Private ruling: CGT rollover
Date of advice: 31 August 2017
Published: December 2017
Ruling period: Year ended 30 June 201D | Year ended 30 June 201E
Date scheme commenced: 1 July 201C

Ruling: Q1: Are the replacement roll-over relief requirements under Subdivision 122-A of the Income Tax Assessment Act 1997 (ITAA 1997) satisfied if the shares owned by you in an Australian trading company and an overseas trading company are transferred to your wholly-owned Australian company (holding company)? | A1: Yes. | Q2: Will the proposed arrangement constitute either a dividend stripping scheme or a scheme having substantially the same effect for the purposes of section 177E of the Income Tax Assessment Act 1936 (ITAA 1936)? | A2: Yes. | Q3: Will the Commissioner make a determination pursuant to section 177EA of the ITAA 1936 in relation to the company dividends paid under the proposed arrangement? | A3: No. Section 177EA is not applicable to the arrangement. | Q4: Will the proposed arrangement constitute a scheme to which section 177D of the ITAA 1936 applies? | A4: Yes. | Q5: Will the Commissioner make a determination pursuant to section 204-30 of the ITAA 1997 in relation to the dividends paid under the proposed arrangement? | A5: No. Subdivision 204-D is inapplicable to the proposed arrangement. | Q6: Will the payment of dividends by the overseas trading company to your holding company out of profits be exempt under section 768-5 of the ITAA 1997? | A6: Yes. However, the profits paid out of pre-acquisition profits will be subject to Part IVA. | Q7: Will the payment of dividends by the overseas trading company to your holding company out of profits be exempt under section 23AI of the ITAA 1936 to the extent there is an attribution debit that arises under subsection 372 in relation to the payment? | A7: Yes.

Relevant facts and circumstances: BACKGROUND 1. You, the Australian trading company and your holding company are residents of Australia for income tax purposes. 1. The Australian trading company was incorporated in Australia in early 201A. 2. The overseas trading company was incorporated overseas during the income year ended 30 June 201B. 3. The overseas incorporated company is a resident of that country and does not carry on business in Australia. 4. You own XY% in each company (the Australian and overseas). Each company has XXX,XXX shares on issue. 5. The two companies sell electronic devices for home and business use. They are run as franchises from overseas. 6. Expansion has caused the current owners of the two companies to reconsider the current ownership structure. 7. You would like to set up an Australian holding company through which to own your investment in the two companies provided that this can qualify for CGT rollover relief. 8. You have recently acquired another company which you wholly own. 9. You intend to transfer your company shares to this newly acquired company. 10. You state that the advantages of interposing a holding company include: a. It allows certain activities to be separated from the trading activities in one company for privacy, confidentiality and/or accountability reasons, if required. For example, certain head office payroll functions could be carried out by the holding company so as to protect sensitive information and/or to quarantine trading versus non-trading activities. b. It allows for the separation of commercially sensitive transactions if it is commercially expedient to do so. c. It allows gearing to be managed ‘off balance sheet’, if required. That is, debt/equity capital management could be done at either the holding company level or at the trading company level, thereby creating maximum leverage flexibility which would not be ‘obvious to your company’s customers. d. It allows profits to be repatriated out of the trading companies, and thereby allows these companies net assets and hence their liability to be reduced, yet retained within a corporate group, via loans, so that the funds could still be used to fund the trading companies’ working capital requirements and commitments. It allows dividends to be paid to the newly acquired holding company which could then be used to loan amounts back to the trading company. 11. Once the shares are transferred, the retained earnings for the Australian and overseas trading companies will be paid out, and in this case, a portion of that retained earnings commensurate with its shareholdings will be paid to your wholly owned holding company).

Relevant legislative provisions: Income Tax Assessment Act 1997 subdivision 122-A | Income Tax Assessment Act 1997 subdivision 204-D | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 subsection 103-25(2) | Income Tax Assessment Act 1997 subsection 768-5 | Income Tax Assessment Act 1936 section 23AI | Income Tax Assessment Act 1936 section 177A | Income Tax Assessment Act 1936 section 177C | Income Tax Assessment Act 1936 section 177CB | Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 section 177E | Income Tax Assessment Act 1936 section 177EA | Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1936 section 317 | Income Tax Assessment Act 1936 section 363 | Income Tax Assessment Act 1936 section 365 | Income Tax Assessment Act 1936 section 372

Reasons for decision: Summary: The replacement roll-over relief requirements under Subdivision 122-A of the ITAA 1997 will be satisfied if the shares owned by you are transferred to your holding company. | Detailed Reasoning - CAPITAL GAINS TAX ROLL-OVER RELIEF: 1. Generally, Subdivision 122-A of the ITAA 1997 allows for the roll-over of a capital gain or loss when an individual or trustee disposes of a capital gains tax (CGT) asset to a company in which just after the disposal, the individual or trustee owns all the shares. | Detailed Reasoning - Disposal or creation of assets – wholly owned company: 1. In order for an individual to obtain roll-over relief under Subdivision 122-A of the ITAA 1997, the CGT event which triggers the capital gain or loss must be one listed in the table of section 122-15. CGT event A1, being the disposal of a CGT asset, is one of the trigger events listed in the table. 2. Under subsection 104-10(1) of the ITAA 1997, CGT event A1 happens if you dispose of a CGT asset. Under subsection 104-10(2) you dispose of a CGT asset if a change of ownership occurs from you to another entity. Shares in a company are CGT assets (section 108-5 of the ITAA 1997). Application to your circumstances 3. The proposed transfer of your shares in your trading companies to your wholly owned holding company will trigger CGT event A1 as a change of ownership will occur effecting a disposal of the shares. Therefore, this requirement is satisfied. | Detailed Reasoning - What is received for the trigger event: 4. Under subsection 122-20(1) of the ITAA 1997, the consideration received (if any) for the disposal of the shares must be only shares in the wholly owned company or in addition to shares in the wholly owned company, the company undertaking to discharge any liabilities in respect of the shares. 5. In addition, subsection 122-20(2) of the ITAA 1997 requires that the shares received in the wholly owned company cannot be redeemable shares. The market value of the shares must be substantially the same as the market value of the shares disposed of, less any liabilities the company undertakes to discharge. 6. As outlined in ATO Interpretative Decision ATO ID 2004/94 Income Tax – Capital gains tax: Subdivision 122-A rollover: no consideration received (ATO ID 2004/94), section 122-20 does not require that consideration must be received for the disposal of an asset to a company in order to obtain the roll-over. Rather, it provides that if there is consideration received for the disposal, then that consideration must be either non-redeemable shares in the company or non-redeemable shares in the company and the company's undertaking to discharge any liabilities in respect of the asset. 7. Under subsection 122-20(3) of the ITAA 1997, the market value of the shares you receive must be the same as the market value of the shares disposed of, less any liabilities the company undertakes to discharge. Application to your circumstances 8. You have provided that you will receive no consideration from the holding company for the transfer of trading company shares from you to the holding company. 9. Thus, section 122-20 of the ITAA 1997 is satisfied. | Detailed Reasoning - Other requirements that must be satisfied: 10. Section 122-25 of the ITAA 1997 lists further requirements that must also be satisfied for roll-over relief to be available under Subdivision 122-A, relevantly being that: a. the individual must own all the shares in the company just after the time of the disposal of their shares to the company (subsection 122-25(1)) b. the disposal of the asset is not one listed in the table in subsection 122-25(2) c. the ordinary and statutory income of the recipient company must not be exempt from income tax because it is an exempt entity for the income year the roll-over occurs (subsection 122-25(5)), and d. the company and individual are Australian residents at the time of disposal (paragraph 122-25(6)(a)). Application to your circumstances 11. You already own all the shares in the holding company. Just after the transfer of your shares in the trading companies to the holding company you will continue to own 100% of the shares in the holding company. Therefore, the requirement in subsection 122-25(1) of the ITAA 1997 will be satisfied. 12. None of the exceptions in the table in subsection 122-25(2) of the ITAA 1997, which lists certain assets for which the roll-over is not available, apply to these circumstances. 13. Subsection 122-25(5) of the ITAA 1997 is satisfied as the ordinary or statutory income of the holding company will not be exempt from income tax due to the holding company being an exempt entity in the year the roll-over occurs. 