ATO Interpretative Decision

ATO ID 2002/788

Income Tax

• This ATO ID has been amended to update legislative references and revise expression in its reasons for decision.

Issue

Would section 45B of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the payment by a company (S) to its non-resident 100% parent company (P)?

Decision

Section 45B of the ITAA 1936 would apply to the payment. The Commissioner would make a determination under subsection 45B(3) that section 45C applies.

Facts

1. S was incorporated in Australia several years ago. It is a 100% subsidiary of a non-resident company, P.

2. S was originally established to acquire an interest in a mining tenement (the Project). Substantially all funds raised by S in its year first year of operation were expended in carrying out exploration and development activities.

3. As the Project generated cash flow from production, S wished to reduce its debt and equity, to reduce its interest cost in Australia and manage its debt and equity ratio appropriately. S decided to make a return of capital payment of part of its paid up capital to P, and to repay part of its debt obligations. The equity payment would be funded from excess cash funds on hand which originated from normal sales.

4. S had accounting profits for its first two years, and it expects a profit also for the current year. However, for income tax purposes no taxable income has been derived for the first two years, so no income tax has been paid to date.

5. There were no material sales of assets by S in the relevant periods.

Reasons for Decision

All legislative references are to the ITAA 1936 unless otherwise indicated.

Paragraph 45B(1)(b) states the purpose of Section 45B is that relevant amounts are treated as dividends for taxation purposes if certain payments, allocations and distributions are made in substitution for dividends.

Subsection 45B(3) allows the Commissioner to make a determination that section 45C applies. Section 45C treats such payments as unfrankable dividends in the hands of the shareholder.

Under subsection 45B(2), for section 45B to apply, the following circumstances must be present:

(a)

a scheme under which a "capital benefit" is provided to a person by a company;

(b)

under the scheme, a taxpayer "obtains a tax benefit"; and

(c)

having regard to the relevant circumstances of the scheme, it would be concluded that the person who entered into or carried out the scheme did so for a purpose (not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit.

Under paragraph 45B(5)(b) the provision of a "capital benefit" includes the distribution of share capital to a shareholder, so circumstance (a) above is satisfied.

Under subsection 45B(9), a "tax benefit" is obtained from capital benefits if the amount of tax payable by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable if the capital benefit had been a dividend.

This test would be satisfied for the partial return of capital payment by S to P as the capital return payment by S would not be taxable to P because the payment would be excluded from the subsection 6(1) definition of "dividend" by paragraph (d) of the definition.

However, if the payment is a dividend then withholding tax would be payable by S, as P is a non-resident company, and any dividends paid now would be unfranked as S has not paid any income tax to date. Therefore, there would be a "tax benefit" in respect of that dividend payment and the test in paragraph 45B(2)(b) would be satisfied.

Paragraph 45B(2)(c) sets out an objective purpose test, having regard to "the relevant circumstances of the scheme" (under which the capital benefit is provided). The test is not satisfied if the purpose (of obtaining a tax benefit) is only incidental, but this purpose does not have to be the dominant purpose of the scheme.

Subsection 45B(8) lists circumstances which are relevant in determining whether any person has the purpose (of enabling a taxpayer to obtain a tax benefit). Paragraph (a) of subsection 45B(8) refers to the extent to which the distribution is attributable to the profits of the company.

S had accounting profits for its first two operating years, and now expects to have a surplus for the current year.

The payment by S to P is effectively distributing profits. As the payment also confers a tax advantage, this suggests that S had the purpose of enabling a taxpayer to obtain a tax benefit.

S has stated that its intention in making the payment had nothing to do with distributing profits, as it had initially forecast a loss from the Project. However, S did have accounting profits for the previous two years, and it expects a profit for the current year. In addition, S has advised that the payment would be funded from excess cash funds on hand which have originated from normal sales, which suggests that retained earnings would be the source of the payment.

S has also stated that substantially all its equity and borrowed funds raised in its first year of operations were incurred in carrying out exploration and development activities. This does not indicate that surplus capital was available for return to P.

In addition, there has been no significant change to S's business structure such as major asset sales; instead there has been normal trading. In these circumstances, a return of capital payment in cash would be considered to have been taken out of retained earnings. Even if the directors take the view that there is too much equity (capital and retained earnings) to be usefully employed, this merely means that an earlier decision to re-invest profits is now to be reversed.

Based on the above, the payment by S to P can be attributed to profits.

Paragraph (b) of subsection 45B(8) refers to the "pattern of distributions of dividends, bonus shares and returns of capital or share premium" as a relevant circumstance. This circumstance is not relevant in this case as S is a recently incorporated company which has not previously paid any dividends.

Paragraph (c) relates to the availability of capital losses for the "relevant taxpayer" (S). S does not have any capital losses available, therefore this factor is not relevant.

Paragraph (d) has no application as no shares in S were acquired pre-CGT.

Paragraph (e) is relevant from the perspective that S is a resident company of Australia for income tax purposes, but P is not. If P was a resident company there would be no dividend withholding tax on any unfranked dividend paid to it by S. As P is a non-resident, this means that there is tax benefit for S in returning capital as opposed to paying an unfranked dividend on which withholding tax would be payable.

Paragraph (f) is satisfied because the cost base of the shares in S held by P is significantly greater than the amount of the capital return.

Paragraph (g) is not relevant to the case at hand as S is not a private company, as it is a subsidiary of a public company.

Paragraph (h) requires a comparison of the interest held in S by P after the distribution, and the interest which would have been held if an equivalent dividend had been paid instead, to see if the interests have been changed. There can be no change in the relative interests of shareholders as P is the only shareholder of S.

Paragraph (i) does not apply as the distribution will be in cash rather than in the form of shares.

Paragraph (j) concerns an increase in the value of a share and its later disposal. This paragraph is not relevant as there is no indication of any change in the rights of S's shares, or that these shares will increase in value.

Taking into account all the "relevant circumstances" it is concluded that section 45B would apply to the arrangement. Accordingly the factors in subparagraphs 177D(b)(i) to (viii) have not been separately considered.

Year of income:  Year ended 30 June 2003

Legislative References:
Income Tax Assessment Act 1936
   subsection 6(1)
   section 45B
   subsection 45B(1)
   paragraph 45B(2)(b)
   paragraph 45B(2)(c)
   subsection 45B(3)
   paragraph 45B(5)(b)
   subsection 45B(8)
   subsection 45B(9)
   section 45C
   subsection 177D(b)

Keywords
Return of capital on shares
Capital reductions
Deemed dividends
Dividend income

Siebel/TDMS Reference Number:  DW223296

Business Line:  Public Groups and International

Date of publication:  2 August 2002

ISSN: 1445-2782