Private ruling: Redeemable preference shares and dividend payments
Date of advice: 25 March 2021
Published: June 2021
Ruling period: Year ended 30 June 20XX to Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the redeemable preference shares (RPS) continue to be treated as equity interests under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: Yes Question 3 Will the future declaration and payment of dividends to RPS holders trigger tax consequences under Division 725 of the ITAA 1997 and cause CGT event K8 to occur under section 104-250 of the ITAA 1997? Answer No Question 4 Will dividends declared in respect of the RPS be frankable distributions as defined in section 202-40 of the ITAA 1997? Answer Yes Question 5 Will the future payment of dividends to the individual holders of the RPS be considered dividend streaming under Subdivision 204-D of the ITAA 1997? Answer No Question 6 Will the individual holders of the RPS continue to be entitled to franking credits under Division 207 of the ITAA 1997? Answer Yes | Q2: Will section 207-155 of the ITAA 1997 or section 177E of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the future payment of dividends to the individual holders of the RPS? Answer No Question 8 Will section 177EA of the ITAA 1936 apply to the future payment of dividends to the individual holders of the RPS? Answer No Question 9 Will the Commissioner make a determination under Part IVA of the ITAA 1936 to the whole, or part, of the arrangement? Answer No

Relevant facts and circumstances: 1. The Company is a private company. 2. The ordinary shares on issue in the Company all have equal dividend and voting rights. 3. The directors of the Company have issued redeemable preference shares (RPS) to individuals associated with the Company. 4. Having canvassed a number of alternatives, the directors of the Company considered that the issue of RPS to the associated individuals would increase their connectivity, engagement and involvement in the business of the Company. 5. The RPS were issued with the following features and conditions attached: • the holder of an RPS has the right to receive discretionary dividends but not in preference to any other class of shares as nominated and declared by the directors • dividends declared and received by RPS holders are non-cumulative • the holder of an RPS has the right to receive capital as the directors may determine to pay, but this shall not exceed the amount paid up on subscription of each RPS • the RPS are redeemable at the option of the Company and upon death or bankruptcy of the holder • the holder of the RPS has the right of return of unpaid capital and any unpaid declared dividends at the time of redemption by the Company • the holder of the RPS has the right to participate and receive capital upon the winding up of the Company only to the extent of capital paid up on the RPS and in priority over other classes of non-preference shares • the RPS were issued for a subscription amount of $1 each • the holder of an RPS can only be a natural person and hold the share beneficially • any dividends declared and paid on the RPS by the Company in a financial year cannot exceed 25% of the total dividends declared and paid by the Company on any ordinary share, and • once issued, an RPS is not transferrable to another person. 6. The Company will not debit its share capital account to fund the payment of dividends to both ordinary shareholders and RPS holders. 7. Dividends paid by the Company will not be made with a variable percentage of franking credits attached depending on the class of share.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-250 | Income Tax Assessment Act 1997 paragraph 149-15(1)(b) | Income Tax Assessment Act 1997 section 202-40 | Income Tax Assessment Act 1997 paragraph 202-45(d) | Income Tax Assessment Act 1997 paragraph 202-45(e) | Income Tax Assessment Act 1997 paragraph 202-45(h) | Income Tax Assessment Act 1997 Subdivision 204-D | Income Tax Assessment Act 1997 Division 207 | Income Tax Assessment Act 1997 section 207-155 | Income Tax Assessment Act 1997 Division 725 | Income Tax Assessment Act 1997 Division 974 | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 section 177E

Reasons for decision: Summary: The RPS will continue to be treated as equity interests under Division 974 of the ITAA 1997 because each RPS on issue results in the individual holder becoming a member and shareholder in the company. If an equity interest also satisfies the debt test, the tie-breaker rule will result in the interest being a debt interest. The RPS will not satisfy the debt test in subsection 974-20(1) of the ITAA 1997, as the directors of the Company have absolute discretion relating to the payment of dividends on the RPS, meaning that there is no effectively non-contingent obligation regarding the RPS. Because the RPS fail the debt test, the tie-breaker rule will not operate, and therefore, they will constitute an equity interest in the Company. Detailed reasoning | Detailed Reasoning - Division 974: Debt vs. Equity: Division 974 of the ITAA 1997 sets out the rules for defining what constitutes equity in a company, and what constitutes debt. This categorisation determines whether a return paid by a company on a financing interest that it has issued will be frankable (i.e. treated as a dividend) or