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Edited version of private ruling
Authorisation Number: 1011619585957
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Ruling
Subject: Capital Streaming
Question:
If the reserves of the company relate to pre-CGT assets will the capital reduction undertaken uniformly to all shareholders in the company result in the streaming or provision of capital benefits under section 45A, 45B or 45C of the Income Tax Assessment Act 1936 (ITAA 1936)?
Answer: No.
This ruling applies for the following period:
Year ending 30 June 2011
Year ending 30 June 2012
The scheme commenced on:
1 July 2010
Relevant facts:
The company was incorporated prior to CGT by two people. One has died and the other is now aging. This person would like to wind up the company to simplify their personal affairs and by doing so, avoid potential complications between any estate beneficiaries. The major shareholder is a Family Unit Trust of which the person is the main beneficiary.
The company has had a substantial property portfolio. The company undertook a capital reduction previously in accordance with a prior private ruling request and has disposed of a number of properties. However, the company's efforts to dispose of its entire portfolio ahead of formal winding up of the company have been frustrated by severe zoning restrictions on some of its remaining properties. These "sterilised" properties were down-zoned by changes to the local Land and Environment Plans (LEP's) enacted long after their acquisition.
The company has tried to find a commercial solution of how to dispose of land that no-one wants to buy because it cannot be used. For example, the company is investigating if it can donate some of its vacant land to a conservation organisation or the local city council.
In the meantime, since no at-arms-length purchaser is likely to buy vacant land which incurs rates and land tax but cannot be put to any practical use, including building on, the applicant has advised the directors that the most practical means of facilitating winding up of the company is to reduce the company's capital further so as to allow for the disposal of property assets directly to the survivor, the main beneficiary of the major shareholder, the Family Unit Trust.
Accordingly the company proposes to undertake a capital reduction per share.
The capital reduction will be undertaken uniformly across all shareholders and will not involve shares being cancelled.
The financial statements show the company had paid-up share capital, capital profits reserve, asset revaluation reserve, accumulated losses and no franking credits. The applicant advises that both the balances of the reserves relate to pre CGT assets. The reduction in the asset revaluation reserve since the previous return of capital reflects the fact that attempts to improve zoning of property have been unsuccessful and the values and costs of these attempts have been written down below cost.
Therefore, if the company could be wound up immediately, the shareholders would receive the proceeds on winding up as a tax free distribution.
The applicant notes that since the last application for a capital reduction, there have been sales of properties which have released capital be releasing the initial cost of property.
All of the shares on issue in the company are pre-CGT shares. The Family Unit Trust owns the majority of shares. One holder of class B shares is a non-resident for taxation purposes which means that a non-resident holds just over 0.2% of the total shares issued.
The company has not paid a dividend for at least 10 years and it will not be feasible to pay dividends in the future because the company has accumulated losses, no franking credits and any distributions of pre CGT profits will be treated as capital distributions on winding up.
The proposed distribution is less than the cost base of the land that has been sold and is considered to be attributable to capital and not to profits.
The proposal will see a pro-rata capital reduction that will apply to all shares equally and there will be no change in the shareholders' relevant interests or voting rights.
Relevant legislative provisions
Income Tax Assessment Act 1936 Section 45(A),
Income Tax Assessment Act 1936 Section 45(B),
Income Tax Assessment Act 1936 Section 45(C) and
Income Tax Assessment Act 1936 Paragraph 177C(b).
Does Part IVA apply to this ruling?
Part IVA of the Income Tax Assessment Act 1936 (ITAA 1936) is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA of the ITAA 1936 applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.
We have not fully considered the application of Part IVA of the ITAA 1936 to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.
If you want us to rule on whether Part IVA of the ITAA 1936 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA of the ITAA 1936 may apply.
For more information on Part IVA of the ITAA 1936, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: Part IVA: the general anti-avoidance rule for income tax.
Reasons for decision
Summary of decision
The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 or subsection 45B(3) of the ITAA 1936 in relation to the proposed distribution, therefore section 45C of the ITAA 1936 will not deem any part of the return of capital distribution to be an unfranked dividend.
Detailed reasoning
Section 45A - streaming of dividends and capital benefits
Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or would receive dividends.
By distributing an amount as a return of capital, the company will provide shareholders with a 'capital benefit' (as defined in paragraph 45A(3)(b) of ITAA 1936). However, there is nothing in the arrangement to indicate that there is a 'streaming' of capital benefits to some shareholders and dividends to other shareholders as all shareholders will receive the capital return in direct proportion to their shareholding. Therefore section 45A of the ITAA 1936 would not apply to the distribution.
Section 45B - schemes to provide capital benefits in substitution for dividends
The purpose of section 45B of the ITAA 1936 is to ensure that amounts paid in substitution for dividends are treated as unfranked dividends for income tax purposes.
Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 applies. This section applies if:
· there is a scheme under which a person is provided with a capital benefit by a company; and
· 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
· 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 the relevant taxpayer to obtain a tax benefit.
The distribution is a 'scheme' within the broad meaning of that term, for the purposes of section 45B of the ITAA 1936.
The meaning of 'provided with a capital benefit' is found in subsection 45B(5) of the ITAA 1936. A person is provided with a capital benefit if:
· shares in a company are issued to the person;
· there's a distribution to the person of share capital; or
· the company does something in relation to shares that has the effect of increasing the value of shares held by that person.
