Private ruling: Proposed issue of shares
Published: March 2015
Ruling period: Year ending 30 June 2015 | Year ending 30 June 2016 | Year ending 30 June 2017 | Year ending 30 June 2018 | Year ending 30 June 2019 | Year ending 30 June 2020
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the Class Shares be treated as equity interests under Division 974 of the Income Tax Assessment Act 1997 (ITAA 1997) upon issue? | A1: Yes | Q2: Will dividends paid in respect of the Class Shares be frankable distributions, as defined in section 202-40 of the ITAA 1997? | A2: Yes | Q3: Will the holders of the Class Shares satisfy the definition of being a qualified person? | A3: Yes | Q4: Can it be concluded that the proposed issue of the Class Shares will be done for the purpose of enabling the relevant taxpayers to obtain an imputation benefit as per section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936)? | A4: No | Q5: Will the streaming distribution provisions contained in Subdivision 204-D of the ITAA 1997 apply in relation to any future payments of dividends on the Class Shares? | A5: No | Q6: Will the dividend stripping provisions contained in section 177E of the ITAA 1936 and section 207-155 of the ITAA 1997 apply in relation to any future payment of dividends on the Class Shares? | A6: No | Q7: Will the distribution washing provisions, as contained in section 207-157 of the ITAA 1997, apply to the proposed payment of future dividends on the Class Shares? | A7: No | Q8: Will the franking credit gross-up and offset rule in section 207-20 of the ITAA 1997 apply to the holders of the Class Shares in Newco? | A8: Yes | Q9: Will the proposed issue of Class Shares result in a direct value shift under Division 725 of the ITAA 1997 and result in CGT event K8 happening under section 104-250 of the ITAA 1997? | A9: No | Q10: Will the declaration of dividends in respect of the Class Shares by Newco give rise to a direct value shift under Division 725 of the ITAA 1997 and result in CGT event K8 happening under section 104-250 of the ITAA 1997? | A10: No

Relevant facts and circumstances: 1. Newco is a private company that was established as part of a group restructure to facilitate the investment in a business by an unrelated, third party. 2. The share capital of Newco will initially be made-up of ordinary shares. 3. Under the proposed scheme, the unrelated, third party will acquire more than 50% of the ordinary shares in Newco. 4. Newco then proposes to issue Class Shares which primarily entitle its holders (Class Shareholders) to a preferential, pre-determined dividend which is calculated and contingent on the future performance of Newco. 5. At a high level, the issue and terms of the Class Shares are designed to provide the original owners of Newco with an incentive to facilitate growth of the business and achieve 'super' profits. 6. The special dividend rights attaching to each Class Share will cease to exist after 5 years when each Class Share will automatically be reclassified as an ordinary share and from that time will carry the same rights as, and be treated pari passu with, other ordinary shares. 7. Dividends that are declared in respect of the Class Shares will be paid to the Class Shareholders of the shares within four years of being declared. 8. The proposed terms of the Class Shares provide that no transfer of these shares will be permitted in the first five years except in special circumstances. 9. At the time that the proposed scheme is implemented, Newco and its subsidiary entities, are not expected to have any retained earnings. Assumptions 10. The shareholders of Newco will be Australian resident entities, as defined in subsection 6(1) of the ITAA 1936. 11. One shareholder in Newco will be an exempting entity as defined in subsection 208-5(1) of the ITAA 1997. 12. Newco will not be an exempting entity. 13. None of the requirements listed in paragraphs 202-45(b) to 202-45(j) of the ITAA 1997 will apply to any future dividends that are to be paid by Newco on the Class Shares. 14. The Class Shareholders will not enter into any 'related payments' as the term is understood in former sections 160APHN and 160APHNA of the ITAA 1936. 15. The Class Shareholders will not enter into any options, futures, other derivative instruments nor use non-recourse finance in respect of the Class Shares, such that they will have materially diminished risks of loss or opportunities for gain, as that term is understood in former section 160APHM of the ITAA 1936. 16. No dividends will be paid on the Class Shares within the first 90 days after they are first issued. 17. The sum of the decrease (if any) in the market value of all the ordinary shares in Newco as a result of the issue of the Class Shares will be less than $150,000.

