Edited version of your private ruling

Authorisation Number: 1012525796894

Ruling

Subject: Proposed loan repayment

Question

Will the Commissioner not make a determination under subsection 45B(3) of the Income Tax Assessment Act 1936 ('ITAA 1936') that section 45C of the ITAA 1936 applies to treat the repayment of the loan by Company A as an unfranked dividend?

Answer

Yes. The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat the repayment of the loan by Company A as an unfranked dividend.

This ruling applies for the following periods:

Year ending 31 December 2013.

The scheme commences on:

Before 31 December 2013.

Relevant facts and circumstances

1. Company A, an Australian resident company, is 100% owned by Company B, which is 100% owned by Company C, both being non-resident entities.

2. Company A borrowed a sum amount of money in May 20XX from an associated foreign entity, Company F. Company F is also 100% owned by Company C.

3. The loan is an interest free 'at call' loan, denominated in Australian dollars. There is no executed loan agreement. The loan was provided to Company A to fund its normal operating activities. The loan balance has not changed from May 20XX.

4. As at end December 20YY, Company A has had accumulated losses of less than $15 million.

5. Company A has not paid dividends in its recent history.

6. Company A intends to repay the interest free 'at call' loan in full, and the proposed repayment would be made during the year ending 31 December 20ZZ. The source of the funds used to repay the loan would be from surplus cash flow, which has arisen from normal trading operations.

7. The Applicant advised that under the terms of subdivisions 974-B and 974-C of the ITAA 1997, the loan is treated as non-share equity for income tax purposes. The non-share capital account has a credit balance of the loan amount.

8. The proposed loan repayment would be debited to the non-share capital account at the date the repayment is made.

9. Company A and Company D, an Australian resident Company, elected to form a multiple entity consolidated group (MEC) in 20WW, with Company A as the 'provisional head company' of the MEC.

10. The Applicant advised that Company D was operating independently of Company A prior to their respective foreign owners, being merged into a group in 20WW. In fact, they had operated as competitors.

11. The financial statements provided indicate that Company D has made profits of approximately more than $5.million and less than $10 million in the year 20WW and 20YY respectively.

12. Company D has not paid dividends over the past 10 years.

13. The loan amount to Company A from Company F has been used solely to fund the operating activities of Company A, and has never been on-lent to Company D or used in any way to generate the profits of Company D.

14. Company F does not have carried forward losses.

Relevant legislative provisions

ITAA 1936 subsection 44(1)

ITAA 1936 Section 45A

ITAA 1936 Section 45B

ITAA 1936 Subsection 45B(1)

ITAA 1936 Subsection 45B(2)

ITAA 1936 Subsection 45B(3)

ITAA 1936 Subsection 45B(5)

ITAA 1936 Subsection 45B(7)

ITAA 1936 Subsection 45B(8)

ITAA 1936 Subsection 45B(9)

ITAA 1936 Subsection 45B(10)

ITAA 1936 Section 45C

ITAA 1936 Subsections 45C(1)

ITAA 1936 Subsections 45C(2)

ITAA 1936 Section 318

ITAA 1936 Subsection 318(2)

ITAA 1936 Paragraph 318(6)(b)

Income Tax Assessment Act 1997 ('ITAA 1997') Section 104-135

ITAA 1997 Section 164-10

ITAA 1997 Section 202-75

ITAA 1997 Section 701-1

ITAA 1997 Subsection 701-1(1)

ITAA 1997 Subdivision 719

ITAA 1997 Subsection 719-25(2)

ITAA 1997 Subdivision 974-B

ITAA 1997 Subdivision 974-C

ITAA 1997 Section 974-75

ITAA 1997 Subsection 974-75(1)

ITAA 1997 Subsection 974-75(4)

ITAA 1997 Subdivision 974-F

ITAA 1997 Section 974-115

ITAA 1997 Section 974-125

ITAA 1997 Subsection 995-1(1)

Reasons for decision

Legislative Scheme

1. The income tax treatment of dividends is covered by Subdivision D - Dividends, Division 2 - Income, Part III - Liability to Taxation of the ITAA 1936.

2. Under subsection 44(1) of the ITAA 1936, for a shareholder who is a non-resident, the assessable income of the shareholder in a company (whether the company is resident or a non-resident) includes dividends (other than non-share dividends) paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia; and non-share dividends paid to the shareholder by the company to the extent to which they are derived from sources in Australia.

3. Section 45B of the ITAA 1936 is an anti-avoidance provision designed to ensure that payments made in substitution for dividends are treated as dividends for income tax purposes (Subsection 45B(1) of the ITAA 1936).

4. Where the Commissioner makes a determination under section 45B of the ITAA 1936 in respect of a capital benefit, the amount of the capital benefit is taken to be an unfranked dividend. The dividend is then deemed to have been paid out of profits of the company and fully assessable to the recipient shareholders (Subsections 45C(1) and 45C(2) of the ITAA 1936).

