Edited version of your private ruling

Authorisation Number: 1012551593558

Ruling

Subject: Return of capital

Question 1

Will any part of the distribution made by Company Q to shareholders (that is debited against the amount standing to the credit of the share capital account of Company Q) be treated as a dividend within the meaning of subsection 6(1) of the Income Tax Assessment Act 1936?

Answer

No.

Question 2

Will the Commissioner seek to make a determination under section 45B of the Income Tax Assessment Act 1936 that section 45C of the Income Tax Assessment Act 1936 applies to deem any part of the distribution made by Company Q to shareholders (that is debited against the amount standing to the credit of the share capital account of Company Q) to be a dividend paid out of profits?

Answer

No.

This ruling applies for the following period:

Year ended 30 June 2014.

The scheme commences on:

The date the proposed return of capital payment is made.

Relevant facts and circumstances

Historical background

Company Q is an Australian company that was incorporated after 20 September 1985 that is the head company of an income tax consolidated group. Company R is a subsidiary member of the Company Q consolidated group.

Company T joined the Company Q consolidated group when all of the shares in Company T were acquired by Company R.

Company T was funded by way of share capital. The share capital and some external borrowings were used to fund the acquisition of shares in Company T.

Company T has key operating subsidiaries in Australia and overseas.

Refinancing and distribution

Company Q will refinance by obtaining additional, external borrowings which will have the effect of increasing the company's gearing ratio. Company Q will use some of the additional borrowings and existing cash to fund a distribution of share capital to shareholders and to make a concurrent dividend distribution. Company Q will obtain some of the funds from dividends made by subsidiaries.

The refinancing is enabled by a change in economic circumstances such that shareholders are more comfortable with a higher debt/equity ratio. It also provides further growth opportunities.

Shareholders in Company Q own ordinary shares and will receive the same proportion of the distribution of share capital and the dividend distribution.

Company Q will debit the entire amount of the distribution of share capital to its share capital account. The dividend distribution will be entirely debited to Company Q's retained earnings. Both amounts will be credited to cash.

The market value of Company Q has increased since the acquisition of Company T and relates to an increase in the value of businesses carried out in the key operating subsidiaries.

Company Q has determined the amount to be debited to its share capital account as the ratio of Company Q's share capital to the company's market value. The dividend amount, as a proportion to the distribution of share capital amount, exceeds that of profits of Company Q and its subsidiaries to the available share capital of Company Q.

Other matters

Company Q has not made any distributions to shareholders since the acquisition of Company T.

The financial statements for Company R accounting consolidated group for the most recent year disclose an accumulated loss amount.

The balance of Company Q's franking account is nil.

No amounts have been transferred to the share capital account of Company Q, and the company's share capital account is not tainted within the meaning of Division 197 of the ITAA 1997.

The shares in Company Q are held by collective investment vehicles (CIVs) including foreign limited partnerships, other foreign CIVs which may be regarded as similar to managed investment schemes, and Australian managed investment schemes.

Foreign beneficial shareholders in Company Q hold a significant proportion of the shares on issue.

Where underlying investors are non-residents, it is expected that no capital losses exist due to the general CGT exemption available for non-Taxable Australian Real Property (non-'TARP') assets.

Where underlying investors are Australian institutional investors, the investors may have capital losses.

The proposed distribution of share capital will not of itself generate capital gains for any shareholder.

Relevant legislative provisions

Income Tax Assessment Act 1936 (ITAA 1936) Subsection 6(1)

ITAA 1936 Section 45B

ITAA 1936 Subsection 45B(1)

ITAA 1936 Paragraph 45B(1)(b)

ITAA 1936 Subsection 45B(2)

ITAA 1936 Paragraph 45B(2)(a)

ITAA 1936 Paragraph 45B(2)(b)

ITAA 1936 Paragraph 45B(2)(c)

ITAA 1936 Subsection 45B(3)

ITAA 1936 Paragraph 45B(3)(b)

ITAA 1936 Subsection 45B(5)

ITAA 1936 Paragraph 45B(5)(b)

ITAA 1936 Subsection 45B(8)

ITAA 1936 Paragraph 45B(8)(a)

ITAA 1936 Paragraph 45B(8)(b)