14. The residency requirement under paragraph 122-25(6)(a) of the ITAA 1997 will be satisfied as both you and the holding company will be Australian residents at the time of the share transfer. | Detailed Reasoning - Company undertakes to discharge a liability: 15. Section 122-35 of the ITAA 1997 provides additional requirements if a CGT asset has been disposed of and the company has undertaken to discharge a liability in respect of it. Application to your circumstances 16. Section 122-35 of the ITAA 1997 does not apply in these circumstances as the holding company is not discharging a liability in respect of the shares of the trading companies. | Detailed Reasoning - Conclusion: 17. The transfer of the trading companies’ shares from you to your wholly owned holding company, in the proposed arrangement, will enable you to roll-over any capital gain or loss as specified in Subdivision 122-A of the ITAA 1997 should you so choose. The choice to obtain roll-over relief under Subdivision 122-A does not require a specific election. The way in which you prepare your income tax return is sufficient evidence of making the choice, as per subsection 103-25(2) of the ITAA 1997. | Summary: 18. The proposed arrangement constitutes either a dividend stripping scheme or a scheme having substantially the same effect for the purposes of section 177E of the ITAA 1936. | Detailed Reasoning - SCHEMES TO REDUCE TAX- STRIPPING OF COMPANY PROFITS: 19. 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. 20. The Explanatory Memorandum to the Income Tax Laws Amendment Bill (No 2) 1981 which introduced section 177E of the ITAA 1936 provides: Part IVA will have within it, in section 177E, a supplementary code to deal with dividend-stripping schemes of tax avoidance and certain variations on such schemes, the effect of which is to place company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. Any property of a company is disposed of as a result of a scheme (paragraph 177E(1)(a)) 21. The first requirement of paragraph 177E(1)(a) of the ITAA 1936 is that there is a scheme by way of or in the nature of dividend stripping or, in the alternative, there must be a scheme having substantially the same effect. | Detailed Reasoning - Scheme: 22. The term ‘scheme’ is defined in section 177A as follows: a. any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings, and b. any scheme, plan, proposal, action, course of action or course of conduct. 23. The definition of scheme is broad, however to satisfy subsection 177A(1) of the ITAA 1936 and establish that a scheme exists, it is necessary that an agreement, arrangement, understanding, plan, proposal, action, course of action or course of conduct exists. Application to your circumstances 24. The proposed scheme includes the following actions that have taken, or will take, place: a. purchase of a company, that is, the holding company b. transfer of your ordinary shares in the trading companies to the holding company utilising division 122-A of the ITAA 1997 to obtain rollover relief c. declaration and payment of a fully franked dividend to ordinary shareholders of the trading companies. 25. If implemented, these steps are agreements, arrangements, plans, course of actions and the like and as such constitute a scheme for the purposes of subsection 177A(1) of the ITAA 1936. First limb - by way of or in the nature of dividend stripping (subparagraph 177E(1)(a)(i)) 26. There are two limbs to subsection 177E(1) of the ITAA 1936. Subparagraph 177E(1)(a)(i) (the first limb) requires there to be “a scheme by way of or in the nature of dividend stripping”. 27. Dividend stripping is not a defined term, however its meaning is considered in Taxation Ruling IT 2627 Income Tax: Application of Part IVA to dividend stripping arrangements , which states at paragraphs 8 to 10: 8. The term ‘dividend stripping’ has no precise legal meaning. Therefore, it is not possible in this Ruling to provide exhaustive definitions of what does and what does not satisfy that expression. 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 year’s 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. 10. No exhaustive list of other examples can be given of what might constitute a dividend stripping scheme for the purposes of section 177E. Having regard to the overall scope and purpose of the section, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form, regardless of the different methods that might be used to achieve this result. 28. A dividend stripping operation has been recognised by the courts as involving the following 6 characteristics: a. a target company, which had substantial undistributed profits creating a potential tax liability either for the company or its shareholders b. the sale or allotment of shares in the target company to another party c. the payment of a dividend to the purchaser or allottee of the shares out of the target company's profits a. the purchaser or allottee escaping Australian income tax on the dividend so declared b. the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers (there being no capital gains liability at the relevant time), and c. the scheme being carefully planned, with all the parties acting in concert, for the predominant if not the sole purpose of their vendor shareholders, in particular, avoiding tax on a distribution of dividends by the target company. 29. “It is … by reference to the presence or absence of those characteristics that the schemes in the present case should be examined for consistency with the broad description contained in para (a)(i) of s 177E(1)” ( Lawrence at 395 per Jessup J). 30. However, in considering the central characteristics of a dividend stripping scheme, the Full Federal Court in Consolidated Press observed that: The terms of the first limb of s177E(1)(a) suggests that a scheme may fall within its scope, even though not all the elements of a standard dividend stripping scheme are present. The use of the words ``by way of or in the nature of'' suggests that variations from the paradigm will not necessarily result in the scheme being excluded from the first limb, provided it retains the central characteristics of a dividend stripping scheme. 31. In other words, variations from 'the paradigm' that, in effect, retain the substance of the central characteristics of a dividend stripping scheme, if not their exact form, could fall within the scope of section 177E of the ITAA 1936. 32. In relation to the fifth characteristic, the Full Court in Consolidated Press noted that the critical point was that the vendor shareholders receive a consideration which is in a tax-free or largely tax-free form. Dominant purpose 33. In relation to the sixth characteristic, for the arrangement to be a scheme to which subsection 177E(1) of the ITAA 1936 applies, a tax avoidance purpose is required. In Commissioner of Taxation v Consolidated Press Holdings Ltd and Others (No 1) (1999) 91 FCR 524 their Honours said (at 570 [174]): In our view, the first limb of s 177E(1) embraces only a scheme which can be said objectively to have the dominant (although not necessarily the exclusive) purpose of avoiding tax. The requirement of a tax avoidance purpose flows from the use by Parliament of the undefined expression "a scheme by way of or in the nature of dividend stripping". What is important is the nature of the scheme, not the subjective motives or intentions of any of the participants or the beneficiaries. The purpose of the scheme is to be assessed from the perspective of the reasonable observer, having regard to the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated. 34. As Jessup J said in Lawrence , those observations “apply equally to para (a)(ii), in the context of which a tax avoidance purpose is just as necessary” (at 403;[88]). 35. The High Court in Federal Commissioner of Taxation v Spotless Services (1996) established that where a scheme makes no commercial sense without the tax benefits, there is a greater likelihood of concluding that it is entered into for the sole or dominant purpose of obtaining a tax benefit. Factors which suggest the scheme had been entered into for commercial reasons or as part of ordinary family dealings will generally lead to the opposite conclusion even if the arrangement is to some extent tax driven. 36. In Federal Commissioner of Taxation v. Hart [2004] 217 CLR 216; HCA 26 at 94, Callinan J, in the context of subparagraph 177D(b)(ii), noted that it was relevant to consider whether the substance of the transaction in question (tax implications apart) could more conveniently, or commercially, or frugally have been achieved by a different transaction or form of transaction. 37. In considering the purpose of the arrangement, it is necessary to examine all of the evidence and to consider the relevant objective features to determine whether the arrangement has been carried out with the sole or dominant purpose of avoiding tax on distributions of profits. 