Edited version of private advice

Authorisation Number: 1052127332430

Date of advice: 16 June 2023

Ruling

Subject: Return of capital and special dividend

Question 1

Will the return of share capital of $XX per share paid by Company A on DD MM 20XX (Return of Capital) constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will the Commissioner make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole or part of the Return of Capital?

Answer

No

Question 3

Will the Commissioner make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole or part of the Return of Capital?

Answer

No

This ruling applies for the following period:

1 July 20XX to 30 June 20XX

The scheme commenced on:

DD MM 20XX

Relevant facts and circumstances

Background

1.    Company A is an Australian tax resident public company listed on the Australian Securities Exchange (ASX). It is the head company of the Company A group.

2.    Company A was incorporated and listed on the ASX after 20 September 1985.

3.    All shares on issue by Company A are ordinary shares.

4.    Company A's share capital account is a share capital account for income tax purposes in accordance with subsection 975-300(1) of the Income Tax Assessment Act 1997 (ITAA 1997). Further, Company A's share capital account is not tainted within the meaning of section 197-50 of the ITAA 1997.

5.    Company A satisfies the definition of 'widely held company' in accordance with section 995-1 of the ITAA 1997.

6.    As of DD MM 20XX, a large majority of Company A's shareholder base consisted of Australian shareholders. Further, Australian shareholders held the majority of Company A's total share ownership. The non-resident shareholding amount of Company A is not sufficient to influence, or confer control of, the company.

7.    Company A does not hold sufficient Australian real property for the shares to pass the principal asset test. Therefore, Company A shares are not taxable Australian property under table item 2 in section 855-15.

8.    In recent years, there has been no interruption to the normal pattern of profit distributions and franking percentages thereof that have been paid to Company A shareholders by Company A.

The Sale

9.    Company A several entities within its group to Company B (the Sale) for a total aggregate cash consideration of approximately A$XX, on a cash-free debt-free basis and subject to usual net working capital and net debt adjustment mechanisms. The Sale constituted a disposal of a significant part of Company A's business.

The return of capital and special dividend

10.  The Return of Capital constituted an equal reduction of Company A's share capital for the purposes of the Corporations Act 2001.

11.  All Company A shareholders at the Record Date received the same return of capital payment of $XX per share and the same aggregate special dividend of $XX per share.

12.  All Company A shareholders at the Record Date received the return of capital on the same terms irrespective of their tax profile and without regard to whether the shareholder derived a greater benefit in accordance with the circumstances in subparagraph 45A(3)(b) of the ITAA 1936 from the return of capital.

13.  No shares were cancelled in connection with the equal capital reduction and no fractional entitlements arose.

14.  Company A did not raise share capital as part of the return of capital.

15.  Company A did not provide ownership interests as part of the return of capital to its shareholders.

16.  The special dividend was unfranked and XX% of the unfranked dividend was declared as conduit foreign income.

Calculation of the distribution under the Slice Approach

17.  Company A adopted the 'slice approach' as outlines in paragraph 73 of Practice Statement Law Administration PS LA 2008/10: Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions (PS LA 2008/10) to determine the allocation between capital invested by Company A in the disposed businesses and the respective dividend.

18.  Under the 'slice approach', the amount of capital invested in the disposed businesses was determined by the ratio of market value of the disposed businesses to the market value of the Company A group.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-135

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Section 197-50

Income Tax Assessment Act 1997 Section 975-300

Income Tax Assessment Act 1997 Subsection 995-1(1)

Reasons for decision

Question 1

Summary

The return of capital by Company A was not a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for income tax purposes.

Detailed Reasoning

Subsection 6(1): 'Dividend'

The term 'dividend' is defined in subsection 6(1) of the ITAA 1936 and includes any distribution made by a company to any of its shareholders, whether in money or other property (paragraph (a) of the definition). The payment of money under the return of capital satisfies this definition.

However, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 excludes money paid by a company to a shareholder where the amount of the money paid is debited against an amount standing to the credit of the share capital account of the company.

The return of capital was debited in full against Company A's share capital account. Company A's share capital account (as defined in section 975-300 of the ITAA 1997) is not tainted (within the meaning of Division 197 of the ITAA 1997).

Subsection 6(4): exception

Subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph (d) of the definition of "dividend" in subsection 6(1) will not apply where, "under an arrangement":

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed.

It is accepted that the Return of Capital was made pursuant to the objective of reducing equity in Company A in an amount considered to be unnecessary to its needs.

As such, the Return of Capital does not fall within the scope of the arrangement contemplated by subsection 6(4).

Conclusion

The Return of Capital is not a 'dividend' under subsection 6(1) of the ITAA 1936, as it is a distribution to the shareholders from an untainted share capital account and does not fall within the scope of the exclusion in subsection 6(4).

Question 2

Summary

The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the return of capital.

Detailed Reasoning

Section 45A

Section 45A of the ITAA 1936 applies when a company streams the provision of capital benefits to shareholders who would derive a greater benefit from the capital benefits than other shareholders and it is reasonable to assume that the other shareholders have received, or will receive, dividends (subsection 45A(1) of the ITAA 1936).

The term 'streaming' is not defined in either the ITAA 1936 or the ITAA 1997. In general, streaming refers to a strategy of selectively directing a certain type of benefit to those entities which will derive the greatest advantage (for particular tax purposes) from that benefit as opposed to another type of benefit.

In the context of section 45A of the ITAA 1936, streaming describes arrangements where capital benefits are allocated to shareholders who have a preference for capital, with all other shareholders receiving dividends. The circumstances in which a shareholder would derive a 'greater benefit' from capital benefits are listed (but not exhaustively) in subsection 45A(4).

