Private ruling: Part IVA - disposal of shares to wholly owned company- share buy back
Published: April 2013
Ruling period: 2011-12 income year | 2012-13 income year | 2013-14 income year
Date scheme commenced: 1 July 2011

Ruling: Q1: Will you obtain a tax benefit in connection with a scheme to which Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies? | A1: Yes.

Relevant facts and circumstances: You and a family member were joint directors and shareholders of ABC Pty Ltd (ABC), an Australian resident entity from the date of incorporation. Due to a disagreement, you and the family member decided to go your separate ways. You and the other family member have been estranged for some time and very little communication goes on between you. During the relevant income year, representatives of you and the other family member made a valuation of what they considered your share in ABC was worth. No independent valuation was undertaken, however the parties did have access to a valuation of the land and buildings owned and used by the ABC business. Soon after you incorporated XYZ Pty Ltd (XYZ), an Australian resident entity, of which you are the sole director and shareholder. You were removed as director of ABC (without your knowledge or consent) and the spouse of the other director was appointed. On the same day you disposed of your shares in ABC to XYZ. When you lodged your relevant income tax return, you elected Rollover Relief under Division 122 of the Income Tax Assessment Act 1997 (ITAA 1997) on the disposal of your shares in ABC to XYZ. As a consequence, the capital gain or loss on the disposal of your shares in ABC to XYZ was disregarded. ABC proposes to offer a selective buy back to all shareholders in ABC. The proposed buy back by ABC will comprise of share capital and a fully franked dividend per share. The buy back will occur in the subsequent income years. XYZ will accept the offer to sell the ABC shares back to ABC under the selective share buy back. You are in the top personal income tax bracket in the relevant income year. You were assessed at the rate of 45 cents in the dollar, plus Medicare liabilities. XYZ has never undertaken any trading activities and there is no intention that it ever will. The company was set up purely to enable the transfer of the ABC shares.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 44(1) | Income Tax Assessment Act 1936 section 177A | Income Tax Assessment Act 1936 subsection 177A(1) | Income Tax Assessment Act 1936 section 177C | Income Tax Assessment Act 1936 subsection 177C(1) | Income Tax Assessment Act 1936 paragraph 177C(1)(c) | Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 paragraph 177D(b) | Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1997 section 6-10 | Income Tax Assessment Act 1997 Division 122 | Income Tax Assessment Act 1997 subsection 207-20(1)

Reasons for decision: Summary: You will obtain a tax benefit in connection with a scheme to which Part IVA of the ITAA 1936 applies. Accordingly the Commissioner will make a determination under section 177F of the ITAA 1936 to cancel the tax benefit obtained in connection with the scheme. | Detailed Reasoning - Detailed reasoning: Part IVA of the ITAA 1936 is a general anti-avoidance provision. It gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA applies. In order for Part IVA of the ITAA 1936 to apply, the following requirements must be satisfied: · there must be a scheme as defined by section 177A of the ITAA 1936, · there must be a tax benefit obtained in connection with the scheme, as defined by section 177C of the ITAA 1936, and · the scheme must be one to which Part IVA applies, as determined by section 177D of the ITAA 1936, where it would be objectively concluded that the taxpayer (or any other person involved in the scheme) had the sole or dominant purpose of entering into the scheme to obtain the tax benefit. | Detailed Reasoning - Scheme: A scheme is 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 any scheme, plan, proposal, action, course of action or course of conduct. The definition of scheme encompasses not only a series of steps which together can be said to constitute a "scheme" or a "plan" but also the taking of one step (subsection 177A(1) of the ITAA 1936). The Commissioner is of the opinion that: · you incorporating XYZ · you disposing of your shares in ABC to XYZ · ABC buying back its shares in a selective share buy back, constitute a scheme as defined by section 177A of the ITAA 1936. | Detailed Reasoning - Alternate Postulate and the tax benefit: A tax benefit in connection with a scheme includes an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out (paragraph 177C(1)(a) of the ITAA 1936). The identification of a tax benefit necessarily requires consideration of the income tax consequences, but for the operation of Part IVA, of an 'alternative hypothesis' or an 'alternate postulate'. This is what would have happened or might reasonably be expected to have happened, if the particular scheme had not been entered into or carried out. This alternative arrangement also forms the background against which the objective ascertainment of the dominant purpose of a person occurs in accordance with section 177D of the ITAA 1936. Under the scheme as described, you are not liable to taxation on the transfer of your shares in ABC to XYZ due to the roll-over relief afforded by Division 122 of the ITAA 1997. Your company XYZ will sell the shares in ABC back to ABC and receive capital and a fully franked dividend per share as consideration for the sale. As the cost base of XYZ's shares in ABC is equal to the capital consideration it will receive, there is no capital gain. However, an amount