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14 Oct 08 Dividend stripping provisions in s 177E applied - Lawrence

The Federal Court (Jessup J) has upheld the Commissioner's assessments on the taxpayer pursuant to s 177E ITAA 1936 ("stripping of company profits"). The taxpayer had entered into an elaborate set of arrangements in relation to two companies, the effect of which was that profits which were held for distribution by the two companies (in which the applicant was the only shareholder) were effectively converted into capital sums held by another company on trust for a class of discretionary beneficiaries which was confined to the applicant and members of his family

Although the Court held that the scheme that the taxpayer entered into was not "by way of or in the nature of dividend stripping" (because it lacked many of the characteristics identified by the Full Federal Court in Consolidated Press (1999) 91 FCR 524), it nevertheless held that it was a scheme "having substantially the effect of a scheme by way of or in the nature of dividend stripping". It did so on the basis of comparing the effect of what actually happened with what might have been the effect if the taxpayer had entered into a notional scheme that did meet the characteristics of a scheme "by way of or in the nature of dividend stripping". The Court concluded, at para 84:

"In both cases, the profits of the target company would effectively have been disposed of, and would no longer have been a potential source of income tax obligations, either for the taxpayer or for anyone else. Both for the taxpayer and for the revenue, the effects of the schemes in the present case were substantially the same as the effect of a scheme by way of or in the nature of dividend stripping."

The Court further held, in accordance with the both the Full Court and the High Court decisions in Consolidated Press, that the scheme that the taxpayer entered into had, as its dominant purpose, the avoidance of tax on the distribution of dividends by the target company.

The Court therefore upheld the assessments to primary tax.

However, in raising the assessment against the taxpayer the Commissioner had also imposed penalties under Subdiv 284-C of Div 284 of Part 4-25 of Sched 1 to the Taxation Administration Act 1953. That penalty was calculated at 50% of the "scheme shortfall amount" pursuant to s 284-160(a)(i) of that Schedule, reduced by 20% pursuant to s 284-225(1) of the Schedule, on the basis that the applicant had disclosed the details of the scheme after the Commissioner told him that a tax audit was to be conducted of his financial affairs. The taxpayer disputed the imposition of penalties on the basis that the only notification from the Commissioner was a s 264 notice, that this was not the notification that a tax audit was to commence, and that therefore the penalties should be reduced by 80% under s 284-225(2) of Sched 1 to the Administration Act. The Court agreed, stating at para 110:

"Counsel for the Commissioner submitted that the s 264 notice, and the covering letter dated 3 May 2005, told the applicant that an examination by the Commissioner of his financial affairs for the purposes of the 1936 Act was to be conducted. I cannot accept that submission. I would accept that, acting reasonably, the applicant might well have had his suspicions when he received this correspondence. But the correspondence did not tell him that there was to be such an examination, however much it might have presaged one. It required him to attend, to give evidence and to produce documents concerning the income or assessment of himself and other entities. That is not the same, in my view, as telling the applicant than an examination of his financial affairs was to be conducted."

On this basis, the Court ordered that the taxpayer's appeal from the assessments be allowed to the extent of the penalties only, which were to be reduced by 80% under s 284-225(2): Lawrence v FCT [2008] FCA 1497 (Federal Court, Jessup J, 10 October 2008).

For a copy of the decision, go here.

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