Edited version of your written advice

Authorisation Number: 1012685549219

Ruling

Subject: Income tax: Proposed capital reduction

Question 1

Will the proposed return of capital constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for income tax purposes and be included in the net income of the Trust 1 and Trust 2 for the purposes of section 95 of the ITAA 1936?

Answer

No

Question 2

Does the Commissioner conclude that section 45A of the ITAA 1936 would apply to treat the whole, or a part, of the capital benefit under the proposed return of capital as a dividend which would be included in the net income of the Trust 1 and Trust 2 for the purposes of section 95 of the ITAA 1936?

Answer

No

Question 2

Does the Commissioner conclude that section 45B of the ITAA 1936 would apply to treat the whole, or a part, of the capital benefit under the proposed return of capital as a dividend which would be included in the net income of the Trust 1 and Trust 2 for the purposes of section 95 of the ITAA 1936?

Answer

No

This ruling applies for the following periods:

The income year ending 30 June 2015

The scheme commences on:

The scheme has yet to commence

Relevant facts and circumstances

The group has reviewed its capital structure and determined the debt relating to the group's corporate activities is more appropriately held at the corporate level and not by Trust 1.

The following transactions are proposed:

• Company A will borrow from a bank;

• Company A will make a pro rata return of capital to its shareholders with the entire amount ultimately being received by Trust 1; and

• The Trust 1 will utilise the entire amount to repay debt it holds attributable to the group's activities

The return of capital will be an equal capital reduction within the meaning of subsection 256B(2) of the Corporations Act 2001.

The return of capital will comply with the requirements of Division 1 Part 2J.1 of Chapter 2J of the Corporations Act 2001.

No shares will be cancelled under the proposed return of capital.

All shares are post-CGT shares

The proposed share capital reduction will result in a net capital gain of approximately $X million.

The practice of the group since its return to profitability has been to pay regular dividends based upon sustainable earnings generated from operations.

The group's policy of paying annual dividends to its shareholders is intended to continue.

Trust 1 and Trust 2 do not have any carried forward losses.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(d)

Income Tax Assessment Act 1936 subsection 6(4)

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 subsection 45A(1)

Income Tax Assessment Act 1936 subsection 45A(2)

Income Tax Assessment Act 1936 subsection 45A(3)

Income Tax Assessment Act 1936 subsection 45A(4)

Income Tax Assessment Act 1936 subsection 45A(5)

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 subsection 45B(2)

Income Tax Assessment Act 1936 subsection 45B(5)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 subsection 45B(9)

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 subsection 95(1)

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 subsection 975-300(1)

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

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

Detailed reasoning

Subsection 6(1) of the ITAA 1936 states:

dividend includes:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and

(b) any amount credited by a company to any of its shareholders as shareholders;

(c) (Repealed by No 63 of 1998)

but does not include:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company; or

(e) …

The term share capital account is defined in subsection 975-300(1) of the Income Tax Assessment Act 1997 (ITAA 1997) to include:

• an account that a company keeps its share capital (paragraph 975-300(1)(a) of the ITAA 1997); or

• any other account (whether or not called a share capital account) that was created on or after 1 July 1998 and the first amount credited was an amount of share capital (paragraph 975-300(1)(b) of the ITAA 1997).

Subsection 975-300(3) of the ITAA 1997 provides that where a company's share capital account is tainted, the account is not a share capital account for the purposes of the Act (subject to certain exclusions). Division 197 of the ITAA 1997 provides what constitutes tainting for the purposes of the Act and the consequences associated with tainting a share capital account.

Subsection 6(4) of the ITAA 1936 states:

Paragraph (d) of the definition of dividend in subsection (1) does not apply if, under an arrangement:

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed.

By virtue of paragraph 6(1)(d) of the ITAA 1936, the proposed return of capital will not constitute a dividend for the purposes of subsection 6(1) of the ITAA 1936. As the proposed return of capital is not a dividend, it will not be included in the assessable income of the Trust 1 and/or the Trust 2 under subsection 95(1) of the ITAA 1936.

Question 2

Detailed reasoning

Subsection 45A(1) of the ITAA 1936 provides:

This section applies in respect of a company that, whether in the same year of income or in different years of income, streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that:

(a) the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

(b) it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive dividends.

However, it does not apply if section 45 applies in relation to the streaming or in the circumstances set out in subsection (5).

Subsection 45A(5) of the ITAA 1936 would have no application to the proposed scheme.

