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Ruling

Subject: Return of Capital

Question 1

Will the Commissioner make a determination pursuant to Section 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies to the return of capital by Company B?

Answer

No

Question 2

Will the Commissioner make a determination pursuant to Section 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the return of capital by Company C?

Answer

No

This ruling applies for the following period:

Income year ended 30 June 2013

The scheme commences on:

During the income year ended 30 June 2013

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Group Structure and Background

Company B is an Australian resident private company and subsidiary of Australian resident private company Company C. The parent entity of Company C is a non-resident entity.

Company B and Company C do not form part of an Australian income tax consolidated group.

The applicant has advised that the parent entity of Company C has negative net equity for accounting purposes, but is required to achieve a positive net position for legal purposes.

Shareholding

The principal activity of Company C is that of a holding company.

On establishment, Company C issued shares to its then parent and contributed capital to Company B. Consideration was received for the issued capital.

The consideration received by Company C was used to acquire assets and shares in various companies that are now subsidiaries, including Company B.

Tax and accounting results

Company C has generally reported losses over the past several years while Company B has generally reported profits for the same period.

The applicant has advised that the accounting carrying value of Company C in the accounts of its parent entity is significantly lower than its present market value.

Dividend history

No dividends have been paid, declared or proposed by Company C or Company B over the past several years.

Returns of capital

Company B proposes to make an equal reduction of share capital, without share cancellation, for the benefit of its sole shareholder Company C.

The capital will be reduced equally across all classes of shares.

Company C proposes, in turn, to make an equal reduction of share capital without share cancellation, for the benefit of its parent entity.

The proceeds of the reductions in share capital will be used to repay a substantial part of the intercompany balances owed by the parent entity to Company C and Company C to Company B.

The applicant submits that neither Company B nor Company C's share capital has been tainted.

Reasons for the return of capital

The applicant submits the following as reasons behind the return of capital:

Return Excess Capital Contributed - Company B previously issued shares to provide Company B with working capital to fund the continued operation of its business in the event further losses were realised. However subsequent to the share issue Company B has generated positive cash flows and reported accounting profits rather than further losses.

Achieve a Commercial Capital Structure for Company B - The issued capital of Company B far exceeds the funding commercially. The return of capital will place the capital structure of Company B on a more commercial basis by reducing its share capital to an amount which better corresponds to the working capital requirements of Company B's business. This will ensure more efficient use of capital by Company B and will support the company's objective of achieving greater business and cash flow efficiencies from its operations.

c) Simplify Intra-Group Accounting and Financial Statement Audits - There are intra-group loans in existence between

· Company B and Company C; and

· Company C and its parent entity.

The existence of these loans gives rise to increased complexity for both financial accounting and financial statement audit purposes, because the loan guarantee needs to be reviewed each year by the group's auditors.

Therefore, the return of capital by Company B to Company C will allow the inter company accounts to reflect more correctly the underlying financial position of the group by the following:

· A partial offset of the loan payable by Company C; and

· Fund a further return of capital by Company C to its parent entity, which will partially offset the loan payable by its parent entity.

d) Satisfy Net Equity Requirements for the parent entity - The immediate parent company of Company C does not have positive net equity for accounting purposes. However as discussed above, it is required to achieve positive net equity for legal purposes.

The return of capital by Company B to Company C will fund a further return of capital by Company C to its parent entity, which will increase the net equity of the parent entity by the amount of the capital returned and thus allow the parent entity to satisfy its positive net equity requirement by having the investment recognised at an amount that is closer to its market value.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45B.

Income Tax Assessment Act 1936 Section 45C.

Income Tax Assessment Act 1936 Section 177A.

Income Tax Assessment Act 1936 Section 177D.

Income Tax Assessment Act 1997 Section 104-135.

Reasons for decision

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Summary

The Commissioner will not make a determination pursuant to section 45B(3) that section 45C applies to the return of capital by Company B.

Detailed reasoning

Application of sections 45B and 45C to the return of capital - Company B to Company C

Section 45B is an anti-avoidance provision, which, if it applies, allows the Commissioner to make a determination that section 45C applies to treat all or part of the return of the share capital amount as an unfranked dividend.

Section 45B applies where certain capital payments are made to shareholders in substitution for dividends. Specifically, the provision applies where:

· there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a));

· 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 (paragraph 45B(2)(b)); and

· having regard to the relevant circumstances of the scheme, 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

Each of these conditions is considered below.