38. The Commissioners view, as outlined in paragraph 24 of Taxation Determination TD 2014/1, is that one objective matter in assessing the tax avoidance purpose of certain ‘dividend access share’ arrangements relates to the complexity of the arrangement. | Detailed Reasoning - Application to your circumstances: 39. The proposed arrangement satisfies the first four characteristics which the courts have identified as being common among dividend stripping schemes: First characteristic: A target company with substantial undistributed profits creating a potential tax liability, either for the company or its shareholders 40. The target companies are the trading companies which both have substantial undistributed profits which would expose you as the original shareholder to a potential tax liability if the profits were paid to you as a dividend. Second characteristic: The sale or allotment of shares in the target company to another party 41. The trading companies’ shares you hold will be transferred to the holding company, an entity other than the original shareholder. Third characteristic: The payment of a dividend to the purchaser or allottee of the shares out of the target company’s profits 42. Dividends out of the current undistributed profits will be paid after your shares in the trading companies have been transferred to the holding company. That is, the holding company will receive these dividends. Fourth characteristic: The purchaser or allottee escaping Australian income tax on the dividend so declared 43. Under the proposed arrangement, no additional tax liability will be incurred by the holding company in respect of the fully franked dividend payment from the Australian trading company, as the benefit of the franking credits attached to the dividend on the shares wholly offsets any tax liability. 44. The holding company will also escape Australian income tax on the dividends paid by the overseas trading company due to the operation of subsection 768-5(1) of the ITAA 1997, which provides: A *foreign equity distribution is not assessable income, and is not *exempt income, of the entity to which it is made if: (a) the entity is an Australian resident and a *corporate tax entity; and (b) at the time the distribution is made, the entity satisfies the participation test in section 768-15 in relation to the company that made the distribution; and (c) the entity: (i) does not receive the distribution in the capacity of a trustee; or (ii) receives the distribution in the capacity of a trustee of a *public trading trust. 45. Section 768-15 of the ITAA 1997 relevantly provides that this test will be met where participation interests in another entity are at least 10%. 46. The dividends from the overseas trading company would be a foreign equity distribution made to an Australian resident corporate tax entity, the holding company, in its own capacity at a time where the holding company would hold XY% of participation interests in the overseas trading company. Thus, the dividends received would be non-assessable non-exempt income in the holding company’s hands. Fifth characteristic: The vendor shareholder 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) 47. The fifth characteristic of a dividend stripping operation requires considering whether the vendor shareholder will receive a capital sum in an amount close to the dividend paid to the holding company. 48. The shares will be transferred for no consideration under subdivision 122-A of the ITAA 1997. 49. Consequently, the fifth characteristic of a dividend stripping operation, as established by the courts, is not present in these circumstances. However, pursuant to Consolidated Press , it is not necessary for all of the elements of a standard dividend stripping scheme to be in place in order for the first limb of paragraph 177E(1)(a) of the ITAA 1936 to be satisfied. In Consolidated Press it was held that ‘by way of or in the nature of’ meant that if a scheme did not meet all elements but has the central characteristics of a dividend strip, it still may satisfy the first limb. 50. However, arguably this criterion is satisfied because as a result of the transfer of shares to the holding company, you will enjoy a significant appreciation in the value of your shares in the holding company because the holding company will now be both the owner of the trading companies’ shares and the recipient of significant cash from the distribution of dividends. Sixth characteristic: 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 51. For section 177E to apply the relevant scheme has to have as its dominant purpose the avoidance of tax on the distribution of dividends by the target company. As noted in TD 2014/1: The important question is whether the form of the transaction is the result of an objective tax avoidance purpose or the result of an objective purpose of achieving a non-tax purpose such as asset protection. Tax avoided 52. If the dividends were paid directly to you as they would be in the current arrangement, you would be assessed on the dividends at your top marginal income tax rates. However, this benefit would be partially offset by franking credits in respect of dividends from the Australian trading company and foreign tax credits in respect of dividends from the overseas trading company (because of overseas withholding tax). Asset protection purpose 53. You claim that the primary reason for the proposed restructure is to protect the assets of the trading companies, namely the cash reserves from third party claims. That is, the restructure is primarily designed to protect the retained earnings of the trading companies from the risk of potential creditors in the event of litigation. 54. In addition, you have provided a number of other reasons summarised in the facts above for the proposed arrangement. Complexity 55. Before carrying out the proposed scheme, the most straightforward manner by which the existing shareholders, including you could arrange for the trading companies’ retained profits to be protected from potential creditors is by having the dividends paid to the current shareholders. You could then deal with your share of the dividends as you see fit. If retaining the cash received from the dividend in a company structure is also required, you could use the cash received to capitalise the holding company. 56. The payment of a dividend to you would be subject to a rate of tax above the company tax rate (‘top-up tax’). Although you would have the benefit of any available franking credits or foreign tax credits due to the proposed quantum of the dividends, this will not be enough to offset the entire tax payable on the dividend. 57. You provide that the alternative scenario of paying dividends (including fully franked dividends) to yourself is not considered appropriate as you do not currently have a need for dividend proceeds. 58. You state that the funds received by the holding company from the trading companies via dividends would be held in the company for your own business activities. You state this would allow you the use of the funds and allow the funds to be protected. 59. However, the use of funds and the asset protection purposes sought to be achieved by the proposed arrangement could arguably be achieved more 'conveniently, commercially and frugally' by a different transaction without the transfer of shares in the trading companies to the holding company. The reasons for establishing and carrying out the proposed arrangement are explicable for the tax reasons only, being the postponement or avoidance of tax by you. The postponement or deferral of income tax to the original shareholder is sufficient to constitute tax avoidance in respect of section 177E. Second limb – substantially the effect of a scheme by way of or in the nature of dividend stripping (subparagraph 177E(1)(a)(ii)) 60. Subparagraph 177E(1)(a)(ii) of the ITAA 1936 (the second limb) requires there to be “a scheme having substantially the effect of a scheme by way of or in the nature of a dividend stripping”. In Lawrence , Jessup J explained at [77]: It seems that the parliament wanted to catch “variations” on dividend stripping schemes, and considered that the unifying principle of all such schemes and variations was that they had the effect of placing company profits in the hands of shareholders in a tax-free form, in substitution for taxable dividends. This is, in my view, a significant indication of parliamentary purpose, since it treats such an effect as distinct from the result of a scheme of the kind contemplated: s 177E does not require that shareholders themselves, as a “result” of the scheme, receive the profits distributed by way of the disposal of property in question. 61. The second limb looks to the ‘effect’ of the arrangement and poses the question as to whether the outcomes achieved are the same in effect as a ‘dividend stripping’ operation. In this regard, Jessup J in Lawrence said at [84]: To answer this question, as it seems to me, requires one to consider a notional scheme which did not in fact exist but which would have the characteristics to which I refer; and to consider then the effect of that notional scheme. 62. Jessup J then referred to a notional scheme under which: ● The taxpayer sold their shares in the target companies to another entity, ● The target company then paid the dividend to the other entity, ● The new shareholder escaping Australian income tax ● The taxpayer receiving a capital sum for the shares in an amount the same as or very close to the dividends paid to the new shareholder. And then concluded at [85]: …the effect thereof would, in my view, have been substantially the same as the effect of the scheme in fact implemented… Both in the notional scheme referred to and in the present case the taxpayer, otherwise presumptively entitled to dividends, would receive a capital payment (or benefit) which would have been funded by the profits of the target company. In the notional scheme the capital receipt would consist of the proceeds of the sale of his or her shares. In the present case an accretion of capital, the same in effect as such a receipt, arise from the increase in the value of the assets held by the [trusts] to which the applicant and his family were beneficially entitled. In both cases, the profits of the target company would effectively have been disposed of, and would no longer have been a potential source of income tax obligations, either for the taxpayer or for anyone else. Both for the taxpayer and for the revenue, the effects of the scheme in the present case were substantially the same as the effect of a scheme by way of or in the nature of dividend stripping. 