Private ruling: Preference shares
Date of advice: 14 February 2017
Published: August 2017
Ruling period: 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 2016

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 the issue of, and subsequent 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 New H and New OH? | A8: Yes | Q9: Will the proposed issue of the 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 New H and New OH 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: This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling. 1. The Group is a privately owned company. Whilst its head office is located in Australia, the Group has global operations with subsidiary entities in overseas countries. 2. The ultimate holding company of the Group is the Corporation and it has formed a tax consolidated group for Australian income tax purposes. The current shareholders of the Corporation comprise one non resident individual, trusts and superannuation funds controlled by persons who include the current and former key executives and management of the Group (“ the Corporation Shareholders ”). 3. The A Co. is an Australian private company, and is a wholly owned subsidiary of J Co. A Co. has formed a tax consolidated group for Australian income tax purposes, which includes all of its Australian 100% owned subsidiaries, including CA Co., a private company. 4. In 20XX, A Co., via its wholly owned subsidiary CA Co., acquired a X% interest in B Co., a private company. The transaction was J Co.'s first investment within Australia, and it was undertaken with the intention that B Co. would become one of Australia's Tier 1 companies in the industry. 5. In order to facilitate the introduction of J Co. as a new investor to the Group it is contemplating a restructure of its group. Broadly, it is envisaged the restructure will result in the following: 6.3 Certain assets and liabilities of the Group's Australian operations, together with the Group's interest in an incorporated overseas joint venture will be transferred to a new company, “ New H ”, of which A Co., via its wholly‐owned subsidiary CA Co., will acquire a X% interest in (with the remaining Y% held by the Corporation Shareholders). This transaction will be referred to as the “ New H Transaction ”; 6.4 The shares in the Group's other overseas operations will be transferred to a new company, “ New OH ”, of which A Co., via a wholly‐owned subsidiary New HH, will acquire a X% interest in (with the remaining Y% held by the Corporation Shareholders). This transaction will be referred to as the “ New OH Transaction ”. 6. Both New H and New OH will be private companies that are residents of Australia for income tax purposes. The shareholders of New H will be CA Co. and the Corporation Shareholders, with CA Co. holding X% of the ordinary shares, whilst the Corporation Shareholders will hold the remaining Y%. The shareholders of New OH will be New HH and the Corporation Shareholders, with New HH holding X% of the Ordinary shares, whilst the Corporation Shareholders will hold the remaining Y%. 7. With one exception, namely one non resident individual, the shareholders of New H and New OH will be Australian resident entities, as defined in section 6(1) of the ITAA 1936. 8. A Co., (as the new ultimate shareholder) wishes the Corporation Shareholders to have a continued key role in the management and direction of both New H and New OH. They have therefore agreed (as a part of the proposed acquisition of the X% interest in both companies) that special Class A Shares and Class B Shares (collectively “the Class Shares”) be issued to the two shareholding groups. The relevant terms and conditions of each arrangement are outlined below. The New H Arrangement 9. The current terms of the Class Shares in New H have been provided and form part of the factual scheme ruled upon. 10. The proposed terms of the New H Ordinary Shares, Class A Shares and Class B shares are as follows: a. For the first three income years, New H's profit distribution policy will require it to distribute 100% of the consolidated profit (after‐tax) to shareholders, unless otherwise resolved by the Board. b. Ordinary Shares will have rights to dividends, capital and voting, pari passu based on the number of shares held. However, the rights to dividends will be subject to preferential dividend rights attaching to the Class Shares, which will be issued to the relevant shareholders as outlined below. c. In the first three years, the Class Shares will have a right to dividends where net profits exceed a target amount for an income year. During these years, the shares will have no voting rights (or rights to attend general meetings) and will not have any rights to participate in share capital (other than a return of the issue price of $1 per share in the event of a Winding Up of the Company). The preferential dividend rights of the Class Shares would be as follows: i. Where net profit is less than the target amount for an income year, Class Shares will not participate in any of the dividends of New H. The ordinary shareholders would therefore have a right to all dividends , pari passu , consisting of 100% of the net profit. ii. Where net profit is equal to or greater than the target amount but below a second target amount for an income year, Class A Shares will have a preferential right to a dividend consisting of a certain percentage of the net profits between this threshold, and Class B Shares would have a preferential right to a dividend consisting of a certain percentage of the net profits between this threshold. Ordinary shareholders would participate in the total residual net profits, pari passu . iii. Where net profit is equal to or greater than the second target amount for an income year, Class A Shares will have a right to a preferential dividend consisting of a certain percentage of the net profits over this range, and Class B shares would have a preferential right to a dividend consisting of certain percentage of the net profits over this range. The Class A preferential rights and Class B preferential rights outlined above would remain for the net profit component between the first and second target amounts. The ordinary shareholders would participate in the total residual net profits, pari