Scheme

A 'scheme' for the purposes of section 45B is taken to have the same meaning as provided in subsection 177A(1) of Part IVA. That definition is widely drawn and includes any agreement, arrangement, understanding, promise or undertaking, scheme, plan or proposal.

The arrangement involving Company B's return of capital to Company C constitutes a 'scheme' for the purposes of section 45B.

The arrangement involving Company C's return of capital to its parent entity constitutes a separate scheme for the purposes of section 45B and is discussed separately below.

Capital benefit

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) to mean:

· the provision of ownership interests in a company to the person;

· the distribution to the person of share capital or share premium;

· something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person.

For the purposes of this subsection, a person may be a company.

As the distribution will be recorded by a debit to Company B's share capital account, Company B will be provided with a capital benefit as defined under paragraph 45B(5)(b).

Therefore for the purposes of paragraph 45B(2)(a) Company C will be provided with a capital benefit by Company B.

Tax benefit

Subsection 45B(9) explains that the relevant taxpayer obtains a tax benefit if, apart from section 45B, the tax payable due to the receipt of the capital benefit, then or in the future, is less than it would have been had the distribution been a dividend instead.

A tax benefit is obtained by Company C. If not for the operation of section 45B, the return of capital would be treated as a cost base reduction. Alternatively, if the amount was paid as a dividend there would be an amount of tax payable by Company C to the extent that the franking credits were insufficient to fully frank the dividend.

Relevant circumstances

For the purposes of paragraph 45B(2)(c), the Commissioner is required to consider the circumstances set out under subsection 45B(8) to determine whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit.

The test of purpose is an objective one. The question is whether, objectively, it would be concluded that a person who entered into or carried out the scheme, or any part of the scheme, did so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. This purpose does not have to be the most influential or prevailing purpose, but it must be more than an incidental purpose.

Subsection 45B(8) lists a number of relevant circumstances which the Commissioner may have regard to in determining whether a person entered into or carried out a scheme for more than an incidental purpose of enabling a taxpayer to obtain a tax benefit. This list is specified to not be exhaustive.

The relevant circumstances under subsection 45B(8) cover both the circumstances of the company and the shareholders.

The factors within paragraphs 45B(8)(i) and 45B(8)(j), pertaining to the provision of ownership interests and demerger, are not relevant to the circumstances of this scheme. The relevant factors are those covered by the circumstances described in paragraphs 45B(8)(a) to (f) and (k).

a) Attribution to profits

Paragraph 45B(8)(a) refers to the extent to which a capital benefit is attributable to realised and unrealised profits of the company. Law Administration Practice Statement PS LA 2008/10 at paragraph 61 specifies that 'attributable to' is concerned with determining whether there is a discernible connection between the distribution and the share capital or profits realistically available for distribution, including the profits of an associate of the company. The connection need not be that of a sole, dominant, direct or proximate cause and effect; a contributory causal connection is sufficient.

In objectively considering this relevant circumstance, regard must be had to the nature of contributed capital and profit together with the availability of each of them to Company B. It is important to note that the mere existence of profits will not automatically trigger the application of section 45B; rather, the availability of profits is but one matter to be considered in the attribution inquiry imposed by paragraph 45B(8)(a).

Company B has generally reported accounting profits in recent years and has no dividend history in this period. Annual profits made have been applied to the prior year accumulated losses. This practice has improved the equity position of Company B to a level sufficient to indicate that the capital injected in an earlier year was not required.

Company B has not released share capital from a disposal of a substantial part of its business but proposes to debit the entire cash distribution to its share capital account.

Although the funds previously raised were applied to repay intercompany debt, the additional capital remains on the balance sheet. The funds were not invested or utilized in a manner that would generate operational profits. Given the improvement to the company's equity position, due to recent profitability, Company B now has capital in excess of operational requirements.

Although the proposed distribution is funded by cash arising from profitable transactions, the distribution is not attributable to profits because there are little or no profits realistically available for distribution at the time of the distribution. Profits from prior years have been applied against accumulated losses at each year end and are no longer available for distribution

This factor does not incline towards requisite purpose.

(b) Distribution culture

Paragraph 45B(8)(b) refers to the pattern of distribution of dividends, bonus shares and returns of paid up capital by the company. Company B has generally been in a profit making position for several years and has a pattern of applying these profits against accumulated losses rather than pay any dividends. These profits have not eliminated prior year losses.

Accordingly, the lack of distributions by Company B is neither indicative for or against the presence of the requisite purpose.

