Edited version of private ruling

Authorisation Number: 1011865171321

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Ruling

Subject: Capital gains tax on liquidation of company and distribution of asset in specie

Question:

Will the asset distributed to the shareholders on liquidation of the company be tax free in the hands of the shareholders under subsection 47(1A) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes

This ruling applies for the following period:

The 2011-12 income year

The scheme commences on:

1 July 2011

Relevant facts and circumstances

There has been no change in the underlying ownership of the company.

The company owns land which was purchased pre-CGT.

Additional shares issued and some shares transferred in post-CGT.

The share structure is made up of pre-CGT and post-CGT shares.

You own some shares in the company.

You and another person, with your spouses, run a partnership.

You satisfy the maximum net asset value test.

The company is to be liquidated in order to remove the asset from the company.

The intent is that the company is to be liquidated and the asset transferred to the shareholders in specie in lieu of cash. The asset will not be sold.

The asset is pre-CGT for the company and therefore tax free for the company.

Relevant legislative provisions

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 1997 Subsection 104-10(5),
Income Tax Assessment Act 1997 Section 104-25,
Income Tax Assessment Act 1997 Subsection 109-5(2),
Income Tax Assessment Act 1997 Section 112-25,
Income Tax Assessment Act 1997 Division 149 and
Income Tax Assessment Act 1997 Section 149-30.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 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 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 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 applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, 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

The distribution of the asset to the shareholders on liquidation of the company will be tax free in the hands of the shareholders under subsection 47(1A) of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Liquidators distributions from the capital reserve account for assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of the ITAA 1936, or a net capital gain under section 104-25 of the Income Tax Assessment Act 1997 (ITAA 1997). If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets will maintain the tax-free status of the distribution from the capital profits reserve account.

A liquidators distribution of capital profits realised on the disposal of assets acquired before 20 September 1985 or a return of share capital, will fall outside the dividend regime in subsections 47(1) and 47(1A) of the Income Tax Assessment Act 1936 (ITAA 1936), and accordingly will not be dividends.

Archer Bros Pty Ltd (In Vol Liq) v. FCT (1953) 90 CLR 140; 27 ALJ 353; 10 ATD 192 (Archers Case) discusses distributions. In a joint judgement, the Full High Court of Australia in Archers Case observed by way of obiter dicta:

By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that…distributions could be made wholly and exclusively out of…particular profits…or income…'

Taxation Ruling TR 95/10 discusses the significance of the Archer Brothers principle in the context of liquidation distributions.

The observations in Archers Case have given rise to what is known as the Archer Brothers principle. The principle is that if a liquidator appropriates a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of the Income Tax Assessment Act. Generally, a liquidator may rely on the Archer Brothers principle, except where a specific provision produces a different result.

Archers Case refers to 'profits' or 'income'. However, if a liquidator ostensibly distributes an amount representing capital actually contributed by shareholders, we accept that the distribution is treated as a non-dividend return of capital.

Provided the liquidator is able to identify the source from which a particular distribution is made, we will accept a liquidators nominated appropriation. For example, identifying pre-CGT non-assessable profits separately to post-CGT capital gains.

If a liquidator can identify the source of funds distributed, then those funds retain the character of the source. So, pre CGT land distributed will remain pre CGT land and would therefore be tax free to the shareholders.

You intend to dispose of the asset from the company to the shareholders as part of winding up the company.

The asset was acquired by the company pre-CGT. In order to maintain the pre-CGT status, the requirements in Division 149 of the Income Tax Assessment Act 1997 (ITAA 1997) need to be met. Section 149-30 of the ITAA 1997 provides that an asset stops being a pre-CGT asset where the underlying beneficial interests of natural persons in the asset changes by 50% or more after 19 September 1985. The underlying interests in the company have not changed by 50% or more since 19 September 1985. The asset has not stopped being a pre-CGT asset due to section 149-30 of the ITAA 1997.

Where a pre-CGT asset is divided after 19 September 1985 the asset will maintain its pre-CGT acquisition date because no CGT event has happened. The dividing of the asset is not itself a CGT event (section 112-25 of the ITAA 1997).

Subsection 47(1) of the ITAA 1936 provides that distributions to shareholders by a liquidator in the course of winding-up a company, to the extent they represent 'income' of the company (other than income properly applied to replace loss of paid up share capital) are deemed for tax purposes to be dividends paid out of profits.

'Income' for the purposes of subsection 47(1) of the ITAA 1936 includes a net capital gain worked out as follows:

Step 1

Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income without indexation.

Step 2

Total the capital gains worked out under step 1. The result is the net capital gain for that year of income.

When the company disposes of its pre-CGT asset, CGT event A1 would apply to the disposal. Subsection 104-10(5) off the ITAA 1997 provides that a capital gain is disregarded if the asset is acquired before 20 September 1985.

Under subsection 47(1) of the ITAA 1936 the distribution would not be included in the calculation of 'income' as step 1 excludes 'a capital gain that is disregarded'.

The distribution of the asset would therefore not be a deemed dividend under subsection 47(1) of the ITAA 1936 and would therefore be tax free to the shareholders.

Further issues for you to consider

Subsection 109-5(2) of the ITAA 1997 provides the rules for the circumstances in which, and the time at which, you acquire a CGT asset as a result of a CGT event happening.

When the asset is distributed to the shareholders, the asset will have a new acquisition date for the shareholders, which will then make the asset a post-CGT asset in the hands of each of the shareholders.