passu . The New OH Arrangement 11. The terms of the New OH Ordinary Shares, Class A Shares and Class B shares are proposed to be established as follows. a. New OH's profit distribution policy is such that it will not pay annual dividends during the first two years after the New OH Transaction, but it will be required to distribute 100% of the aggregated net profit (after-tax) over the first three income years following the New OH Transaction. b. Ordinary Shares will have rights to dividends, capital and voting, pari passu based on the number of shares held. However, the rights to dividends will be subject to preferential dividend rights attaching to Class A and Class B shares, which will be issued to the relevant shareholders as outlined below. c. In the first three years, the Class Shares will have a right to dividends where the aggregated net profit during the first three income years exceeds a target amount. During this period, the shares will have no voting rights (or rights to attend general meetings) and will not have any rights to participate in share capital (other than a return of the issue price of $1 per share in the event of a Winding Up of the Company). The preferential dividend rights of the Class Shares would be as follows: i. Where aggregated net profit over the three year period is less than the target amount, the Class Shares will not participate in any of dividends of New OH. The ordinary shareholders would therefore have a right to all dividends, pari passu , consisting of 100% of the aggregated net profit. ii. Where aggregated net profit over the three year period is equal to or greater than the target amount but below a second target amount, Class A Shares will have a preferential right to a dividend consisting of a certain percentage of the net profits between this threshold, and Class B Shares would have a preferential right to a dividend consisting of a certain percentage of the net profits between this threshold. Ordinary shareholders would participate in the total residual net profits, pari passu . iii. Where aggregated net profit over the three year period is equal to or greater than the second target amount, Class A Shares will have a preferential right to a dividend consisting of a certain percentage of the net profits over this range, and Class B shares would have a preferential right to a dividend consisting of a certain percentage of the net profits over this range. The Class A preferential rights and Class B preferential rights outlined above would remain for the net profit component between the first and second target amounts. The ordinary shareholders would participate in the total residual net profits, pari passu . Terms common to both Arrangements 12. Whilst the profit distribution policy for New H will differ from that of New OH, there are certain terms and conditions of the New H Class Shares that are the same as the New OH Class A Shares and Class B Shares. These are as follows: a. The proposed terms of the Class Shares provide that no transfer of the shares will be permitted in the first three years except in specific circumstances as defined. b. At the end of three years, the Class Shares will have no profit distribution rights. There will remain a preferred entitlement that is limited to the amount of capital subscribed. 13. CA Co. and the Corporation Shareholders have agreed the price for the subscription of the Class Shares in both New H and New OH. 14. It is highlighted that, as a part of the proposed terms between the parties, the New H Group will not have any retained earnings (or minimal retained earnings) at the time that the new shareholder, A Co., is introduced. Accordingly, the rights to dividends attaching to the share classes will be in respect of future net profits to be derived by the group. 15. At a high level, the Class Shares are designed to provide an incentive for the New H Group (and the New OH Group) to derive super profits. The parties believe that the proposed terms and conditions that will attach to the Class Shares will help to strongly encourage the owners of the business to achieve the ultimate objective of facilitating the New H Group in striving to become a Tier 1 company in the industry within Australia in a relatively short period of time. 16. 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 either New H or New OH on the Class Shares. Assumptions 17. The number of New H and New OH ordinary shares on issue has not yet been determined, and will be based on an assessment of the market value of New H (and its controlled entities), and New OH (and its controlled entities). 18. A Co. will be ultimately wholly‐owned by J Co, a foreign resident. A Co. will be an exempting entity as defined in subsection 208-5(1) of the ITAA 1997. 19. Neither New H and New OH qualify as an exempting entity as that term is defined in subsection 208-5(1) of the ITAA 1997. Bother entities will not satisfy the requirement that 95% of their accountable membership interests are held by prescribed persons (such as non residents). 20. Neither the Corporation Shareholders nor A Co. will enter into any 'related payments' as the term is understood in former section 160APHN and section 160APHNA of the ITAA 1936. 21. Neither the Corporation Shareholders nor A Co. will enter into any options, futures or other derivative instruments nor use non‐recourse finance in respect of the proposed Class A Shares or Class B Shares, such that either entity will have materially diminished risks of loss or opportunities for gain, as that term is understood in former section 160APHM of the ITAA 1936. 22. No dividends will be paid on the proposed the Class Shares within the first 90 days after they are first issued. 23. There will be no sale or transfer and reacquisition of the Class Shares by the shareholders within the first three years. 24. The ordinary shares of New H and New OH will issue at market value and any change to the market value of the ordinary shares resulting from the issue of the Class Shares or payment of dividends in respect of the Class Shares will be temporary. It is also assumed that any resultant change to the market value will be reversed when the rights attached to the Class Shares expire after the three year period (as per the terms of the Class Shares).