deductible (i.e. treated as interest on a debt). The objects of Division 974 are set out in section 974-10 of the ITAA 1997. Subsection 974-10(1) of the ITAA 1997 provides as follows: An object of this Division is to establish a test for determining for particular tax purposes whether a scheme, or the combined operation of a number of schemes: (a) gives rise to a debt interest; or (b) gives rise to an equity interest. Further, subsection 974-10(2) of the ITAA 1997 states that: Another object of this Division is that the test referred to in subsection (1) is to operate on the basis of the economic substance of the rights and obligations arising under the scheme, or schemes, rather than merely on the basis of the legal form of the scheme, or schemes. | Detailed Reasoning - Equity interest: The meaning of an 'equity interest' in a company is defined in section 974-70 of the ITAA 1997. A scheme, or related schemes, gives rise to an equity interest in a company under section 974-70 of the ITAA 1997 if the scheme, or the notional scheme, satisfies the equity test in section 974-75 of the ITAA 1997 and does not satisfy the 'tie-breaker' test in paragraph 974-70(1)(b) of the ITAA 1997- i.e. the interest must not be a debt interest, or form part of a larger interest that is a debt interest. A scheme, or notional scheme, satisfies the equity test in relation to a company if it gives rise to an interest of the kinds listed in the table contained in subsection 974-75(1) of the ITAA 1997. Item 1 of the table covers all kinds of shares, including redeemable preference shares. As with other items in the table, interests covered by item 1 will not be equity interests if they are debt interests (paragraph 974-70(1)(b) of the ITAA 1997). As discussed in ATO Interpretative Decision ATO ID 2003/873 income tax: Debt/Equity interest: Redeemable Preference Shares- equity interest redeemable preference shares are equity interests, as defined in subsection 974-70(1) of the ITAA 1997, because: • the issue of [redeemable preference shares] is a scheme (as defined in subsection 995-1(1)); • the scheme falls within one of the items in the equity interest table in subsection 974-75(1) (principally the [redeemable preference shares] give rise to an interest as a member of the issuing company, Item 1 of the equity interest table); • as the [redeemable preference shares] satisfy item 1 of the equity interest table, pursuant to subsection 974-75(2), it does not have to satisfy the financing arrangement definition; and • the [redeemable preference shares] are not characterized as, and do not form part of the larger interest that is characterized as a debt interest (as defined in subsection 974-15(1)) in the issuing company. The RPS satisfy the equity test, because each RPS on issue results in the individual holder becoming a member and shareholder in the company. Notwithstanding the above, it is also 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. | Detailed Reasoning - Debt interest: Subsection 974-15(1) of the ITAA 1997 defines the meaning of a 'debt interest' as follows: A scheme gives rise to a debt interest in an entity if the scheme, when it comes into existence, satisfies the debt test in subsection 974-20(1). Subsection 974-20(1) of the ITAA 1997 states that a scheme satisfies the debt test 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 RPS will not satisfy the debt test in subsection 974-20(1) of the ITAA 1997, as there is no effectively non-contingent obligation to provide a financial benefit. This is because: • the directors of the Company have absolute discretion to declare and pay dividends on the RPS; • dividends on the RPS are non-cumulative; and • the redemption of the RPS will be at the discretion of the Company's directors, which entitles the individual RPS holder to a return of their subscribed capital. | Detailed Reasoning - Conclusion: In accordance with section 974-70 of the ITAA 1997, as the RPS will fail the debt test, they will constitute equity interests in the Company. Question 2 | Summary: The ordinary shareholders will continue to maintain a greater than 50% beneficial interest in the ordinary income of the Company under paragraph 149-15(1)(b) of the ITAA 1997 despite the dividends paid on the RPS because the dividends declared and paid on the RPS by the Company in a financial year cannot exceed 25% of the total dividends declared and paid by the Company on any existing ordinary shares. Therefore, a majority underlying interest will continue to be maintained by the existing ordinary shareholders in the Company's income, satisfying paragraph 149-15(1)(b) of the ITAA 1997. Detailed reasoning Division 149 of the ITAA 1997 will apply where there is a change in the majority underling interests in a pre-CGT asset owned by a company or trust. Specifically, subsection 149-30(1) of the ITAA 1997 provides that: The asset stops being a pre-CGT asset at the earliest time when majority underlying interests in the asset were not held by ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985. ATO Interpretive Decision ATO ID 2011/107 Capital Gains Tax: Division 149 majority underlying interests - new shareholder covers the situation where a new shareholder with a discretionary right to 100% of the dividends of a company is admitted to the membership of the company. In this