Edited version of your private ruling

Authorisation Number: 1012602432022

Ruling

Subject: Return of Capital

Question 1

Will the whole or any part of the proposed capital return represent a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') and be subject to dividend withholding tax pursuant to section 128B of the ITAA 1936?

Answer

No.

Question 2

Will the Commissioner seek to make a determination under section 45B that section 45C of the ITAA 1936 applies to the whole, or any part, of the capital return made to the majority shareholder?

Answer

No.

This ruling applies for the following periods:

1 July 2013 to 30 June 2014.

The scheme commences on:

On or after 1 January 2014

Relevant facts and circumstances

The taxpayer

The taxpayer is an Australian incorporated company and resident of Australia for income tax purposes.

The taxpayer is the head company of an income tax consolidated group, consisting of the taxpayer and its wholly owned Australian subsidiaries.

The taxpayer carries on a business of providing services in Australia.

The taxpayer does not have any foreign subsidiaries or permanent establishments.

The taxpayer's entire issued share capital is made up of ordinary shares.

All shares in the taxpayer were acquired after 19 September 1985.

The taxpayer's management has determined that the taxpayer will distribute an amount of capital between all of the taxpayer's shareholders.

The return of capital will be made following receipt of this private binding ruling from the Commissioner.

The taxpayer is more than 99.99% owned by one shareholder ('majority shareholder').

Less than 0.01% of the shares in the taxpayer are owned by another shareholder ('minority shareholder').

Majority shareholder

The majority shareholder is incorporated outside of Australia and is not an Australian resident for tax purposes.

The majority shareholder is a member a consolidated group ('majority shareholder's group').

The majority shareholder's group is a global group that invests capital in companies.

The majority shareholder does not have Australian capital losses that would be available to be recouped against any capital gain arising from a return of capital.

The majority shareholder does not have any plans to sell its interests in the taxpayer in the foreseeable future.

Minority shareholder

The taxpayer has no knowledge of or access to the minority shareholder's taxation circumstances, including its residency status for income tax purposes or if it has any capital losses.

The taxpayer has not considered the minority shareholder's specific circumstances in developing the proposal to return capital to shareholders because of the minority shareholder's small shareholding and entitlement to a small proportion of the capital return.

Transaction

The taxpayer has negotiated a borrowing facility from an Australian third party lender which it intends to draw upon to implement the return of capital.

The taxpayer has sufficient franking credits available to pay the fully franked dividend.

The return of capital will be debited against the taxpayer's share capital account.

The taxpayer's share capital account (as defined in section 975-300 of the Income Tax Assessment Act 1997 ('ITAA 1997')) is not tainted for the purpose of section 197-50 of the ITAA 1997.

No membership interests are being changed or cancelled and there will be no dilution of shareholding as a consequence of the capital return.

The taxpayer's management has determined that the taxpayer's debt to equity ratio is low in comparison to other organisations with a similar profile to the taxpayer and an increase in the debt to equity ratio would be commercially appropriate.

The return of capital will increase the tax payer's debt to equity ratio.

Another purpose of the transaction is to return capital to the taxpayer's majority shareholder, to enable the majority shareholder to use those funds elsewhere within the majority shareholder's group.

In an earlier period of time, the taxpayer undertook an off-market share buy-back under which it bought back a number of its shares.

The taxpayer has not made any distributions to shareholders since the share buy-back that occurred in that earlier period of time.