ITAA 1936 Paragraph 45B(8)(c)

ITAA 1936 Paragraph 45B(8)(d)

ITAA 1936 Paragraph 45B(8)(e)

ITAA 1936 Paragraph 45B(8)(f)

ITAA 1936 Paragraph 45B(8)(k)

ITAA 1936 Subsection 45B(9)

ITAA 1936 Subsection 45B(10)

ITAA 1936 Section 45C

ITAA 1936 Subsection 45C(1)

ITAA 1939 Subsection 177A(1)

ITAA 1936 Subsection 177D(2)

ITAA 1936 Paragraph 177D(2)(a)

ITAA 1936 Paragraph 177D(2)(b)

ITAA 1936 Paragraph 177D(2)(c)

ITAA 1936 Paragraph 177D(2)(d)

ITAA 1936 Paragraph 177D(2)(e)

ITAA 1936 Paragraph 177D(2)(f)

ITAA 1936 Paragraph 177D(2)(g)

ITAA 1936 Paragraph 177D(2)(h)

Income Tax Assessment Act 1997 (ITAA 1997) Section 197-50

ITAA 1997 Subsection 197-50(1)

ITAA 1997 Section 975-300

ITAA 1997 Subsection 975-300(1)

ITAA 1997 Subsection 975-300(3)

ITAA 1997 Subsection 995-1

Reasons for decision

All legislative references are to provisions of the Income Tax Assessment Act 1936 (ITAA 1936) unless otherwise stated.

Question 1

Summary

The distribution of share capital made by Company Q to its shareholders that is debited against the company's share capital account will not be treated as a dividend within the meaning of subsection 6(1).

Detailed reasoning

Relevant legislation

For taxation law purposes, the term 'dividend' is defined in subsection 6(1) of to include:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and

(b) any amount credited by a company to any of its shareholders as shareholders;

(c) (Repealed by No 63 of 1998)

but does not include:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company; or

(e) moneys paid or credited, or property distributed, by a company for the redemption or cancellation of a redeemable preference share if:

(i) the company gives the holder of the share a notice when it redeems or cancels the share; and

(ii) the notice specifies the amount paid-up on the share immediately before the cancellation or redemption; and

(iii) the amount is debited to the company's share capital account;

except to the extent that the amount of those moneys or the value of that property, as the case may be, is greater than the amount specified in the notice as the amount paid-up on the share; or
(f) a reversionary bonus on a life assurance policy.

The term 'share capital account' is defined in subsection 975-300(1) of the Income Tax Assessment Act 1997 (ITAA 1997) as:

(a) an account that the company keeps of its share capital; or

(b) any other account (whether or not called a share capital account) that satisfies the following conditions:
(i) the account was created on or after 1 July 1998;

(ii) the first amount credited to the account was an amount of share capital.

Subsection 975-300(3) of the ITAA 1997 provides that a share capital account is not treated as such where it is tainted other than for the following provisions:

(a) subsection 118-20(6); and

(b) Division 197; and

(ba) paragraph 202-45(e); and

(c) the definition of paid-up share capital in subsection 6(1) of the Income Tax Assessment Act 1936; and

(d) subsection 44(1B) of the Income Tax Assessment Act 1936; and

(f) subsection 159GZZZQ(5) of the Income Tax Assessment Act 1936.

Where a share capital account is not already tainted, subsection 197-50(1) of the ITAA 1997 states that:

A company's *share capital account becomes tainted when an amount to which this Division applies is transferred to the account …

Application to the relevant facts and circumstances of Company Q

As set out above:

· The term 'dividend' includes any distribution made by a company to any of its shareholders;

· A distribution that is debited against an amount standing to the credit of the company's share capital account is not a dividend unless the share capital account is tainted. In some limited circumstances, a tainted share capital account continues to be treated as a share capital; account.

In the circumstances of Company Q, an amount will be recorded as a debit to the share capital account of Company Q. As the share capital account is not a tainted share capital account within the meaning of Division 197 of the ITAA 1997, paragraph (d) of the definition of 'dividend' in subsection 6(1) will apply such that the amount debited to the share capital account of Company Q will not be a dividend for the purposes of subsection 6(1).

