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Edited version of private advice
Authorisation Number: 1051742272216
Date of advice: 28 August 2020
Ruling
Subject: International restructure
Question 1
Will amounts arising from Y Co's disposal of its shares in Z Co to HO Co Country A be included in the assessable income of H Co Australia (as the provisional head company (PHC) of the H Co Australia MEC Group) under section 456 of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer
No
Question 2A
In relation to the disposal of X Co's shares in Y Co to H Co, will CGT event A1 happen pursuant to section 104-10 of the Income Tax Assessment Act 1997 (ITAA 1997)?
Answer
Yes
Question 2B
If the answer to Question 2A is yes, and a capital loss is made, will the capital loss be subject to Subdivision 170-D of the ITAA 1997?
Answer
Yes
Question 3
Answer
Yes
Question 4
Will the dividend declared by H Co Finance Australia to H Holdings Country A constitute a frankable distribution under section 202-40 of the ITAA 1997?
Answer
Yes
This ruling applies for the following period:
A specified year
The scheme commences on:
A specified date
Relevant facts and circumstances
A detailed factual background and structure was provided with the private ruling application.
The following are the relevant entities for the purposes of the edited version of the private ruling:
Head Co:
· Company incorporated in Country G
· Resident of Country G for tax purposes
· Top company of the H Co Australia multiple entry consolidated (MEC) group
· Indirectly wholly owns H Co Australia, H Co Finance Australia and all other members of the H Co Australia MEC group.
H Co:
· Company incorporated in the Country A
· A resident of the Country A for Country A tax purposes
· Indirectly wholly owned by Head Co
· Indirectly can control the exercise of XX% of the voting power in H Co Australia; and
· Has the right to receive XX% of any dividends paid by, or distributions of capital made by, H Co Australia; and
· Has sufficient influence over H Co Australia as described in subsection 318(6) of the ITAA 1936.
H Co Australia:
· Is a company incorporated in Australia and a resident of Australia for income tax purposes
· Is the PHC of the H Co Australia MEC group
· Is wholly owned by S Co
· Has a franking account balance of approximately AUD xxx; and
· Has a conduit foreign income balance of AUD xxx.
S Co:
· Is a company incorporated in Country P; and
· Is wholly owned by R Co.
R Co:
· Is a company incorporated in the Country A
· Is a resident of the Country A for tax purposes; and
· Is indirectly wholly owned by Head Co.
X Co:
· Is a company incorporated in Australia and therefore is a resident of Australia for Australian tax purposes pursuant to subsection 6(1) of the ITAA 1936
· Is an investment holding company
· Holds XX% of the issued share capital in Y Co
· Is indirectly wholly owned by H Co Australia; and
· Is a subsidiary member of the H Co Australia MEC group.
Y Co:
· Is a company incorporated in the Country A
· Is a resident of the Country A for Country A tax purposes
· Is an investment holding company
· Holds X% of the issued share capital of Z Co; and
· Is wholly owned by X Co.
H Co Finance Australia:
· Is a company, incorporated in Australia and therefore is a resident of Australia for Australian tax purposes pursuant to subsection 6(1) of the ITAA 1936
· Is an eligible tier-1 company of the H Co Australia MEC Group
· Prepares accounts in accordance with Australian accounting standards; and
· Is wholly owned by H Holdings Country A.
H Holdings Country A:
· Is a company incorporated in the Country A
· Is a resident of the Country A for Country A tax purposes; and
· Is indirectly wholly owned by Head Co.
HO Co Country A:
· Is a company incorporated in the Country A
· Is a resident of the Country A for Country A tax purposes; and
· Holds XX% of the issued share capital of Z Co.
Z Co:
· Is a company incorporated in the Country A
· Is a resident of the Country A for Country A tax purposes; and
· Has one asset, being a receivable owed by R Co which comprised a GBP xxx interest-free loan.
The percentage ownership that one entity has in another entity is representative of the "direct control interest" or "direct attribution interest" one entity has in another entity for the purposes of the controlled foreign company (CFC) rules in Part X of the ITAA 1936.