Subsection 45A(3) of the ITAA 1936 states (relevantly):

A reference to the provision of a capital benefit to a shareholder in a company is a reference to any of the following:

(a) …

(b) the distribution to the shareholder of share capital or share premium;

(c) …

Subsection 45A(4) of the ITAA 1936 provides a non-exhaustive list of circumstance where a shareholder derives a greater benefit from capital benefits than another shareholder including where:

• some or all of the shares in the company held by the shareholder are pre-CGT shares (paragraph 45A(4)(a) of the ITAA 1936);

• the shareholder is a non-resident (paragraph 45A(4)(b) of the ITAA 1936);

• the cost base of the relevant share is not substantially less than the value of the applicable capital benefit (paragraph 45A(4)(c) of the ITAA 1936);

• the shareholder has a net capital loss for the year of income in which the capital benefit is provided (paragraph 45A(4)(d) of the ITAA 1936);

• the shareholder is a private company who would not be entitled to a rebate under former section (paragraph 45A(4)(e) of the ITAA 1936); and

• the shareholder has income tax losses (paragraph 45A(4)(f) of the ITAA 1936)

Where section 45A of the ITAA 1936 applies, the Commissioner can make a determination that section 45C of the ITAA 1936 applies to the whole or any part of the capital benefits pursuant to subsection 45A(2) of the ITAA 1936.

No particular shareholder would derive a greater benefit than the other shareholder. As such, paragraph 45A(1)(a) of the ITAA 1936 is not satisfied.

It follows that as subsection 45A(1) of the ITAA 1936 is not satisfied that section 45A of the ITAA 1936 would have no application to the whole or any part of any capital benefits provided to the shareholders. The Commissioner would therefore not make a determination under section 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies.

As the amount of the return of capital will not be deemed to be a dividend, there would be no amount included in the net income of the Trust 1 and/or Trust 2 for the purposes of section 95 of the ITAA 1936.

Question 3

Detailed reasoning

The purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts are treated as dividends for taxation purposes if certain payments, allocations and distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 states:

This section applies if:

(a) 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); and

(b) a taxpayer (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit under the scheme (paragraph 45B(2)(b) of the ITAA 1936); 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 (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit.

Where the above requirements are met, the Commissioner may make a determination that section 45C of the ITAA 1936 applies to the whole or part of the capital benefit.

Law Administration Practice Statement PS LA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions (PS LA 2008/10) provides guidance to tax officers in determining whether section 45B of the ITAA 1936 applies to, relevantly, a share capital reduction.

Scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936)

The term 'scheme' takes the same meaning as that provided in subsection 995-1(1) of the ITAA 1997 and includes:

(a) any arrangement*; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The term 'arrangement' is defined in subsection 995-1(1) of the ITAA 1997 as meaning:

…any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings.

A distribution of share capital to a person is a capital benefit as stated in paragraph 45B(5)(b) of the ITAA 1936.

The proposed return of capital would fall within this definition and constitute a scheme (or part thereof) for the purposes of section 45B of the ITAA 1997.

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

Obtains a tax benefit

In addition to being provided with a capital benefit, paragraph 45B(2)(b) of the ITAA 1936 also requires that the shareholder obtains a tax benefit. Subsection 45B(9) of the ITAA 1936 states:

A relevant taxpayer obtains a tax benefit if an amount of tax payable or any other amount payable by the relevant taxpayer would be less than the amount that would have been payable or would be payable at a later time than it would have been payable, if the capital benefit had been a dividend.

The potential difference between the tax payable due to the provision of the capital benefit (i.e. the return of capital) and the tax payable had the capital benefit been in the form of a dividend would constitute obtaining a tax benefit for the purposes of section 45B of the ITAA 1997.

Relevant taxpayer obtains a tax benefit

As stated above, the relevant taxpayer needs to obtain the tax benefit. However, as stated in paragraph 45B(2)(b) of the ITAA 1936, the relevant taxpayer may or may not be the person provided with the capital benefit.

Paragraph 46 of PS LA 2008/10 states:

The 'relevant taxpayer' is the taxpayer who obtains a tax benefit, within the meaning of subsection 45B(9), under the scheme. Under a share capital reduction or non-share capital reduction, the relevant taxpayer (or taxpayers) will ordinarily be one or more of the owners or shareholders of the company, as it is they who are provided with the capital benefit and thus, a tax benefit…

There are relevant taxpayers under the proposed return of capital that would obtain a tax benefit.

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 (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936)

After having regard to the relevant circumstances as listed in section 45B of the ITAA 1936, it must be concluded that a person entered into or carried out the scheme for the purpose of obtaining a tax benefit. The purpose need not be the dominant purpose but must be more than incidental.

Each of the applicable circumstances detailed in subsection 45B(8) of the ITAA 1936 is discussed below. As the proposed capital reduction is not a demerger, paragraph 45B(8)(j) of the ITAA 1936 need not be considered.

Relevant circumstances

(a) Extent to which the capital benefit is attributable to capital or profits (realised or unrealised)

The first relevant circumstance concerns the extent to which the capital benefit (i.e. the return of share capital) is attributable to capital and profits (realised or unrealised) of a company or of an associate of the company.