Further, the circumstances where paragraph 6(1)(d) does not apply as an exception to the definition of 'dividend' - which are set out in subsection 6(4) - are not and will not be present in this arrangement. If the circumstances were present, the return of capital would constitute a dividend.

Question 2

Summary

The Commissioner will not make a determination under section 45B that section 45C applies to deem any part of the distribution of share capital as a dividend paid out of profits.

Detailed reasoning

Relevant legislation

Disregarding demergers, the purpose of section 45B as set out in subsection 45B(1) is:

…to ensure that relevant amounts are treated as dividends for taxation purposes if:

…

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

The operative provision in section 45B is subsection 45B(2), as it relates to the provision of a 'capital benefit'. Subsection 45B(2) applies if:

(a) there is a scheme under which a person is provided with … 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 … 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.

For subsection 45B(2) to apply to a distribution of share capital payment, each of paragraphs 45B(2)(a), (b) and (c) must be present in the circumstances of the payment.

The effect of subsection 45B(2) is that the Commissioner may make a Determination pursuant to subsection 45B(3) that section 45C applies to treat the distribution of capital for Australian income tax purposes as an unfranked dividend. Subsection 45B(3) states:

The Commissioner may make, in writing, a determination that:

…

(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.

Paragraph 45B(2)(a) requirement - scheme for the provision of a capital benefit to a person

Subsection 45B(10) states that scheme has the meaning given by paragraph 995-1(1) of the ITAA 1997. Subsection 995-1(1) of the ITAA 1997 states that 'scheme' means:

(a) any arrangement; or

(b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise.

Subsection 45B(5) states that a reference to a person being provided with a capital benefit is a reference to:

(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.

'Person' is defined in subsection 6(1), and in subsection 995-1 of the ITAA 1997, to include a company. It is sufficient to consider each legal holder of shares in Company Q as the relevant 'person'.

As the amount will be debited to the share capital account of Company Q, the scheme for the distribution of share capital to each shareholder is a scheme for the provision of a capital benefit in accordance with paragraph 45B(5)(b).

Conclusion for the paragraph 45B(2)(a) requirement

The paragraph 45B(2)(a) requirement is present.

Paragraph 45B(2)(b) requirement - tax benefit

The meaning of obtaining a tax benefit is set out at section 45B(9) which states:

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 capital benefit had been an assessable dividend.

In the present circumstances, each shareholder of Company Q is a relevant 'taxpayer'.

The distribution of share capital to the shareholders of Company Q constitutes a capital benefit. If the distribution were instead an assessable dividend rather than a return of capital payment, it is likely that the shareholders of Company Q would pay more tax than is otherwise payable in respect

of the distribution of share capital (being the capital benefit). Consequently, the receipt of the capital benefits will give rise to a 'tax benefit'.

This is because the alternative dividend in the circumstances of Company Q would be an unfranked dividend which would be subject to withholding tax for non-resident recipients, and income tax at marginal rates for resident recipients.

Conclusion for the paragraph 45B(2)(b) requirement

The paragraph 45B(2)(b) requirement is present.

Paragraph 45B(2)(c) requirement - conclusion as to purpose

Paragraph 45B(2)(c) requires the Commissioner to make a conclusion as to the purpose of enabling a taxpayer to obtain a tax benefit. Subsection 45B(8) sets out the relevant circumstances of the scheme to include:

(a) the extent to which the … capital benefit is attributable to capital or the extent to which the … 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;

…

(k) any of the matters referred to in subsection 177D(2).

The matters referred to in subsection 177D(2) are:

(a) the manner

(b) the form and substance of the scheme;

(c) the time at which the scheme was entered into and the length of the period during which the scheme was carried out;

(d) the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme;

(e) 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;

(f) any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme;

(g) any other consequence for the relevant taxpayer, or for any person referred to in paragraph (f), of the scheme having been entered into or carried out;

(h) the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in paragraph (f).

Consideration of factors as to purpose

Paragraph 45B(2)(c) requires the Commissioner to consider the 'relevant circumstances' of the scheme with regard to various, non-exhaustive factors set out in subsection 45B(8). A consideration of these circumstances determines whether any part of a scheme to provide capital benefits was entered into for a purpose, other than an incidental purpose, of enabling the relevant taxpayer to obtain a tax benefit.