Characteristics of shareholders

Paragraph 45B(8)(c) refers to whether the relevant taxpayer has capital losses that would be carried forward to a later income year, but for the scheme. Generally, a capital return would be favourable to a taxpayer with capital losses, in that any capital gains would result in a more favourable tax position than when compared to receiving an unfranked dividend. The sole shareholder Company C had a nil capital loss balance for the year ended 30 June 2011.

As such, the distribution of capital does not indicate the requisite purpose.

Paragraph 45B(8)(d) refers to whether any of the ownership interest in the company was acquired, or taken to have been acquired, by the taxpayer prior to 20 September 1985.

All capital held in Company B was acquired by Company C after 20 September 1985 and as such, this does not indicate the requisite purpose.

Paragraph 45B(8)(e) refers to whether the relevant taxpayer is a non-resident.

As Company C is an Australian resident entity that would be assessed on capital gains, this does not indicate the requisite purpose.

Paragraph 45B(8)(f) refers to whether the cost base is not substantially less than the value of the capital benefit. Where the cost base is similar or greater in value than the capital benefit provided, the relevant taxpayer would not be exposed to a capital gain where the provision of the capital benefit involves the subsequent cancellation of a share. In this case, even though the cost base of the shares is more than the value of the capital benefit, there is no subsequent cancellation of the shares.

This factor does not indicate the requisite purpose.

Paragraph 45B(8)(h) refers to, when share capital or share premium is distributed, whether the interest held by the relevant taxpayer after the distribution is the same as it would be, had a dividend been paid instead. This relevant circumstance proceeds from the premise that when a dividend is paid the shareholder's interest remains unchanged, and that a distribution of capital made in similar circumstances may be performing the same function as a dividend and be made in substitution for it. As Company C is the sole shareholder in Company B, there is no change in the interest held.

Therefore, this does indicate the requisite purpose may be present.

(k) Matters in subparagraphs 177D(b)(i) to 177D(b)(viii)

Paragraph 45B(8)(k) refers to the matters in subparagraphs 177D(b)(i) to 177D(b)(viii). These are matters by reference to which a scheme is able to be examined from a practical perspective in order to identify and compare its tax and non-tax objectives. These matters include, among other things, the form and substance of the scheme and its financial implications for the parties involved.

Subparagraph 177D(b)(i) gives regard to the manner in which the scheme was entered into or carried out. The scheme is proposed as a precursor to Company C returning capital to its parent entity, who must achieve a positive net asset position. There is no distribution of cash resulting from the capital return by Company B; rather, it results in offsetting the intercompany loan owed by Company C to Company B.

Subparagraph 177D(b)(ii) gives regard to the form and substance of the scheme. The share capital reduction constitutes the form and the substance of the scheme. The company is returning share capital previously contributed which, as a result of profitable operations, is now excess to operational requirements.

Subparagraph 177D(b)(iii) gives regard to the time at which the scheme was entered into and the length of the period during which the scheme was carried out. The timing and duration of the scheme has been determined by the legal requirement for the parent entity to return to a positive net equity position. The actual distribution time is determined by the issue of a private ruling from the Commissioner.

Subparagraph 177D(b)(iv) gives regard to the result that would be achieved under the Act, but for the operation of section 45B. A capital return has the advantage of not being income in the shareholder's hands. In this case, but for any operation of section 45B, the cost base of these affected shares will be reduced by the amount of the capital returned under CGT event G1 under section 104-135 Income Tax Assessment Act 1997 (ITAA 1997). In addition, another tax consequence resulting from a share capital reduction is that Company B can preserve franking credits, particularly if the company has scarce franking credits.

Subparagraph 177D(b)(v) gives regard to 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 relevant taxpayer, Company C, would obtain a reduction in liabilities, with an equal decrease in investment held in Company B, but no change in their proportionate ownership interest.

Subparagraph 177D(b)(vi) gives regard to any change in financial position of any person in connection with the relevant taxpayer, being a change that has, will, or may reasonably be expected to result from the scheme. The parent entity of Company C will be placed in a better reported financial position after the return of capital. This return of capital assists Company C to also carry out a return of capital to its parent entity that will help bring it into a positive net asset position for accounting purposes.

Subparagraph 177D(b)(vii) gives regard to 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. Company B has no history of dividend distributions, bonus share issues and/or returns of capital in recent years. A capital reduction of the amount proposed is commercially sustainable and will not impact on the company's ability to provide dividends at a future time. In addition, the return of capital is to fund a further return of capital by Company C to its parent entity which will assist in strengthening its financial position.

