Private ruling: Family restructure
Published: March 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014
Date scheme commenced: 1 July 2012

Ruling: Q6: Will the proposed arrangement be characterised as a dividend stripping scheme in terms of section 177E of the ITAA 1936? Advice/Answers No

Relevant facts and circumstances: Background Two siblings currently hold a substantial asset portfolio which they are wanting to divide between their respective families as part of a succession planning initiative. The scheme Under this succession planning initiative, two companies will be voluntarily wound up. Shares in each of the two companies are currently held by the same shareholders - shareholder A (a trust) and shareholder B (a company). Currently the profits of the companies consist of realised capital gains (CGT) (both pre CGT and post CGT gains) and accumulated taxable profits. The assets of the companies consist of receivables from related entities in relation to the sale of specific assets of the companies. The companies will distribute all the taxable profits (including the post CGT gains) as by way of dividends to their shareholders. Following this, each company will issue a parcel of shares to one of their shareholders (shareholder A). These shares will be offered at a significant discount to market value. A liquidator will then be appointed to each company to effect a member's voluntary liquidation. On liquidation of the companies an in specie distribution of all the assets (receivables from the related entities) of the respective companies will be made proportionally to the shareholdings held by the respective shareholders. This will result in almost all of the assets of the companies being distributed to shareholder A. Following the liquidation of the companies, the entitlements of shareholder A with respect to the receivables will continue to accrue and be paid to the extent that cash flow is available. Rationale for the restructure The proposed restructure is intended to deliver the benefit of accrued pre capital gains tax profits to shareholder A for the benefit of the Shareholder A's family. In this respect the accrued pre capital gains tax profit will be quarantined in shareholder A for the benefit of the objects of shareholder A including existing family members and future generations. If the discounted shares are not issued, each company can still be liquidated. This course of action however, would deliver a larger portion of the pre capital gains tax reserves to Shareholder B, which would not represent an assessable dividend for tax purposes on liquidation. However, a significant proportion of the capital profits reserves would effectively be quarantined in Shareholder B. In the ordinary course these capital profits reserves could subsequently be distributed on liquidation of Shareholder B as a non-assessable distribution to its shareholders. Shareholder B currently holds significant assets, which it is currently intended will be retained for the benefit of its shareholders. The disposal of Shareholder B's assets would impose an unnecessary stamp duty burden. In due course, it is anticipated Shareholder B will be liquidated and the value of the assets contributed to its shareholders for existing and future family members.

Relevant legislative provisions: Income Tax Assessment Act 1936 Division 7A, | Income Tax Assessment Act 1936 section 44, | Income Tax Assessment Act 1936 section 45B, | Income Tax Assessment Act 1936 section 45C, | Income Tax Assessment Act 1936 Part IVA, | Income Tax Assessment Act 1936 section 177E, | Income Tax Assessment Act 1997 section 6-5 and | Income Tax Assessment Act 1997 Division 725.

Reasons for decision: Summary: The issue of discount shares to the Shareholder A will not be ordinary income or a dividend for tax purposes. | Detailed Reasoning - Detailed reasoning: Subsection 6-5(1) of the ITAA 1997 provides that the assessable income of a taxpayer includes income according to ordinary concepts (ordinary income). The legislation does not provide specific guidance on the meaning of income according to ordinary concepts. However, a substantial body of case law exists which identifies likely characteristics. In GP International Pipecoaters Pty Ltd v. Federal Commissioner of Taxation (1990) 170 CLR 124 at 138; 90 ATC 4413 at 4420; (1990) 21 ATR 1 at 7, the Full High Court stated: To determine whether a receipt is of an income or of a capital nature, various factors may be relevant. Sometimes the character of receipts will be revealed most clearly by their periodicity, regularity or recurrence; sometimes, by the character of a right or thing disposed of in exchange for the receipt; sometimes, by the scope of the transaction, venture or business in or by reason of which money is received and by the recipient's purpose in engaging in the transaction, venture or business. Amounts that are periodical, regular or recurrent, relied upon by the recipient for their regular expenditure and paid to them for that purpose are likely to be ordinary income, as are amounts that are the product in a real sense of any employment of, or services rendered by, the recipient. Amounts paid in substitution for salary or wages foregone or lost may also be ordinary income. Ultimately, whether or not a particular receipt is ordinary income depends on its character in the hands of the recipient. The whole of the circumstances must be considered and the motive of the payer may be relevant to this consideration. The acquiring of shares at a discount does not have any of the characteristics of ordinary income and accordingly there will be no amount included in shareholder A's assessable income under section 6-5 of the ITAA 1997. Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends, as defined in subsection 6(1) of the ITAA 1936, paid to the shareholders out of profits derived by the company from any source (if the shareholder is a resident of Australia) and from an Australian source (if the shareholder is a non-resident). The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of 'dividend' in subsection 6(1) excludes a distribution from the meaning of 'dividend' if the amount of a distribution is debited against an amount standing to the credit of the company's share capital account. The term 'share capital account' is defined in section 975-300 of the ITAA 1997 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. However, subsection 975-300(3) of the ITAA 1997 provides that an account is not a share capital account if it is tainted. A share capital account is tainted if an amount to which Division 197 of the ITAA 1997 applies is transferred to the share capital account where the account is not already tainted. The issue of the discount shares to shareholder A does not represent any amount paid out of profits derived by either company, nor is it a distribution from either company to the shareholder. Accordingly, the issue of the discount shares will not be assessable as a dividend under section 44 of the ITAA 1936. | Summary: The Commissioner will not make a determination pursuant to section 45B Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies to the whole or a part of the capital benefit comprising the issue of shares to shareholder A. | Detailed Reasoning - Detailed reasoning: Section 45B of the ITAA 1936 is an anti-avoidance measure to treat certain payments, allocations and distributions that are made in substitution for dividends to be dividends for taxation purposes. Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 applies. Relevantly, this section may apply if: · there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); and · under the scheme a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b) of the ITAA 1936); and · having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). | Detailed Reasoning - Capital benefit: Subsection 45B(5) of the ITAA 1936 provides that a taxpayer is 'provided with a capital benefit' if they are either provided with an ownership interest in a company, distributed share capital or share premium, or something is done that increases the value of their ownership interest. Practice Statement Law Administration PSLA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions says at paragraph 43: Generally a capital benefit can be provided to a shareholder (or a non-shareholder) by issuing ownership interests, distributing share capital or share premium, or altering the character of an ownership interest in a way which increases its value in the hands of the owner, for example by adding preferential rights. This method of providing a capital benefit may not affect the company's economic position, but it nonetheless advantages the taxpayer economically by adding value to their ownership interests, which can subsequently be realised in their hands. In the present case shareholder A will be receiving a capital benefit from each of the companies by the provision of shares at a substantial discount to market value. | Detailed Reasoning - Tax benefit: Subsection 45B(9) of the ITAA 1936 provides that a taxpayer 'obtains a tax benefit' if their tax payable would have been more had the 'capital benefit' been a dividend. Because the receipt of the discounted shares does not constitute assessable income of shareholder A, it follows that on receipt of those shares (the 'capital benefit'), shareholder A will receive a tax benefit. | Detailed Reasoning - The scheme: For the purposes of consideration of the application of section 45B of the ITAA 1936, the relevant scheme is considered to be the issue to of shares at a discount to market value to shareholder A. | Detailed Reasoning - Relevant circumstances: The objective conclusion as to the requisite purpose in relation to the tax benefit arising from the issuing of the discount shares is made having regard to the relevant circumstances of the scheme, including those set out in subsection 45B(8) of the ITAA 1936. The relevant circumstances listed in subsection 45B(8) of the ITAA 1936 include the tax and non-tax (ie business and other financial) implications of the scheme, the latter covered largely by the matters in paragraph 177D(b) of the ITAA 1936, which are included in subsection 45B(8) of the ITAA 1936 by virtue of paragraph (k). All of the circumstances listed in subsection 45B(8) must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose. Having regard to all the relevant circumstances of this scheme, the Commissioner will not come to the objective conclusion that a non-incidental purpose of providing the capital benefit to shareholder A is to obtain a tax benefit. The Commissioner will therefore not make a determination under subsection 45B(3)(b) that section 45C of the ITAA 1936 applies. | Summary: Division 7A of the ITAA 1936 will not apply to the issue of the shares or the distribution of assets on liquidation of the companies. | Detailed Reasoning - Detailed reasoning: Generally, Division 7A of Part III of the ITAA 1936 (Division 7A) applies where a private company has made a payment or loan to, or