Edited version of your written advice

Authorisation Number: 1051389563292

Date of advice: 27 June 2018

Ruling

Subject: Return of capital to shareholders

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 the whole or any part of the return of share capital by the Company to its shareholder (‘the Capital Return’)?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 20xx

The scheme commences on:

1 July 20xx

Relevant facts and circumstances

A subsidiary of the Company (‘Subsidiary’) carries on a primary production business from its premises (‘the Premises’). The Subsidiary is a member of a tax consolidated group (‘the Group’), of which the head entity is the Company.

Prior to the Capital Return, the sole shareholder of the Company was a trust (‘the Trust’). The Trust was settled under the terms set out in the Trust’s deed.

Prior to the Capital Return, the Subsidiary sold the Premises and on the same day the Group used these funds to:

n return share capital to the Company under section 256B of the Corporations Act 2001 (‘the Capital Return’)

n pay a dividend to the Company

n repay Group debt.

Management of the Group concluded that the capital returned was surplus to the Group’s operational requirements.

The Trust acquired shares in the Company after 20 September 1985.

The Group does not have a formal dividend policy, and no entity that was part of the Group has ever paid a dividend, because the Group has preferred to reinvest profits into the business to repay debt, purchase assets, and develop the Premises, rather than pay dividends.

The Trust did not have any capital losses at the time of the Capital Return.

The Premises

The Premises were acquired by the Trust in the 2000s and comprise land, associated property, plant and equipment, and major improvements to the land.

The purchase and development of the Premises was funded by the Trust until all assets and liabilities relating to the business of primary production were transferred to the Subsidiary, which then subsequently funded the development. The funding sources were:

n capital raising

n loans

n retained earnings.

Restructure

Prior to a restructure, the Premises were owned, and the primary production business was carried on by, the Trust.

Approximately one year prior to the restructure, the management of the Trust started considering restructuring to form the Group. Management identified the following benefits of a restructure:

n Facilitation of future diversification and investments.

n Asset protection.

n Reduction of stamp duty.

n Profits could be retained within a corporate structure and utilised for the business.

n Allows future acquisitions or mergers to make use of CGT rollovers.

n Allows new investors to acquire shares.

n Allows businesses carried on by third party companies to be acquired in the future and be consolidated with existing group businesses.

The Trust ultimately decided on and implemented the following restructure:

1. The registration of the Company and Subsidiary.

2. The transfer of all assets (including the Premises) and liabilities comprising the business from the Trust to the Subsidiary, in exchange for the Trust receiving a number of shares, at $1 each, equal to the market value of the business.

3. The transfer of all shares held by the Trust in the Subsidiary to the Company, in exchange for the Trust receiving a number of shares in the Company, at $1 each, equal to the market value of the shares in the Subsidiary.

4. The Company electing to form a tax consolidated group.

Issue of shares

Prior to the restructure being implemented, using draft financial statements and a independent valuation report, and on the basis of net asset value, the Trust determined the value of the business. This determination formed the basis for the issue of shares in the Subsidiary and the issue of the corresponding shares in the Company, as described above. Such issue was made pursuant to the intention of the parties that shares with a value of $1 be issued in a number equal to the value of the business transferred from the Trust.

Consolidated group

Multiple existing companies formed part of the newly formed consolidated group. These entities were acquired by the Subsidiary from the Trust in exchange for shares in the Subsidiary.

The restructure was completed when the Company notified the Commissioner of Taxation that they had elected to form a tax consolidated group.

Merger with a third party

Some months after the restructure, the Trust undertook a merger with a third party. The Trust acquired 100% of the third party in exchange for cash and a right to some of the capital and income of the Trust.

There were no unrealised profits in the third party at the time of the merger.

Immediately after the Trust acquired the third party, the entities wholly owned by the third party were acquired by the Company from the Trust.

As in the restructure, the intention of the parties was that shares with a value of $1 be issued in a number equal to the value of the entities transferred from the Trust.

Sale of the premises

The Group first considered selling the Premises some years prior to the actual sale in order to:

n reduce shareholder risk through returning capital, whilst continuing to operate the primary production business at the Premises through a long-term lease

n reduce business risk by repaying debt facilities

n facilitate shareholder preference to have capital for investment in other opportunities, rather than investing in the Premises.

The buyer is not an associate of the Group or the Trust. The sale price for the premises was determined on an arms-length basis between the Group and the buyer.

