Edited version of your written advice

Authorisation Number: 1012826613094

Date of advice: 18 June 2015

Ruling

Subject: Return of capital

Question 1

Will the distribution to Shareholder A by Company N in the form of the proposed capital return constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

Will the Commissioner make a determination pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return?

Answer

No.

Question 3

Will the Commissioner make a determination pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return?

Answer

No.

This ruling applies for the following periods:

Year ending xx/xx/xxxx

The scheme commences on:

During the year ending xx/xx/xxxx

Relevant facts and circumstances

1. Company N is the head company of an Australian tax consolidated group.

2. Company N has not conducted any share buy-backs or bonus share issues, and there has not been any capital injection into Company N since its inception.

3. Company N proposes to pay a dividend to shareholders (the proposed dividend) and immediately thereafter to undertake a capital return (the proposed capital return).

4. The proposed dividend and the proposed capital return will be distributed equally to each shareholder of Company N as at the nominated relevant entitlement date.

5. The proposed dividend will be funded from current year profits of Company N arising as a result of receipt of a dividend from one of its subsidiaries. The dividend received by Company N will not be offset in the accounting records of Company N against any accumulated losses of Company N prior to the proposed dividend being declared and paid.

6. It is expected that the proposed dividend will be fully franked. Company N had previously paid fully franked dividends and returned share capital to its shareholders.

7. Company N has a sufficient franking credit balance in its franking account to frank the proposed dividend to 100%.

8. The proposed dividend will not be sourced, directly or indirectly, from the share capital of Company N or any other entity in the Company N Group.

9. Company N will source the entire amount of cash for the proposed capital return from a capital return to be made to Company N by one of its subsidiaries.

10. The share capital account of Company N is not a 'tainted' share capital account for the purposes of section 197-50 of the ITAA 1997.

11. Company N's management is of the view that it has a surplus cash.

12. The excess cash is surplus to its on-going business needs. Company N's strong cash flow generating ability is expected to add further to this surplus position.

13. Additionally, no significant investment opportunities have been identified in the immediate or foreseeable future to which the surplus cash could be applied.

14. The proposed dividend will result in Company N paying out the majority of its available distributable profits balance. A minor amount of profits will not be paid out at this time for various commercial and business reasons.

15. The proposed capital return is considered to be the most efficient mechanism to return surplus capital to shareholders.

16. There is no arrangement whereby the share capital account of Company N will be credited in connection with the proposed debiting of the share capital account required to effect the capital return by the company.

17. The proposed capital return represents the surplus capital remaining that was not previously distributed. Following the distribution of the proposed capital return, Company N does not have further surplus capital to return to shareholders.

18. Apart from a small unrealised gain recorded in one of Company N's subsidiaries, Company N and its 'associate' subsidiaries (as defined in section 318 of the ITAA 1936 do not have any unrealised profits or gains (either recorded or unrecorded).

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 45A(2)

Income Tax Assessment Act 1936 subsection 45B(3)

Reasons for decision

Detailed reasoning

Subsection 6(1) of the ITAA 1936 defines a 'dividend' (subject to certain exclusions) to include the following:

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

The proposed capital return will be a distribution of money to both shareholders in proportion to the number of shares held at the record date, thus satisfying paragraph 6(1)(a) of the ITAA 1936.

Paragraph (d) of the definition of 'dividend' contained in subsection 6(1) of the ITAA 1936, excludes the following distributions from the definition:

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.

The term 'share capital account' has the meaning given 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.

Subsection 975-300(3) of the ITAA 1997 states that an account is not a share capital account, except for certain limited purposes, if it is tainted. Section 197-50 of the ITAA 1997 states that a share capital account is tainted if an amount to which Division 197 of the ITAA 1997 applies, is transferred to the account and the account is not already tainted.

The proposed capital return will be debited against Company N's untainted share capital account. As the share capital account of Company N is not tainted within the meaning of Division 197 of the ITAA 1997, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 applies.

However, subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 will not apply where, '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 property so paid, credited or distributed.

The applicant has submitted that the proposed capital return will be sourced from the cash reserves of Company N Group. There is no arrangement whereby the share capital account of Company N will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction.

Therefore, the distribution to Shareholder A by Company N in the form of the proposed capital return will not constitute a dividend as defined in subsection 6(1) of the ITAA 1936.