The company has indicated that the proposed distribution is a return of share capital which is considered the provision of a capital benefit to the shareholders.
A taxpayer 'obtains a tax benefit', as defined in subsection 45B(9) of the ITAA 1936, where:
· the amount of tax payable; or
· any other amount payable under the ITAA 1936 or the Income Tax Assessment Act 1997 (ITAA 1997);
by the taxpayer would, apart from the operation of section 45B:
· be less than the amount that would have been payable; or
· be payable at a later time than it would have been payable;
if the capital benefit had instead been a dividend.
In this situation, since the capital reduction is in relation to pre-CGT shares, any capital gain is disregarded. However, if the capital benefit had been received as a dividend, then your shareholders would have tax payable in relation to the distribution. Clearly the share holders will 'obtain a tax benefit' as defined in subsection 45B(9) of the ITAA 1936.
What needs to be determined is whether, as provided in paragraph 45B(2)(c) of the ITAA 1936, having regard to the relevant circumstances of the scheme, as set out under subsection 45B(8) of the ITAA 1936, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a tax benefit.
The test of purpose is an objective one. Having regard to the relevant circumstances of the scheme, the purpose test will be met if, 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 to obtain a tax benefit.
Each of the "relevant circumstances" is considered separately as follows:
(a) The extent to which the capital benefit is attributable to capital and profits (realised and unrealised) of the company or of an associate of the company.
The company has not paid a dividend for at least 10 years and it is not feasible to pay dividends in the future because of accumulated losses, no franking credits and any distributions of pre CGT profits will be treated as capital distributions on winding up. The proposed capital distribution is less than the cost base of the land that was sold and is attributable to capital not to profits. It is a return on share capital per share.
(b) The pattern of distributions of dividends, bonus shares and returns of capital by the company or an associate of the company.
As stated above, the company has not paid a dividend for at least 10 years as they have been operating at a loss. Future distributions are expected to be in the form of distributions of capital on winding up. Therefore it cannot be concluded that the proposed distribution is a substitution for dividends.
(c) Whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income.
All the shares are pre-CGT assets and the shareholders will not make a capital gain from the proposed distribution. There are no capital losses recorded for any of the shareholders that apart from the proposed course of action would be carried forward to a later year of income.
(d) Whether some or all of the ownership interests in the company or in an associate of the company held by the relevant taxpayer were acquired before 20 September 1985.
All of the shares were acquired by shareholders pre-CGT. Therefore, the shareholders will not be subject to capital gains tax in relation to the proposed distribution. There would have been CGT consequences had the shares been acquired post-CGT.
(e) Whether the relevant taxpayer is a non-resident.
Of the shareholders, only one is a non-resident whose shareholding amounts to only about 0.2%.
(f) Cost base of the share is not substantially less than the value of the capital benefit.
The proposed return of capital would reduce the cost base of each share in the company. As the shares are all pre-CGT this will not affect the final capital gains tax position. The distribution of capital will not trigger a taxable CGT event.
(g) Repealed.
(h) Whether the interest held by each shareholder has been affected.
As the proposed capital reduction applies to all shares equally, there is no change in each shareholder's relevant interest in the company.
(i) Provision of shares or increase in value of shares
The proposed distribution is will not provide any ownership interests to shareholders and will not increase the value of a shareholder's shares.
(j) Demerger
This paragraph is not relevant since the proposed capital distribution does not involve a demerger.
(k) Matters referred to in subparagraphs 177D(b)(i) to (vii)
These factors are considered below:
(i) The manner in which the scheme was entered into or carried out - the capital reduction is a return of capital to shareholders in the course of winding up.
(ii) The form and substance of the scheme - the return of capital is both in substance and form a capital reduction by a company that is in the course of winding up its operations and is returning surplus capital to its shareholders.
(iii) The time at which the scheme was entered into and on the length of the period during which the scheme was carried out - the capital reduction is proposed to be carried out within a relatively short time frame.
(iv) The result in relation to the operation of this Act that, but for Part IVA, would be achieved by the scheme - the whole of the return to the shareholders is a return of capital and no part of the distribution would be assessable as a dividend.
(v) Any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme - the shareholders would receive a distribution of capital in proportion to their interests.
(vi) Any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result, or may reasonably be expected to result, from the scheme - it is unlikely that the financial position of any person who has, or has had, a connection with the shareholders will change due to the capital reduction.
(vii) Any other consequence for the relevant taxpayer or for any person referred to in sub paragraph (vi), of the scheme having been entered into or carried out - there are no other material consequences resulting from the scheme.
(viii) The nature of any connection (whether for business, family or other nature) between the relevant taxpayer and any person referred to in sub paragraph (vi) - this relevant circumstance is unlikely to apply given that the shareholders are the only relevant taxpayers under the proposed scheme.
Summary
The existence of one or more of the foregoing circumstances does not imply that the requisite purpose exists for the purposes of subsection 45B(2)(c) of the ITAA 1936.
All the relevant circumstances should be considered in the wider context of the reason for the whole transaction. In performing such an overall assessment, these circumstances indicate that enabling shareholders to obtain a tax benefit is no more than an incidental purpose of entering into, or carrying out, the scheme.
The proposed payments to your shareholders cannot be reasonably treated as being in substitution of dividends in the context of subsection 45B(1) of the ITAA 1936 having regard to the relevant circumstances.