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Ruling

Subject: Share capital reduction - section 45B

Question 1

Will the Commissioner make a determination under paragraph 45B(3)(b) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies in relation to the whole or part of the capital benefit to be provided by the company to the shareholder acting as trustee for the family trust?

Answer

No

This ruling applies for the following period:

Year ending 30 June 2012

The scheme commences on:

1 July 2011

Relevant facts and circumstances

The company is seeking to return an amount of share capital to its sole shareholder during the year ending 30 June 2012.

The shareholder owns the shares in the company in its capacity as the trustee of the family trust.

The company is, and has been at all relevant times, a resident company for Australian income tax purposes.

The share capital account of the company is not tainted for the purposes of Division 197 of the ITAA 1997.

As at 30 June 2011 the company had a retained earnings deficit.

The company had a positive Asset Revaluation Reserve (ARR) in relation to its holding of B shares as at 30 June 2011. However, until the investment in B shares is realised by the company, its directors believe it would be imprudent to distribute significant amounts from the ARR.

The disposal of A shares resulted in an accounting loss.

The company does not have a distribution policy. However, it has paid unfranked and franked dividends when profits have been available

The company paid unfranked dividends to its shareholder, as trustee for the family trust, in some income years, effectively representing all profits generated in each of those income years. In another year, the company also paid a fully-franked dividend. No other dividend has been paid by the company since that time.

In some years dividends were not paid as asset write-downs taken to the asset revaluation reserve in accordance with accounting principles effectively meant that the company had a retained earnings deficit.

In recent years company has been restricted by agreements with external lenders from making distributions (other than nominal amounts).

The company has not distributed any bonus shares or made any returns of capital to date.

The capital return amount represents an excess amount of share capital that is currently held by the company, which has come about due to the realisation of significant investments.

The company will not require any external funding for the proposed capital return.

The proposed return of capital will cause CGT event G1 of the Income Tax Assessment Act 1997 (ITAA 1997) to happen in respect of the shares held by the shareholder.

The family trust is a discretionary trust.

It is anticipated that the beneficiaries will be presently entitled to the income of the family trust for the 30 June 2012 income year and (by virtue of that present entitlement) will include an amount as a capital gain under subsection 115-215(3) of the ITAA 1997 referable to the capital return.

Historically, the family trust has not accumulated net (taxable) income and has distributed such income to its beneficiaries.

The proposed capital return would not be income of the family trust for the purposes of Division 6 of Part III of the ITAA 1936.

Some beneficiaries of the family trust will obtain a tax benefit under the scheme. Consequently, such members will be 'relevant taxpayers' for section 45B of the ITAA 1936 purposes.

The shareholder will not be assessed and liable to pay tax under Division 6 of Part III of the ITAA 1936 in its capacity as trustee of the family trust in respect of the net income of the family trust for the year ending 30 June 2012.

The shareholder as trustee for the family trust will not obtain a tax benefit under the scheme for the purposes of subsection 45B(2) of the 1936 Act. Consequently, the trustee will not be a 'relevant taxpayer' for section 45B of the ITAA 1936 purposes.

The shareholder is a resident of Australia for taxation purposes.

None of the beneficiaries of the family trust are, or will be, a non-resident of Australia for the year ending 30 June 2012.

None of the beneficiaries of the family trust are, or will be, under a legal disability for the purposes of applying Division 6 of Part III of the ITAA 1936 to the net income of the shareholder in its capacity as trustee for the family trust for the year ending 30 June 2012.

As at 30 June 2011, beneficiaries of the family trust had net capital losses to be carried forward.

The ownership interest in the company held by the shareholder as trustee for the family trust was acquired post 20 September 1985.

Relevant legislative provisions

Income Tax Assessment Act 1936

Section 45B

Subsection 45B(1)

Subsection 45B(2)

Paragraph 45B(2)(a)

Paragraph 45B(2)(b)

Paragraph 45B(2)(c)

Subsection 45B(3)

Paragraph 45B(3)(b)

Subsection 45B(5)

Subsection 45B(8)

Paragraph 45B(8)(a)

Paragraph 45B(8)(b)

Paragraph 45B(8)(c)

Paragraph 45B(8)(d)

Paragraph 45B(8)(e

Paragraph 45B(8)(f)

Paragraph 45B(8)(h)

Paragraph 45B(8)(i)

Paragraph 45B(8)(k)

Subsection 45B(9)

Subsection 45B(10)

Section 45C

Subsection 45C(1)

Subsection 177A(1)

Subparagraph 177D(b)

Subparagraph 177D(b)(i)

Subparagraph 177D(b)(ii)

Subparagraph 177D(b)(iii)

Subparagraph 177D(b)(iv)

Subparagraph 177D(b)(v)

Subparagraph 177D(b)(vi)

Subparagraph 177D(b)(vii)

Subparagraph 177D(b)(viii)

Section 318

Income Tax Assessment Act 1997

Section 104-135

Subsection 115-215(3)

Division 197

Subsection 995-1(1)

Reasons for decision

The Commissioner may make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies only if section 45B of the ITAA 1936 applies.