forgiven the debt of, an entity in an income year and in that income year either: · The entity was a shareholder or shareholder's associate of the private company at the time the payment, loan or debt forgiveness was made, or · A reasonable person would conclude that the loan, payment or debt forgiveness was made because the entity had been a shareholder or shareholder's associate at some time. An entity includes an individual (section 109ZD and paragraph 960-100(1)(a) of the ITAA 1936). An associate includes a relative of an entity (section 109ZD of the ITAA 1936 and section 318 of the ITAA 1936). The general rule is that a private company is taken to pay a dividend to an entity at the end of the income year in which the payment (including the transfer of property) or loan is made or the debt is forgiven (refer to sections 109C, 109D and 109F of the ITAA 1936). Such dividends are included in the assessable income of the shareholder or associate under section 44 of the ITAA 1936. However, a distribution paid by a liquidator during the course of winding up a company will not be deemed to be a dividend under sections 109C or 109D of the ITAA 1936 (section 109NA of the ITAA 1936). Therefore the in specie distribution of the assets of the companies on their winding up will not be treated as deemed dividends for the purposes of Division 7A. | Detailed Reasoning - Issuing of discount shares: Taxation ruling TR 2008/5 discusses the tax consequences for a company issuing shares for assets or for services. Appendix 1 to TR 2008/5 includes a discussion on what occurs when a company issues shares and states that when a company issues shares it is not committing to any sale, transfer, conveyance or disposition of any of its property (based on the High Court decision in Ord Forrest Pty Ltd v. Federal Commissioner of Taxation (1973-74) 130 CLR 124 ( Ord Forrest ) (paragraph 30 of TR 2008/5). Accordingly, it is accepted that the issue of the discount shares will not be a 'transfer of property' for the purposes of paragraph 109C(3)(c) of the ITAA 1936 and consequently, Division 7A will not apply to the issue of the shares at a discount. | Summary: The value shifting rules in Part 3-95 of the Income Tax Assessment Act 1997 (the ITAA 1997) will apply to the issue of the discount shares. | Detailed Reasoning - Detailed reasoning: Where a direct value shift (DVS) occurs that has consequences under Division 725 of the ITAA 1997, the rules in the Division apply to modify the adjustable values of affected interests to take account of material changes in market value that are attributable to the DVS. The rules in Division 725 may also generate a capital gain on those interests that have decreased in market value as a result of the DVS. Division 725 of the ITAA 1997 will apply to a scheme if there is a DVS as defined under section 725-145 of the ITAA 1997. A DVS will occur when: - there is a decrease in the market value of one or more equity interests in a company and either: · equity interests in the company are issued at a discount to market value (subsection 725-145(2) of the ITAA 1997; or · there is an increase in the market value of one or more equity interests in the company (subsection 725-145(3); and - the changes in market value and the issue of equity interests are reasonably attributable to things done under the scheme. In accordance with subsection 725-155, the decrease in the market value of the existing shares in the companies will be a 'down interest' (subsection 725-155(1) of the ITAA 1997). In accordance with subsection 725-155(2) of the ITAA 1997, the shares issued at a discount will be 'up interests'. Therefore there is a direct value shift that consists of the decrease in market value of the down interests and the issue at a discount of the up interests (the discount shares). | Detailed Reasoning - CGT consequences and adjustable value: If there is a taxing event generating a gain, CGT event K8 will happen (section 104-250 of the ITAA 1997). The table to section 725-245 details the circumstances when a DVS will be a taxing event generating a gain for down interests. In relation to down interests, the consequences will depend on whether there has been a pre-shift gain or loss. A pre-shift gain will occur in circumstances where, immediately before the value shift occurs, market value of the interests is greater than the adjustable value of those interests (subsection 725-210(2) of the ITAA 1997). If the market value is equal to or less than the adjustable value there will be a pre-shift loss (subsection 725-210(3) of the ITAA 1997). The meaning of adjustable value is discussed in section 725-250 of the ITAA 1997 In working out whether there is a taxing event generating a gain and if so, the amount of the gain, the adjustable value will be the cost base of the asset (subsection 725-240(2) of the ITAA 19997). The table in subsection 725-250(2) of the ITAA 1997 specifies what the consequences will be to the adjustable value of an up or down interest. Any decrease in adjustable value and calculation of the amount of the gain are calculated in accordance with the method statement in section 725-365 of the ITAA 1997: Any uplifts in adjustable values of up interests will be calculated in accordance with the method statement in either section 725-370 or 725-375 of the ITAA 1997. | Detailed Reasoning - Consequences of the DVS for Shareholder B: In accordance with item 4 in the table in section 725-245 of the ITAA 1997, there will be a taxing event generating a gain in relation