The buyer acquired the Premises from the Subsidiary prior to the Capital Return.

The Subsidiary has entered into a 30 year lease for the Premises, with two ten year extension options.

The sale of the premises gave rise to an assessable balancing adjustment and a capital gain due to the operation of Division 40-F of the ITAA 1997. The balancing adjustment reversed deductions taken for tax depreciation in previous years.

Immediately prior to the sale of the Premises, the Company’s franking account balance was nil.

Return of capital

Following the sale of the Premises, the Subsidiary:

n paid a fee to the selling agent

n repaid group bank debt

n transferred the balance of the proceeds of sale to the Company by

● paying a dividend

● returning share capital to the Company

On the same day, the Company then:

n returned share capital to the Trust (the Capital Return)

n repaid an existing liability

n paid a dividend to the Company.

No amounts have been transferred that would result in the Company’s share capital account becoming tainted under Division 197 of the Income Tax Assessment Act 1997.

The Company’s share capital account has been reduced by the amount of share capital returned.

There has been no change in the ownership of the Company or any other entity in the Group as a result of the return of capital.

The Trust has accounted for the return of capital by reducing the value of its investment in the Company on its balance sheet. The dividend has been accounted for as dividend income on the Trust’s income statement.

The Trust has used the cash received as a result of the return of capital and payment of dividend to:

n repay an existing liability to beneficiaries

n retain cash as required by the bank that is providing debt facilities

n return capital to beneficiaries

n pay the net income of the trust to beneficiaries.

All dividend income received by the Trust from the Company that originated from the proceeds of the sale of the Premises will be net income of the Trust and distributed to the beneficiaries of the Trust.

Relevant legislative provisions

Section 45B of the Income Tax Assessment Act 1936

Section 45C of the Income Tax Assessment Act 1936

Section 177D of the Income Tax Assessment Act 1936

Section 318 of the Income Tax Assessment Act 1936

Section 104-135 of the Income Tax Assessment Act 1997

Section 995-1 of the Income Tax Assessment Act 1997

Reasons for decision

Section 45B of the ITAA 1936 is an anti-avoidance provision that allows the Commissioner to make a determination that section 45C of the ITAA 1936 applies to treat all or part of a return of a capital amount as an unfranked dividend if certain conditions are satisfied.

Section 45B of the ITAA 1936 applies where certain capital payments are made to shareholders in substitution for dividends. Specifically, the provision applies where:

n there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936)

n 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 (paragraph 45B(2)(b) of the ITAA 1936), and

n 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 (paragraph 45B(2)(c) of the ITAA 1936).

Scheme

Subsection 45B(10) of the ITAA 1936 provides that ‘scheme’ for the purposes of section 45B of the ITAA 1936 has the same meaning as provided in subsection 995-1(1) of the 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 Capital Return and the actions that gave rise and gave effect to it constitute a scheme for the purposes of section 45B of the ITAA 1936.

Capital benefit

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:

n an ownership interest in a company is provided to the person

n there is a distribution to the person of share capital or share premium, or

n the company does something in relation to the ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) held by that person.

The Company distributed an amount to the Trust. As the distribution was debited to the Company’s share capital account, the Trust was provided with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936 in the form of a distribution of share capital.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides that a relevant taxpayer ‘obtains a tax benefit’, for the purposes of section 45B, if:

n the amount of tax payable, or

n any other amount payable under the ITAA 1936 or the ITAA 1997

would, apart from the operation of section 45B of the ITAA 1936:

n be less than the amount that would have been payable, or

n be payable at a later time than it would have been payable

if the capital benefit had instead been an assessable dividend.

A return of capital would ordinarily be subject to the CGT provisions.

Under CGT event G1, the cost base of the shares would be reduced up to the amount of the return of capital, that is, effectively tax would be deferred, and only to the extent that the return of capital exceeds the cost base would a capital gain arise (section 104-135 of the ITAA 1997).

In contrast, a dividend would generally be included in the assessable income of the Trust in the income year in which it is paid and ultimately taxed in the hands of the unit holders of the Trust, or in the hands of the trustee of the Trust in the event that the net income of the trust is not distributed to the beneficiaries.

If the return of capital had instead been an assessable dividend, the Trust would incur a greater tax liability and/or tax liabilities would be payable at an earlier time. Therefore, the Trust will obtain a tax benefit, as defined in subsection 45B(9) of the ITAA 1936, from the Capital Return.

