Edited version of your written advice

Authorisation Number: 1051321700482

Date of advice: 20 December 2017

Ruling

Subject: Tax treatment of distributions made by a liquidator

Question 1

Will the distribution made to you in the course of the liquidation of the Australian Company Pty Ltd, to the extent to which it is made out of a reserve that represents a capital gain that has been reduced to nil under Subdivision 768-G of the Income Tax Assessment Act 1997 (‘ITAA 1997’), be treated as a dividend under subsection 47(1) of the Income Tax Assessment Act 1936 (‘ITAA 1936’) having regard to the extended meaning of ‘income derived by a company’ in subsection 47(1A) of the ITAA 1936, and therefore, assessable income under section 44 of the ITAA 1936?

Answer

No

Question 2

Will the distribution made to you in the course of the liquidation of the Australian Company Pty Ltd, to the extent to which it is made out of a reserve representing non-assessable non-exempt dividends under Section 768-A of the ITAA 1997, be treated as a dividend under subsection 47(1) of the ITAA 1936 having regard to the extended meaning of ‘income derived by a company’ in subsection 47(1A) of the ITAA 1936, and therefore, assessable income under section 44 of the ITAA 1936?

Answer

Yes

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Background

The Australian Company Pty Ltd (‘The Australian Company’) is an Australian resident private company. You are the Australian resident shareholder of the Australian Company (as trustee of the Australian Company Trust).

The Australian Company is in the final stages of negotiating the sale of its XX% interest in a foreign company.

The capital gain that the Australian Company will make on the sale of its shares in the foreign company will be reduced to nil pursuant to Subdivision 768-G of the ITAA 1997.

The gain will be accounted for in the books of the Australian Company as a 768-G Reserve Account.

The Australian Company has also recorded in its accounts a Division 768-A Reserve account representing foreign dividends received from the foreign company that are non-assessable non-exempt income pursuant to Division 768-A of the ITAA 1997.

Once the shares in the foreign company are sold, the Australian Company will initiate a formal members voluntary liquidation.

The liquidator will distribute the 768-G Reserve account, representing the capital gain that has been reduced to nil, to you.

The liquidator will distribute the 768-A Reserve account, representing the non-assessable non-exempt dividends, to you.

The liquidation process will not exceed 12 months.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 102-20

Income Tax Assessment Act 1997 Section 102-25

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 768-505

Income Tax Assessment Act 1997 Subdivision 768-A

Income Tax Assessment Act 1997 Subdivision 768-G

Income Tax Assessment Act 1936 Section 6-23

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Subsection 47(1)

Income Tax Assessment Act 1936 Subsection 47(1A)

Reasons for decision

These reasons for decision accompany the Notice of private ruling for the Australian Company Trust. While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision. All subsequent legislative references are to the ITAA 1997 unless otherwise stated.

Issue 1 – Income Tax

Question 1

Summary

A capital gain, which is reduced to nil pursuant to Subdivision 768-G, is not ‘income derived by the company’ for the purposes of subsection 47(1) of the ITAA 1936, or within the extended meaning of those words in subsection 47(1A) of the ITAA 1936. Therefore, a distribution made to you in the course of the liquidation of the Australian Company, to the extent to which it is made out of a reserve that represents a capital gain that has been reduced to nil under Subdivision 768-G, will not be a deemed dividend under subsection 47(1) of the ITAA 1936, and therefore, is not assessable income under section 44 of the ITAA 1936?

The amount will be capital proceeds from the ending of the shares (CGT event C2).

Detailed reasoning

Liquidator’s distribution

At common law, a distribution to a shareholder by a liquidator is capital, not income, in the hands of the shareholder since it is a realisation of the shareholder’s interest in the company: FC of T (NSW) v Stevenson (1937) 4 ATD 415 ; (1937) 59 CLR 80; FC of T v Blakely (1951) 9 ATD 239 at 245, 247; (1951) 82 CLR 388 at 402, 407; FC of T v Brewing Investments Ltd [2000] FCA 920; 2000 ATC 4431 per Hill J at 18 - 19

However, subsection 47(1) of the ITAA 1936 provides that distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall be deemed to be dividends paid to the shareholders by the company out of profits derived by it for the purposes of the income tax legislation.

In subsection 47(1) of the ITAA 1936, income has its ordinary meaning and does not include amounts, such as capital profits, that are specifically included in assessable income of a taxpayer by various provisions of the income tax law. This was recognised in the Explanatory Memorandum to the Taxation Laws Amendment (Company Distributions) Bill 1987 which introduced subsection 47(1A) of the ITAA 1936 to extend the meaning of the phrase ‘income derived by a company’ for the purposes of subsection 47(1) of the ITAA 1936.

