Edited version of private advice

Authorisation Number: 1012619231706

Ruling

Subject: Return of capital

Issue 1

Proposed Capital return

Question 1

Will the proposed dividend declared and paid by Company H and debited against the amounts standing to the credit of the retained earnings account be unfrankable pursuant to paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997)?

Answer

No

Question 2

Will Company H be required to withhold an amount from the proposed capital return in accordance with section 12-210 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953)?

Answer

No

Question 3

Will the Commissioner make a determination in relation to the proposed capital return pursuant to subsection 45C(3) Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 4

On the basis that the proposed capital return will not be a dividend for income tax purposes, will a franking debit arise in the franking account of Company H pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of the ITAA 1936 or ITAA 1997?

Answer

No

This ruling applies for the following periods:

Year ending XX/XX/XXXX

The scheme commences on:

XX/XX/XXXX

Relevant facts and circumstances

1. Company H is the head company of an Australian consolidated group.

2. Company H has not conducted any previous returns of capital, share buy-backs or bonus share issues since its inception. There have not been any capital injections into Company H since its inception.

Capital management proposal

3. Company H intends to pay a dividend to shareholders (the proposed dividend) and to immediately thereafter undertake a return of capital (the proposed capital return) to shareholders. It is expected that the proposed dividend will be fully franked. The capital return is proposed to be undertaken by way of a pro-rata capital reduction.

4. The proposed dividend and the proposed capital return will be applied equally to each holder of fully paid ordinary shares as at the nominated relevant entitlement date (the Record Date).

5. Company H will source the entire amount of cash for the proposed capital return from a capital return to be made to Company H by one of its subsidiaries.

Proposed dividend

6. Company H expects to declare the proposed dividend in xx/xx/xxxx with payment to be made no later than xx/xx/xxxx.

7. The proposed dividend will be funded from current year profits of Company H arising as a result of receipt of a dividend from its subsidiaries. The dividend received by Company H will not be offset in the accounting records of Company H against any accumulated losses of Company H prior to the proposed dividend being declared and paid.

8. Company H will source the dividend proposed to be paid to its shareholders from available current year period profits, which will be evidenced by appropriate directors' resolutions and the way in which the accounts are prepared and approved by the directors of Company H.

9. Company H will satisfy all of the requirements of section 254T of the Corporations Act which stipulates the circumstances in which a company may pay a dividend in relation to the payment of the proposed dividend. Company H will also satisfy all provisions of its Constitution in relation to the declaration and payment of the proposed dividend.

10. The proposed dividend will not be sourced directly or indirectly from the share capital of Company H or any other entity in the Company H Group.

11. Company H has a sufficient franking credit balance in its franking account to frank the proposed dividend to 100%.

Proposed capital return

12. Company H's management is of the view that it has a surplus of capital.

13. As at xx/xx/xxxx, the Company H Group's cash balance exceeded its total liabilities balance.

14. Therefore the excess cash is surplus to its on-going business needs. Company H's strong cash flow generating ability is expected to add further to this surplus position.

15. Additionally, no significant investment opportunities have been identified in the immediate or foreseeable future to which the surplus capital could be applied.

16. The proposed dividend will result in Company H paying out majority of its available distributable retained profits balance. A minor amount of retained profits will not be paid out at this time for various commercial and business reasons.

17. Company H paid a dividend in the year ended xx/xx/xxxx. Company H expects to pay a dividend in later income years when circumstances allow for a dividend to be paid.

18. The proposed capital return is considered to be the most efficient mechanism to return surplus capital to shareholders.

19. As at xx/xx/xxxx, Company H, as head Company of the Company H tax consolidated group had a balance of franking credits that can be used to pay fully franked dividends.

20. The share capital account of Company H is not a "tainted" share capital account as defined in section 197-50 of the ITAA 1997.

21. There is no arrangement whereby the share capital account of Company H will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction.

22. A majority of the consolidated surplus cash has been generated from operating activities of the Company H group.

23. Company H and its "associate" subsidiaries (as defined in section 318 of the ITAA 1936 do not have any unrealised profits or gains (either recorded or unrecorded).

