Edited version of your written advice

Authorisation Number: 1013027165369

Date of advice: 27 June 2016

Ruling

Subject: Capital return

Question 1

Will section 45A of the Income Tax Assessment Act 1936 (ITAA 1936) apply to ABC's return of capital?

Answer

No.

Question 2

Will section 45B of the ITAA 1936 apply to ABC's return of capital?

Answer

No.

This ruling applies for the following periods:

Income year ending 30 June 2016

Income year ending 30 June 2017

Income year ending 30 June 2018

The scheme commenced in:

Income year ending 30 June 2016

Relevant facts and circumstances

Background

1. X holds 100% of the units in ABC.

2. ABC is a public trading trust pursuant to Division 6C of the ITAA 1936. ABC has elected to form a tax consolidated group under Subdivision 713-C of the Income Tax Assessment Act 1997 (ITAA 1997). ABC is therefore effectively treated as a company for income tax purposes.

3. XYZ is wholly-owned by ABC and a subsidiary member of the ABC tax consolidated group.

Investment in B Co

4. X established ABC and XYZ for the purposes of acquiring the shares in B Co.

5. ABC and XYZ were capitalised with sufficient funds so that the entire acquisition of the shares in B Co was funded with capital subscriptions.

6. Just prior to the sale of B Co, X, XYZ and UT1 (an Australian unit trust) held all the issued ordinary shares in B Co.

Shareholder loans from XYZ to B Co

7. Following the acquisition of B Co, additional funding was provided by XYZ to B Co through interest-free shareholder loans in order to meet B Co's working capital requirements (Shareholder Loans).

8. The Shareholder Loans were funded by:

• equity contributions from X, via ABC; and

• an external USD denominated interest bearing bank facility obtained by ABC.

9. The external bank debt has previously been repaid in full by ABC. The repayments were funded entirely from proceeds received by ABC from X for the issue of additional units.

Repayment of Shareholder Loans and disposal of B Co

10. X, XYZ and UT1 entered into a contract to sell all their respective shares in B Co to D Co.

11. Pursuant to the share sale agreement with D Co, B Co was required to repay the outstanding Shareholder Loans to XYZ prior to the transfer of B Co's shares. To facilitate this, D Co provided loans to B Co to enable it to repay the outstanding balance of the Shareholder Loans.

12. The outstanding balance of the Shareholder Loans was repaid in full immediately before the sale transaction was finalised.

Proposed return of capital

13. Following the disposal of B Co, XYZ was left with surplus cash.

14. The Board of Directors of XYZ proposes to distribute an amount as a return of capital to X, via ABC (the Capital Return).

15. To implement the Capital Return, it is intended the following steps will be undertaken:

a) XYZ will make a return of capital to ABC; and

b) ABC will make a return of capital (of the same amount as in step (a)) to X.

16. The Capital Return will not involve the cancellation of any shares/units in XYZ or ABC.

17. The Capital Return will be undertaken in accordance with the terms of ABC's Trust Deed and the requirements of section 256B of the Corporations Act 2001 (Cth).

18. The entire amount of the proposed Capital Return will be debited to the issued share capital accounts of XYZ (in respect of step (a) of the Capital Return) and ABC (in respect of step (b) of the Capital Return).

Other matters

19. All the units in ABC were issued after 20 September 1985.

20. Whilst ABC has distributed dividends and returns of capital in the past, it does not have an established policy of regularly making distributions.

21. No amounts have been transferred to ABC's share capital account (as defined in section 975-300 of the ITAA 1997) from any of its other accounts. Accordingly, ABC's share capital account is not tainted (within the meaning of Division 197 of the ITAA 1997).

22. The cost base of X's units in ABC is greater than the amount of the Capital Return.

23. X has no carried forward capital losses.

Relevant legislative provisions

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 Section 45B

Income Tax Assessment Act 1936 Subsection 45B(2)

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 Subsection 45B(5)

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

Income Tax Assessment Act 1936 Subsection 45B(8)

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 1997 Section 104-135, and

Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision

Question 1

Summary

Section 45A of the ITAA 1936 will not apply to ABC's proposed return of capital.