would be included in XYZ's assessable income for the franked dividends (subsection 44(1) of the ITAA 1936), and the associated franking credits (subsection 207-20(1) of the ITAA 1997). XYZ will be liable to taxation on the amount of fully franked dividends it receives at the company tax rate of 30 cents in the dollar. XYZ will make full use of the franking credits attached to the dividend distribution, effectively eliminating any taxation liability that would otherwise arise. The Commissioner considers it a reasonable alternative that you would not have interposed a company and instead would personally sell your ABC shares back to ABC when it undertakes the selective buy back. Part IVA does not prevent the interposition of entities per se. But where the interposition of an entity is part of a scheme to divert income which would have been (or might reasonably have been expected to have been) derived by the principal and having regard to the section 177D factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the taxpayer to obtain the tax benefit, it will attract the application of Part IVA. Under the alternate postulate, you personally would receive capital per share and franked dividends from ABC for each of the shares you held in ABC. As the cost base of your shares in ABC is equal to the capital consideration you would receive for these shares, there is no capital gain that you would include in your assessable income. However, an amount would be included in your assessable income for the franked dividends (subsection 44(1) of the ITAA 1936), and the associated franking credits (subsection 207-20(1) of the ITAA 1997). You would be liable to taxation on the amount of the fully franked dividends at the personal income tax rate of 45 cents in the dollar, plus Medicare. You would make full use of the franking credits attached to the dividend distribution, effectively reducing your taxation liability on the dividends by 30 cents in the dollar. The alternate postulate achieves the purpose of disposing of the shares in ABC and removing your remaining connection to ABC. This alternate postulate illustrates that, when compared to the tax effect under the scheme, it is apparent that you have an amount not included in your assessable income that might reasonably be expected to be included, but for the scheme (paragraph 177C(1)(a) of the ITAA 1936). It is noted that you would make full use of the franking credits attached to the dividends (in the amount of 30% per share). This is consistent to the scheme which results in the company receiving the fully franked dividend (and making full use of the attached franking credits). Given that you are in the 45% tax bracket plus Medicare levy, the imputation credit attached to the franked dividend would not be enough to offset the total amount of tax payable by you if you were in receipt of the income as described in the alternate postulate. Under the scheme, the imputation credit would have offset the total amount of tax payable on the dividends. | Detailed Reasoning - The dominant purpose to obtain a tax benefit (paragraph 177D(b)): Section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which the taxpayer has obtained a tax benefit if, after having regard to eight specified factors, it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. The consideration of purpose or dominant purpose under paragraph 177D(b) of the ITAA 1936 requires an objective conclusion to be drawn. The conclusion required by section 177D of the ITAA 1936 is not about a person's actual, i.e. subjective, dominant purpose or motive. It is possible for Part IVA to apply notwithstanding that the dominant purpose of obtaining the tax benefit was consistent with the pursuit of commercial gain. A conclusion about a relevant person's purpose for section 177D of the ITAA 1936 is the conclusion of a reasonable person based on all the facts and evidence that are relevant to considering the eight factors for the scheme. These eight factors and how we consider they apply to the scheme are described below. You are the relevant taxpayer. | Detailed Reasoning - (i) The manner in which the scheme is carried out: In considering the manner in which the scheme was entered into, or carried out, it is necessary to identify any aspect of the scheme that is apparently explicable for no purpose other than a tax purpose. The presence of a step or steps in a scheme that would not be expected to be present in a more straightforward or ordinary method of achieving the outcome of the scheme, may indicate that the scheme is artificial or contrived. In your case, the manner in which the scheme was carried out or entered into is more complicated or contrived when compared with the alternate postulate. Specifically, the interposition of XYZ between ABC and yourself, and the transfer of your shares in ABC to XYZ, is the insertion of steps into the transaction which is not commercially explicable when compared with the alternate postulate. The incorporation of XYZ, a non-trading company, and its interposition between ABC and yourself is not considered to be the way in which ordinary business or family dealings are conducted. This factor points toward the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. | Detailed Reasoning - (ii) The form and substance of the scheme: The economic and commercial substance of the scheme is the buy back of shares in ABC by ABC. In contrast, the form of the scheme involves steps interposing XYZ in the share buy back by ABC which has no effect on the economic or commercial substance or effect of the scheme, other than obtaining a tax benefit. XYZ was created and incorporated by you purely for the purpose of transferring the