Relevant legislative provisions

Income Tax Assessment Act 1936 Subsection 6(1)

Income Tax Assessment Act 1936 Paragraph 6(1)(d)

Income Tax Assessment Act 1936 Subsection 6(4)

Income Tax Assessment Act 1936 Subsection 44(1)

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Subsection 45B(2)

Income Tax Assessment Act 1936 Paragraph 45B(2)(a) to (c)

Income Tax Assessment Act 1936 Subsection 45B(3)

Income Tax Assessment Act 1936 Subsection 45B(5)

Income Tax Assessment Act 1936 Paragraph 45B(5)(a) and (b)

Income Tax Assessment Act 1936 Subsection 45B(8)

Income Tax Assessment Act 1936 Paragraphs 45B(8)(a) to (k)

Income Tax Assessment Act 1936 Subsection 45B(9)

Income Tax Assessment Act 1936 Subsection 45B(10)

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Section 128B

Income Tax Assessment Act 1936 Subsection 177D(2)

Income Tax Assessment Act 1936 Paragraphs 177D(2)(a) to (k)

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 Section 197-50

Income Tax Assessment Act 1997 Section 975-300

Income Tax Assessment Act 1997 Subsection 975-300(3)

Income Tax Assessment Act 1997 Subsection 995-1(1)

Taxation Administration Act 1953 Division 359 of Schedule 1

Reasons for decision

Question 1:

Summary

The return of share capital to the taxpayer's shareholders will not be a dividend as defined in subsection 6(1) of the ITAA 1936 and will not be subject to dividend withholding tax pursuant to section 128B of the ITAA 1936.

Detailed reasoning

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) and from an Australian source (if the shareholder is a non-resident).

The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph 6(1)(d) of the definition of 'dividend' 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.

'Share capital account' is defined in section 975-300 of the Income Tax Assessment Act 1997 ('ITAA 1997') as an account which the company keeps of its share capital, or any other account created after 1 July 1998 where the first amount credited to the account was an amount of share capital.

Subsection 975-300(3) of the ITAA 1997 states that an account is generally taken not to be a share capital account if it is tainted. Section 197-50 of the ITAA 1997 states that a share capital account is tainted if an amount to which Division 197 of the ITAA 1997 applies, is transferred to the account and the account is not already tainted.

The taxpayer's issued share capital consists solely of ordinary shares. The return of share capital will be debited against the taxpayer's share capital account. The share capital account is not tainted for the purpose of section 197-50 of the ITAA 1997.

The exclusion in paragraph 6(1)(d) of the definition of dividend is limited by subsection 6(4) of the ITAA 1936 which applies in circumstances where, under an arrangement:

a) a company raises share capital, receiving either cash or property from a person or group of persons, crediting the amount of money or value of the property to its share capital account; and

b) returns the cash or property received to another person or group of persons, debiting the amount of money or value of the property to its share capital account.

Subsection 6(4) of the ITAA 1936 will have no application in respect of the taxpayer's return of capital. The funds for the return of capital are sourced from capital originally raised from the taxpayer's shareholders and, as such, the taxpayer will debit its share capital account by the amount of the return of capital.

Paragraph 6(1)(d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 applies to exclude the distribution of capital from falling within the definition of a dividend. Therefore, the return of share capital will not constitute a dividend for income tax purposes and the taxpayer's shareholders will not be liable for dividend withholding tax on the return of capital pursuant to section 128B of the ITAA 1936.

Question 2:

Summary

The Commissioner will not seek to make a determination under section 45B that section 45C of the ITAA 1936 applies to the whole, or any part, of the capital return made by the taxpayer to its majority shareholder.

Detailed reasoning

Section 45B of the ITAA 1936 applies where certain capital payments, including a return of capital, are paid to shareholders in substitution for dividends. The purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts distributed to shareholders of a company are treated as dividends for tax purposes if certain payments, allocations and distributions are made in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 sets out the conditions under which the Commissioner may make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies. Specifically, the conditions provided for under subsection 45B(2) are that:

a) there is a scheme under which a person is provided with a capital benefit by a company;

b) under the scheme, a taxpayer (the relevant taxpayer), who may or may not be the person provided with 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, other than an incidental purpose of enabling the relevant taxpayer to obtain a tax benefit.

Each condition is considered below.

