Private ruling: Part IVA of the Income Tax Assessment Act 1936
Date of advice: 25 September 2015
Published: September 2015
Ruling period: 1 July 2014 to 30 June 2015 | 1 July 2015 to 30 June 2016

Ruling: Q1: Having regard to the matters in subsection 177D(2) of the Income Tax Assessment Act 1936 (ITAA 1936) with respect to the nomination of X as Principal of the Q Trust, would the Commissioner make a determination under section 177F of the ITAA 1936 to cancel any tax benefits that may be obtained under the scheme so as to defeat the effective distribution of the income of The Z Trust to B Pty Ltd? | A1: No. | Q2: Having regard to the matters in subsection 177D(2) of the ITAA 1936 with respect to the distribution of franked income from The Z Trust to B Pty Ltd, would the Commissioner make a determination under section 177F of the ITAA 1936 to cancel any tax benefits that may be obtained under the scheme so as to defeat the effective distribution of the income of The Z Trust to B Pty Ltd? | A2: No.

Relevant facts and circumstances: The Z Trust The trustee of The Z Trust is Z Holdings Pty Ltd (Z Holdings). Y is a former spouse of X but remains a named beneficiary of the trust. Y and X are both residents of Australia. The Z Trust has a family trust election in place nominating X as the test individual. The share capital of Z Investments Pty Ltd (Z Investments) includes ordinary shares, which are owned by The Z Trust. Z Investments had retained earnings. B Pty Ltd B Pty Ltd was incorporated during the year ended 30 June 2015 with Y as the sole director. The share capital of B Pty Ltd includes one ordinary share, which is beneficially owned by the Q Trust. B Pty Ltd is a beneficiary of The Z Trust. Q Trust The trustee of the Q Trust is Q Pty Ltd and the beneficiaries of the Q Trust are Y and the children from the marriage with X. The terms of the trust deed for Q Trust provide that the Principal has the right to remove and appoint the trustee of Q Trust. Further, the trust deed provides for the resignation of the Principal and the appointment of a replacement Principal. Distribution of Franked Dividends Prior to a marital property settlement between X and Y, a franked dividend is proposed to be declared and paid by Z Investments to Z Holdings, the trustee of The Z Trust. The dividend will equate to 100% of the retained earnings of Z Investments and will be fully franked. Z Holdings as trustee for The Z Trust will make B Pty Ltd specifically entitled to part of the dividend. S Investments Pty Ltd, an entity controlled by X, will be made specifically entitled to the remainder of the dividend. Family Trust Election A family trust election is proposed to be made by Q Pty Ltd to treat the Q Trust as a family trust prior to 30 June 2015 and 2015 will be the income year specified in the election. The Trustee intends to nominate X in the family trust election as the individual whose family group is to be taken into account in relation to the election. In the year ending 30 June 2016 by an instrument duly executed under the terms of the Q Trust, X will resign as Principal of the Q Trust and Y will be appointed. Assumptions In providing this ruling we have made the following assumptions. Q Pty Ltd will make the proposed family trust election for the 2015 income year in writing and in the approved form.

Relevant legislative provisions: Income Tax Assessment Act 1936 Subsections 177A(1) and (5), | Subsection 177C(1) | Paragraph 177C(1)(a) | Subsection 177D(2) | Paragraphs 177D(2)(a), (b), (c), (d), (e), (f), (g) and (h) | Section 177F | Income Tax Assessment Act 1936 Schedule 2F Section 272-90 | Income Tax Assessment Act 1997 Section 207-10 | Subsections 207-15(2), | Subdivision 207-B | Subsections 207-35(1), (2), (3) and (4) | Section 207-37 | Subdivision 207-F | Sections 207-145 and 207-150 | Section 960-115

Reasons for decision: Summary: Summary Although the arrangement is a scheme within the terms of subsection 177A(1) of the ITAA 1936 there is no "tax benefit" within the terms of subsection 177C(1). Accordingly, subsection 177D(2) does not apply to the appointment of X as the Principal of the Q Trust. Consequently the Commissioner would not apply section 177F to cancel any tax benefits that may be obtained under the scheme described below so as to defeat the effective distribution of the income of The Z Trust to B Pty Ltd. The relevant taxpayer in relation to this scheme is The Z Trust. The scheme It is considered that the scheme includes the following: • The settlement of the Q Trust with Q Pty Ltd as trustee. The terms of the trust deed include the appointment of X as Principal of the Q Trust with the power to appoint and remove beneficiaries and the trustee when the trust deed was executed • The Q Trust will make a family trust election with X as the specified or test individual and the income year ended 30 June 2015 as the specified income year. • The incorporation of B Pty Ltd and the issue of one ordinary share by B Pty Ltd to Q Pty Ltd as trustee for the Q Trust. • The payment of a fully franked dividend by Z Investments to Z Holdings as trustee for The Z Trust. • The distribution by The Z Trust of part of the dividend with attached franking credits to B Pty Ltd. (Note: B Pty Ltd is a beneficiary of The Z Trust in terms of the trust deed of The Z Trust). • The resignation of X as Principal of the Q Trust in the income year ending 30 June 2016 prior to the marital property settlement between Y and X. • The appointment of Y as Principal of the Q Trust. Detailed reasoning All legislative references are to provisions of the Income Tax Assessment Act 1936 unless otherwise specified. Subsection 177A(1) states that a scheme includes "any scheme, plan, proposal, action, course of action or course of conduct". Therefore the arrangement described in the private ruling application upon which the Commissioner has been asked to rule is a scheme within the terms of subsection 177A(1). It is necessary to identify the tax benefit obtained by a taxpayer under the scheme. Subsection 177C(1) defines four kinds of tax benefit relating broadly to: (i) an amount not being included in the assessable income of the taxpayer of a year of income; (ii) a deduction being allowable to the taxpayer in the relation to a year of income; (iii) a capital loss being incurred by the taxpayer during a year of income; (iv) a foreign tax credit being allowable to the taxpayer. Section 177D provides that Part IVA applies to a "scheme" in connection with which the taxpayer has obtained a "tax benefit, if after having regard to the eight specified factors in subsection 177D(2), it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. An outcome from the nomination of Y as the Principal of the Q Trust is that the trustee of the Q Trust is able to make a family trust election with X as the specified or primary individual. (Refer to question 1 of this document for a detailed discussion). Accordingly, as the primary individual of The Z Trust and the Q Trust is the same person, namely X, the family group is the same in both instances. This is in accordance with section 272-90 of Schedule 2F which states whether a person is a member of the family group of the primary individual specified in the family trust election. In the present case the Q Trust and B Pty Ltd are both members of the X family group. Therefore the proposed distribution from The Z Trust to B Pty Ltd, a beneficiary of The Z Trust, will not attract family trust distribution tax (FTDT). The absence of a liability for FTDT by The Z Trust does not fall within the definitions of a tax benefit in section 177C. It is thus concluded that as no tax benefit exists in this scheme section 177D does not apply to the nomination of X as the Principal of the Q Trust. Therefore the Commissioner would not apply section 177F to cancel any tax benefits that may be obtained under the scheme so as to defeat the effective distribution of the income of The Z Trust to B Pty Ltd. Summary There is a scheme within the terms of subsection 177A(1) of the ITAA 1936, and there is a "tax benefit" within the terms of subsection 177C(1) that arises from that scheme. The tax benefit is that if it were not for the existence of B Pty Ltd and the distribution of trust income from The Z Trust to that company the trust income would be distributed to Y and be included in assessable income. Although it is acknowledged by the applicant that such a tax benefit results from the carrying out of the scheme it is argued that obtaining the tax benefit is not the dominant purpose of the relevant taxpayer. Consideration was given to the eight matters in subsection 177D(2) in order to ascertain the dominant purpose of the relevant taxpayer. While some circumstances indicate that the dominant purpose was to obtain a tax benefit others do not. On balance after weighing up all the factors and considering the context in which the distribution of trust income takes place, namely the broader property settlement upon the breakdown of the marriage of X and Y, it is concluded that the dominant purpose of the parties is an equitable split of the asset between X and Y. Thus the Commission will not make a determination under section 177F to cancel any tax benefits obtained under the scheme. The relevant taxpayer in relation to this scheme is Y. The Scheme It is considered that the scheme includes the following: • The settlement of the Q Trust with Q Pty Ltd as trustee. The terms of the trust deed include the appointment of X as Principal of the Q Trust with the power to appoint and remove beneficiaries and the trustee when the trust deed was executed. • The Q Trust will make a family trust election with X as the specified or test individual and the income year ended 30 June 2015 as the specified income year. • The incorporation of B Pty Ltd and the issue of one ordinary share by B Pty Ltd to Q Pty Ltd as trustee for the Q Trust. • The payment of a fully franked dividend by Z Investments to Z Holdings as trustee for The Z Trust. • The distribution by The Z Trust of 50% of the dividend with attached franking credits to B Pty Ltd. (Note: B Pty Ltd is a beneficiary of The Z Trust in terms of the trust deed of The Z Trust). • The resignation of X as Principal of the Q Trust in the income year ending 30 June 2016 prior to the date of the marital property settlement between Y and X. • The appointment of Y as Principal of the Q Trust. Detailed reasoning All legislative references are to provisions of the Income Tax Assessment Act 1936 unless otherwise specified. Section 177D provides that Part IVA applies to a "scheme" in connection with which the taxpayer has obtained a "tax benefit" if, after having regard to the eight specified factors in subsection 177D(2), it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling the taxpayer to obtain the tax benefit. The question whether Part IVA applies to a "scheme" starts with a consideration of whether any person participated in the scheme for the sole or dominant purpose of securing for the taxpayer a tax benefit in connection with the scheme. This ensures that the examination of the tax benefit happens in the context of examining a participant's purpose. (Note: See Part IVA amendments in Chapter 1 of Explanatory Memorandum to Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Act 2013) A 'scheme' is defined by subsection 177A(1). The scheme as described above comes within this definition of a scheme. Paragraph 177C(1)(a) defines a "tax benefit" to include "an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out." Considering the facts of this case, it is considered that in the absence of the scheme the trust distribution would have been made directly to Y instead of to B Pty Ltd. This is what would have, or might reasonably be expected to have occurred, if the scheme had not occurred. The tax benefit associated with this case, is therefore an amount of income which is not being included in the assessable income of Y. This falls within the within the terms of paragraph 177C(1)(a). It is therefore necessary to consider, having regard to the eight specified factors in subsection 177D(2), whether it would be concluded that a person who entered into or carried out the scheme, or any part of it, did so for the purpose of enabling Y to obtain a tax benefit. The legislation and leading cases make it clear that "purpose" in section 177D means dominant purpose: subsection 177A(5); FCT v Spotless Services Ltd [1996] HCA 34; FCT v Hart [2004] HCA 26 ( Hart ); FCT v Peabody [1994] HCA 43. In undertaking this analysis, we have followed ATO Practice Statement PS LA 2005/24 "Application of General Anti-Avoidance Rules". Each of these eight factors in subsection 177D(2) is considered below: (a) The manner in which the scheme was entered into or carried out Paragraph 177D(2)(a) requires consideration of this feature of the scheme. The scheme is not carried out at arm's length and all the parties are related, but that does not in the present case indicate that the dominant purpose is to obtain a tax benefit given the marital context. That is to say the breakdown of the marriage and the pending property settlement between Y and X. Although obtaining the tax benefit is one of the purposes of the scheme, it is not considered to be the dominant purpose. If the only advantage to carrying out a transaction in one way over other possible means is the tax treatment of the transaction, this indicates that the purpose of the scheme is to obtain a tax benefit: Hart . Yet, in the present case, it could be argued that the only advantage in making the trust distribution to B Pty Ltd over making it to Y is the tax treatment of the distribution. Also, the distribution to B Pty Ltd could be seen as involving the interposition of an entity in the family group and engaging in transactions with it principally or solely to obtain a tax benefit (as in FCT v Consolidated Press Holdings Ltd [1999] FCA 1199). In the absence of the interposition of the Q Trust into the family group of entities and making X its test individual for a limited period of time, the tax benefit would not be obtained. However, where there is a choice between two commercial transactions, each with different financial and tax consequences, the fact that tax considerations are relevant does not necessarily mean obtaining the tax benefit is the dominant purpose in choosing which transaction will be entered into. The mere fact that more tax might be payable if Part IVA applies to defeat a scheme does not mean the dominant purpose of a scheme is to obtain a tax benefit: FCT v Macquarie Bank Limited [2013] FCAFC 13. In the present case, the scheme is being carried out as a one-off transaction in the broader marital property settlement following the breakdown of the marriage of X and Y. In this context, the dominant purpose of the scheme is to effect an equitable split of a particular asset. (b) The form and substance of the scheme Paragraph 177D(2)(b) requires consideration of this feature of the scheme. A discrepancy between the business and practical effect, or the commercial and economic substance, of a scheme on the one hand, and its legal form on the other, may indicate that the dominant purpose of the scheme was to obtain a tax benefit: FCT v Sleight [2004] FCAFC 94; PS LA 2005/24. In the present case, the form of the scheme is to make B Pty Ltd part of the X family group and then make the distribution of retained earnings in Z Investments to it, to split the retained earnings. The substance of the scheme is to separate out the joint ownership of the retained earnings between the parties, as part of the redistribution of the ownership of assets, Accordingly, there is no apparent discrepancy between the form and economic substance of the scheme, and so the factor in paragraph 177D(2)(b) is neutral in that it does not indicate one way or another whether the dominant purpose of the scheme was to obtain the tax benefit or not. (c) The time at which the scheme was entered into and the length of the period during which the scheme was