Whenever a tax advantage arises through the interpolation of a trust, care should be taken to assess the application of the anti-avoidance provisions.

Trusts allow income that might otherwise be taxed at the trustee rate, or to a beneficiary on the highest marginal rate (currently the same as the trustee rate), to be diverted to a beneficiary on a lower marginal rate. This is the case whether the trust is actively trading or a passive investor.

Trusts can also play a role in a structure where although overt avoidance is not intended it can arise through the advantages derived from the structure.

For this reason the anti-avoidance provisions of the Income Tax Act continue to be an important element in tax-planning considerations. The general anti-avoidance provision has two components. The first provides for a tax avoidance arrangement (s YA 1) to be voided against the Commissioner for income tax purposes (s BG 1) and the second allows for any tax advantage under the arrangement to be counteracted: s GA 1.

For the purposes of the Income Tax Act, a “tax avoidance arrangement” is defined in s YA 1 as an arrangement that has tax avoidance as:

• its purpose or effect, or
• one of its purposes or effects, whether or not any other purpose or effect is referable to ordinary business or family dealings, if the tax avoidance purpose or effect is not merely incidental.

“Tax avoidance” is defined in s YA 1 to include directly or indirectly:

• altering the incidence of income tax
• relieving any person from liability to pay income tax
• avoiding, reducing or postponing any liability to income tax.

The breadth of the definition makes it difficult to determine with any certainty the demarcation between acceptable “tax planning” and unacceptable “tax avoidance” that is subject to anti-avoidance provisions.

While care is required, not every advantageous structure will amount to tax avoidance. Consider this example from QB 14/11.

Scenario 1: Interest deductions where shareholder loans replaced

Company A, wholly-owned by a family trust, received $1 million in shareholder loans from the trust. Company A has used the shareholder loans to finance its business operations for the purpose of deriving assessable income.

Company A borrows $1 million, secured over the assets of the trust, from a third-party lender at arm’s length market interest rates to repay the shareholder loans to the trust.

The trust uses the repaid funds to acquire a holiday home for use by the trust’s beneficiaries.

Company A deducts interest incurred on the loan from the third-party lender from its business income.

Answer

The Commissioner’s view is that, without more, s BG 1 would not apply to this arrangement to deny Company A interest deductions under s DB 6 or s DB 7 for the interest incurred in respect of the loan from the third-party lender.

Specific regimes

The general anti-avoidance measure is complemented by specific tax regimes that have the effect of re-characterising any arrangement in contravention of those provisions to a transaction that is conducted at arm’s length: subparts GB, GC. These general and specific anti-avoidance provisions, neither of which override the other, work in tandem.

It is also important to appreciate that the Goods and Services Tax Act 1985 has its own anti-avoidance provisions that can have application to structures involving a trust that may not always be appreciated. See Corporate Trustees Associated for GST Purposes.

Company restructure for commercial and estate planning

TDS 25/19 considers whether s BG 1 applies applied to the payment by a company (the Company) of a fully imputed dividend to new companies (NewCos) and the use of a holding company to acquire shares in the Company.   The background facts are set out in TDS 25/19 at [3] to [6] as follows:

1.The Arrangement in this ruling is the restructure of a family business (the Company) as part of commercial and estate planning given the advancing years of the founding family members. The Arrangement involves several other companies that have been left out of this summary for simplicity.

2. The Company has issued classes of voting and non-voting shares. Three family members (a parent and two siblings) hold the voting shares. The majority of the non voting shares are held by the family trusts of each of the three family members (Family Trusts A, B and C), with the spouse of each sibling holding a minority interest.

3. The stated commercial or private purposes of the Arrangement are to:

• implement a commercial and estate plan to ensure the Company is effectively controlled and governed going forward by a holding company with a board of directors (including independent commercial directors) and for the benefit of the two siblings’ family trusts, following the founding family members’ deaths; and
• preserve the imputation credits that have accumulated for future use by the Company’s original trust shareholders.

4. To implement the commercial and estate plan, the following steps were proposed:

• The spouses gift their minority interests in the non-voting shares to the relevant sibling’s family trust.
• Each of the three family trusts incorporates a separate company (NewCos A, B and C) and sells its non-voting shares to its respective NewCo for market value in a share-for-share exchange. All non-voting shares in the Company are then held by the three NewCos.
• The Company pays a fully imputed dividend to the holders of the non-voting shares (that is, NewCos A, B and C), paid either as a credit to the shareholders with the shareholders simultaneously reinvesting that amount as additional share equity into the Company or as a fully imputed taxable bonus issue.
• The voting shares the three family members hold are gifted to Family Trusts A and B (being the two siblings’ family trusts). This results in all voting shares being held by the two siblings’ family trusts.
  Family Trusts A and B then sell these voting shares to NewCos A and B for market
  value in a share-for-share exchange.
• NewCos A and B incorporate HoldCo and sell all the shares they hold in the
  Company for market value to HoldCo in a share-for-share exchange.

5. The result of the above transactions is that the two siblings’ family trusts each owns 50% of a newly incorporated holding company that has a commercial board of directors and the holding company, in turn, holds all the voting shares and a majority of the non-voting shares in the Company. Some non-voting shares remain held by the parent’s NewCo for now, and these are expected to transfer to the HoldCo structure following the parent’s death. The Company’s imputation credits pass to the three
NewCos held by the original family trust shareholders, where they remain for future use.

The Tax Counsel Office (TCO) concluded that s BG 1 did not apply to the payment by the Company of a fully imputed dividend to the NewCos and the use of HoldCo to acquire shares in the Company.  As noted at [24]:

“While shares are being transferred within a group structure under the Arrangement, the usual dividend avoidance concerns do not arise. This is because the transfers do not generate any ability to remove funds from the Company outside the dividend regime under the guise of a capital receipt. This is due to share-for-share exchanges being used, which means no cash flows and no uplift in ASC are created. Any future funds the Company distributes will be subject to the dividend rules in the usual manner. Therefore, the transfers implement the Applicants’ commercial and estate planning objectives and do not create any material tax advantage.”

References:

• Question We’ve Been Asked QB 14/11, issued on 13 October 2014
• Income Tax Act 2007, s BG 1, DB 6, DB 7
• Goods and Services Tax Act, s 76
• TDS 25/19