Edited version of your private ruling

Authorisation Number: 1012374054987

Ruling

Subject: Income Tax: Capital Gains Tax: Return of capital

Question 1

Is the proposed return of capital a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Is the proposed return of capital a dividend taxable under section 44 of the ITAA 1936?

Answer

No

Question 3

Will the Commissioner make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA1936 will apply to the proposed return of capital?

Answer

No

Question 4

Is the cost base of the shareholders shares in F Co reduced in accordance with subsection 104-135(4) of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of CGT event G1?

Answer

Yes

This ruling applies for the following period

Year ended 31 December 20xx

Year ended 31 December 20yy

The scheme commenced on

Not yet commenced.

Relevant facts and circumstances

F Co is a proprietary company incorporated in New South Wales before 20 September 1985. F Co is and always has been directly or indirectly owned by a family owned group of companies based overseas.

F Co is directly owned by B Co (the shareholder), an overseas company in the group and a non-resident company for Australian tax purposes. The shareholder acquired the shares in F Co as a consequence of a change to the corporate structure of the family group. For the purposes of this ruling the shares in F Co are post-CGT shares. F Co sold two of its divisions some time ago to related companies.

F Co has not entered into transactions or done anything that has tainted its share capital account and accordingly Division 197 of the ITAA 1997 has no adverse consequence for F Co.

F Co does not own any Australian real property for the purposes of Division 855 of the ITAA 1997.

F Co now proposes to return excess share capital to its shareholder by means of a reduction in share capital to establish the optimal level of working capital.

The proposed capital return contemplated is to distribute on a pro-rata basis to its shareholder (pursuant to subsection 256B(1) of the Corporations Act 2001 (Cth) (the Corporations Act)).

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 6(4)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 paragraph 45B(2)(a)

Income Tax Assessment Act 1936 paragraph 45B(2)(b)

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

Income Tax Assessment Act 1936 paragraph 45B(3)(b)

Income Tax Assessment Act 1936 subsection 45B(5)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 section 177A

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 section 115-10

Income Tax Assessment Act 1997 section 197-50

Income Tax Assessment Act 1997 subsection 975-300

Income Tax Assessment Act 1997 subsection 975-300(3)

Reasons for decision

Question 1

The term "dividend" in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph 6(1)(d) of the definition of 'dividend' excludes a distribution from the meaning of 'dividend' if the amount of the distribution is debited against an amount standing to the credit of the company's share capital account.

The capital return was wholly debited against the share capital account of F Co.

There have been no transfers to F Co's 'share capital account', as defined in section 975-300 of the ITAA 1997, prior to the return of capital which would:

a) have caused the share capital account to become tainted in terms of section 197-50 of the ITAA 1997; or

b) prevented F Co's share capital account from being treated as a share capital account for the purposes of paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1836.

Therefore, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 applies and the return of capital is not a dividend.

Question 2

Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends, as defined in subsection 6(1) of the ITAA 1936, paid to the shareholders out of profits derived by the company from any source (if the shareholder is a resident of Australia) and from an Australian source (if the shareholder is a non-resident of Australia).

Since the proposed distribution is not a 'dividend' under subsection 6(1) of the ITAA 1936, it would not be assessable under subsection 44(1) of the ITAA 1936.

Question 3

Summary

Having regard to all the relevant circumstances of this scheme, the Commissioner would not therefore come to the objective conclusion that a non-incidental purpose of providing the capital benefit to the sole shareholder of F Co is to obtain a tax benefit. The Commissioner would therefore not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies.

Detailed reasoning

Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. It allows the Commissioner to make a determination that section 45C of the ITAA 1936 applies to a capital benefit. The effect of such a determination is that all or part of the distribution of capital received by the shareholder under the return of capital is treated as an unfranked dividend.

Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B of the ITAA 1936 applies where:

· there is a 'scheme' under which a person is provided with a capital benefit by a company: paragraph 45B(2)(a) of the ITAA 1936;

· under the scheme a person (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit: paragraph 45B(2)(b) of the ITAA 1936; and

· having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into or carried out the scheme or any part of the scheme for a purpose (other than an incidental purpose) of enabling a taxpayer to obtain a tax benefit: paragraph 45B(2)(c) of the ITAA 1936.

For the purposes of paragraph 45B(2)(c) of the ITAA 1936, the Commissioner is required to consider the 'relevant circumstances' set out in subsection 45B(8) of the ITAA 1936 to determine whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit. However, the list of relevant circumstances in subsection 45B(8) of the ITAA 1936 is not exhaustive and regard may be had to other circumstances on the basis of their relevance.

The test of purpose is an objective one. The question is whether it would be concluded that a person who entered into or carried out the scheme did so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. The requisite purpose does not have to be the most influential or prevailing purpose but it must be more than an incidental purpose.

The purpose which causes section 45B of the ITAA 1936 to apply may be the purpose of any party to the scheme.

What is the scheme?

A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of Part IVA of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition.

