In a recent single judge decision of the Federal Court, the application of the General Anti-Avoidance Rule (GAAR) applicable to franking credit schemes was considered.
The facts involved the Commonwealth Bank (Bank) issuing stapled securities (Relevant Securities) consisting of an unsecured subordinated note issued by the New Zealand branch of the Bank (the Notes) and a preference share issued by the Bank (the Preference Shares). The offer of these stapled interests was only available to persons within Australia although this did not prohibit a nonresident acquiring the Relevant Securities as in fact occurred.
It was common ground between the parties that under the debt-equity rules, the Relevant Securities were equity and not debt and that the Notes were to be treated as non-share equity and not as debt. This meant that the interest on the Notes was to be treated as a non-deductible non-share dividend and therefore the interest was both frankable and required to be franked, notwithstanding the fact that the characteristics of the Notes were much more like those of debt interests than of equity interests.
Because the Notes were issued by the New Zealand branch of the Bank, the interest on the Notes was deductible in that country. However because the recipients of the interest were Australian residents holding the Relevant Securities, those taxpayers were entitled to a franking credit on their distributions.
As a result of this structure the Bank was able to claim a deduction for its interest costs and still provide the holder of Relevant Securities with franked distributions and therefore obtain its Tier 1 financing under the APRA rules at a much cheaper price than if the interest distributions were not franked.
The Commissioner sought to apply Part IVA, and in particular the franking credit scheme GAAR to the transaction. In order for the franking credit scheme GAAR to apply there are 5 pre-requisites namely:
- there is a scheme for a disposition of membership interests in a corporate tax entity
- a frankable distribution has been paid to a person in respect of the membership interests
- the distribution was a franked distribution
- the person (the relevant taxpayer) would, but for the operation of the GAAR provisions, receive imputation benefits as a result of the distribution
- having regard to the relevant circumstances of the scheme, it would be concluded that one of the persons who entered into or carried out the scheme did so for a purpose (not necessarily being the dominant purpose, but not including an incidental purpose) of enabling the relevant taxpayer to obtain an imputation benefit.
In determining a person’s purpose 11 circumstances (10 matters specific to franking credit schemes with the 11th consisting of the 8 matters that apply to the GAAR for tax schemes generally) need to be considered.
In this case the first four pre-requisites were satisfied and the Court only had to consider whether the fifth pre-requisite applied i.e. whether a purpose of the Bank, not being an incidental purpose, in issuing the Relevant Securities was to enable holders of the Relevant Securities to obtain an imputation benefit.
Firstly the Court confirmed that, as with the GAAR for tax schemes generally, in relation to the franking credit scheme GAAR, it was only the imputed purpose, worked out objectively, that mattered and regard was not to be had to the actual or subjective motives of the relevant person.
Secondly the Court confirmed that as with the GAAR for tax schemes generally, in relation to the franking credit scheme GAAR, it is possible to arrive at the relevant conclusion as to purpose by making a global assessment of the facts, so long as it is clear that all of the relevant individual matters referred to in the section are taken into account.
Thirdly the Court confirmed that as with the GAAR for tax schemes generally, in relation to the franking credit GAAR, there is no inconsistency between a finding that the purpose of a person lay in the pursuit of some commercial benefit in the course of carrying out a business, and a finding that a non-incidental purpose was to enable a relevant taxpayer to obtain an imputation benefit.
The Court however went on to consider the 11 circumstances referred to in the section to determine whether the relevant purpose in the carrying out of the scheme was present.
The Court held that having regard to all of the relevant matters and circumstances, on balance they pointed towards the relevant purpose of enabling holders of the Relevant Securities to obtain an imputation benefit.
The Court found that the basic and fundamentally important aspect of the terms of the Notes was to enable the holders of the Relevant Securities to obtain an imputation benefit. This imputation benefit was obtained even though the characteristics of those Relevant Securities were more akin to debt than equity. However by issuing the Relevant Securities in New Zealand, the Bank was able to obtain a deduction in New Zealand in respect of the distributions but had the advantage, in terms of cost, of offering Australian residents the imputation benefit.
Therefore the Commissioner was entitled to deny the imputation credits to all of the investors in the Relevant Securities.