Private ruling: Frankable distribution, CGT event a1 and dividend stripping
Date of advice: 14 May 2019
Published: July 2019
Ruling period: Year ended 30 June 2019
Date scheme commenced: 1 July 2018

Ruling: Q1: Will the proposed in-specie dividend to be paid to the shareholders of Company X be a frankable distribution under section 202-40 of the Income Tax Assessment Act 1997 ( ITAA 1997)? | A1: Yes | Q2: Will Company X have a CGT event A1 under section 104-10 of the ITAA 1997 on distribution of the units in Unit Trust Y as an in-specie dividend? | A2: Yes | Q3: Will section 177E of the ITAA 1936 apply in relation to the payment of the in-specie dividend declared by Company X? | A3: No | Q4: Will section 177EA of the ITAA 1936 apply in relation to the payment of the in-specie dividend declared by Company X? | A4: No | Q5: Will section 204-30 of the ITAA 1997 apply to empower the Commissioner of Taxation (Commissioner) to make a determination prescribed in subsection 204-30(3) of the ITAA 1997? | A5: No

Relevant facts and circumstances: Company X Company X is an Australian public company listed on the Australian Securities Exchange (ASX) and is an Australian tax resident. Since listing on the ASX, Company X made a number of investments. Company X obtained a controlling interest in the shares of a company that operates a specific business activity. The acquisition was a departure from Company X’s historical operations as an investment company. Aside from the Company X business activity, Company X has engaged in numerous other investment activities. Company X continues to monitor and review the market to identify potential investments. Since its takeover of the other company, its investment activities have been overshadowed by the other company’s operations. Company X’s investment activities, and the differences to the Company X other activities, have not been well understood and appreciated by the market. Company X continues to seek out future investments. Proposed Structure It is proposed that Company X be restructured into a dual entity stapled structure. Company X’s business activities will continue to be carried on by the existing Company X group of companies. Company X’s cash and shares will be held in the stapled unit trust. Unit Trust Y will be capitalised to an appropriate level so that it has the capital to pursue opportunities which may arise in the future. The steps to the proposed transaction (the Arrangement) will be as follows: A. Company X establishes a wholly-owned unit trust (Unit Trust Y) as a subsidiary member of the Company X tax consolidated group. B. Company X subscribes for units in Unit Trust Y. C. Unit Trust Y will acquire assets from the tax consolidated group. D Company X will declare and pay a fully-franked in-specie dividend distribution of the units in Unit Trust Y to all shareholders of Company X. Shareholders will receive [one] unit in Unit Trust Y for each one share in Company X held as at the ex-div date. Company X will pay the in-specie distribution fully out of Australian sourced retained profits. No debit to share capital will be made. The distribution will be fully franked. E. At the time of the distribution, the units in Unit Trust Y are stapled to the shares in Company X. The stapled interests, consisting of one share in Company X and one unit in Unit Trust Y, will be traded on the ASX as a single parcel. Unit Trust Y will be a managed investment scheme and be managed by Company X under a management agreement. It would have an independent Responsible Entity acting as trustee and custodian. Unit Trust Y would also be a managed investment trust. Unit Trust Y will not be a public trading trust for the purposes of Division 6C of the ITAA 1936 as the trustee will not carry on an active trading business. Reason for Unit Trust and Stapled Structure Unit Trust Y / Stapled Structure will: ● provide an appropriate investment vehicle for certain investment opportunities that may arise in the future ● create two separate and distinct listed entities with fundamentally different operating models ● allow Unit Trust Y to be capitalised to an appropriate level and to pursue strategic opportunities including holding long term strategic passive investments, and ● further clarify that the cash, Company X’s shareholding and future investments of Unit Trust Y are not commercially exposed to the vagaries of the other business activity. Company X is of the view that the stapled structure will be better received by the market and should enhance value for shareholders into the future. As at 1 July 2018, Company X’s franking account balance was in credit. Company X generally declares and pays fully franked dividends to shareholders every six months. Company X Shareholder / Unitholders Being an ASX listed company there is a broad range of shareholders in Company X. Only a small percentage of shareholders are individuals and foreign residents. Assumption The distribution by Company X of a fully franked in-specie dividend will be assessable to the Company X shareholders under subsection 44(1) of the ITAA 1936.