Relevant legislative provisions: Income Tax Assessment Act 1997, section 104-250 | Income Tax Assessment Act 1997, section 202-30 | Income Tax Assessment Act 1997, section 202-40 | Income Tax Assessment Act 1997, section 202-45 | Income Tax Assessment Act 1997, Subdivision 204-D | Income Tax Assessment Act 1997, section 204-30 | Income Tax Assessment Act 1997, section 207-20 | Income Tax Assessment Act 1997, section 207-70 | Income Tax Assessment Act 1997, section 207-75 | Income Tax Assessment Act 1997, paragraph 207-145(1)(a) | Income Tax Assessment Act 1997, section 207-155 | Income Tax Assessment Act 1997, section 207-157 | Income Tax Assessment Act 1997, subsection 208-5(1) | Income Tax Assessment Act 1997, Division 725 | Income Tax Assessment Act 1997, subsection 725-70(1) | Income Tax Assessment Act 1997, subsection 725-90(1) | Income Tax Assessment Act 1997, paragraph 725-145(1)(b) | Income Tax Assessment Act 1997, subsection 960-120(1) | Income Tax Assessment Act 1997, section 960-130 | Income Tax Assessment Act 1997, section 960-135 | Income Tax Assessment Act 1997, Division 974 | Income Tax Assessment Act 1997, subsection 974-15(1) | Income Tax Assessment Act 1997, section 974-20 | Income Tax Assessment Act 1997, section 974-70 | Income Tax Assessment Act 1997, section 974-75 | Income Tax Assessment Act 1997, subsection 974-120(1) | Income Tax Assessment Act 1997, section 974-135 | Income Tax Assessment Act 1997, paragraph 974-160(1)(a) | Income Tax Assessment Act 1997, subsection 995-1(1) | Income Tax Assessment Act 1936, subsection 6(1) | Income Tax Assessment Act 1936, former Division 1A | Income Tax Assessment Act 1936 , former section 160APHD | Income Tax Assessment Act 1936 , former section 160APHM | Income Tax Assessment Act 1936 , former section 160APHN | Income Tax Assessment Act 1936 , former section 160APHNA | Income Tax Assessment Act 1936 , former section 160APHO | Income Tax Assessment Act 1936, section 177E and | Income Tax Assessment Act 1936, section 177EA.

Reasons for decision: Summary: 18. The Class Shares are considered to be equity interests under Subdivision 974-C of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 19. The Class Shares satisfy the equity test in subsection 974-75(1) of the ITAA 1997. The Class Shares fail the debt test in subsection 974-20(1) of the ITAA 1997 as they do not meet the effectively non-contingent obligation requirement in paragraph (c) of that subsection. Equity test 20. Section 974-75 of the ITAA 1997 sets out the requirements for a scheme to satisfy the equity test in relation to a company. 21. The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The issue of the Class Shares would fall within the definition of a scheme. 22. A scheme gives rise to an equity interest in the company under section 974-70 of the ITAA 1997 if the scheme satisfies the equity test in section 974-75 of the ITAA 1997 and the interest is not a debt interest under section 974-20 of the ITAA 1997. 23. A scheme satisfies the equity test in relation to a company if it gives rise to an interest of the kind listed in subsection 974-75(1) of the ITAA 1997 which are: 1 An interest in the company as a member or stockholder. 2 An interest that carries a right to a variable or fixed return from the company where the right or the amount of the return is in substance or effect contingent on the economic performance (whether past, current or future) of the company or a 'connected entity'. 3 An interest that carries a right to a variable or fixed return from the company where the right or the amount of the return is at the discretion of the company or a connected entity. 4 An interest issued by the company that: (a) gives its holder (or a connected entity of the holder) a right to be issued with an equity interest in the company or a connected entity of the company; or (b) is an interest that will or may convert into an equity interest in the company or a connected entity of the company. 24. Each Class Share will satisfy the equity test in subsection 974-75(1) of the ITAA 1997 as the interest arising from its issue is an interest covered by item 1 of the table listed in subsection 974-75(1) of the ITAA 1997. 25. As item 1 of the table listed in subsection 974-75(1) of the ITAA 1997 is satisfied it is unnecessary, in the present context, to further consider whether any other items in the table are also satisfied for the purposes of passing the equity test. 26. Therefore, each Class Share will be an equity interest unless they are characterised as debt interests under section 974-20 of the ITAA 1997. Debt test 27. 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). 28. 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. 