Edited version of your written advice

Authorisation Number: 1012727249254

Ruling

Subject: Share Capital Reduction Scheme

Question 1

Will the Commissioner exercise his discretion under section 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) to apply section 45C if the proposed Share Capital Reduction occurs?

Answer

No

This ruling applies for the following period(s)

1 July 2014 - 30 June 2015

The scheme commences on

1 July 2014

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company X contends it has exposure to business and industrial relations risks.

The balance sheet of Company X reflects:

a) issued capital of X%; and

b) retained profits of Y%.

The Trust is a shareholder of Company X.

Company X wishes to;

a) pay out Y% of its retained profits as dividends to the Trust; and

b) return X% of the share capital to Trust (Share Capital Reduction) in accordance with the requirements of the Corporations Act 2001.

The Trust will be including the full amount of the dividend, plus the appropriate franking credits in its assessable income in the year ended 30 June 201X as a result of substantially all of the retained profits being paid out as dividends. It is contended that any tax benefit obtained is merely incidental to the purpose of the Share Capital Reduction.

The Trust wishes to pay the dividend and reduce its Share Capital as a means of reducing the net asset position of Company X and therefore its exposure to business risks.

Dividends have been paid by Company X.

The Share Capital Reduction will not result in a cancellation of shares.

The Trust is an Australian resident. Company X does not have accumulated capital losses and holds only post CGT shares.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1936 Subsection 45A(2)

Income Tax Assessment Act 1936 Subsection 45B(1)

Income Tax Assessment Act 1936 Subsection 45B(2)

Income Tax Assessment Act 1936 Subsection 45B(3)

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 Paragraph 45A(3)(b)

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

Income Tax Assessment Act 1936 Paragraph 45B(5)(b)

Income Tax Assessment Act 1936 Paragraph 45B(8)(a)

Income Tax Assessment Act 1936 Paragraph 45B(8)(b)

Income Tax Assessment Act 1936 Paragraph 45B(8)(c)

Income Tax Assessment Act 1936 Paragraph 45B(8)(d)

Income Tax Assessment Act 1936 Paragraph 45B(8)(e)

Income Tax Assessment Act 1936 Paragraph 45B(8)(f)

Income Tax Assessment Act 1936 Paragraph 45B(8)(g)

Income Tax Assessment Act 1936 Paragraph 45B(8)(h)

Income Tax Assessment Act 1936 Paragraph 45B(8)(i)

Income Tax Assessment Act 1936 Paragraph 45B(8)(j)

Income Tax Assessment Act 1936 Paragraph 45B(8)(k)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(i)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(ii)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(iii)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(iv)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(v)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(vi)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(vii)

Income Tax Assessment Act 1936 Subparagraph 177D(b)(viii)

Income Tax Assessment Act 1997 Section 975-300

Reasons for decision

Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends, as defined in subsection 6(1), 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).

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

'Share capital account' is defined in section 975-300 of the ITAA 1997 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital.

Anti-avoidance provisions

Sections 45A and 45B are two anti-avoidance provisions which, if they apply, allow the Commissioner to determine that all or part of a distribution is treated as an unfranked dividend that is paid by the company out of profits to the shareholder.

Section 45A - streaming of dividends and capital benefits

Section 45A applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Company X intends to provide its shareholder with a 'capital benefit' (as defined in paragraph 45A(3)(b)) as the distribution is paid from its share capital account.

In this case there is a single shareholding, therefore 'streaming' of capital benefits to some shareholders in preference to others, cannot occur.

Accordingly, section 45A will not apply to the return of capital and the Commissioner will not make a determination under subsection 45A(2) that section 45C applies in relation to the return of capital to the Trust.

Section 45B - schemes to provide capital benefits in substitution for dividends

The purpose of section 45B of the ITAA 1936 is to ensure relevant amounts are treated as dividends for taxation purposes where certain distributions are made to shareholders in substitution of dividends.

