1013074872402 | Legal database

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Edited version of your written advice

Authorisation Number: 1013074872402

Date of advice: 19 August 2016

Ruling

Subject: Capital Gains Tax

Questions and Answers

1. Is the return on capital assessable as a dividend?

No

2. Will CGT event G1 happen when the return of capital is made?

Yes

This ruling applies for the following periods

Year ending 30 June 20YY

The scheme commences on

1 July 20XX

Relevant facts and circumstances

The Company currently has a balance sheet with the following amounts listed:


Assets
	Land & Buildings	$A
	Plant	$B
	Intangibles	$C
	Cash	$E
	Receivables	$F

The market value of the Land & Building is approximately $Y, this value is considerably more than the market value of the other assets.

The Company has three non-resident shareholders. Each holds at least 10% of the shares in the Company.

The Company ceased trading in the 20XX financial year. Its sole operation for 20YY and beyond is rental of the Land & Building.

The Company has carried forward losses.

The Company intends to payout the retained profits in the form of a fully franked dividend, after this the net assets of the company would be the same as its payed up share capital.

The Company then intends to pay a capital return of Zc per share. The return of capital will be recorded as a debit to the Company's share capital account.

The capital return is not more than the cost base of the shares.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Subsection 855-10(1)

Income Tax Assessment Act 1997 Section 855-20

Income Tax Assessment Act 1997 Section 855-25

Income Tax Assessment Act 1997 Section 855-30

Income Tax Assessment Act 1997 Section 960-195

Income Tax Assessment Act 1997 Section 975-300

Reasons for decision

Subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) includes in a shareholder's assessable income any dividends, as defined in subsection 6(1) of the ITAA 1936, paid to the shareholder 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' is defined in subsection 6(1) ITAA 1936 and includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of 'dividend' excludes a distribution from the meaning of 'dividend' if the amount of the distribution is debited against an amount standing to the credit of the company's share capital account.

The term 'share capital account' is defined in section 975-300 of the Income Tax Assessment Act 1997 (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 return of capital will be recorded as a debit to the Company's share capital account. As the share capital account of the Company's 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 will apply. Accordingly, the return of capital is not a dividend as defined in subsection 6(1) of the ITAA 1936.

Capital gains tax

Under subsection 855-10(1) of the ITAA 1997, an entity disregards a capital gain or capital loss from a CGT event if they are a foreign resident, or the trustee of a foreign trust for CGT purposes, just before the CGT event happens and the CGT event happens in relation to a CGT asset that is not 'taxable Australian property'.

The term 'taxable Australian property' is defined in the table in section 855-15 of the ITAA 1997. The table sets out five categories of CGT assets:

Item 1	taxable Australian real property;
Item 2	an indirect Australian real property interest not covered by item 5;
Item 3	a CGT asset used at any time in carrying on a business through a permanent establishment in Australia and which is not covered by item 1, 2 or 5;
Item 4	an option or right to acquire a CGT asset covered by item 1, 2 or 3; and
Item 5	a CGT asset that is covered by subsection 104-165(3) of the ITAA 1997 (choosing to disregard a gain or loss on ceasing to be an Australian resident).

Section 855-20 of the ITAA 1997 defines taxable Australian real property as:

(a) real property situated in Australia (including a lease of land, if the land is situated in Australia); or

(b) a mining, quarrying or prospecting right (to the extent that the right is not real property), if the minerals, petroleum or quarry materials are situated in Australia.

Indirect Australian real property interests are defined in section 855-25 of the ITAA 1997 as:

A *membership interest held by an entity (the holding entity) in another entity (the test entity) at a time is an indirect Australian real property interest at that time if:

a. the interest passes the *non-portfolio interest test (see section 960-195):

i. at that time; or

ii. throughout a 12 month period that began no earlier than 24 months before that time and ended no later than that time; and

b. the interest passes the principal asset test in section 855-30 at that time.

The foreign shareholders hold a membership interest in the Company by virtue of holding ordinary shares in the Company.

Section 960-195 of the ITAA 1997 provides that an interest held by an entity (the holding entity) in another entity (the test entity) passes the non-portfolio interest test at a time if the sum of the *direct participation interests held by the holding entity and its *associates in the test entity at that time is 10% or more.

Individually the foreign resident shareholders each hold a direct participation interest of 10% or more, therefore they meet the non-portfolio interest test.

The principal asset test is set out in section 855-30 of the ITAA 1997. Essentially, a membership interests passes the principal asset test if the sum of the market values of the test entity's assets that are taxable Australian real property exceeds the sum of the market values of its assets that are not taxable Australian real property.

As the market value of the taxable Australian real property held by the Company exceeds the market value of the Company's other assets, the interests held by the non-resident shareholders pass the principal asset test.

Therefore, as the Company's shares held by foreign residents are an indirect Australian real property interest. Accordingly, the capital gains provisions cannot be ignored when determining the Australian tax treatment of the capital return.

CGT event G1 capital payment for shares

CGT events are the different types of transactions that may result in a capital gain or capital loss.

CGT event G1 occurs when a company makes a payment in respect of a share and some or all of the payment is not a dividend to be included in the shareholder's assessable income. The time of the CGT event is when the company makes the payment.

Return of capital

The Company will make a return of capital to shareholders. Consequently, shareholders are required to apply CGT event G1 to all of their shares.

CGT event G1 happens when a return of capital is paid to shareholders in respect of the shares that they owned at the time of the payment. A separate CGT event G1 happens to each and every share that is taken into account by the company when working out the amount of the return of capital.

Where the return of capital is less than the cost base of the share at the time of the payment, the cost base and the reduced cost base of the share are reduced (but not below nil) by the amount of the return of capital.

A shareholder will make a capital gain where the return of capital per share is more than the cost base of their share. The amount of the capital gain is equal to this excess.

Where a shareholder makes a capital gain as a result of the return of capital, the cost base and reduced cost base of the share are reduced to nil.

Once the cost base is reduced to nil, any further or greater return of capital will result in a capital gain.

Therefore, the non-resident shareholders will be required to reduce the cost base of their shares by the amount of the capital return.

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