Edited version of your private ruling

Authorisation Number: 1012523577513

Ruling

Subject: Distribution from a company and assessable income

Question

Will the distribution of a pre-CGT profit, from the disposal of a pre-CGT asset of the company, distributed to you as part of a voluntary deregistration of the company, be included in you assessable income for the financial year ended 30 June 20XX?

Answer:

No

This ruling applies for the following period(s)

Year ended 30 June 2010

The scheme commences on

1 July 2009

Relevant facts and circumstances

The arrangement that is the subject of the private ruling is described below. This description is based on the following documents. These documents form part of and are to be read with this description. The relevant documents are:

o your application for private ruling

o a deed of transfer in respect of the purchase of the property

o copy of land title search for the property

o annual statement of the company confirming your shareholding percentage

o balance sheet of the company

o statement by members of the company confirming company has ceased business and has nil asset or liabilities

You are an Australian resident.

You were a shareholder of Company A, a company incorporated outside of Australia.

You held percentage of the issued capital of the company, which you acquired prior to 20 September 1985.

Company A's only asset was a property purchased by the company prior to 20 September 1985.

The company did not acquire any other asset subsequent to the acquisition of this property.

In the 200X financial year, the company sold the property. The business of the company ceased at this time.

Following the cessation of the business of the company, the shareholders of the company wished to access the funds of the company. Accordingly, the process of the voluntary deregistration of the company commenced.

After taking into account taxes and expenses, the only asset of the company was the funds from the sale of the property and capital. This was derived from the pre-CGT capital profit reserves of the company from the sale of the property and contributed capital.

The shareholders of the company, pursuant to a members meeting, resolved to access the capital and capital profits reserves of the company. Accordingly, an amount of money was credited in the books of the company in favour of you, and was a distribution of the pre-CGT profit from the sale of the property and contributed capital that was paid to your personal bank account in cash.

Following the distribution of the capital and capital profit reserves of the company the members resolved that, on the basis that the company had ceased to carry on a business and no longer had any assets or liabilities, and an application be made for the company to be deregistered.

The company was deregistered within 6 months of the distribution to you.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 47(1)

Income Tax Assessment Act 1936 Subsection 47(1A)

Income Tax Assessment Act 1936 Subsection 47(2A)

Income Tax Assessment Act 1936 Subsection 47(2B)

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1997 Section 118-20

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-25

Reasons for decision

Detailed reasoning

Distribution on company liquidation

Taxation Determination TD 2001/27 discusses the treatment of a final distribution made by a liquidator. Paragraph 1 of TD 2001/27 states:

The full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997. After the winding-up of a company, CGT event C2 happens to the shares when the company ceases to exist in accordance with the Corporations Act 2001.

However, subsection 47(1) of the ITAA 1936 states that distributions made by a liquidator to shareholders of the company when winding up the company, as long as it is not to replace paid-up share capital, is deemed to be a dividend if it is from income derived by the company. Therefore, to the extent that the payment represents a return of capital actually contributed by the shareholders, they are not assessable as dividends.

If all or part of a final distribution made by a liquidator of a company is deemed by subsection 47(1) of the ITAA 1936 to be a dividend paid out of profits, it will be assessable income of the shareholder of the company under subsection 44(1) of the ITAA 1936.

Importantly, where a capital gain accrues to the taxpayer in these situations, the anti-overlap provisions of section 118-20 of the Income Tax Assessment Act 1997 (ITAA 1997) would apply to ensure that a capital gain is reduced by an amount included in assessable income if the amount would have also been taken into account in calculating the capital gain.

Subsection 44(1) of the ITAA 1936 provides that the assessable income of a resident shareholder in a company includes:

i. dividends (other than non-share dividends) that are paid to the shareholder by the company out of profits derived by it from any source; and

ii. all non-share dividends paid to the shareholder by the company

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

1. An amount (other than a net capital gain) that is included in the company's assessable income for the year; and

2. A net capital gain that would be included in the company's assessable income for the year, excluding those capital gains that are disregarded (such as pre-CGT capital gains).