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 subsection 104-10(1) | Income Tax Assessment Act 1997 section 108-5 | Income Tax Assessment Act 1997 section 202-40 | Income Tax Assessment Act 1997 subsection 202-40(1) | Income Tax Assessment Act 1997 section 202-45 | Income Tax Assessment Act 1997 Subdivision 204-D | Income Tax Assessment Act 1997 section 204-30 | Income Tax Assessment Act 1997 subsection 204-30(1) | Income Tax Assessment Act 1997 subsection 204-30(3) | Income Tax Assessment Act 1997 paragraph 204-30(3)(a) | Income Tax Assessment Act 1997 paragraph 204-30(3)(b) | Income Tax Assessment Act 1997 paragraph 204-30(3)(c) | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 subsection 44(1) | Income Tax Assessment Act 1936 subsection 177A(1) | Income Tax Assessment Act 1936 section 177D | Income Tax Assessment Act 1936 subsection 177D(b) | Income Tax Assessment Act 1936 section 177E | Income Tax Assessment Act 1936 paragraph 177E(1)(a) | Income Tax Assessment Act 1936 paragraph 177E(1)(b) | Income Tax Assessment Act 1936 , paragraph 177E(1)(c) | Income Tax Assessment Act 1936 paragraph 177E(1)(d) | Income Tax Assessment Act 1936 paragraph 177E(1)(c) | Income Tax Assessment Act 1936 paragraph 177E(1)(d) | Income Tax Assessment Act 1936 paragraph 177E(1)(e) | Income Tax Assessment Act 1936 paragraph 177E(1)(f) | Income Tax Assessment Act 1936 paragraph 177E(1)(g) | Income Tax Assessment Act 1936 paragraph 177E(2)(a) | Income Tax Assessment Act 1936 section 177F | Income Tax Assessment Act 1936 section 177EA | Income Tax Assessment Act 1936 subsection 177E(3) | Income Tax Assessment Act 1936 paragraph 177EA(3)(e) | Income Tax Assessment Act 1936 subsection 177EA(14) | Income Tax Assessment Act 1936 subsection 177EA(16) | Income Tax Assessment Act 1936 subsection 177EA(17)

Reasons for decision: Summary: The proposed in-specie dividend to be paid to the shareholders of Company X will be a frankable distribution under section 202-40 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: A distribution is a frankable distribution under subsection 202-40(1) of the ITAA 1997, to the extent that is not an unfrankable distribution under section 202-45. Company X will declare and pay an in-specie dividend distribution of the units in Unit Trust Y to all shareholders of Company X. Company X will pay the in-specie distribution fully out of Australian sourced retained profits. No debit to share capital will be made. In this case, the in-specie dividend is not an unfrankable distribution pursuant to the operation of section 202-45 of the ITAA 1997. Therefore it is a frankable distribution under section 202-40 of the ITAA 1997. | Summary: Company X will have a CGT event A1 under section 104-10 of the ITAA 1997 on distribution of the units in Unit Trust Y as an in-specie dividend. | Detailed Reasoning - Detailed reasoning: Subsection 104-10(1) of the ITAA 1997 provides that CGT event A1 happens if you dispose of a CGT asset. Units in a unit trust are a CGT asset under section 108-5 of the ITAA 1997. The distribution of the units in Unit Trust Y to Company X shareholders as an in-specie dividend will result in Company X disposing of its units in Unit Trust Y. Accordingly, CGT event A1 happens on the in-specie distribution of the units, which are CGT assets, from Company X to Company X shareholders. | Summary: Section 177E of the ITAA 1936 will not apply in relation to the payment of the in-specie dividend declared by Company X. | Detailed Reasoning - Detailed reasoning: Section 177E of the ITAA 1936 is a specific provision within the general anti-avoidance provisions found in Part IVA of the ITAA 1936. Section 177E specifically brings within the ambit of Part IVA dividend stripping, including schemes having substantially the effect of dividend stripping, as a circumstance under which section 177F of the ITAA 1936 can operate to cause the vendor of the shares involved in the transaction to be subject to tax on the property disposed of by the company after the sale of the shares. The conditions that will attract the operation of section 177E of the ITAA 1936 are outlined in paragraphs 177E(1)(a) through to (d) 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 DDMMYY. Where all of the above conditions are met, the effect of paragraphs 177E(1)(e) to (g) of the ITAA 1936 is that the scheme is taken to be a scheme to which Part IVA applies, and the taxpayer is taken to have obtained a tax benefit in connection with the scheme equal to the notional amount. | Detailed Reasoning - The