29. The application of the debt test to the Class Shares is considered below. In order to satisfy the debt test, the scheme must satisfy all five limbs in subsection 974-20(1) of the ITAA 1997. (a) the scheme is a financing arrangement for the entity. 30. As the scheme gives rise to an interest covered by item 1 of the table in subsection 974-75(1) of the ITAA 1997, subsection 974-120(1) of the ITAA 1997 stipulates that this requirement of the debt test does not need to be satisfied. (b) the entity, or connected entity of the entity, receives or will receive a financial benefit or benefits under the scheme. 31. Subsection 974-20(4) of the ITAA 1997 inter alia provides that a financial benefit to be received is taken into account only if it is one that another entity has an effectively non-contingent obligation to provide. The concept of effectively non-contingent obligation is discussed below under requirement (c). 32. Under the terms of the Class Shares, the Class Shareholder must pay a subscription price. 33. Newco will therefore receive a financial benefit under the scheme, namely the subscription price for each Class Share, as paragraph 974-160(1)(a) of the ITAA 1997 states that a financial benefit includes 'anything of economic value'. A Class Shareholder who subscribes for the Class Shares will have an effectively non-contingent obligation to provide the subscription price. 34. This requirement of the debt test is therefore satisfied. (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. 35. An 'effectively non-contingent obligation' is defined in subsection 995-1(1) of the ITAA 1997 to have the meaning given in section 974-135 of the ITAA 1997. 36. Subsection 974-135(1) of the ITAA 1997 states that there is an effectively non-contingent obligation to take action under a scheme if, having regard to the pricing, terms and conditions of the scheme, there is in substance or effect a non-contingent obligation to take that action. 37. Subsection 974-135(3) of the ITAA 1997 provides inter alia that an effectively non-contingent obligation is an obligation that is not contingent on any event, condition or situation other than the ability or willingness of that entity or connected entity to meet the obligation. 38. The relevant obligations that fall for consideration under section 974-135 of the ITAA 1997 are Newco's obligations to: (i) pay dividends on the Class Share, and (ii) return any amount of the issue price of the Class Share 39. In relation to the obligation to pay dividends, it is evident that under the terms of the Class Shares, the payment of dividends on these shares by Newco is contingent upon the profitability of the company. As a result of this attribute, the dividend rights attaching to the Class Shares will not provide an effectively non-contingent obligation to provide a financial benefit. 40. Under the terms of the Class Shares, the Class Shareholders may also receive an amount equal to the redemption amount in respect of each Class Share held. The receipt of such a payment will however only occur in the event of a winding up of Newco or a reduction of capital and therefore is also not considered to create an effectively non-contingent obligation to provide a financial benefit. 41. Because Newco, and any connected entity, does not have an effectively non-contingent obligation to provide a financial benefit in relation to the Class Shares, the Class Shares will not satisfy the debt test in subsection 974-20(1) of the ITAA 1997 and accordingly we have not considered the application of paragraphs 974-20(1)(d) and 974-20(1)(e) of the ITAA 1997 to the present situation. 42. Therefore in accordance with section 974-70 of the ITAA 1997, as the Class Shares fail the debt test, they will constitute equity interests in Newco. | Detailed Reasoning - Question 2: Will dividends paid in respect of the Class Shares be frankable distributions, as defined in section 202-40 of the ITAA 1997? | Summary: 43. The Class Shares are equity interests as defined in section 974-75 of the ITAA 1997. The distributions under the Class Shares do not fall under any of the paragraphs in section 202-45 of the ITAA 1997. Therefore, the distributions of dividends from Newco to the Class Shareholders are capable of being franked under section 202-40 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 44. Any dividends paid on the Class Shares will be a distribution in accordance with item 1 in the table in subsection 960-120(1) of the ITAA 1997. Section 202-30 of the ITAA 1997 provides that distributions and non-share dividends are frankable unless it is specified they are unfrankable. Subsection 202-40(1) of the ITAA 1997 provides that a distribution is frankable to the extent that it is not unfrankable under section 202-45 of the ITAA 1997. 