Subsection 47(1A) of the ITAA 1936 provides that a reference in subsection (1) to ‘income derived by a company’ includes a reference to:

a) an amount (except a net capital gain) included in the company’s assessable income for a year of income; or

b) a net capital gain that would be included in the company’s assessable income for a year of income if the ITAA 1997 required a net capital gain to be worked out as follows:

Method statement

Step 1. Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income.

Step 2. Total the capital gain or gains worked out under Step 1. The result is the net capital gain for the year of income.

Subsection 44(1) of the ITAA 1936 states that the assessable income of a resident shareholder in a company includes dividends that are paid to the shareholder by the company out of profits derived from any source.

The CGT participation exemption

Subdivision 768-G provides for a reduction in capital gains and losses arising from the disposal of a non-portfolio investment in a foreign company to the extent that the foreign company carried on an active business. An Australian resident company that has a capital gain or capital loss arising from a specifically listed CGT event that happens in relation to a share in a foreign resident company and that holds a direct voting percentage of 10% or more in the foreign company for a certain period before the CGT event happens reduces the capital gain or loss by a percentage that reflects the degree to which the assets of the foreign company are used in an active business.

Application to your circumstances

In the facts covered by this ruling, the liquidator of the Australian Company will make a distribution to you in the course of the liquidation of the Australian Company, out of a reserve that represents a capital gain that has been reduced to nil under Subdivision 768-G.

Of primary relevance is the extended meaning of ‘income derived by a company’ in subsection 47(1A) of the ITAA 1936 and in particular paragraph 47(1A)(b) of the ITAA 1936 and the application of the Method statement. A capital profit made in these circumstances is not ordinary income, and therefore, would not otherwise be ‘income derived by the company’ for the purposes of subsection 47(1) of the ITAA 1936.

In this regard, the first step of the Method Statement involves working out each capital gain (except a capital gain that is disregarded) that the company has made during that year of income.

However, because the capital gain made from the disposal of the shares will be reduced to nil under section 768-505, it is considered that the taxpayer will not make a ‘capital gain’ for the purposes of Step 1 of the Method Statement or a ‘net capital gain’ under paragraph 47(1A)(b) of the ITAA 1936.

The reduced net capital gain would also not constitute an amount (except a net capital gain) included in the company’s assessable income for a year of income (paragraph 47(1A)(a) of the ITAA 1936).

While the distribution made to you in the course of the liquidation of the Australian Company, to the extent to which it is made out of a reserve that represents a capital gain that has been reduced to nil under Subdivision 768-G, would not be treated as an assessable dividend, it will still form part of the capital proceeds for the ending of your shares in the liquidated company which will trigger CGT event C2.

Under section 108-5, an asset for CGT purposes is any form of property or a legal or equitable right that is not property. Under section 102-20, you make a capital gain or capital loss as a result of a CGT event. Section 104-25 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled

b) being released, discharged or satisfied

c) expiring; or

d) being abandoned, surrendered or forfeited; or

….

The time of the event is when you enter into the contract that results in the asset ending or if there is no contract, when the asset ends: subsection 102-25(2).

Taxation Determination TD 2001/27 considers how Parts 3-1 and 3-3 of the ITAA 1997 treat a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the ITAA 1936) to be a dividend. Paragraph 1 of the ruling states that:

The full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997. After the winding-up of a company, CGT event C2 happens to the shares when the company ceases to exist in accordance with the Corporations Act 2001 (see Taxation Determination TD 2000/7 paragraphs 3 and 4).

If all or part of a final distribution made by a liquidator of a company is deemed by subsection 47(1) of the ITAA 1936 to be a dividend paid out of profits, and to be assessable income of a shareholder under subsection 44(1) of the ITAA 1936, this does not alter the position stated in paragraph 1 of TD 2001/27. However, subsection 118-20(1), when read with subsection 118-20(1A), ensures that no part of the final liquidator's distribution is taxed both as a dividend and as a capital gain.

Subsection 118-20(1) states that a capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of this part) includes an amount (for any income year) in:

a) you assessable income or exempt income; or

b) if you are a partner in a partnership, the assessable income or exempt income of the partnership.

Subsection 118-20(1A) states that subsection (1) applies to an amount that, under a provision of this Act (outside of this part), is included in:

a) your assessable income or exempt income; or

b) if you are a partner in a partnership, the assessable income or exempt income of the partnership;

in relation to a CGT asset as if it were so included because of the CGT event referred to in that subsection if the amount would also be taken into account in working out the amount of a capital gain you make.