Subsection 45B(1) deals with certain amounts being treated as dividends for taxation purposes where:

(a) …

(b) certain payments, allocations and distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 provides the application of this section:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company; and

(b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with the demerger benefit or the capital benefit, obtains a tax benefit; and

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

Commissioner to determine that section 45BA or 45C applies

Subsection 45B(3) of the ITAA 1936 states;

The Commissioner may make, in writing, a determination that:

(a) section 45BA applies in relation to the whole, or a part, of the demerger benefit; or

(b) section 45C applies in relation to the whole, or a part, of the capital benefit.

A determination does not form part of an assessment.

If section 45B applies, the Commissioner may make a determination that section 45C applies in relation to the whole, or a part, of the distribution to the shareholders. Under section 45C, the whole, or a part, of the distribution is taken to be an unfranked dividend paid by the company to its shareholders.

Section 45C of the ITAA 1936 then prescribes the tax treatment of these distributions as unfranked dividends;

If the Commissioner makes a determination under subsection 45A(2) or 45B(3), the amount of the capital benefit, or the part of the benefit, is taken, for the purposes of this Act, to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time that the shareholder or relevant taxpayer is provided with the capital benefit.

Application to the Trust

As per subsection 45B(1) of the ITAA 1936 we need to examine whether the return payment of equity is a dividend.

A scheme

A 'scheme' for the purposes of section 45B has the meaning given by subsection 995-1(1) of the ITAA 1997. Scheme means any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The arrangement involving the return of capital from Company X to its sole shareholder, the Trust is a scheme for the purposes of section 45B. The scheme will be entered into and carried out by Company X.

This is 'scheme' for the purposes of section 45B.

Capital benefit

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) and includes a distribution by a company to a person of share capital.  The return of capital will be paid by Company X to the Trust.  A trust does not fall within the definition of person so it is therefore necessary to consider whether the trust can be the entity provided with a capital benefit. 

Practice Statement PSLA 2008/10; Application of section 45B to the Income Tax Assessment Act 1936 to share capital reductions states at paragraph 39: 

39. In so far as it relates to the provision of a capital benefit, subsection 45B(2) provides that section 45B applies where:

• there is a scheme under which a person is provided with a capital benefit by a company

• under the scheme, a taxpayer (the 'relevant taxpayer'), who may or may not be the person provided with the capital benefit, obtains a tax benefit, and

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

The relevant taxpayer is further examined;

The relevant taxpayer

46. 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. However, there is no requirement that the relevant taxpayer be the person who is provided with the capital benefit.

47. This practice statement proceeds on the basis that the relevant taxpayer(s) are the owners or shareholders of the company in order to provide useful guidance on the application of section 45B. However, tax officers should recognise that there may be cases where the relevant taxpayer is someone other than a shareholder in the company.

In this case Company X is the company making the capital distribution.  The Trust is the shareholder of the company and the taxpayer being provided the capital benefit under the scheme.  Therefore, in this case, the Trust is the 'relevant taxpayer'.

There is a distribution of share capital and a benefit is provided to the Trust.  A capital benefit under paragraph 45B(5)(b) has been provided.

A tax benefit

A taxpayer 'obtains a tax benefit', as defined in subsection 45B(9), if:

A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, 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 taxpayer will obtain a tax benefit under the proposed return of capital as defined in subsection 45B(9). The tax benefit that would be obtained is either that:

(a)   the tax payable by a shareholder would be less if the whole share capital amount were assessed as a dividend or due to the shares having a pre-CGT status or being able to offset capital losses; or

(b)   a shareholder will obtain the benefit of deferring payment of tax due to the capital return resulting only in the cost base of the shares being reduced. The shareholders would only include in their assessable income the amount by which the capital benefit exceeded the cost base of the shares. The shareholders would then be assessed at a later time when a later CGT event happens to the shares.

The relevant taxpayer in the present case will be the Trustee of the Trust and the relevant beneficiaries of the trust. If the Share Capital Reduction proceeds and section 45B does not apply, $ will be returned to the Trust with retained profits. The retained profit portion of the dividend will be fully franked, however the capital portion will not be. The Trust will obtain a tax benefit.