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 subsection 45A(2);

Income Tax Assessment Act 1936 subsection 45B;

Income Tax Assessment Act 1936 paragraph 45B(1)(a);

Income Tax Assessment Act 1936 paragraph 45B(1)(b);

Income Tax Assessment Act 1936 subsection 45B(2);

Income Tax Assessment Act 1936 paragraph 45B(2)(a);

Income Tax Assessment Act 1936 paragraph 45B(2)(b);

Income Tax Assessment Act 1936 paragraph 45B(2)(c);

Income Tax Assessment Act 1936 subsection 45B(3);

Income Tax Assessment Act 1936 paragraph 45B(3)(b);

Income Tax Assessment Act 1936 subsection 45B(5);

Income Tax Assessment Act 1936 subsection 45B(8);

Income Tax Assessment Act 1936 paragraphs 45B(8)(a);

Income Tax Assessment Act 1936 paragraphs 45B(8)(b);

Income Tax Assessment Act 1936 subsection 45B(9);

Income Tax Assessment Act 1936 section 45C;

Income Tax Assessment Act 1936 subsection 45C(3);

Income Tax Assessment Act 1936 section 318;

Income Tax Assessment Act 1997 section 197-50;

Income Tax Assessment Act 1997 section 202-5;

Income Tax Assessment Act 1997 paragraph 202-5(a);

Income Tax Assessment Act 1997 paragraph 202-5(b)

Income Tax Assessment Act 1997 section 202-15;

Income Tax Assessment Act 1997 paragraph 202-20(a);

Income Tax Assessment Act 1997 section 202-40;

Income Tax Assessment Act 1997 subsection 202-40(1)

Income Tax Assessment Act 1997 section 202-45;

Income Tax Assessment Act 1997 paragraph 202-45(e);

Income Tax Assessment Act 1997 section 205-10;

Income Tax Assessment Act 1997 section 205-30;

Income Tax Assessment Act 1997 subsection 205-30(1);

Income Tax Assessment Act 1997 section 701-1;

Income Tax Assessment Act 1997 section 960-115;

Income Tax Assessment Act 1997 section 960-120;

Income Tax Assessment Act 1997 subsection 975-300(1);

Income Tax Assessment Act 1997 subsection 995-1(1);

Taxation Administration Act 1953 Schedule 1 Section 12-210; and

Corporations Act 2001 section 254T.

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for Company H.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Will the proposed dividend declared and paid by Company H and debited against the amounts standing to the credit of the retained earnings account be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997?

Summary

No. Paragraph 202-45(e) of the ITAA 1997 will not prevent the franking of the proposed dividend to be declared and paid by Company H and debited against the amounts standing to the credit of the retained earnings account.

Detailed reasoning

An entity can frank a distribution if certain conditions are satisfied. Section 202-5 of the ITAA 1997 sets out the conditions under which an entity can frank a distribution and it states:

An entity franks a distribution if:

(a) the entity is a franking entity that satisfies the residency requirement when the distribution is made; and

(b) the distribution is a frankable distribution; and

(c) the entity allocates a franking credit to the distribution.

A 'franking entity' is defined in section 202-15 of the ITAA 1997 to include a 'corporate tax entity'. A 'corporate tax entity', pursuant to section 960-115 of the ITAA 1997, includes a company.

Company H is a company incorporated in Australia and an Australian resident for tax purposes. Furthermore, at the time of the distribution to be made by Company H, it will remain an Australian resident under paragraph 202-20(a) of the ITAA 1997. Therefore, Company H will be a franking entity for the purposes of paragraph 202-5(a) of the ITAA 1997.

The distribution also needs to be a frankable distribution (paragraph 202-5(b) of the ITAA 1997). The kinds of distributions that can be franked are defined in section 202-40 of the ITAA 1997 as distributions and non-share dividends, unless it is specified that they are unfrankable under section 202-45 of the ITAA 1997.

Subsection 202-40(1) of the ITAA 1997 states that:

1) 'A *distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45.'

