Edited version of private ruling

Authorisation Number: 1011618486995

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Ruling

Subject: Capital gains tax (CGT): liquidator's distribution

Issue 1

Can you apply the small business 50% reduction in section 152-205 of the Income Tax Assessment Act 1997 (ITAA 1997) to the liquidator's distribution of the capital profit active asset reserve from the company of which you are a shareholder?

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Issue 2

Can you apply the discount method in Division 115 of the ITAA 1997 to calculate your capital gains in relation to the liquidator's distribution of the capital profit active asset reserve?

No.

This ruling applies for the following period:

Year ended 30 June 2010

The scheme commences on:

1 July 2009

Relevant facts and circumstances

A company of which you are the sole shareholder received a discretionary trust capital gain distribution for the previous income year.

The capital gain was grossed up as the trust had applied the small business 50% reduction and used the discount method to calculate the capital gain. The small business 50% active asset reduction was then applied by the company to the capital gain, resulting in a net capital gain.

The company is to be wound up as its director is now deceased. You have been appointed director.

The date of this application will be the date for wind up for the purposes of this private ruling.

As of the date of wind up, a dividend payable on the ordinary share capital of the company to you will be declared by minutes of a meeting of directors.

Also as of the date of wind up, a liquidator's distribution of the capital profit active asset reserve to you will be declared for the above amount less the cost base of the shares.

The capital profit active asset reserve consists of the 'exempt' 50% component resulting from the application of the small business 50% active asset reduction.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 47

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-35

Income Tax Assessment Act 1997 Division 115

Income Tax Assessment Act 1997 Section 152-205

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.

Reasons for decision

In the context of liquidation distributions, Taxation Determination TD 95/10 indicates that a benefit may flow through to the shareholders providing that what is known as the Archer Brothers principle applies.

The principle is that if a liquidator appropriates (or sources) a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of section 47 of the Income Tax Assessment Act 1936 (ITAA 1936). TD 95/10 states that the Commissioner will accept that a liquidator may rely on the Archer Brothers principle, except where a specific provision in either the ITAA 1936 or ITAA 1997 produces a different result.

Specifically, the Commissioner considers that the Archer Brothers principle applies if:

· the company accounts have been kept so that a liquidator can clearly identify a specific profit or fund in making a distribution, and

· it is clear from either the accounts or statement of distribution that the liquidator has appropriated the specific profit or fund in making the distribution.

In practice, what this means is that income, profits, or capital gains will retain their specific character in the hands of the shareholders upon the winding up of the company if the Archer Brothers principle is applied. Specifically, the benefit of any exemptions and reductions applied by the company would flow through to the shareholders in such circumstances by virtue of paragraph 47(1A)(b) of the ITAA 1936 which states that only the net capital gain (that is, after taking into account reductions) is taken into account.

Applying the above to your circumstances

In your case, the capital profits active asset reserve of the company is to be distributed to you, and the Archer Brothers principle discussed above will apply in this case. The distribution of the capital profits active asset reserve represents a distribution by a liquidator.

The company, however, is a legal entity, separate from its shareholders. While in the case of partnerships, and sole traders, the benefits of capital gain exemptions and reductions flow directly to the individuals who represent the immediate taxing point, and for trusts, the benefit of any exemption or reduction flows when a distribution is made, it remains that any benefit from an exemption will only be applied once.

Any benefits in relation to the small business 50% reduction and the discount method for calculating capital gains will already have been applied by the company by way of a direct reduction in the case of small business 50% reduction, and a deduction for the amount of the distributing trust's net capital gain under subsection 115-215(6) of the ITAA 1997, following the grossing up of the distribution under paragraph 115-215(3)(c) of the ITAA 1997.

Therefore, as the benefits of these concessions will already have been applied by the company, you, as shareholder of the company, will not be able to apply any further benefits from these concessions in relation to the distribution of the capital profits active asset reserve.

Treatment of the distribution

The liquidator's distribution of the 'exempt' 50% component of the capital gain distribution in the capital profit active asset reserve is not deemed to be a dividend under subsection 47(1) of the ITAA 1936.

The 'exempt' 50% component is not 'income derived by the company' according to ordinary concepts for the purposes of subsection 47(1) of the ITAA 1936. Nor is it 'income derived by the company' under the extended definition of that expression in subsection 47(1A) of the ITAA 1936.

For the capital gains provisions in the ITAA 1997, the liquidator's distribution of the 'exempt' 50% component represents capital proceeds for the cancellation of the shares (CGT event C2 under section 104-25 of the ITAA 1997) in the case of a final distribution or an interim distribution which is followed within 18 months by the dissolution of the company.

In the case of other interim liquidation distributions in respect of post-CGT shares, it is an amount to which CGT event G1 (about capital payments for shares) in section 104-35 of the ITAA 1997 applies.

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