63. The effect of a dividend stripping operation is that retained profits of a target company are diverted from the original shareholders to another entity (whether by dividend or otherwise) and their economic benefit released (by whatever means) to those same shareholders (or associates) in a manner which results in less tax being payable. Application to your circumstances 64. As in Lawrence , the effects under a notional scheme under which you sold your shares in the trading companies to a new purchaser would have been substantially the same as the proposed arrangement. Under the notional scheme the entire profit would be released in a capital form and subjected to less tax. 65. The Commissioner does not consider that for an arrangement to fall within section 177E of the ITAA 1936, the release of profits must necessarily be in capital form. Transfer of Australian trading company shares to holding company 66. Under the proposed arrangement, the particular means by which the retained profits are proposed to be removed from the Australian trading company will result in the profits being released via a fully franked intercompany dividend which is in a form subjected to less tax. Transfer of overseas trading company shares to holding company 67. Under the proposed arrangement the particular means by which the retained profits are proposed to be removed from the overseas trading company will result in the profits being released via a dividend received as non-assessable non-exempt income pursuant to subsection 768-5 of the ITAA 1997, which is in a form subjected to less tax. 68. The effect of the proposed arrangement is to divert the trading companies’ retained profits from you as the original shareholder to the holding company in a manner that results in less tax payable through the deferral of tax on a distribution to the ordinary shareholder. You are and have relevantly been the true economic owner of the trading companies’ profits. 69. Accordingly, the Commissioner concludes the proposed arrangement constitutes a scheme ‘having substantially the effect of a scheme by way of, or in the nature of, a dividend stripping’, such that subparagraph 177E(1)(a)(ii) of the ITAA 1936 applies. | Detailed Reasoning - Disposal of property: 70. The second element of paragraph 177E(1)(a) of the ITAA 1936 is whether any property of the company is disposed of as a result of a scheme by way of or in the nature of dividend stripping. Paragraph 177E(2)(a) states that a reference in subsection 177E(1) to the disposal of property of a company shall be read as including the payment of a dividend by the company. Application to your circumstances 71. As the target company, the trading companies will pay a dividend to the new shareholder, the holding company, this second element of paragraph 177E(1)(a) of the ITAA 1936 is also satisfied. | Detailed Reasoning - Disposal of property represents a distribution of company profits (paragraph 177E(1)(b)): 72. Paragraph 177E(1)(b) of the ITAA 1936 requires that the Commissioner forms the opinion that the disposal of property represents, in whole or in part, a distribution of the profits of the company. This distribution can be made to a shareholder or to another person in the accounting period in which the disposal occurred or of any earlier or later accounting periods. 73. Subsection 177E(2) of the ITAA 1936 further provides that the disposal of property includes: a. payment of a dividend by a company b. making of a loan by a company (whether or not it is intended or likely that the loan will be repaid) c. a bailment of property by a company, and d. any transaction that directly or indirectly diminishing the value of any property of the company. Application to your circumstances 74. The relevant disposal of property under the proposed scheme, that is the payment of a dividend by the trading companies to the holding company will represent a distribution of profits of the target company, thereby satisfying the requirement of paragraph 177E(1)(b) of the ITAA 1936. | Detailed Reasoning - Profits paid immediately before the scheme was entered into (paragraph 177E(1)(c)): 75. Paragraph 177E(1)(c) of the ITAA 1936 broadly provides that had the company paid a dividend out of profits immediately before the scheme was entered into, the Commissioner may determine that this represents a disposal of property and would have been included, or could have reasonably expected to be included, by reason of the payment of that dividend in the assessable income of the taxpayer. Application to your circumstances 76. If, immediately prior to the execution of the proposed scheme, the trading companies paid a dividend out of profits, an amount (referred to as the ‘notional amount’ for the purposes of subsection 177E(1) of the ITAA 1936) would have been included, by reason of the payment of that portion of the dividend to you (as the existing shareholder), in the assessable income of you, thereby satisfying the requirement of paragraph 177E(1)(c) of the ITAA 1936. | Detailed Reasoning - Date of commencement of the scheme (paragraph 177E(1)(d)): 77. Paragraph 177E(1)(d) requires that the scheme was entered into after 27 May 1981. Application to your circumstances 78. The proposed scheme will be entered into after 27 May 1981, thereby satisfying the requirement of paragraph 177E(1)(d) of the ITAA 1936. | Detailed Reasoning - Conclusion: 79. Because, in the context of the proposed scheme, all the criteria in paragraphs 177E(1)(a) to (d) of the ITAA 1936 are satisfied, in accordance with paragraphs 177E(1)(e), (f) and (g): a. the proposed scheme is taken to be a scheme to which Part IVA applies b. for the purposes of section 177F, you (as the existing shareholder) will be deemed to have obtained a tax benefit in connection with the scheme equal to the amount referred to in paragraph 177E(1)(c) which, but for the scheme, would have been included in your income, and c. the amount of that tax benefit is taken to be the notional amount. 80. Accordingly, if the proposed arrangement were implemented, the Commissioner would exercise his discretion to make a determination under paragraph 177F(1)(a) of the ITAA 1936 to include that tax benefit in your assessable income. 81. Subsection 177F(2) requires that where the Commissioner determines that an amount is to be included in the assessable income of a taxpayer, that amount shall be deemed to be included in assessable income by virtue of such provisions of the ITAA as the Commissioner determines. It would be appropriate in the event of a determination being made pursuant to paragraph 177F(1)(a) above, for the Commissioner to determine that the tax benefit received from the disposition of dividends from the trading companies be deemed to be included in your assessable income pursuant to section 44 of the ITAA 1936 which assesses dividends paid to a shareholder out of profits of a company. 82. We further note that where a franked distribution is made to an entity as part of a dividend stripping operation, per paragraph 207-145(1)(d) of the ITAA 1997, then for the purposes of the ITAA: …(e) the amount of the franking credit on the distribution is not included in the assessable income of the entity under section 207-20 or 207-35; and (f) the entity is not entitled to a tax offset under this Division because of the distribution; … | Summary: 83. The Commissioner will not make a determination pursuant to section 177EA of the ITAA 1936 in relation to the Australian trading company dividends paid under the proposed arrangement as the section is not applicable to the proposed arrangement. | Detailed Reasoning - Detailed reasoning: 84. Section 177EA of the ITAA 1936 is a general anti-avoidance rule that safeguards the operation of the imputation system. It is directed at franking credit trading involving the transfer of franking credits on a dividend from investors who cannot fully use them to investors who can. If the section applies, the Commissioner may debit the company's franking account or deny the franking credit benefit to the recipient of the dividend. 85. Specifically, subsection 177EA(3) of the ITAA 1936 provides that for section 177EA to apply, the following must be present: a. there is a scheme for the disposition of shares, or interest in shares, in a company b. a franked distribution has been paid, or expected to be paid, directly or indirectly c. the relevant taxpayer would, or could reasonably be expected to, receive imputation benefits from the distribution, and d. having regard to the circumstances of the scheme it would be concluded that the scheme was entered into for the purpose of enabling the relevant taxpayer to obtain imputation benefits. 86. The meaning of the term 'scheme for a disposition' is provided in subsection 177EA(14) and includes, but is not limited to, the following: a. issuing or creating membership interests b. entering into any contract, arrangement or the like which affects the legal or equitable ownership of membership interests or interests in membership interests c. creating, varying or revoking a trust in relation to the membership interests or interests in the membership interests d. creating, altering or extinguishing a right, power or liability attaching to a membership interest or interest in a membership interest, and e. substantially altering any of the risks of loss, or opportunities for profit or gain, involved in holding the membership interest or interest in the membership interest. 87. Paragraph 177EA(3)(e) of the ITAA 1936 provides relevant circumstances that must be considered in determining whether a person has the requisite purpose and includes, but is not limited to, the factors listed in subsection 177EA(17). These relevant circumstances cover 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 disposal 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 to obtain an imputation benefit. 