Edited version of private advice

Authorisation Number: 1052226582918

Date of advice: 27 February 2024

Ruling

Subject: Liquidation distributions and cancellation of share

Question 1

Is the interim distribution made to you as the shareholder of the Company in the course of the voluntary winding up included in your assessable income under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 of the ITAA 1936?

Answer

Yes.

Question 2

Is all or part of the final distribution made to you as the shareholder of the Company in the course of the voluntary winding up included in your assessable income under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 of the ITAA 1936?

Answer

Yes.

Question 3

Does capital gains tax (CGT) event C2 in section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997) happen on the cancellation of the share in the Company following the voluntary winding up?

Answer

Yes.

Question 4

Does section 118-20 of ITAA 1997 reduce the amount of a capital gain arising from event C2 by any amount of income assessable under section 44 of ITAA 1936?

Answer

Yes.

Question 5

Does the Double Taxation Agreement between Australia and Country A apply in any way that alters the way liquidator's distribution or cancellation of shares are taxed?

Answer

No.

This ruling applies for the following periods:

Income year ended 30 June 20XX

Income year ended 30 June 20XX

Income year ended 30 June 20XX

Income year ended 30 June 20XX

The scheme commenced on:

28 April 20YY

Relevant facts and circumstances

You were born in Australia.

You moved to Country A in XXXX. You lived in the Country A until XXXX when you moved to Country B.

You lived in Country B between XXXX and XXXX.

During the period when you lived in the Country A and Country B, you were a non-resident of Australia.

Whilst living in the Country A you incorporated a Country A Private Limited Company (the Company).

You have been the sole director and shareholder of the Company since incorporation.

The Company was used by you to earn personal service income while you lived and worked in the Country A until XXXX. During this time the Company paid tax in Country A on the profits and any wages or dividends paid to you were also taxed in Country A.

When you returned to Australia on XXXX, based on the Company balance Sheet as at XXXX provided by you, the company had a value of $XX, which was the Company capital and reserves.

The 'Profit and loss account' in the Company Balance Sheet as at XXXX shows a balance of $XX.

The value of the Company on the date when you became a tax resident of Australia, (as calculated by you using the ATO published average exchange rate in XXXX) was $XX.

On XXXX you, in your capacity as a member of the Company, appointed a liquidator to the Company so that the Company could be voluntarily liquidated.

On XXX you received an interim liquidator's distribution of $XX.

The finalisation of the liquidation is still in progress, the company is still registered in Country A. The delay in finalising the liquidation and cancelling the shares has been caused by slow processing times at the Country A revenue authority.

Upon finalisation, the liquidator will pay a final liquidator distribution to you and cancel the one share of the Company.

The liquidator's distribution says "the distribution(s) of the shares is expected to happen during the XXXX or XXXX financial year, which will be more than 18 months after the first liquidator distribution.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1936 subsection 47(1A)

Income Tax Assessment Act 1936 subsection 47(2A)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(5)

Income Tax Assessment Act 1997 section 118-20

Reasons for decision

Question 1: Application of subsection 47(1) to interim distribution

Section 47 of ITAA 1936 specifically deems certain amounts to be dividends paid to shareholders out of the profits derived by the Company.

Specifically, subsection 47(1) of the ITAA 1936 states:

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, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Subparagraph 47(1A)(a) of the ITAA 1936 provides:

A reference in subsection (1) to income derived by a company includes a reference to an amount (except a net capital gain) included in the company's assessable income for a year of income; or

Paragraph 44(1)(a) of the ITAA 1936 provides:

The assessable income of a shareholder in a company (whether the company is a resident or a non-resident) includes:

(a) if the shareholder is a resident:

(i) dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and

(ii) all non-share dividends paid to the shareholder by the company; and

The use of the term 'income' in the context of subsection 47(1) of the ITAA 1936 has been interpreted in Gibb v FCT (1966) 118 CLR 628 as meaning income according to ordinary concepts rather than 'assessable income'. Hence, amounts that are deemed to be assessable income but are not of an income or revenue character are not considered, for the purposes of subsection 47(1) to be 'income'.

The meaning of the term 'income' has been artificially extended by subsection 47(1A) of the ITAA 1936 for these purposes to include:

•               any amount, other than a net capital gain, that is assessable income of the company, and

•               any net capital gain (except a disregarded capital gain) that would arise under the CGT provisions if each capital gain were calculated without regard to indexation and any capital losses were ignored.

As outlined above, subsection 47(1A) of the ITAA 1936 was included to extend the meaning of 'income' under subsection 47(1) and is not a restrictive provision. This is evidenced by the use of the words "income derived by a company includes a reference to..." [emphasis added]. The term 'includes' provides that it is extending the definition rather than limiting it to the term 'assessable income', as defined under the Act. Accordingly, for the purpose of subsection 47(1), income takes on its ordinary meaning.

The Macquarie Dictionary (online edition 2019) defines 'income' as "the returns that come in periodically, especially annually, from one's work, property, business, etc; revenue; receipts."

In addition to this, a case relevant to this issue is Federal Commissioner of Taxation v Brewing Investments Ltd [2000] FCA 920 (Brewing Investments).