Scheme

For paragraph 45B(2)(a) of the ITAA 1936 to be satisfied, a taxpayer must be provided with a capital benefit by a company under a scheme. A scheme for the purposes of section 45B has the meaning given by subsection 995-1(1) of the ITAA 1997 (see subsection 45B(10)). A scheme is broadly defined in subsection 995-1(1) to mean:

a) any arrangement; or

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

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. Relevantly, it includes the provision of ownership interests in a company to a person, and the distribution to a person of share capital (see paragraphs 45B(5)(a) and (b) of the ITAA 1936).

As the taxpayer's return of capital to its shareholders will be debited to the taxpayer's share capital account, the Commissioner considers that the capital return arrangement is a scheme under which a person is provided with a capital benefit by the company. Therefore, paragraph 45B(2)(a) of the ITAA 1936 will be satisfied in respect of the taxpayer's return of capital to its shareholders.

Tax Benefit

For paragraph 45B(2)(b) of the ITAA 1936 to be satisfied, a taxpayer must obtain a tax benefit. Pursuant to subsection 45B(9) of the ITAA 1936, a 'tax benefit' will be obtained from a capital benefit if the amount of tax payable by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable if the capital benefit had been a dividend. Generally, where there is a distribution of share capital, a tax benefit will arise as a shareholder or the relevant taxpayer will pay less tax on the distribution than they would have if the amount had instead been a 'dividend'.

In addition to this general circumstance, the relevant taxpayer also obtains a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends.

The return of capital to be distributed by the taxpayer will not be assessable in the hands of its shareholders because the payment would be excluded from the definition of 'dividend' in subsection 6(1) of the ITAA 1936. For this reason, the shareholders will obtain a tax benefit as defined in subsection 45B(9) of the ITAA 1936. Therefore, paragraph 45B(2)(b) of the ITAA 1936 will be satisfied in respect of the taxpayer's return of capital to its shareholders.

Relevant circumstances

Paragraph 45B(2)(c) of the ITAA 1936 sets out an objective purpose test, having regard to the relevant circumstances of the scheme (under which the capital benefit is provided). Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to objectively consider the 'relevant circumstances of the scheme' pursuant to subsection 45B(8) of the ITAA 1936 as to whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a 'tax benefit'. The test is not satisfied if the purpose (of obtaining a tax benefit) is only incidental, notwithstanding this, the purpose does not have to be the dominant purpose of the scheme. That is, the test is satisfied so long as the purpose of obtaining a tax benefit is not incidental.

In the application of the purpose test consideration is given to the relevant circumstances of the scheme as set out in paragraphs 45B(8)(a) to (k) of the ITAA 1936. However, the list of relevant circumstances in subsection 45B(8) is not exhaustive and regard may be had to other circumstances on the basis of their relevance.

For the purposes of this specific ruling, the relevant circumstances of the company and the tax profile of its shareholders are addressed below.

(a) Extent to which the capital benefit is attributable to profits of the company

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company. Whether the return of capital is attributable to profit is essentially concerned with determining whether there is a discernible connection between the amount distributed as share capital and the share capital and profits that are available for distribution.

The taxpayer had retained earnings and franking credits.

The objective purpose of the taxpayer's payment is to return shareholder's capital so that they can invest in other projects and increase the taxpayer's debt to equity ratio to a level that is commercially appropriate for the taxpayer.

Paragraph 74 of Law Administration Practice Statement PS LA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions (PS LA 2008/10) is particularly relevant to the taxpayer's circumstances, in providing that:

… if the occasion for the share capital reduction is to increase the company's gearing ratio (the debt to equity ratio) it should be borne in mind that equity includes both retained profits and share capital and that this is an occasion that affects both. This means that an increase in the gearing ratio can be achieved just as effectively by returning profits as reducing share capital, including by way of dividend. Generally, in the absence of other relevant factors which indicate otherwise, tax officers should regard the capital distribution as being attributable to the share capital and retained earnings on a proportionate basis.