Status of the interest free 'at call' loan

5. Company A borrowed the interest free 'at call' loan in May 20XX. Under subsection 974-75(4) of the ITAA 1997, interest free 'at call' loans that were provided up to 30 June 2005 were treated as 'debt'. Immediately after subsection 974-75(4) of the ITAA 1997 ceased to have effect, the loan then became an Equity Interest under Item 3 of the Table in subsection 974-75(1) of the ITAA 1997, because it did not satisfy the 'debt test' under Subdivision 974-B of the ITAA 1997. As such, the loan is a non-share equity interest under Subdivision 974-C of the ITAA 1997.

6. Any distribution by a company in respect of a non-share equity interest constitutes a non-share distribution (Section 974-115 of the ITAA 1997). All non-share distributions are non-share dividends to the extent that they are not debited against either the company's non-share capital account or its share capital account (Section 974-120 of the ITAA 1997). Finally, to the extent that a non-share distribution is not a non-share dividend, it represents a non-share capital return (Section 974-125 of the ITAA 1997).

7. By virtue of subsection 43B(1) of the ITAA 1936, section 45B of the ITAA 1936 applies to non-share equity interests in the same way it applies to a share, to an equity holder in the same way it applies to a shareholder and to a non-share dividend in the same way it applies to a dividend.

8. Under subsection 45B(7) of the ITAA 1936, a non-share distribution is a distribution of share capital to the extent to which it is a non-share capital return. Thus, distributions that involve non-share capital returns may come within the scope of section 45B of the ITAA 1936 where they are considered to represent a disguised distribution of profits.

Consolidation

9. In 20WW, Company A and Company D formed a MEC under Subdivision 719 - B: MEC groups and their members, Division 719: MEC groups, of the ITAA 1997.

10. As Company A is the 'provisional head company', all other members of the MEC (including Company D) will be taken to be subsidiaries in the MEC (see subsection 719-25(2) of the ITAA 1997).

11. Under the single entity rule, for head company and entity core purposes, entities that are subsidiary members of a consolidated group are taken to be parts of the head company of the group, rather than separate entities (see subsection 701-1(1) of the ITAA 1997). Here, head company and entity core purposes include working out the head company's and the entities' liability for income tax purposes for any period during which the entities are members of the consolidated group (see section 701-1 of the ITAA 1997).

12. In the present case, the recipient entity (being the relevant taxpayer for the purposes of section 45B of the ITAA 1936) is an entity that is outside the consolidated group. The objective of section 45B of the ITAA 1936 is the making of a determination by the Commissioner under subsection 45B(3)(b) of the ITAA 1936 whereby all or part of the relevant capital benefit is treated as an unfranked dividend in the hands of the recipient on the basis that it represents a distribution of profits that have been disguised as a distribution of share capital. In certain circumstances, the Commissioner may also make a further determination that results in the posting of a debit to the company's franking account. Consequently, as the potential application of section 45B of the ITAA 1936 cannot be viewed as fulfilling a core purpose, the single entity rule will not apply in this instance.

13. If it applies, section 45B of the ITAA 1936 allows the Commissioner to make a determination under paragraph 45B(3)(b) of the ITAA 1996 that section 45C of the ITAA 1936 applies to all or part of any capital benefit provided to a recipient entity. The effect of this is to treat the capital benefit, or a portion thereof, as an unfranked dividend in the hands of the recipient entity on the basis that it represents a distribution of profits that have been disguised as a distribution of share capital.

14. In this case, for the purposes of identifying the extent to which the proposed distribution may be attributable to capital or profits under subsection 45B(8) of the ITAA 1936, it is necessary to consider the realised and unrealised gains of both the company making the distribution and its associates (see paragraph 69 of PSLA 2008/10). As the single entity rule does not apply, this requires that the subsidiary entity in question (Company D) satisfies the requirements of being an 'associate' in order for their details to be considered in this context.

15. The meaning of 'associate' is defined in subsection 995-1(1) of the ITAA 1997 by reference to section 318, Part X - Attribution of income in respect of controlled foreign companies of the ITAA 1936, in particular subsection 318(2) of the ITAA 1936. It includes another entity which has sufficient influence over Company A either in its own right or in conjunction with other entities. Paragraph 318(6)(b) of the ITAA 1936 says a company is 'sufficiently influenced' by others if the company is accustomed to act in accordance with the directions, instructions or wishes of those others, is under an obligation (formal or informal) or might reasonably be expected to do so.

16. Here, the words 'might reasonably be expected' are an objective test, not a subjective test, requiring a determination of what a reasonable person possessed of knowledge of the facts could be expected to conclude.