to the down interests held by Shareholder B. The amount of the gain is calculated in accordance with section 725-365 of the ITAA 1997 and will be a CGT event K8. However, as the down interests held by Shareholder B are all pre-CGT assets that gain will be disregarded under subsection 104-250(5) of the ITAA 1997. Immediately prior to the issue of the discount shares, the market value of the down interests was greater than their adjustable value. Therefore, in accordance with subsection 725-210(2) there will be a pre shift gain in relation to the down interests held by Shareholder B. There will be a decrease in the adjustable value of the down interests held by Shareholder B calculated in accordance with section 725-365 of the ITAA 1997 (item 6 in the table to section 725-250 of the ITAA 1997). | Detailed Reasoning - Consequences of the DVS for Shareholder A: The up interests (the discount shares) will all held by shareholder A and are post CGT assets. Therefore, there will be no taxing event for shareholder A in relation to the down interests held by it as the down interests are not covered by any of the items in the table to section 725-425 of the ITAA 1997. Where value has shifted from down interests owned by shareholder A to up interests owned by shareholder A, item 1 of the table in section 725-250 of the ITAA 1997 specifies that the decrease in adjustable value of the down interests will be calculated in accordance with the method statement in section 725-365 of the ITAA 1997 and the uplift in relation to the up interests in accordance with the method statement in section 725-370 of the ITAA 1997. Additionally, shareholder A will also own up interests in relation to which the down interests were owned by other affected owners (Shareholder B). In relation to these up interests, the uplift to the adjustable value of these interests will be calculated in accordance with the method statement in section 725-375 of the ITAA 1997. | Summary: The Commissioner will not make a determination pursuant to section 177F of the ITAA 1936 to cancel any tax benefit that might be achieved by the scheme. | Detailed Reasoning - The general anti-avoidance provisions: Part IVA 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 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. Under s 177D(b) of ITAA 1936 , the matters are: (i) the manner in which the scheme was entered into or carried out; (ii) the form and substance of the scheme; (iii) the time at which the scheme was entered into and the length of the period during which the scheme was carried out; (iv) the result in relation to the operation of ITAA 1936 that, but for Pt IVA , would be achieved by the scheme; (v) 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; (vi) 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; (vii) any other consequence for the relevant taxpayer, or for any related person, of the scheme having been entered into or carried out; and (viii) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any other related person. After considering the relevant tax benefits obtained and the factors in paragraph 177D(b) of the ITAA 1936, Part IVA is not considered to apply to this arrangement. | Summary: The proposed arrangement will not be characterised as a dividend stripping scheme in terms of section 177E of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Section 177E of the ITAA 1936 applies to certain schemes that are considered to be 'dividend stripping arrangements'. Subsection 177E(1) of the ITAA 1936 sets out the conditions that will attract the operation of section 177E of the ITAA 1936. These are: · there must be a scheme by way of or in the nature of dividend stripping or having substantially the same effect as a dividend stripping scheme by way of disposal of property of a company, · in the opinion of the Commissioner the disposal of the property represents a distribution of profits of the company, · whether the payment of a dividend out of profits immediately before the scheme was entered into would, or might reasonably be expected to, have included an amount in the assessable income of any taxpayer, and · the scheme was entered into after 27 May 1981. It should be noted that the application of section 177E of the ITAA 1936 does not require the existence of a tax benefit or a tax avoidance purpose before the section will apply. Income tax ruling IT 2627 discusses the application of Part IVA to dividend stripping arrangements. In the absence of a precise legal meaning to the term 'dividend stripping' states the following: 9. However, it can be said that 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. It is not considered that section 177E of the ITAA 1936 has any application in relation to the current arrangement.

Question 1: Will the issue of shares at a discount to shareholder A be ordinary income or a dividend for tax purposes? | Question 2: Will the Commissioner make a determination pursuant to section 45B Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies to the whole or a part of the capital benefit comprising the issue of shares to shareholder A? | Question 3: Will Division 7A of the ITAA 1936 apply to the issue of the shares or the distribution of assets on liquidation of the companies? | Question 4: Will the value shifting rules in Part 3-95 of the Income Tax Assessment Act 1997 (the ITAA 1997) apply? | Question 5: Will the Commissioner make a determination pursuant to section 177F of the ITAA 1936 to cancel any tax benefit that might be achieved by the scheme?