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

The purpose which causes section 45B to apply may be the purpose of any party to the scheme.

For the distribution of share capital, the circumstances covered by paragraphs 45B(8)(i) and 45B(8)(j) which are concerned with the provision of ownership interests and demergers respectively, are not relevant. The relevant matters are those set out in paragraphs 45B(8)(a) - (f), 45B(8)(h) and 45B(8)(k).

Paragraph 45B(8)(a): Attribution

Paragraph 45B(8)(a) refers to the extent to which the capital benefit is attributable to capital and profits (realised or unrealised) of the company or an associate (within the meaning of section 318) of the company.

In this instance, the proposed distribution will coincide with Company Q refinancing its external borrowings and increasing its gearing ratio. A portion of the borrowings is intended to be used by Company Q to return capital to shareholders. The capital being returned to the shareholders pursuant to the scheme is capital that is being replaced with debt.

A change in gearing may arise just as much by a change in equity as in profits. Company Q will pay a dividend amount concurrently with the distribution of share capital payment. Company Q determined the dividend amount as a proportion of the difference between the market value of Company Q and the company's share capital account.

The dividend amount exceeds the proportion worked out as that of the profits of Company Q and its subsidiaries to the available share capital of Company Q.

It is considered that this factor does not tend towards a conclusion as to the requisite purpose.

Paragraph 45B(8)(b): distribution culture

Paragraph 45B(8)(b) directs attention to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by a company or an associate (within the meaning in section 318) of the company. The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution of capital may suggest dividend substitution.

Company Q has not paid any dividends since the acquisition of Company T. However the fact that a company may not have made any distributions previously, whether of profit or share capital, does not of itself point away from the requisite purpose.

Prior to acquisition, Company T had a history of dividend payments.

It is considered that this factor tends moderately towards a conclusion as to requisite purpose.

Paragraph 45B(8)(c): capital losses

Paragraph 45B(8)(c) relates to whether the shareholders possess capital losses that, apart from the scheme, would be carried forward to a later year of income. As Company Q has a number of non-resident shareholders that would be entitled to disregard any capital gains or capital losses made, the factor relates mainly to resident shareholders. Company Q is not aware of the capital loss profile of all shareholders.

This factor tends neither towards nor against a conclusion of requisite purpose.

Paragraph 45B(8)(d): pre-CGT ownership interests

Paragraph 45B(8)(d) refers to whether the shareholders acquired, or are taken to have acquired, their shares in the company before 20 September 1985. Company Q was established after this date. This factor does not tend towards a conclusion as to requisite purpose.

Paragraph 45B(8)(e): residency of the shareholders of the company

Paragraph 45B(8)(e) requires consideration of whether the shareholders of the company are non-residents. The implication of non-residency is that it would normally point towards a tax preference for a distribution of capital rather than of profits. Foreign beneficial shareholders in Company Q hold a significant proportion of the shares on issue.

It is considered that this factor tends towards a conclusion as to requisite purpose.

Paragraph 45B(8)(f): cost base of the ownership interests

Paragraph 45B(8)(f) is concerned with whether the cost base of the relevant ownership interest is not substantially less than the value of the return of capital. The total cost base of shares held in Company Q is expected to be consistent with the company's issued share capital. As such, the cost base of shares should not be substantially less than the value of the proposed distribution.

It is considered that this factor tends only slightly towards a conclusion as to requisite purpose.

Paragraph 45B(8)(h): nature of interest after the return of capital

Paragraph 45B(8)(h) requires a comparison of the respective interests held by shareholders after the distribution. As the proposed distribution of share capital is to be proportional to all shareholders and will not result in the cancellation of any shares in Company Q, each shareholder's substantive interests will remain the same as if a dividend was paid instead. In the circumstances of this arrangement, this factor tends only slightly towards a conclusion as to purpose.
Paragraph 45B(8)(k): Part IVA matters

Paragraph 45B(8)(k) refers to the matters in paragraphs 177D(2)(a) to (h). These are matters by reference to which a scheme may be examined from a practical perspective in order to identify and compare its tax and non-tax objectives.