situation, ATO ID 2011/107 states: However, the issue of a share to Company H introduced a new shareholder in whose favour a distribution of income could be made. Due to the discretionary right to dividends which all shares carry, Company B can distribute the dividends to one shareholder to the exclusion of the other shareholders. This means that Company B could pay 100% of any dividends to Company H, who in turn could distribute it to T, who in turn could distribute it to any of the individuals who are members of the class of beneficiaries. Accordingly, the possibility exists that the ultimate owners (individuals X, Y and Z) who between them collectively had majority underlying interests in the asset immediately before 20 September 1985 may receive less than 50% of the ordinary income that may be derived by Company B from the asset. In the above example, the requirement in paragraph 149-15(1)(b) of the ITAA 1997 is not satisfied, because the possibility exists for more than 50% of the ordinary income derived from the asset to be distributed to shareholders who did not hold shares prior to 20 September 1985. However, the circumstances in ATO ID 2011/107 are distinguishable from your situation because the dividends payable on the RPS are capped at no more than 25% of the total dividends paid to the existing ordinary shareholders. As such, the discretionary payment of dividends on an ad hoc basis to the RPS holders will not affect the existing majority underlying ownership interests, as the existing owners will maintain a greater than 50% interest in the ordinary income generated by the Company. Thus, a majority underlying interest will continue to be maintained by the existing ordinary shareholders in the Company's income, thereby satisfying paragraph 149-15(1)(b) of the ITAA 1997. Question 3 | Summary: The declaration of dividends in respect of the RPS by the Company will not trigger CGT event K8 by virtue of the direct value shifting rules contained in Division 725 of the ITAA 1997. Detailed reasoning There is a direct value shift under section 725-145 of the ITAA 1997 if, as a result of things done under a scheme, there is a decrease in the market value of one of more equity or loan interests in a company (the down interests) and either: • equity or loan interests in the company are issued at a discount (the up interests) or • there is an increase in the market value of one or more equity or loan interests in the company (the up interests). A direct value shift may result in consequences under Division 725 of the ITAA 1997 which would include a realignment of the value of the equity or loan interests for tax purposes to reflect changes in market value attributable to the direct value shift and, in some cases, a capital gain being generated on the down interests (CGT event K8 in section 104-250 of the ITAA 1997). Based on the terms of the RPS, it is arguable that the value of the RPS (the up interests) may increase and the value of the ordinary shares (the down interests) may decrease when the Company declares a dividend in relation to the RPS. Therefore, on face value, a direct value shift may occur where the dividend declaration is considered to be one of the '...things done under the scheme...' causing the direct value shift. However, in accordance with subsection 725-90(1) of the ITAA 1997, a direct value shift will have no consequences under Division 725 of the ITAA 1997 if: (a) the one or more things referred to in paragraph 725-145(1)(b) of the ITAA 1997 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. The legislative context shows that the term 'state of affairs' is used to refer to the factual circumstance that is the trigger or cause for the value shift. The state of affairs is one but for which the direct value shift would not have happened (paragraph 725-90(1)(a) of the ITAA 1997). The example that follows subsection 725-90(1) of the ITAA 1997 reads: 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. The relevant state of affairs here is that a dividend is payable to the holders of the RPS. This state of affairs will cease to exist when the dividend is paid, an event that will happen within the four year period. The exception in section 725-90 of the ITAA 1997 will therefore apply and consequently Division 725 of the ITAA 1997 will not apply nor will CGT event K8 happen. Question 4 | Summary: Dividends declared in respect of the RPS will be frankable distributions as defined in section 202-40 of the ITAA 1997. A dividend is frankable to the extent that it is not unfrankable. Distributions in respect of non-equity shares (paragraph 202-45(d) of the ITAA 1997) or those sourced from your share capital account (paragraph 202-45(e) of the ITAA 1997) are unfrankable. Because the RPS are not non-equity shares, and the Company will not be debiting its share capital account in order to pay dividends on the RPS, dividends on the RPS will not be unfrankable as a result of paragraphs 202-45(d) or (e) of the ITAA 1997. Additionally, based on the information provided, because the issue of the RPS does not involve the issue of bonus shares, or the provision of capital benefits to shareholders, paragraph 202-45(h) of the ITAA 1997 will not operate to make dividends on the RPS unfrankable. Detailed reasoning A distribution, or a non-share dividend, is a 'frankable