The circumstances of the taxpayer in Brewings Investments are similar to the current matter because:

-                      a resident shareholder owns all the shares in a foreign company

-                      the foreign company did not derive any relevant income from Australian sources

-                      the shareholder receives liquidation distributions from the voluntary liquidation of the foreign company

In Brewing Investments, the Full Federal Court found that:

1)            Section 47 itself has no territorial limits (paragraph 48)

Hill J, with whom Heery J and Sundberg J agreed stated in paragraph 28:

Parke Davis & Co v FC of T (1959) 11 ATD 545 ; (1959) 101 CLR 521 was decided in the same year. In that case a subsidiary company of the taxpayer, incorporated in Colorado and a non-resident, was liquidated and its assets distributed on liquidation to its parent which was also not a resident of Australia. The assets distributed included profits derived from sources in Australia as well as profits sourced outside Australia. It was held that s 47(1) was to be treated as having an application independent of considerations of locality [emphasis added].

While subsection 47(1) of the ITAA 1936 cannot operate by itself to make a distribution assessable income, it can operate 'for the purposes of the Act' on its own to deem a liquidation distribution that represents income derived by the company to be dividends paid to the shareholders by the company out of profits derived by it. The exception is income which has been properly applied to replace a loss of paid-up capital. Once an amount is deemed under subsection 47(1) to be dividends paid to the shareholder by the company out of profits derived by it, we then consider the assessability of the amount under subsection 44(1) of the ITAA 1936 (paragraph 49).

Application to your circumstances

As the interim distribution made to you by the liquidator was paid out of the reserve of the Company titled 'profits and losses' in the XXXX Balance Sheet, the total amount in this reserve at that time was XXXX and the only other amount in 'capital and reserves' was XXXX of paid up capital, it is reasonable to accept that this distribution met the income requirement under section 47 of ITAA 1936. As the distribution was paid out of a reserve attributable to profits derived by the Company, it can reasonably be concluded that the distribution can be sourced to income derived by the Company. As the amounts represented 'income derived by a company', it is captured under section 47, even if it is income of a foreign company (unless it is income which has been properly applied to replace a loss of paid-up capital).

Subsection 47(1) then operates 'for the purposes of the Act' to deem the liquidation distribution to be dividends paid to you by the Company out of profits derived by it.

You were a resident of Australia when you received the liquidation distribution. Therefore, the amount deemed to be dividends under subsection 47(1) is assessable to you under paragraph 44(1)(a).

Question 2: Application of subsection 47(1) to final distribution

For the reasons outlined under question 1, above, the final distribution is made from the profit and loss reserve of the Company, it will be a deemed dividend pursuant to section 47(1) of the ITAA 1936 and is assessable to you in the income year in which it is paid.

Question 3: CGT event C2 on cancellation of share

Under section 108-5 of the ITAA 1997, an asset for CGT purposes is any form of property or a legal or equitable right that is not property. Under section 102-20 of the ITAA 1997, you make a capital gain or capital loss as a result of a CGT event. 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

b)           being released, discharged or satisfied

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 102-25(2) ITAA 1997.

Application to your circumstances

On the cancellation of the share and deregistration of the Company, there will be a CGT C2 event. The interim and final distribution amounts received by you from the liquidator will be capital proceeds for the purpose of the C2 event. Under section 855-45 of the ITAA 1997 the cost base of your shares will be the market value of the shares when you became a resident of Australia. If the total amount distributed to you is less than your cost base you will make a capital loss. Event G1 will not occur as there is no 'non-assessable part'. Subsection 104-135(6) of ITAA 1997 is set out as follows:

"You disregard a payment by a liquidator for the purposes of this section if the company ceases to exist within 18 months of the payment."

The note to this subsection states:

"The payment will be part of your capital proceeds for CGT event C2 happening when the share ends."

It is not unreasonable to conclude that, if subsection 104-135(6) operates to disregard the operation of event G1 that this means the standard operation of event C2 applies to liquidations, i.e. that the interim payment is part of CGT proceeds for event C2. Further, subsection 116-20(1) of ITAA 1997 provides that capital proceeds are received 'in respect' of a CGT event happening. An interim payment can reasonably be considered to be received in respect of the cancellation of the shares, being event C2.

Question 4: Section 118-20 reduce the amount of the capital gain from event C2

Subsection 118-20(1) of the ITAA 1997 states that a capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of this part) includes an amount (for any income year) in:

a)            your assessable income or exempt income; or

b)            if you are a partner in a partnership, the assessable income or exempt income of the partnership.

Application to your circumstances

In your case as your cost base will be approximately XXXX and your assessable dividend will likely be no more than this amount, it is likely that the application of section 118-20 will reduce the amount of any capital gain arising to nil. To the extent that your capital proceeds are less than your cost base a capital loss will arise.

Question 5: Impact of DTA to taxing rights

Paragraph 10(1) of the DTA provides that:

Dividends paid by a company which is a resident of a Contracting State for the purposes of its tax, being dividends beneficially owned by a resident of the other Contracting State, may be taxed in that other state.

Accordingly, where the Company is a Country A resident for tax purposes and the dividends are paid to you, as a resident of Australia, those dividends may be taxed in Australia.

Paragraph 10(2) of the DTA then states that the dividends in the above circumstances may also be taxed in the Country A, according to the law of that State but is limited to the percentages outlined further in the Article.

As the Company is an Australian resident company from the time you became an Australian resident both the State of source, being the State in which the dividend is paid from, and the State of the beneficiary's residence, would both be Australia. In these circumstances, Australia would have exclusive taxing rights.

Application to your circumstances

The dividends paid to you are assessable in Australia, as provided for under the DTA. If you have paid tax in Country A, you may be entitled to an Australian foreign income tax offset, which provides relief from double taxation.

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