Subsection 45B(2) of the ITAA 1936 relevantly provides 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.

The requirement under paragraph 45B(2)(a) of the ITAA 1936

Paragraph 45B(2)(a) of the ITAA 1936 requires the scheme to be one under which a person is provided with a capital benefit.

Subsection 45B(10) of the ITAA 1936 provides, in relation to the term 'scheme' that it:

… has the meaning given by subsection 995-1(1) of the Income Tax Assessment Act 1997.

Subsection 995-1(1) of the ITAA 1997 defines a 'scheme' as:

(a) any *arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Subsection 995-1(1) of the ITAA 1997 defines an 'arrangement' 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.

The proposed return of share capital to be made by the company to its sole shareholder, as trustee for the family trust, during the year ending 30 June 2012 and the creation of a present entitlement(s) to the income of the family trust for the year ending 30 June 2012 is the 'scheme' for current purposes.

Subsection 45B(5) of the ITAA 1936 relevantly provides that a reference to a person being provided with a capital benefit is a reference to any of the following:

(a) …;

(b) the distribution to the person of share capital or share premium;

(c) …

The proposed share capital distribution by the company to the shareholder as trustee for the family trust will constitute the provision of a capital benefit to a person for the purposes of subsection 45B(5) of the ITAA 1936.

Thus, as the capital benefit will be provided to the shareholder as trustee of the family trust under the scheme, as proposed, paragraph 45B(2)(a) of the ITAA 1936 will be satisfied.

The requirement under paragraph 45B(2)(b) of the ITAA 1936

Subsection 45B(9) of the ITAA 1936 provides that a taxpayer 'obtains a tax benefit' if:

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 demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend.

The beneficiaries of the family trust will obtain a tax benefit under the scheme. Consequently, such beneficiaries will be 'relevant taxpayers' for section 45B of the ITAA 1936 purposes.

The requirement under paragraph 45B(2)(c) of the ITAA 1936

Paragraph 45B(2)(c) of the ITAA 1936 requires that regard be had to the relevant circumstances of the scheme to enable an objective determination of whether the requisite conclusion is reached.

Subsection 45B(8) of the ITAA 1936 inclusively defines the meaning of the term 'relevant circumstances of a scheme'.

The requisite conclusion, for current purposes, before section 45B of the ITAA 1936 could apply would be 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 non-incidental purpose of enabling a relevant taxpayer to obtain a tax benefit.

Each of the paragraphs in subsection 45B(8) of the ITAA 1936 are discussed below

Paragraph 45B(8)(a) of the ITAA 1936 - Attribution

This paragraph relevantly refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or of an associate (within the meaning in section 318 of the ITAA 1936) of the company.

The term 'profits' is not defined in the income tax law and takes its ordinary meaning. It has a wide scope and is not limited to the Corporations Act's conception of the term. [MacFarlane v. FC of T (1986) 67 ALR 624 at 644-645.] The word 'profits', as it is generally understood, implies a gain made by a business and disclosed by a comparison between the state of that business at one point in time and its state at another. [In Re Spanish Prospecting Company (1911) 1 Ch 92 per Fletcher Moulton LJ at 98, FC of T v. Slater Holdings Ltd (1984) 156 CLR 447; 84 ATC 4883; 15 ATR 1299 at CLR 460; ATC 4889; ATR 1306, FC of T v. Sun Alliance Investments Pty Ltd ( In liq ) [2005] HCA 70 at [67]] Thus, in strict legal terms, an unrealised gain, whether or not it is of a 'permanent character' and whether or not it meets the technical requirements for distribution of the Corporations Act, constitutes profits for the purposes of paragraph 45B(8)(a) of the ITAA 1936. [MacFarlane v. FC of T (1986) 67 ALR 624 at 644-645, FC of T v. Sun Alliance Investments Pty Ltd ( In liq ) [2005] HCA 70 at [61] to [68]]

As at 30 June 2011 the company had a retained earnings deficit. In addition, the disposal of the A shares resulted in an accounting loss.

On the other hand, the company had a positive Asset Revaluation Reserve (ARR) as at 30 June 2011 in relation to its holding of B shares. However, until the investment in B shares is realised by the company, its directors believe it would be imprudent to distribute amounts from the ARR.

Therefore, having regard to the quantum of realised and unrealised profit of the company it is reasonable to conclude that some portion of the proposed capital distribution is attributable to profits.

This factor points towards the requisite purpose.

Paragraph 45B(8)(b) of the ITAA 1936 - The distribution culture

This paragraph refers to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318 of the ITAA 1936) of the company.

The company does not have a distribution policy. However, it has paid unfranked and franked dividends when profits have been available. The company paid unfranked dividends to its shareholder, as trustee for the family trust, in some income years effectively representing all profits generated in each of those income years. In another year the company also paid a fully-franked dividend. No other dividend has been paid by the company since that time.