Question 2

Detailed reasoning

Section 45A of the ITAA 1936 applies if:

• a company streams the provision of capital benefits and the payment of dividends to its shareholders;

• this is done in such a way that the capital benefits are received by shareholders (the advantaged shareholders) who would in the year of income the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and

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

According to subsection 45A(3) of the ITAA 1936, the meaning of the 'provision of capital benefits' includes:

(a) the provision to the shareholder of shares in the company.

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

(c) something that is done in relation to a share that has the effect of increasing the

value of a share (which may or may not be the same share) held by the shareholder.

It has been submitted by the applicant that:

• Company N is not providing shares to its shareholders in relation to the proposed capital return.

• Company N is distributing part of the balance standing to the credit of its share capital account to its shareholders.

• Nothing is proposed to be 'done' by Company N that has the effect of increasing the value of shares held by its shareholders.

As the distribution to the shareholders of share capital is a provision of capital benefit as specifically defined in paragraph 45A(3)(b) of the ITAA 1936, the proposed capital return by Company N will constitute the provision of capital benefits for the purposes of section 45A of the ITAA 1936.

Company N proposes to provide a 'capital benefit' as defined in paragraph 45A(3)(b) of the ITAA 1936 to all of its shareholders in the same proportion as their shareholdings.

In order for the Commissioner to be able to make a determination under subsection 45A(2) of the ITAA 1936, it must be the case that YANZ streams the provision of capital benefits and the payment of dividends to shareholders in such a way that:

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

The circumstances in which a shareholder would in a year of income, derive a greater benefit from capital benefits than another shareholder include, but are not limited to, any of the circumstances set out in subsection 45A(4) of the ITAA 1936, some of which exist in relation to the shareholders of Company N. 

In the present circumstances, because the proposed capital return is being made on a pro-rata basis equally across all shareholders and there is no anticipated change to the dividend policy of Company N, the applicant has submitted that there will be no 'advantaged shareholders' and no 'other shareholders'.

On the basis that all shareholders will receive the same amount of capital per share, Company N cannot be said to be 'streaming' capital benefits to some shareholders to the exclusion of other shareholders.

Therefore, section 45A of the ITAA 1936 will have no application in respect of the proposed capital return. Accordingly, the Commissioner will not make a determination pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return.

Question 3

Detailed reasoning

Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if certain payments, allocations and distributions are made in substitution for dividends (paragraph 45B(1)(b) of the ITAA 1936).

Where the requirements of subsection 45B(2) of the ITAA 1936 are satisfied, paragraph 45B(3)(b) of the ITAA 1936 empowers the Commissioner to make a determination that section 45C of the ITAA 1936 will apply in relation to the whole, or a part, of the capital benefit.

Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if:

(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.

Relevant scheme

A scheme for the purposes of section 45B of the ITAA 1936 has the meaning given by subsection 995-1(1) of the ITAA 1997 (subsection 45B(10) of the ITAA 1936). A scheme is defined in subsection 995-1(1) of the ITAA 1997 to mean:

(a) any arrangement; or

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

Paragraph 41 of 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 that a share capital reduction would normally constitute either a scheme or part of a scheme for the purposes of section 45B.

Accordingly, the proposed capital return by Company N is considered to be a 'scheme' for the purposes of section 45B of the ITAA 1936.

Capital benefit

Subsection 45B(5) of the ITAA 1936 defines 'provided with a capital benefit' as a reference to a person being provided with a capital benefit to any of the following:

(a) the provision of ownership interest 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 the ownership interest (which may or may not be the same interest) that is held by the person.

Under the present scheme, Company N proposes to make a capital distribution to each of its shareholders by debiting its share capital account. Thus, Company N will be providing its shareholders with a 'capital benefit' as defined in paragraph 45B(5) of the ITAA 1936.

Does the relevant taxpayer obtain a tax benefit?

For paragraph 45B(2)(b) of the ITAA 1936 to be satisfied, the provision of the capital benefit must be accompanied by an associated tax benefit.

The meaning of 'obtaining a tax benefit' is contained in subsection 45B(9) of the ITAA 1936. Essentially, the relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under the ITAA 1936 and ITAA 1997, by the relevant taxpayer would, apart from section 45B, 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.

Accordingly, the tax effect of paying the amount as a dividend must be considered when determining whether the taxpayer has obtained a tax benefit or not. An assessable dividend is ordinarily a payment to a shareholder out of profits and included in their assessable income under subsection 44(1) of the ITAA 1936 or subject to withholding tax, in the case of non-resident shareholders.