45. Section 202-45 of the ITAA 1997 specifically states: The following are unfrankable: (a) (Repealed by No 101 of 2003) (b) a distribution to which paragraph 24J(2)(a) of the Income Tax Assessment Act 1936 applies that is taken under section 24J of the Income Tax Assessment Act 1936 to be *derived from sources in a prescribed Territory, as defined in subsection 24B(1) of the Income Tax Assessment Act 1936 (distributions by certain *corporate tax entities from sources in Norfolk Island); (c) where the purchase price on the buy-back of a *share by a *company from one of its *members is taken to be a dividend under section 159GZZZP of that Act - so much of that purchase price as exceeds what would be the market value (as normally understood) of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place; (d) a distribution in respect of a *non-equity share; (e) a distribution that is sourced, directly or indirectly, from a company's *share capital account; (f) an amount that is taken to be an unfrankable distribution under section 215-10 or 215-15; (g) an amount that is taken to be a dividend for any purpose under any of the following provisions: (i) unless subsection 109RB(6) or 109RC(2) applies in relation to the amount - Division 7A of Part III of that Act (distributions to entities connected with a *private company); (ii) (Repealed by No 79 of 2007); (iii) section 109 of that Act (excessive payments to shareholders, directors and associates); (iv) section 47A of that Act (distribution benefits - CFCs); (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 45C of that Act (streaming dividends and capital benefits); (i) a *demerger dividend; (j) a distribution that section 152-125 or 220-105 says is unfrankable. 46. For the purposes of this ruling, the Commissioner has assumed that none of the requirements, listed in paragraphs 202-45(b) to 202-45(j) of the ITAA 1997, will apply to any future dividends that are paid by Newco on its Class Shares. It is also noted that as a consequence of the conclusion reached in relation to Question 1 above that the Class Shares are an equity interest, paragraph 202-45(d) of the ITAA 1997 will have no application. On this basis, it is therefore considered that any dividends paid on the Class Shares will not fall within the items listed in section 202-45 of the ITAA 1997. 47. The dividends paid in respect of the Class Shares will therefore be frankable distributions within the meaning of sections 202-30 and 202-40 of the ITAA 1997 . | Detailed Reasoning - Question 3: Will the holders of the Class Shares satisfy the definition of being a qualified person? | Summary: 48. It is considered that a Class Shareholder will be a 'qualified person' in relation to a dividend paid in respect of their Class Shares and therefore will be entitled to a tax offset in respect of the franking credit allocated to that dividend. | Detailed Reasoning - Detailed reasoning: 49. Pursuant to paragraph 207-145(1)(a) of the ITAA 1997, an entity must be a 'qualified person' in relation to a dividend in order to be entitled to a tax offset in respect of the franking credit allocated to the dividend. 50. Division 1A of former Part IIIAA of the ITAA 1936 (the former Division 1A) contains the measures known as the holding period rule and the related payment rule. In broad terms, the former Division 1A of the ITAA 1936 provides the statutory tests that must be satisfied for a taxpayer to be a 'qualified person' with respect to a franked distribution they have received and thus be entitled to a tax offset for the franking credit attached to the distribution. 51. The test of what constitutes a 'qualified person' is provided in former section 160APHO of the ITAA 1936 as follows: A taxpayer who has held shares or an interest in shares on which a dividend has been paid is a qualified person in relation to the dividend if: (a) where neither the taxpayer nor an associate of the taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the primary qualification period in relation to the dividend; or (b) where the taxpayer or an associate of a taxpayer has made, is under an obligation to make, or is likely to make, a related payment in respect of the dividend - the taxpayer has satisfied subsection (2) in relation to the secondary qualification period in relation to the dividend. 52. Former subsection 160APHO(2) of the ITAA 1936, referred to in the preceding paragraph, sets out the holding period requirement. Broadly, if a taxpayer is not under an obligation to make a related payment in relation to a dividend or distribution, the taxpayer will have to satisfy the holding period requirement within the primary qualification period. If a taxpayer is under an obligation to make a related payment in relation to a dividend or distribution, the taxpayer will have to satisfy the holding period requirement within the secondary qualification period. 