Paragraph 202-45(e) of the ITAA 1997 specifically makes the following unfrankable:

'a distribution that is sourced, directly or indirectly, from a company's *share capital account'

Accordingly, a 'distribution' is a frankable distribution to the extent that it is not 'sourced, directly or indirectly, from a company's share capital account'. To determine whether the dividend to be paid by Company H is a frankable distribution pursuant to section 202-40 of the ITAA 1997, a starting point is to define the relevant terms according to income tax law.

A 'distribution' that is made by a company, as referred to in section 202-40 of the ITAA 1997 is defined in section 960-120 of the ITAA 1997 as:

'a dividend, or something that is taken to be a dividend, under this Act.'

Subsection 6(1) of the ITAA 1936 provides a definition of 'dividend' and it states:

'dividend includes:

(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;

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;…'

The term 'share capital account' (as referred to in paragraph (d) of the definition of dividend in subsection 6(1) of the ITAA 1936) is defined in subsection 975-300(1) of the ITAA 1997 as 'an account that the company keeps of its share capital' or 'any other account…[where] the first amount credited to the account was an amount of share capital'.

The proposed dividend will not be debited against the share capital account of Company H. It will be debited against the retained earnings account of Company H.

The proposed dividend payment to be made will constitute an amount of money to be paid to its shareholders by Company H. Further, the applicant has also confirmed that the whole amount of the proposed dividend will be debited in full to the current year profit account of Company H and not against any amounts standing to the credit of its share capital account. Hence the distribution to be made by Company H will be a dividend pursuant to subsection 6(1) of the ITAA 1936 and therefore a 'distribution' as defined in section 960-120 of the ITAA 1997.

As set out above, paragraph 202-45(e) of the ITAA 1997 makes a distribution 'sourced, directly or indirectly, from a company's share capital account' unfrankable. The question of whether a distribution is 'sourced, directly or indirectly, from a company's share capital account' is one based in fact and law.

In the present scheme, Company H expects to declare a proposed dividend in the current year. Company H advised that the company will satisfy all the requirements in section 254T of the Corporations Act for the declaration and payment of this dividend.

The proposed dividend will not be sourced directly or indirectly from the share capital account of Company H but will be funded from current year profits. A number of subsidiaries within the Company H group have positive retained earnings balances based on stand-alone legal entity accounts. These current year profits will arise from the receipt by Company H of dividends from its subsidiaries.

Company H will source the dividend proposed to be paid to its shareholders from available current year period profits, which will be evidenced by appropriate directors' resolutions and the way in which the accounts for are prepared and approved by the directors of Company H . Accordingly, paragraph 202-45(e) of the ITAA 1997 will not prevent the franking of the proposed dividend, notwithstanding the accumulated accounting losses as XX/XX/XXXX.

Company H has sufficient franking credits to fully frank the proposed dividend, thereby completing the requirements in section 202-5 of the ITAA 1997.

Therefore, the proposed dividend would not be a type of distribution identified within paragraph 202-45(e) of the ITAA 1997 as being unfrankable.

Accordingly, the proposed dividend declared and paid by Company H and debited against the amount standing to the credit of the current year profits account will not be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997.

Question 2

Will Company H be required to withhold an amount from the proposed capital return in accordance with section 12-210 of Schedule 1 to the TAA 1953?

Summary

No. Company H will not be required to withhold an amount from the proposed capital return in accordance with section 12-210 of Schedule 1 to the TAA 1953.

Detailed reasoning

Section 12-210 of Schedule 1 to the TAA 1953 provides that a company that is an Australian resident must withhold an amount from a dividend it pays if:

(a) according to the register of the company's members, the entity, or any of the entities, holding the *shares on which a dividend has been paid has an address outside Australia; or

(b) that entity, or any of those entities, has authorised or directed the company to pay the dividend to an entity or entities at a place outside Australia.

According to the register of members of Company H, Shareholder B has an address outside Australia.

Subsection 6(1) of the ITAA 1936 defines a "dividend" (subject to certain exclusions) to include the following:

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

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

The capital reduction will be a distribution of money to all shareholders in proportion to the number of shares held at the Record Date. Therefore, this element of the definition will be satisfied.

Paragraph (d) of the definition of 'dividend' contained in subsection 6(1) of the ITAA 1936, excludes the following distributions from the definition:

(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 .