distribution' to the extent that it is not unfrankable under section 202-45 of the ITAA 1997 (section 202-40 of the ITAA 1997). Therefore, to determine the extent to which a distribution, or non-share dividend is frankable, you must first determine the extent (if any) to which it is unfrankable. In the current circumstances, paragraphs 202-45(d), (e) and (h) of the ITAA 1997 are relevant. Paragraphs (d), (e) and (h) of 202-45 of the ITAA 1997 state that the following distributions are unfrankable: (d) a distribution in respect of a non-equity share; and (e) a distribution that is sourced, directly or indirectly, from a company's share capital account. .... (h) an amount that is taken to be an unfranked dividend for any purpose: (i) under section 45 of that Act (streaming bonus shares and unfranked dividends); (ii) because of a determination of the Commissioner under section 54C of that Act (streaming dividends and capital benefits); | Detailed Reasoning - Paragraph 202-45(d): Section 995-1 of the ITAA 1997 defines a 'non-equity share' as being a share that is not an equity interest in the company. It has already been determined in question one that the RPS will be treated as equity interests under Division 974 of the ITAA 1997. Therefore, as the distribution is not in respect of a non-equity share, paragraph 202-45(d) of the ITAA 1997 will not apply to deem the dividends unfrankable. | Detailed Reasoning - Paragraph 202-45(e): Further, the Company will not debit its share capital account to fund the payment of dividends to both ordinary shareholders and RPS shareholders of the company. Therefore, paragraph 202-45(e) of the ITAA 1997 will not apply. Paragraph 202-45(h) Paragraph 202-45(h) of the ITAA 1997 makes reference to sections 45, 45A and 45B of the ITAA 1936, which are general anti-avoidance rules that in general terms refer to: • Capital streaming arrangements where bonus shares are provided to some shareholders and unfranked or minimally franked dividends are paid to other shareholders (section 45 of the ITAA 1936). • Capital streaming arrangements where capital benefits (other than merely providing shares) are provided to some shareholders, and dividends (usually not fully franked dividends) are paid to other shareholders where the shareholders receiving the capital benefits derive greater benefit from them than the other shareholders (section 45A of the ITAA 1936). • Situations where capital benefits (other than merely providing shares) are provided in substitution for dividends in circumstances where a person enters into the arrangement with a purpose of ensuring that a taxpayer's tax liability is less that it would have been if the capital benefit had been a dividend (section 45B of the ITAA 1936). Section 45 of the ITAA 1936 The application of section 45 is set out in subsection 45(1) of the ITAA 1936 in the following terms: 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. Based on the information provided, this scheme does not involve issuing bonus shares to shareholders as an alternative to paying dividends or paying minimally franked dividends to some shareholders in preference to others. As such, section 45 of the ITAA 1936 will have no application to these circumstances. Section 45A of the ITAA 1936 Section 45A applies in the circumstances set out in subsection 45A(1) of the ITAA 1936, which states that: 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 capital benefits and the payment of dividends to its shareholders in such a way that: (a) the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and (b) it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends. .... Based on the information provided, this scheme does not involve the provision of capital benefits and the payment of dividends as set out in subsection 45A(1) of the ITAA 1936. As such, the Commissioner would not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies. Section 45B of the ITAA 1936 Of relevance, section 45B of the ITAA 1936 will apply (subsection 45B(2) of the ITAA 1936) if: (a) there is a scheme under which a person is provided with .... 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 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. Based on the information provided, this scheme does not involve the provision of capital benefits and the provision of a tax benefit as set out in subsection 45B(2) of the ITAA 1936. As such, the Commissioner would not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies. Conclusion paragraph 202-45(h) Based on the information provided, there will be no amounts taken to be an unfranked dividend in accordance with sections 45, 45A or 45B of the ITAA 1936 relating to this scheme. As such paragraph 202-45(h) of the ITAA 1997 will not operate to deny franking credits on a distribution made in respect of the RPS. Conclusion In accordance with the above, the dividends declared in respect of the RPS will not be unfrankable distributions due to the operation of paragraphs (d), (e) or (h) of section 202-45 of the ITAA 1997. Question 5 | Summary: The future payment of dividends to the individual holders of the RPS will not be considered dividend streaming under Subdivision 204-D of the ITAA 1997. Broadly, dividend streaming involves structuring distributions by a corporate entity in such a way as to give those members who benefit