In conclusion, the distribution made to you in the course of the liquidation of the Australian Company, to the extent to which it is made out of a reserve that represents a capital gain that has been reduced to nil under Subdivision 768-G will not be deemed a dividend paid by the company out of profits under subsection 47(1) of the ITAA 1936. It will form part of the capital proceeds for the ending of your shares on liquidation which will trigger CGT event C2.

Question 2

Summary

The distribution made to you in the course of the liquidation of the Australian Company, to the extent to which it is made out of a reserve representing non-assessable non-exempt dividends under Section 768-A, will be deemed a dividend paid to you out of the profits of the company under subsection 47(1) of the ITAA 1936, and therefore, assessable income under section 44 of the ITAA 1936.

The amount will be capital proceeds from the ending of the shares (CGT Event C2). However, subsection 118-20(1), when read with subsection 118-20(1A), will operate to reduce the capital gain to the extent that the payment is assessable as a dividend.

Detailed reasoning

Non Portfolio Dividends

Under Subdivision 768-A, where an Australian resident corporate tax entity receives a foreign equity distribution from a foreign company, either directly or indirectly through one or more interposed trusts or partnerships, and the Australian corporate tax entity holds a participation interest of at least 10% in the foreign company, the distribution is non-assessable non-exempt income for the Australian corporate tax entity.

Non-assessable non-exempt income

Pursuant to section 6-23 of ITAA 1936, non-assessable non-exempt income is ordinary or statutory income that is expressly made not assessable income and not exempt income in the ITAA 1997, ITAA 1936 (the ITA Acts) or in any other Commonwealth law.

Liquidator’s distribution

As discussed above, a liquidator’s distribution to a shareholder in course of winding up a company, will be a deemed dividend under subsection 47(1) of the ITAA 1936 to the extent to which the distribution represents 'income derived by the company' according to ordinary concepts or 'income derived by the company' under the extended meaning of that expression in subsection 47(1A) of the ITAA 1936 (other than income which has been applied to replace a loss of paid up share capital).

As ‘income’ under subsection 47(1) of the ITAA 1936 bears its ordinary meaning, it include an amount which is made exempt income or non-assessable non-exempt income under a provision of the ITA Acts or any other Commonwealth law, provided the amount is income under ordinary concepts.

A distribution (e.g. dividend) by a company of profits is ordinary income in the hands of its shareholders, as recognised by Hill J in FC of T v Brewing Investments Ltd [2000] FCA 920; 2000 ATC 4431 at 16 (and again at 42):

16. In terms of company law and the law of income tax the distribution by a company of profits, be they profits accumulated or current year profits, is seen as the ``detachment'', ``release'' or ``liberation'' of the profits. The share itself remains in existence and is held by the shareholder. So, as the Privy Council said in Hill v Permanent Trustee Co of New South Wales Ltd [1930] AC 720, a case concerned with the meaning of ``income'' for trust law purposes, it was said at 734 that:

``If payment to the shareholders is made out of profits it is income of the shares, and no statement of the company or its directors can change it from income into corpus.''

The treatment of an amount of ordinary income as exempt income or non-assessable non-exempt income under a provision of the ITA Acts or any other Commonwealth law does not divest it of its character as ordinary income for the purposes of subsection 47(1) of the ITAA 1936. Further, the definition of income in subsection 47(1A) of the ITAA 1936 is inclusive i.e. it states that ‘income derived by a company’ for the purposes of subsection 47(1) of the ITAA 1936 includes assessable income. It does not limit the meaning of the phrase ‘income derived by the company’ in subsection 47(1) of the ITAA 1936 to ordinary income that is ‘assessable income’.

Application to your circumstances

The distribution made to you in the course of the liquidation of the Australian Company, to the extent to which it is made out of a reserve representing non-assessable non-exempt dividends under Section 768-A, will be a deemed dividend under subsection 47(1) of the ITAA 1936, and therefore, assessable income under section 44 of the ITAA 1936 because those dividends received from the foreign company fall within the ordinary meaning of ‘income derived by the company’ for the purposes of subsection 47(1) of the ITAA 1936.

It is noted that the amount will also form part of the capital proceeds from the ending of the shares (CGT Event C2). However, subsection 118-20(1), when read with subsection 118-20(1A), will operate to reduce the capital gain to the extent that the amount is assessable as a dividend.

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).