Relevant legislative provisions: Income Tax Assessment Act 1997, section 104-250 | Income Tax Assessment Act 1997, Subdivision 202-C | Income Tax Assessment Act 1997, section 202-30 | Income Tax Assessment Act 1997, section 202-40 | Income Tax Assessment Act 1997, subsection 202-40(1) | 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, subsection 204-30(8) | Income Tax Assessment Act 1997, Subdivision 207-F | 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, section 207-145 | Income Tax Assessment Act 1997, subsection 207-145(1) | Income Tax Assessment Act 1997, paragraph 207-145(1)(a) | Income Tax Assessment Act 1997, paragraph 207-145(1)(b) | Income Tax Assessment Act 1997, paragraph 207-145(1)(da) | Income Tax Assessment Act 1997, section 207-150 | Income Tax Assessment Act 1997, section 207-155 | Income Tax Assessment Act 1997, section 207-157 | Income Tax Assessment Act 1997, subsection 207-157(1) | Income Tax Assessment Act 1997, subsection 207-157(3) | Income Tax Assessment Act 1997, subsection 208-5(1) | Income Tax Assessment Act 1997, Division 725 | Income Tax Assessment Act 1997, subsection 725-90(1) | Income Tax Assessment Act 1997, subsection 725-90(2) | Income Tax Assessment Act 1997, subsection 725-145(1) | 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, section 974-135 | Income Tax Assessment Act 1997, subsection 974-135(3) | 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 subsection 160APHJ(4) | Income Tax Assessment Act 1936 , former subsection 160APHM(2) | 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 | Income Tax Assessment Act 1936, section 177EA | Income Tax Assessment Act 1936, subsection 177EA(3) | Income Tax Assessment Act 1936, paragraph 177EA(5)(b) | Income Tax Assessment Act 1936, section 177F

Reasons for decision: Summary: The Class Shares are considered to be equity interests under Subdivision 974-C of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Division 974 of the ITAA 1997 operates to determine whether an interest is a debt interest or an equity interest for tax purposes. Under subsection 974-70(1) of the ITAA 1997 a scheme gives rise to an equity interest in a company if it satisfies the equity test in subsection 974-75(1) and the interest is not characterised as a debt interest in the company or a connected entity. | Detailed Reasoning - Equity test: Section 974-75 of the ITAA 1997 sets out the requirements for a scheme to satisfy the equity test in relation to a company. The term 'scheme' is defined broadly in subsection 995-1(1) of the ITAA 1997 to mean any arrangement, 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. 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. 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. The issue if the Class Shares is covered by Item 1 of the table in subsection 974-75(1) of the ITAA 1997, namely an interest in the company as a member or stockholder of the company. Therefore, the Class Shares will be an equity interests unless they are characterised as debt interests under section 974-20 of the ITAA 1997. | Detailed Reasoning - Debt test: Under Subsection 974-15(1) of the ITAA 1997 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). In order to satisfy the debt test, the scheme must satisfy all five elements in subsection 974-20(1) of the ITAA 1997. In this case, the scheme does not satisfy paragraph (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. An 'effectively non-contingent obligation' has the meaning given in section 974-135 of the ITAA 1997. 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. Subsection 974-135(3) of the ITAA 1997 provides 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. Both A Co. and the Corporation Shareholders are proposing to subscribe for the Class A Shares and Class B Shares in each of New H and New OH. All returns on the Class Shares are contingent on the economic performance of New H and New OH. In fact, returns on these shares will only be generated in periods of exceptional economic performance. Additionally, the Class Shares will not be redeemable. Therefore not only will there will be no effectively non-contingent obligation with respect to the returns on the Class Shares, but there will also be no effectively non-contingent obligation in relation to the principal amounts invested by A Co. and the Corporation Shareholders. Consequently, as all returns under the Class Shares will be contingent on the economic performance of New H and New OH, the debt test in subsection 974 20(1) will not be satisfied. 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 New H and New OH. | Summary: 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 New H or New OH to the Class Shareholders are capable of being franked under section 202-40 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subdivision 202-C of the ITAA 1997 outlines which distributions can be franked. Subsection 202-40(1) provides that a distribution is frankable to the extent that it is not unfrankable under section 202-45. Section 202-45 of the ITAA 1997 specifically lists distributions that are unfrankable: 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 (certain dividends paid by authorised deposit-taking institutions) or 215-15 (certain non-share dividends); 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) section 109 of that Act (excessive payments to shareholders, directors and associates); (iii) 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 (payments to CGT concession stakeholders) or 220-105 (certain distributions by X franking company) says is unfrankable. None of the requirements, listed in paragraphs 202-45(c) to 202-45(j) of the ITAA 1997, will apply to any future dividends that are paid by either New H or New OH on the Class Shares. 