Private ruling: Exempting credits
Published: October 2012
Ruling period: xx/xx/xxxx to xx/xx/xxxx
Date scheme commenced: xx/xx/xxxx

Ruling: Q1: Is Non-resident 1 an eligible continuing substantial member in relation to dividend 1 and dividend 2 within the meaning of section 208-155 of the Income Tax Assessment Act 1997? | A1: Yes | Q2: Are dividend 1 and dividend 2 received by Non-resident 1 wholly or partially free from withholding tax under section 128B of the Income Tax Assessment Act 1936? | A2: Yes

Relevant facts and circumstances: Non-resident 1 (NR1) is a company incorporated offshore. NR1 is a non-resident for Australian income purposes and has held shares in Resident Entity 1 (RE1) since January 200X. NR1's shareholding in RE1 has always exceeded Y%. RE1 is a company incorporated in Australia and is an Australian resident company for Australian income tax purposes. RE1 is the head company of the RE1 income tax consolidated group (the RE1 group). RE1, as head company, elected to form a consolidated group for Australian income tax purposes on 1 July 2002. RE1 has a year end of xx/xx for financial reporting and income tax purposes. Former Exempting Entity 1 (FEE1) is a company incorporated in Australia. FEE1 is an Australian resident company for Australian income tax purposes. In 2011, FEE1 and its wholly owned subsidiaries joined the RE1 consolidated group. At the joining time: · FEE1 was a 'former exempting entity' pursuant to section 208-10 ITAA 97. FEE1 had an exempting account credit balance of approximately $X; and · RE1 was neither an exempting entity nor a former exempting entity. Upon FEE1 joining the RE1 group, RE1 became a former exempting entity pursuant to section 709-165 ITAA 97. On xx/xx/2011, NR1 received a payment of a dividend from RE1 of approximately $Y (dividend 1) on its shares in RE1. At this time, NR1 held approximately Z% of the ordinary issued shares in RE1. On xx/xx/2012, NR1 received a payment of a dividend from RE1 of approximately $W (dividend 2) on its shares in RE1. At this time, NR1 held approximately Z% of the ordinary issued shares in RE1. Dividend 1 was 100% franked with an exempting credit (but no franking credits) for all RE1 shareholders. The exempting credits amount for NR1 was approximately $V. Dividend 2 was X% franked with an exempting credit (but no franking credits) for all RE1 shareholders. The exempting credits amount for NR1 was approximately $Y.

Relevant legislative provisions: Income Tax Assessment Act 1936 Section 128B | Income Tax Assessment Act 1997 Section 208-155 and | Income Tax Assessment Act 1997 Section 709-165.

Reasons for decision: Summary: The test to determine whether an entity is an eligible continuing substantial member is contained in subsection 208-155 of Division 208 of the Income Tax Assessment Act 1997. In relation to consolidated groups Subdivision 709-B modifies the way Division 208 operates. | Detailed Reasoning - Subdivision 709-B: Section 709-165 ITAA 97 operates where · the head company of a consolidated group is neither an exempting entity nor a former exempting entity; and · a corporate tax entity becomes a subsidiary member of the group at a time (also the joining time); and · the entity is a former exempting entity at the joining time. Section 709-165 ITAA 97 is relevant to this scheme as at the time immediately before FEE1 joined the RE1 consolidated group RE1 was neither an exempting entity nor a former exempting entity. At the time FEE1 joined the RE1 consolidated group, FEE1 was a former exempting entity. Therefore the rules in section 709-165(2) ITAA 97 will apply to the RE1 consolidated group. The rules are; Rules applying to consolidated group Item Rule 1 The *head company becomes a *former exempting entity at the joining time 2 The *head company has both a *franking account and an *exempting account 3 If the *subsidiary member's *exempting account has an *exempting surplus at the joining time: (a) a debit equal to that surplus arises in that account at the joining time; and (b) a credit equal to that surplus arises in the exempting account of the *head company at the joining time 4 If the *subsidiary member's *exempting account has an *exempting deficit at the joining time: (a) a credit equal to that deficit arises in that account at the joining time; and (b) a debit equal to that deficit arises in the subsidiary's *franking account just before the joining time 5 The *subsidiary member's *exempting account does not operate during the period: (a) starting just after the joining time; and (b) ending when the entity ceases to be a subsidiary member of the group 6 Item 1 of the table in section 208-115 does not apply to the *head company 7 Item 1 of the table in section 208-120 does not apply to the *head company 8 Item 1 of the table in section 208-130 does not apply to the *head company 9 Item 1 of the table in section 208-145 does not apply to the *head company For the purposes of applying the provisions of s208-155 ITAA 97 according to item 1 of the table above RE1 became a former exempting entity at the time which FEE1 joined the RE1 consolidated group, which was xx 2011. Subsection 208-155(1) ITAA 97 provides that a member of a former exempting entity is an eligible continuing substantial member in relation to a distribution if the provisions in section 208-155 ITAA 97 are satisfied. In relation to a company subsection 208-155(2) requires that both at the time when the distribution was made and the time immediately before the entity ceased to be an exempting entity, the member was entitled to not less than Y% of · if the voting shares in the relevant former exempting entity are not divided into classes - those voting shares; or · if the voting shares in the relevant former exempting entity are divided into 2 or more classes - the shares in one of those classes. The relevant distributions were made by RE1 on xx/xx/2011 (dividend 1) and xx/xx/2012 (dividend 2) and at both these times NR1 held approximately Z% of the ordinary issued shares in RE1. Under item 1 of the table in s709-165(2) RE1 became a former exempting entity on xx 2011, the time at which FEE1 joined the RE1 consolidated group. Although ss208-155(2) states that the second test time is the time immediately before the entity ceased to be an exempting entity, RE1 was never actually an exempting entity in its own right. RE1 was deemed to be a former exempting entity by virtue of which states that "the head company becomes a former exempting entity at the joining time". In a case involving consolidated groups it is necessary to read subsection 208-155 in light of the provisions of section 709-165 as subdivision 709-B modifies the way Division 208 applies The Commissioner has taken the view that the expression ' becomes a former exempting entity at the joining time ' in item 1 of the table in s709-165(2) necessarily means the head company ' ceased to be an exempting entity ' for the purposes of 208-155(2) and that this also is taken to occur at the joining time. On this basis the second test time for the purposes of testing whether NR1 is an eligible continuing substantial member will be on xx 2011, the time at which FEE1 joined the RE1 consolidated group. Subsection 208-155(3) is satisfied on the basis that NR1 was at the relevant times a foreign resident for Australian tax purposes. Subsection 208-155(4) provides that where the assumptions in subsections 208-155(5) are made if the member was a person referred to in any of paragraphs (3)(a) to (d) - the member would (if a foreign resident) be exempt from withholding tax on the distribution or (if an Australia resident) be entitled to a franking credit or a tax offset in relation to the distribution. The assumptions relevant to this scheme under subsection 208-155(5) referred to in subsection (4) are that: · the relevant former exempting entity was an exempting entity at the time it made the distribution; and · the distribution was a franked distribution made to the member. In this case you assume RE1 was an exempting entity at the time it made the distribution and the distribution was a franked distribution to NR1. NR1 as the member is a foreign resident as referred to in para 208-155(a) and would be exempt from withholding tax on the distribution under that assumption. On this basis the test in s208-155 ITAA 97 as modified by s709-165 ITAA 97 are satisfied by NR1 , NR1 is an eligible continuing substantial member in relation to the relevant distributions made by RE1 | Detailed Reasoning - Question 2: Section 128B deals with liability to withholding tax. Subparagraph 128B(3)(ga)(iii) exempts from withholding tax the part of the dividend that is franked with an exempting credit in the case of a dividend paid by a former exempting entity to an eligible continuing substantial member. Subparagraph 128B(3)(ga)(iii) applies to dividend 1 and dividend 2 on the basis that; · the dividends were paid by RE1 which was deemed to be a former exempting entity by virtue of item 1 in the table of ss709-165(2) · NR1 was an eligible continuing substantial member in relation to the relevant dividends · Dividend 1 was 100% franked with an exempting credit and dividend 2 was Z% franked with an exempting credit. On this basis dividend 1 of approximately $Y franked to 100% will be wholly free from withholding tax. Dividend 2 of approximately $X franked to Z% will be partially free from withholding tax to the extent that it is franked with exempting credits.

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