The capital reduction will be debited against the amount standing to the credit of the untainted share capital account held by Company H. In this regard, the exclusion contained in paragraph (d) is prima facie applicable to the pro-rata capital reduction to be undertaken by Company H.

However, subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph (d) of the definition of "dividend" in subsection 6(1) of the ITAA 1936 will not apply where, "under an arrangement":

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property ; and

(b) the company pays or credits any money , or distributes property to another person, and debits its share capital account with the amount of the money or the value of property so paid, credited or distributed.

In the present circumstances, the paragraph (d) exclusions do not apply as the arrangement is not one that triggers the operation of subsection 6(4) of the ITAA 1936 as the capital reduction is not part of an arrangement stipulated in paragraphs (a) and (b) above.

The return of capital will be sourced from the cash reserves of the Company H group. There is no arrangement whereby the share capital account of Company H will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction. Accordingly, there is no arrangement whereby the share capital account of will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction.

As subsection 6(4) of the ITAA 1936 does not apply to negate the effect of paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936, the moneys paid by the company to its shareholders as a capital return do not constitute a dividend under subsection 6(1) of the ITAA 1936.

On the basis that the proposed capital return to be made by Company H will not satisfy the definition of dividend in subsection 6(1) of the ITAA 1936 for the reasons given above, Company H will have no obligation to withhold an amount from the payment of the capital return amount to Shareholder B for the purposes of section 12-210 of Schedule 1 to the TAA 1953.

Further for the reasons given under Question 3 below, the Commissioner will not make a determination under either subsection 45A(2) of the ITAA 1936 or subsection 45B(3) of the ITAA 1936 that section 45C applies to treat the capital benefit under the pro-rata capital reduction as an unfranked dividend. Accordingly, Company H will have no obligation to withhold an amount from the payment of the proposed capital return amount to Shareholder B for the purposes of section 12-210 of Schedule 1 to the TAA 1953.

Question 3

Will the Commissioner make a determination in relation to the proposed capital return pursuant to subsection 45C(3) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Summary

No. The Commissioner will not make a determination under subsection 45C(3) of the ITAA 1936 in relation to the proposed capital return.

Detailed reasoning

Subsection 45C(3) of the ITAA 1936 states:

If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company:

(a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and

(b) the amount of the franking debit is the amount that, if the ad:

(i) paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and

(ii) fully franked the dividend;

would have been the amount of the franking credit of the company that would have arisen as a result of the dividend.

In order for subsection 45C(3) of the ITAA 1936 to be met, it is first necessary for the Commissioner to make a determination under section 45B of the ITAA 1936 in respect of the whole or part of the capital benefit. The effect of section 45C of the ITAA 1936 applying to a capital benefit is that the amount of the capital benefit, or part of the benefit, is taken to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time at which they are paid the capital benefit.

Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if:

• Components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger (paragraph 45B(1)(a) of the ITAA 1936); or

• Certain payments, allocations and distributions are made in substitution for dividends (paragraph 45B(1)(b) of the ITAA 1936).

Where the requirements of subsection 45B(2) of the ITAA 1936 are satisfied, paragraph 45B(3)(b) of the ITAA 1936 empowers the Commissioner to make a determination that section 45C of the ITAA 1936 will apply in relation to the whole, or a part, of the capital benefit.

Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); 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 (paragraph 45B(2)(b) of the ITAA 1936); 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 (paragraph 45B(2)(c) of the ITAA 1936).

(a) Is there a relevant scheme under which a person is provided with a capital benefit?

"Relevant scheme"

A scheme for the purposes of section 45B of the ITAA 1936 has the meaning given by subsection 995-1(1) of the ITAA 1997. A scheme is defined in subsection 995-1(1) of the ITAA 1997 to mean;

(a) any arrangement, agreement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; or

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

Practice Statement Law Administration PS LA 2008/10 (PS LA 2008/10) provides guidance on the application of section 45B of ITAA 1936 to share capital reductions. At paragraph 41 it is stated that a share capital reduction would normally constitute either a scheme or part of a scheme for the purposes of section 45B.