Relevant circumstances

For the purposes of paragraph 45B(2)(c) of the ITAA 1936, the Commissioner is required to consider the relevant circumstances set out in subsection 45B(8) of the ITAA 1936 to determine whether any part of the scheme was entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit (the ‘requisite purpose’). The test of purpose is an objective one. The relevant circumstances are considered in turn below.

Attribution

Paragraph 45B(8)(a) requires consideration of the extent to which the capital benefit is attributable to capital or to unrealised or realised profits of the Company and its associates (within the meaning of section 318 of the ITAA 1936).

Management of the Group have concluded that the capital returned was surplus to the Group’s operational requirements.

Where a capital distribution is attributable to the disposal of business assets, a reasonable approach should be taken in determining the extent to which share capital was invested in the disposed assets and is available to be distributed to shareholders. The circumstances of the scheme indicate that the funds used by the Company to make the capital return to the Trust originate from the sale proceeds of the disposal of the Premises by the Subsidiary.

The source of the funds can be traced from the share capital that was issued by the Subsidiary to the Trust and then by the Company to the Trust as part of a restructure of the business, through to the Capital Return, as follows:

Transfer of business (restructure)

Prior to the restructure, and since the Premises were acquired, the Trust held the Premises and carried on a primary production business at the Premises. During the restructure, the Trust transferred the business (including the Premises) to the Subsidiary.

When undertaking the restructure, it was the intention of parties for shares with a value of $1 to be issued in a number equal to the value of the business being transferred between entities. The Trust determined the value of the business based on net asset value, using financial statements, and a independent valuation report. As a result, shares of $1 were issued by the Subsidiary to the Trust as consideration for the transfer of the business from the Trust to the Subsidiary.

After considering the circumstances surrounding the restructure, the Commissioner considers that the effective capitalisation was not done to obtain a tax benefit (within the meaning of subsection 45B(9)) from the Capital Return.

Transfer of Subsidiary by the Trust to the Company (restructure)

The Trust exchanged all of its shares in the Subsidiary for an equal number of shares in the Company. This was per the intention of the parties for shares with a value of $1 to be issued in a number equal to the value of the business being transferred between entities As discussed above, this was based on a valuation by the Trust at the time of the restructure.

The capital that has been returned is a reduction of the agreed share capital issued to the Trust in consideration for the acquisition of the whole of the share capital of the Subsidiary.

Development of Premises by the Subsidiary (post-restructure)

Prior to the sale of the Premises, the Subsidiary had retained earnings. It is reasonable to conclude based on the accounts supplied for the Subsidiary that these earnings substantially arose following the development of the Premises.

It then follows that the Subsidiary has not applied its retained earnings to its development of the Premises, the disposal of which has funded the capital return to the Company.

Disposal of Premises by the Subsidiary

Although a profit arose on the disposal of the Premises by the Subsidiary, the Premises were sold for an amount which is less than cost. The profit arose only to the extent that the proceeds exceeded the written down value, that is, the profit represents a clawback of depreciation.

Distribution of sale proceeds (including Capital Return)

Following the disposal of the Premises the Subsidiary had retained earnings, with a portion of the retained earnings attributable to the accounting profit on the disposal of the Premises. The whole of the retained earnings were distributed to the Company by way of a dividend, and nearly all of the share capital was returned to the Company via a capital return.

Prior to the sale of the Premises, the Company had accumulated losses. As such, immediately prior to the capital return by the Subsidiary to the Company, the Company had no retained earnings to distribute. A portion of the share capital in the Company represents the share capital issued to the Trust in consideration for the acquisition of the whole of the share capital of the Subsidiary. The balance of the share capital represents the share capital issued to the Trust in exchange for the entities of a third party.

Following the payment of the dividend from the Subsidiary, the Company had retained earnings. The Company subsequently returned capital and paid a dividend to the Trust.

Overall

In summary:

n The capital returned by the Company to the Trust can be traced to the proceeds from the disposal of the Premises, the acquisition and development of which was funded through a combination of capital, debt and retained earnings.

n The share capital out of which the Subsidiary made the capital return to the Company was issued as consideration for the business acquired from the Trust. The capital returned by the Company to the Trust matches the share capital issued by the Company to the Trust in exchange for all the shares in the Subsidiary in the restructure.

n Although a profit arose on the disposal of the Premises, this represents a clawback of depreciation and was, in any case, paid as part of the dividend by the Subsidiary to the Company, and distributed to the Trust by the Company as a dividend.