Detailed reasoning

Section 45A of the ITAA 1936 applies in circumstances where a company streams the provision of capital benefits to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders have received, or will receive, dividends (the disadvantaged shareholders).

Where the circumstances of subsection 45A(1) of the ITAA 1936 are satisfied, the Commissioner may make a determination under subsection 45A(2) that section 45C of the ITAA 1936 applies. The effect of such a determination is that the capital benefit is taken to be an unfranked dividend.

A capital benefit is defined in subsection 45A(3) of the ITAA 1936 to include the provision to shareholders of shares in the company, the distribution of share capital or share premium or the doing of something to increase the value of a share held by the person.

The proposed distribution by ABC to X will be sourced from its share capital account and will therefore constitute the provision of a capital benefit. However, the capital benefit will be provided to all shareholders in the same proportion as their respective shareholdings. As X holds all of the issued units in ABC, it will receive the entire capital benefit. Consequently, it cannot be concluded that capital benefits will be streamed to some holders while dividends are streamed to others. Hence, section 45A of the ITAA 1936 will not apply to ABC's Capital Return.

Question 2

Summary

Section 45B of the ITAA 1936 will not apply to ABC's proposed return of capital.

Detailed reasoning

Section 45B of the ITAA 1936 is an anti-avoidance provision which applies where certain capital payments, including a return of capital, 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.

Subsection 45B(2) of the ITAA 1936 sets out the conditions that must be met in order for section 45B to apply. Relevantly, section 45B applies where:

• there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a)),

• 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 (paragraph 45B(2)(b)), and

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

Each of these conditions is considered below.

Provided with a capital benefit from a scheme

Subsection 45B(10) of the ITAA 1936 provides that 'scheme' in section 45B of the ITAA 1936 has the meaning given by subsection 995-1(1) of the ITAA 1997. That definition is widely drawn and includes any arrangement or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The Capital Return will constitute a scheme for the purposes of paragraph 45B(2)(a) of the ITAA 1936.

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It states that a person is provided with a capital benefit if:

• an ownership interest in a company is issued to the person;

• there is a distribution to the person of share capital; or

• the company does something 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) held by that person.

As ABC's Capital Return will be debited entirely to its issued share capital account, its sole unitholder, X, will receive a distribution of share capital. Therefore, it will be provided with a 'capital benefit' for the purpose of paragraph 45B(5)(b) of the ITAA 1936.

Tax benefit

The meaning of the phrase 'obtaining a tax benefit' is defined in subsection 45B(9) of the ITAA

1936 as:

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 demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend.

The 'relevant taxpayer' in this situation is ABC's sole unitholder, X. A receipt of share capital where the amount received is less than the cost base of the shares will result in a cost base reduction under CGT event G1, per section 104-135 of the ITAA 1997. Only to the extent that an amount of share capital received exceeds the cost base of the share does a capital gain arise under CGT event G1. In contrast, if the Capital Return had been an 'assessable dividend' instead, it is likely that X would incur a greater tax liability. X will therefore obtain a tax benefit from the Capital Return as defined in subsection 45B(9) of the ITAA 1936.

A more than incidental purpose

For the purposes of paragraph 45B(2)(c) of the ITAA 1936, the Commissioner is required to consider the relevant circumstances set out under subsection 45B(8) 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.

The test of purpose is an objective one. The question is whether, objectively, 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. The purpose does not have to be the most influential or prevailing, but it must be more than an incidental purpose.

Having regard to paragraphs 45B(8)(a) to (k) of the ITAA 1936, it is considered that the relevant circumstances when applied to the Capital Return, on balance, do not point towards the requisite purpose.

The Capital Return will be by way of an equal share capital reduction undertaken in accordance with section 256B of the Corporations Act 2001 (Cth). The proposed transaction comes about due to XYZ having surplus funds following its disposal of B Co, a pre-requisite of which was the requirement that B Co repay the outstanding Shareholder Loans. The amount of the Capital Return can be traced to the investment in B Co (in the form of the Shareholder Loans) and, therefore, a capital only distribution is considered to reasonably reflect the substance of the distribution. Furthermore, the Capital Return 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.

As the requisite purpose is not present, section 45B of the ITAA 1936 will not apply to ABC's Capital Return.

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