Subparagraph 177D(b)(viii) gives regard to the nature of any connection between the relevant taxpayer and any person referred to in subparagraph (vi). That is, whether the distribution takes the form of capital or profits is a decision made in the interest of both shareholders and the business, as these interests converge. Ordinarily this would be the connection between the company and the shareholder. This connection or relationship has a bearing on the nature of corporate distributions. In these circumstances, the relevant relationship is not simply of shareholder and company, but of a connection to a group. Company B and Company C are wholly owned entities in a larger group of companies and the return of capital from Company B to Company C is motivated by the need to increase the net equity of its parent entity.

From consideration of the factors contained in subparagraphs 177D(b)(i) to (viii) it is submitted that it could not be concluded that Company B entered into or carried out the return of capital or any part of the arrangement for the purpose of enabling a taxpayer to obtain a tax benefit. The practical implications of the scheme are consistent with it being, in form and substance, a distribution of share capital and the tax benefit is incidental to the main or substantial purpose of the return of capital proposed by the company.

Conclusion

The circumstances of the scheme indicate that the return of capital is a way for Company C to reduce their liabilities and simplify their balance sheet, by using the return of capital to repay the loan they owe to Company B.

Company B has generally made profits over recent years, but have offset prior year profits against accumulated carried forward losses. These prior year profits have been applied against prior year losses and therefore are no longer available for distribution.

Financially there is a tax advantage for Company C to receive a payment of capital rather than a dividend. A capital payment would not attract a tax liability whereas a dividend would be taxed.

Overall, notwithstanding that there is a capital and tax benefit provided to Company C, in considering the relevant circumstances in paragraph 45B(8), most of the factors do not indicate there is the requisite purpose required by paragraph 45B(2)(c). In particular the lack of distributable profits (realised or unrealised) and the connection to a prior capital raising which has become excess to requirements are strong indicators that the payment to Company C is not made in substitution for a dividend.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies to the whole or any part of the return of capital.

Section 45C

As the Commissioner will not make a determination under subsection 45B(3) in relation to the scheme as described, section 45C will not deem any part of the return of share capital to be an unfranked dividend for the purposes of the ITAA 1936 or the ITAA 1997.

Question 2

Summary

The Commissioner will not make a determination pursuant to Section 45B(3) that section 45C applies to the return of capital by Company C.

Detailed reasoning

Application of sections 45B and 45C to the return of capital - Company C to its parent entity

Section 45B is an anti-avoidance provision, which, if it applies, allows the Commissioner to make a determination that section 45C applies to treat all or part of the return of the share capital amount as an unfranked dividend.

Section 45B applies where certain capital payments are made to shareholders in substitution for dividends. Specifically, the provision applies where:

· there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a));

· 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 (paragraph 45B(2)(b)); and

· having regard to the relevant circumstances of the scheme, 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

Each of these conditions is considered below.

Scheme

A 'scheme' for the purposes of section 45B is taken to have the same meaning as provided in subsection 177A(1) of Part IVA. That definition is widely drawn and includes any agreement, arrangement, understanding, promise or undertaking, scheme, plan or proposal.

The arrangement involving Company C's return of capital to its parent entity constitutes a 'scheme' for the purposes of section 45B.

Capital benefit

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) to mean:

· the provision of ownership interests in a company to the person;

· the distribution to the person of share capital or share premium;

· something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person.

For the purposes of this subsection, a person may be a company.

As the distribution will be recorded by a debit to Company C's share capital account, its parent entity will be provided with a capital benefit as defined under paragraph 45B(5)(b).

Therefore for the purposes of 45B((2)(a) the parent entity will be provided with a capital benefit by Company C.

Tax benefit

Subsection 45B(9) explains that the relevant taxpayer obtains a tax benefit if, apart from section 45B, the tax payable due to the receipt of the capital benefit, then or in the future, is less than it would have been had the distribution been a dividend instead.

A tax benefit is obtained by the parent entity. If not for the operation of section 45B, the return of capital would be treated as a cost base reduction, whereas if the amount was paid as a dividend the amount would attract a tax liability.

Relevant circumstances

For the purposes of paragraph 45B(2)(c), the Commissioner is required to consider the circumstances set out under subsection 45B(8) to determine whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer to obtain a tax benefit.

The test of purpose is an objective one. The question is whether, objectively, it would be concluded that a person who entered into or carried out the scheme, or any part of the scheme, did so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. This purpose does not have to be the most influential or prevailing purpose, but it must be more than an incidental purpose.

