Edited version of your written advice

Authorisation Number: 1051496319982

Date of advice: 4 April 2019

Ruling

Subject: Proposed in specie liquidation distribution to foreign resident shareholder

Question 1

Will any part of the distribution made by the liquidator in the course of the proposed liquidation of Company A be treated as a dividend under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will any part of the distribution made by the liquidator in the course of the proposed liquidation of Company A 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?

Answer

No

Question 3

Is an amount required to be withheld by Company A in respect of the proposed liquidator’s distributions by Company A to Company B pursuant to section 12-210 of the Taxation Administration Act 1953 (TAA)?

Answer

No

Question 4

Will any capital gain arise to Company B as a result of the liquidation of SMG when either CGT event C2 or CGT event G1 occurs?

Answer

No

This ruling applies for the following period:

For the income year ended 30 June XXXX

The scheme commences on:

1 July XXXX

Relevant facts and circumstances

Company A is an Australian incorporated company and resident in Australia for tax purposes.

Company A is a wholly owned subsidiary of a foreign resident company (Company B). Company B operates a business in the foreign country.

Company A acts as an investment company, holding a significant stake in another foreign resident company (Company C). Company C is incorporated in, and a tax resident of, a foreign country and only operates a business and holds assets in that foreign country.

Company A’s primary source of income is dividends from Company C.

Acquisition of Company A by Company B

A few years ago 100% of the issued share capital of Company A was acquired by Company B. The shares were acquired by Company B on capital account.

Immediately prior to the acquisition, Company A was a wholly owned subsidiary of an Australian resident company, Company D, and was a subsidiary member of the Company D consolidated group. The Company D consolidated group acquired its 100% interest in Company A at an earlier time and at that time Company A joined the consolidated group.

Following acquisition by Company B, Company A exited the Company D consolidated group.

Financial position of Company A

Company A’s assets consist of cash and cash equivalents and its investment in Company C. Company A’s investment in Company C appeared in its financial accounts of Company A at historic book value.

Company A has in recent years received dividends from Company C and paid dividends to Company B. Those dividends were unfranked and declared to be conduit foreign income.

Under the tax consolidation “exit history rule” Company A had inherited the reset tax cost base of the assets that it held on leaving the Company D consolidated group. This cost base has not been subject to alteration by the operation of the tax law since that time.

The current market value of the shares in Company C is less than the tax cost base of the shares that Company A had inherited.

Company A’s share capital account is not tainted for the purposes of the ITAA 1936.

Proposed liquidation of Company A and in-specie distribution of shares in Company C

Company B is intending to liquidate Company A by way of Member’s Voluntary Liquidation under Part 5.5 of the Corporations Act 2001(Cth).

Prior to liquidation Company A will distribute any current year or accumulated profits reserve by way of dividend to Company B.

Immediately prior to entering liquidation, the balance sheet of Company A is expected to be as follows:

DR Cash and equivalents

DR Investment in Company C

CR Share Capital (net of accumulated losses)

The book value of the assets to be distributed as recorded in the financial accounts will not exceed the share capital account. Under the proposed liquidation, Company A would distribute its remaining assets in specie by way of liquidator’s distribution to its sole shareholder Company B. This includes a distribution of the shares in Company C and cash and cash equivalents.

Company A will not make a capital gain on the disposal of the shares in Company C upon the making of the in specie distribution (on the basis that the market value of the shares in Company C is less than the cost base and reduced cost base of the shares in Company C).

The accounting entries for the distribution will be as follows:

DR Share Capital (sum of below)

CR Cash and equivalents (to nil)

CR Investment in Company C (to nil)

No other capital gains events, other than those related to the disposal of the shares in Company C will arise for Company A in the relevant income period of the liquidation.

Relevant legislative provisions

Subsection 6(1) of the Income Tax Assessment Act 1936

Subsection 47(1) of the Income Tax Assessment Act 1936

Subsection 47(1A) of the Income Tax Assessment Act 1936

Section 128B of the Income Tax Assessment Act 1936

Section 12-210 of the Taxation Administration Act 1953

Section 12-225 of the Taxation Administration Act 1953

Section 12-300 of the Taxation Administration Act 1953

Section 104-25 of the Income Tax Assessment Act 1997

Section 104-35 of the Income Tax Assessment Act 1997

Section 855-10 of the Income Tax Assessment Act 1997

Section 855-15 of the Income Tax Assessment Act 1997

Section 855-20 of the Income Tax Assessment Act 1997

Section 855-25 of the Income Tax Assessment Act 1997

Section 855-30 of the Income Tax Assessment Act 1997

Subdivision 690-GP of the Income Tax Assessment Act 1997

Reasons for Decision

Question 1

Summary

No part of the distribution made by the liquidator in the course of the proposed liquidation of Company A will be treated as a dividend under subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

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 which is wound up: 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 4437.

In Commissioner of Taxation (NSW) v Stevenson (1937) 59 CLR 80, Rich, Dixon and McTiernan JJ said at 98-99:

But an entirely different set of considerations arises when accumulated profits exist in a company which winds up. In the liquidation the excess of its assets over its external liabilities is distributed among the shareholders in extinguishment of their shares. The shareholders, in other words, as contributories receive nothing but the ultimate capital value of the intangible property constituted by the shares. The res itself ceases to exist. The profits are not detached, released or liberated, leaving the share intact as a piece of property. There is no dividend upon the share. There is no distribution of profits because they are profits. The shareholder simply receives his proper proportion of a total net fund without distinction in respect of the source of its components and he receives it in replacement for his share. [emphasis added]

The definition of dividend in subsection 6(1) of the ITAA 1936 is ‘any distribution made by a company to any of its shareholders, whether in money or other property; and any amount credited by a company to any of its shareholders’ [emphasis added]. Consequently, the term ‘dividend’ is broad¹, and there is support for the view that it is wide enough to include distributions made by the liquidator of a company to its shareholders.²

However, it is necessary to bear in mind that section 47 of the ITAA 1936 expressly deals with distributions by a liquidator and was an original section of the ITAA 1936³. In that context, the section was intended to cover the field with which it dealt. Section 44 of the ITAA 1936 will not apply, except to the extent that section 47 deems the distributions to be dividends.

Further, it is noted that section 44 of the ITAA 1936 provides that if another provision of the ITAA 1936 includes or excludes some or all of the dividend from the shareholder’s income, section 44 will not apply to that amount so included or excluded.

The relevant provision to consider in these circumstances is section 47 of the ITAA 1936 which specifically deals with distributions by liquidators in the course of a winding up.

Question 2

Summary

No part of the distribution made by the liquidator in the course of the proposed liquidation of Company A will 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.

Detailed reasoning

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 the term income derived has its ordinary meaning (income according to ordinary concepts) and does not include amounts, such as capital profits, that are specifically included in the 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 1936⁴.

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 Income Tax Assessment Act 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.

Notwithstanding this extended definition of ‘income’ in subsection 47(1A) it is accepted by the Commissioner, in accordance with Archer Brothers Pty Ltd (In Liq) v FCT (1953) 90 CLR 140 (Archer Brothers), that subsection 47(1) cannot operate to deem any more than the amount actually distributed to be a dividend (see paragraph 2 of Taxation Determination TD 2000/5 Income tax: capital gains: does the requirement to disregard capital losses in Step 2 of the method statement in paragraph 47(1A)(b) of the Income Tax Assessment Act 1936 affect the application of the Archer Brothers principle?)

Application to your circumstances

Immediately prior to entering liquidation, the balance sheet of Company A is expected to be as follows:

DR Cash and equivalents

DR Investment in Company C

CR Share Capital (net of accumulated losses)

Under the proposed liquidation the remaining assets of Company A are to be distributed in specie by way of liquidator’s distribution to its sole shareholder Company B. This includes a distribution of the shares in Company C and residual cash and cash equivalents.

In the case of an in specie distribution of assets in the course of a liquidation, it is considered that any capital gain that arises on the transfer of the assets to the shareholders is, in a real sense, directly distributed. Therefore, the distribution of the assets can represent income derived by the company within the extended meaning in subsection 47(1A).

The distribution of the shares in Company C in specie to Company B will result in a disposal and CGT Event A1 for Company A⁵. On the assumption the market value⁶ of the shares is still less than the tax cost base (as inherited by Company A) then no capital gain (but rather a capital loss) will arise for Company A on the (deemed) disposal of the Company C shares. Therefore, Company A 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.

On that basis, no amount of the distribution of the assets in the course of winding up Company A will be deemed to be 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.

Question 3

Summary

Company A is not required to withhold an amount from the proposed liquidator’s distributions from Company A to Company B pursuant to section 12-210 of the Taxation Administration Act 1953.

Detailed reasoning

Subject to certain exclusions, section 128B applies to levy income tax on income that is derived by a non-resident that consists of a dividend paid by an Australian resident company. Non-residents are liable to pay withholding tax on the dividend income at the rate prescribed by Parliament under subsection 128B(4) of the ITAA 1936 and section 7 of the Income Tax (Dividends, Interest and Royalties Withholding Tax) Act 1974.

To ensure the efficient collection of withholding tax, an amount on account of the withholding tax is required to be withheld pursuant to the Pay as you go (PAYG) withholding provisions of Part 2-5 of Schedule 1 to the TAA 1953.

Section 12-210 of Schedule 1 to the TAA provides that a resident company must withhold an amount from a dividend it pays to a shareholder who according to the register of company members has an address outside Australia.

Section 12-225 of Schedule 1 to the TAA extends the withholding obligations to a distribution made by a liquidator to a foreign resident in the course of winding up a company to the extent that the payment is treated as a dividend under section 47 of the ITAA 1936.

However, no withholding is required from a dividend if no withholding tax is payable in respect of it under section 128B of the ITAA 1936: section 12-300 of Schedule 1 to the TAA.

In summary, section 128B(4) in conjunction with subsection 128B(1) of the ITAA 1936 imposes withholding tax on income that consists of a dividend. Section 12-210 of the TAA imposes an obligation to withhold from a dividend (or a deemed dividend under subsection 47(1)) but not if no withholding tax is payable in respect of the dividend under section 128B.

Consistent with the reasoning given above, no part of the proposed liquidation distribution from Company A to Company B is treated as a dividend or deemed to be a dividend under subsection 47(1) having regard to the extended meaning of ‘income derived by a company’ in subsection 47(1A) of the ITAA 1936. Further, no withholding tax is payable in respect of the proposed distribution under section 128B of the ITAA 1936.

Therefore, no obligation to withhold will arise for Company A under section 12-210 of the TAA in respect of the proposed liquidation distributions.

Question 4

Summary

A capital gain that arises to Company B as a result of the proposed liquidation of Company A when either CGT event C2 or CGT event G1 occurs will be disregarded under section 855-10 of the ITAA 1997.

Detailed reasoning

Section 104-25 of the ITAA 1997 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

a) being redeemed or cancelled; or

b) being released, discharged or satisfied; or

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 104-25(2) of the ITAA 1997. A taxpayer will make a capital gain if the capital proceeds from the ending are more than the asset's cost base or a capital loss if those capital proceeds are less than the asset's reduced cost base: subsection 104-25(3) of the ITAA 1997.

CGT event G1 happens pursuant to section 104-135 of the ITAA 1997 if a company makes a payment to a shareholder in respect of a share they own in the company, some or all of the payment (the non-assessable part) is not a dividend, or an amount that is taken to be a dividend under section 47, and the payment is not included in the shareholder's assessable income. The payment can include giving property.

The time of the event is when the company makes the payment: subsection 104-35(2) of the ITAA 1997. The shareholder makes a capital gain if the amount of the non-assessable part is more than the share’s cost base. If a capital gain is made, the share’s cost base and reduced cost base are reduced to nil: subsection 104-135(3). Where the amount of the non-assessable part is not more than the share's cost base, that cost base and the share’s reduced cost base are reduced by the amount of the non-assessable part: subsection 104-135(4) of the ITAA 1997.

However, in accordance with subsection 104-135(6) of the ITAA 1997, you disregard a payment by a liquidator for the purposes of section 104-135 where the company ceases to exist within 18 months of the payment (i.e. CGT Event G1 is specifically excluded in favour of CGT event C2).

Taxation Determination TD 2001/27 Income tax: capital gains: how do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('ITAA 1997') treat: (a) a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') to be a dividend; and (b) an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1)? considers how Parts 3-1 and 3-3 of the ITAA 1997 treat interim and final liquidation distributions, including where all or part of it is deemed by subsection 47(1) of the ITAA 1936) to be a dividend.

In respect to final liquidation distributions, paragraph 1 of TD 2001/27 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 section 44 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) of the ITAA 1997, ensures that no part of the final liquidator's distribution is taxed both as a dividend and as a capital gain.

TD 2001/27 explains how CGT Event G1 may apply to the non-assessable part of an interim liquidation distribution:

6. CGT event G1 (about capital payments for shares) in subsection 104-135(1) of the ITAA 1997 may result in capital gains being made and (or) the need for cost base and reduced cost base reductions in respect of shares in a company in liquidation. However, it may do so only to the extent that the interim distribution made by the company's liquidator is not an amount that is deemed to be a dividend under subsection 47(1) of the ITAA 1936 (referred to in section 104-135 and in this Taxation Determination as the 'non-assessable part') and the company does not cease to exist within 18 months of the distribution being paid…

Therefore, CGT Event C2 will happen in respect of the shares held by Company B under the proposed liquidation when Company A ceases to exist. CGT Event G1 will only apply to the payment (distribution) made by the liquidator to Company B if Company A does not cease to exist within 18 months of the distribution being made.

Disregarding capital gains or losses for foreign residents

Division 855 of the ITAA 1997 sets the conditions under which foreign residents are entitled to disregard a capital gain or capital loss arising from a CGT event.

Subsection 855-10(1) of the ITAA 1997 provides as follows:

Disregard a *capital gain or *capital loss from a *CGT event if:

(a) you are a foreign resident, or the trustee of a *foreign trust for CGT purposes, just before the CGT event happens; and

(b) the CGT event happens in relation to a *CGT asset that is not *taxable Australian property.

Section 855-15 of the ITAA 1997 sets out 5 categories of *CGT assets that are taxable Australian property:

CGT assets that are taxable Australian property
Item	Description
1	*Taxable Australian real property (see section 855-20)
2	A *CGT asset that:
	(a)	is an *indirect Australian real property interest (see section 855-25); and
	(b)	is not covered by item 5 of this table
3	A *CGT asset that:
	(a)	you have used at any time in carrying on a *business through:
		(i)	if you are a resident in a country that has entered into an *international tax agreement with Australia containing a *permanent establishment article - a permanent establishment (within the meaning of the relevant international tax agreement) in Australia; or
		(ii)	otherwise - a *permanent establishment in Australia; and
	(b)	is not covered by item 1, 2 or 5 of this table
4	An option or right to *acquire a *CGT asset covered by item 1, 2 or 3 of this table
5	A *CGT asset that is covered by subsection 104-165(3) (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 (TARP) as follows:

A*CGT asset is taxable Australian real property if it is:

(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.

In this case, it is relevant to consider item 2 of the table in section 855-15 of the ITAA 1997.

An indirect Australian real property interest is defined in section 855-25(1) of the ITAA 1997 and includes shares (i.e. a *membership interest) held by an entity in another entity if the interest passes the non- portfolio interest test (broadly the holder has a 10% or more interest in the entity) and passes the principal asset test in section 855-30 at the relevant test time.

An interest passes the non-portfolio interest test if the sum of direct participation interests held by a foreign resident and its associates in the test entity is 10% or more: section 960-195 of the ITAA 1997. Participation interests in entities are defined in Subdivision 690-GP of the ITAA 1997.

The interest Company B holds in Company A passes the non-portfolio interest test as Company A is a wholly owned subsidiary of Company B.

The purpose of the principal asset test in section 855-30 of the ITAA 1997 is to define when an entity's underlying value is principally derived from Australian real property: subsection 855-30(1).

Subsection 855-30(2) of the ITAA 1997 provides that a membership interest held by the holding entity in the test entity passes the principal asset test if the sum of the market values of the test entity's 'assets' that are TARP exceeds the sum of the market values of its 'assets' that are not TARP.

Subsection 855-30(3) of the ITAA 1997 provides that for the purposes of subsection (2), an asset of an entity (the 'first entity') that is a membership interest in another entity (the 'other entity') is treated as if it were instead the following two assets:

(a) an asset that is taxable Australian real property (the 'TARP asset');

(b) an asset that is not taxable Australian real property (the 'non-TARP asset').

The market values of the TARP assets and the non-TARP assets are worked out according to the table in subsection 855-30(4). Where the first entity holds a direct participation interest in the other entity of at least 10 per cent and the holding entity holds a total participation interest in the other entity of at least 10 per cent, the market value of the taxable Australian real property and non-taxable Australian real property assets is based on the market values of the assets of the other entity. The value of the membership interest that an entity (first entity) holds in another entity (the other entity) that is taxable Australian real property is calculated by multiplying the sum of the values of the assets of the other entity that are taxable Australian real property by the first entity's direct participation interest in the other entity. Similarly, the value of the membership interest that an entity (first entity) holds in another entity (the other entity) that is not taxable Australian real property is calculated by multiplying the sum of the values of the assets of the other entity that are not taxable Australian real property by the first entity's direct participation interest in the other entity.

The assets held by Company A at the time of the proposed liquidation distribution will be cash or cash equivalents and shares in Company C which is incorporated in, and a tax resident of, a foreign country. Company C only operates a business in that country and holds its assets in that foreign country.

It is accepted that the shares held by Company B in Company A will not pass the principal asset test. Therefore, the shares held by Company B in Company A will not constitute an indirect Australian real property interest and will not be taxable Australian property.

Therefore, Company B will disregard any capital gain made pursuant to CGT Event C2 or CGT Event G1 under section 855-10 of the ITAA 1997 because Company B will be a foreign resident just before the CGT event happens and the CGT event will happen in relation to the shares in Company A that are not taxable Australian property.

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