Edited version of your written advice

Authorisation Number: 1012894384371

Date of advice: 16 October 2015

Ruling

Subject: Income tax - return of share capital

Questions and answers

1. Will the proposed return of share capital give rise to a dividend to individual X or individual Y or the Company?

No.

2. Will the Commissioner make a determination under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies to the whole, or a part of the return of capital.

No.

3. Will the proposed return of share capital trigger a capital gains tax event G1?

Yes.

This ruling applies for the following period

1 July 2015 to 30 June 2016

Relevant facts and circumstances

The Company was incorporated.

Since inception, individual X and individual Y have each held one ordinary share in the Company.

Individual X and Y are both directors of the Company.

In the financial year ended dd mm yy individual X and Y paid cash into the Company.

In the financial year ended dd mm yy individual X and Y paid cash into the Company.

A Form 484: Change to company details was lodged with the Australian Securities and Investment Commission (ASIC), notifying ASIC of the purported issue of B class shares to each of individual X and individual Y.

A current ASIC search of the company shows that B class shares are on issue.

There were no director or shareholder meetings or director resolutions to authorise the issue of B class shares. No other documentation was prepared in relation to the purported share issue.

The following documents normally associated with share issues were not prepared;

• Director's resolution to issue shares

• Share certificates

• Application by member

• Change to share register

• Documentation providing terms of share issue

Basic bookkeeping records for the Company were maintained sufficiently to complete tax returns.

The Company's balance sheets show the amounts received from individual X and Y as being recorded in the share capital reserves of the Company.

The notes to the Company's financial statements state the amounts are contributed equity. Similarly, the amount was not shown as a liability in the lodged income tax returns.

Formal financial statements were not prepared for the Company.

The Company has retained earnings.

No interest or other returns have been paid in reference to the purported B class shares.

Individual X and Y are currently married but have now separated and are looking to separate their financial affairs. As part of this process, it has been proposed that the Company will refund to individual X and Y, each receiving 50%, of the total funds received by the Company in the financial years ended dd mm yy and dd mm yy.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 6

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 45B

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 subsection 45B(5)

Income Tax Assessment Act 1936 paragraph 45B(5)(a)

Income Tax Assessment Act 1936 paragraph 45B(5)(b)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 paragraph 45B(8)(a)

Income Tax Assessment Act 1936 paragraph 45B(8)(b)

Income Tax Assessment Act 1936 paragraph 45B(8)(c)

Income Tax Assessment Act 1936 paragraph 45B(8)(d)

Income Tax Assessment Act 1936 paragraph 45B(8)(e)

Income Tax Assessment Act 1936 paragraph 45B(8)(f)

Income Tax Assessment Act 1936 paragraph 45B(8)(h)

Income Tax Assessment Act 1936 paragraph 45B(8)(i)

Income Tax Assessment Act 1936 paragraph 45B(8)(j)

Income Tax Assessment Act 1936 paragraph 45B(8)(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 1997 Section 104-135

Income Tax Assessment Act 1997 subsection 104-135(3)

Income Tax Assessment Act 1997 subsection 104-135(4)

Income Tax Assessment Act 1997 Section 975-300

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

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 considered the application of Part IVA to the arrangement you asked us to rule on.

Reasons for decision

Distribution is not a dividend

Subsection 44(1) of the Income Tax Assessment Act 1936 (ITAA 1936) includes in a shareholder's assessable income any dividends, as defined by subsection 6(1) of the ITAA 1936, paid to a shareholder out of profits derived by the company from any source (if a resident of Australia for tax purposes) and from an Australian source (if 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, this broad definition is confined by later paragraphs in the definition which expressly exclude certain items from being a dividend for income tax purposes.

A specific exclusion is paragraph (d) of subsection 6(1) of the ITAA 1936, which provides:

... 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: ...

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

As the return of capital has been debited against an amount standing to the credit of the Company's share capital account, the return of capital will not constitute a dividend because of the exclusion in paragraph (d) in the definition of 'dividend' in subsection 6(1) of the ITAA 1936.

Section 45B of the ITAA 1936 - schemes to provide capital benefits in substitution for dividends

Section 45B of the ITAA 1936 applies where certain payments are made to shareholders in substitution for dividends.

Subsection 45B(2) of the ITAA 1936 sets out the conditions under which the Commissioner will make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies. These conditions 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 could 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 the relevant taxpayer to obtain a tax benefit.

Each of these conditions 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 of the ITAA 1936 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) of the ITAA 1997 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 Company's return of capital to its shareholders will be debited to the Company'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, the arrangement involving the return of capital to the Company's shareholders will constitute a scheme for the purposes of section 45B of the ITAA 1936.

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'.

The return of capital distributed by the Company 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 Company'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.

Having regard for the relevant circumstances under subsection 45B(8) of the ITAA 1936, it cannot be concluded that the scheme will be entered into or carried out for a more than incidental purpose of enabling the Company's shareholders to obtain a tax benefit because the objective purpose of the Company's payment to the shareholders is to return the capital contributions made by the shareholders for shares which were never issued.

Accordingly, the Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or a part, of the return of capital.

Capital Gains Tax

Under section 104-135 of the ITAA 1997 a Capital Gains Tax (CGT) Event G1 will happen if a company makes a payment to a shareholder in respect of a share they own in a company and some or all of the payment is not a dividend as defined in subsection 995-1(1) of the ITAA 1997, or an amount is taken to be a dividend under section 47 of the ITAA 1936.

Under subsection 104-135(4) of the ITAA 1997, if the proposed return of capital is not more than the cost base of the Company's share at the Payment Date, the cost base and the reduced cost base of each company share is reduced (but not below nil) by the amount of the proposed return of capital.

Under subsection 104-135(3) of the ITAA 1997, the Company shareholder will make a capital gain if the proposed return of capital is more than the cost base of their company share. The amount of capital gain is equal to this excess.

Further, under subsection 104-135(3), if a shareholder of the Company makes a capital gain, the cost base and reduced cost base of the Company share is reduced to nil. A shareholder of the Company cannot make a capital loss when CGT event G1 happens.

In this instance the cost base of the purported B class shares is $ for each of individual X and individual Y, reflecting the cash paid by them to the Company.