Explanatory Memorandum(Circulated by the authority of the Treasurer the Hon Ralph Willis, M.P.)
Chapter 3 Capital Gains Tax - Payment of rebatable dividends from certain share premium accounts and revaluation reserves. Subdivision J of Division 3 (Part 3) of the Bill
3.1 The Bill will amend the capital gains tax (CGT) provisions of the Act so that any capital gain computed having regard to the disposal consideration for shares in a company or the amount of capital paid back on shares will not be reduced by the amounts of the payments that are treated as rebatable dividends. These amendments relate to:
- liquidator's distributions;
- off-market share buy-backs;
- other disposals of shares; and
- amounts paid in connection with a reduction of capital.
Purpose of amendments
3.2 Subsection 160ZA(4) of the Act ensures that an amount taxed as ordinary income is not taxed again as a capital gain. The subsection applies if the disposal of an asset gives rise both to a capital gain under the capital gains tax (CGT) provisions of the Act and also assessable income under another provision of the Act. In such cases, subsection 160ZA(4) reduces the capital gain by the assessable income included under the other provision of the Act.
3.3 Dividends paid from one resident company to another are fully or partially rebatable under section 46 or 46A of the Act. A rebatable dividend is included in assessable income but is effectively made tax free or partly tax free by the grant of a tax rebate. This tax rebate is referred to as the inter-corporate dividend rebate.
3.4 Some corporate shareholders who derive a capital gain from the disposal of shares held in a company are able to structure the disposal in such a way that it also gives rise to a rebatable dividend. In such a case, subsection 160ZA(4) has the effect of reducing the amount of the capital gain by the amount of the dividend. This would give the correct result of avoiding double taxation if income tax is payable on the dividend. However, income tax is effectively not paid on the dividend if the taxpayer is a resident company that qualifies for the inter-corporate dividend rebate and the dividend is paid out of untaxed amounts.
3.5 The anti-avoidance provisions of Part IVA of the Act could apply where a tax advantage is obtained by converting one form of assessable income into a rebatable dividend. However, Part IVA has to be applied on a case by case basis and would apply only where, on the facts, it would be concluded that there is a sole or dominant object of tax avoidance.
3.6 The capital gain that should arise on the disposal of shares in a company may be reduced because certain distributions made by a company in relation to the disposal are treated as rebatable dividends.
3.7 The amendments will prevent a capital gain, whether arising from the disposal of shares, share buy-backs, liquidators' distributions or the repayment of capital on shares, from being reduced:
- because part of the payment relating to the disposal, share buy-back, or the liquidator's distribution is treated as a rebatable dividend and excluded from the capital gain; or
- because part of the payment or distribution is treated as a rebatable dividend and excluded from the disposal consideration on which the capital gain is computed.
3.8 The amendments relate only to distributions made by a company to the shareholders where the distribution is treated as funded from share premium accounts created in a specified way (see paragraph 3.18) or reserves created on the revaluation of specified assets (see paragraph 3.19) [Clause 63].
Date of effect
3.9 The amendments apply to:
- liquidator's distributions;
- off-market share buy-backs;
- other disposals of shares; and
- payments in connection with a reduction of capital; made after 12:00 midday Eastern Summer Time 12 January 1994 [Clause 71].
3.10 The amendments provide that a capital gain that would arise on the disposal of shares cannot be reduced by making distributions that could be treated as funded out of certain share premium balances and revaluation reserves. The taxation provisions that are affected by the amendments relate to:
- off-market share buy-backs - sections 159GZZZJ to 159GZZZT;
- liquidator's distributions - section 47;
- other disposals of shares - section 160M; and
- amounts of capital paid back on shares - section 160ZL.
Off-market share buy-backs
3.11 A company can purchase, for cancellation, shares issued by the company. An on-market purchase is broadly where the shares are traded on a stock exchange and the buy-back is made in the ordinary course of business of the stock exchange. An on-market purchase also does not include a transaction described as 'special' under the rules of that stock exchange. An off-market purchase is any buy-back that is not an on-market purchase. The relevant provisions are contained in Division 16K of Part III of the Act (section 159GZZZJ to 159GZZZT).
3.12 Section 159GZZZP provides that an amount paid by the company in an off-market purchase, reduced by the sum of the paid up value of the shares and any part of the purchase price that is drawn from the company's share premium account, is treated as a dividend paid out of profits to the shareholder. The part of the purchase price that is not treated as a dividend is treated as consideration for the sale of the shares (section 159GZZZQ).
3.13 Under the current law, a liquidator's interim distribution that is not a dividend represents repayment of capital on a share. Section 160ZL would apply to such a distribution.
3.14 A liquidator's final distribution constitutes a payment on the disposal of the shares. Section 47 of the Act deals with liquidator's distributions. A liquidator's distribution funded from a revaluation reserve, for example, could constitute a dividend.
Other disposals of shares
3.15 The capital gain or loss on the sale of shares, for example, would be affected by a repayment of capital on those shares. This is because the cost base, indexed cost base or reduced cost base by reference to which the gain or loss is calculated will be affected by the repayment of capital. A dividend may also be paid as part of the consideration for the disposal of shares.
3.16 Currently, section 160ZL of the Act applies to a payment which represents a repayment of capital on shares in a company. It does not apply to a dividend or a payment made on the disposal of the shares.
3.17 Section 160ZL has the effect that a payment to which that section relates reduces the cost base, indexed cost base or reduced cost base of the shares in relation to which the payment was made. If the payment exceeds the indexed cost base of the shares, a capital gain is recognised.