PS LA 2008/10 states the following:

• section 45B does not apply on a profits first basis but does pre-suppose an objection non-tax basis for distributing capital rather than profits [34]

• there should be compelling, objective and commercial reasons as to why capital is being distributed rather than profits (other than tax preferences of shareholders) [38]

• a contributory causal connection between the amount distributed as share capital and the share capital and profits realistically available for distribution is sufficient for the purpose of determining attribution [60]

• the pertinent characteristics of share capital and profits, the availability of each and the reason for the share capital reduction are all relevant in determining attribution [62]

• capital distributions funded from debt do not preclude it from being attributable to profits [68]

• for the purposes of determining attribution, realised and unrealised gains constitutes profits [70]

• the mere existence of profits will not automatically trigger section 45B and any commercial concerns as to distributing profits should be taken into account. [72]

The proposed return of capital is being funded from debt capital and is being undertaken to move the debt from the trust level to the corporate level while also achieving greater financial transparency and accountability.

After taking into account the above, the proposed return of capital cannot be said to be attributable to profits and does not indicate a more than incidental purpose of obtaining a tax benefit.

(b) Pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate of the company

PS LA 2008/10 states the following:

• an interruption to the normal pattern of profit distribution with a distribution of capital may suggest dividend substitution [77]

• maintenance of a company's ordinary dividend policy does not preclude a distribution of share capital occurring in place of an extraordinary distribution of profit [78]

• the company's distribution culture, and commercial exigencies and changes to distribution culture brought about by a change to its guiding mind are relevant considerations. [79]

Given the pattern of distributions of dividends and historical returns of share capital, the proposed return of capital cannot be said to indicate a more than incidental purpose of obtaining a tax benefit.

(c) Whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year

Paragraph 85 of PS LA 2008/10 states:

Paragraph 45B(8)(c) considers whether the shareholders of a company receiving the capital benefit have any capital losses they could apply to the capital benefit as this would result in reduced or no CGT implications for shareholders. Where shareholders have capital losses that can be applied against the capital benefit this would suggest that the capital benefit was provided for the purpose of securing a tax benefit.

The relevant taxpayers do not have carried forward capital losses. This factor does not indicate the proposed return of capital has a more than incidental purpose of obtaining a tax benefit.

(d) Whether some or all of the ownership interests in the company or in an associate of the company held by the relevant taxpayer were acquired, or are taken to be acquired, before 20 September 1985

Paragraph 86 of PS LA 2008/10 states:

Paragraph 45B(8)(d) directs attention to whether some or all of the ownership interests held by the shareholders of the company were acquired or are taken to have been acquired by then before 20 September 1985. Where taxpayers receive a capital distribution in respect of a pre-CGT asset there would ordinarily be no CGT implications for the shareholders and this could influence the company's decision to return capital to shareholders.

As all shares are post-CGT shares, this factor is not applicable and therefore does not indicate the proposed return of capital has a more than incidental purpose of obtaining a tax benefit.

(e) Whether the relevant taxpayer is a non-resident

Paragraph 87 of PS LA 2008/10 states:

The implication of non-residency is that it would normally point towards a tax preference for a distribution of capital over profit.

This factor is not applicable as the relevant taxpayers are residents for tax purposes and therefore does not indicate the proposed return of capital has a more than incidental purpose of obtaining a tax benefit.

(f) Whether the cost base of the relevant ownership interest is not substantially less than the value of the capital benefit

Paragraph 88 of PS LA 2008/10 states (in a share capital reduction context):

Where the cost base of the ownership interest is similar or greater in value than the capital benefit provided, the capital distribution will not expose the relevant taxpayer to a capital gain…This could point towards a tax preference for capital over profit.

Put simply, paragraph 45B(8)(f) of the ITAA 1936 is predicated on the proposition that the higher the cost base of a share to which a capital benefit accrues the more the cost base of the share can absorb before a capital gain results.

The proposed return of capital will result in a net capital gain of approximately $X million. The cost base of the shares is substantially less than the value of the capital benefit.

This factor does not point towards the proposed capital reduction having a more than incidental purpose of obtaining a tax benefit.

(h) Schemes involving the distribution of share capital or share premium

PS LA 2008/10 provides:

• this is an examination of the effect of the capital reduction on the substance of the shareholder's interest in the company directly and relative to other shareholders [89]

• where a distribution is made and the shareholder's interest remains unchanged, a distribution of share capital may be performing the same function of a dividend and may be made in substitution for it [90]

• from a shareholder's perspective, an equal share capital reduction under which no shares are cancelled is not dissimilar economically to a special dividend [91]

The proposed scheme is an equal capital reduction under which no shares held by Trust 1 or Trust 2 would be cancelled. This factor points towards the proposed capital reduction having more than an incidental purpose of obtaining a tax benefit.

