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Edited version of your private ruling
Authorisation Number: 1012464503128
Ruling
Subject: Liquidators distribution
Questions and Answers:
Should your distribution received from the liquidator to extinguish your claim as an investor, which includes a claim for both return of capital investment and earnings, be deemed ordinary income due to the term "dividend" being used?
No.
Can the distribution be allocated as partly a return of capital and therefore a capital gains tax (CGT) event as it represents your claim on capital investment?
Yes.
Can you apportion the liquidator's distribution on a pro-rata basis between capital and earnings?
No.
Is the portion of your distribution, which represents your claim for earnings, ordinary income?
Yes.
Is the remainder of the liquidator's distribution capital proceeds that relate to a CGT event?
Yes.
This ruling applies for the following period:
Year ending 30 June 2012
The scheme commences on:
1 July 2011
Relevant facts and circumstances
During the year ended 30 June 2005, you made a investment in a company via a promissory note. The principal sum was to be paid on expiry date, with interest to be paid monthly in arrears. The company subsequently went into liquidation.
The liquidator accepted your claim for the principal sum and for the unpaid interest earnings. The unpaid interest earnings represented 10% of your claim. During the year ended 30 June 2012, you received around 33% of your claim as liquidators "dividends".
Relevant legislative provisions
Income Tax Assessment Act 1997 Section 995
Income Tax Assessment Act 1936 Section 47
Reasons for decision
Dividends
Section 995 of the Income Tax Assessment Act 1997 states the term 'dividend' has the meaning given by subsections 6(1) and (4) and 6BA(5) and section 94L of the Income Tax Assessment Act 1936. Broadly, a dividend includes any distribution made by a company to any of its shareholders.
Also, subsection 47(1) of the Income Tax Assessment Act 1936 provides distributions to shareholders of a company by a liquidator in the course of winding up the company, to the extent to which they represent income derived by the company (other than income which has been properly applied to replace a loss of paid-up share capital) shall, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.
In your case, your entire liquidator's distribution from the liquidators was not a distribution made by a company to a shareholder out of profits. Therefore, your distribution from the liquidators is not a dividend for taxation purposes.
Appropriation of payments
In law, principal and interest are distinct debts, which may be separately recovered (Dickenson v. Harrison (1817) 146 ER 465).
The question as to whether components of a payment represent principal or represent interest is decided by the rules of appropriation.
The rules governing the appropriation of payments were summarised in the Federal Court of Australia case of Re Walsh; Ex parte Deputy Commissioner of Taxation (NSW) (1982) 60 FLR 355; (1982) 42 ALR 727; (1982) 13 ATR 40; (1982) 82 ATC 4223. Here, Lockhart J said:
A debtor who owes two debts to a creditor is entitled to appropriate a payment which he makes to his creditor to one debt rather than to the other. If he omits to do so, the creditor may make the appropriation. If neither makes any appropriation, the law appropriates the payment to the earlier debt. If there is specific appropriation by the debtor cadit quaestio. In the absence of a specific appropriation it is a question of fact whether there was any appropriation by the debtor. To constitute an appropriation there must be more than an intention to appropriate by the debtor.
Where there is the absence of any actual or express appropriation by the debtor or the creditor and a debtor owes both interest and principal, a payment is treated as applicable to interest in priority to principal. In the High Court of Australia case of Falk v Haugh (1935) 53 CLR 163 applies, Rich, Dixon, Evatt & McTiernan JJ said (at pp172-173):
It has long been a rule that when payments are received generally on account of a debt, which is in part interest and in part principal, they are treated as applicable to interest in priority to principal.
The rule affords only a presumption in the absence of any actual or express appropriation by the debtor or the creditor.
In your case, an actual appropriation of payments was made by the debtor under your promissory note contract, where interest was to be paid monthly in arrears and the principal sum was to be paid on expiry date. As the payment of interest was due prior to the payment of the principal sum, the appropriation made by the debtor was of interest in priority to principal. It follows your entire claim for interest earnings will be ordinary income and the remainder of your distribution will be capital proceeds that relate to a CGT event.