53. For the purposes of this ruling, it has been assumed that a Class Shareholder will not be under an obligation to make a related payment in relation to a dividend received from Newco. Consequently a Class Shareholder will be required to satisfy the holding period requirement within the primary qualification period. 54. In the current circumstances, the Class Shares are considered to be, prior to their reclassification, preference shares. Therefore to satisfy the holding period rule, a Class Shareholder must have continuously held their Class Shares 'at risk' for at least 90 days during the primary qualification period (former paragraph 160APHO(1)(a) of the ITAA 1936). It is noted that when calculating the 90 day period the day of acquisition of the shares, the day (if any) on which the shares were disposed of, and any days on which a shareholder has materially diminished risks of loss or opportunities for gain in respect of the shares are excluded. 55. The primary qualification period, as described in the former section 160APHD of the ITAA 1936, will begin on the day after the day on which a Class Shareholder acquires their Class Shares and end on the 90th day after the day on which the Class Shares become ex dividend in relation to the entitlement to receive any dividend. 56. For the purposes of this ruling, it has been assumed that a Class Shareholder will not have materially diminished risks of loss or opportunities for gain in respect of their Class Shares and that no dividends will be paid on the Class Shares within the first 90 days after they are first issued. On this basis, a Class Shareholder will be a 'qualified person' in relation to any dividend paid by Newco and be entitled to a tax offset in respect of the franking credit allocated to that dividend. | Detailed Reasoning - Question 4: Can it be concluded that the proposed issue of the Class Shares will be done for the purpose of enabling the relevant taxpayers to obtain an imputation benefit as per section 177EA of the ITAA 1936? | Summary: 57. The issuing of the Class Shares will not be a scheme or arrangement to which section 177EA of the ITAA 1936 applies. | Detailed Reasoning - Detailed reasoning: 58. Section 177EA of the ITAA 1936 is a general anti avoidance provision that applies where one of the purposes (other than an incidental purpose) of the scheme is to obtain an imputation benefit. 59. Specifically, section 177EA of the ITAA 1936 applies if the following conditions, set-out in subsection 177EA(3) of the ITAA 1936 are satisfied: (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 expected to be payable, to a person 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; and (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. 60. It is considered that the conditions in paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied in respect of the issue of the Class Shares because: (a) the issue of Class Shares constitutes a scheme for the disposition of a membership interest (paragraph 177EA(3)(a) of the ITAA 1936). Pursuant to paragraph 177EA(14)(a) of the ITAA 1936, a 'scheme for a disposition of membership interests or an interest in membership interests' includes a scheme that involves the issuing of membership interests. The issuance of Class Shares is a scheme that involves the issuing of membership interests because, once the Class Shares are issued, the Class Shareholders are members of Newco and the Class Shares are not debt interests (sections 960-130 and 960-135 of the ITAA 1997); (b) frankable distributions are expected to be payable to the Class Shareholders (paragraph 177EA(3)(b) of the ITAA 1936). The Commissioner accepts that dividends payable to the Class Shareholders will be frankable distributions to the extent that the dividends on the Class Shares do not fall within the list of unfrankable distributions in section 202-45 of the ITAA 1997; (c) franked distributions are expected to be paid to the Class Shareholders (paragraph 177EA(3)(c) of the ITAA 1936). It is expected that these distributions will be franked; and (d) it is reasonable to expect that an imputation benefit will be received by the relevant taxpayers as a result of distributions made to the Class Shareholders given that Newco expects to frank the distributions on the Class Shares: paragraph 177EA(3)(d) of the ITAA 1936. 61. As the threshold requirements of section 177EA of the ITAA 1936 have been met, it is necessary to consider the 'relevant circumstances' of the scheme in determining whether it could 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 the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit. 62. In the current circumstances, it is evident that the issue of the Class Shares is primarily a commercial decision that has been implemented to incentivise the Class Shareholders to grow the business and thus attract a greater share of the profits in the relevant years. 