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. | Summary: The Class Shareholders will each be a 'qualified person' in relation to a dividend paid in respect of their Class Shares. Consequently, the Class Shareholders will include the franking credit on the distribution in their assessable income and be entitled to a tax offset in respect of the franking credit allocated to that dividend. | Detailed Reasoning - Detailed reasoning: Where an entity receives a franked distribution the general rule under section 207-20 of the ITAA 1997 applies to include the amount of franking credit on the distribution in the assessable income of the receiving entity. The receiving entity is also entitled to a tax offset equal to the franking credit. However, where the distribution is made in one or more of the circumstances listed in subsection 207-145(1) the amount of franking credit will not be included in the assessable income of the receiving entity and they will not be entitled to a tax offset for the distribution. The first circumstance, as described in paragraph 207-145(1)(a) of the ITAA 1997, is where the entity is not a 'qualified person' in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936. Division 1A of former Part IIIAA of the ITAA 1936 ( 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. The test for 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. 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. For the purposes of this Ruling, it has been assumed that neither the Corporation Shareholders nor A Co. will enter into any 'related payments' as the term is understood in former section 160APHN and section 160APHNA of the ITAA36. Consequently a Class Shareholder will be required to satisfy the holding period requirement within the primary qualification period. The Class Shares are considered to be 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. 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. In calculating the number of days that a shareholder is taken to continuously hold shares or interests, any days on which the taxpayer has materially diminished risks of loss or opportunities for gain in respect of the shares or interest are to be excluded as per subsection 160APHO(3). An entity is taken to have materially diminished risks of loss or opportunities for gain on a particular day if the taxpayer's net position on that day in relation to the shares has less than YY% of those risks and opportunities. For the purposes of this ruling application, both A Co., via its wholly‐owned subsidiaries CA Co. and New HH, (as the holder of the Class A Shares), and the Corporation Shareholders (as the holders of the Class B Shares), will only hold a 'long position' in relation to the shares, as defined in former subsection 160APHJ(4). As the holders of the Class Shares hold a long position with a delta of +1, they will not be taken to have 'materially diminished' risks of loss as defined in subsection 160APHM(2). Furthermore, there is no arrangement in effect, or contemplated, to enter into options, forward contracts or other derivative instruments, or non‐recourse finance, that could give the effect of materially diminishing the risks of loss. For the purposes of this Ruling, it has been assumed that no dividends will be paid on the Class Shares within the first 90 days after they are first issued. Accordingly, the shareholders will hold their shares (legally) for at least 90 days before receiving a dividend. On this basis, a Class Shareholder will be a 'qualified person' in relation to any dividend paid by New H or New OH and be entitled to a tax offset in respect of the franking credit allocated to that dividend. | Summary: The issuance of the Class Shares will not be a scheme or arrangement to which section 177EA of the ITAA 1936 applies. | Detailed Reasoning - Detailed reasoning: Paragraph 207‐145(1)(b) of the ITAA 1997 has the effect that shareholders will not be entitled to the franking credit gross up and offset under section 207‐20 where the Commissioner has made a determination under paragraph 177EA(5)(b) of the ITAA 1936. 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. Specifically, section 177EA of the ITAA 1936 applies if the following conditions, set-out in subsection 177EA(3) 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. The conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 are satisfied in respect of the issue of the Class Shares. To satisfy the purpose test in paragraph 177EA(3)(e) it needs to be established that the Class Shares have been issued with the purpose of the shareholders obtaining an imputation benefit. 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 B Shareholders to grow the business and thus attract a greater share of the profits in the relevant years. Any imputation benefit received by the Class Shareholders will merely be incidental to the commercial purpose. Thus, section 177EA of the ITAA 1936 will have no application to the future payment of dividends to the Class Shareholders. | Summary: 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: 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. The Commissioner can make a determination under section 204-30 of the ITAA 1997 to impose a penalty franking debit or deny an imputation benefit where distributions or other benefits are streamed. The Commissioner may make a determination 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. For section 204-30 of the ITAA 1997 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. 