88. The requisite purpose is further explained in paragraph 8.124 of the Explanatory Memorandum (EM) to the Taxation Laws Amendment Bill (No. 3) 1998 that accompanied the introduction of section 177EA as follows: 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 (ie. 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. 89. Therefore, in determining whether or not the requisite purpose is present, the relevant circumstances will reveal whether the scheme seeks to undermine the principles of the dividend imputation system by streaming franking credits to select shareholders. Application to your circumstances 90. The transfer of your shares in the Australian trading company to the holding company is a transaction that affects the legal ownership of the membership interests in a trading company, thereby satisfying the definition of a scheme for a disposition of membership interests pursuant to subsection 177EA(14) of the ITAA 1936, and paragraph 177EA(3)(a) is satisfied. As the scheme will also involve the expected payment of a franked distribution by the Australian trading company, paragraph 177EA(3)(b) will also be satisfied. 91. Paragraph 177EA(3)(c) of the ITAA 1936 will also be satisfied as the holding company will receive franking credits associated with the dividend. 92. However, having regard to the circumstances of the proposed scheme, it is not being entered into for the purpose of enabling the holding company to obtain the franking credits. The Commissioner considers that the purpose of the scheme is to enable you to have control of dividends paid by the Australian trading company without being subject to top-up tax, as described above. Although franking credits will be obtained by the holding company, this is merely a transferring of credits from one corporate entity to another. If dividends are paid by the holding company to you, you will have access to the same franking credits that you would have earlier been entitled to prior to the arrangement. Consequently, this criterion is not met and section 177EA of the ITAA 1936 does not apply to the proposed scheme. | Summary: 93. The proposed arrangement constitutes a scheme to which section 177D of the ITAA 1936 will apply. | Detailed Reasoning - Detailed reasoning: 94. If we are incorrect in our view that the proposed arrangement satisfies section 177E, we nonetheless consider that the scheme will be entered into with the sole or dominant purpose to obtain a tax benefit to which section 177D applies. 95. Part IVA is a general anti-avoidance provision. Broadly, it allows the Commissioner the discretion to cancel a tax benefit obtained by a taxpayer in relation to a scheme where the sole or dominant purpose of the scheme was to obtain a tax benefit. 96. You have argued that Part IVA should not apply to your circumstances due to the application of paragraph 177C(2)(a) of the ITAA 1936. 97. Paragraph 177C(2)(a) of the ITAA 1936 provides that Part IVA will not apply to the obtaining of a tax benefit under a scheme in relation to an amount not being included in a taxpayer’s assessable income where: a. the non-inclusion is attributable to the making of a choice expressly provided for by the ITAA 1936 or ITAA 1997; and b. the scheme was not carried out for the purposes of allowing such a choice to be made. 98. TR 2005/19 relevantly provides: 89. Prima facie, the tax benefit appears to be excluded by subparagraph 177C(2)(a)(i) of the ITAA 1936 in that the non-inclusion of an amount in assessable income cannot be a tax benefit where its non-inclusion is attributable to the making of a choice by the taxpayer which is available to it under the ITAA 1997 and/or the ITAA 1936. 90. However subparagraph 177C(2)(a)(ii) of the ITAA 1936 also applies. The scheme was structured in this way for the dominant purpose (subjective or objective) of creating the circumstances for Company A to be able to choose to obtain roll-over under Subdivision 124-M of the ITAA 1997 in regards to the disposal of its shares in Company B, within the meaning contemplated in subparagraph 177C(2)(a)(ii). Accordingly, whilst the tax benefit arises out of the making of a choice by Company A within the meaning of subparagraph 177C(2)(a)(i) of the ITAA 1936, the circumstances leading up to the availability of that choice were created by the entry of Company A into the scheme. Application to your circumstances 99. Similarly in your circumstances, prima facie, the tax benefit appears to be excluded by subparagraph 177C(2)(a)(i). However, subparagraph 177C(2)(a)(ii) also applies. As discussed, the scheme was structured in this way to allow you to choose to obtain the roll-over under subdivision 122-A of the ITAA 1997 in regards to your disposal of shares in the trading companies within the meaning contemplated in subparagraph 177C(2)(a)(ii). 100. Accordingly, whilst the tax benefit arises out of the making of a choice by you within the meaning of subparagraph 177C(2)(a)(i) of the ITAA 1936, the circumstances leading up to the availability of that choice would be created by the entry of you into the proposed arrangement. 101. By entering into the scheme, you seek to indefinitely defer additional tax payable on the payment of a dividend on your shares in the trading companies. Accordingly, the tax benefit is the taxable amount that you would be liable to if the dividends were received directly by you. Schemes to reduce tax 102. Broadly, for section 177D of the ITAA 1936 to apply the following requirements must be satisfied: a. there must be a scheme as defined by section 177A of the ITAA 1936 b. there must be a tax benefit as defined by section 177C of the ITAA 1936 obtained in connection with the scheme, and c. the scheme must be one to which Part IVA apples, as determined by section 177D of the ITAA 1936, where it would be concluded that the taxpayer (or any other person involved in the scheme) had the sole or dominant purpose of entering into the scheme to obtain the tax benefit. Scheme 103. Part IVA requires the consideration of a ‘scheme’ which is defined in subsection 177A(1). Tax Benefit 104. There must be a tax benefit obtained by the taxpayer in order for Part IVA of the ITAA 1936 to potentially apply. Section 177C broadly provides that a tax benefit in relation to a scheme relates to: a. amounts not being included in assessable income that would otherwise have been included in assessable income b. amounts included as an allowable deduction that would otherwise not have been included as an allowable deduction c. capital losses incurred that would otherwise not have been incurred d. foreign income tax offsets being allowable that would otherwise not have been allowable, and e. no liability to withholding tax on an amount that would otherwise have had a liability. 105. Section 177CB of the ITAA 1936 applies to deciding whether any of the tax benefits under section 177C would have occurred, or might reasonably be expected to have occurred, if a scheme had not been entered into or carried out. 106. Section 177CB of the ITAA 1936 puts it beyond doubt that the 'would have' and 'might reasonably be expected to have' limbs of each of the paragraphs in subsection 177C operate as alternative bases for identifying relevant tax effects. 107. Under subsections 177CB(3) and (4) of the ITAA 1936, a decision that a tax effect 'might reasonably be expected to have' occurred if a scheme had not been entered into or carried out must be made on the basis of a postulate that is a reasonable alternative to the scheme, having particular regard to the substance of the scheme and its results and consequences for the taxpayer, and disregarding any potential tax results and consequences. 108. The identification of a tax benefit requires consideration of the tax consequences of a ‘counterfactual’, or alternative hypothesis, that would have resulted had the scheme not been entered into. As stated by Gummow and Hayne JJ in Hart at [66]: When [section 177C(1)] is read in conjunction with [former] s177D(b) it becomes apparent that the inquiry directed by Pt IVA requires comparison between the scheme in question and an alternative postulate. To draw a conclusion about purpose from the eight matters identified in [former] s177D(b) will require consideration of what other possibilities existed. 109. The Explanatory Memorandum to the Tax Laws Amendment (Countering Tax Avoidance and Multinational Profit Shifting) Bill 2013 which introduced the most recent changes to Part IVA of the ITAA 1936 provides the following: 1.102 A tax advantage cannot meaningfully be linked to a scheme by comparing the tax consequences of the scheme to the tax consequences that would have flowed if the parties had chosen to pursue some other objective. To provide a meaningful comparison, the tax consequences of the scheme should be compared with the tax consequences of an alternative that is reasonably capable of achieving for the taxpayer substantially the same non-tax results and consequences as those achieved by the scheme . (emphasis added) 110. Guidance for identifying the counterfactuals of the scheme can be found in Law Administration Practice Statement PS LA 2005/24: Application of the General Anti-Avoidance Rules (PS LA 2005/24). In particular, paragraph 109 lists the following considerations for determining the counterfactuals: a. the most straightforward way of achieving the commercial and practical outcome of the scheme (disregarding the tax benefit) b. commercial norms, such as standard industry behaviour c. social norms, such as family obligations d. behaviour of the parties around the time of the scheme compared with the period of the scheme’s operation, and e. actual cash flow. 111. PS LA 2005/24 further explains that if: a. the scheme had no effect other than the obtaining of the relevant tax benefit(s), it will be reasonable to assume that nothing would have happened if it was not carried out, and b. a tax benefit is obtained in connection with the scheme which also achieves a wider commercial objective, then it would be reasonable to expect that in absence of the scheme the wider commercial objectives would have been pursued by an alternative arrangement. | Detailed Reasoning - Dominant purpose: 112. Part IVA also requires consideration of the purpose for which the scheme was entered into. Specifically, section 177D of the ITAA 1936 refers to the purpose of the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme. The person need not be the taxpayer. 