63. Additionally, it is considered that the characteristics of the Class Shares do not readily lend themselves to franking credit trading because: • the proportion of net profit that is distributed amongst the Class Shares and ordinary shares in Newco is predetermined in the terms of the Class Shares; • Newco does not have any existing profits as at the time of sale of shares to the unrelated, third party and the allocation of the Class Shares; • the payment of a dividend on the Class Shares prior to their reclassification is contingent on Newco's net profit in each year; • if Newco's net profit does not exceed the pre-determined targets, dividends will be paid to the holders of ordinary shares in proportion to their holdings; • dividends paid on the Class Shares and ordinary shares will be franked to the same percentage; • prior to their reclassification, the Class Shares cannot be transferred except in exceptional circumstances; and • the shareholders in Newco are Australian residents as defined in subsection 6(1) of the ITAA 1936. 64. Taking the above into account, it is considered that any imputation benefit received by the Class Shareholders will merely be incidental to the commercial purposes outlined. 65. Thus, based on what you have told us, section 177EA of the ITAA 1936 will have no application to the future payment of dividends to the Class Shareholders. | Detailed Reasoning - Question 5: Will the streaming distribution provisions contained in Subdivision 204-D of the ITAA 1997 apply in relation to any future payments of dividends on the Class Shares? | Summary: 66. The Commissioner will not make a determination under Subdivision 204-D of the ITAA 1997 that the imputation benefits attaching to dividends paid on the Class Shares are being streamed. | Detailed Reasoning - Detailed reasoning: 67. 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. 68. 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. 69. 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. 70. 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: (a) is not an Australian resident; (b) is not entitled to use the tax offset under Division 207 of the ITAA 1997; (c) 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; (d) 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; (e) 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; and (f) is an exempting entity. 71. In the current circumstances, one of the shareholders in Newco is an exempting entity (as defined in subsection 208-5(1) of the ITAA 1997) and therefore other shareholders in Newco, who are Australian residents, may derive a greater benefit from the franking credits attached to any dividends paid by Newco. 72. It is therefore necessary to consider whether, under the proposed scheme, Newco can be considered to 'stream' its distributions to those shareholders who will derive a greater benefit from the franking credits. 73. The terms streams and streaming are not defined for the purposes of Subdivision 204-D of the ITAA 1997, however it is understood to refer to a company selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits: refer to paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill of 2002. 74. In the current circumstances, it is evident from the terms of the Class Shares that, once the net profit of Newco exceeds specified targets, the quantum of the dividend (and in turn the quantum of the associated franking credits) that is paid to the Class Shareholders increases significantly. It is arguable that this attribute directs a greater proportion of franking credits to Australian residents that are better able to utilise the associated franking credits than otherwise may have been paid to an exempting entity. 75. However, in contrast, the following features suggest that Newco is not streaming franking credits to those shareholders who will derive a greater benefit from the franking credits: • any dividends paid to the Class Shareholders and ordinary shareholders will be franked to the same extent; • the terms and entitlements associated with the Class Shares have been pre-determined prior to their issue; • if Newco's net profit does not exceed the specified targets, any dividends will be paid to the holders of ordinary shares in proportion to their holdings; • although the Class Shareholders receive a greater proportion of the net profit of Newco once the specified targets are exceeded, this dividend will not be paid to the total exclusion of the other shareholders who still receive a dividend; and • there are valid commercial reasons for the structure of the different types of shares in Newco and the associated dividend rights. 