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. In the current circumstances, it is assumed that Kajima Australia is an exempting entity (as defined in subsection 208-5(1) of the ITAA 1997) and therefore the CC shareholders, being Australian residents (with one possible exception), may derive a greater benefit from the franking credits attached to any dividends paid. It is therefore necessary to consider whether, under the proposed scheme, New H and New OH can be considered to 'stream' their distributions to those shareholders who will derive a greater benefit from the franking credits. The terms 'stream' 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 2002 . The structure of distributions as defined in the terms of the Class Shares represents a profit split that has been negotiated between the parties at arm's length. The terms and entitlements of shareholders under the profit split have been pre-determined prior to issue. Although a greater proportion of franked distributions will go to shareholders who can benefit most from the imputation credits, this increase in dividend is connected to performance targets as an incentive for Corporation Shareholders and it is reasonable to conclude that the arrangement is commercially driven and not a selective direction of franked distributions. 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. | Summary: The Commissioner does not consider that the scheme involving the issue of the Class Shares is a dividend stripping scheme, as intended by 207-155 of the ITAA 1997, or section 177E of the ITAA 1936. The ability to frank dividends paid on the Class Shares will not be affected by these provisions. | Detailed Reasoning - Detailed reasoning: Where a scheme is a dividend stripping scheme sections 207-145 and 207-150 of the ITAA 1997 will operate to deny franking credits on distributions from dividend stripping operation. Section 177E(1)(e) of the ITAA 1936 provides that the arrangement under which the dividend stripping was carried out should be taken to be a scheme to which Part IVA applies. As a result, section 177F will apply to cancel the tax benefit associated with a scheme in whole or part. Under section 207-155 of the ITAA 1997 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. 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. 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 following characteristics of a dividend stripping scheme are listed in paragraph 17 of TD 2014/1: ● 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. In the current circumstances, all entitlements to distributions under the Class Shares are in respect of income years following the issue of the shares. The Class Shares will have no entitlement to any retained earnings that may be in existence when the Class Shares are issued. Any dividends paid on the Class Share 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 207-155 of the ITAA 1997, or section 177E of the ITAA 1936. The ability to frank any dividends paid on the Class Shares will not be affected by these provisions. | Summary: 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: Under paragraph 207‐145(1)(da) of the ITAA97, a member will not be entitled to a franking credit gross up and offset where the distribution is part of a distribution washing arrangement. The distribution washing rules in section 207-157 of the ITAA 1997 will apply to franked distribution in respect of a membership interest (washed interest) where two requirements have been 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. Without limiting paragraph 207-157(1), subsection 207-157(3) of the ITAA 1997 further provides that 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; (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). The proposed terms of the Class Shares provide that no transfer of the shares will be permitted in the first three years except in special circumstances as defined. At this stage there is no planned disposal or transfer of the Class Shares and it is assumed that where any of the shareholders do dispose of or transfer the Class Shares within the first three years there will be no reacquisition of the Class Shares or substantially identical interests. As there is no disposal and subsequent acquisition of substantially identical membership interests section 207-157(1)(a) of the ITAA 1997 is not satisfied. Therefore, paragraph 207-145(1)(da) will not operate to deny a franking credit gross up and offset to the Class Shareholders on the future payment of dividends on the Class Shares. | Summary: The franking credit gross up and offset rule in section 207-20 will apply to the Class Shareholders. | Detailed Reasoning - 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. Recipient must satisfy the residency requirement 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. In the current circumstances, with one exception, namely one non-resident individual, the shareholders of New H and New OH will be Australian resident entities, as defined in section 6(1) of the ITAA36. Therefore the residency requirement in section 207-75 of the ITAA 1997 will be satisfied in relation to the resident shareholders and consequently section 207-70 of the ITAA 1997 will have no application to them. 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 sets out the circumstances where franking credits will not be available to recipients. 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. 