Therefore, any portion of a distribution that represents income of a company will be assessable in terms of subsection 47(1) of the ITAA 1936 as a deemed dividend. This portion includes any capital gain from investments and property that arise in the year the company is wound up. The balance will be a capital receipt and CGT event C2 will occur on cancellation or surrender of the shares.

Taxation Determination TD 95/10 deals with liquidation distributions and it states that the source of a liquidator's distribution determines the character of the distributed amount for the purposes of section 47 and other provisions of the ITAA 1936. It is not essential for separate accounts to be maintained, provided the liquidator is able to identify a fund or profit from which a distribution is made.

If a company purchases investment properties prior to 20 September 1985 and there has been no change in shareholdings of the company since 20 September 1985, any capital gain made on disposal of the properties is, or will be, a pre-CGT gain and therefore will be disregarded under subsection 104-10(5) of the ITAA 1997.

In addition, if a capital profits reserve (comprised of profits on the sale of pre-CGT assets), and any capital profits eventually realised from the sale of pre-CGT properties (to which an asset revaluation reserve may relate) are, or will be, sourced from disregarded capital gains, they would not be considered income derived by the company within the definition in subsection 47(1A) of the ITAA 1936.

Therefore, any amount of a distribution by a liquidator to a shareholder, that includes the profits from the sale of pre-CGT properties, will not be included in the assessable income of the shareholder of the company under subsection 44(1) of the ITAA 1936, as the amount will not be a dividend in the hands of the shareholder due to the exclusion in subsection 47(1A) of the ITAA 1936.

Instead, on the winding-up of a company, CGT event C2 happens to the shares as the company ceases to exist. If shares in a company were acquired by the shareholders prior to 20 September 1985, any capital gain or loss made on cancellation of the shares, by the shareholders, will be a pre-CGT capital gain or loss, and therefore will be disregarded under subsection 104-25(5) of the ITAA 1997.

Distribution on informal liquidation

Subsection 47(2A) of the ITAA 1936 provides that where:

a) 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;

b) 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

c) 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.

An informal liquidation could occur, for example, where the company's business is discontinued and the shareholders simply appropriate the assets to themselves without making a formal application to the court for a winding up.

Accordingly, any distribution is treated similarly to that discussed above, in that to the extent that the distribution is made out of 'income' derived by the company, other than income properly applied to make good lost capital, it is treated as a dividend in the shareholders' hands and is assessable.

Importantly, subsection 47(2B) of the ITAA 1936 provides that, unless the company is deregistered within three years after the distribution or such further time as the Commissioner allows, the distribution is deemed to be a dividend paid by the company, as a going concern, out of its profits.

Application to your circumstances

In your case, the business of the company has been discontinued voluntarily on the disposal of its only asset (the property). In connection with the discontinuance, cash from the disposal of the company's only asset (the property) has been paid to the shareholders of the company, which includes you, pursuant to a resolution at a members meeting of shareholders of the company.

As the distribution of cash constitutes proceeds of the disposal by the company of a pre-CGT asset, it will not be considered 'income' for the purposes of subsection 47(1) of the ITAA 1936, due to the exception under section 47(1A) of the ITAA 1936. As the distribution of cash is not considered 'income' of the company, it will not be deemed a dividend in your hands (the shareholder). As the distribution is not deemed a dividend it will not be included in your assessable income under subsection 44(1) of the ITAA 1936.

Further, CGT event C2 will happen to the shares when the company is deregistered, as the company ceases to exist. However, as the shares in the company were acquired by you prior to 20 September 1985, any capital gain or loss made by you on cancellation of the shares, will be a pre-CGT capital gain or loss, and therefore will be disregarded under subsection 104-25(5) of the ITAA 1997.

In addition, as the company was deregistered within three years after the distribution to you, subsection 47(2B) of the ITAA 1936 will have no application.