Accordingly, the proposed return of capital by Company H is considered to be a "scheme" for the purposes of section 45B of the ITAA 1936.

"Capital benefit"

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It provides that a person is provided with a capital benefit if:

• An ownership interest in a company is issued to the person;

• There is a distribution to the person of share capital; or

• The company does something in relation to an ownership interest that has the effect of increasing the value of the ownership interest (which may or may not be the same interest) held by that person.

Under the present scheme, Company H proposes to make a capital distribution to each of its shareholders by debiting its share capital account. Accordingly, Company H will be providing its shareholders with a 'capital benefit' as defined in subsection 45B(5) of the ITAA 1936.

(b) Does a taxpayer (the relevant taxpayer) who may or may not be the person provided with the demerger benefit or the capital benefit, obtain a tax benefit?

"Does the relevant taxpayer obtain a tax benefit?"

The relevant taxpayer is the taxpayer who obtains a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936. Under the present scheme, Company H's shareholders are the entities who are being provided with a capital benefit. If paragraph 45B(2)(b) of the ITAA 1936 is to apply, the provision of the capital benefit must be accompanied by an associated tax benefit.

The meaning of 'obtaining a tax benefit' is contained in subsection 45B(9) of the ITAA 1936. Essentially, the relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under the ITAA 1936 and ITAA 1997, by the relevant taxpayer would, apart from section 45B, 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 has been a dividend.

Accordingly, the tax effect of paying the amount as a dividend must be taken into account in determining whether the taxpayer has obtained a tax benefit or not. 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'.

An assessable dividend is ordinarily a payment to a shareholder out of profits and included in their assessable income under subsection 44(1) of the ITAA 1936 or subject to withholding tax, in the case of non-resident shareholders.

No tax benefit should arise in the circumstances of Company H's shareholders because even if the capital return amount was otherwise a dividend, it would be fully franked, such that no Australian income tax consequences should arise for either resident or non-resident shareholders.

However, in addition to the general circumstances, the relevant taxpayer also obtains a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends. This scenario is identified by the Explanatory Memorandum to the Bill enacting section 45B of the ITAA 1936:

For example, obtaining a tax benefit would include circumstances where the amount of tax assessed as being payable by the relevant taxpayer in respect of the capital benefits is substantially the same as would have been the case had the relevant taxpayer received a dividend, but the relevant taxpayer has income losses, or the company providing the capital benefits has franking credits, which are preserved for future income years (and therefore reduce tax in those years).

Preservation of franking credits for use in the future would ordinarily mean that a tax benefit is obtained within the meaning of subsection 45B(9).

In the present scheme, the applicant has confirmed that Company H has sufficient franking credits to fully frank the entire distribution, were the capital component to be paid instead as a dividend. To the extent that franking credits are not needed to be used in respect of the capital component of the distribution, franking credits are thereby preserved for use in future years to reduce the income tax of resident shareholders, or the withholding tax of non-resident shareholders.

Accordingly, the preservation of franking credits for future income years (because part of the distribution is in the form of a return of capital) will constitute the provision of a tax benefit.

(c) Relevant Circumstances

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'. As the test of purpose is an objective test, the question is whether it would be concluded that a person who entered into or carried out the scheme did so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit.

The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. Paragraphs 45B(8)(a) and 45B(8)(b) of the ITAA 1936, are relevant for the purposes of determining the requisite purpose pursuant to paragraph 45B(2)(c) of the ITAA 1936.

a) Paragraph 45B(8)(a) of the ITAA 1936: 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.

Attribution to capital or profits

Under this paragraph, it is necessary to consider the source of the distribution and whether it is properly attributable to capital or profit (realised and unrealised) of the company or an associate of the company. Whether the proposed distribution of capital is 'attributable' to profit is essentially a practical matter 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.

As outlined in paragraph 71 of PS LA 2008/10, the notion of profits 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.