Relevant legislative provisions
Income Tax Assessment Act 1936, subsection 6(1)
Income Tax Assessment Act 1936, section 317
Income Tax Assessment Act 1936, section 318
Income Tax Assessment Act 1936, section 340
Income Tax Assessment Act 1936, subsection 350(1)
Income Tax Assessment Act 1936, section 357
Income Tax Assessment Act 1936, paragraph 361(1)(a)
Income Tax Assessment Act 1936, subsection 362(1)
Income Tax Assessment Act 1936, section 456
Income Tax Assessment Act 1997, section 104-10
Income Tax Assessment Act 1997, subsection 108-5(1)
Income Tax Assessment Act 1997, subdivision 170-D
Income Tax Assessment Act 1997, section 170-270
Income Tax Assessment Act 1997, subsection 170-260(3)
Income Tax Assessment Act 1997, subsection 170-255(1)
Income Tax Assessment Act 1997, section 170-265
Income Tax Assessment Act 1997, section 170-275
Income Tax Assessment Act 1997, section 202-40
Income Tax Assessment Act 1997, section 202-45
Income Tax Assessment Act 1997, section 701-1
Income Tax Assessment Act 1997, section 719-2
Income Tax Assessment Act 199, subsection 960-120(10)
Reasons for decision
Question 1
Summary
Amounts arising from the sale of the Z Co shares from Y Co to HO Co Country A will not be included in the assessable income of H Co Australia (as provisional head company of the H Co Australia MEC Group) under section 456 of the ITAA 1936.
Detailed reasoning
All legislative references are to the ITAA 1936 unless otherwise specified.
At Step 1 of the proposed transaction, HO Co Country A will purchase all of the shares held by Y Co in Z Co for fair market value (Z Co Sale). The book value of Y Co's investment in Z Co is GBP xxx,xxx,xxx, so an accounting gain of GBP xx,xxx is expected to arise for Y Co.
As per the facts, at the time of the Z Co sale (Step 1) and prior to the Y Co sale at Step 2 of the transaction:
· Y Co will be a CFC;
· H Co Australia will be an attributable taxpayer in relation to Y Co; and
· H Co Australia will have an attribution percentage of XX% in Y Co.
Section 456 is about assessability of a CFC's attributable income. Subsection 456(1) states that:
Subject to subsection (2), where a CFC has attributable income for a statutory accounting period in respect of an attributable taxpayer, the taxpayer's attribution percentage of the attributable income is included in the assessable income of the taxpayer of the year of income in which the end of the statutory accounting period occurs.
To determine the implications of the Z Co sale (Step 1) for H Co Australia following the Y Co sale (Step 2), it is necessary to establish if Y Co is a CFC and H Co Australia an attributable taxpayer with an attribution percentage in respect of Y Co at the end of the relevant statutory accounting period.
Section 381 provides that a company's attributable income must be calculated where, at the end of the company's statutory accounting period:
a) The company is a CFC; and
b) There are one or more attributable taxpayers in relation to that company.
Accordingly, the attributable income of a foreign company only needs to be calculated if it is a CFC at the end of its statutory accounting period; and there is at least one attributable taxpayer in relation to that CFC at the end of the CFC's statutory accounting period. The notes on section 381 in the Explanatory Memorandum to the Taxation Laws Amendment (Foreign Income) Bill 1990 confirms the following:
...A company which is not a CFC at the end of its statutory accounting period, even though it may have been a CFC at some other time during that period, will not have an attributable income for that period...The section also makes it clear that the attributable income is only to be calculated for those taxpayers that are attributable taxpayers at the end of the CFC's statutory accounting period. A person who was an attributable taxpayer during that period, but is not so at the end of the period, is not required to calculate the attributable income for that period.
It follows that as it is only necessary to calculate the attributable income for a taxpayer that is an attributable taxpayer at the end of a statutory accounting period, it is only necessary to calculate the attributable percentage for that taxpayer at this point in time for the purposes of subsection 456(1) (being the end of the statutory accounting period).
It is considered that Y Co is a CFC. on the basis that:
· It is not a resident of Australia for the purposes of subsection 6(1);
· It is a resident of the Country A for Country A tax purposes; and
· H Co Australia is an Australian X% entity with an associate-inclusive control interest in Y Co of XX%. While H Co Australia has a direct control interest and indirect control interest in Y Co of nil, its associate, H Co, has a direct control interest of XX% in Y Co.
Furthermore, H Co Australia is an attributable taxpayer of Y Co at the end of Y Co's statutory accounting period on the basis that:
· H Co Australia is a Part X Australian entity as it is a resident of Australia for the purposes of subsection 6(1); and
· H Co Australia, together with its associate H Co, has an associate inclusive control interest in Y Co of XX%.
As the Z Co and Y Co sales both occur in before the end of the same statutory accounting period, H Co Australia's (as provisional head company of the H Co Australia MEC group) attribution percentage will be nil. Accordingly, amounts arising from the sale of the Z Co shares from Y Co to HO Co Country A will not be included in the assessable income of H Co Australia (as provisional head company of the H Co Australia MEC Group) under section 456 of the ITAA 1936.
Question 2A
Yes, in relation to the disposal of X Co's shares in Y Co to H Co, CGT event A1 will happen pursuant to section 104-10 of the ITAA 1997.
All references are to the ITAA 1997 unless otherwise specified.