A more than incidental purpose of enabling a taxpayer to obtain a tax benefit

Under paragraph 45B(2)(c), the purpose of the person, or one of the persons, who entered into or carried out the scheme, or any part of the scheme, is determined having regard to the 'relevant circumstances of the scheme'. Subsection 45B(8) provides a (non-exhaustive) list of the relevant circumstances.

The test of purpose is an objective one. The question is whether it would be concluded that the person, or one of the persons, who entered into or carried out the scheme, or any part of the scheme, did so for the purpose of enabling a taxpayer to obtain a tax benefit. The requisite purpose need not be the dominant purpose, but it must be more than an incidental purpose.

The relevant circumstances of the scheme in the present case are discussed below (insofar as they are relevant).

Paragraph 45B(8)(a) of the ITAA 1936

Paragraph 45B(8)(a) refers to the extent to which the capital benefit is attributable to capital or attributable to profits (realised and unrealised) of the company or an associate of the company.

The Share Capital Reduction is attributable to the issued capital of the company not realised profits. It is contended the company now has sufficient turnover to enable it to release the excess share capital that was contributed by its shareholder and to continue operating its business.

The Share Capital Reduction will not be paid out of realised or unrealised profits, all the realised profits will be substantially paid out as dividends.

This circumstance is not incidental to a requisite purpose as described in paragraph 45B(2)(c).

Paragraph 45B(8)(b) of the ITAA 1936

Paragraph 45B(8)(b) refers to the pattern of distribution of dividends, bonus shares and returns of capital or share premium.

Company X has paid dividends. The percentage of current year profits that have been paid out as dividends has varied from year to year. 

The return of capital will not alter Company X's pattern of paying dividends each year to its shareholder. In addition to the return of capital, Company X will pay approximately 96% of its retained profits as fully franked dividends to its shareholder.

This circumstance is not incidental to a requisite purpose as described in paragraph 45B(2)(c).

Paragraph 45B(8)(c) of the ITAA 1936

Paragraph 45B(8)(c) refers to whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income.

The Trust does not have any capital losses.

Paragraph 45B(8)(d) of the ITAA 1936

Paragraph 45B(8)(d) refers to whether some or all of the ownership interests in the company held by the relevant taxpayer were acquired, or taken to have been acquired, by the relevant taxpayer before 20 September 1985.

All issued shares are post CGT assets.

Paragraph 45B(8)(e) of the ITAA 1936

Paragraph 45B(8)(e) refers to whether the relevant taxpayer is a non-resident.

The Trust is a resident for tax purposes.

Paragraph 45B(8)(f) of the ITAA 1936

Paragraph 45B(8)(f) refers to whether the cost base of the relevant ownership interest is not substantially less than the value of the applicable capital benefit.

The cost base of the shares is approx. 2% less than the intended capital distribution. This means that the cost base is not less than the value of the applicable capital benefit.

This circumstance is not incidental to a requisite purpose as described in paragraph 45B(2)(c).

Paragraph 45B(8)(g) of the ITAA 1936

This factor is repealed.

Paragraph 45B(8)(h) of the ITAA 1936

Paragraph 45B(8)(h) refers to whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital.

The interest held by the shareholder after any capital distributions would be the same as the interest had an equivalent dividend been paid instead of the distribution of share capital or share premium.

This circumstance points toward the requisite purpose in paragraph 45B(2)(c).

Paragraph 45B(8)(i) of the ITAA 1936

Paragraph 45B(8)(i) refers to whether 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 was entered into;

This factor is not applicable to this case.

Paragraph 45B(8)(j) of the ITAA 1936

Paragraph 45B (8)(j) is for a demerger only.

This factor is not applicable.

Paragraph 45B(8)(k) of the ITAA 1936

Paragraph 45B(8)(k) refers to the matters in subparagraphs 177D(b)(i) to 177D(b)(viii).

