Tribunal deems restructure of plumbing business as 'dividend stripping scheme'

One of the key issues examined by the Tribunal was whether loans received by Botella from a related entity, PPD, satisfied section 109N of the ITAA 1936.

The commissioner's position was that the loans were not complying Division 7A loans because section 109N(1)(a) requires that a loan agreement is made in writing and there was no agreement prior to the company's tax return lodgment.

Counsel for the applicants argued that although there was no separate written loan agreement between PPD and Botella as a shareholder, clause 19(a) of PPD's constitution deemed loans made by PPD to members to be in accordance with the pro-forma loan agreement set out in Schedule 1 of the constitution.

The tribunal said it agreed with the commissioner's view that the deeming of a pro-forma loan agreement in PPD's constitution to apply to a loan did not satisfy the requirement that a loan agreement had been made in writing.

"In effect, the deeming clause does not provide that any loan is made under a written agreement. This is because the essential terms of the agreement, namely, the agreement whereby PPD agreed to loan Botella a specified sum of money, and Botella agreed to repay that money to PPD was not made under a written agreement but by virtue of advances taking place," the tribunal said.

"Therefore, the deeming clause cannot turn a loan which occurred by conduct, and which was then recorded as a book entry, into a loan agreement which is made under an agreement that is in writing."

The tribunal said it was clear the loans made were not separately agreed in writing but undertaken by way of advances and book entries.

For these reasons, it determined that section 109N was not satisfied and confirmed that the payment from PPD should have been characterised as a deemed dividend to Botella under section 109D.

The other major issues examined by the court were whether a number of transactions undertaken between Botella, Pipeline Plumbing Developments and Pipeline Plumbing Holdings constituted a scheme in the nature of dividend stripping under section 177E of the Income Tax Assessment Act 1936.

The applicants argued that the transactions were an internal corporate reorganisation primarily for asset protection purposes.

During the 2019 income year, PPH was incorporated, and Botella sold 100 per cent of his shareholding in PPD to PPH in return for PPH issuing 1,009,018 shares to Botella. Botella chose to obtain CGT roll-over relief under Subdivision 122-A of the ITAA.

PPD declared a franked dividend of $1,008,918 to be paid to PPH, with a franking credit of $382,693. Subsequently, PPH claimed a tax offset under Division 207 of the ITAA 1997 equal to the franking credit, reducing its tax payable on the dividend to nil for the income tax year ended 30 June 2019.

In September 2018, PPD issued a promissory note to PPH for $1,008,918, in satisfaction of the dividend that had previously been declared. PPH then endorsed the promissory note issued by PPD in favour of Botella, and PPH recorded this as a loan from PPH to Botella.

Botella presented the promissory note to PPD as repayment of the loans PPD had advanced to Botella, which remained outstanding at the end of the income year ended 30 June 2018.

The commissioner said there was a scheme involving dividend stripping and that the amount of $1,008,918 was included in Botella's assessable income for the 2019 income year.

The ATO also amended the income tax assessment for Pipeline Plumbing Holdings for the 2019 income year to remove franking credits. The Commissioner also assessed Botella for both a false and misleading statement shortfall penalty and a scheme shortfall penalty. Both penalties totalled $235,958.55.

The commissioner submitted that these transactions carried out Botella, PPD and PPH in the 2019 income year exhibited each of the common characteristics of a dividend stripping scheme.

The Tax Office claimed that the scheme involved the disposal of property that represented profits in the company because undistributed profits of PPD were disposed of by the payment of a franked dividend in that amount to PPH.

The tribunal ruled that the applicants had failed to establish that the transactions were not dividend stripping schemes.

"I was not persuaded that the characteristics of the scheme and the objective circumstances in which the scheme was designed and operated were not for the dominant purpose of avoiding tax," tribunal deputy president Gina Lazanas said.

The applicants said that if the loans from the company were deemed dividends by the tribunal, the amount of deemed dividends should be limited by the private company's distributable surplus under section 109D.

The tribunal concluded that the PPD's liability for unpaid payroll tax as at 30 June 2018 constituted a present legal obligation and therefore should have been deducted from PPD's net assets when calculating the distributable surplus for the 2018 income year.

Based on the evidence, the total amount of PPD’s unpaid payroll tax as at 30 June 2018 was calculated to be $343,884.33, which the parties agreed to.

"With respect to the penalties on the payroll tax liability, they were not able to be treated as a present legal obligation as they were only imposed after the financial year ending 30 June 2018 on the basis of unpaid liabilities, and so had not crystallised as at 30 June 2018," the tribunal said.

The tribunal varied the ATO's objection decision in relation to the calculation of the distributable surplus but upheld the other tax assessments made by the Commissioner of Taxation.