The Federal Court has held that arrangements involving a share buy-back by a company owned by a discretionary trust and the distribution of retained earnings to the trust without any additional tax being paid constituted a reimbursement agreement for the purposes of s 100A of the ITAA 1936.
IP Co was 99% owned by the IP Trust. In the 2014 income year, IP Co used retained earnings (largely comprising trust distributions sourced from business profits of a private group) to buy back shares held by the IP Trust. The IP trustee also amended the trust deed to make the buy-back dividend corpus of the trust. The share buy-back dividend was then retained by the IP Trust as capital.
The IP Trust also received ordinary income (dividends and a distribution) in the 2014 income year. The proceeds of the buy-back were deemed by ITAA 1936 to be a dividend. The deemed dividend was fully franked.
A newly introduced corporate beneficiary (BE Co) of the IP Trust was made presently entitled to the trust income and therefore was liable to pay tax in respect of the whole of the net income of the trust. However, the tax payable on the share buy-back dividend was wholly offset by the franking credit and thus BE Co paid no additional tax as a result. In effect, the profits of IP Co were transferred to its shareholder (the IP trustee) in capital form and without subjecting any person to tax beyond the level of corporate tax already paid on the profits, as reflected in the franking credit.
The ATO issued an assessment to the trustee of the IP Trust, taxing it under s 99A of the ITAA 1997 in respect of the relevant trust income, on the basis that s 100A of the ITAA 1936 deemed BE Co not to be presently entitled to that income.
The Federal Court firstly held that the assessment was not an amended assessment, as contended by BE Co, and that the ATO was authorised to issue the assessment. The Court then went on to conclude that BE Co’s present entitlement to income of the IP Trust for the 2014 income year arose out of a reimbursement agreement for the purposes of s 100A and therefore it was taken not to be presently entitled to the trust income. The Court also held that s 207-35(6) increased the liability of the IP trustee to tax under s 99A by the amount of the franking credit and the amount of the share buy-back dividend. Finally, the Court held that the share buy-back dividend was made as part of a scheme which was in the nature of “dividend stripping” (only relevant if the s 100A issue was wrongly decided).
(BBlood Enterprises Pty Ltd v Commissioner of Taxation [2022] FCA 1112, Federal Court, Thawley J, 19 September 2022.)
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