Private ruling: Succession planning - sections 177E and 177EA of the ITAA 1936
Date of advice: 3 July 2020
Published: August 2020
Ruling period: Year ending 31 December 20XX | Year ending 31 December 20XX | Year ending 31 December 20XX | Year ending 31 December 20XX | Year ending 31 December 20XX | Year ending 31 December 20XX | Year ending 31 December 20XX
Date scheme commenced: 1 January 20XX

Ruling: Q1: Is the arrangement a scheme to which section 177E of Part IVA of the Income Tax Assessment Act 1936 applies? | A1: No | Q2: Is the arrangement a scheme to which section 177EA of Part IVA of the Income Tax Assessment Act 1936 applies? | A2: No

Relevant facts and circumstances: Company A carries on a business of executive coaching. Company A has accumulated substantial funds from the success of its business. Person B is the Company's founder and sole shareholder. Person B's Will bequeaths shares in Company A to her child who has worked in Company A for a number of years. Person B wishes for part of the accumulated funds in Company B to be bequeathed to the grandchildren. To give effect to this, Person B incorporated Company C which they are the sole shareholder of. Company A has issued Company C with dividend access shares for the purpose of allowing part of the accumulated profits of Company A to be paid to Company C, and subsequently to Person B's children, grandchildren and great-grandchildren. The shares of Company C will pass to Person B's two children, their grandchildren and great-grandchildren under the Will and it is expected that Company C will pay dividends to those persons. To date, Company A has paid $XXX,XXX to Company C. Company C will not pay tax on these amounts because the dividends it has received are fully franked. When these amounts are paid subsequent to Person B's death, they will be assessable income of the recipients and subject to income tax. Person B is not compensated in the operation of this scheme which was entered into solely to benefit their progeny.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 section 177E | Income Tax Assessment Act 1936 section 177EA

Reasons for decision: Summary: Section 177E of the Income Tax Assessment Act 1936 does not apply to the scheme described in this private binding ruling. | Detailed Reasoning - Detailed reasoning: For the arrangement to be a scheme to which Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) applies, it must be shown that, having regard to all the matters listed in subsection 177D(2) of the ITAA 1936, the sole or dominant purpose or the sole or dominant purpose of some other party, in entering the arrangement was to obtain a tax benefit. The sole or dominant purpose of a taxpayer in entering into a scheme is 'their most influential and prevailing or ruling purpose' per the High Court in Federal Commissioner of Taxation v Spotless Services (1996) 186 CLR 404 (Spotless Services). In Spotless Services, it is established that there is a greater likelihood of concluding that a scheme is entered for the sole or dominant purpose of obtaining a tax benefit if it makes no commercial sense without the tax benefits. Where there are factors which suggest the scheme has been entered into for commercial reasons, it will generally lead to the opposite conclusion, even if the arrangement is to some extent tax driven. The relevant question in applying Part IVA of the ITAA 1936 is not whether the taxpayer or another person would not have entered the scheme 'but for' the tax benefit, but what was the taxpayer's dominant purpose in entering the scheme. Section 177E of the ITAA 1936 is an anti-avoidance provision that is designed to prevent tax benefits being obtained as part of a dividend stripping scheme or a scheme with substantially the same effect as a dividend stripping scheme. Paragraph 5 of 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? gives: '... the application of Part IVA depends on the facts of the particular case the Commissioner considers that a dividend access share arrangement that includes all of the elements described in paragraph 4 of this Determination is a scheme 'by way of or in the nature of dividend stripping' within the meaning of section 177E where the relevant purpose exists ...' Paragraph 6 of TD 2014/1 explains: 'In deciding whether there is a scheme 'by way of dividend stripping' or 'in the nature of dividend stripping' within the meaning of section 177E of Part IVA it is necessary to determine if there is an objective purpose of tax avoidance in respect of the scheme. In determining objective purpose, a simple assertion that another non-tax purpose exists will not of itself conclusively determine the issue. Any such assertion must: · be supported by the other available evidence; and · not be inconsistent with the objective facts of the case having regard to all the other relevant evidence.' The term 'dividend stripping' has no precise legal meaning; however it has been the subject of judicial discussion. Lawrence v Commissioner of Taxation [2008] FCA 1497 adopted the following characteristics from cases such as FC of T v Consolidated Press Holdings and Ors; CPH Property Pty Ltd v FC of T (2001) 207 CLR 235 (Consolidated Press) and Federal Commissioner of Taxation v Patcorp Investments Ltd (1976) 140 CLR 247: · a target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders · the sale or allotment of shares in the target company to another party · the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits · the purchaser or allottee escaping Australian income tax on the dividend so declared · the vendor shareholders receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains tax at the relevant times), and · the scheme being 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 by the target company. In Consolidated Press, it was held that the placement of section 177E of the ITAA 1936 is important when interpreting the meaning of dividend stripping. The legislature had used the language of tax avoidance in section 177E of the ITAA 1936 to supplement the general anti-avoidance provisions. Therefore, the dominant purpose of the scheme is determinative of whether there is a scheme by way of or in nature of dividend stripping. Based on the above relevant facts and circumstances, a reasonable person would conclude that Person B's sole or dominant purpose in entering the scheme was for a reason other than obtaining a tax benefit. It is also not considered that this arrangement has the characteristics of a dividend stripping scheme. The dominant purpose of the entities entering into the arrangement is to benefit the progeny of Person B rather than to obtain a tax benefit. Therefore, it is not considered that section 177E of the ITAA 1936 has any application in relation to the arrangement so described in this ruling. | Detailed Reasoning - Question 2: Is the arrangement a scheme to which section 177EA of Part IVA of the Income Tax Assessment Act 1936 applies? | Summary: Section 177EA of the Income Tax Assessment Act 1936 does not apply to the scheme described in this private binding ruling. | Detailed Reasoning - Detailed reasoning: The circumstances which are relevant in determining whether a person has the requisite purpose as referred to in paragraph 177EA(3)(e) of the ITAA 1936 include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936 . These relevant circumstances encompass a range of matters which taken individually or collectively will reveal whether or not the requisite purpose exists. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In all cases however, the terms of the disposition and the relevant circumstances must be considered to determine whether they tend towards or against, or are neutral, as to the conclusion of a purpose of enabling the relevant taxpayer to obtain an imputation benefit. The requisite purpose is further clarified when read in conjunction with the objective of section 177EA of the ITAA 1936 which is set out in paragraph 8.124 of the Explanatory Memorandum to the Taxation Laws Amendment Bill No.3 (1998) ('EM'): 'One of the underlying principles of the dividend imputation system is that the benefits of imputation should only be available to the true economic owners of shares, and only to the extent that those taxpayers are able to use the franking credits themselves. Franking credit trading, which broadly is the process of transferring franking credits on a dividend from investors who cannot fully use them (such as non-residents and tax-exempts) to others who can fully use them undermines this principle. Similarly, dividend streaming (i.e. the streaming of franking credits to select shareholders) undermines the principle that, broadly speaking, tax paid at the company level is imputed to shareholders proportionately to their shareholdings.' Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the arrangement seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders as envisaged in the preceding extract of the EM. Having regard to the terms and circumstances of the scheme, the requirements of section 177EA of the ITAA 1936 have not been satisfied, and therefore it is not considered that section 177EA of the ITAA 1936 has any application in relation to this arrangement.