Private ruling: Part IVA
Published: April 2015
Ruling period: Year ended 30 June 2015 | Year ended 30 June 2016
Date scheme commenced: 1 July 2014

Ruling: Q1: Upon payment of a dividend on the X Class share, will Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) apply? | A1: No. | Q2: Upon payment of a dividend on the X Class share, will section 177E of Part IVA of the ITAA 1936 apply? | A2: No.

Relevant facts and circumstances: Prior to a date, a shareholder owned one X Class share in the company. They had owned this share since the company was established after 19 September 1985. X Class shareholders are not entitled to vote and are not entitled to participate in the distribution of any surplus assets. They are only entitled to receive dividends declared by the Directors on that class of shares under a clause of the Constitution. They do not have a preferential right to receive dividends. Prior to a date, the shareholding of the company was: XX ordinary share(s) owned by shareholder 2, YY X Class share(s) owned by a shareholder; YY Y Class share owned by shareholder 3; YY Z Class share(s) owned by shareholder 4; and YY B Class share(s) owned by shareholder 5. A shareholder has recently separated from the sole director and major shareholder of the company (their spouse, shareholder 2). The creation of the new company is to provide an investment entity and asset protection for the shareholder. The new company was created on an earlier date. Since a date, a shareholder's Class X share in the company has been held by the new company. As a result of this transfer, a shareholder received one ordinary share in the new company. They now own a few ordinary shares in the new company, which constitute 100% of the issued shares in the new company. A shareholder is an Australian resident for tax purposes. The new company is an Australian resident for tax purposes and not a tax exempt entity. It did not hold any other assets or liabilities at the time of acquiring the company share. Presently no dividend has been paid or declared by the director of the company to the X Class shareholder. A dividend will be paid to the X Class shareholder in the near future. This payment will be fully franked and will be a one-off payment. No dividends will be paid to other shareholders at the same time. The dividend payment is to facilitate the split of marital assets between a shareholder and shareholder 2, and will be a balancing amount that ensure that split of all of their assets are split 50:50. Family Court proceedings are yet to commence. A shareholder is not giving up any assets or undertaking any tasks in exchange for the dividend payment. The dividend will be paid from retained profits and not from a share capital account.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 177E | Income Tax Assessment Act 1936 section 177EA | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1997 section 204-30 | Income Tax Assessment Act 1997 subdivision 204-D