17. Thus the definition of 'associate' is broad and includes Company D and Company F. Consequently, in analysing the relevant circumstances of the proposed distribution by Company A, the circumstances of both Company A (the head company) and Company D (the subsidiary) must also be considered.

18. Bringing this together, PS LA 2008/10 says:

61. The inquiry contemplated by the words 'attributable to' is essentially a practical one concerned with determining whether there is a discernible connection between the amount distributed as share capital and the share capital and profits that are 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.

62. Therefore, in determining whether the distribution of share capital is attributable to either share capital or profits, tax officers should take account of the pertinent characteristics of share capital and profits and the availability of each in the circumstances of the company (including the availability of profits in associates) and in the context of the pertinent scheme.

19. In effect this means that in considering the application of section 45B of the ITAA 1936, the retained earnings in the relevant period of Company D may be considered even though the loan repayment is to be made by Company A to Company F.

20. The financial statements provided by the Applicant indicate that the post consolidation retained earnings of Company D, when taken together with accumulated losses of Compamy A, are not sufficient to support the proposed distribution of the non-share capital. Also, the loan made to Company A was never on-lent or otherwise made available to Company D. All of the cash to be utilised in the repayment of the loan was derived from operations of Company A.

21. The application of section 45B of the ITAA 1936 to this scenario is considered in futher details below.

Section 45B of the ITAA 1936

22. Section 45B of the ITAA 1936 provides:

Section 45B Schemes to provide certain benefits

Purpose of section

(1) The purpose of this section is to ensure that relevant amounts are treated as dividends for taxation purposes if:

(a) components of a demerger allocation as between capital and profit do not reflect the circumstances of a demerger; or

(b) certain payments, allocations and distributions are made in substitution for dividends.

Application of section

(2) This section applies if:

(a) there is a scheme under which a person is provided with a demerger benefit or 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 demerger benefit or 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.

Commissioner to determine that section 45BA or 45C applies

(3) The Commissioner may make, in writing, a determination that:

(a) section 45BA applies in relation to the whole, or a part, of the demerger benefit; or

(b) section 45C applies in relation to the whole, or a part, of the capital benefit.

A determination does not form part of an assessment.

Note: If section 45BA applies in relation to the whole, or a part, of a demerger benefit, this benefit may be a capital benefit.

Meaning of provided with a demerger benefit

(4) [Not relevant to this matter]

Meaning of provided with a capital benefit

(5) A reference to a person being provided with a capital benefit is a reference to any of the following:

(a) the provision of ownership interests in a company to the person;

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

(c) 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.

(6) [Not relevant to this matter]

(7) For the purposes of this section, a non-share distribution to an equity holder is taken to be the distribution to the equity holder of share capital to the extent to which it is a non-share capital return.

Meaning of relevant circumstances of scheme

(8) The relevant circumstances of a scheme include:

(a)  the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;

(b)  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 company;

(c)  whether the relevant taxpayer has capital losses that, apart from the scheme, would be unutilised (within the meaning of the Income Tax Assessment Act 1997 ) at the end of the relevant year of income;

(d)  whether some or all of the ownership interests in the company or in an associate (within the meaning in section 318) 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;

(e)  whether the relevant taxpayer is a non-resident;

(f)  whether the cost base (for the purposes of the Income Tax Assessment Act 1997 ) of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit;

(h)  if the scheme involves the distribution of share capital or share premium--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;

(i)  [Not relevant to this matter]

(j)  [Not relevant to this matter]

(k)  any of the matters referred to in subparagraphs 177D(b)(i) to (viii).

Meaning of obtaining a tax benefit

(9) A relevant 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.

(10) In this section:

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

Application of section 45B of the ITAA 1936 under subsection 45B(2)of the ITAA 1936

23. There are three elements that must be satisfied under subsection 45B(2) of the ITAA 1936.

Paragraph 45B(2)(a)of the ITAA 1936

24. There is a 'scheme' that 'provides a capital benefit' under paragraph 45B(2)(a) of the ITAA 1936.

25. As indicated in subsection 45B(10) of the ITAA 1936, the meaning of 'scheme' has the meaning given by subsection 995-1(1) of the ITAA 1997. Here, the meaning of 'scheme' is referenced to subsection 177A(1) of Part IVA of the ITAA 1936. The meaning of 'scheme' has a broad application¹ and applies to the facts in this matter.

26. To the extent that the scheme representing the repayment of the 'at call' loan represents a return of non-share capital, it constitutes the provision of a capital benefit as defined in paragraph 45B(5)(b) of the ITAA 1936.

Paragraph 45B(2)(b)of the ITAA 1936

27. The 'relevant person' obtains a 'tax benefit' under paragraph 45B(2)(b) of the ITAA 1936.

28. Here the 'relevant person' does not need to be the shareholder, or the 'person' that receives the capital benefit. In this case, that is Jarius.