The company has effectively paid dividends in years when profit was available. In some years dividends were not paid as asset write-downs taken to the asset revaluation reserve in accordance with accounting principles effectively meant that the company had a retained earnings deficit.

In recent years, the company has been restricted by agreements with external lenders from making distributions (other than nominal amounts).

The company has not distributed any bonus shares or made any returns of capital to date.

This factor does not point towards the requisite purpose.

Paragraph 45B(8)(c) of the ITAA 1936 - Capital losses

This paragraph refers to whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income.

As at 30 June 2011, all beneficiaries of the family trust had net capital losses to be carried forward.

This factor points towards the requisite purpose.

Paragraph 45B(8)(d) of the ITAA 1936 - pre-CGT ownership interests

This paragraph refers to whether some or all of the ownership interests in the company or in an associate (within the meaning in section 318 of the ITAA 1936) of the company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985.

The ownership interest in the company held by the shareholder as trustee for the family trust was acquired post 20 September 1985.

This factor does not point towards the requisite purpose.

Paragraph 45B(8)(e) of the ITAA 1936 - Residency of the shareholders of the company

This paragraph refers to whether the relevant taxpayer is a non-resident.

The shareholder of the company is an Australian resident for taxation purposes as are the potential beneficiaries of that trust.

This factor, does not point towards the requisite purpose.

Paragraph 45B(8)(f) of the ITAA 1936 - Cost base of the ownership interests

This paragraph refers to whether the cost base (for the purposes of the ITAA 1997) of the relevant ownership interest is not substantially less than the value of the capital benefit.

The distribution of the capital benefit would result in CGT event G1 of the ITAA 1997 happening. This gain would be fully distributable to the beneficiaries of the family trust.

This factor points away from the requisite purpose.

Paragraph 45B(8)(h) of the ITAA 1936 - Nature of interest after the return of capital

This paragraph requires that regard be had to whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium.

In this case the company has a single shareholder such that a selective share capital reduction would not be possible in any case.

Further, the relevant taxpayers are merely discretionary beneficiaries of the family trust and do not hold an interest in the company.

This factor does not point towards the requisite purpose.

Paragraph 45B(8)(i) of the ITAA 1936 - Scheme involving the later disposal of ownership interests

This is not a relevant circumstance of this scheme.

Paragraph 45B(8)(j) of the ITAA 1936 - Transactions between the entity and an associate

This is not a relevant circumstance of this scheme.

Paragraph 45B(8)(k) of the ITAA 1936 - The Part IVA matters

This paragraph requires that regard be had to any of the matters referred to in subparagraphs 177D(b)(i) to (viii) of the ITAA 1936.

Subparagraph 177D(b)(i) of the ITAA 1936 - the manner in which the scheme was entered into or carried out

Under the scheme the company will not require any external funding for the proposed capital return.

Also, the proposed return of capital will be distributed to the beneficiaries of the family trust in accordance with the trust's normal practice.

Subparagraph 177D(b)(ii) of the ITAA 1936 - the form and substance of the scheme

In legal form, the scheme is the return of share capital of the company to its shareholder. However, having regard to the source of the capital, the substance is arguably the part return of capital and part distribution of profits.

Subparagraph 177D(b)(iii) of the ITAA 1936 - the time at which the scheme was entered into and the length of the period during which the scheme was carried out

The proposed scheme is to be implemented prior to 30 June 2012.

Subparagraph 177D(b)(iv) of the ITAA 1936 - the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme

Under the proposed scheme, the capital return is expected to result in a capital gain to the shareholder as trustee for the family trust. As the shareholder has held its shares in the company for more than 12 months, the capital gain will be discountable under Division 115 of the ITAA 1997. The discounted capital gain will then be distributed to the family trust's beneficiaries, in proportion to their present entitlement to the income of the trust estate in the year ended 30 June 2012.

Subparagraph 177D(b)(v) of the ITAA 1936 - 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

Under the proposed scheme the beneficiaries of the family trust will receive distributions which will enable individual investment decisions to be made.

Subparagraph 177D(b)(vi) of the ITAA 1936 - 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

In this instance, the company's net assets would decrease by the amount of the return of capital. The amount of the net assets would decrease by the same amount whether the distribution was in the form of a return of capital or a dividend.

Subparagraph 177D(b)(vii) of the ITAA 1936 - any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out

There does not appear to be any other relevant consequences.

Subparagraph 177D(b)(viii) of the ITAA 1936 - the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi)

In this case, all of the relevant entities are members of the same family group.

The overall conclusion for paragraph 45B(8)(k) of the ITAA 1936 is that these factors do not point towards the requisite purpose.

Overall conclusion:

Having regard to all the relevant circumstances of the scheme, the Commissioner objectively concludes that the scheme will be carried out for not more than an incidental purpose of enabling a relevant taxpayer to obtain a tax benefit. The Commissioner would, therefore, not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies.