Private ruling: Business restructure
Date of advice: 11 July 2022
Published: October 2022
Ruling period: Income year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the proposed arrangement be a scheme for the stripping of company profits under subsection 177E(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No | Q2: Will the proposed arrangement be a scheme to obtain a tax advantage in relation to franking credits pursuant to section 177EA of the ITAA 1936? | A2: No

Relevant facts and circumstances: The Trading Company has the same two Directors and Shareholders. Neither the Trading Company nor the individual Directors or other entities in the Group have tax losses or are non-residents. The Trading Company has retained earnings but instead of paying dividends, these retained earnings have been loaned to related entities within the Group (Related Party Loans). The Trading Company has significant retained earnings and the risks inherent in operating the business has been identified as a weakness in the family's business structure proposes. The risks to business operations and in succession planning have materialised in the past for the Directors who experienced litigated claims and family disputation. The proposed business restructure will address certain risks to business operations and family succession planning posed by the current group structure. It is not intended the Related Party Loans will be repaid in the immediate or medium term. Large repayments would only be made if assets were sold and there are no plans to sell any assets.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 177E | Income Tax Assessment Act 1936 paragraph 177E(1)(a) to (d) | Income Tax Assessment Act 1936 subparagraphs 177E(1)(a)(i) and (ii) | Income Tax Assessment Act 1936 section 177EA | Income Tax Assessment Act 1936 paragraphs 177EA(3)(a) to (e)

Reasons for decision: Summary: The proposed arrangement is not a scheme for the stripping of company profits under subsection 177E(1) because it will not be carried out with the dominant purpose of avoiding tax. The scheme has the characteristics of a dividend stripping scheme required for the application of section 177E except for the dominant purpose of tax avoidance. The primary purpose of the scheme is the mitigation of risks posed by nature of the Trading Company's business; and the avoidance of past difficulties experienced in passing the business to future generations. While the purpose of the proposed arrangement is to manage identified risks, it is possible for this purpose to change over time to tax avoidance. To provide certainty to the ruling the taxpayer has agreed the ruling be provided on an assumption which eliminates the possibility of tax avoidance by the structure formed by the proposed arrangement for the period of review. | Detailed Reasoning - Detailed reasoning: Section 177E operates to cancel any tax benefit that arises under a dividend stripping arrangement and is engaged where the four pre-conditions set out in paragraphs 177E(1)(a) to (d) of Part IVA are satisfied so there is: (i) a dividend stripping scheme resulting in a disposal of property (paragraph (1)(a)); and (ii) a distribution of company profits (paragraph (1)(b)); and (iii) an amount included in assessable income (paragraph (1)(c)); and (iv) a scheme entered into after 27 May 1981, whether inside or outside Australia (paragraph (1)(d)). Paragraph 177E(1)(a) sets out the key test that there must be a ' scheme ' that is, in relation to a company, either (emphasis added): '(i) a scheme by way of or in the nature of dividend stripping ; or (ii) a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping; ' The term ' dividend stripping ' is not defined in section 177E and has no precise legal meaning. Taxation Ruling IT 2627 ( Application of Part IVA to dividend stripping arrangements ') (IT 2627) while declining to provide an exhaustive list of what might constitute a dividend stripping scheme sets out a description of what a traditional dividend stripping scheme might entail (emphasis added): '...in its traditional sense a dividend stripping scheme would include one where a vehicle entity (the stripper) purchases shares in a target company that has accumulated or current years' profits that are represented by cash or other readily realisable assets. The stripper pays the vendor shareholders a capital sum that reflects those profits and then draws off the profits by having paid to it a dividend (or a liquidation distribution) from the target company [1] '. An important element in identifying a dividend stripping scheme will be the release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods used to achieve this result [2] . | Detailed Reasoning - Are the Proposed Transactions a Dividend Stripping Scheme?: The scheme formed by the Proposed Transactions meets some of the ' common characteristics of dividend stripping schemes ' set out by Gibbs J in Patcorp Investments [3] cited with approval by the High Court in FC of T v Consolidated Press Holdings Ltd and Ors [4] and set out in Taxation Determination TD 2014/1 [5] (TD 2014/1) described below (emphasis added): 'i. A target company with substantial undistributed profits creating a potential tax liability, either in the company or its shareholders ii. The sale or allotment of shares in the target company to another party iii. The payment of a dividend to the purchaser or allottee of the share out of the target company's profits iv. The purchaser or allottee escaping Australian income tax on the dividend declared v. 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 vi. 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 [6] ' | Detailed Reasoning - Tax Avoidance Purpose: Section 177E does not expressly state there must be a purpose or dominant purpose of avoiding tax. However, the High Court held in FCT v Consolidated Press Holdings Ltd [7] that such a dominant purpose of tax avoidance is required (objectively determined) in the same way the general provisions of Part IVA require such a dominant purpose. The risks to business operations and in succession planning have materialised for the Directors who experienced litigated claims and family disputation. This explains the motivation for adopting the structure of the proposed arrangement which is consistent with the structuring adopted for the ownership of significant assets including their family home. This consistency together with the response to materialised risks makes it more likely the dominant purpose of the proposed arrangement is asset protection and succession planning rather than tax avoidance. The structure of the proposed arrangement has been considered to determine whether it will achieve the asset protection objective of reducing the risk of the retained earnings (funding the Related Party Loans) being exposed to a trustee in bankruptcy of the Directors in the event of their bankruptcy. While arguments are available to a trustee under the Bankruptcy Act 1966 the law is unsettled and the outcome of an argument made is uncertain. This is likely to be a disincentive to a trustee and there is no reason to doubt the structure formed by the proposed arrangement will achieve the asset protection objective motivating the reorganisation. As the proposed arrangement lack the dominant purpose of tax avoidance they are not a dividend stripping scheme for the purposes of paragraph 177E(1)(a) and section 177E does not apply. | Summary: The proposed arrangement is not a scheme to obtain a tax advantage in relation to franking credits pursuant to section 177EA of the ITAA 1936. The franking credit benefits are merely incidental to the primary purpose of mitigating risks posed by the nature and size of the business of the Trading Company and the avoidance of difficulties in succeeding the business to future generations. Therefore, the purpose requirement in paragraph 177EA(3)(e) is not satisfied and section 177EA does not apply. | Detailed Reasoning - Detailed reasoning: Section 177EA is attracted where a scheme involving the disposition of shares is entered into with a purpose of enabling a taxpayer to obtain a franking credit benefit. It applies where: Paragraph 177EA(3)(e) requires the taxpayer to have carried out the scheme (or any part of the scheme) for the purpose of obtaining an imputation benefit and defines this purpose to exclude ' an incidental purpose ' (emphasis added): '...for a purpose ( whether or not the dominant purpose but not including an incidental purpose ) of enabling the relevant taxpayer to obtain an imputation benefit'. The High Court considered what amounts to an ' incidental purpose ' in Mills v Commissioner of Taxation [8] and noted that even though a purpose can be central to a scheme it may nevertheless still be an incidental purpose to another purpose: '... a purpose can be incidental even where it is central to the design of a scheme if that design is directed to the achievement of another purpose. Indeed, the centrality of a purpose to the design of a scheme directed to the achievement of another purpose may be the very thing that gives it a quality of subsidiarity and therefore incidentality [9] '. As previously detailed at Question 1, the dominant purpose of the proposed arrangement is more likely asset protection and the avoidance of risk in succession planning. The imputation benefits are merely incidental to this purpose and section 177EA does not apply. The scheme is not a dividend stripping scheme for the purpose of section 177E because it lacks the dominant purpose of tax avoidance and the franking benefits flowing from the scheme are merely incidental to the primary purpose of the scheme to mitigate business risks and succession planning so section 177EA does not apply. Accordingly, the facts do not support a finding that the requisite purpose of obtaining a tax advantage by obtaining imputation benefits is present. As a result, the proposed arrangement is not a scheme to obtain a tax advantage in relation to franking credits pursuant to section 177EA. [1] IT 2627, Paragraph 9. [2] IT 2627, Paragraph 10. [3] Federal Commissioner of Taxation v Patcorp Investments Ltd (1976) 140 CLR 247. [4] (2001) 47 ATR 229. [5] 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? [6] Paragraph 17. [7] 2001 ATC 4343. [8] [2012] HCA 51. [9] Ibid at [66].

Reasons for decision: All legislative references refer to the Income Tax Assessment Act 1936 unless otherwise stated. | There is a disposal of shares or interests in shares (paragraph 177EA(3)(a)); and | A franked dividend is paid (paragraphs 177EA(3)(b) and (c)); and | The shareholder would, or could reasonably be expected to, receive franking credit benefits from the dividend (paragraph 177EA(3)(d)); and | Having regard to specified circumstances, it would be concluded that a purpose of at least one of the participants was to obtain a franking credit benefit. It is not necessary that this purpose is the dominant purpose but it is not sufficient that it is merely incidental (paragraph 177EA(3)(e)).