Subsection 45B(8) lists a number of factors in paragraphs 45B(8)(a) to 45B(8)(k) that are relevant circumstances in determining whether a person entered into or carried out a scheme for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit. This list is specified to not be exhaustive.

The relevant circumstances under subsection 45B(8) cover both the circumstances of the company and the shareholders.

The factors within paragraphs 45B(8)(i) and 45B(8)(j), pertaining to the provision of ownership interests and demerger, are not relevant to the circumstances of this scheme. The relevant factors are those covered by the circumstances described in paragraphs 45B(8)(a) to (f) and (k).

a) Attribution to profits

Paragraph 45B(8)(a) refers to the extent to which a capital benefit is attributable to realised and unrealised profits of the company. Law Administration Practice Statement PS LA 2008/10 specifies that 'attributable to' is concerned with determining whether there is a discernible connection between the distribution and the share capital or profits realistically available for distribution, including the profits of an associate of the company. The connection need not be that of a sole, dominant, direct or proximate cause and effect; a contributory causal connection is sufficient.

In objectively considering this relevant circumstance, regard must be had to the nature of contributed capital and profit together with the availability of each of them to Company C. It is important to note that the mere existence of profits will not automatically trigger the application of section 45B; rather, the availability of profits is but one matter to be considered in the attribution inquiry imposed by paragraph 45B(8)(a).

The return of capital from Company C to its parent entity will be funded from the initial return of capital from Company B to Company C. The return of capital by Company B to Company C decreases the liabilities on Company C's balance sheet and therefore releases surplus capital for Company C to complete a return of capital to its parent entity.

The return of capital from Company C to its parent entity will be effected by a reduction in the loan its parent entity owes to Company C. This will assist its parent entity in getting into a positive net equity position.

The amount Company C will receive from Company B, in the form of a capital return, will not constitute profits for Company C.

Since its incorporation, Company C has generally reported accounting losses. Dividends can only be paid out of profits and Company C does not have profits.

Furthermore, for the year ended 30 June 2012, there were no current year profits. Company C's management accounts reflect an estimated loss for the 2012 financial year. Company C will not have profits available for distribution (either realised or unrealised).

Company C's subsidiaries have reported profits for the 2012 financial year. However the accumulated net profits from these entities will not be enough to offset the total accumulated losses that Company C have carried forward from prior years.

As Company C is in a loss position, the capital return can not be attributable to profits. This would indicate the capital return is not paid in substitution for dividends and does not point towards the requisite purpose.

(b) Distribution culture

Paragraph 45B(8)(b) refers to the pattern of distribution of dividends, bonus shares and returns of paid up capital by the company. Company C have been generally making losses since their incorporation. Company C has not declared, proposed or paid a dividend.

Accordingly, the lack of distributions by Company C is neither indicative for or against the presence of the requisite purpose.

Characteristics of shareholders

Paragraph 45B(8)(c) refers to whether the relevant taxpayer has capital losses that would be carried forward to a later income year, but for the scheme. Generally, a capital return would be favourable to a taxpayer with capital losses, in that any capital gains would result in a more favourable tax position than when compared to receiving an unfranked dividend. As the shares in Company C do not qualify as 'taxable Australian property,' they are not subject to CGT.

As such, the distribution of capital does not indicate the requisite purpose.

Paragraph 45B(8)(d) refers to whether any of the ownership interest in the company was acquired, or taken to have been acquired, by the taxpayer prior to 20 September 1985. All capital held in Company C was acquired by its parent entity subsequent to 20 September 1985.

As such, this does not indicate the requisite purpose.

Paragraph 45B(8)(e) refers to whether the relevant taxpayer is a non-resident. As its parent entity would not be assessed on capital gains, this points to a tax preference for a distribution of capital over profit.

This does point towards the requisite purpose.

Paragraph 45B(8)(f) refers to whether the cost base is substantially less than the value of the capital benefit.

As CGT does not apply to the shares in Company C, this factor is not relevant and therefore does not indicate the requisite purpose.

Paragraph 45B(8)(h) refers to, when share capital or share premium is distributed, whether the interest held by the relevant taxpayer after the distribution is the same as it would be had a dividend been paid instead. This relevant circumstance proceeds from the premise that when a dividend is paid the shareholder's interest remains unchanged, and that a distribution of capital made in similar circumstances may be performing the same function as a dividend and be made in substitution for it. As its parent entity is the sole shareholder in Company C, there is no change in the interest held.