76. Taking the above into consideration, 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. | Detailed Reasoning - Question 6: Will the dividend stripping provisions contained in section 177E of the ITAA 1936 and section 207-155 of the ITAA 1997 apply in relation to any future payment of dividends on the Class Shares? | Summary: 77. The Commissioner does not consider that the scheme involving the issue of the Class Shares is a dividend stripping scheme, as intended by section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936 and therefore the frankability of any dividends paid on the Class Shares will not be affected by these provisions. | Detailed Reasoning - Detailed reasoning: 78. 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. 79. 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. 80. 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. 81. 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 to10 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. 82. 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 is: • the vendor shareholders [receive] 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 [is] 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. 83. In the current circumstances, at the time that the Class Shares are issued, Newco and its subsidiary entities do not have any accumulated profits. Any dividends paid on the Class Shares will therefore not be attributable to profits that have accumulated prior to the issue. The Commissioner therefore does not consider that the issue of the Class Shares is a dividend stripping scheme, as intended by section 207-155 of the ITAA 1997, or section 177E of the ITAA 1936 and therefore the frankability of any dividends paid on the Class Shares will not be affected by these provisions. | Detailed Reasoning - Question 7: Will the distribution washing provisions, as contained in section 207-157 of the ITAA 1997 apply to the proposed payment of future dividends on the Class Shares? | Summary: 84. The distribution washing provisions contained in section 207-157 of the ITAA 1997 will not apply to the proposed payment of future dividends on the Class Shares. | Detailed Reasoning - Detailed reasoning: 85. Section 207-157 of the ITAA 1997 applies to a franked distribution received by a member of a corporate tax entity on a membership interest (the washed interest ) if: (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. 86. A membership interest is 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; or (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). 87. If the conditions in section 207-157 of the ITAA 1997 are met, a member will not be entitled to a franking credit gross-up and offset on the distribution. 88. The proposed restructure involves the Newco Shareholders disposing of some Newco ordinary shares to an unrelated, third party as well as the issuance of new Class Shares to some Newco Shareholders. The Commissioner accepts that, for the initial five years of the proposed restructure, the Newco ordinary shares and Class Shares are not substantially identical in the manner envisaged in subsection 207-157(3) of the ITAA 1997. In addition, there is also no dividend distribution declared or payable prior to the proposed disposal of Newco ordinary shares to the unrelated, third party. Accordingly, section 207-157 of the ITAA 1997 will not apply to the proposed payment of future dividends on the Class Shares. 89. It should be noted that the Commissioner has not considered the application of the distribution washing provisions to any dividend distribution following any potential sale or transfer of the Class Shares in the event that the Class Shareholders exercise their put or call options, or that a Relevant Event occurs. | Detailed Reasoning - Question 8: Will the franking credit gross-up and offset rule in section 207-20 of the ITAA 1997 apply to the holders of the Class Shares in Newco? | Summary: 90. 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. 91. 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. 92. Based on the facts of the proposed arrangement, the assumptions outlined at the start of this ruling and the analysis detailed above, none of the integrity measures will affect the availability of franking credits for recipients of dividends relating to the Class Shares. | Detailed Reasoning - Detailed reasoning: 93. 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. 94. 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. Recipient must satisfy the residency requirement 95. Section 207-70 of the ITAA 1997 denies an entitlement to franking credits if the entity receiving the franked distribution does not satisfy the residency requirement contained in section 207-75 of the ITAA 1997. 96. In the current circumstances, it has been assumed for the purposes of this ruling that all the Class Shareholders are Australian residents and therefore the residency requirement in section 207-75 of the ITAA 1997 will be satisfied and consequently section 207-70 of the ITAA 1997 will have no application. Other integrity measures affecting the availability of franking credits for recipients 97. 