The phrase 'provision of a capital benefit' to a shareholder in a company is defined in subsection 45A(3) of the ITAA 1936 and includes the distribution to the shareholder of share capital (paragraph 45A(3)(b)). The share capital paid to Company A shareholders under the return of capital means that there was the provision of a capital benefit to Company A shareholders.

In this case, the following factors are relevant in determining whether there was a streaming of capital benefits to Company A shareholders:

•         The return of capital was affected as a pro-rata / equal capital reduction.

•         All Company A shareholders at the Record Date received the same return of capital payment of $XX per share and the same special dividend of $YY per share.

•         Company A is a widely held public company.

•         All Company A shareholders at the Record Date received the return of capital on the same terms irrespective of their tax profile and without regard to whether the shareholder would derive a greater benefit from the return of capital.

In consideration of the above factors, the Commissioner is satisfied that there was no streaming of capital benefits. Accordingly, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies in relation to the whole, or a part, of the capital benefit provided to Company A shareholders. No part of the reduction of share capital will be treated as a dividend for income tax purposes under section 45A.

Question 3

Summary

The Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or any part, of the return of capital.

Detailed Reasoning

Section 45B

Section 45B of the ITAA 1936 applies where certain capital benefits are, having regard to the relevant circumstances of the scheme in subsection 45B(8), considered to have been provided to shareholders by a company for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit.

Where section 45B applies, the Commissioner may make a determination that all or part of the capital benefit is taken to be a dividend paid by the company for income tax purposes. Paragraph 45B(3)(b) of the ITAA 1936 states the following:

(3) The Commissioner may make, in writing, a determination that:

...

(b) section 45C applies in relation to the whole, or a part, of the capital benefit.

Subsection 45C(3) provides the following:

(3) If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or the part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company:

(a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and

(b) the amount of the franking debit is the amount that, if the company had:

(i) paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and

(ii) fully franked the dividend;

would have been the amount of the franking credit of the company that would have arisen as a result of the dividend.

Under subsection 45B(2), the Commissioner will make the relevant determination where:

•         there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a))

•         under the scheme, a person (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)), and

•         having regard to the relevant circumstances of the scheme, it would be concluded that a person who entered into or carried out the scheme or any part of the scheme did so for a more than incidental purposes of enabling the relevant taxpayer to obtain the tax benefit (paragraph 45B(2)(c)).

Scheme

Subsection 45B(10) provides that, in section 45B, 'scheme' has the meaning given by subsection 995-1(1) of the ITAA 1997.

That term means any arrangement (itself defined by subsection 995-1(1) of the ITAA 1997 as any arrangement, agreement, understanding, promise or undertaking, whether express or implied, and whether or not enforceable (or intended to be enforceable) by legal proceedings), or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

The payment of the return of capital by Company A to its shareholders is a scheme for the purposes of section 45B.

Under which a person is provided with a capital benefit by a company

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936.

As the reduction of share capital is a distribution to the shareholders of Company A of share capital, Company A has provided its shareholders with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936.

A taxpayer obtains a tax benefit

Under subsection 45B(9) of the ITAA 1936, a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by the relevant taxpayer would, apart from section 45B, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the capital benefit had been an assessable dividend.

Australian resident shareholders

From a resident shareholder's perspective, the Return of Capital is only assessable in the hands of an Australian resident shareholder, to the extent that a capital gain arises under CGT event G1. Any capital gain is taxable if the Return of Capital exceeds the cost base of the share and the amount may be reduced by the CGT discount. If the capital benefit had been an assessable dividend, it would have been included in the assessable income of all resident shareholders, on which tax would be payable.

Therefore, Australian resident shareholders could receive a tax benefit as a result of receiving the Return of Capital.

Non-resident shareholders

Non-residents are not exposed to capital gains on the disposal of shares unless those shares are not 'taxable Australian property' as defined in section 855-15. Item 2 under section 855-15 is the only relevant item to Company A's circumstances in this case. Item 2 defines taxable Australian property to include an indirect Australian real property interest.

Subsection 855-25(1) provides that 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 principal asset test under subsection 855-30(2) of the ITAA 1997 is as follows:

A membership interest held by an entity (the holding entity) in another entity (the test entity) 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.

To the extent that a non-resident shareholder, either alone or together with any associates, beneficially hold (or have held at any time in the previous 12 months) less than 10% of Company A shares, the non-portfolio interest test will not be satisfied and therefore, the Company A shares will not be an indirect Australian real property interest for those shareholders.

Company A shares do not constitute 'taxable Australian property of non-resident shareholders in accordance with table item 2 of section 855-15 of the ITAA 1997. Accordingly, the return of capital is not assessable in the hands of non-resident shareholders.

The relevant circumstances

Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to consider the 'relevant circumstances of the scheme', which are listed (non-exhaustively) in subsection 45B(8) of the ITAA 1936, in order to reach an objective conclusion about whether a person who entered into or carried out the scheme or any part of the scheme did so for a more than incidental purpose of enabling the relevant taxpayer to obtain a tax benefit.

Each of the factors under subsection 45B(8) of the ITAA 1936 were examined by the Commissioner and applied to the relevant circumstances of Company A's scheme.

Some of the relevant circumstances of the scheme incline towards the existence of the requisite purpose. However, having regard to all of the relevant circumstances of Company A's Return of Capital, the Commissioner considers that the scheme was not entered into or carried out for a more than incidental purpose of enabling Company A shareholders to obtain a tax benefit.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit constituted by the distribution of share capital to Company A shareholders. No part of the return of capital will be treated as a dividend for income tax purposes under section 45B of the ITAA 1936.

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