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Ruling

Subject: Division 7A, debt forgiveness and winding up a company

Question 1

Does the gift of Shareholder A's shares in the Company to Shareholder B amount to a commercial debt forgiveness within the meaning of Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Do the commercial debt provisions in Division 245 of the ITAA 1997 apply in respect of the debt owed by Shareholder B to the Company and which is proposed to be offset against Shareholder B's entitlement as shareholder?

Answer

No

Question 3

Will Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) result in any taxable dividends pursuant to the transaction?

Answer

No

Question 4

Will Shareholder B receive any assessable dividends from the Company in the course of winding up the company?

Answer

Yes

Question 5

Does Capital Gains Tax event K6 in section 104-230 of the ITAA 1997 result in a capital gain on the transfer of the shares in the Company from Shareholder A to Shareholder B?

Answer

Yes

Question 6

Will CGT event C2 happen when the Company is deregistered?

Answer

Yes

This ruling applies for the following periods:

1 July 2012 to 30 June 2013

The scheme commences on:

1 July 2012

Relevant facts and circumstances

1. The Company owns a property.

2. Most of the property was acquired prior to 1985 except for a small parcel of land that was transferred to the Company after 1985.

3. There are 2 shareholders in the Company - shareholders A and B.

4. Shareholder A acquired their shares in the Company prior to 1985.

5. The directors of the Company are Shareholder B and Shareholder A.

6. The Company has no assets apart from the property.

7. The company has the following liabilities:

(a) Loan payable to Shareholder A ("Shareholder A's Loan"), and

(b) Loan payable to Shareholder B ("Shareholder B's Loan").

8. The family has been working on a succession planning proposal which started several years ago when Shareholder A retired from the family business and the Company now plans to transfer the property to Shareholder B.

9. As part of the succession plan the family want to take advantage of the intergenerational stamp duty exemption on the transfer of the property. The stamp duty exemption is available only if the property is transferred direct from the Company to Shareholder B.

10. It is proposed that the transfer of, and payment for, the property will occur as follows:

Step A - The Company will revalue the property in its books to market value.

Step B - The Company will lend the purchase price to Shareholder B subject to the terms of an agreement that complies with section 109N of the ITAA 1936.

Step C - The Company will sell the property to Shareholder B at market value. This will be documented in a legally binding contract and subsequent transfer. The capital gain incurred by the Company on the sale will be credited to a pre-CGT capital profits reserve in its accounts

Step D - Shareholder A will assign Shareholder A's Loan to Shareholder B. The assignment will be a simple assignment whereby Shareholder A agrees to assign all rights to repayment of the loan to Shareholder B with no conditions.

Step E - The losses in the company will be written off.

Step F - Shareholder B's Loan will be offset against the Debt from Shareholder B.

Step G - Shareholder A will transfer their shares in the Company to Shareholder B as a gift. The shares were acquired by Shareholder A before 19 September 1985, so are pre- CGT and no tax is payable. The transfer will be effected by means of a simple transfer document with no conditions.

Step H - The amount owed to the Company by Shareholder B will be offset against their entitlement as a shareholder by book entry.

Step I - The Company, having neither assets nor liabilities will be deregistered under section 601AA of the Corporations Act 2001.

Relevant legislative provisions

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 Division 7A

Income Tax Assessment Act 1997 Division 245

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 Sub-division 108-D

Reasons for decision

Question 1

The gift of Shareholder A's shares in the Company to Shareholder B does not amount to a commercial debt forgiveness within the meaning of Division 245 of the Income Tax Assessment Act 1997 (ITAA 1997).

Reasons for decision

Division 245 of the ITAA 1997 relates to the forgiveness of commercial debts.

Section 245-15 sates that Division 245 of the ITAA 1997 also applies to a *non-equity share issued by a company as if it were a debt to which section 245-10 applies that is owed by the company to the relevant shareholder.

Subsection 995-1(1) of the ITAA 1997 defines the following terms:

Equity interest in an entity has the meaning given by:

· In the case of a company - Subdivision 974-C; and

· In the case of a trust or partnership - section 820-930.

Non-equity share means a *share that is not an equity interest in the company.

Share in a company means a share in the capital of the company, and includes stock; and Item 1 in the table in subsection 974-5(1) of the ITAA 1997 provides that an equity interest will be an interest in the company as a member or stockholder of the company.

Therefore, the shares that Shareholder A holds in the Company will be equity interests.

Accordingly, the gifting of these shares will not be covered by the commercial debt forgiveness provisions in Division 245 of the ITAA 1997.

Question 2

The commercial debt provisions in Division 245 of the ITAA 1997 do not apply in respect of the debt owed by Shareholder B to the Company and which is proposed to be offset against Shareholder B's entitlement as shareholder.

Reasons for decision

Division 245 of the ITAA 1997 relates to the forgiveness of commercial debts.

Section 245-10 of the ITAA 1997 stipulates that a debt will be a 'commercial debt' if:

· the whole or any part of interest, or of an amount in the nature of interest, paid or payable by you in respect of the debt has been deducted, or can be deducted, by you; or

· interest, or an amount in the nature of interest, is not payable by you in respect of the debt but, had interest or such an amount been payable, the whole or any part of the interest or amount could have been deducted by you; or

· interest or an amount mentioned in paragraph (a) or (b) could have been deducted by you apart from the operation of a provision of this Act (other than paragraphs 8-12(a), (b) and (c)) that has the effect of preventing a deduction.

Section 245-35 of the ITAA 1997 states that a debt is forgiven if and when:

· the debtor's obligation to pay the debt is released or waived, or is otherwise extinguished other than by repaying the debt in full; or

· the period within which the creditor is entitled to sue for the recovery of the debt ends, because of the operation of a statue of limitations, without the debt having been paid.

The debt will also be forgiven in certain circumstances where the creditor assigns the right to receive payment to another entity (section 245-36 of the ITAA 1997).

Section 245-40 of the ITAA 1997 lists specific circumstances where the forgiveness of a debt will not come within the operation of Division 245 of the ITAA 1997.

Shareholder B's debt to the Company will only come within the provisions of Division 245 of the ITAA 1997 if she will be entitled to claim a tax deduction for any interest that may be payable on the loan.

However, as the loan will be repaid in full by way of distributions from the Company to Shareholder B, there will be no debt forgiveness in terms of subsection 245-35(a) of the ITAA 1997.

Accordingly, Division 245 of the ITAA 1997 will have no application when Shareholder B's loan to the Company is repaid in full by distributions from the Company.

Question 3

Division 7A of the Income Tax Assessment Act 1936 (ITAA 1936) will not result in any taxable dividends pursuant to the transaction.

Reasons for decision

Generally, Division 7A of Part III of the ITAA 1936 (Division 7A) applies where a private company has made a payment or loan to, or forgiven the debt of, an entity in an income year and in that income year either:

· The entity was a shareholder or shareholder's associate of the private company at the time the payment, loan or debt forgiveness was made, or

· A reasonable person would conclude that the loan, payment or debt forgiveness was made because the entity had been a shareholder or shareholder's associate at some time.

An entity includes an individual (section 109ZD and paragraph 960-100(1)(a) of the ITAA 1936).

An associate includes a relative of an entity (section 109ZD of the ITAA 1936 and section 318 of the ITAA 1936).

The general rule is that a private company is taken to pay a dividend to an entity at the end of the income year in which the payment or loan is made or the debt is forgiven (refer to sections 109C, 109D and 109F of the ITAA 1936). Such dividends are included in the assessable income of the shareholder or associate under section 44 of the ITAA 1936.

However, section 109D of the ITAA 1936 will not apply to loans made by a private company where the loan meets the criteria specified in section 109N of the ITAA 1936.

Shareholder B is a shareholder in the Company.

However, provided the terms and conditions attached to the loan that the Company makes to Shareholder B at step C complies with the requirements of section 109N of the ITAA 1936, the provisions of Division 7A will not apply to that loan.

Under the proposed transactions the Company is not forgiving any debts, therefore it is not necessary to consider the application of section 109F of the ITAA 1936 which relates to debt forgiveness.

Accordingly the proposed transactions will not result in any deemed dividends pursuant to Division 7A, provided the loan that the Company makes to Shareholder B meets all the criteria specified in section 109N of the ITAA 1936.

Question 4

Shareholder B will receive some assessable dividends from the Company in the course of winding up the Company.

Reasons for decision

Subsection 47(1) of the ITAA 1936 deems certain amounts distributed to shareholders of a company by a liquidator in the course of winding up a company to be a dividend where the amounts distributed by the liquidator represent income derived by the company (whether before or during liquidation), other than income which has been properly applied to replace a loss of paid-up capital.

Subsection 47(1A) of the ITAA 1936 extends the meaning of income for the purposes of subsection 47(1) of the ITAA 1936 to include:

· an amount (other than a net capital gain) that is included in the company's assessable income for the year, or

· a net capital gain that would be included in the company's assessable income for a year of income if the Income Tax Assessment Act 1997 required a net capital gain to be worked out as follows:

Subsection 47(2A) of the ITAA 1936 applies where there is an informal winding up of a company.