Reasons for decision: Detailed Reasoning - General anti-avoidance provisions - the application of Part IVA of the ITAA 1936: Part IVA of the ITAA 1936 applies to a scheme where, having regard to a number of objective factors or matters, it would be concluded that one of the scheme participants who entered into or carried out the scheme or any part of the scheme did so for the dominant purpose of enabling the relevant taxpayer to obtain a tax benefit in connection with the scheme. A 'scheme' is defined in subsection 177A(1) of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan or proposal. The factual arrangement described above (ie the taking out of the loan, purchase of units in the unit trust, subsequent purchase of a property and rental of that property to the son) will constitute a 'scheme'. Under section 177C of the ITAA 1936 a tax benefit received in relation to a scheme will include an amount for a deduction being allowable where that deduction would not have been allowable, or might reasonably be expected not to have been allowable if the scheme had not been entered into. Part IVA was amended in 2013 to insert section 177CB which applies in relation to schemes entered into after 15 November 2012. Under subsection 177CB(3) when postulating what might reasonably be expected to have occurred in the absence of a scheme, the alternative must represent a reasonable alternative to the scheme in the sense that it could reasonably take the place of the scheme. In your case, a reasonable alternative to the scheme would be for a shareholder to retain ownership of the X Class share and for them to receive the dividend, without interposing the new company. Under this alternative postulate, they would still be entitled to the benefits of the dividend payment (they are the only shareholder of the new company so currently no one else would benefit from dividend payments to the new company). Therefore, there is no tax benefit under the scheme. Accordingly, Part IVA will not apply. | Detailed Reasoning - Section 177E of the ITAA 1936: In the Explanatory Memorandum to the bill introducing Part IVA of the ITAA 1936 in 1981, it states that section 177E of the ITAA 1936 was designed to operate as a self-contained code within Part IVA for dealing with so called dividend stripping schemes which might not otherwise have come within the general ambit of sections 177C and 177D of the ITAA 1936, particularly because of perceived difficulties in identifying a "tax benefit". Where section 177E of the ITAA 1936 operates, it deems the scheme to be one to which Part IVA applies (paragraph 177E(1)(e)). This makes it unnecessary to consider the operation of section 177D of the ITAA 1936 and whether an entrant into the scheme did so for the purpose of obtaining a tax benefit. Section 177E of the ITAA 1936 also deems the taxpayer to have obtained a tax benefit, being the non-inclusion in assessable income of the amount that would have been included if the company had paid the dividend described by paragraph 177E(1)(c) (paragraphs 177E(1)(f) and (g)). This makes it unnecessary to consider the operation of section 177C of the ITAA 1936. If section 177E of the ITAA 1936 operates in a particular case, the Commissioner may apply section 177F of the ITAA 1936 to determine precisely what adjustments should be made in the assessments of the vendor shareholders and of other taxpayers affected by the scheme. Subsection 177F(1) of the ITAA 1936 uses the word "may". This gives the Commissioner a discretion whether or not to make a determination ( Fletcher v. F.C. of T . 88 ATC 4834). A determination will usually be made where the Commissioner believes the provisions of Part IVA are satisfied. However, the discretion will not be exercised if cases arise where the view is formed that there is no real avoidance of tax ( Taxation Ruling IT 2627 Income Tax: application of Part IVA to dividend stripping arrangements [IT 2627], at paragraph 31). This can be particularly relevant to the application of section 177E of the ITAA 1936, where there need not be a tax benefit or a tax avoidance purpose before the section applies. Section 177E of the ITAA 1936 operates where four pre-conditions, set out in paragraphs 177E(1)(a)-(d) of Part IVA, are satisfied. Paragraph 177E(1)(a) is the first of the four pre-conditions that needs to be satisfied for section 177E to operate. Paragraph 177E(1)(a) requires that: as a result of a scheme that is, in relation to a company: • a scheme by way of or in the nature of dividend stripping; or • a scheme having substantially the effect of a scheme by way or in the nature of a dividend stripping; any property of the company is disposed of. IT 2627, at paragraph 10, states the Commissioner's view that in determining what might constitute a dividend stripping scheme for the purposes of section 177E, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form. In your case, the company intends to actually pay a dividend to the new company. The dividend to be paid by the company to the new company, and will be assessable to the new company. Under the arrangement, the payment of a fully franked dividend by the company to the new company will be 'tax neutral,' as the new company will be required to include the 'grossed up' amount of the dividends in their assessable income, and be entitled to a tax offset for the attached franking credits for an amount equal to the tax that they are liable to pay on the distribution. Therefore, there will not be any 'release of profits of a company to its shareholders in a non-taxable form', and no 'real avoidance of tax' as a result of the proposed arrangement being entered into. As there will not be any release of profits of a company to its shareholders in a non-taxable form under the proposed arrangement, it is considered that there will be no scheme by way of or in the nature of dividend stripping, or scheme having substantially the effect of a scheme by way or in the nature of a dividend stripping. Therefore, the requirements of paragraph 177E(1)(a) of the ITAA 1936 will not be satisfied, and accordingly 177E of the ITAA 1936 will not apply. Furthermore, it is considered that even if it was determined that section 177E of the ITAA 1936 did operate in relation to the arrangement, given that the arrangement does not involve any 'real avoidance of tax', the Commissioner would not exercise his discretion under section 177F(1) of the ITAA 1936 to make a determination to include any amounts in the assessable income of the taxpayers involved - in accordance with paragraph 31 of IT 2627. Accordingly, section 177E of Part IVA of the ITAA 1936 will not apply to the arrangement.