scheme: ‘Scheme’ is defined broadly in subsection 177A(1) of the ITAA 1936. In this case, the scheme comprises the following proposed steps: A. Company X establishes a wholly-owned unit trust (Unit Trust Y) as a subsidiary member of the Company X tax consolidated group. B. Company X subscribes for units in Unit Trust Y. C. Company X will declare and pay a fully-franked in-specie dividend distribution of the units in Unit Trust Y to all shareholders of Company X. Shareholders will receive [one] unit in Unit Trust Y for each one share in Company X held as at the ex-div date. Company X will pay the in-specie distribution fully out of Australian sourced retained profits. No debit to share capital will be made. The distribution will be fully franked. D. At the time of the distribution, the units in Unit Trust Y are stapled to the shares in Company X. The stapled interests, consisting of one share in Company X and one unit in Unit Trust Y, will be traded on the ASX as a single parcel. Has property of a company been disposed of as a result of the scheme? For the purposes of section 177E of the ITAA 1936, disposal of property of a company includes the payment of a dividend by the company (paragraph 177E(2)(a)). The payment by Company X of a fully franked in-specie dividend distribution of the units in Unit Trust Y to all shareholders of Company X will constitute disposal of property as a result of the scheme. Does that disposed property represent a distribution of profits of the company? Company X will pay the in-specie distribution fully out of Australian sourced retained profits. Accordingly, that payment will be a disposal of property representing a distribution of the profits of the company. Would an amount have been included in the assessable income of a taxpayer if the company had paid a dividend equal to the disposal of property immediately before the scheme was entered into? An amount would be included in the assessable income of each of the Company X shareholders if Company X had paid dividends of an equivalent amount to its shareholders immediately before the scheme is entered into. Is the scheme by way of or in the nature of dividend stripping? ‘Dividend stripping’ is not defined in the ITAA 1936. Dividend stripping has been recognised by the courts as involving the following six characteristics: ● a target company which has substantial undistributed profits, creating a potential tax liability either for the company or its shareholders ● the sale or allotment of shares in the target company to another party ● the payment of a dividend to the purchaser or allottee of the shares out of the target company’s profits ● the purchaser escaping Australian income tax on the dividend so declared ● 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 tax liability at the relevant time), and ● the scheme being carefully planned, with all the parties acting in concert, for the predominant if not sole purpose of the vendor shareholders avoiding tax on a distribution of dividends by the target company. The Full Federal Court in Consolidated Press observed that the use of the words ‘by way of or in the nature of’ in paragraph 177E(1)(a) suggests that variations from these paradigmatic six characteristics will not necessarily result in the scheme being excluded, provided it retains the central characteristics of a dividend stripping scheme. Application to Company X (a) Target company with substantial undistributed profits creating a potential tax liability for the company or its shareholders Company X has substantial undistributed profits that could create a potential tax liability for Company X or its shareholders. (b) Sale or allotment of shares in the target company to another party In this case there is no sale or direct allotment of shares in Company X to another entity. However, some of the value of Company X will be transferred to Unit Trust Y and this value will be distributed to its shareholders through the payment of the in-specie dividend. (c) Payment of a dividend to the purchaser or allottee of shares out of the target company’s profits Company X will declare and pay an in-specie dividend distribution of the units in Unit Trust Y to all its shareholders. The in-specie distribution will be paid fully out of Australian sourced retained profits. (d) The purchaser or allottee escapes Australian income tax on the dividend declared In this case the shareholders of Company X do not escape Australian income tax as the payment by Company X of the in-specie dividend will be assessable to the Company X shareholders under subsection 44(1) of the ITAA 1936. (e) 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 purchaser Company X shareholders will not receive any capital sum in respect of the proposed scheme. (f) The scheme being carefully planned, with all