Edited version of your written advice

Authorisation Number: 1012953696254

Date of advice: 5 February 2016

Ruling

Subject: Return of Capital

Question

Will the Commissioner make a determination under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies to deem any part of the proposed capital return to be a dividend and hence assessable for income tax purposes ?

Answer

No.

This ruling applies for the following periods:

Year ending 30 June 2016

Year ending 30 June 2017

The scheme commences on:

1 July 2015

Relevant facts and circumstances

Shareholder A acquired 100% of Company X on incorporation.

Shareholder A died and their shares in Company X passed on to the executor of shareholder A's estate. The shares will ultimately be passed on to the beneficiaries when the estate is settled.

The share structure of Company X currently has ordinary and A class shares on issue.

All shares in Company X are post CGT shares.

A Class shares

When Company X was set up shareholder A contributed a certain capital amount. However, Company X's insurer's required Company X to have an additional amount as capital.

Based upon this context, shareholder A invested the additional amount of capital in A class shares in Company X's balance sheet.

The A class shares were always intended to be short term (and were designed to be akin to interest free debt).

The A class shares have no voting or dividend rights, and no rights to surplus on winding up.

The A class shares can be redeemed/cancelled at any time at the option of the A class shareholder.

The executor of the estate of shareholder A is in the process of tidying up shareholder A's affairs and those of the main beneficiaries. The executor is looking to repay debts which are owing by shareholder A and the beneficiaries of their estate.

Repayment of A Class Shares

The executor of shareholder A's estate has requested Company X to return the additional amount of capital paid on the A class shares to the estate and then cancel the A class shares.

This capital return (return of capital) is to be funded out of Company X's working capital, although some borrowings may be required to fund part of the return of capital.

Company X is permitted to return share capital under its Constitution.

It is a selective capital reduction pursuant to subsection 256B of the Corporations Act 2001.

Company X has never returned capital to a shareholder previously.

Company X has no history of paying dividends to its shareholders.

The estate of shareholder A does not have any capital losses.

The estate of shareholder A is a resident trust.

The payment will be a capital benefit funded solely out of its share capital account.

Company X's share capital account is not tainted.

Relevant legislative provisions

Income tax Assessment Act 1936 section 45B

Income tax Assessment Act 1936 subsection 45B(2)

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

Income tax Assessment Act 1936 subsection 45B(3)

Income tax Assessment Act 1936 paragraph 45B(5)(b)

Income tax Assessment Act 1936 subsection 45B(8)

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 subsection 45B(9)

Income tax Assessment Act 1936 subsection 45B(10)

Income tax Assessment Act 1936 section 45C

Income tax Assessment Act 1936 subsection 177D(2)

Income tax Assessment Act 1936 section 318

Income tax Assessment Act 1997 section 104-135

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

Corporations Act 2001 section 256B

Reasons for decision

Summary

The Commissioner will not make a determination under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 will deem any part of the return of capital to be an unfranked dividend.

Detailed reasoning

Subsection 45B(2) of the ITAA 1936 provides that section 45B will apply 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 to obtain a tax benefit.

Each of these conditions is considered below.

Scheme

Subsection 45B(10) of the ITAA 1936 provides that 'scheme' in section 45B has the same meaning as provided in subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997). That definition is widely drawn and includes any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The return of capital as described in the facts constitutes a scheme within the meaning of subsection 995-1(1) of the ITAA 1997.

Provided with a capital benefit

The transaction will involve the provision of a capital benefit (being a share capital reduction by way of a return of share capital to the shareholder) as defined in paragraph 45B(5)(b) of the ITAA 1936.

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' 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,

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.

Ordinarily, a return of capital would be subject to the CGT provisions under the income tax law. Unless the amount of the distribution exceeds the cost base of the shares, there will only be a cost base reduction under CGT event G1 (section 104-135 of the ITAA 1997). It is only to the extent (if any) that the distribution exceeds the cost base of the shares that a capital gain arises. A dividend would generally be included in the assessable income of a resident shareholder. Therefore, the shareholder will obtain a tax benefit from the capital return.

Purpose

As all the other criteria in subsection 45B(2) of the ITAA 1936 are satisfied, the application of section 45B turns on whether, having regard to the relevant circumstances of the scheme, it may be concluded objectively that a more than incidental purpose of one of the persons who entered into or carried out the scheme was to enable a taxpayer to obtain a tax benefit.

Relevant circumstances

Subsection 45B(8) of the ITAA 1936 lists the relevant circumstances of the scheme which the Commissioner must have regard to when determining whether or not the requisite purpose exists. The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. The relevant circumstances listed in subsection 45B(8) of the ITAA 1936 encompass a range of matters which, when taken individually or collectively, will reveal whether the requisite purpose exists or not. They are discussed below (insofar as they are relevant).

In this instance, paragraphs 45B(8)(c) to 45B(8)(h) of the ITAA 1936 do not incline for or against the requisite purpose. The circumstances covered by paragraphs 45B(8)(i) and 45B(8)(j) of the ITAA 1936, pertaining to the provision of ownership interests and demerger respectively are not relevant. The relevant matters are those covered by the circumstances described in paragraphs 45B(8)(a), 45B(8)(b) and 45B(8)(k) of the ITAA 1936, which are considered below.

Paragraph 45B(8)(a) of the ITAA 1936: the attribution question

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital and profits (realised and unrealised) of Company X or its associates. The investment in Company X was entirely sourced out of share capital. The attribution under the scheme correctly reflects the extent of share capital and profit in the return of capital.

Accordingly, the circumstances do not incline towards a finding that the requisite purpose exists.

Paragraph 45B(8)(b) of the ITAA 1936: pattern of distributions

Paragraph 45B(8)(b) 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 here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution of capital may suggest dividend substitution.

As outlined above, Company X has never distributed a dividend to its shareholders or previously made any distribution of capital.

The proposed return of capital is not an interruption to any profit distribution pattern, but rather a mechanism to return capital to shareholders which is considered excess to current requirements.

Accordingly, this circumstance does not incline towards a finding that the requisite purpose exists.

Paragraph 45B(8)(k) of the ITAA 1936: any of the matters referred to in subsection 177D(2) of the ITAA 1936.

The matters referred to in paragraphs 177D(2)(a) to (h) are matters of reference for 'the dominant purpose' test in Part IVA. However, in the context of section 45B they facilitate the 'more than incidental purpose test' and do not introduce a different purpose test. Furthermore, they are matters by reference to which one is able to examine a return of capital from a broad, practical perspective in order to identify and compare its tax and non-tax objectives.

In the current circumstances, the scheme, being a proposed return of capital to its shareholder, seeks to legitimately return an amount of excess share capital raised. The return will release capital which is excess to its current needs. In this case, the practical implications of the scheme are consistent with it being, in form and substance, a return of capital.

Conclusion

Having regard to the relevant circumstances of the scheme, set out in subsection 45B(8), it cannot be concluded that the scheme was entered into or carried out for more than an incidental purpose of obtaining a tax benefit.

Accordingly, the Commissioner will not make a determination pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the capital benefit received under the proposed return of capital.

Copyright notice

© Australian Taxation Office for the Commonwealth of Australia

You are free to copy, adapt, modify, transmit and distribute material on this website as you wish (but not in any way that suggests the ATO or the Commonwealth endorses you or any of your services or products).