most from imputation credits (e.g. taxable residents) a greater imputation benefit than those who benefit less (e.g. non-residents). Dividend streaming may occur by making franked distributions to some members ('favoured members') of the entity, and unfranked distributions to other members ('disadvantaged members'). Merely refraining from making a distribution to a particular class of member does not, of itself, constitute dividend streaming. Rather, it is the structuring of the distribution in such a way as to stream the benefit of imputation credits so that the favoured members, who can better utilise the franking credits, receive a disproportionate amount of the imputation credits, compared to the disadvantaged members who derive little or no benefit from the imputation credits. In the case of the RPS, when a dividend is declared and paid by the Company to both its ordinary shareholders and RPS shareholders, these dividends will be franked to the same extent. In these circumstances, based on the facts provided, the Commissioner would not make a determination under Subdivision 204-D of the ITAA 1997. Detailed reasoning The term 'streaming' is not defined in the ITAA 1997. Paragraph 3.28 of the explanatory memorandum to the New Business Tax System (Imputation) Bill 2002 describes streaming as: .... selectively directing the flow of franked distributions to those members who could most benefit from imputation credits. Section 204-30 of the ITAA 1997 contains a specific anti-streaming rule which, once the trigger conditions contained in subsection 204-30(1) are met, allows the Commissioner to make a determination under subsection 204-30(3) of the ITAA 1997 to impose sanctions that negate any imputation benefit that may result from dividend streaming. Subsection 204-30(1) of the ITAA 1997 states that: 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 . In the current circumstances, when a dividend is declared and paid by the Company to both its ordinary shareholders and RPS shareholders, these dividends will be franked to the same extent. Taking this into consideration, it would be difficult to conclude in these circumstances that one class of shareholder is being treated more favourably than another, resulting in dividend streaming. Accordingly, it is concluded that there will be no streaming for the purposes of Subdivision 204-D of the ITAA 1997. As such, the Commissioner will not make a determination under Subdivision 204-D of the ITAA 1997 that imputation benefits are being streamed. Question 6 | Summary: The individual holders of the RPS will continue to be entitled to franking credits under Division 207 of the ITAA 1997. Section 207-20 of the ITAA 1997 allows a tax offset for an amount of franking credit associated with dividends, for Australian resident recipients of franked distributions. There are integrity measures that affect the availability of these franking credits, which are contained in section 207-145 of the ITAA 1997. Franking credits can be denied if the recipient is not a qualified person, for a scheme involving dividend stripping, dividend streaming, or franking credit trading. Based on the information provided, none of the integrity measures will affect the availability of franking credits for recipients of dividends relating to the RPS on the basis that the recipient is an Australian resident and a qualified person. Detailed reasoning Generally, where a corporate tax entity makes a franked distribution to one of its members, section 207-20 of the ITAA 1997: • includes the franking credit attached to a franked distribution in the assessable income of the recipient of the dividend, and • allows a tax offset equal to the franking credit on the distribution. There are exceptions to the general availability of franking credits, for instance, when the recipient is a non-resident of Australia, or when other integrity measures apply. | Detailed Reasoning - Recipient must satisfy the residency requirement: Section 207-70 of the ITAA 1997 denies franking credits as a result of section 207-20 of the ITAA 1997, if the entity receiving the franked distribution does not satisfy the residency requirement contained in section 207-75 of the ITAA 1997. Of relevance is subsection 207-75(1) of the ITAA 1997, which states: An entity that receives a distribution satisfies the residency requirement at the time the distribution is made if: (a) in the case of an individual - the individual is an Australian resident at that time .... Thus, in general, to be entitled to franking credits, the recipient must be an Australian resident. In the case of a distribution from the Company relating to the RPS, it would be a matter for the individual recipient of the franked dividend to determine that they are an Australian resident at the time when the dividend was made, and to establish eligibility for any franking credits attached to the RPS. | Detailed Reasoning - Other integrity measures affecting the availability of franking credits for recipients: Subdivision 207-F of the ITAA 1997 contains integrity measures which, in certain circumstances, can deny franking credits to recipients if the imputation system is manipulated. Section 207-145 of the ITAA 1997, in part, sets out the following circumstances which require consideration in this case where franking credits will not be available