Explanatory Memorandum(Circulated by the authority of the Treasurer the Hon Ralph Willis, M.P.)
Chapter 4 Capital Gains Tax- Rebatable dividends out of pre-acquisition profits. Subdivision J of Division 3 (Part 3) of the Bill.
4.1 The Bill will provide that a capital loss that would otherwise be derived by a controller of a company or an associate of the controller on the disposal of any share in the company will be reduced by any distribution made by the company to the controller or the associate that is a rebatable dividend paid out of pre-acquisition profits.
Purpose of the amendments
4.2 The amendment will prevent a controller of a company or an associate of a controller from being able to generate a capital loss on the disposal of shares in the company in circumstances where the controller or associate does not suffer an economic loss to the extent of that capital loss.
4.3 Under the current law, a capital loss could be generated in relation to the disposal of shares in a company where there is no equivalent economic loss. This could arise where the shares are sold after the pre-acquisition profits of the company have been distributed in the form of rebatable dividends. Pre-acquisition profits, in relation to a shareholding in a company, are profits retained in the company at the time the shareholding was acquired.
4.4 The following example illustrates a case where a capital loss is generated where there is no equivalent economic loss.
Company X acquired all the shares of company Y for their market value of $10,000. At the time of acquisition of the shares, the balance sheet of company Y was as follows:
4.5 The dividends paid by company Y to company X qualified for the dividend rebate under section 46 of the Act. Consequently, no company tax was paid on those dividends. Moreover, company X has recovered the full amount of its investment of $10,000 in company Y in the form of dividends ($8,000) and disposal consideration ($2,000). Nevertheless, under the current law, company X may claim a capital loss of $8,000. This is the difference between the cost of the shares ($10,000) and the disposal consideration ($2,000).
4.6 The anti-avoidance provisions of Part IVA of the Act could apply where there is a scheme by way of or in the nature of dividend stripping or a scheme having substantially the effect of a scheme by way of or in the nature of dividend stripping. However, it should be the general rule that a capital loss should not be able to be claimed where the result of the course of action is that there is no economic loss to the taxpayer.
4.7 The amendments to the law will have the effect that a capital loss cannot be claimed by company X in the circumstances shown in the example [Clause 63].
Date of effect
4.8 The amendment will apply in relation to disposals of shares made on or after the date of introduction of the Bill [Clause 71].
4.9 Section 160Z provides that a capital loss arises in relation to the disposal of an asset where the reduced cost base to the taxpayer of the asset exceeds the consideration in respect of the disposal. Section 160ZH sets out the meaning of the cost base of an asset acquired by the taxpayer while section 160ZK deals with the calculation of the reduced cost base of the asset. Section 160ZD deals with the determination of the consideration for the disposal of an asset.
4.10 Sections 46 and 46A provide that a resident company which receives a dividend from another resident company can, depending on the circumstances, qualify for a full or a partial rebate of tax payable in relation to that dividend. A full rebate has the effect of freeing the dividend from tax while a partial rebate reduces the tax payable on that dividend.
4.11 The amendments deal with the situation where a company shareholder disposes of shares held in another company after that other company has distributed some or all of its pre-acquisition profits. The amendments apply only where the shares were held by the controller of the company or by another company that is an associate of the controller. The amendments will also only apply where the pre-acquisition profits were distributed as dividends that were fully or partly rebatable.
Controlling shareholder and associate
4.12 The expressions 'controller' and 'associate' are explained in the notes in Chapter 5.
Effect of the amendments
4.13 The amendments will reduce the reduced cost base of shares held by the shareholder in calculating the capital loss arising on the disposal of the shares. It will not affect the calculation of the gain, if any, on the disposal of the shares [Clause 68 - new subsections 160ZK(1A) and (3B).]
4.14 It will apply where:
- there is an arrangement under which a distribution has been made by a company to the controlling shareholder or an associate;
- the distribution was wholly or partly a rebatable dividend; and
- it is reasonable to treat the distribution as having been made out of the pre-acquisition profits of the company.
[Clause 68 - new subsection 160ZK(5)]
4.15 The concept of an arrangement is only used to allow a link to be made between a distribution out of pre-acquisition profits and the period by reference to which the test of whether there is a controller of the company is applied. It does not limit in any other way the application of the amendments to a distribution made by the company out of pre-acquisition profits.
4.16 Where the dividend qualifies for a full dividend rebate, the reduced cost base of the shares is to be reduced by the full amount of the dividend. Where the dividend qualifies for a partial rebate only, the reduced cost base is to be reduced by a proportionate part of the dividend [Clause 68 - new subsection 160ZK(6)].