or an associate of a shareholder) at the end of a year of income if the private company pays an amount to the entity during the year. 114. Payment has the meaning in subsection 109C(3) of ITAA 1936: • a payment to the extent that it is to the entity, on behalf of the entity or for the benefit of the entity; and • a credit of an amount to the extent that it is: i. to the entity; or ii. on behalf of the entity; or iii. for the benefit of the entity; and • a transfer of property to the entity. 115. However, a loan to an entity is not a payment to the entity (subsection 109C(3A) of ITAA 1936). 116. Payments converted to loans before the private company's lodgment day are treated as loans (subsection 109D(4A) of the ITAA 1936). 117. A private company is taken to pay a dividend at the end of the company's income year if the private company makes a loan during the income year to a shareholder or associate of a shareholder and (subsection 109D(1) of ITAA 1936: • The loan is not repaid in full before the lodgment day for the current year, and • Subdivision D does not prevent the payment from being taken to pay a dividend. 118. A loan that is put on an agreement that meets requirements of section 109N of ITAA 1936 is one of the circumstances where Subdivision D prevents the company from being taken to have paid a dividend. 119. Under the Proposed Transaction, the three parties, Company A, Company B and Person A, will sign a document: • that acknowledges the debt owed by Person A to Company A • in which Company B agrees to have the dividend payable by Company A to Company B offset against Person A's loan • in return, Person A agrees to repay the loan otherwise owing to Company A, to then be repaid to Company B, on the same terms and conditions as Company A had with Person A for each year's loan. Those new loans between Company B and Person A will: o be separate loans for a term equivalent to the period remaining on each of the respective original loans with Company A, and o will be put on loan agreements that comply with section 109N of the ITAA 1936 before the lodgment date for the year of income in which the loan is made. o Company B agrees to have the dividend on the RPS offset against 120. Person A's loan is a payment made by Company B on behalf of Person A and for the benefit of Person A. 121. The payment made by Company B to Person A is converted to a loan that complies with section 109N of ITAA 1936 before the lodgment date for the year of income in which the loan is made. 122. Accordingly, the payment is taken to a be a loan made by Company B to Person A and is not taken to be a dividend at the end of the XX income year as it complies with the requirements of section 109N of the ITAA 1936. [1] Tax 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? [2] Commissioner of Taxation v. Consolidated Press Holdings Ltd (No 1) (1999) 91 FCR 524; [1999] FCA 1199 at 156 [3] [2012] HCA 51 [4] Ibid at [66]

a dividend stripping operation under section 207‐155 of the ITAA 1997; or | This ruling applies for the following period :