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 . | Summary: The proposed issue of the Class Shares will not have consequences under Division 725 of the ITAA 1997 and will not result in CGT event K8 happening under section 104-250 of the ITAA 1997 where the exception under subsection 725-90(1) applies. | Detailed Reasoning - Detailed reasoning: Division 725 of the ITAA 1997 may apply where there is a direct value shift under a scheme involving equity interests in an entity. Under section 725-145(1) there is a direct value shift where, under a scheme there is an increase in the value of the equity interests - or the interests are issued at a discount - and a decrease in the value of other interests in the target entity. An interest is issued at a discount where the market value of the interest when issued exceeds the amount of the payment that the issuing entity receives. Where there is a direct value shift, Division 725 will have consequences if these conditions are satisfied: ● the control test ● the participant in the scheme test ● there are affected owners of interests in the target entity, and ● no exception applies. A direct value shift will not have consequences under Division 725 if it is reversed. Under section 725-90(1) a direct value shift does not have consequences if: c) the one or more things referred to in paragraph 725-145(1)(b) brought about a state of affairs, but for which the direct value shift would not have happened; and d) 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. Will the Class Shares be issued at a discount? The market value of the Class Shares has not been determined. The Commissioner does not comment on and has not reached any conclusions in relation to the market value of the Class Shares or sought a valuation. Therefore, the issue of whether the Class Shares are issued at a discount will not be determined in this ruling. Do any exceptions apply? Section 725-90(1) of the ITAA 1997 operates such that where there is a direct value shift arising from the issue of the class shares it will not have consequences under the division if the value shift is reversed. Under the terms of the Class Shares they will only have rights to dividends for a period of three years from issue. At the end of the three year period the Class Shares will have no rights to dividends and no other rights. For the purposes of this ruling it is assumed that the ordinary shares will issue at market value and any change to the market value of the ordinary shares resulting from the issue of the Class Shares will be temporary. It is also assumed that any resultant change to the market value will be reversed when the rights attached to the Class Shares expire after the three year period (as per the terms of the Class Shares). Based on this assumption, it can be concluded that it is more likely than not that the 'state of affairs' brought about by the issue of the Class Shares will cease to exist within four years from the time the Class Shares are issued. Therefore, the exception in subsection 725-90(1) of the ITAA 1997 will apply and any direct value shift resulting from the issue of the class shares will have no consequence. As a result, CGT event K8 will also not happen. However, the exception will not apply if the Class Shareholders dispose of their shares within the three year period during which the rights to dividends may exist for the Class Shareholders. In this case, subsection 725-90(2) of the ITAA 1997 will apply to any realisation event that happens to the interests. Should there be a realisation event during the three year period there will be consequences under the division and CGT event K8 will happen. | Summary: The declaration of dividends in respect of the Class Shares by New H and New OH will have no consequences under Division 725 of the ITAA 1997 and will not result in CGT event K8 happening under section 104-250 of the ITAA 1997 where the exception on subsection 725-90(1) applies. | Detailed Reasoning - Detailed reasoning: Whether a direct value shift occurs as a result of the declaration of dividends in respect of the Class Shares has not been determined. If a direct value shift does occur, according to the exception in section 725-90(1) of the ITAA 1997 there will be no consequences under Division 725 if the value shift is reversed within four years. Under the terms of the Class Shares dividends will only be paid within the first three years and only if certain profit targets are reached. After the three year period the Class Shareholders will have no rights to dividends. For the purposes of this ruling it is assumed that the ordinary shares will issue at market value and any change to the market value of the ordinary shares resulting from the payment of dividends in respect of the Class Shares will be temporary. It is also assumed that any resultant change to the market value will be reversed when the rights attached to the Class Shares expire after the three year period (as per the terms of the Class Shares). In the event that there is any direct value shift attributable to the declaration of dividends it is more likely than not that the state of affairs causing the value shift will cease to exist after the three year period during which a right to dividends may exist for the Class Shareholders. Therefore, the exception in section 725-90(1) of the ITAA 1997 will apply and there will be no consequences under Division 725 in relation to any potential direct value shift caused by the declaration of dividends. It follows that CGT event K8 will also not happen.