Subsection 47(2A) of the ITAA 1936 sates:

Where:

· the business of a company has been, or is in the course of being, discontinued otherwise than in the course of a winding up of the company under any law relating to companies;

· in connexion with the discontinuance, any moneys of the company have been or other property of the company has been, on or after 19 October 1967, distributed, otherwise than by the company, to shareholders of the company; and

· the moneys or other property so distributed are not, for the purposes of this Act, dividends;

· the distribution shall, subject to subsection (2B), be deemed to be, for the purposes of this section, a distribution to the shareholders by a liquidator in the course of winding up the company.

Subsection 47(2B) of the ITAA 1936 states that subsection 47(2A) only applies where the company ceases to exist within 3 years after the distribution, or such further period as the Commissioner allows.

Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends as defined in subsection 6(1), paid to the shareholder out of profits derived by the company from any source if the shareholder is a resident of Australia.

Subsection 44(1) of the ITAA 1936 however does not apply to a dividend to the extent to which it is either assessable or exempt under another provision of the ITAA.

The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders, whether in money or other property (paragraph (a)), or any amount credited by a company to any of its shareholders as shareholder (paragraph (b)). However, paragraph (d) specifically excludes a distribution from the definition of 'dividend' if the amount of the distribution is debited against an amount standing to the credit of the share capital account of the company.

At the conclusion of the proposed transactions the Company is to be deregistered under section 601AA of the Corporations Act 2001, which deals with voluntary deregistration. Therefore, there will be an 'informal' winding up of the Company.

At steps F, G and H of the proposed transactions, the amount owed to the Company by Shareholder B will be offset against their entitlements as a shareholder, and their loan to the Company. Thus in effect, Shareholder B will be receiving payment from several sources: the capital profits reserve, equity account and retained profits.

The capital profits reserve consists of the capital gain made by the Company on the sale of the property to Shareholder B. The capital gain made on that part of the property that was acquired by the Company prior to 20 September 1985 can be disregarded (subsection 104-10(5) of the ITAA 1997).

However, that portion of the property that the company acquired after 1985 will be a separate CGT asset (refer Subdivision 108-D of the ITAA 1997), and any capital gain made on the transfer of that parcel of land to Shareholder B will not be able to be disregarded.

Therefore, provided the Company is deregistered within three years of step H occurring, a distribution to Shareholder B of that portion of the capital profits reserve that relates to the capital gain made on the pre-CGT portion of the property will be excluded (as a result of paragraph 47(1A)(b)) from being a deemed dividend under section 47 of the ITAA 1936.

That portion of the capital profits reserve that relates to the capital gain made on the post-CGT portion of the property will be deemed to be a dividend under subsection 47(1) (as a result of the operation of paragraph 47(1A)(a)).

The distribution of the paid up capital is not a distribution of income and therefore will not be assessable as a deemed dividend under section 47 of the ITAA 1936.

However, the distribution to Shareholder B of the amount in the retained profits reserve will be a dividend as defined in subsection 6(1) of the ITAA 1936 and will therefore be assessable to Shareholder B pursuant to subsection 44(1).

Question 5

There will be a NIL capital gain from CGT event K6 in section 104-230 of the ITAA 1997 on the transfer of the shares in the Company from Shareholder A to Shareholder B.

Reasons for decision

CGT event A1 happens if you dispose of a CGT asset (section 104-10 of the ITAA 1997). A CGT asset is any kind of property or a legal or equitable right that is not property (section 108-5 of the ITAA 1997). You dispose of a CGT asset if a change of ownership occurs from you to another entity.

A capital gain or capital loss from CGT event A1 is disregarded if the relevant asset was acquired before 20 September 1985 (paragraph 104-10(5)(a) of the ITAA 1997).

The transfer to Shareholder B of Shareholder A's shares in the Company will be a CGT event A1 for Shareholder A ('Shareholder A's CGT event A1'). However, as these shares were acquired prior to 20 September 1985, any capital gain or loss made in relation to that CGT event A1 will be disregarded.

CGT event K6 in section 104-230 of the ITAA 1997 happens if all of the following conditions are satisfied:

· a specific CGT event happens in relation to shares in a company or an interest in a trust you acquired pre-CGT (paragraphs 104-230(1)(a) and 104-230(1)(b) of the ITAA 1997);

· there is no roll-over for the other CGT event (paragraph 104-230(1)(c) of the ITAA 1997); and

· immediately before the other event happens the market value of the post CGT property of the company or trust is at least 75 per cent of the net value of the company or trust (paragraph 104-230(1)(d) and subsection 104-230(2) of the ITAA 1997).

Thus, CGT event K6 only happens if, just before the other CGT event happened (in this case Shareholder A's CGT event A1), the market value of post-CGT property of the company is at least X% of the net value of the company.