to recipients: • the entity in receipt of the dividend is not a qualified person • the Commissioner has made a determination under paragraph 204-30(3)(c) of the ITAA 1997 relating to dividend streaming • the distribution is part of a dividend stripping operation • the Commissioner has made a franking credit benefit determination under paragraph 177EA(5)(b) of the ITAA1936, general anti-avoidance rules relating to franking credit trading and dividend streaming, or • the distribution is one to which section 207-157 (which is about distribution washing) applies. | Detailed Reasoning - Qualified person: In order to be a 'qualified person', the holding period, and related payments rules contained in the former sections 160APHC to 160APHU of the ITAA 1936 must be satisfied. Broadly: • the holding period rule, (with some exceptions) requires taxpayers to hold shares at risk for more than 45 days (90 days for preference shares), and • the related payments rule, requires taxpayers who are under an obligation to make a related payment in relation to a dividend to hold the relevant shares at risk for more than 45 days (90 days for preference shares) during the qualification period. The main exception to the above is the small shareholders exception for natural persons whose tax offset entitlement does not exceed $5,000 for the income year. In the case of the Company, the qualified person requirement is a matter for the recipient of the franked distribution, not the Company. It would be up to an individual recipient of a dividend from the Company to ensure that they are a qualified person, in order to maintain eligibility for any franking credit from the RPS. | Detailed Reasoning - Paragraph 204-30(3)(c) of the ITAA 1997: The application of Subdivision 204-D of the ITAA 1997, relating to dividend streaming, is considered at question 5 of this ruling. As explained in question 5, as the RPS arrangement does not constitute dividend streaming, the Commissioner's powers to make a determination under subsection 204-30(3) of the ITAA 1997 are not enlivened. Therefore, based on the facts you have provided, the Commissioner would not make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny franking credits to recipients of dividends from the RPS. | Detailed Reasoning - Part of a dividend stripping operation: The application of section 207-155 of the ITAA 1997, which relates to dividend stripping, is considered at question 7 of this ruling. In short, based on the facts you have provided, it is considered that the RPS are not part of a dividend stripping scheme and therefore the entitlement to franking credits by recipient of dividends from the RPS will not be denied on this basis. | Detailed Reasoning - Paragraph 177EA(5)(b) of the ITAA 1936: The application of the anti-avoidance rules in section 177EA of the ITAA 1936 is considered at question 8 of this ruling. As the reasoning at question 8 explains, based on what you have told us, the Commissioner will not be making a determination under subsection 177EA(5) of the ITAA 1936 to deny franking credits associated with dividends paid on the RPS. | Detailed Reasoning - Distribution washing: The distribution washing rules in section 207-157 of the ITAA 1997 will apply to a franked distribution received in respect of a membership interest (washed interest) where two requirements are met: (a) the washed interest was acquired after the member, or a connected entity of the member, disposed of a substantially identical membership interest, and (b) a corresponding franked distribution is made to the member, or the connected entity, on the substantially identical interest. For the purposes of this provision, a membership interest is considered to be 'substantially identical' to the washed interest if it is any one or more of the following: (a) fungible with, or economically equivalent to, the washed interest; (b) a membership interest in the same *corporate tax entity as the washed interest and of a class that is the same as, or not materially different from, the washed interest; (c) a membership interest in the same corporate tax entity as the washed interest and of a class that is exchangeable at a fixed rate for an interest of the same class as the washed interest; (d) a membership interest in another corporate tax entity that holds predominantly membership interests that are covered by any of the preceding paragraphs; (e) a membership interest in another corporate tax entity that is exchangeable at a fixed rate for interests that are covered by any one or more of paragraphs (a) to (c). Based on the facts provided, there is no planned disposal/redemption of the RPS nor a reacquisition of the RPS or a substantially identical interest. In this regard, it is noted that under the terms of the RPS, once issued, an RPS is not transferrable to another person. As there is no planned disposal and subsequent acquisition of substantially identical membership interests, the requirements in section 207-157 of the ITAA 1997 will not be satisfied. According, any entitlement to franking credits by the recipient of dividends from the RPS will not be denied on the basis of distribution washing. | Detailed Reasoning - Conclusion: Based on what you have told us, franking credits under section 207-20 of the ITAA 1997 will be available to Australian resident holders