113. The meaning of the purpose is clarified by subsection 177A(5), which explains that, where there are two or more purposes, it is the dominant purpose that is relevant: A reference in this Part to a scheme or a part of a scheme being entered into or carried out by a person for a particular purpose shall be read as including a reference to the scheme or the part of the scheme being entered into or carried out by the person for 2 or more purposes of which that particular purpose is the dominant purpose. 114. When determining whether the purpose of the scheme was to enable a tax benefit, the Commissioner must have regard to the following eight factors specified in subsection 177D(2): a. the manner in which the scheme was entered into or carried out b. the form and substance of the scheme c. the time the scheme was entered into and the length of time during which the scheme was carried out d. the result that, but for the operation of Part IVA, would be achieved by the scheme e. any change in the financial position of the relevant taxpayer that has resulted, or will result from, the scheme f. any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer g. any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f) of the scheme having been entered into or carried out, and 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 (f). 115. Focussing on the various elements of Part IVA should not obscure the way in which the Part as a whole is intended to operate. What constitutes a scheme is ultimately meaningful only in relation to the tax benefit that has been obtained since the tax benefit must be obtained in connection with the scheme. Likewise, the dominant purpose of a person in entering into or carrying out the scheme, and the existence of the tax benefit, must be considered against a comparison with reasonable alternative schemes capable of carrying out the commercial objectives of the arrangement. 116. In summary, section 177D of the ITAA 1936 provides that Part IVA applies to a scheme in connection with which a taxpayer has obtained a tax benefit if, after having regard to the eight specified factors, it would be concluded that any person who entered into or carried out the scheme, or any part of it, did so for the dominant purpose of enabling the relevant taxpayer to obtain the tax benefit. 117. In Peabody v Federal Commissioner of Taxation (1993) 40 FCR 531 the Court explained that although the Commissioner has to consider each of the factors provided by former subsection 177D(b), this doesn’t mean that each of the factors must point to the dominant purpose, stating that: Some of the matters may point in one direction and others may point in another direction. It is the evaluation of these matters, alone or in combination, some for, some against that [former] s177D requires in order to reach the conclusion to which 177D refers. 118. The Commissioner’s support of this view is provided in PS LA 2005/24 which states at paragraph 88 that all factors of subsection 177D(2) need to be taken into account with regard to the relevant evidence, and weighed together, to identify the dominant purpose of the scheme. | Detailed Reasoning - Application to your circumstances: Scheme 119. As discussed above the proposed arrangement satisfies the requirements for a scheme pursuant to subsection 177A(1) of the ITAA 1936. Tax benefit 120. For the purposes of this arrangement, only paragraph (a) of the definition of ‘tax benefit’ in subsection 177C(1) of the ITAA 1936 is relevant. 121. To identify the ‘tax benefit’, it is necessary to identify the counterfactual or ‘alternative postulate’. The stated non-tax outcome of the proposed arrangement is, amongst other things, the protection of the trading companies’ assets, particularly its retained earnings. 122. The Commissioner accepts that you have a goal of distancing the cash reserves of the trading companies from the possible reach of creditors by paying dividends – the Commissioner’s concern lies with the choice of methods to accomplish this. And it is a normal incident of operating a profitable company that dividends will be paid to shareholders. Accordingly, it is not considered that a reasonably likely possibility would be for the trading companies to pay no dividends and retain the cash surplus. The trading companies will need to ‘do something’ to achieve the commercial purpose of asset protection. In this instance, to postulate that if the proposed scheme did not proceed the taxpayer would do nothing and simply retain the cash surplus would be inconsistent with the commercial purpose sought by the trading companies. 123. We now turn to the enquiry under section 177CB(3) which looks to what reasonable alternatives to the scheme can be put forward. Taking into account the factors listed in paragraph 109 of PS LA 2005/24, the Commissioner considers there is one reasonable alternative postulate to the proposed scheme, being that the trading companies will simply pay a dividend to the original shareholders, including yourself. This alternative postulate is a more straightforward way of achieving the desired commercial outcome. 124. Under the proposed scheme, the receiving company, the holding company would not pay any tax on the dividends received from the trading companies. 125. If the proposed arrangement is not entered into under the alternative postulate, a dividend would be included in your assessable income. 126. The value of the tax benefit, in the case of the dividend paid by the Australian trading company would be equivalent to the difference between the applicable individual marginal tax rate and the franking credits attached to the dividend. 127. The value of the tax benefit, in the case of the dividend paid by the overseas trading company would be equivalent to the difference between the applicable individual marginal tax rate and the foreign tax credits (foreign income tax offset) attached to the dividend. 128. Paragraph 177CB(4)(b) explains that potential tax liabilities are not to be taken into account in assessing the likelihood or reasonableness of any alternative postulate 129. You have not provided any further alternative counterfactual scenarios for consideration. 130. The above alternative postulate satisfies the requirement for a tax benefit pursuant to paragraph 177C(1)(a) of the ITAA 1936. Dominant purpose 131. A conclusion about a relevant person’s purpose for section 177D of the ITAA 1936 is the conclusion of a reasonable person based on all the facts and evidence that are relevant to considering the eight factors for the scheme. 132. To determine if the purpose in entering into the proposed arrangement is to obtain a tax benefit, consideration of the eight factors specified in subsection 177D(2) is provided below: (i) The manner in which the scheme is entered into or carried out 133. This factor enables the presence of any artificiality or contrivance to be identified by analysing the various steps or actions which comprise the scheme. 134. The identified scheme involves the purchase of a wholly owned holding company (already incorporated), the subsequent transfer of your shares in the trading companies to the holding company and declaration and payment of dividends from the trading companies to its ordinary shareholders. 135. Comparing the proposed scheme to the manner in which the alternative postulate would have been implemented, there are additional steps that would not be expected in the more straightforward method of achieving the stated outcome of asset protection. These additional steps include the establishment of a wholly owned company, the holding company, and the transfer of your shares to the holding company. 136. These additional steps indicate the predominant purpose of the scheme is to avoid tax. (ii) The form and substance of the scheme 137. This factor requires an examination of what the scheme appears to do (form) in comparison to what is actually achieves in a commercial and economic sense (substance). A discrepancy between the form and substance of a scheme is often an indication that it has been implemented in a particular way as a means of obtaining a tax benefit. 138. The form of the scheme is that the trading companies will pay a part of their retained profits as a dividend to the wholly owned company, the holding company. Legally, the holding company will be the entity that holds and controls these retained earnings. The holding company will possibly lend funds back to the trading companies as required. After the scheme has been implemented you will continue to control your interests in the trading companies through the holding company. 139. The substance of the scheme also achieves the outcomes mentioned in paragraph 11. However, the majority of these outcomes are achievable without the transfer of shares to the holding company and certainly without the subsequent dividend to the holding company. 