Therefore, this does indicate the requisite purpose may be present.

(k) Matters in subparagraphs 177D(b)(i) to 177D(b)(viii)

Paragraph 45B(8)(k) refers to the matters in subparagraphs 177D(b)(i) and 177D(b)(viii). These are matters by reference to which a scheme is able to be examined from a practical perspective in order to identify and compare its tax and non-tax objectives. These matters include, among other things, the form and substance of the scheme and its financial implications for the parties involved.

Subparagraph 177D(b)(i) gives regard to the manner in which the scheme was entered into or carried out. The scheme is proposed to assist its parent entity to achieve a positive net asset position. As with the capital return from Company B to Company C, there is no distribution of cash resulting from the capital return by Company C to its parent entity. Instead, the return of capital results in the offsetting of an intercompany loan owed by its parent entity to Company C.

The reasons for both returns of capital indicate a strategy to simplify the corporate structure and create a more efficient capital structure.

Subparagraph 177D(b)(ii) gives regard to the form and substance of the scheme. The share capital reduction constitutes the form and substance of the scheme. The distribution is sourced from a capital distribution received by Company C.

Subparagraph 177D(b)(iii) gives regard to the time at which the scheme was entered into and the length of the period during which the scheme was carried out. The timing and duration of the scheme has been determined by the legal requirement for its parent entity to return to a positive net equity position. The actual distribution time is determined by the issue of a private ruling from the Commissioner.

Subparagraph 177D(b)(iv) gives regard to the result that would be achieved under the Act, but for the operation of section 45B. Its parent entity, would obtain a reduction in liabilities and in their interest in Company C, with no change in percentage ownership interest. There would be no tax consequence under the Act, as the shares held by its parent entity are not subject to CGT.

Subparagraph 177D(b)(v) gives regard to 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 relevant taxpayer, the parent entity, would obtain a reduction in liabilities, with an equal decrease in investment held in Company C, but no change in their proportionate ownership interest.

Subparagraph 177D(b)(vi) gives regard to any change in financial position of any person in connection with the relevant taxpayer, being a change that has, will, or may reasonably be expected to result from the scheme. The parent entity will be able to reflect an improved financial position as a consequence of the return of capital if the scheme goes ahead.

Subparagraph 177D(b)(vii) gives regard to 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. Company C generally has no history of dividend distributions, bonus share issues and/or returns of capital since incorporation. A capital reduction of the amount proposed is commercially sustainable.

Subparagraph 177D(b)(viii) gives regard to the nature of any connection between the relevant taxpayer and any person referred to in subparagraph (vi). That is, whether the distribution takes the form of capital or profits is a decision made in the interest of both shareholders and the business, as these interests converge. Ordinarily this would be the connection between the company and the shareholder. This connection or relationship has a bearing on the nature of corporate distributions. In these circumstances, the relevant relationship is not simply of shareholder and company, but of connection to a larger international group of companies. The return of capital from Company C to its parent entity is motivated by the need to increase the net equity of its parent entity.

From consideration of the factors contained in subparagraphs 177D(b)(i) to (viii) it is submitted that it could not be concluded that Company C entered into or carried out the return of capital or any part of the arrangement for the purpose of enabling a taxpayer to obtain a tax benefit. The practical implications of the scheme are consistent with it being, in form and substance, a distribution of share capital and the tax benefit is incidental to the main or substantial purpose of the return of capital proposed by the company.

Conclusion

The circumstances of the scheme indicate that the return of capital is a way for the parent entity to reduce their liabilities and simplify their balance sheet, by using the return of capital to repay the loan they owe to Company C.

Company C has generally not made profits since its incorporation, and is in an accumulated loss position. The return of capital is attributable to share capital.

Financially there is a tax advantage for the parent entity to receive a payment of capital rather than a dividend. As the parent entity is a non resident entity, a capital payment would not be subject to CGT whereas a dividend would be taxed.

Overall, notwithstanding that there is in fact a capital and tax benefit provided to the parent entity, in considering the relevant circumstances in paragraph 45B(8), after weighing up the factors they do not indicate the requisite purpose. In particular the lack of distributable profits (realised or unrealised) and the connection to the capital return from Company B are strong indicators that the payment to Company C is not made in substitution for a dividend.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies to the whole or any part of the return of capital.

Section 45C

As the Commissioner will not make a determination under subsection 45B(3) in relation to the scheme as described, section 45C will not deem any part of the return of share capital to be an unfranked dividend for the purposes of the ITAA 1936 or the ITAA 1997.