At Step 2 X Co proposes to sell its shares in Y Co to H Co for Y Co's net book value of GBPxxx million
Shares in a company are specifically listed as an example of a CGT asset in Note 1 to section 108-5. Therefore, the Y Co shares held by X Co (and H Co Australia as the provisional head company of the MEC group) are a CGT asset.
Section 104-10 provides that CGT event A1 happens when a taxpayer disposes of a CGT asset. A taxpayer disposes of a CGT asset if there is a change in the beneficial ownership of the asset. The time of the event is when the contract is entered into for the disposal, or in the absence of a contract, when the change in ownership occurs.
Accordingly, CGT event A1 will happen when H Co Australia (as the PHC of the H Co Australia MEC group) disposes of all of its shares in Y Co to H Co. H Co Australia will make:
(a) A capital gain to the extent that the capital proceeds from the disposal are greater than the cost base of the asset;
(b) A capital loss to the extent that the capital proceeds from the disposal are less than the reduced cost base of the asset; or
(c) Neither a capital gain nor a capital loss if the capital proceeds are greater than the reduced cost base of the shares but less than the cost base of the asset.
It follows that in relation to the disposal of X Co's shares in Y Co to H Co, CGT event A1 will happen pursuant to section 104-10 and H Co Australia will make a capital gain or loss in respect of sale at the time the contract for the disposal is entered into with H Co.
Summary
Yes, if a capital loss is made, the capital loss will be subject to Subdivision 170-D of the ITAA 1997.
Detailed reasoning
All references are to the ITAA 1997 unless otherwise specified.
Subdivision 170-D applies to defer a capital loss if a company (the "originating company") that is a member of a linked group disposes of a CGT asset to another entity that is:
a) A member of the same linked group; or
b) A connected entity or an associate of such a connected entity.
Per section 170-270, if Subdivision 170-D applies, the capital loss made by the originating company as a result of the deferral event is disregarded; and the originating company's entitlement to the deferred capital loss is triggered when certain events occur (as set out in section 170-275).
On the facts provided, with regard to the Y Co sale, H Co Australia (as the PHC of the H Co Australia MEC group) is the "originating entity" and H Co is the "other entity".
As, H Co (indirectly via R Co and S Co) can control XX% of the voting power in H Co Australia; and has the right to XX% of any dividends paid by, or distribution of capital made by H Co Australia, it is considered that H Co and H Co Australia are members of the same linked group for the purposes of subsection 170-260(2) and the operation of Subdivision 170-D.
On the facts provided, Subdivision 170-D will apply to the Y Co sale if a capital loss is made on the basis that:
· There is a deferral event which involves H Co Australia (as the PHC of the H Co Australia MEC group) and H Co;
· The deferral event is CGT event A1 and it is assumed that H Co Australia (as the PHC of the H Co Australia MEC group) made a capital loss from the deferral event;
· H Co Australia is an Australian resident at the time of the deferral event; and
· At the time of the deferral event, H Co Australia (as the provisional head company of the H Co Australia MEC group) and H Co are members of the same linked group.
It follows that any capital loss made by H Co Australia as a result of the Y Co sale is disregarded, and its entitlement to the deferred capital loss is triggered when a subsequent event set out in section 170-275 occurs.
Summary
The single entity rule (section 701-1 of the ITAA 1997) will apply where the loan between H Co Finance and X Co is forgiven as they are members of the H Co Australia MEC group.
Detailed reasoning
All references are to the ITAA 1997 unless otherwise specified.
As per the facts, X Co is indirectly wholly-owned by H Co Australia; and is a subsidiary member of the H Co Australia MEC group. H Co Finance is an eligible tier-1 company of the H Co Australia MEC Group. At Step 3 of the proposed transaction X Co lends the proceeds of the Y Co sale to H Co Finance, being the AUD equivalent of GBP xxx million. At step 4, X Co then forgives that loan to H Co Finance.
The SER in section 701-1 provides that entities that are subsidiary members of a consolidated group for a period, are taken to be a part of the head company of the group, rather than separate entities, during that period, for the head entity and entity core purposes. Generally, a MEC group is not considered to be a consolidated group. However, per section 719-2, where the term "consolidated group" is used in Part 3-90 (except for Divisions 703 and 719), it will include MEC groups. Accordingly, the reference to "consolidated group" in the SER in section 701-1 extends to include MEC groups.
The effect of the SER for Australian income tax purposes is established in Taxation Ruling TR 2004/11 Income tax: consolidation: the meaning and application of the single entity rule in Part 3-90 of the Income Tax Assessment Act 1997.
On applying TR 2004/11 to the facts, due to the operation of the SER in section 701-1, any intragroup transactions between members of the H Co Australia MEC group should be disregarded. Accordingly, for the purposes of section 701-1, the forgiveness of the loan owed by H Co Finance to X Co will not result in any Australian income tax consequences for H Co Australia as the provisional head entity of the MEC group.