Taxation Ruling TR 2004/18 Income tax: capital gains: application of CGT event K6 (about pre-CGT shares and pre-CGT trust interests) in section 104-230 of the Income Tax Assessment Act 1997 discusses what is meant by the term 'property' for CGT event K6 purposes. TR 2004/18, at paragraph 53, says that the reference to 'property' in subsection 104-230(2) of the ITAA 1997 will include, amongst other things, debts owed to the company.

Immediately prior to the transfer of shares at step G, the Company will have one asset only - the loan to Shareholder B. This loan will be taken out at step B of the proposed transactions and therefore will be post CGT property of the Company.

The 'net value' is defined in subsection 995-1(1) of the ITAA 1997 to mean, for an entity, 'the amount by which the sum of the market values of the assets of the entity exceeds the sum of its liabilities'.

TR 2004/18 states at paragraph 99:

In the context of section 104-230, the term 'liabilities' extends to legally enforceable debts due for payment and to presently existing obligations to pay either a sum certain or ascertainable sums. It does not extend to contingent liabilities, future obligations or expectancies.

Immediately prior to CGT event A1 happening to the shares, the Company will not have any liabilities as the amounts in the capital profits reserve, retained profits or equity accounts are not liabilities of the company. Therefore, the net value of the Company will be the outstanding amount on the loan by the Company to Shareholder B).

The market value of the post CGT property (the sum of the market value of the post CGT property taken into account under paragraph 104-230(2)(a), in this case the company's loan to Shareholder B) is equal to the net value of the company, therefore subsection 104-230(2) of the ITAA 1997 is satisfied.

TR 2004/18 outlines a two step process for calculating the capital gain for CGT event K6.

Step 1 (Paragraph 29 of TR 2004/18)

Step 1 amount = Capital proceeds x	Market value of post CGT property
	Market value of all property

Step 2 (Paragraph 32 of TR 2004/18)

Step 1 amount x	Market value excess
	Market value of post CGT property

(Note: The excess of the market value of property taken into account under subsection 104-230(6) over the sum of the cost bases of that property)

The step 1 amount will be the capital proceeds as the market value of the post CGT property will be the same as the market value of all property.

The step 2 amount will be NIL. The market value of the post CGT property (the loan to Shareholder B) will be equal to the cost base of that loan, therefore there will be no market value excess.

Accordingly, there will be a NIL capital gain for CGT event K6.

Question 6

CGT event C2 will happen when the Company is deregistered.

Reasons for decision

CGT event C2 will happen when shares that you own are cancelled, surrendered or redeemed (section 104-25 of the ITAA 1997).

A company ceases to exist on deregistration, and therefore any issued shares in that company will be cancelled at the time that the company is deregistered.

In accordance with Taxation Determination TD 2000/7 Income tax: capital gains: when does a CGT event happen to shares in a company, for the purposes of Part 3-1 and Part 3-3 of the Income Tax Assessment Act 1997, if the company is deregistered under the Corporations Law, the time that the CGT event C2 happens is when the company is deregistered in accordance with subsection 601AA(4) of the Corporations Law.

A taxpayer makes a capital gain as a result of CGT event C2 happening if the capital proceeds from the asset ending are more than the cost base of that asset. They make a capital loss if those capital proceeds are less than the asset's reduced cost base.

As the transfer of Shareholder A's shares in the Company to Shareholder B at step G is undertaken for NIL consideration and Shareholder B and Shareholder A are not dealing at arm's length, the market value substitution rule in section 112-20 of the ITAA 1997 will apply. Therefore Shareholder B is deemed to have acquired the shares at market value.

The full amount of a final distribution made on the winding-up of a company constitutes the capital proceeds from the ending of the shareholder's shares in the company (TD 2001/27). Therefore the total proceeds received by Shareholder B on the winding-up of the Company will be the total of the capital profits reserve, equity account and retained profits.

Paragraph 104-23(5)(a) states that you can disregard any capital gain or capital loss that you make from CGT event C2 if you acquired the asset prior to 20 September 1985.

At the time of winding up the Company, of the issued shares in the Company owned by Shareholder B, one of those shares was acquired prior to 20 September 1985. Therefore any capital gain or loss made by Shareholder B in relation to that share will be disregarded.

Furthermore, under section 118-20 of the ITAA 1997, any capital gain made from CGT event C2 can be reduced by any amount that is included in your assessable income or exempt income under any other provision of the ITAA.

Therefore, any capital gain from CGT event C2 that Shareholder B may make on winding up of the company, will be reduced by those amounts that are included in Shareholder B's assessable income under subsections 44(1) or 47(1) (refer to the answer in relation to question 4 above).