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. 98. Section 207-145 of the ITAA 1997 sets out the following circumstances 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 franking credit benefit determination under paragraph 177EA(5)(b) of the ITAA 1936, general anti-avoidance rules relating to franking credit trading and dividend streaming; • 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, or • the distribution is one to which section 207-157 of the ITAA 1997 (about distribution washing) applies. 99. As detailed in the above analysis in Questions 3 to 7, the Commissioner considers that, based on the facts of the proposed scheme, the availability of franking credits on dividends paid on the Class Shares will not be affected by the exclusions specified in section 207-145 of the ITAA 1997. 100. It is therefore considered that the franking credit gross-up and offset rule in section 207-20 of the ITAA 1997 will apply on dividends paid to the holders of the Class Shares in Newco. | Detailed Reasoning - Question 9: Will the proposed issue of Class Shares result in a direct value shift under Division 725 of the ITAA 1997 and result in CGT event K8 happening under section 104-250 of the ITAA 1997? | Summary: 101. The total decrease in the market value (if any) of the ordinary shares that is attributable to any direct value shift arising from the issue of the Class Shares will be less than $150,000. Consequently subsection 725-70(1) of the ITAA 1997 will preclude the arrangement from any consequences under the direct value shifting rules in Division 725 of the ITAA 1997 and therefore CGT event K8 will not happen as a result of the issue of the Class Shares. | Detailed Reasoning - Detailed reasoning: 102. 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). 103. 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 (see CGT event K8 in section 104-250 of the ITAA 1997). 104. A direct value shift will not have consequences under Division 725 of the ITAA 1997 if the sum of the decreases in market value of all the down interests under the same scheme does not exceed $150,000: subsection 725-70(1) of the ITAA 1997. 105. In this regard, subsection 725-70(1) of the ITAA 1997 specifically states: For a down interest of which you are an affected owner, the direct value shift has consequences under this Division only if the sum of the decreases in the market value of all down interests because of direct value shifts under the same scheme as the direct value shift is at least $150,000. 106. In the current circumstances, Newco intends to issue the Class Shares for $1 each. You have contended that the issue price reflects the market value of this interest taking into consideration the entitlements attaching to the Class Shares. For the purposes of this ruling, it has been assumed that the sum of the decrease (if any) in the market value of all the ordinary shares in Newco as a result of the issue of the Class Shares will be less than $150,000. 107. Therefore as the total decrease (if any) in the market value of the ordinary shares that is attributable to the direct value shift is less than $150,000, subsection 725-70(1) of the ITAA 1997 will preclude the arrangement from any consequences under the direct value shifting rules in Division 725 of the ITAA 1997. | Detailed Reasoning - Question 10: Will the declaration of dividends in respect of the Class Shares by Newco give rise to a direct value shift under Division 725 of the ITAA 1997 and result in CGT event K8 happening under section 104-250 of the ITAA 1997? | Summary: 108. The declaration of dividends in respect of the Class Shares by Newco will not trigger CGT event K8 by virtue of the direct value shifting rules contained in Division 725 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 109. As previously noted, a direct value shift under section 725-145 of the ITAA 1997 occurs 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). 110. Based on the terms of the Class Shares, you have indicated that the value of the Class Shares (the up interests) may increase and the value of the ordinary shares (the down interests) may decrease when Newco declares a dividend in relation to the Class Shares. 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. 111. 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. 112. 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. 113. The relevant state of affairs here is that a dividend is payable to the holders of the Class Shares. 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.

Will the Class Shares be treated as equity interests under Division 974 of the ITAA 1997 upon issue?