140. However, in substance both pre and post the arrangement, you will remain the sole individual entitled to access and control the share of these profits through your shareholdings. While the holding company may be the legal owner of the retained profits, it is you who determines and controls how these funds are dealt with, albeit through a company structure. 141. In substance, you retain control of that part of the trading companies’ profits received by the holding company without being subject to additional tax at the individual marginal tax rate. This discrepancy between form and substance points toward the application of Part IVA. (iii) The time at which the scheme was entered into and the length of the period during which the scheme will be carried out 142. This factor deals with particular ‘timing’ aspects of the manner in which a scheme is entered into or carried out. It requires consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements. 143. The scheme will be carried out in a short period of time. There is nothing in the proposed arrangement to suggest the timing of the steps will contribute to a tax advantage. 144. In this instance, we consider that there are no significant timing issues in relation to the scheme. This factor is therefore neutral with regard to the application of Part IVA. (iv) The result in relation to the operation of this Act, but for this part, would be achieved by the scheme 145. This factor focuses on the tax benefit and any other tax consequence resulting from the scheme. 146. As a result of the scheme, you will not be assessable on receipt of dividends, thereby avoiding additional tax on the dividend at your individual marginal tax rate. 147. The dividends will be paid to the holding company. The holding company will be taxed at the company tax rate on the dividends from the Australian trading company which will result in nil tax payable given the dividends will be fully franked. The holding company will also not be liable to any tax on its receipt of dividends from the overseas trading company pursuant to subsection 768-5 of the ITAA 1997. 148. When considered in isolation, this would point to Part IVA applying. (v) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may be reasonably expected to result, from the scheme 149. This factor focuses on the overall financial impact of the scheme for the relevant taxpayer. It requires consideration of issues such as whether the financial changes are consistent with what would normally be expected from such an arrangement, or whether the only financial change that occurs is as a result of the tax benefit. The absence of any practical change in the overall financial position of a taxpayer is likely to add weight to the dominance of the tax purpose when all factors are weighed together. 150. Given your objective of protecting the cash reserves of the trading companies from creditors by paying dividends, there are two possible financial outcomes depending on whether this is achieved via the taxpayers’ scheme or via the counterfactual. Under the scheme, the individuals receive funds net of tax and under the counterfactual the individuals’ wholly owned companies receive a capital injection that is not reduced by tax. Accordingly under the scheme, the individuals have more assets working on their behalf than under the counterfactual and the value of their shares in their holding companies will reflect this. 151. Given that your financial position will be enhanced under the scheme relative to the counterfactual, explicable only by the tax consequences, this factor points to the application of Part IVA. (vi) Any change in the financial position of any person who has, or has had, any connection with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme 152. This factor is as per factor (v) except that it relates to the financial impact on any other person who is in any way affected by or involved in the scheme. This factor also requires consideration in conjunction with the other factors, particularly factor (ii). 153. From the information provided, there is no change in the financial position of any other person as a result of the scheme. This factor is therefore neutral with regard to the application of Part IVA. 12. Any other consequences for the relevant taxpayer or person connected 154. This factor considers any other non-financial consequence for the taxpayer or any other person involved in the scheme, which might add weight to the dominance of the tax purpose when all factors are weighed together. 155. In your case we cannot identify any other consequences. This factor is therefore neutral with regard to the application of Part IVA. (vii) The nature of any connection between the relevant taxpayer and any person referred to in subparagraph (vi) 156. This factor focusses on the nature of the connection between the taxpayer and any other person whose financial position is reasonably expected to change as a result of the scheme or for whom there are any other consequences from the scheme. 157. This indicator is not relevant as no other connected person is involved in the scheme. This factor is therefore neutral with regard to the application of Part IVA. Conclusion on objective purpose test 158. Having regard to the eight factors in section 177D of the ITAA 1936, it is reasonable to conclude that the dominant purpose for entering into or carrying out the scheme will be to obtain a tax benefit. Conclusion of application of 177D of the ITAA 1936 159. In conclusion, the proposed arrangement constitutes a scheme to which 177D of the ITAA 1936 applies. | Summary: 160. The dividend streaming provisions of Subdivision 204-D do not apply in these circumstances as you and the holding company derive the same benefit from the franking credits on the dividends paid by the trading companies. Thus, the Commissioner will not make a determination under section 204-30 if the proposed arrangement were carried out. | Detailed Reasoning - Dividend streaming: 161. Subdivision 204-D of the ITAA 1997 contains provisions which aim to prevent the streaming of franking credits to one member of a corporate tax entity in preference to another. 162. Subsection 204-30(1) of the ITAA 1997 gives the Commissioner the power to make a determination if an entity streams one or more distributions (or one or more distributions and the giving of other benefits), whether in a single franking period or in a number of franking periods, in such a way that: a. an imputation benefit is, or apart from section 204-30 would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a)) b. the member ('favoured member') would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b)), and c. the other member ('disadvantaged member') of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c)). 163. If subsection 204-30(1) of the ITAA 1997 is satisfied, subsection 204-30(3) of the ITAA 1997 enables the Commissioner to make one or more written determinations with the following effects: a. imposing franking debits in the distributing entity's franking account b. imposing exempting debits on the distributing entity's exempting account, and c. denying the imputation benefit on the distribution that flowed directly or indirectly to the favoured member. 164. Subsections 204-30(7) to 204-30(10) of the ITAA 1997 are directly relevant to the application of paragraph 204-30(1)(b). 165. Subsection 204-30(7) of the ITAA 1997 provides that subsection 204-30(8) lists some of the cases in which a member of an entity derives a greater benefit from franking credits than another member of the entity. It is not an exhaustive list. 166. Subsection 204-30(8) of the ITAA 1997 then states that: A member of an entity derives a greater benefit from franking credits than another member of the entity if any of the following circumstances exist in relation to the other member in the income year in which the distribution giving rise to the benefit is made, and not in relation to the first member: (a) the other member is a foreign resident; (b) the other member would not be entitled to any tax offset under Division 207 because of the distribution; (c) the amount of income tax that, apart from this Division, would be payable by the other member because of the distribution is less than the tax offset to which the other member would be entitled; (d) the other member is a corporate tax entity at the time the distribution is made, but no franking credit arises for the entity as a result of the distribution; (e) the other member is a corporate tax entity at the time the distribution is made, but cannot use franking credits received on the distribution to frank distributions to its own members because: (i) it is not a franking entity; or (ii) it is unable to make frankable distributions; (f) the other member is an exempting entity. 167. Subsections 204-30(9) and 204-30(10) of the ITAA 1997 provide a member of an entity will derive a greater benefit from franking credits than another member, when a distribution is made by an exempting entity or the distribution is franked with an exempting credit or venture capital credit. 168. The term ‘member’ of an entity is defined in subsection 960-130(1) of the ITAA 1997. Item 1 of subsection 960-130(1) describes the member of a company to be a member of the company or a stockholder in the company. 169. The term ‘streaming’ is not defined for the purposes of Subdivision 204-D of the ITAA 1997. However, guidance on the meaning of the term can be found in the Explanatory Memorandum (EM) to the New Business Tax System (Imputation) Bill 2002 , which states that streaming is 'selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits'. 170. In providing guidance on when a member derives a greater benefit from imputation credits, paragraph 3.42 of the EM states that ‘a difference in marginal tax rates of members of a corporate tax entity does not, by itself, indicate that some members derive a greater benefit from imputation credits than others.’ Application to your circumstances 171. After the transfer of the shares to the holding company, it is proposed that the trading companies will pay dividends on those shares, with no other benefits being provided. At the time of the dividend payment, the holding company will own XY% of the shares in each of the trading companies. 172. Prior to the transfer of the shares to the holding company, you owned XY% of the shares in each of the trading companies. As such, you were a member of the trading companies under subsection 960-130(1) of the ITAA 1997. 173. You and the holding company would both be members of the trading companies during the franking period in which the proposed franked dividend will be paid. However, you and the holding company would not be members at the same time. 174. The three paragraphs of subsection 204-30(1) of the ITAA 1997 are key to the making of any determination in relation to dividend streaming. Paragraph 204-30(1)(a) of the ITAA 1997 175. As a resident company recipient of a franked distribution, it is expected that a franking credit will arise in the franking account of the holding company. Consequently, upon receipt of the distribution, the holding company will be taken to have received an imputation benefit under paragraph 204-30(6)(c) of the ITAA 1997, thus satisfying paragraph 204-30(1)(a). Paragraph 204-30(1)(b) of the ITAA 1997 176. Paragraph 204-30(1)(b) of the ITAA 1997 requires examining whether the holding company who will receive the imputation benefit, will be taken to derive a greater benefit from franking credits than another member of the trading companies, yourself. This in turn requires a consideration of the factors in subsection 204-30(8) for the income year the franked distribution is made. 177. As both you and the holding company are Australian residents, paragraph 204-30(8)(a) of the ITAA 1997 is not satisfied. 178. You and the holding company will both be entitled to a tax offset for the imputation credits and therefore, paragraph 204-30(8)(b) of the ITAA 1997 is not satisfied. 179. Paragraph 204-30(8)(c) of the ITAA 1997 examines whether the amount of income tax that, apart from Division 204, would be payable by you (the other member) because the distribution is less than the tax offset to which you would be entitled. Given that you are an Australian resident natural person, you would be entitled to a refund of any imputation credits in excess of tax payable. Therefore paragraph 204-30(8)(c) will not apply. 180. As you are a natural person rather than a corporate entity or exempting entity, paragraphs 204-30(8)(d), (e) and (f) of the ITAA 1997 will not apply. 181. For the reasons stated above, paragraph 204-30(1)(b) will not apply to the present case. The holding company will not derive a greater benefit than you in relation to the franking credits from the proposed franked dividend. 182. Further to the above considerations, it is noted that the holding company would pay tax on any franked dividend at a lesser rate than you, an individual resident member of the company. The fact that tax may be paid at differing rates by different members of the company will not by itself be sufficient grounds for a determination of dividend streaming to be made. 183. For completeness, subsections 204-30(9) and 204-30(10) of the ITAA 1997 are not relevant in the present case, as the distribution is not made by an exempting entity, and the distributions are not franked with an exempting credit or venture capital credit. 184. As paragraph 204-30(b) of the ITAA 1997 does not apply, the requirements of section 204-30(1) have not been met. 185. Accordingly, the payment of the proposed fully franked dividend from the trading companies to the holding company is not a transaction where the Commissioner will make a determination pursuant to section 204-30 of the ITAA 1997. | Summary: 186. The payment of dividends by the overseas trading company to the holding company out of profits will be exempt under section 768-5 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: 187. Under section 768-5 of the ITAA 1997 a distribution is not assessable income and is not exempt income if, at the time the distribution is made: a. it is a foreign equity distribution (section 768-5(1)), b. the recipient entity is an Australian resident corporate tax entity (paragraph 768-5(1)(a)), c. it satisfies the participation test in section 768-15 of the ITAA 1997 in relation to the company that made the distribution (paragraph 768-5(1)(b)), and d. it does not receive the distribution in the capacity of a trustee or a trustee of a public trading trust (paragraph 768-5(1)(c)). 188. A foreign equity distribution is defined in subsection 995-1(1) of the ITAA 1997 as having the meaning given by section 768-10, which relevantly provides that it is a distribution made by a company that is a foreign resident in respect of an equity interest in the company. 189. The participation test in section 768-15 of the ITAA 1997 is satisfied in relation to another entity if the sum of the direct and indirect participation interests in the other entity are at least 10%. Application to your circumstances 190. A dividend paid by the overseas trading company is a distribution made by a company that is a foreign resident in respect of an equity interest in the company. It is a foreign equity distribution. 191. The recipient of the dividend, after the implementation of the proposed scheme would be the holding company, an Australian resident company. 192. After the implementation of the proposed scheme, the holding company will directly hold 25% of the equity interests in the overseas trading company, thus satisfying the participation test in section 768-15 of the ITAA 1997. 193. The holding company would receive the dividend in its own capacity, thus satisfying paragraph 768-5(1)(c) of the ITAA 1997. 194. Thus, should the proposed scheme be implemented, dividends paid by the overseas trading company to the holding company out of profits would be non-assessable non-exempt income. 195. The dividends paid out of pre-acquisition profits under the proposed scheme would be subject to Part IVA as discussed above. | Summary: 196. The payment of dividends by the overseas trading company to the holding company out of profits will be exempt under section 23AI of the ITAA 1936 to the extent there is an attribution debit that arises under section 372 of the ITAA 1936 in relation to the payment. | Detailed Reasoning - Detailed reasoning: 197. Section 23AI(1) of the ITAA 1936 relevantly provides that where an attribution account payment of the kind referred to in paragraph 365(1)(a) of the ITAA 1936, which includes a dividend paid by a company to a shareholder, is made to an entity (other than a partnership or taxpayer in the capacity of a trustee of a trust), if, on the making of the payment, an attribution debit arises for the entity making the payment, then the payment will be non-assessable, non-exempt income in the taxpayer’s hands to the extent of the debit. 198. Subsection 372 of the ITAA 1936 states: An attribution debit arises for an attribution account entity (in this section called the eligible entity ) in relation to a taxpayer if: (a) the eligible entity makes an attribution account payment to the taxpayer or to another attribution account entity; and (b) immediately before the eligible entity makes the attribution account payment, there is an attribution surplus for the eligible entity in relation to the taxpayer. 199. An attribution account entity, under section 363 of the ITAA 1936, relevantly includes a company that is not a Part X Australian resident. A Part X Australian resident is defined in section 317 as meaning: a resident within the meaning of section 6, but does not include an entity where: (a) there is a double tax agreement in force in respect of a foreign country; and (b) that agreement contains a provision that is expressed to apply where, apart from the provision, the entity would, for the purposes of the agreement, be both a resident of Australia and a resident of the foreign country; and (c) that provision has the effect that the entity is, for the purposes of the agreement, a resident solely of the foreign country. 200. In relation to the residence of a company, section 6 of the ITAA 1936 provides a company will be a resident of Australia if it is incorporated in Australia, or carries on business in Australia and has either its central management and control in Australia or its voting power controlled by Australian resident shareholders. Application to your circumstances 201. As the overseas trading company is not incorporated in and does not carry on business in Australia, it is not a resident of Australia. The overseas trading company is incorporated in and is a resident of an overseas country. There is a double tax agreement in force in respect of that country. The DTA provides that residence of a person is determined by its residence for tax purposes. According to the DTA, the overseas trading company would not, in the first instance be both a resident of Australia and that country as required by paragraph 363(b) of the ITAA 1936. Thus, the overseas trading company is not a Part X Australian resident and is eligible as an attribution account entity. 202. Thus, if the overseas trading company pays a dividend to the holding company and if on the making of the payment an attribution debit arises for the entity making the payment, then the payment will be non-assessable, non-exempt income in the holding company’s hands to the extent of the debit. An attribution debit will only arise in relation to the dividend if, immediately before payment there is an attribution surplus for the overseas trading companies in relation to the taxpayer.