Edited version of private advice

Authorisation Number: 1052162760856

Date of advice: 4 September 2023

Ruling

Subject: Return of capital

Question 1

Will the Return of Capital constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) or be assessable as dividend income pursuant to section 44 of the ITAA 1936?

Answer

No

Question 2

As a consequence of the Return of Capital, is Company A required under subsection 45D(1A) of the ITAA 1936 to give a copy of the Commissioner's determination under subsection 45A(2) or paragraph 45B(3)(b) to its shareholders?

Answer

No

This ruling applies for the following period:

1 October 20XX to 30 September 20XX

The scheme commences on:

DD MM 20XX

Relevant facts and circumstances

Group A

1.    Company A is an Australian resident company and the ultimate Australian parent entity of the Group A.

2.    Company B is a non-resident and is the immediate parent company of Company A. Company C is the ultimate parent of Company A and Company B.

3.    Company A was incorporated in Australia.

The acquisition of the Group A

4.    On DD MM 20XX, Company A entered into a senior, secured Syndicated Facility Agreement (SFA).

5.    The SFA was entered to:

•                     partly fund the acquisition of Group A

•                     pay out the existing debt

•                     fund future growth, and

•                     provide ongoing liquidity support.

6.    On DD MM 20XX, Company A completed its acquisition of Group A through the acquisition of 100% of the shares in Company D for a total consideration of A$XX.

7.    The acquisition was funded by the equity capital raised from Company B, together with debt funding sourced from the SFA.

Equity Capital Structure of Company A

8.    Company A has two class of shares on issue, ordinary shares and B Class shares.

9.    As at DD MM 20XX, Company A had a total of X ordinary shares on issue to Company A with total share capital of $XX ($XX per ordinary share).

10.  On DD MM 20XX, Company A issued X B Class shares to Australian key management personnel and eligible employees (the Participants).

11.  As at DD MM 20XX, Company A had a total of X B Class shares on issue with total share capital of $XX.

12.  Of the X B Class shares on issue, X (X%) are issued to Australian resident Participants and X (X%) are issued to non-resident Participants.

Refinance of the SFA

13.  Company E an Australian subsidiary of Company A and a subsidiary member of the Company A TCG, is proposing to enter into a new facility of $X to repay and replace the existing SFA.

14.  Group A management and treasury undertook a review of its capital structure and ongoing funding requirements.

15.  As a result of this review, a decision was made to enter into the SFA which will increase the facility limit to $X.

16.  Group A management considers the increased facility limit:

•                     Optimises the capital structure for the group by ensuring an appropriate mix of debt/equity funding and favourable debt funding.

•                     Is supportable with reference to the relevant financial ratios.

•                     Provides the ability to support ongoing working capital and liquidity requirements but also to fund and drive growth.

17.  The SFA will be entered into with a syndicate of lenders.

Return of Capital

18.  Company A proposes to return capital of $X per ordinary share and B Class share, for a total return of capital of $X (the Return of Capital).

19.  The Return of Capital will be provided proportionately to the sole ordinary shareholder (Company B) and the Participants.

20.  The Return of Capital seeks to return equity capital that is surplus to the Group A requirements going forward.

21.  The Return of Capital will not vary the rights of the issued shares.

22.  No ordinary share or B Class share will be cancelled as a result of the Return of Capital.

23.  The Return of Capital will be effected in accordance with section 256B(2) of the Corporations Act 2001.

Franking account

24.  At DD MM 20XX, the Group A TCG had a franking account balance of $X and has a benchmark franking percentage of X%.

Dividend history

25.  Group A's informal dividend policy was, based on management forecasts, to return approximately $X per annum (based on expected realised after tax profit after capital expenses and debt servicing costs, supportable with available cash). Any additional earnings in excess of the annual dividend were to be retained by Group A for reinvestment in the business.

26.  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.

27.  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.

Other

28.  Company B's ownership interest in Company A does not constitute taxable Australian property for the purposes of Division 855 of the ITAA 1997.

29.  Company B does not have any capital losses that may be applied to the Return of Capital.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 subsection 6(4)

Income Tax Assessment Act 1936 subsection 44(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 1936 subsection 45D(1A)

Income Tax Assessment Act 1936 section 128B

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 to shareholders will not constitute a dividend as defined in subsection 6(1) of the ITAA 1936 or be assessable as dividend income pursuant to section 44 of the ITAA 1936.

Detailed Reasoning

All legislative references are to the ITAA 1936 unless otherwise identified.

The term 'dividend' is defined in subsection 6(1) to include:

(a)          any distribution made by a company to any of its shareholders, whether in money or other property

However, paragraph (d) of the definition of 'dividend' excludes:

moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company.

The term 'share capital account' is defined in subsection 975-300(1) of the ITAA 1997 as an account that the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital.

Subsection 975-300(3) of the ITAA 1997 states that an account is not a share capital account if it is tainted.

The Issued Capital - Ordinary Shares account and the Issued Capital - B Class Shares account of Company A are share capital accounts for income tax purposes in accordance with subsection 975-300(1) of the ITAA 1997. The Issued Capital - Ordinary Shares and the Issued Capital - B Class Shares account of Company A are treated as a single share capital account for income tax purposes in accordance with subsection 975-300(2) of the ITAA 1997.

The return of capital of approximately $XX ($XX per ordinary share and B Class share) will be debited in full against Company A's share capital account. Company A has confirmed that its 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. Therefore, the entire amount of the return of capital payment proposed to be made to shareholders will not be a 'dividend' as defined in subsection 6(1).