At paragraph 62 of PS LA 2008/10, the Commissioner of Taxation directs tax officers as follows in relation to assessing the extent to which the capital benefit is attributable to capital and profits:

"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….. Tax officers should have regard to the occasion for the share capital reduction, that is, the circumstances surrounding the making of the capital distribution"

No part of the proposed capital return is attributable to the profits of Company H or an associate of Company H because substantially all of the available profits will have been distributed to the shareholders of Company H as a result of the payment of the proposed dividend. The proposed capital return is a distribution to shareholders that is being made in addition to the distribution of available profits by way of dividend.

Paragraph 61 of PS LA 2008/10 outlines that the inquiry contemplated by the words 'attributable to' involves 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.

In the present case, there will be some minor amounts retained and unrealised profits of Company H remaining after distribution of the proposed dividend, However on balance it is considered that no discernible connection is found between these remaining profits and the proposed return of share capital. It is considered that the proposed distribution of capital is not attributable to profits, and it can therefore be concluded that this circumstance does not incline towards the requisite purpose.

b) Paragraph 45B(8)(b) of the ITAA 1936: the pattern of distributions made by a company or an associate of the company.

This paragraph directs attention to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or an associate (within the meaning in section 318 of the ITAA 1936) of the company. The inference is that an interruption to the normal pattern of profit distribution and replacement with a distribution of capital may suggest dividend substitution.

Company H paid a fully franked dividend in the year ended xx/xx/xxxx. The applicant has stated that this indicates a conservative approach to profit distribution, where a distribution occurred due to accumulated retained earnings being positive and surplus cash representing those profits being available to fund the distribution.

The applicant has also submitted that Company H will distribute substantially all of its retained earnings prior to making the return of capital. Therefore there is no indication that the proposed capital return distribution by Company H is being used to replace standard profit distributions.

It is therefore concluded that this circumstance does not indicate that the requisite purpose exists.

Conclusion

Having regard to the relevant circumstances of the scheme, it has been concluded that the proposed return of capital is not being 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 Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the capital benefit being provided to the shareholders of Company H under the scheme.

Accordingly, the Commissioner will also not make a further determination pursuant to subsection 45C(3) of the ITAA 1936 because subsection 45B(3) of the ITAA 1936 will not apply to the scheme.

Question 4

On the basis that the proposed capital return will not be a dividend for income tax purposes, will a franking debit arise in the franking account of Company H pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of the ITAA 1936 or ITAA 1997?

Summary

No. A franking debit will not arise in the franking account of Company H pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of ITAA 1997 or ITAA 1936, on the basis that the proposed capital return will not be a dividend for income tax purposes.

Detailed reasoning

Section 205-10 of the ITAA 1997 provides that each entity that is a corporate tax entity has a franking account. Company H, as a corporate entity, has a franking account.

Subsection 202-40(1) of the ITAA 1997 states:

(1) A distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45.

The table contained in subsection 205-30(1) of the ITAA 1997 sets out when a debit will arise in the franking account of an entity and the amount of the debit (which is called a franking debit). Item 3 of the table contained in subsection 205-30(1) of the ITAA 1997 provides that a franking debit arises for an entity in circumstances where the entity franks a 'distribution' in contravention of the franking benchmark rule.

Subsection 995-1(1) of the ITAA 1997 refers to section 960-120 of the ITAA 1997 for the meaning of distribution. Item 1 of the table in section 960-120 of the ITAA 1997 states that a company will be taken to have made distribution where it pays a dividend or something taken to be a dividend under either the ITAA 1936 or ITAA 1997.

As discussed in question 2 above, the proposed capital return to be undertaken by Company H will not constitute a 'dividend' as defined in subsection 6(1) of the ITAA 1936. Therefore, the amount of capital returned by Company H will not be a 'distribution' for these purposes.

Accordingly, the proposed capital reduction amount will not be frankable distribution in accordance with subsection 202-40(1) of the ITAA 1997.

Paragraph 202-45(e) of the ITAA 1997 states that a distribution will be unfrankable to the extent that it is sourced, directly or indirectly, from a company's share capital account.

In the current circumstances, the proposed capital return will be debited against the amount standing to the credit of the untainted share capital account held by Company H and will therefore be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997.

Accordingly, on the basis that the proposed capital return will not be a dividend for income tax purposes, a franking debit will not arise in the franking account of Company H pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of the ITAA 1936 or ITAA 1997.