However, Explanatory Memorandum to the Taxation Laws Amendment (Company Law Review) Bill 1998 identifies a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends as stated below:

For example, obtaining a tax benefit would include circumstances where the amount of tax assessed as being payable by the relevant taxpayer in respect of the capital benefits is substantially the same as would have been the case had the relevant taxpayer received a dividend, but the relevant taxpayer has income losses, or the company providing the capital benefits has franking credits, which are preserved for future income years (and therefore reduce tax in those years).

In the present scheme, the applicant has confirmed that Company N has sufficient franking credits to fully frank the entire distribution, were the capital component to be paid instead as a dividend. However, to the extent that franking credits are not needed to be used in respect of the capital component of the distribution, franking credits are thereby preserved for use in future years to reduce the income tax of resident shareholders, or the withholding tax of non-resident shareholders.

Accordingly, the preservation of franking credits for future income years would constitute the obtaining of a tax benefit.

Relevant circumstances

Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to objectively consider the 'relevant circumstances of the scheme' pursuant to subsection 45B(8) of the ITAA 1936 as to whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a 'tax benefit'.

The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. Under the proposed scheme paragraphs 45B(8)(a), 45B(8)(b) and 45B(8)(k) of the ITAA 1936 are relevant for the purposes of determining the requisite purpose pursuant to paragraph 45B(2)(c) of the ITAA 1936.

Paragraph 45B(8)(a) of the ITAA 1936

This paragraph 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.

Under this paragraph, it is necessary to consider the source of the distribution and whether it is properly attributable to capital or profit (realised and unrealised) of the company or an associate of the company. Whether the proposed distribution of capital is 'attributable' to profit is essentially a practical matter concerned with determining whether there is a discernible connection between the amount distributed as share capital and the share capital and profits that are realistically available for distribution.

The applicant contends that no part of the proposed capital return is attributable to the profits of Company N or an associate of Company N because substantially all of the available profits will have been distributed to the shareholders of Company N as a result of the payment of the proposed dividend. The proposed capital return is a distribution to shareholders that is being made in addition to the distribution of available profits by way of dividend. The surplus cash of the group remaining after the proposed dividend represents surplus share capital of the group. The management of the business have determined that this share capital is surplus to its needs.

Paragraph 72 of PS LA 2008/10 states that:

The mere existence of profits will not automatically trigger application of section 45B; rather, the availability of profits is but one matter to be considered in the attribution inquiry posed by paragraph 45B(8)(a).

This means that the mere fact that some profits may be available in subsidiaries should not automatically mean that section 45B of the ITAA 1936 is triggered.

In the present case, there will be some amounts of profits of Company N remaining after distribution of the proposed dividend, However on balance it is considered that no discernible connection is found between these remaining profits and the proposed return of share capital. It is considered that the proposed distribution of capital is not attributable to profits, and it can therefore be concluded that this circumstance does not incline towards the requisite purpose.

Paragraph 45B(8)(b) of the ITAA 1936

This paragraph directs attention to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or an associate (within the meaning in section 318 of the ITAA 1936) of the company. The inference is that an interruption to the normal pattern of profit distribution and replacement with a distribution of capital may suggest dividend substitution.

Company N had previously paid fully franked dividends and returned share capital. The applicant has stated that this indicates a conservative approach to profit distribution, where a distribution occurred due to accumulated retained earnings being positive and surplus cash representing those profits being available to fund the distribution.

The applicant has also submitted that Company N will distribute substantially all of its profit prior to making the return of capital. Therefore, there is no indication that the proposed capital return by Company N is being used to replace standard profit distributions.

The Company N Group has surplus capital due to strong operating cash flows and is returning share capital that was not previously returned to shareholders. Company N does not have further surplus capital to return to shareholders following the distribution of the proposed capital return.

Given the above circumstances, the pattern of distributions does not indicate that the requisite purpose exists.

Paragraph 45B(8)(k)

This paragraph refers to the matters in subparagraphs 177D(2)(a) to (h) 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. These matters include, among other things, the form and substance of the scheme and its financial implications for the parties involved. In this case, the practical implications of the scheme for Company N and its shareholders are consistent with it being, in form and substance, a return of share capital.

Conclusion

In view of the above, section 45B of the ITAA 1936 does not apply and the Commissioner will not make a determination pursuant to subsection 45B(3) of the ITAA 1936 that 45C of the ITAA 1936 applies to the proposed capital return.

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