Income tax: can section 23AJ of the Income Tax Assessment Act 1936 apply to a dividend paid by a company (not being a Part X Australian resident) to the trustee of a trust, which then pays it to an Australian resident company beneficiary?

No. Section 23AJ of the Income Tax Assessment Act 1936 (ITAA 1936) [1] cannot apply to a dividend when it is paid by a company (not being a Part X Australian resident) to the trustee of a trust, which then pays it to an Australian resident company beneficiary.

When the final Determination is issued, it is proposed to apply both before and after its date of issue. However, the Determination will not apply to taxpayers to the extent that it conflicts with the terms of settlement of a dispute agreed to before the date of issue of the Determination (see paragraph 75 to 77 of Taxation Ruling TR 2006/10).

Section 23AJ of the ITAA 1936 provides that: A non-portfolio dividend (as defined in section 317) paid to a company is not assessable income, and is not exempt income, of the company if: (a) the company is an Australian resident and does not receive the dividend in the capacity of a trustee; and (b) the company that paid the dividend is not a Part X Australian resident (as defined in that section).

A dividend paid to a company, in its capacity as a trustee of a trust, is not a non-portfolio dividend as defined in section 317. Therefore, section 23AJ does not apply to the dividend.

Section 317 defines a 'non-portfolio dividend' to be: a dividend (other than an eligible finance share dividend or a widely distributed finance share dividend) paid to a company where that company has a voting interest, within the meaning of section 160AFB, [2] amounting to at least 10% of the voting power, within the meaning of that section, in the company paying the dividend.

Subsection 160AFB(4) provides that a company shall be taken to have a voting interest in another company, if the first-mentioned company is the 'beneficial owner' of shares in the other company that carry the right to exercise any of the voting power in that other company. The phrase 'beneficial owner' is not defined for the purposes of section 160AFB. Accordingly, the phrase 'is to be construed in context and must reflect the purposes of the section in which it occurs. [3]

Section 160AFB provides the rules for grouping an Australian resident company with related foreign companies for the purposes of Division 18. When section 160AFB was enacted, an Australian resident company was entitled to a foreign tax credit for the tax paid on the profits out of which a dividend had been paid to the Australian resident company by its foreign subsidiary. Section 160AFB was intended to ensure that an Australian resident company would only be entitled to this foreign tax credit if the Australian resident company held a sufficient ownership interest in the foreign company, such that the foreign company could be regarded as part of the Australian resident company's corporate group.

Having regard to the context of section 160AFB, the Commissioner considers that a company will be the beneficial owner of shares for the purposes of subsection 160AFB(4) when it holds the bundle of rights associated with ownership of those shares for its own benefit, and not for the benefit of others. By construing the phrase in this way, the original intention of Division 18 is maintained, such that an Australian resident company would have only been entitled to a foreign tax credit in respect of the underlying tax paid by the foreign company that would have been a part of the Australian resident company's corporate group.

The trustee is not the beneficial owner of shares for the purposes of section 160AFB if the shares are trust property. The shares are held by the legal owner (the trustee) for the benefit of others (the beneficiaries). Accordingly, the trustee does not have the requisite voting interest in the company paying the dividend, and the dividend is not a non-portfolio dividend.

Even if a dividend paid to a company in its capacity as trustee of a trust was a non-portfolio dividend, section 23AJ does not apply to a dividend, in any event, because paragraph 23AJ(a) requires that the company receiving the non-portfolio dividend not do so in its capacity as a trustee of a trust.

Divisions 6B and 6C of the ITAA 1936, contain provisions which modify the income tax provisions in respect of the taxation of corporate unit trusts [4] (or the trustee thereof) and public trading trusts [5] (or trustee thereof). Section 102L of the ITAA 1936 specifies when a reference to a company includes a corporate unit trust or a corporate unit trustee. Likewise, section 102T of the ITAA 1936 specifies when a reference to a company will include a public trading trust or a trustee of the public trading trust. Neither section specifies that the reference to the company that is paid a dividend in section 23AJ of the ITAA 1936 includes a corporate unit trustee and public unit trustee. The definition of 'company' in subsection 6(1) of the ITAA 1936 or section 995-1 of the Income Tax Assessment Act 1997 does not expressly include a corporate unit trustee or public unit trustee such that the reference to the company that is paid a dividend in section 23AJ of the ITAA 1936 would include these types of trustees. Therefore, the express exclusion in section 23AJ of the ITAA 1936 which applies to a dividend paid to a company, in its capacity as trustee, applies to a dividend paid to a trustee of a corporate unit trust or a trustee of a public trading trust.

Where a dividend is paid in respect of shares which are held by a corporate trustee that is part of a consolidated group, and all the beneficiaries of the trust are members of the same consolidated group, the dividend can be a non-portfolio dividend. When a group of entities consolidates for tax purposes, the single entity rule (SER) [6] applies to deem the head company to own the assets of the subsidiary members. As a consequence, when the trust and the trustee are part of the same consolidated group, the head company will be taken to have full ownership of the shares legally owned by the trustee, meaning all the rights associated with ownership of the shares are held by the head company for its own benefit. Accordingly, the head company will be taken to be the beneficial owner of the shares, and can have the relevant voting interest required under the definition of non-portfolio dividends in section 317.

The dividend will also be taken to have been paid to a company for the purposes of section 23AJ. The SER operates to deem the dividend paid to the trustee to have been paid to the head company. As a result the dividend can be non-assessable non-exempt income of the head company.

It has been argued that section 23AJ can apply to a dividend that is paid by a company (not being a Part X Australian resident company) to the trustee of a trust which then pays it to an Australian resident company beneficiary, provided that the dividend would have qualified as a non-portfolio dividend if it had been paid directly to the Australian resident company. The argument is that, in these circumstances, the dividend has 'in substance' or 'indirectly' been paid by the company (not being a Part X Australian resident company) to the corporate beneficiary.

The Commissioner does not accept this argument. The fact that the dividend has been paid to a trustee, the registered owner of the shares, cannot be ignored for the purposes of section 23AJ. When there is an interposed trust estate between the paying company and the Australian resident company beneficiary, it is the trustee and not the corporate beneficiary who receives the dividend. Federal Commissioner of Taxation v. Angus [7] is authority for the proposition that what the beneficiary receives is not a dividend, but rather a distribution of trust income. Accordingly the requirement in section 23AJ that a dividend be paid to a company is not satisfied. Even where the dividend is paid in respect of shares held by a trustee of a bare trust, or paid in respect of shares held by a trustee as nominee for a resident company which is the sole beneficiary of the trust, the dividend is still paid to the trustee.

We invite you to comment on this draft Taxation Determination. Please forward your comments to the contact officer by the due date. (Note: the Tax Office prepares a compendium of comments for the consideration of the relevant Rulings Panel. The Tax Office may use a sanitised version (names and identifying information removed) of the compendium in providing its responses to persons providing comments. Please advise if you do not want your comments included in a sanitised compendium.) Due date: 26 October 2007 Contact officer details have been removed following publication of the final ruling.