29. There is a 'tax benefit' under subsection 45B(9) of the ITAA 1936 as the repayment of the loan instead of a dividend reduces tax payable, being the withholding tax payable on a dividend.

Paragraph 45B(2)(c)of the ITAA 1936

30. Section 45B of the ITAA 1936 only applies if, 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 to obtain a tax benefit.

31. This is an objective test, not a subjective test.²

32. According to the Explanatory Memorandum to Taxation Laws Amendment (Company Law Review) Bill 1998, at paragraphs 1.31 and 1.32:

1.31 New section 45B requires a purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling a taxpayer to obtain a tax benefit. The words in parentheses are inserted for more abundant caution; a reference to a purpose of a scheme is usually understood to include any main or substantial purpose of the scheme, and the words in parentheses clarify that this is the intended meaning here. Thus while new section 45B does not require the purpose of obtaining a tax benefit to be the ruling, most influential or prevailing purpose, neither does it include any purpose which is not a significant purpose of the scheme.

1.32 A purpose is an incidental purpose when it occurs fortuitously or in subordinate conjunction with one of the main or substantial purposes of the scheme, or merely follows that purpose as its natural incident.

33. A person (or persons) can be found objectively to have two or more purposes, none of which is merely incidental. In such a case, all that is necessary for section 45B of the ITAA 1936 to apply is that one of those purposes is a more than incidental purpose of obtaining a tax benefit (either as a demerger benefit or a capital benefit).³

34. It is necessary then to examine the 'relevant circumstances' under subsection 45B(8) of the ITAA 1936.

Purpose: subsection 45B(8)of the ITAA 1936

35. The list of 'relevant circumstances' in subsection 45B(8) of the ITAA 1936 is not exhaustive and regard should be had to all of the circumstances to determine whether they tend towards, against or are neutral as to the conclusion of a purpose of enabling the relevant taxpayer to obtain a tax benefit.⁴

36. In this regard, the words of paragraph 57 of PS LA 2008/10 are particularly useful:

The relevant circumstances listed in subsection 45B(8) encompass a range of matters which, when taken individually or collectively, will reveal whether the requisite purpose exists or not. Due to the diverse nature of these circumstances, some may be of no consequence in ascertaining whether or not that purpose exists. In all cases however, tax officers should have regard to all the circumstances, and determine whether they tend towards, against or are neutral as to the conclusion of a purpose of enabling the relevant taxpayer to obtain a tax benefit.

37. Having carefully considered the relevant circumstances listed in subsection 45B(8) of the ITAA 1936 and taken into consideration all of the relevant facts and circumstances associated with the scheme, the Commissioner concludes it is more likely than not that they tend towards the conclusion that any purpose of enabling the relevant taxpayer to obtain a tax benefit (by way of a capital benefit), is merely incidental.

Conclusions

38. Based on the information to hand, Company A intends repaying an interest free 'at call' loan to an offshore associate group company, Company F.

39. The Applicant agrees that the interest free 'at call' loan represents a non-share equity interest to which section 45B of the ITAA 1936 may potentially apply (Subsection 43B (1) of the ITAA 1936). Any distribution by a company in respect of a non-share equity interest constitutes a non-share distribution (Section 974-115 of the ITAA 1997). All non-share distributions are non-share dividends to the extent that they are not debited against either the company's non-share capital account or its share capital account (Section 974-120 of the ITAA 1997). As the proposed distribution is expected to be debited against the company's non-share capital account, it will constitute a non-share capital return. Consequently, by virtue of subsection 45B(7) of the ITAA 1936, it represents a capital benefit as defined in subsection 45B (5)(b) of the ITAA 1936.

40. If the payment was a dividend distribution, Company F would be subject to dividend withholding tax. Consequently, the provision of the capital benefit would give rise to a tax benefit, making Company F the relevant taxpayer for the purposes of section 45B of the ITAA 1936.

41. Thus, the loan repayment meets the threshold requirements of section 45B of the ITAA 1936.

42. However, section 45B of the ITAA 1936 only applies if, 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 to obtain a tax benefit.

43. Based on the consideration of the list of 'relevant circumstances' in subsection 45B(8) of the ITAA 1936 and taking into consideration all of the relevant facts and circumstances associated with the scheme, it is more likely than not that they tend towards the conclusion that any purpose of enabling the relevant taxpayer to obtain a tax benefit, is merely incidental.

44. Therefore, in this case, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA applies to treat the repayment of the loan by Company A as an unfranked dividend.

¹ See paragraph 40 of PS LA 2008/10.

² See paragraph 55 of PSLA 2008/10.

³ See paragraph 55 of PSLA 2008/10.

⁴ See paragraphs 56 and 57 of the PSLA 2008/10.