An independent experts report (IER) was prepared in relation to an off-market takeover offer for the taxpayer undertaken. The IER provided a valuation of the taxpayer that was well in excess of the total shareholder funds disclosed in its accounts, suggesting that the taxpayer may have a substantial amount of unrealised profits.

Paragraphs 70 to 72 of PSLA 2008/10 elaborate on the meaning of profits for the purposes of paragraph 45B(8)(a) of the ITAA 1936:

70. … an unrealised gain, whether or not it is of a 'permanent character' and whether or not it meets the technical requirements for distribution of the Corporations Act, constitutes profits for the purposes of paragraph 45B(8)(a).

71. Therefore, the notion of 'profits' in paragraph 45B(8)(a) may be wider than that under the Corporations Act. The attribution inquiry extends beyond profits legally distributable by the company to profits which, as a practical matter of fact, are available to be harvested by the company for distribution at that time or at a future time.

72. Nevertheless, tax officers should also take account of the nature and circumstances of the particular company, its distribution culture and whether there are commercial concerns with distributing the profits, including distributing any unrealised profits if relevant, in determining whether section 45B applies. For example, a corporate group could have some unrealised profit that may be so ephemeral as to render its distribution imprudent. …

Paragraph 15 of Taxation Ruling TR 2003/8 Distributions of property by companies to shareholders - amounts to be included as an assessable dividend states that:

So long as the market value of the company assets exceeds the total amount (as shown in its books of account) of its liabilities and share capital what remains is profits. If the distribution is not debited to share capital the distribution is one of profits.

The valuation provided in the IER was determined using a capitalisation of future maintainable earnings approach. Since the IER was conducted, the taxpayer has not attributed an amount to unrealised profits in its books of account. It is also noted that a formal valuation of the individual assets disclosed on the taxpayer's balance sheet has not been performed, nor do the actions or accounts of the taxpayer demonstrate that it has recognised the unrealised profits contained in the IER as being attributed to the shareholder funds available for distribution.

The Commissioner accepts that the total shareholder funds disclosed in the taxpayer's most recent accounts represent the total equity available for distribution.

On the basis of a comparison between the return of capital being made and the equity available for distribution, the return of capital portion will be made on a proportionate basis and can be wholly attributed to share capital and not to any realised or unrealised profits. Therefore, the return of capital will be sourced from the shareholder's issued capital.

This circumstance tends towards the capital return being attributable to the excess capital contributed by the shareholders and not to any realised or unrealised profits.

(b) Pattern of distributions

Paragraph 45B(8)(b) of the ITAA 1936 refers to 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. The Commissioner has explained in paragraph 77 of PSLA 2008/10 that a pattern of making capital distributions (with the capital performing the function of dividends) may point towards the company engaging in dividend substitution.

Paragraph 77 of Law Administration Practice Statement PS LA 2008/10 provides that distributions include special dividends and share buy-backs. In an earlier period, the taxpayer undertook an off-market share buy-back under which it bought back a number of its shares.

The taxpayer has not made any distributions to shareholders since the buy back. The absence of a pattern of distributions does not indicate that the return of capital is in substitution for a dividend. The funds for the return of capital will be sourced to the original capital that was raised by the taxpayer from the issue of shares. The capital return will be made in addition to a payment of a dividend in proportion to the underlying equity of the taxpayer that is to be replaced with debt.

No conclusion is drawn in relation to this circumstance.

(c) Capital losses

Paragraph 45B(8)(c) of the ITAA 1936 refers to whether shareholders have capital losses, that, apart from the scheme, would be carried forward to a later year of income.

The majority shareholder of shares in the taxpayer, has no capital losses which may be available to recoup against any capital gain arising on the return of capital.

The taxpayer has no knowledge of or access to information to determine whether the minority shareholder, the holder of less than 0.01% of the shares in the taxpayer has Australian capital losses which might be available to recoup against any capital gain arising on the return of capital. However, it is noted that the taxpayer has not considered any capital losses that may be available to the minority shareholder when developing the proposal to return capital to shareholders because of the minority shareholder's small shareholding.  