parties acting in concert, for the predominant purpose of the vendor shareholder avoiding tax on a distribution of dividends by the target company In this case, the distribution by Company X of an in-specie dividend to the shareholders of Company X will be assessable to the Company X shareholders under subsection 44(1) of the ITAA 1936. Therefore, there will be no tax avoided on the distribution of dividends by Company X. | Detailed Reasoning - Conclusion on whether there is a dividend stripping scheme: The proposed transaction is not being carried out with a sole or dominant purpose of avoiding taxation on an anticipated profit distribution. Company X shareholders will incur Australian income tax liability on the in-specie dividend. In this case, there is no scheme by way of or in the nature of dividend stripping, or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. | Detailed Reasoning - Conclusion on application of section 177E: Section 177E of the ITAA 1936 will not apply in relation to the payment of the in-specie dividend declared by Company X. | Summary: Section 177EA of the ITAA 1936 will not apply in relation to the payment of the in-specie dividend declared by Company X. | Detailed Reasoning - Detailed reasoning: Section 177EA of the ITAA 1936 is a general anti avoidance provision that applies where one of the purposes (other than an incidental purpose) of a person entering into a scheme is to enable a taxpayer to obtain an imputation benefit. Specifically, section 177EA of the ITAA 1936 applies if the following conditions, set out in subsection 177EA(3) are satisfied: (a) there is a scheme for a disposition of shares or an interest in shares in a company; and (b) either: (i) a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or (ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of the interest in membership interests, as the case may be; and (c) the distribution was, or is expected to be, a franked distribution or a distribution franked with an exempting credit; and (d) except for this section, the person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and (e) having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit. It is considered that the first four conditions in subsection 177EA(3) of the ITAA 1936 are satisfied in respect of the proposed scheme because: a) under the scheme, the units in Unit Trust Y distributed as an in-specie dividend will be stapled to the shares in Company X on a one to one basis and traded as a single listed security. A scheme for disposition of shares is defined in section 177EA(14) of the ITAA 1936 to include the creating, altering or extinguishing of a right, power or liability attaching to, or otherwise relating to, the shares. As the stapling of the units in Unit Trust Y and shares in Company X will result in the creation of rights otherwise relating to the shares in Company X, the scheme should likely constitute a scheme for a disposition of shares. b) the in-specie distribution of the units in Unit Trust Y is a frankable dividend payable in respect of shares in Company X c) the dividend will be fully franked, and d) the Company X shareholders will receive imputation benefits, as defined in subsection 177EA(16) of the ITAA 1936 as a result of the dividend or future distributions. As these threshold requirements of section 177EA of the ITAA 1936 have been met, it is necessary to consider the 'relevant circumstances' of the scheme in determining whether it could be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit. | Detailed Reasoning - Determining purpose: paragraph 177EA(3)(e) of the ITAA 1936: The test of purpose under section 177EA of the ITAA 1936 is a test of objective purpose. The question posed by the test is whether, objectively, it would be concluded that a person who entered into or carried out the scheme under which the disposition of shares occurs, did so for the purpose of obtaining a tax advantage relating to franking credits. A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with another purpose, or merely follows another purpose as its natural incident. In determining whether it would be concluded that a person entered into or carried out a scheme involving the disposition of shares or an interest in shares for a purpose, not being merely an incidental purpose, of enabling a taxpayer to obtain a tax advantage in relation to franking credits, regard must be had to the terms of the disposition and the relevant circumstances. Under subsection 177EA(17) of the ITAA 1936, the relevant circumstances of a scheme include listed factors and the last factor includes any of the eight matters listed in paragraph 177D(b) of the ITAA 1936 used in connection with the general provisions of Part IVA of the ITAA 1936. Taxation Ruling TR 2009/3 discusses the relevant circumstances