(i) If the scheme involves the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests:

(i) the period for which the ownership interests are held by the holder of the interests; and

(ii) when the arrangement for the disposal of the ownership interests

The proposed scheme does not involve the provision of ownership interests and the later disposal of those interests. As such, this factor is not relevant in determining whether the proposed capital reduction has a more than incidental purpose of obtaining a tax benefit.

(k) Any of the matters referred to in subparagraphs 177D(b)(i) to (viii)

Generally speaking, the eight matters in Part IVA of the ITAA 1936 will assist in objectively determining whether the requisite purpose for section 45B of the ITAA 1936 is present given the facts, circumstances and outcomes associated with the scheme.

(i) the manner in which the scheme was entered into or carried out

Paragraph 101 of PS LA 2008/10 states:

Subparagraph 177D(b)(i) refers to the manner in which the scheme was entered into or carried out. This is a reference to consideration of the method or procedure by which the particular scheme in question was established; in other words, a reference to consideration of the decisions, steps and events that combine to make up the scheme.

The steps to be undertaken in the proposed return of capital do not suggest contrivance or artificiality.

The manner of the proposed scheme does not point to the requisite purpose. This factor is neutral in determining whether the requisite purpose of obtaining a tax benefit exists.

(ii) the form and substance of the scheme

Paragraph 102 of PS LA 2008/10 states:

…the form of the scheme is the visible aspect of the scheme; the substance of the scheme is its essential nature which is normally determined from its commercial and economic implications.

There is no disparity between the form and substance of the scheme.

This factor is neutral in determining whether the requisite purpose of obtaining a tax benefit exists.

(iii) the timing at which the scheme was entered into and the length of the period during which the scheme was carried out

Paragraph 104 of PS LA 2008/10 states:

…This factor requires not only reference to time measurement but also reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself. In particular, it enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements.

There is no significance attached to timing of the proposed scheme and length of period during which the proposed scheme would be carried out.

This factor is neutral in determining whether the requisite purpose of obtaining a tax benefit exists.

(iv) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

As stated in paragraph 108 of PS LA 2008/10:

…The issue…becomes a matter of identifying the tax results of the scheme if section 45B were not to apply. In regard to this matter, it is critical to consider just what constitutes the scheme, as this will have a direct bearing on the breadth and scope of the tax results for the relevant taxpayers that are taken into consideration.

Paragraph 109 of PS LA 2008/10 provides:

• a share capital reduction will not be a dividend for the purposes of subsection 6(1) of the ITAA 1936; and

• where there is no cancellation of shares, the cost base of affected shares will be reduced by the amount of capital returned and a capital gain realised to the extent the distribution exceeds the shareholder's cost base.

All things considered, this factor is neutral in determining whether the requisite purpose exists.

(v) any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme

Paragraph 114 of PS LA 2008/10 states:

…The most significant financial change for shareholders is that they receive a cash distribution. If the scheme is an equal share capital reduction, the shareholders will receive the distribution with their proportionate interests in the company…remaining essentially the same. This would point towards the requisite purpose.

All things considered, this factor is neutral in determining whether the requisite purpose exists.

(vi) Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme

Paragraph 115 of PS LA 2008/10 states:

…In relation to a share capital reduction the company would generally be the only other party whose financial position will change as a result of the scheme.

Paragraph 116 of PS LA 2008/10 continues:

The financial result for a company of returning capital to the shareholders is that it divests itself of that amount of value. A less direct financial result may be that a distribution of share capital would forestall shareholder demand for the comparable alternative of a franked distribution, and, in turn, the need for the company to ensure that it has sufficient franking credits to make such a franked distribution.

Paragraphs 117 to 119 of PS LA 2008/10 discuss the financial effect of gearing and direct consideration of the nature of the company's business, it's gearing history and benefits from substituting debt for equity.

All things considered, this factor is neutral in determining whether the requisite purpose exists.

(vii) Any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

Paragraph 121 of PS LA 2008/10 states:

The decision to reduce share capital as opposed to paying out a dividend may be a consequence of the distribution culture of the company. Accordingly, tax officers should have regard to the objective consequences of the share capital reduction on the company with respect to its dividend history and its ability to provide stable dividends in the future…

All things considered, this factor is neutral in determining whether the requisite purpose exists.

(viii) The nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

The return of capital is happening within a privately owned group of companies and trusts. These entities are all related.

All things considered, this factor is neutral in determining whether the requisite purpose exists.

Conclusion

The relevant circumstances do not point to the scheme being income tax driven. The Commissioner concludes that section 45B of the ITAA 1936 does not apply to the proposed return of capital.

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