shares in ABC, and this new entity will not undertake any trading activities. By interposing XYZ between ABC and yourself, you will be able to obtain a tax benefit. This factor points toward the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. | Detailed Reasoning - (iii) The time at which the scheme was entered into and the length of the period during which the scheme was carried out: XYZ was incorporated following the decision that you and the other family member go your separate ways. In order to remove you as shareholder from ABC, a share buy back was proposed where ABC would buy back your shares in ABC. After coming to the decision that you were going to dispose of your shares in ABC you created and incorporated XYZ. You disposed of your shares in ABC to XYZ prior to the share buy back. You were also removed as director of ABC on the same day. The timing of the creation of the non-trading company XYZ, and the subsequent sale of your shares in ABC to XYZ point toward the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. | Detailed Reasoning - (iv) The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme: The income tax result that will be achieved by the scheme (but for Part IVA) for you when compared with the alternate postulate is that your assessable income will not include the fully franked dividend from ABC when the share buy back occurs. Under the scheme, your taxation liability is reduced, as is the Medicare levy that will be levied on you when compared with the alternate postulate. As you are in the 45% tax bracket plus Medicare levy, the franking credits attached to the dividends would not be enough to offset the total amount of tax that would be payable by you if you were to receive the dividends personally. The income tax result that will be achieved by the scheme (but for Part IVA) for XYZ is that it will include the fully franked dividends and associated franking credits in its assessable income when the share buy back occurs. As the company tax rate is 30%, XYZ will be able to eliminate its tax liability by utilising the franking credits attached to the fully franked dividends. As companies are not liable for the Medicare levy there will be no Medicare levy levied on the franked dividend. By directing the fully franked dividend to XYZ the amount of overall tax payable by you and your wholly owned company XYZ is lower due to the difference in income tax rates for you (45%, plus Medicare) as opposed to XYZ (30%). The reduction in income tax and Medicare levy payable by you point toward the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. (v) 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 By disposing of your ABC shares to XYZ you are able to reduce the amount of tax that you are personally liable for. Instead you (indirectly) pay a lesser amount of tax on the income in a company of which you are the sole director and shareholder. This factor points toward the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. (vi) 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 Under the alternate postulate XYZ would not have been created and incorporated. Under the scheme, XYZ was created and incorporated, and will receive the fully franked dividend and attached franking credits. You are the sole director and shareholder of XYZ. It is expected that you will benefit from the available cash in XYZ; however the form of this benefit is not known at this time. ABC will have a lower amount of retained profits after paying the dividend. This factor is neutral in reaching a conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. (vii) Any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out No other consequence is identified. This factor is neutral in reaching a conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. (viii) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi) You are the sole director and shareholder of XYZ. You and the other family member were both directors of ABC until you were removed as director and the new director was appointed. You and the other family member have been estranged for some time and very little communication goes on between you. This factor is neutral in reaching a conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. | Detailed Reasoning - Conclusion: While factors (vi) to (viii) are neutral, factors (i) to (v) point towards the conclusion that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. Factors (i) to (v) focus on how the scheme was implemented and the effects of the scheme. The scheme appears to be more complex than is necessary to achieve the relevant family or commercial objective, that is, you selling your shares in ABC so that you and the other family member can go your separate ways. The scheme includes the interposition of XYZ between ABC and yourself, a step that appears to serve no real purpose other than to gain a tax advantage. The results under the scheme, and change in financial position for you and your company XYZ, being an overall reduction in the taxation liability incurred on the sale of the shares in ABC leads to an objective conclusion that the dominant purpose for entering into the scheme was to obtain the tax benefit. When considering the eight factors individually and when weighed together in a practical and common sense way, it is clear that you entered into or carried out the scheme, or any part of it, for the dominant purpose of enabling yourself to obtain a tax benefit. As such, Part IVA of the ITAA 1936 applies. The Commissioner would make a determination under section 177F of the ITAA 1936 to cancel the tax benefit that will be obtained, or would, but for section 177F be obtained, by you in connection with the scheme.