Private ruling: Dividend collar strategy
Date of advice: 30 June 2015
Published: June 2015
Ruling period: Income year ending 30 June 2015 | Income year ending 30 June 2016 | Income year ending 30 June 2017 | The scheme is yet to commence.

Ruling: Q1: Will the Commissioner make a determination pursuant to paragraph 177EA(5)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) to deny the franking credits attached to dividends received by you on shares where you have entered into a both a share price collar and a dividend collar in respect of the dividend paying share? | A1: Yes

Relevant facts and circumstances: The entity is an unregistered managed investment scheme. Of the direct and indirect investments entered into by the entity, a significant asset sector is the Australian Equities Sector. The Investment Manager has been engaged by the entity to develop a strategy to improve the excess return generated by the Australian equity portfolio compared to the market benchmark (the excess is also known as "alpha"). The strategy involves the use of variable put and call options respect of shares and dividends in a particular company.

Relevant legislative provisions: Income Tax Assessment Act 1936 s ubsection 6(1) | Income Tax Assessment Act 1936 section 26BC | Income Tax Assessment Act 1936 Part IVA | Income Tax Assessment Act 1936 subsection 177D(2) | Income Tax Assessment Act 1936 s ection 177EA | Income Tax Assessment Act 1936 s ubsection 177EA(3) | Income Tax Assessment Act 1936 subsection 177EA(5) | Income Tax Assessment Act 1936 subsection 177EA(14) | Income Tax Assessment Act 1936 subsection 177EA(17) | Income Tax Assessment Act 1936 Division 1A, Part IIIAA | Income Tax Assessment Act 1936 s ection 160APHD | Income Tax Assessment Act 1936 subsection 160APHJ(9) | Income Tax Assessment Act 1997 Subdivision 207-A | Income Tax Assessment Act 1997 s ection 202-40 | Income Tax Assessment Act 1997 section 202-45 | Income Tax Assessment Act 1997 subsection 204-30(6) | Income Tax Assessment Act 1997 subsection 207-20(1) | Income Tax Assessment Act 1997 section 215-10 | Income Tax Assessment Act 1997 section 275-115 | Income Tax Assessment Act 1997 section 960-120 | Income Tax Assessment Act 1997 section 960-130 | Income Tax Assessment Act 1997 section 960-135 | Income Tax Assessment Act 1997 section 960-140 | Income Tax Assessment Act 1997 section 995-1

Reasons for decision: Summary: 1. All legislative references are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936) unless specified otherwise. 2. Pursuant to subsection 177EA(3), section 177EA applies if: (a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; 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. 3. Where the provision applies, the Commissioner may make a determination that a debit arises in the franking account of the corporate tax entity which made the distribution pursuant to paragraph 177EA(5)(a). Alternatively, the Commissioner may make a determination that no imputation benefit arises for the relevant (recipient) taxpayer pursuant to paragraph 177EA(5)(b). 4. For section 177EA to apply, each of the conjunctive requirements in subsection 177EA(3) must be present. These are noted below in relation to your circumstances. (a) The proposed investment strategy will constitute a scheme for the disposition of membership interests for the purposes of paragraph 177EA(3)(a). (b) The ordinary shares to be acquired and disposed of pursuant to the investment strategy constitute ordinary membership interests pursuant to sections 960-130, 960-135 and 960-140 of the ITAA 1997. Implementing the investment strategy will involve a change of ownership of the underlying membership interests such that this condition is satisfied. (c) The paragraph 177EA(3)(b) requirement is satisfied if either subparagraph 177EA(3)(b)(i) or subparagraph 177EA(3)(b)(ii) is present: … (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 … (d) The subparagraph 177EA(3)(b)(ii) requirement will be satisfied in the circumstances of the proposed investment strategy as a frankable distribution will be paid or is payable to the entity. (e) Under the proposed investment strategy, it is expected that the underlying shares targeted would be paying franked distributions, thus the paragraph 177EA(3)(c) requirement will be satisfied in the circumstances. (f) As the entity holds ordinary membership interests' in ASX listed entities and thus be a 'member' of such entities it is expected the entity would receive imputation benefits as a result of receiving franked distributions. Therefore paragraph 177EA(3)(d) is satisfied. | Detailed Reasoning - Paragraph 177EA(3)(e) conclusion as to purpose requirement: 5. The conclusion as to the purpose of enabling a relevant taxpayer to obtain an imputation benefit is to be made having regard to the relevant circumstances of the scheme. 6. As set out in subsection 177EA(17), the meaning of the relevant circumstances of the scheme include: (a) the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding membership interests, or having interests in membership interests, in the corporate tax entity that are respectively borne by or accrue to the parties to the scheme, and whether there has been any change in those risks and opportunities for the relevant taxpayer or any other party to the scheme (for example, a change resulting from the making of any contract, the granting of any option or the entering into of any arrangement with respect to any membership interests, or interests in membership interests, in the corporate tax entity); (b) whether the relevant taxpayer would, in the year of income in which the distribution is made, or if the distribution flows indirectly to the relevant taxpayer, in the year in which the distribution flows indirectly to the relevant taxpayer, derive a greater benefit from franking credits than other entities who hold membership interests, or have interests in membership interests, in the corporate tax entity; (c) whether, apart from the scheme, the corporate tax entity would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity referred to in paragraph (b); (d) whether, apart from the scheme, a franked distribution would have flowed indirectly to another entity referred to in paragraph (b); (e) if the scheme involves the issue of a non-share equity interest to which section 215-10 of the Income Tax Assessment Act 1997 applies - whether the corporate tax entity has issued, or is likely to issue, equity interests in the corporate tax entity: (i) that are similar, from a commercial point of view, to the non-share equity interest; and (ii) distributions in respect of which are frankable; (f) whether any consideration paid or given by or on behalf of, or received by or on behalf of, the relevant taxpayer in connection with the scheme (for example, the amount of any interest on a loan) was calculated by reference to the imputation benefits to be received by the relevant taxpayer; (g) whether a deduction is allowable or a capital loss is incurred in connection with a distribution that is made or that flows indirectly under the scheme; (ga) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is sourced, directly or indirectly, from unrealised or untaxed profits; (h) whether a distribution that is made or that flows indirectly under the scheme to the relevant taxpayer is equivalent to the receipt by the relevant taxpayer of interest or of an amount in the nature of, or similar to, interest; (i) the period for which the relevant taxpayer held membership interests, or had an interest in membership interests, in the corporate tax entity; (j) any of the matters referred to in subsection 177D(2). 7. In considering the relevant circumstances section 177EA applies to deny the entity its entitlement to franking credits. This is because the combination of the dividend option collar and the collar over the relevant shares will materially diminish entity's exposure to risk and opportunities in respect to both potential trading gains and expected dividends to a level that is inconsistent with an ordinary ownership interest in a company and consistent with a purpose of obtaining an imputation benefit.