In the present circumstances it is appropriate that the scheme for the purposes of section 45B of the ITAA 1936 be widely cast. A key incident of any scheme will, of course, be the distributions or 'things done' which constitute the provision of a capital benefit. Equally however, those events or circumstances under which tax benefits are provided, including the main purpose for the provision of those benefits, are also key incidents of the scheme to which section 45B of the ITAA 1936 has regard.

As such, the present 'scheme' is properly to be regarded as encompassing the proposed distribution by F Co of to its sole shareholder (a non-resident company).

What is the capital benefit?

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. Relevantly, it includes the provision of ownership interests in a company to a person, and the distribution to a person of share capital (paragraphs 45B(5)(a) and (b)) of the ITAA 1936).

The term capital benefit is defined in subsection 45B(5) of the ITAA 1936.

That subsection provides as follows:

A reference to a person being provided with a capital benefit is a reference to any of the following:

a) the provision of ownership interests in a company to the person;

b) the distribution to the person of share capital or share premium;

c) something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person.

In the present circumstances, the shareholder of F Co is provided with a capital benefit as the distribution will be paid out of the share capital account.

What is the tax benefit?

A shareholder 'obtains' a 'tax benefit', as defined in subsection 45B(9) of the ITAA 1936, where:

· the amount of tax payable; or

· any other amount payable under the ITAA 1936 or the ITAA 1997, by the taxpayer would, apart from the operation of section 45B of the ITAA 1936:

· be less than the amount that would have been payable; or

· be payable at a later time than it would have been payable,

· if the capital benefit had instead been a dividend.

In the present circumstances, the shareholder of F Co will obtain a tax benefit through receiving a distribution that will not be assessable income.

Relevant circumstances

The objective conclusion as to the requisite purpose in relation to the tax benefit arising from the capital distribution is made having regard to the relevant circumstances of the scheme, including those set out in subsection 45B(8) of the ITAA 1936.

The relevant circumstances listed in subsection 45B(8) of the ITAA 1936 include the tax and non-tax (i.e. business and other financial) implications of the scheme, the latter covered largely by the matters in paragraph 177D(b) of the ITAA 1936, which are included in subsection 45B(8) of the ITAA 1936 by virtue of paragraph (k). All of the circumstances listed in subsection 45B(8) of the ITAA 1936 must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose.

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company. Despite the fact that the distribution is taking the form of share capital it can in fact be attributed to the profits of F Co.

The return of capital will be funded from available cash deposited in a bank account operated by another company within the corporate group. At present, this amount is listed as a receivable in F Co's recent balance sheet.

It is also important to note that the applicant has clearly stated that there was no realised profit from the sale of the divisions completed in the previous years.

The applicant has stated that there are no available profits from which to pay dividends at the time the distribution will be made to the shareholder. Therefore, none of the distribution can be attributed to current year profits.

As the scheme in this case has been identified as a distribution of share capital that is in excess to F Co's requirements, none of the distribution can be attributed to the profits of F Co.

Therefore the capital benefit is entirely attributed to share capital and so no requisite purpose exists.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company. F Co has a history of paying out dividends from its profits. Currently, F Co has a small amount of retained earnings after the payment of its recent dividend.

As F Co has paid out its profits already, it cannot be argued that the capital return is in any way a substitution for a dividend. The proposed distribution will therefore be sourced from share capital. Therefore no requisite purpose exists.

Paragraph 45B(8)(c) of the ITAA 1936 refers to whether the relevant taxpayer has any capital losses that may be utilised in the scheme. In this case, the applicant has given an assurance that the sole shareholder, has no capital losses. Therefore no requisite purpose exists.

Paragraph 45B(8)(d) of the ITAA 1936 refers to whether the relevant taxpayer has any pre CGT shares. In this case, it is taken that B Co has acquired its shares after 19 September 1985.

Paragraph 45B(8)(e) of the ITAA 1936 refers to the issue of shareholders being non-residents. In this instance, the sole shareholder, will receive a tax preferenced capital return. As there are no available profits to pay a dividend, this factor does not indicate that a requisite purpose exists.

Paragraph 45B(8)(f) of the ITAA 1936 refers to whether the CGT cost base of the shares is not substantially less than the applicable capital amount. The taxpayer has indicated that the cost base of the shares will exceed the capital benefit.

Paragraph 45B(8)(g) of the ITAA 1936 - repealed.

Paragraph 45B(8)(h) of the ITAA 1936 refers to whether the proportionate interests of the shareholders after the distribution remains the same as the interest would have been if an equivalent dividend have been paid instead. In this case, as the shareholder is the sole shareholder, this factor is effectively not applicable.

Paragraph 45B(8)(i) of the ITAA 1936 deals with the provision of ownership interests and the later disposal of those interests. This paragraph is not applicable.

Paragraph 45B(8)(j) of the ITAA 1936 is not applicable.

Paragraph 45B(8)(k) of the ITAA 1936 refers to the matters in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936. These are matters by reference to which a scheme is able to be examined from a practical perspective in order to identify and compare its tax and non-tax objectives. The matters include the manner in which the scheme is carried out, its form and substance, and its financial and other implications for the parties involved.

In the present case, the practical implication of the proposed scheme is for F Co to return capital amount to its sole shareholder. The capital return proposal was formulated by the directors of F Co as an effective way to return excess capital that is no longer needed.

