Edited version of private advice

Authorisation Number: 1052340114318

Date of advice: 20 December 2024

Ruling

Subject: Return of capital - dividend

Question 1

Will the return of paid-up capital by XP constitute a 'dividend' within the definition of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 and section 128B of the ITAA 1936?

Answer 1

No

This ruling applies for the following period:

Year ending 30 June 20XX

The scheme commences on:

X/XX/20XX

Relevant facts and circumstances

1.              XP is a corporate limited partnership and is an Australian tax resident. XP has a substituted accounting period, with a year ending 31 December.

2.              The limited partners of XP are foreign investors and are not Australian residents for tax purposes. Interests in XP are held as post-CGT assets.

3.              Following its formation, XP acquired and operate several properties in Australia.

4.              In 20XX, XP acquired X% of Y Co and formed a tax consolidated group.

5.              Assets of Y Co include land and other land entitlements.

6.              In 20XX, XP disposed of the property held in Y Co and another property it directly owned.

7.              XP declared and paid a partly franked dividend to its limited partners which exhausted the profits from sale of the properties.

8.              As a result of the sales of the properties XP now has surplus funds. The limited partners have indicated they do not intend to reinvest the surplus funds via XP acquiring further assets. As a result, XP now proposes to pay the surplus funds ($XM) as a capital return payment to its limited partners.

9.              Under the proposed capital return, each limited partner will receive a capital payment proportional to their interest held in XP. The payment will represent a partial return of the capital invested in XP by each limited partner.

10.          The proposed journal entries in the accounts of XP effecting the capital return payment will be:

Table 1: Capital return payment

11.          XP continues to hold the remaining properties which it uses to carry on its business in Australia. Based on a recent valuation of XP's assets, the asset value in XP's financial statements would be understated by potentially $XX million, representing an unbooked unrealised gain of the same amount.

12.          XP directors will undertake to return any realised profits as dividends prior to returning the proposed capital amount. This will ensure the retained profits are distributed in preference to any return of capital.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(d)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 44(1A)

Income Tax Assessment Act 1936 Division 5A

Income Tax Assessment Act 1936 section 94J

Income Tax Assessment Act 1936 section 94L

Income Tax Assessment Act 1936 section 94M

Income Tax Assessment Act 1936 section 94P

Income Tax Assessment Act 1936 section 94Q

Income Tax Assessment Act 1936 section 128B

Income Tax Assessment Act 1997 section 975-300

Reasons for decision

All legislative references are to the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

Question

Will the return of paid-up partners' capital by XP constitute a 'dividend' within the definition of subsection 6(1) for the purposes of section 44 and section 128B?

Summary

The return of paid-up capital by XP will not constitute a dividend for the purposes of section 44 and section 128B.

Detailed reasoning

1.              Where a partnership is a corporate limited partnership, Division 5A provides for several modifications that are to be made in applying the income tax law so as to treat corporate limited partnerships as companies. Relevantly, section 94J states:

A reference in the income tax law (other than the definitions of dividend, and resident or resident of Australia, in section 6 of this Act and other than Division 355 of the Income Tax Assessment Act 1997) to a company or to a body corporate includes a reference to the partnership.

2.              Section 94L is headed 'Dividend includes distribution of corporate limited partnership' and states:

A reference in the income tax law (other than subsection 44(1A) of this Act) to a dividend or to a dividend within the meaning of section 6:

(a)           includes a reference to a distribution made by the partnership, whether in money or in other property, to a partner in the partnership; and

(b)           does not include a reference to a distribution to the extent to which the distribution is attributable to profits or gains arising during a year of income in relation to which the partnership was not a corporate limited partnership.

3.              Subsection 94M(1) states:

If the partnership pays or credits an amount to a partner in the partnership:

(a)           against the profits or anticipated profits of the partnership; or

(b)           otherwise in anticipation of the profits of the partnership;

(whether or not the amount of the profits or anticipated profits is ascertainable), the amount paid or credited is taken, for the purposes of the income tax law, to be a dividend paid by the partnership to the partner out of profits derived by the partnership.

4.              Subsection 6(1) defines a 'dividend' as including:

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

(b)           any amount credited by a company to any of its shareholders as shareholders;

(c)            (Repealed by No 63 of 1998)

but does not include:

(d)           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; or

(e)           moneys paid or credited, or property distributed, by a company for the redemption or cancellation of a redeemable preference share if:

                               (i)                  the company gives the holder of the share a notice when it redeems or cancels the share; and

                              (ii)                  (the notice specifies the amount paid-up on the share immediately before the cancellation or redemption; and

                             (iii)                  the amount is debited to the company ' s share capital account;

                            (iv)                  except to the extent that the amount of those moneys or the value of that property, as the case may be, is greater than the amount specified in the notice as the amount paid-up on the share; or

(f)             a reversionary bonus on a life assurance policy.

5.              Pursuant to paragraph 6(1)(d) above, a dividend does not include 'moneys paid or credited by a company to a shareholder...' 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.'

6.              The term 'share capital account' is defined in section 975-300 of the Income Tax Assessment Act 1997 as an account which 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.

7.              Section 94P states a reference to a share in income tax law includes a reference to an interest in a corporate limited partnership.

8.              Section 94Q states a reference to a shareholder includes a reference to a partner in a corporate limited partnership.

9.              Accordingly, where a distribution is made to the limited partners of a corporate limited partnership, the distribution is treated as being made by a company for Australian income tax purposes and is debited against the partners' capital, with:

(a)           the partners treated as being shareholders for income tax purposes, and

(b)           the distribution treated as being debited against a share capital account.

10.           As XP is a corporate limited partnership, it is treated as a company for Australian income tax law purposes in accordance with Division 5A.

11.           The proposed $XM capital return payment will be debited against the limited partners' capital account, which is treated as a share capital account for income tax purposes. Therefore, this distribution will be excluded from being a dividend pursuant to the exception set out in paragraph 6(1)(d) of the definition of a 'dividend'.

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