Private ruling: Withholding Tax Avoidance
Published: July 2013
Ruling period: Year ended 30 June 2013
Date scheme commenced: 1 July 2012

Ruling: Q1: Does the Commissioner of Taxation consider that a tax benefit arises under section 177CA of the ITAA 1936 in respect of the arrangement described in this ruling? | A1: Yes | Q2: If the answer to Question 1 is yes, does the Commissioner of Taxation consider that section 177D of the ITAA 1936 applies in respect of the tax benefit arising under section 177CA of the ITAA 1936? | A2: No

Relevant facts and circumstances: The Applicant applied for a Private Binding Ruling (the Application) on behalf of Company C (non-resident). Company B and Company C had an Agreement in respect to usage of Company C's brands, trademarks and intellectual property. Changes occurred in Company B's (resident) manufacturing and supply chain arrangements which resulted in the Agreement terminating.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 177A. | Income Tax Assessment Act 1936 section 177CA. | Income Tax Assessment Act 1936 section 177D. | Income Tax Assessment Act 1936 subsection 177F(2A).

Reasons for decision: Summary: Subsection 177F(2A) of the ITAA 1936 provides that where a tax benefit in the form of the avoidance of withholding tax has been obtained, or would but for that section be obtained, by a taxpayer in connection with a scheme, the Commissioner may determine that the taxpayer is subject to withholding tax under s 128B of the ITAA 1936. The Commissioner can make a determination under subsection 177F(2A) of the ITAA 1936 if the following prerequisites are satisfied: 1. there is a 'scheme' as defined in subsection 177A(1) of the ITAA 1936 2. a taxpayer has obtained a 'tax benefit' in connection with the 'scheme' This requires consideration of whether: (i) a taxpayer has obtained a 'tax benefit' within the meaning of subsection 177CA(2) of the ITAA 1936; (ii) the 'tax benefit' was obtained 'in connection with' the scheme in accordance with section 177D(a) of the ITAA 1936; and (iii) the 'tax benefit' is not an excluded tax benefit by reason of section 177C(2) or (2A) of the ITAA 1936 3. having regard to the eight matters listed in section 177D(b) of the ITAA 1936, it would be concluded that a person who entered into or carried out the scheme did so for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. | Detailed Reasoning - Section 177A(1) of ITAA 1936 - Scheme: 'Scheme' is defined in section 177A(1) of the ITAA 1936 to mean: a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and b) any scheme, plan, proposal, action, course of action or course of conduct. For the purposes of determining the existence of a 'tax benefit' under section 177CA of the ITAA 1936, the 'Scheme' involved a number of steps/events that resulted in the change in manufacturing and supply chain arrangements of Company B. | Detailed Reasoning - Section 177CA of the ITAA 1936 - Withholding Tax Avoidance: Section 177CA of the ITAA 1936 provides: (1) [Application] This section applies in relation to a particular amount if a taxpayer is not liable to pay withholding tax on an amount where that taxpayer would have, or could reasonably be expected to have, been liable to pay withholding tax on the amount if a scheme had not been entered into or carried out. (2) [Tax Benefit] For the purposes of this Part, if this section applies in relation to an amount , the taxpayer is taken to have obtained a tax benefit in connection with the scheme of an amount equal to the amount mentioned in subsection (1). (Emphasis added) A 'tax benefit' will only be obtained by a taxpayer in connection with a 'scheme' if the requirements of section 177CA of the ITAA 1936 are satisfied. To identify a 'tax benefit' in subsection 177CA(2) of the ITAA 1936, it is necessary to consider what the taxpayer might reasonably be expected to have done had the scheme not been entered into. (the Counterfactual) This inquiry requires a comparison between: 1. the consequences of the scheme in question; and 2. the consequences of what would have occurred had the scheme not been carried out, the counterfactual. As to the circumstances which might "reasonably be expected" to have occurred within the meaning of section 177C of the ITAA 1936, it was stated in FCT v Peabody (1994) 181 CLR 359 at 385 that: A reasonable expectation requires more than a possibility. It involves a prediction as to events which would have taken place if the relevant scheme had not been entered into or carried out and the prediction must be sufficiently reliable for it to be regarded as reasonable. In FCT v Lenzo (2008) 167 FCR 255 at [137] Sackville J (Heerey and Siopis JJ agreeing), after referring to Peabody , said that section 177C of the ITAA 1936: '... contemplates a reasonable prediction as to events that would have taken place had the scheme not been entered into'. | Detailed Reasoning - 1. Consequence of the 'Scheme' in question: The Scheme involved the termination of the Agreement Company C had with Company B. Due to this termination, Company C no longer received payments in respect to usage of its brands, trademarks and intellectual property that would have been paid by Company B had the Agreement not terminated. The amount of royalty withholding tax Company C would have been liable to pay prior to the Scheme was eliminated as a consequence of the Scheme. To determine the 'tax benefit' for the purpose of section 177CA of the ITAA 1936, a comparison between the Scheme and the counterfactual (that is what the taxpayer might reasonably be expected to have done had the scheme not been entered into) is required. | Detailed Reasoning - 2. The Counterfactual: The Applicant submitted, and the Commissioner accepts that a relevant 'counterfactual' would have achieved some (or all) of the Objectives. | Detailed Reasoning - Tax Consequence under the counterfactual: Under the counterfactual, the Applicant submits that royalties to Company C (and its associated royalties withholding tax) would still be paid. | Detailed Reasoning - Exclusions: The exclusions listed in subsections 177C(2) and 177C(2A) of the ITAA 1936 are not applicable to the Scheme. | Detailed Reasoning - Conclusion to Tax Benefit (subsection 177CA(2) of the ITAA 1936): By comparing the tax outcome under the Scheme and the tax outcome under the counterfactual, an Australian withholding tax benefit can be identified from the implementation of the Scheme. As a result a 'tax benefit' within the meaning of section 177CA of the ITAA 1936 is present for the purposes of Section 177CA of the ITAA 1936. | Detailed Reasoning - Question 2: After examining each of the eight factors specified in subsection 177D(b) of the ITAA 1936, it would be concluded that Company C did not enter into, or carried out the scheme, or any part of it, for the dominant purpose of enabling Company C to obtain the section 177CA withholding tax benefit. The Scheme involved the termination of the Agreement Company C had with Company B. Due to this termination, Company C no longer received payments in respect to usage of its brands, trademarks and intellectual property that would have been paid by Company B had the Agreement not terminated. Consequently, a withholding tax benefit arose from the elimination of royalties and the associated royalty withholding tax that accompanied the termination. This withholding tax benefit is a normal consequence of a transaction of this nature.