Paragraph 177D(2)(a)

Paragraph 177D(2)(a) refers to the manner in which the scheme was entered into or carried out. This is a reference to consideration of the decisions, steps and events that combine to make up the scheme. The manner in which Company Q made the distribution is consistent with ordinary commercial schemes for a distribution of share capital payment.

Paragraph 177D(2)(b)

Paragraph 177D(2)(b) refers to the form and substance of the scheme. The form of the scheme is the visible aspect of the scheme; the substance of the scheme is its essential nature which is normally determined from its commercial and economic implications. The distribution of share capital made by Company Q constitutes the form of an ordinary commercial capital return scheme. The distribution of share capital to the shareholders of Company Q is attributable to share capital invested in Company Q. Accordingly the substance of the scheme is consistent with its form.

Paragraph 177D(2)(c)

Paragraph 177D(2)(c) directs attention to the time at which the scheme was entered into and the length of the period during which the scheme was carried out. This factor requires not only reference to time measurement but also reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself. In particular, it enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities or requirements.

The return of capital made by Company Q coincides with the company refinancing its external borrowings and increasing its gearing ratio. A portion of the borrowings was used by Company Q to make the distribution of share capital. The refinancing was necessary for a number of reasons, including a change in economic circumstances such that shareholders are more comfortable with a higher debt/equity ratio. It also provides further growth opportunities.

The timing of the return of capital involving refinancing in the circumstances of this arrangement reflects commercial purposes and provides a reason for the distribution of capital that is outside the ordinary course of business.

Paragraph 177D(2)(d)

Paragraph 177D(2)(d) is concerned with the result that would arise but for the operation of the section. This factor requires consideration of whether Company Q is distributing what are effectively profits to shareholders as preferentially-taxed capital rather than dividends. If section 45B did not apply, the tax results of the scheme would be that CGT event G1 would have happened to all shareholders, with the most likely result that the shareholders would have reduced the cost base of their shares by the amount of the return of capital payment received (the 'non-assessable part'). Where a non-resident shareholder made a capital gain pursuant to CGT event G1 happening, the capital gain would most likely be disregarded pursuant to Division 855. Non-residents hold a number of shares in Company Q.

Paragraph 177D(2)(e)

Paragraph 177D(2)(e) directs attention to any change in the financial position of the shareholders that results, will result or may reasonably be expected to result from the share capital reduction scheme. Upon the return of capital by Company Q, shareholders will receive cash with their proportionate interests in the company remaining the same.

Paragraph 177D(2)(f)

Paragraph 177D(2)(f) is concerned with the change in financial position for any other person including Company Q as a result of the scheme. To effect the return of capital, Company Q will divest itself of the distribution of share capital amount by debiting its share capital account by the same amount.

For Company Q, the share capital reduction is expected to increase the company's gearing ratio as a result of the issue of new debt and a return of share capital.

Paragraph 177D(2)(g)

Paragraph 177D(2)(g) directs attention to any 'other' consequence of the return of capital scheme for the shareholders or the company. The distribution of share capital by Company Q will not affect the company's ability to pay dividends, as it is expected that subsidiaries will continue to pay dividends in future to Company Q.

Paragraph 177D(2)(h)

Finally, paragraph 177D(2)(h) is concerned with the nature of the relationship between (participating) shareholders and Company Q. Company Q has advised that the distribution of share capital was made possible due to a restructuring of the company's debt arrangements. The debt restructure, along with greater shareholder comfort around a higher debt/ equity ratio, enabled excess share capital to be returned to shareholders.

Conclusion: 45B(8)(k)- Part IVA matters

The Commissioner considers that the factors set out in paragraphs 177D(2)(a)-(h), which are considered pursuant to paragraph 45B(8)(k), do not incline towards a conclusion as to requisite purpose.

Conclusion for the paragraph 45B(2)(c) requirement

Having regard to the relevant circumstances of the scheme, which are set out in various paragraphs in subsection 45B(8), the Commissioner concludes that Company Q and its shareholders did not enter the scheme for the distribution of share capital the purpose of enabling the shareholders of Company Q to obtain a tax benefit.

Overall conclusion

As the paragraph 45B(2)(c) requirement was not present, the Commissioner will not make a Determination pursuant to subsection 45B(3) that section 45C applies to the distribution of share capital payment.