An analysis of paragraph 177D(b) of the ITAA 1936 is set out below:

(i) subparagraph 177D(b)(i) of the ITAA 1936: The manner of scheme was entered into or being carried out

The scheme consists of the distribution to shareholders of $1,600,000 of capital. The scheme was entered into as the most effective manner to return excess capital back to shareholders.

After considering the manner of how this scheme, in its entirety, is proposed to be entered into, it could not be concluded that the manner of the scheme could be said to be entered into for the purposes of obtaining a tax benefit for the sole shareholder of F Co.

(ii) subparagraph 177D(b)(ii) of the ITAA 1936: The form and substance of the scheme

The amount of capital to be returned to shareholders corresponds with the amount of capital that is in excess of F Co's operational requirements.

Therefore, having regard to the form and substance of the proposed capital return, it could not be concluded that the scheme is being entered into or carried out to obtain a tax benefit.

subparagraph 177D(b)(iii) of the ITAA 1936: Timing of the scheme

The timing of the capital return is effectively after all available profits have been paid to the sole shareholder. The timing of the proposed capital return is not indicative of a scheme entered into in obtaining a tax benefit.

(iv) subparagraph 177D(b)(iv) of the ITAA 1936: The result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

Because the distribution will be debited against F Co's share capital account, the distribution falls outside the definition of dividend in subsection 6(1) of the ITAA 1936, and is not received as income in the shareholders' hands. Instead, under CGT Event G1, the cost base of the shares for those shareholders subject to CGT will be reduced by the amount of the capital returned.

(v) subparagraph 177D(b)(v) of the ITAA 1936: The change in financial position of the taxpayers (shareholders) who choose to participate in the scheme

The shareholders financial position will be altered because they will be receiving a cash distribution. Having said this, this is not indicative of F Co entering into a scheme with the purpose of obtaining a tax benefit.

(vi) subparagraph 177D(b)(vi) of the ITAA 1936: The change in financial position of any person who has a connection with the relevant taxpayer

With exception of the sole shareholder, there are no parties related to F Co that stand to benefit from the proposed scheme. With this in mind, it could not be said that F Co has entered this scheme for the purpose of obtaining a tax benefit.

(vii) subparagraph 177D(b)(vii) of the ITAA 1936: Any other consequence for the taxpayer as a result of the proposed scheme

This requires consideration of the nature of the company's business and how this impacts on its ability to pay dividends, as well as objective shareholder and 'market' expectations in relation to F Co's distributions. Payment of the return of capital will not impact on F Co's ability to pay dividends. It is a payment out of excess funds, and will not affect the profitability of the company. Given the company's history of paying dividends, it is considered that the return of capital in this instance is not indicative of a tax scheme.

(viii) subparagraph 177D(b)(viii) of the ITAA 1936: Connection between the taxpayer and any other person referred to in subparagraph 177D(b)(vi) of the ITAA 1936:

This subparagraph has no relevance as there is no other entity connected to F Co that stands to obtain a tax benefit as a result of the scheme.

It is concluded, therefore, that the results achieved by the scheme, unaffected by section 45B of the ITAA 1936, were not tax driven results and the requisite purpose of enabling the shareholder of F Co to "obtain a tax benefit" is not present.

Having regard to the 'relevant circumstances' of the scheme as set out in subsection 45B(8), it cannot be concluded that a person would enter into, or carry out, the capital return for a more than incidental purpose of enabling the sole shareholder of F Co to obtain a tax benefit.

Accordingly, section 45B of the ITAA 1936 has no application to the scheme proposed by F Co.

Conclusion

Having regard to all the relevant circumstances of this scheme, the Commissioner would not therefore come to the objective conclusion that a non-incidental purpose of providing the capital benefit to the sole shareholder of F Co is to obtain a tax benefit. The Commissioner would therefore not make a determination under subsection 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies.

Question 4

Section 104-135 of the ITAA 1997 contains the rules dealing with CGT event G1. CGT event G1 happens if a company makes a payment to a taxpayer in respect of a share the taxpayer owns in the company and some or all of the payment is not a ''dividend'' (subsection 995-1(1) of the ITAA 1997), is not an amount that is a distribution by a liquidator which is taken to be a dividend under section 47 of the ITAA 1936 and is not included in the taxpayer's assessable income. The amount that is not a dividend or taken to be a dividend under section 47 of the ITAA 1936 is referred to in section 104-135 of the ITAA 1997 as the ''non-assessable part'' in relation to the payment made by the company.

If CGT event G1 happens and the non-assessable part of a payment made by a company to a taxpayer in respect of a share in the company is not more than the cost base (indexed, if appropriate) of that share, the cost base and reduced cost base of the share in the hands of the taxpayer are decreased by the amount of the payment: subsection 104-135(4) of the ITAA 1997.

The timing of this event is when F Co makes the payment to its sole shareholder in respect to the share: subsection 104-135(2) of the ITAA 1997.

The shareholder cannot make a capital loss from CGT event G1 under subsection 104-135(3) of the ITAA 1997.

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