Edited version of your written advice

Authorisation Number: 1012908680337

Date of advice: 9 November 2015

Ruling

Subject: Return of share capital to overseas parent company

Question 1

Will the return of capital by you to your parent company constitute a dividend within the definition of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 2

Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat the amount of the capital benefit, or any part of that capital benefit, made by you to your parent company as the payment of an unfranked dividend?

Answer

No

Question 3

Will CGT event G1 happen to your parent company under section 104-135 of the Income Tax Assessment Act 1997 (ITAA 1997) such that there is nil capital gain for your parent company and the cost base in each of its shares in you will be reduced by the amount of the capital returned in respect of each share?

Answer

Yes

This ruling applies for the following period:

01 January 2015 to 31 December 2015

The scheme commences on:

01 January 2015

Relevant facts and circumstances

1. You are an Australian resident proprietary company limited by shares.

2. 100% of your shares are owned by your parent company who is not a resident of Australia.

3. You propose to return share capital to your parent company.

4. Your retained earnings are significantly less than the amount of share capital you propose to return to your parent company.

5. You have never paid dividends to shareholders and never returned share capital or share premium.

6. Your Board of Directors considers that insufficient profits have been generated to support the payment of dividends.

7. Your management has reviewed its capital requirements and concluded that an amount of share capital is surplus to current and expected requirements.

8. You propose to return the excess capital to your parent company.

9. Your management considers that the proposed return of share capital can be made without prejudicing the company and would be in the best interests of both the company and its shareholder.

10. You will debit the return of capital from your share capital account.

11. The return of capital will be funded by either a combination of cash reserves and debt, or by debt.

12. The return of capital to your parent company will be made from all shares equally, with no cancellation of shares. No new shares will issue.

13. Your parent company has no Australian capital losses.

14. Your share capital account is untainted for the purpose of Division 197 of the ITAA 1997.

15. The return of capital will be less than your current paid up capital.

Relevant legislative provisions

Income Tax Assessment Act 1936, subsection 6(1)

Income Tax Assessment Act 1936, subsection 44(1)

Income Tax Assessment Act 1936, subsection 45B

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

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

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

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

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

Income Tax Assessment Act 1936, section 45C

Income Tax Assessment Act 1936, section 128B

Income Tax Assessment Act 1936, subsection 128B(3)(ga)

Income Tax Assessment Act 1936, subsection 177A(1)

Income Tax Assessment Act 1936, subsection 177D(2)

Income Tax Assessment Act 1997, section 104-135

Income Tax Assessment Act 1997, subsection 104-135(2)

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

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

Income Tax Assessment Act 1997, Division 197

Income Tax Assessment Act 1997, section 197-50

Income Tax Assessment Act 1997, Division 855

Income Tax Assessment Act 1997, section 855-25

Income Tax Assessment Act 1997, subsection 975-300(3)

Reasons for decision

Question 1

Summary

The proposed return of capital will not be a dividend as defined in subsection 6(1) 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) of the ITAA 1936, paid to the shareholders 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 of Australia).

Section 128B of the ITAA 1936 provides that an Australian resident company that pays a dividend to a non-resident shareholder will be liable to pay withholding tax on the dividend. Where a dividend is franked, there is no liability to pay withholding tax on the franked part of the dividend (paragraph 128B(3)(ga) of the ITAA 1936).

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 (d) 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.

The term 'share capital account' is defined in section 975-300 of the 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 not a share capital account, except for certain limited purposes, 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 proposed return of capital will be debited against an amount standing to the credit of your share capital account. You have confirmed no amount has been transferred to the share capital account from another account. As your share capital account is not tainted within the meaning of Division 197 of the ITAA 1997, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 will apply. Accordingly, the proposed return of capital will not be a dividend as defined in subsection 6(1) of the ITAA 1936.

Question 2

Summary

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 proposed return of capital, deeming the scheme to be a dividend and hence assessable for income tax purposes.

Detailed reasoning

The relevant circumstances under subsection 45B(8) of the ITAA 1936 cover both the circumstances of you and your parent company. In this instance, as your parent company is your sole shareholder, paragraphs 45B(8)(c) to (h) do not incline for, or against, a conclusion as to purpose. The circumstances covered by paragraphs 45B(8)(i) and (j), pertaining to the provision of ownership interests and demerger, are not relevant. In this case, the relevant matters are those covered by the circumstances described in paragraphs 45B(8)(a), (b) and (k).

Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital and profits (realised and unrealised) of the company or an associate (within the meaning of section 318) of the company. For the year ending 31 December 2015, you propose to return to your parent company a capital return sourced from surplus capital funds due to a change in your business strategy and trading activity. Therefore, the proposed capital distribution to be provided to your shareholder is wholly attributable to excess surplus cash or borrowings. No part of the return is attributable to your specific profits, realised or unrealised. Further, it is considered that the share capital to be returned is genuinely surplus to your needs.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate (within the meaning of section 318) of the company. To date you have not paid any dividends and your retained earnings are not sufficient to make the proposed capital payment. Accordingly, it is considered that this factor does not suggest that the return of capital has been made in substitution for a dividend.

Paragraph 45B(8)(k) of the ITAA 1936 refers to the matters in subparagraphs 177D(b)(i) to (viii). These are matters by reference to which a scheme is able to be examined from a practical perspective, in order to identify and compare its tax and non-tax objectives. The matters include the manner in which the scheme is entered into or carried out, its form and substance and its financial and other implications for the persons involved. You have demonstrated that the scheme seeks to return an amount of share capital referable to payments of capital previously made by your parent company. The return will release capital which you have stated is excess to your current needs. In this case the practical implications of the scheme for you and your shareholder are consistent with it having been, in form and substance, a return of capital.

In conclusion, having regard to the relevant circumstances of the scheme, it cannot be concluded that you will enter into or carry out the proposed scheme for the purpose of enabling your shareholder to obtain a tax benefit. It cannot be said that the return of capital is attributable to your profits, nor does your pattern of distributions indicate that the return of capital is being made in substitution for dividends. Similarly, the manner in which the proposed scheme is to be carried out, and the form and substance of the proposed scheme, do not indicate that the proposed capital return will be made in substitution for dividends. If any tax benefit arises from the scheme to you or your parent company then it can be concluded that such a benefit is merely incidental.

Question 3

Summary

CGT event G1 will happen to your parent company under section 104-135 of the ITAA 1997 such that there is nil capital gain for your parent company and the cost base in each of its shares in you will be reduced by the amount of the capital returned in respect of each share.

Detailed reasoning

Section 104-135 of the ITAA 1997 provides that CGT event G1 happens where:

(a) a company makes a payment to you in respect of a share you own in the company (except for CGT event A1 or C2 happening in relation to the share); and

(b) some or all of the payment (the non-assessable part ) is not a dividend, or an amount that is taken to be a dividend under section 47 of the Income Tax Assessment Act 1936; and

(c) the payment is not included in your assessable income.

Your parent company will receive a payment in respect of its shares in you. The payment will not be a dividend, and will not be included in the assessable income of your parent company.

CGT event G1 will happen when you make the payment under the Scheme to your parent company (subsection 104-135(2) of the ITAA 1997).

Subsection 104-135(3) of the ITAA 1997 provides that:

You make a capital gain if the amount of the non-assessable part is more than the share's cost base. If you make a capital gain, the share's cost base and reduced cost base are reduced to nil.

Note 1: You cannot make a capital loss

Subsection 104-135(4) of the ITAA 1997 provides that:

…if the amount of the non-assessable part is not more than the share's cost base, that cost base and its reduced cost base are reduced by the amount of the non-assessable part.

Based on the facts of the scheme, the proposed return of capital to your parent company will be less than the cost base of the shares owned by them. As such, the return of capital will not give rise to a capital gain. It is not possible make a capital loss as a result of CGT event G1, so your parent company will not make a capital loss either.

However, your parent company's cost base and reduced cost base for each of their shares in you, in accordance with subsection 104-135(4) of the ITAA 1997, will be reduced by the proposed capital payment, apportioned to each share.

As your parent company is a non-resident of Australia for taxation purposes, Division 855 of the ITAA 1997, which concerns the treatment of capital gains and losses made by foreign residents, would normally need to be considered. However, as the return of capital, in accordance with Section 104-135 of the ITAA 1997 does not give rise to a capital gain or loss, the provisions of Division 855 of the ITAA 1997 will not be enlivened, and do not require consideration.