However, subsection 6(4) provides:

Paragraph (d) of the definition of dividend in subsection (1) does not apply if, 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.

Having regard to the relevant facts and circumstances, section 6(4) does not apply.

Accordingly, the Return of Capital will not constitute a 'dividend' under subsection 6(1), 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).

For completeness, as per subparagraph 44(1)(a)(i), the assessable income of a resident shareholder includes dividends paid out of profits derived by the company from any source. Subparagraph 44(1)(b)(i) includes in the assessable income of a non-resident shareholder a dividend paid out of profits derived by the company from sources in Australia. As the return of capital is not a dividend, Subparagraphs 44(1)(a)(i) and 44(1)(b)(i) will not apply.

Question 2

Summary

Subsection 45D(1A) will not apply as the Commissioner will not make a determination under section 45A or section 45B. Accordingly, Company A is not required to issue any Commissioner's determinations under subsection 45A(2) or subparagraph 45B(3)(b) to its shareholders.

Detailed Reasoning

Subsection 45D(1A) provides that if the Commissioner makes a determination under section 45A, 45B or 45C, the Commissioner must give a copy of the determination to the company concerned (Company A).

Under subsection 45D(1A), that company must, in the case of a determination under section 45A or 45B of the ITAA 1936, give a copy of the notice to:

(a)          The advantaged shareholder referred to in section 45A; or

(b)          The relevant taxpayer referred to in section 45B.

Subsection 45D(1A) only applies in the event that the Commissioner gives notice of a determination to a company in accordance with subsection 45D(1). Accordingly, the critical issue is whether the Commissioner will make a determination under section 45A or 45B resulting in the Commissioner giving notice of a determination under subsection 45D(1).

Section 45A

Section 45A applies in circumstances where a company streams the provision of capital benefits to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholder), and it is reasonable to assume that the other shareholders have received or will receive dividends (the disadvantaged shareholders).

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

In the context of section 45A, 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).

A provision of capital benefits includes a distribution to the shareholder of share capital or share premium pursuant to paragraph 45A(3)(b). The share capital proposed to be paid to Company A shareholders under the Return of Capital constitutes the provision of capital benefits.

Having regard to the relevant facts and circumstances, the Commissioner is satisfied that there will be 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 received by Company A shareholders under the scheme, being the return of capital payment.

Section 45B

The purpose of section 45B is to ensure that relevant amounts are treated as dividends for tax purposes if certain payment, allocations, and distributions are made in substitution for dividends (paragraph 45B(1)(b)).

Subsection 45B(2) states that section 45B applies if:

(a)          there is a scheme under which a person is provided with ... a capital benefit by a company; and

(b)          under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with ... the capital benefit, obtains a tax benefit; and

(c)           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.

Where section 45B applies, the Commissioner may make a determination under paragraph 45B(3)(b) that section 45C applies in relation to the whole, or a part, of the capital benefit. If the Commissioner makes a determination under paragraph 45B(3)(b), the Commissioner may make a further determination under subsection 45C(3) which would result in a franking debit arising in the company's franking account in respect of the capital benefit.

Scheme

Subsection 45B(10) provides that the term 'scheme' in section 45B has the same meaning as provided in subsection 995-1(1) of the ITAA 1997. A 'scheme' for the purpose of section 45B is defined in subsection 995-1(1) of the ITAA 1997 to mean:

              i.                any arrangement; or

             ii.                any scheme, plan, proposal, action, course of action or course of conduct whether unilateral or otherwise.

An 'arrangement' is also defined in 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'.

This definition is taken to have the same meaning as provided in subsection 177A(1) of Part IVA. 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 arrangement to return share capital, constitutes a scheme for the purposes of section 45B.

Capital Benefit

Subsection 45B(5) provides that a person is provided with a 'capital benefit' if they are provided with an ownership interest in a company, receive distributions of share capital or share premium, or something is done that increases the value of their ownership interest.

The Return of Capital is to be debited to Company A's share capital account and therefore constitutes a distribution of share capital. Accordingly, the Return of Capital will constitute a provision of a 'capital benefit' for the purposes of paragraph 45B(5)(b).

Tax Benefit

Subsection 45B(9) states that a taxpayer 'obtains a tax benefit' where:

... an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer, would, apart from this section, 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.

A tax benefit is not limited to income tax liabilities arising to the issuer but can also include the non-application of withholding tax obligations imposed in relation to payments to non-residents.

Tax Consequences of the Return of Capital

The Return of Capital was affected as a reduction of share capital, and therefore, the distribution is not subject to tax unless the return of capital exceeds the cost basis of the shares. Therefore, shareholders pay less tax than if the return of capital had been an assessable dividend. Consequently, the Return of Capital causes shareholders to obtain a tax benefit (paragraph 45B(2)(b) and subsection 45B(9)).

The relevant circumstances

Paragraph 45B(2)(c) requires the Commissioner to consider the 'relevant circumstances of the scheme', which are listed (non-exhaustively) in subsection 45B(8), 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) 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, subsection 45D(1A) does not apply as the Commissioner will not make a determination under section 45A or section 45B in respect of the whole or any part of, the capital benefit provided to Company A shareholders in relation to the Return of Capital. Company A is not required to issue any Commissioner's determinations under subsection 45A(2) or paragraph 45B(3)(b) to its shareholders.

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).