Dividend stripping

Was the payment of a dividend made in the course of a scheme that was by way of or in the nature of dividend stripping, or had substantially the effect of a scheme by way of or in the nature of dividend stripping for the purposes of section 160APHA of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. The payment of the dividend was made in the course of a scheme that was by way of or in the nature of dividend stripping for the purposes of section 160APHA of the ITAA 1936. Accordingly, no franking credit arises upon the payment of the dividend under subsection 160APP(6) of the ITAA 1936.

Acquiring Co purchased 100% of the interest in a company (Target Co), which held a number of wholly owned operating subsidiaries. The acquisition was financed entirely by a short-term bridging loan obtained from a bank.

Following acquisition, Target Co and its subsidiaries sold various assets and realised profits. During the course of the restructure Target Co received dividends from various subsidiaries, which included distribution of profits generated from the sale/transfer of businesses and other assets. The profit amounts generated by the group during the course of the restructure had not been recognised in the accounts of Target Co or its subsidiaries prior to Acquiring Co purchasing the group. Target Co used the dividends from the subsidiaries, together with part of the profits it made on its sales of subsidiaries and other assets to pay a dividend to Acquiring Co. Finally, Target Co was sold to an offshore company.

The dividend and the consideration on sale approximated the amount paid by Acquiring Co on acquisition of Target Co.

For tax purposes, Acquiring Co included the dividend in its assessable income and claimed a rebate in respect of the dividend pursuant to section 46 of the ITAA 1936. In the following year (the year in which Target Co was sold), Acquiring Co returned a carry forward net capital loss in relation to the disposal of Target Co.

The Explanatory Memorandum (EM) to the introduction of section 160APHA of the ITAA 1936 states that: '...a dividend is to be regarded as one that is paid as part of a dividend stripping operation if the payment of the dividend arose out of, or was made in the course of, a scheme that - • was by way of or in the nature of dividend stripping (paragraph (a)), or • had substantially the effect of a scheme by way of or in the nature of dividend stripping (paragraph (b)).

Schemes by way of, or in the nature of, dividend stripping schemes include those where a person purchases for a capital sum the shares in a target company that has accumulated profits, and then draws off the profits by effecting the payment of a dividend by the target company.'

In section 177A of the ITAA 1936, "scheme" means any agreement, arrangement, understanding, promise or undertaking whether express or implied and whether or not legally enforceable. Any scheme, plan, proposal, action, course of action or course of conduct, including such activity of a unilateral nature, is also treated as a "scheme". The scheme in the present case has been identified as comprising the elements set out in the facts above.

The term "dividend stripping" is not defined in the ITAA 1936, however, the features mentioned in the EM are present in this case. Acquiring Co purchased for a capital sum the shares in a target company that had accumulated profits (although unrealised), and then extracted profits by effecting the payment of a dividend by the target company.

Further guidance may be gained from section 46A of the ITAA 1936, which directs attention to several factors which are required to be taken into account by the Commissioner in considering whether a dividend should be regarded as having arisen out of a 'transaction, operation, undertaking, scheme or arrangement by way of dividend stripping'. The matters to be taken into consideration are: (a) whether, as a result of the payment of the dividend, there has been a whole or substantial reimbursement of the amount paid for the shares; (b) whether the dividend payment is considered to have substantially contributed to the reduction in the value of the shares; (c) whether, the right to receive dividends is limited as to the total amount that may be paid, the source of the profits from which dividends may be paid, or the period during which the dividends may be paid; and (d) any other relevant matters.

In this case, it is considered that the dividend provided a substantial reimbursement to the outlay for shares and that the dividend payment is considered to have substantially contributed to the reduction in the value of Target Co shares, immediately upon its payment to Acquiring Co.

FC of T v. Consolidated Press Holdings Ltd (No 1) 91 FCR 524 (the CPH case ), which dealt with the stripping of company profits under section 177E of the ITAA 1936, can also provide guidance in identifying a dividend stripping scheme. In the CPH case , the Full Federal Court stated that the central characteristics of a dividend stripping scheme, as identified by reference to established case law decisions, were: [F1] (a) A target company with substantial accumulated profits; (b) The sale of the shares in the target company to another party; (c) The payment of dividends to the purchaser out of the target company's profits; (d) The purchaser escaping Australian tax on the dividends so declared; (e) The vendor shareholders receiving a capital sum approximating the dividend paid by the target; and (f) A scheme carefully planned and carried through by the stripper and a number of other persons acting in concert.

It is considered that Target Co was a company with significant accumulated profits, although these profits had not yet been booked at the date it was acquired. Target Co's accounts just prior to acquisition recorded assets at historical cost, however it was acquired for its market value (2.5 times historical cost).

Acquiring Co's consolidated accounts show that it treated the dividend as having been paid out of the pre-acquisition reserves of Target Co. In following the requirements of accounting standard AASB 1015, Acquiring Co has acknowledged that the profits (from which the dividend was paid) existed prior to acquisition.

Target Co's shareholders sold Target Co to Acquiring Co.

Once acquired, Target Co and its subsidiaries began to dispose of their assets. The subsidiaries paid dividends to Target Co from the profits on the sale of assets. Target Co then paid a dividend to Acquiring Co.

For tax purposes, Acquiring Co included the dividend in its assessable income and claimed a rebate under section 46 of the ITAA 1936 in respect of this dividend.

It is submitted that the absence of this typical, rather than essential, feature does not take the subject arrangement out of section 160APHA of the ITAA 1936. It should be noted that the dividend and the consideration on sale approximated the amount paid by Acquiring Co on acquisition.

It is acknowledged that there were genuine commercial reasons for the takeover and subsequent restructure. However, the manner in which the restructure was undertaken and the very substantial dividend payment attract tax ramifications of a kind that section 160APHA of the ITAA 1936 was enacted to address. It is considered that the takeover, subsequent restructure and extraction of funds as a whole indicate that the arrangement was carefully planned and carried through.