of the RPS who are qualified persons. | Summary: Section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936 will not apply to the future payment of dividends to the individual holders of the RPS. Dividend stripping does not have a precise legal meaning, but it generally refers to a scheme whereby an entity purchases shares in a company (Target Company) with substantial accumulated profits that are in cash, or a readily realisable form. The purchase price reflects the value of the accumulated profits. Once the shares are acquired, a dividend approximating the purchase price is paid to the acquiring entity. The scheme is carefully planned, with all parties acting in concert for the predominant or sole purpose of the vendor shareholders, avoiding tax on a distribution of dividends by the Target Company. The issue of the RPS does not exhibit the characteristics of a dividend stripping scheme because: • the RPS were issued at a nominal price of $1.00 • there does not appear to be a dominant purpose of the existing shareholders of the Company avoiding tax on dividends paid by the Company, and • there was a commercially justifiable reason for issuing the RPS. Therefore, the Commissioner would not consider the issue of the RPS a dividend stripping scheme, as intended by section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Section 207-155 of the ITAA 1997 states that: 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 effect of a scheme by way of, or in the nature of, dividend stripping. The threshold condition for the application of section 177E of the ITAA 1936, found in paragraph 177E(1)(a) of the ITAA 1936, is in substantially the same terms to section 207-155 of the ITAA 1997. The consequences of a scheme being considered a dividend stripping scheme are found in: • sections 207-145 and 207-150 of the ITAA 1997, which operate to deny franking credits on distributions from a dividend stripping operation, and • section 177E of the ITAA 1936, which is a general anti-avoidance provision relating specifically to dividend stripping schemes, where the tax benefit associated with a dividend scheme can be cancelled in whole or part, if determined by the Commissioner. Dividend stripping is not a defined term, and it does not have a precise legal meaning. The meaning of dividend stripping is considered in paragraphs 8-10 of Taxation Ruling IT 2627 Income Tax: application of Part IVA to dividend stripping arrangements, which state: 8. The term 'dividend stripping' has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression. 9. However, it can be said that in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current years' profits that are represented by cash or other readily-realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company. 10. No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result. Dividend stripping is further considered in 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? The characteristics of a dividend stripping scheme are listed in paragraph 17 of TD 2014/1, of relevance: • 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 ...., and • 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 from the company. The individual holders of the RPS subscribed to capital in the Company at a nominal market value of $1.00 with no consideration flowing directly to the existing, ordinary shareholders. It therefore could not be said that the existing shareholders in the Company would be receiving a capital sum for shares in an amount the same, or very close to the dividends paid (or potentially paid) to the RPS holders. Additionally, the following characteristics of the RPS do not readily lend themselves to constituting a scheme with the sole or predominant purpose of avoiding tax, because: • the dividends on the RPS cannot exceed 25% of the total dividends declared and paid by the Company on any ordinary shares • the holder of the RPS can only be a natural person and hold their share beneficially, and • once issued, the RPS is not transferrable to another person. Based on the above, it cannot be said that the existing shareholders of the Company are acting in concert with the RPS shareholders for the sole or predominant purpose of avoiding tax on distributions from the Company. Furthermore, there will be no release of profits of the Company in a non-taxable form. The RPS were issued to increase the RPS member's connectivity, engagement, and involvement in the family business, which is critical to the continuity of the Company into the future, and what you believe to be a commercially justifiable reason for this course of action. Having regard to the characteristics and objective purpose of the RPS issue, the Commissioner would not consider the current arrangement a dividend stripping scheme, or in the nature of dividend stripping. Question 8 | Summary: Section 177EA of the ITAA 1936 will not apply to the future payment of dividends to the individual holders of the RPS. For the purposes of subsection 177EA(3) of the ITAA 1936, it cannot be concluded that a purpose of at least one of the participants was to enable a relevant taxpayer to obtain an imputation benefit, other than as an incidental benefit. This is because the characteristics of the RPS do not lend themselves to franking credit trading or dividend streaming and no proposed or actual shareholder of the company will obtain a greater benefit from franking credits than any other. Detailed reasoning Section 177EA of the ITAA 1936 is directed at schemes involving franking credit trading and dividend streaming. The reason for the introduction of section 177EA into Part IVA of the ITAA 1936 was explained in the explanatory memorandum to the Taxation Laws Amendment Bill (No 3) 1998 (paragraph 8.124) as follows: One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (i.e. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings. The rules in section 177EA of the ITAA 1936 are intended to act as a back-up to the specific anti-streaming rules in Subdivision 204-D of the ITAA 1997, and associated provisions that came into operation at the same time. Subsection 177EA(3) of the ITAA 1936 sets out the circumstances that section 177EA of the ITAA 1936 applies, they are: (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 is expected to be payable 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; (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. Key to the operation of subsection 177EA(3) of the ITAA 1936 is paragraph (e), where, after a consideration of the circumstances, there must be a purpose, which is more than a merely incidental purpose, of obtaining, or enabling the relevant taxpayer to obtain, an imputation benefit a result of a scheme. In the case of the RPS, you have explained that their issue forms part of the succession planning for the Company to increase the RPS shareholders' connectivity, engagement, and involvement with the family business. As previously explained in question 5 of this ruling, the RPS scheme does not constitute dividend streaming. The characteristics of the RPS do not readily lend themselves to franking credit trading because: • when dividends are paid on RPS they cannot be greater than 25% of the total dividends declared and paid by the Company on any ordinary share • the RPS can only be held by a natural person who must beneficially hold the share, and • once issued the RPS are not transferrable to another person. Therefore, taking the above into consideration, it is considered that any imputation benefit received by the holders of the RPS will merely be incidental to the purpose of the scheme. Accordingly, in these circumstances, section 177EA of the ITAA 1936 will have not apply to the future payment of dividends to the individual holders of the RPS. Question 9 | Summary: The Commissioner will not make a determination under section 177F of the ITAA 1936 that Part IVA applies in respect of the RPS issued and the future payment of dividends to the individual holders of the RPS as specified in the scheme. Detailed reasoning Part IVA of the ITAA 1936 is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit. The Scheme Subsection 177A(1) of the ITAA 1936 defines a 'scheme' as: (a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and (b) any scheme, plan, proposal, action, course of action or course of conduct. The issue of the RPS and the future payment of dividends to the individual holders of the RPS is considered to be a scheme for the purposes of subsection 177A(1) of the ITAA 1936. Tax Benefit Broadly, a 'tax benefit' is defined in subsection 177C(1) of the ITAA 1936 as: • an amount not being included in the assessable income of the taxpayer as a result of the scheme (paragraph 177C(1)(a) of the ITAA 1936) • a deduction being allowable to the taxpayer as a result of the scheme (paragraph 177C(1)(b) of the ITAA 1936) • a capital loss being incurred by the taxpayer as a result of the scheme (paragraph 177C(1)(ba) of the ITAA 1936 • a foreign income tax offset is allowable under the scheme (paragraph 177C(1)(bb) of the ITAA 1936) • an innovation tax offset being allowable under the scheme (paragraph 177C(1)(bba) of the ITAA 1936) • an exploration credit being issued to the taxpayer as a result of the scheme (paragraph 177C(1)(bbaa) of the ITAA 1936), or • withholding tax not being payable as a result of the scheme (paragraph 177C(1)(bc). Whether a scheme has been carried out for the dominant purpose of enabling a taxpayer to obtain a tax benefit is determined according to the provisions of section 177D of the ITAA 1936. In accordance with subsection 177D(2) of the ITAA 1936, the following factors are to be considered in determining the purpose of a scheme: (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, and (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) Having regard to the characteristics and objective purpose of the RPS issue, it is accepted that on the particular facts of this case, a dominant purpose of obtaining a tax benefit is not present. Consequently, this arrangement involving the issue of the RPS and the future payment of dividends to the RPS holders is not a scheme to which Part IVA applies by operation of section 177D of the ITAA 1936. As section 177D of the ITAA 1936 does not apply, a determination would not be made under section 177F of the ITAA 1936 to cancel any tax benefit that may be obtained under the arrangement due to the operation of section 177D of the ITAA 1936.

Will the ordinary shareholders continue to maintain a greater than 50% beneficial interest in the ordinary income of the Company under paragraph 149-15(1)(b) of the ITAA 1997 despite the dividends paid on the RPS?