Summary
Yes, the dividend declared by H Co Finance to H Holdings Country A will constitute a frankable distribution under section 202-40 of the ITAA 1997.
Detailed reasoning
All references are to the ITAA 1997 unless otherwise specified.
At step 5 of the proposed transaction, H Co Finance will declare a dividend to H Holdings Country A and will use the funds loaned to it by X Co to pay the dividend. H Co Finance intends to declare part of the dividend to be CFI and attach franking credits to the balance of the dividend such that the entire dividend is either declared to be CFI or franked.
Taxation Ruling TR 2012/5: Income tax: section 254T of the Corporations Act 2001 and the assessment and franking of dividends paid from 28 June 2010, at paragraph 2 gives the Commissioner's view that a dividend must be paid out of profits for it to satisfy the definition under subsection 6(1) of the ITAA 1936. Paragraph 2 states that 'profits' mean:
...profits recognised in a company's accounts which are available for distribution by way of dividend. Profits include: (i) revenue profits from ordinary business and trading activities, dividends received from other companies, and realised capital profits recognised in the statement of financial performance in a company's accounts; and (ii) unrealised capital profits of a permanent character recognised in a company's accounts. ...
The dividend paid by H Co Finance to H Holdings Country A will satisfy the definition of "dividend" under subsection 6(1) of the ITAA 1936 on the basis that there is a distribution from H Co Finance to its shareholder, H Holdings Country A. On the facts provided, the dividend will be paid out of profits on the basis that the forgiveness of the loan owing by H Co Finance to X Co will generate profit under Australian accounting standards that is recognised in the accounts of H Co Finance. Further, the profits will be available for distribution as a dividend as they have not been appropriated or earmarked for other purposes.
As per section 202-45, a distribution is frankable to the extent that it is not unfrankable. A distribution is unfrankable if, broadly, it is:
a) In the case of an off-market share buy-back by a company where there is a deemed dividend component, the excess of the purchase price over the market value of the share (if the buy-back did not take place and was never proposed to take place);
b) A distribution in respect of a non-equity share;
c) A distribution that is sourced, directly or indirectly, from a company's share capital account;
d) An amount that is taken to be unfrankable under sections 215-10 or 215-15 of the ITAA 1997;
e) A deemed dividend under Division 7A of the ITAA 1936 (under certain circumstances);
f) A deemed dividend under section 47A of the ITAA 1936;
g) An amount that is taken to be an unfranked dividend under section 45 or 45C of the ITAA 1936;
h) A demerger dividend; and
i) A distribution that is unfrankable under sections 152-125 or 220-105 of the ITAA 1997.
Paragraphs 3 to 5 of TR 2012/5 gives further consideration to the limitation regarding a distribution that is sourced, directly or indirectly, from a company's share capital account, as follows:
3. Paragraph 202-45(e) of the ITAA 1997 does not prevent a company from franking a dividend paid to its shareholders that is paid out of profits recognised in the company's accounts and available for distribution, and is paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act, merely because the company has unrecouped accounting losses accumulated in prior years or has lost part of its share capital. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936.
4. Paragraph 202-45(e) of the ITAA 1997 does not prevent a company from franking a dividend paid to its shareholders out of an unrealised capital profit of a permanent character recognised in its accounts and available for distribution, provided that the company's net assets exceed its share capital by at least the amount of the dividend, and the dividend is paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act. That dividend will be assessable income of its resident shareholders under paragraph 44(1)(a) of the ITAA 1936.
5. Paragraph 202-45(e) of the ITAA 1997 prevents the franking of a distribution paid by a company to its shareholders where that distribution is a reduction or return of share capital, including an unauthorised reduction or return of share capital that does not comply with section 254T or Part 2J.1 of the Corporations Act, even if it is labelled as a dividend. That distribution will be taxed as a capital gains tax (CGT) event under the CGT provisions in Part 3-1 of the ITAA 1997, or will be taxed as an assessable unfranked dividend, depending on the particular facts and circumstances of the payment.
On the facts provided, the distribution will not be sourced (either directly or indirectly) from H Co Finance's share capital account, but rather, will be paid from current year profits. Further, none of the other circumstances in which a distribution will be unfrankable in section 202-45 are relevant. Accordingly, the distribution should not be unfrankable under section 202-45.
The dividend declared by H Co Finance to H Holdings Country A will constitute a frankable distribution under section 202-40 on the basis that:
· The dividend satisfies the requirements of subsection 6(1) of the ITAA 1936;
· The dividend is to be paid out of profits that are recognised in accordance with AASB standards and are available for distribution (as they have not been appropriated or earmarked for another purpose);
· The dividend is to be paid in accordance with H Co Finance's constitution; and
· The dividend will be paid without breaching section 254T or Part 2J.1 of the Corporations Act 2001.
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