• Subparagraph 177D(b)(i) of the ITAA 1936

This matter refers to the manner in which the scheme was entered into and carried out.

In this case the scheme involves Company X paying a return of capital which equates to 1/3 of the total to the shareholder. The retained profit portion will make up 2/3 which will be fully franked.

The share distribution will be made up of almost the entire retained profits and capital reserve. The decision to reduce the issued capital was made to protect is exposure to liability.

Furthermore, the directors are concerned about exposure in relation to issues arising from claims made under industrial relations legislation.

Regardless of these contentions, the retained profit reserve is being distributed as well as the capital account.

On balance, this matter does not point toward the requisite purpose in paragraph 45B(2).

• Subparagraph 177D(b)(ii) of the ITAA 1936

This matter looks to the form and substance of the scheme.

The legal form of the scheme is a return of capital to its shareholder of 1/3 per share or 33.3% of the total share. However (and significantly) almost all of the retained profit account will be distributed in the same transaction. In comparison, the substance of the scheme is a distribution to shareholders of retained profits plus capital. The retained profit portion is equal to 66.6% of the total distribution.

On balance, this factor does not point toward the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(iii) of the ITAA 1936

This matter refers to the time at which the scheme was entered into and the length of the period during which the scheme was carried out.

It is envisaged the scheme will occur in the financial year ended 30 June 201X. The scheme has not been entered into at this point, although it is a single transaction rather than an ongoing scheme.

On balance, this factor does not point toward the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(iv)of the ITAA 1936

This matter refers to the result the scheme would achieve under the ITAA 1936 and the ITAA 1997 but for the application of section 45B.

But for section 45B, the return of capital would not be a dividend.

CGT event G1 may happen for a shareholder when a return of capital is paid. A capital gain is made if the return of capital exceeds the shareholder's cost base for the shares. The shares are 'taxable Australian property', any capital gain that arises is payable by the shareholder. A dividend paid is assessable income for a resident shareholder.

However, it is important to note that in this case the cost base required for the capital gain would not exceed its earnings. The impetus here is if an otherwise taxable CGT amount which would not occur. It is probable there would not be an assessable capital gain amount to declare. Furthermore, the retained earnings are fully taxable and will be declared as such.

But for section 45B, a return of capital is preferable to an unfranked dividend (i.e. less tax payable) for the shareholder.

This factor contributes toward the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(v) of the ITAA 1936

This matter refers to any change in the financial position of the relevant taxpayer.

Apart from the amount of tax saved, the financial position of the shareholder is the same as if they had a CGT event (in which case there would be likely a nil tax affect). In either case the shareholder receives distribution of capital.

This factor does not point toward the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(vi) of the ITAA 1936

This matter refers to the change in the financial position of any person connected with the relevant taxpayer.

Company X's financial position will reduce due to the return of capital payment (i.e. $1 million). This is no different to the effect of paying the equivalent to the trust and declaring a capital gain/loss.

This factor is neutral in terms of indicating the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(vii) of the ITAA 1936

This matter requires consideration of any other consequences of the scheme for the relevant taxpayer or any person connected with the relevant taxpayer.

There are no other consequences of the scheme being entered into or carried out for either Company X or its shareholder, the Trust.

This factor does not point toward the requisite purpose in paragraph 45B(2)(c).

• Subparagraph 177D(b)(viii) of the ITAA 1936

This matter looks to the nature of any connection between the relevant taxpayer and any other person connected with the relevant taxpayer.

The connection between the relevant parties is the relationship of shareholder and company.

This factor is neutral in terms of indicating the requisite purpose in paragraph 45B(2)(c).

Conclusion on purpose under paragraph 45B(2)(c)of the ITAA 1936

Having regard to the relevant circumstances of the scheme, it is concluded that the Trust will enter into the scheme, for an incidental purpose of enabling a tax benefit. Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) that section 45C applies to the return of capital. This is the portion of capital which makes up 33% of the total distribution. The retained profits will be distributed as franked dividends. The balance of capital is not attributable to the profits of Company X or an associate of the company.

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