Share premium accounts
3.18 The amendments dealing with distributions made out of share premium accounts relate to arrangements under which a company issues shares at a premium and the funds made available by the share issue are used to make a distribution to, or for the benefit of, persons who were shareholders of the company prior to that share issue [Clause 64 - new subsection 159GZZZMA(1); Clause 70 new subsection 160ZLA(1)].
3.19 A revaluation reserve, or part of a revaluation reserve, to which the proposals apply is a reserve representing profits on the revaluation of an asset where, if the company had disposed of the asset immediately after the revaluation:
- any profit that would have arisen on the disposal of the asset would have been included in the company's assessable income or any loss would have been allowed as a deduction from assessable income;
- the CGT provisions of Part IIIA would have applied or would have applied but for a roll-over relief available under Division 17 of that Part. [Clause 64- new subsection 160GZZZMA(4); Clause 70 - new subsection 160ZLA(4)].
Rebatable dividend adjustment
3.20 The expression 'rebatable dividend adjustment' is used to refer to the amount of the rebatable dividend that is to be:
- excluded from the amounts by which a capital gain is reduced under subsections 160ZA(4) or 160ZA(5) [Clause 67 - new subsections 160ZA(4A) and 160ZA(5A)];
- included as an amount paid out of share premium or as purchase consideration under paragraph 159GZZZQ(b) for the purposes of determining whether a capital gain or loss arises on the off-market share purchase [Clause 65 - new subsection 159GZZZP(1A); Clause 66 - new subsection 159GZZZQ(2)]; or
- included under section 160ZL as an amount distributed as repayment of capital on shares [Clause 69 - new subsection 160ZL(5)].
Ordering arrangements for distributions
3.21 A company may have a share premium balance of the type described in paragraph 3.18, a revaluation reserve of the type described in paragraph 3.19, and other funds at the time a distribution is made. The ordering arrangement has the effect that the distribution is to be taken to be attributable first to any share premium, then to any revaluation reserve and finally to other funds of the company. [Clause 70 - new subsections 160ZLA(2) and (6)].
3.22 The rebatable dividend adjustment could arise from amounts distributed by the company from a share premium account of the type referred to in paragraph 3.18 or a revaluation reserve referred to in paragraph 3.19.
3.23 The amount that is treated as distributed by the company to a particular shareholder out of share premium arising from an arrangement is calculated using the formula:
Amount of distribution made to the shareholder * (total share premium/total of amounts distributed to shareholders under the arrangement)
The resulting amount is reduced by the share premium, if any, paid by the shareholder for the shares issued under the arrangement and in relation to which the distribution is made [Clause 70 - new subsections 160ZLA(2) and (3)].
3.24 Similarly, the amount treated as distributed by the company to a shareholder out of its revaluation reserve is calculated using the formula:
Amount of distribution made to the shareholder * (total revaluation reserve/total of amounts distributed to shareholders under the arrangement)
[Clause 70 - new subsection 160ZLA(5)]
3.25 If the distributions made from the share premium and the revaluation reserves are fully rebatable, the rebatable dividend adjustment is the total amount of those distributions.
3.26 If the distributions made from the share premium account and the revaluation reserves qualify for a partial rebate, the rebatable dividend adjustment is calculated using the formula:
Distributions from share premium
revaluation reserves * (Amount of dividend rebate obtained/Amount of the full dividend rebate on the dividend amount of the distribution)
[Clause 70 - new subsections 160ZLA(3) and (7)]
3.27 Any part of a liquidator's interim distributions to a shareholder that is funded from a share premium account of the type referred to in paragraph 3.18 or from a revaluation reserve of the type referred to in paragraph 3.19, and which is a rebatable dividend, is to be included in the amounts to which section 160ZL would apply. [Clause 69 - new subsection 160ZL(5)].
3.28 Currently, section 160ZL of the Act applies to a payment not being a dividend, which represents a return of capital on shares. After the amendment, section 160ZL will apply to a dividend to the extent that it is a rebatable dividend funded from a share premium account or a revaluation reserve referred to in paragraphs 3.18 and 3.19 respectively.
3.29 A capital gain computed in relation to the liquidator's final distribution will not be reduced under subsection 160ZA(4) to the extent that the distribution is a rebatable dividend funded from a share premium account of the type referred to in paragraph 3.18 or a revaluation reserve of the type referred to in paragraph 3.19. [Clause 67 - new subsections 160ZA(4A) and (5A)].
3.30 The amendments provide that the amount of the purchase consideration for an off-market share buy-back that is taken into account in calculating the capital gain or loss on the buy-back will include the amount of a rebatable dividend paid in relation to revaluation reserves referred to in paragraph 3.19. Under the current law, the purchase consideration taken into account in calculating the capital gain already includes payments in relation to a share premium account.
3.31 The amendments have the effect that a share buy-back price will not be treated as a dividend not only to the extent that it is treated as funded from a share premium account but also the extent that it relates to a rebatable dividend from a revaluation reserve of the type referred to in paragraph 3.19. [Clause 64 - new section 159GZZZMA; Clause 65 - new subsection 159GZZZP(1A); Clause 66 - new subsection 159GZZZQ(2)].
3.32 The ordering arrangements for distributions will have the effect that any amount paid by the company for the share buy-back is treated as first paid from any share premium account of the type referred to in paragraph 3.18, then from any revaluation reserve of the type referred to in paragraph 3.19 [Clause 64 - new subsections 159GZZZMA(2), (5) and (6)].
3.33 The amount funded from the share premium or the revaluation reserve will not be treated as a dividend if the dividend is fully rebatable. Where the dividend qualifies for a partial rebate, a part of the distribution will not be treated as a dividend [Clause 64 - new subsections 159GZZZMA(3) and (7)].