It is reasonable to conclude that of the amount distributed by the Company to the Trust, the capital return is not attributable to realised or unrealised profits of the Company or an associate.

Distribution culture

Paragraphs 45B(8)(b) requires consideration of the pattern of distributions by the Company or associates.

Neither the Company nor the Subsidiary has had retained earnings of amounts which would permit the payment of significant dividends. Further, the Group has preferred to reinvest profits into the business to repay debt, purchase assets, and develop the Premises, rather than pay dividends. The Subsidiary has never paid a dividend to the Company, and the Company has never paid a dividend to the Trust. Therefore, this circumstance does not incline towards the conclusion as to requisite purpose.

Characteristics of shareholders

Paragraphs 45B(8)(c) to (f) require consideration of the following circumstances:

n whether the relevant shareholder has any capital losses that, apart from the scheme, would be unutilised at the end of the relevant year of income (paragraph 45B(8)(c)).

n The Trust did not have any capital losses at the time of the Capital Return. This does not indicate a preference for a capital return over a dividend.

n whether some or all of the shares held by the Trust in the Company were acquired or are taken to be pre-CGT (paragraph 45B(8)(d)).

n The Trust’s shares in the Company are not pre-CGT shares.

n whether the Trust is a non-resident (paragraph 45B(8)(e)).

n The implication of the Trust being a non-resident would be that it points towards a tax preference for a distribution of capital. The Trust is an Australian resident for tax purposes.

n whether the cost base of the Trust’s shares in the Company is not substantially less than the value of the capital benefit (paragraph 45B(8)(f)).

n The cost base of the Trust’s shares in the Company is greater than the Capital Return. This factor points towards a preference for a capital return over a dividend.

Overall, although this may incline towards the conclusion as to requisite purpose, these circumstances carry less weight in relation this particular scheme than paragraph 45B(8)(a).

Nature of interest after the return of capital

Paragraph 45B(8)(h) requires consideration of whether the Trust’s shares in the Company after the share capital reduction will be the same as the interest would have been had an equivalent dividend been paid instead of the distribution of share capital. If the shareholder continues to own the same number of shares and retains the same proportional interest in the company, the outcome is consistent with that which would be achieved in the context of a dividend.

Immediately following the Capital Return, the Trust continued to own 100% of the shares in the Company. Therefore, this circumstance moderately contributes towards a conclusion that the capital return was made in substitution for a dividend, but this carries less weight in relation this particular scheme than paragraph 45B(8)(a).

Paragraphs 45B(8)(i)-(j)

Paragraph 45B(8)(i) is relevant for cases where a scheme involves the provision of ownership interests, or an increase in the value of ownership interests, and the later disposal of those interests. Paragraph 45B(8)(j) is about demergers. These circumstances are not relevant.

Part IVA matters

Paragraph 45B(8)(k) requires consideration of the matters referred to in subsection 177D(2) of the ITAA 1936. Although these factors appear in Part IVA of the ITAA 1936, these factors are relevant in the context of section 45B to consider whether the scheme will be carried out for a more than incidental purpose of enabling the relevant taxpayer to ‘obtain a tax benefit’ (as defined in subsection 45B(9)) in consequence of the provision of a capital benefit.

These matters operate together to direct attention to the means by which the tax benefit has been obtained, and broadly include:

n the manner in which the scheme was entered into or carried out

n the form and substance of the scheme

n the timing of the scheme,

n the financial, tax and non-tax effects of the scheme, and

n the nature of any connection between the taxpayer and other parties to the scheme.

Many of the other relevant circumstances discussed above amplify or elaborate on the matters in subsection 177D(2) and to this extent there is some overlap.

The return of capital by the Company will enable the relevant taxpayer, the Trust, to obtain a tax benefit. However, an examination of the Capital Return from a broad practical perspective by reference to the matters in subsection 177D(2), to identify its tax and non-tax objectives, does not suggest that the scheme was carried out for the requisite purpose.

Overall

Having regard to the relevant circumstances of the Capital Return to the Trust, it cannot be concluded that the scheme was entered into or carried out for a more than incidental purpose of enabling the Trust to obtain a tax benefit (within the meaning of subsection 45B(9)).

Conclusion

Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies to the Capital Return.

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