carried out Paragraph 177D(2)(c) requires consideration of this feature of the scheme. The timing of the steps in a scheme in a year of income may indicate a preoccupation with obtaining a tax benefit in that year ( Krampel Newman Partners Pty Ltd v FCT [2003] FCA 123), but where steps in a scheme are pushed into a particular year of income, that will not necessarily be enough to indicate the purpose was a tax benefit: WD and HO Wills (Australia) Pty Ltd v FCT [1996] FCA 1284 ( WD and HO Wills ). Therefore, the timing of the scheme which straddles two income years and the retirement of X as Principal of the Q Trust soon after the scheme is put into effect does not indicate one way or another whether the dominant purpose of the scheme was to obtain the tax benefit or not under paragraph 177D(2)(c). (d) The result of the scheme in relation to the operation of income tax legislation, but for the operation of Part IVA Paragraph 177D(2)(d) requires consideration of this feature of the scheme. The result of the scheme is examined from two aspects - the availability of franking credits which are ultimately attributable to B Pty Ltd and the making of the family trust election by Q Trust. A Franking credits (i) A tax benefit which exists in this scheme involves franking credits associated with the distribution. Those franking credits originate with the fully franked dividend to be paid by Z Investments to Z Holdings as the trustee for The Z Trust. The Z Trust currently has a family trust election in force, nominating X as the specified beneficiary. (ii) In turn the franking credits will be attached to the distribution from The Z Trust to B Pty Ltd when The Z Trust distributes 50% of the dividends to this beneficiary. (iii) Consequently as the Q Trust is a shareholder in B Pty Ltd the franking credits should be able to be passed on to the Q Trust. Note that the Q Trust will be a family trust as the trustee will make a family trust election nominating X as the specified or test individual. Turning to the fully franked distribution which is to be made by Z Investments to Z Holdings as trustee for The Z Trust and from The Z Trust to B Pty Ltd, it is necessary to consider the application of Division 207 of the Income Tax Assessment Act 1997 (ITAA 1997). Subdivision 207-A relates to the effect of receiving a franked distribution generally and contains a general rule in section 207-10 of the ITAA 1997. Section 207-10 provides that as a general rule, if a member of an entity receives a franked distribution then an amount equal to the franking credit on the distribution is included in the member's assessable income; and the member is entitled to a tax offset equal to the franking credit on the distribution However subsection 207-15(2) of the ITAA 1997 denies the application of the general rule to a distribution made to the trustee of a discretionary trust, which in this case is the trustee of The Z Trust. Thus, it is necessary to consider Subdivision 207- B of the ITAA 1997 which deals with franked distributions made to or received through certain trustees. In the present case, subsection 207-35(1) of the ITAA 1997 would apply to require a gross-up of the franking credit where the distribution is made to, or flows indirectly through, a trustee. Subsection 207-35(2) of the ITAA 1997 provides that the amount of the franking credit is in addition to any other amount included in the assessable income of the trust under any other provision of the ITAA 1997. In relation to a beneficiary, subsection 207-35(3) of the ITAA 1997 sets out the criteria which must be satisfied for subsection 207-35(4) to apply to allocate franking credits to partners and beneficiaries. Pursuant to subsections 207-35(3) and (4) of the ITAA 1997 B Pty Ltd as beneficiary of The Z Trust will include in its assessable income an amount equal to its share of the franking credit on distribution and the attributable franked distribution amount mentioned in section 207-37. The distribution from The Z Trust to a beneficiary, B Pty Ltd, also requires consideration of Subdivision 207-F of the ITAA 1997. Those provisions create the appropriate adjustments to cancel the effect of the gross-up and tax offset rules where the entity concerned has manipulated the imputation system in a manner not permitted under the income tax law. However, for the reasons set out below it has been found that no such manipulation has occurred such that Subdivision 207-F of the ITAA 1997 will not apply to deny the gross-up and tax offset rules. Section 207-145 of the ITAA 1997 relates to a distribution made to an entity while section 207-150 relates to a distribution that flows indirectly to an entity. Both sections specify the same tests in order for them to apply to deny the gross-up and tax offset rules. Relevantly, an entity will not be entitled to a franking credit if it is not a qualified person within the meaning of that that expression under Division 1A of former Part IIIA of the ITAA 1936. Broadly unless the trustee of a non-fixed trust has elected for it to be a "family trust", a beneficiary with no fixed interest will not be a "qualified person" for the purposes of the 45 day rule. (Former subsections 160APHL(10) and 160APHU(1) in former Part IIIA of the ITAA 1936.) As mentioned previously, the trustee of The Z Trust has made a family trust election with X as