This circumstance is not indicative as to purpose and no conclusion is drawn in relation to this circumstance.

(d) Pre-CGT ownership interests

Paragraph 45B(8)(d) of the ITAA 1936 refers to whether any of the ownerships interests in the company or an associate of the company were held by the shareholders before 20 September 1985.

Neither of the two shareholders of the taxpayer acquired any of their ownership interests in the taxpayer before 20 September 1985.

This circumstance is not indicative as to purpose and no conclusion is drawn in relation to this circumstance.

(e) Residency of the owners of the taxpayer

Paragraph 45B(8)(e) of the ITAA 1936 directs attention to whether the relevant taxpayer is a non-resident.

The implication of non-residency is that it would normally point towards a tax preference for a distribution of capital rather than of profits because a distribution of capital to a non-resident shareholder would not be assessable to that shareholder.

The majority shareholder is a non-resident of Australia for income tax purposes. The taxpayer has no knowledge of or access to information to determine whether the minority shareholder is a resident of Australia for income tax purposes. However, the taxpayer has not considered the minority shareholder's residency in developing the proposal to return capital to shareholders because of the minority shareholder's small shareholding.

Other than the preservation of franking credits, there is no immediate direct tax benefit to the shareholders from receiving the return of share capital rather than a dividend. Therefore this circumstance is not indicative as to purpose and no conclusion is drawn in relation to this circumstance.

(f) Cost base of the ownership interests - whether the cost base is not substantially less than the capital benefit

For the purposes of paragraph 45B(8)(f) of the ITAA 1936, if the cost base of the relevant ownership interest is substantially less than the return of capital, this circumstance may be indicative of purpose.

The cost base of the relevant ownership interest is substantially more than the capital return. Therefore this circumstance is not indicative as to purpose and no conclusion is drawn in relation to this circumstance.

(h) 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.

Following the return of capital, the taxpayer's shareholders will have an identical interest in the taxpayer as they had prior to the payment. No shares will be cancelled as a result of the capital return and there will be no dilution of shareholding in the taxpayer as a consequence of the capital return. This circumstance is therefore not indicative as to purpose and no conclusion is drawn in relation to this circumstance.

(k) Any matters referred to in s 177D(2) of the ITAA 1936

Paragraph 45B(8)(k) also includes any matters referred to in subsection 177D(2) of the ITAA 1936 to be a relevant circumstance of the scheme. The matters provided in subsection 177D(2) are:

a) the manner in which the scheme was entered into or carried out;

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).

On balance it is considered that the matters raised in paragraphs 177D(2)(a) to 177D(2)(h) of the ITAA 1936 do not lead to a conclusion that a purpose, other than an incidental purpose, of obtaining a tax benefit exists in relation to the entering of the scheme.

Conclusion

The applicant has provided factors supporting commercial objectives for the return of share capital and distribution to its shareholders.

These are considered against the factors that would incline towards the conclusion that the scheme is being implemented for a more than incidental purpose for the relevant taxpayer to obtain a tax benefit.

Notwithstanding that paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 are satisfied and having regard to the relevant circumstances of the scheme as stipulated within subsection 45B(8) of the ITAA 1936 it cannot be concluded that the scheme will be implemented for a more than incidental purpose of enabling the relevant person to obtain a tax benefit for the purposes of paragraph 45B(2)(c) of the ITAA 1936.

Therefore, the return of share capital to the taxpayer's shareholders will not be a dividend as defined in subsection 6(1) of the ITAA 1936 and will not be subject to dividend withholding tax pursuant to section 128B of the ITAA 1936.

The Commissioner will not make a determination under section 45C of the ITAA 1936 because subsection 45B(3) of the ITAA 1936 will not apply to any part of the return of share capital to the majority shareholder.