outlined in subsection 177EA(17) of the ITAA 1936. Paragraph 51 of TR 2009/3 states that the requirements of paragraph 177EA(3)(e) will be satisfied if: … having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit. In arriving at a conclusion, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The listed circumstances there encompass a range of circumstances which, taken individually or collectively, indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme. In this case, Company X will be restructured into a dual entity stapled structure with Company X’s retail activities to be carried on by the existing Company X group of companies. Company X’s cash and shares will be held in the stapled unit trust, and the unit trust will be capitalised to an appropriate level so that it has the capital to pursue opportunities which may arise in the future. Although Company X shareholders obtain an imputation benefit, this benefit is, on balance, incidental to the scheme. | Detailed Reasoning - Conclusion: Having regard to the above circumstances and factors as outlined in section 177EA of the ITAA 1936, it is concluded that Company X will not enter into the scheme or any part of the scheme for a purpose (whether or not the dominant purpose, but not including an incidental purpose) to obtain an imputation benefit. Therefore, section 177EA of the ITAA 1936 will not apply in relation to the payment of the in-specie dividend declared by Company X. | Summary: Section 204-30 of the ITAA 1997 will not apply to empower the Commissioner to make a determination prescribed in subsection 204-30(3) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Subdivision 204-D of the ITAA 1997 was introduced as a specific anti-avoidance provision. It is intended to apply where a company streams dividends so as to provide franking credit benefits to shareholders who benefit most from these credits, in preference to shareholders who would gain either no benefit, or a lesser benefit, from a franked dividend payment. If section 204-30 of the ITAA 1997 applies the Commissioner is vested with a discretion, pursuant to subsection 204-30(3), whether or not to make a determination to debit the company's franking account pursuant to paragraph 204-30(3)(a), that a specified exempting debit arises in the exempting account of the entity pursuant to paragraph 204-30(3)(b), or that no imputation benefit is to arise in respect of the dividend to those shareholders who derive a greater benefit pursuant to paragraph 204-30(3)(c). Subsection 204-30(1) of the ITAA 1997 states: This section empowers the Commissioner to make determinations 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 this section would be, received by a *member of the entity as a result of the distribution or distributions; and (b) the member would *derive a *greater benefit from franking credits than another member of the entity; and (c) the other 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. The member that derives the greater benefit from franking credits is the favoured member . The member that receives the lesser imputation benefits is the disadvantaged member . In order for subdivision 204-D of the ITAA 1997 to be applicable, the scheme must involve streaming. Streaming is not a defined term, but the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 at paragraph 3.28 describes streaming as ‘selectively directing the flow of franked distributions to those members who can most benefit from imputation credits’. The shares in Company X are held by a wide range of shareholders and the in-specie dividend will be paid to all Company X shareholders holding shares at the ex-dividend date, in proportion to their respective shareholding. Accordingly, Company X will not be selectively directing the flow of franked distributions under the Arrangement. As the scheme does not involve streaming, subdivision 204-D of the ITAA 1997 will not apply. Therefore, section 204-30 of the ITAA 1997 will not apply to empower the Commissioner to make a determination prescribed in subsection 204-30(3) of the ITAA 1997. | Detailed Reasoning - Further issues for you to consider: Taxpayer Alert TA 2017/1 Re-characterisation of income from trading businesses (TA 2017/1) highlights some of the ATO’s concerns with arrangements which attempt to fragment integrated trading businesses in order to re-characterise trading income into more favourably taxed passive income. TA 2017/1 refers to stapled structures as a mechanism being used in these arrangements. The Treasury Laws Amendment (Making Sure Foreign Investors Pay Their Fair Share of Tax in Australia and Other Measures) Act 2019 was introduced following the release of TA 2017/1, and includes measures to address risks posed by stapled structures and limit access to concessions to foreign investors.