the specified individual. Further it was concluded that B Pty Ltd formed part of X's family group in relation to The Z Trust pursuant to section 272-90 of Schedule 2F to the ITAA 1936. Consequently, The Z Trust and B Pty Ltd are qualified persons for the purposes of Division 1A of former Part IIIA of the ITAA 1936. Accordingly, but for the operation of Part IVA B Pty Ltd (a corporate tax entity in terms of section 960-115 of the ITAA 1997) will be entitled to a tax offset in terms of subdivision 207-B of the ITAA 1997 for the income year in which the distribution is made. The tax offset is equal to the franking credit on the distribution. B Making of the election As a family trust with a family trust election in place, the Q Trust will be able to claim prior or current year tax losses (not capital losses) or debt deductions. It will also be excluded from having to comply with the trustee beneficiary reporting rules. For any interests in a company held by the Q Trust, the trustee of the Q Trust will be taken to own the interests as an individual, for the purposes of whether the company passes the continuity of ownership test and so is able to carry forward its losses and claim them against income earned in the future. The Commissioner recognises that there are reasons why a family trust might enter into a family trust election, so their existence does not definitively indicate that the dominant purpose of the scheme was to obtain the tax benefit..(See "Family trust elections (FTEs) and interposed entity elections (IEEs) - Questions and answers" on the ATO website www.ato.gov.au). (e) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme Paragraph 177D(2)(e) requires consideration of this feature of the scheme. There will be a change for the better in the financial position of Y within the meaning of paragraph 177D(2)(e) when the scheme is carried out as more tax would have been payable if the distribution was made directly to Y rather than to B Pty Ltd, a company controlled by Y. However, the indication that this tax benefit was the dominant purpose in entering into the scheme needs to be weighed against the broader context of the property settlement upon the breakdown of the marriage of X and Y. (f) Any change in the financial position of any person who has, or has had, any connection, (whether of a business, family or other nature) with the relevant taxpayer being a change that has resulted, will result, or may reasonably be expected to result, from the scheme Paragraph 177D(2)(f) requires consideration of this feature of the scheme. There will be changes in the financial position of Z Investments and B Pty Ltd as a result of the scheme within the meaning of paragraph 177D(2)(f): (i) the retained earnings and franking account balance of Z Investments will be reduced; (ii) in accordance with subsection 207-35(1) of the ITAA 1997 The Z Trust will include in its assessable income for the year, the amount of the franking credit on the distribution; and (iii) B Pty Ltd will include in its assessable income, by virtue of subsection 207-35(3) of the ITAA 1997, its share of the franking credit on the distribution and the amount of the distribution received from The Z Trust. These circumstances do not indicate that obtaining the tax benefit was the dominant purpose of the scheme when weighed against the broader context of the property settlement as a result of the breakdown of the marriage of X and Y. (g) Any other consequences for the relevant taxpayer, or for any person referred to in paragraph 170D(2)(f), of the scheme having been entered into or carried out There are no other apparent consequences of the scheme as contemplated by paragraph 177D(2)(g) that indicate that the dominant purpose of the scheme was to obtain a tax benefit. (h) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph 170D(2)(f) The family connection between Y as the relevant taxpayer and the other parties whose financial position changes because of the scheme could be seen as an indication that obtaining the tax benefit was the dominant purpose of the scheme (paragraph 177D(2)(h)). Where arrangements have been made between related companies, careful scrutiny is necessary to ascertain, for example, whether the documentation accurately reflects what the parties contemplate will occur and whether expressed reasons for a particular course of action are to be taken at face value: WD and HO Wills . This principle may apply equally for related parties such as family members. However, in the present case, the expressed reasons for the particular course of action can be taken at face value, that is, the equitable split of a particular asset as part of a broader property settlement upon the breakdown of the marriage of X and Y. Conclusion On balance, weighing up all the factors set out above, the dominant purpose of the participants in entering into the scheme was not to obtain a tax benefit. While some circumstances indicate that the dominant purpose was to obtain a tax benefit, others do not. In the context of the broader property settlement, the dominant purpose of the parties is the equitable split of an asset between Y and X on the breakdown of their marriage. Accordingly, the Commissioner will not make a determination under section 177F to cancel any tax benefit that may be obtained under the scheme as described earlier.