Edited version of your written advice

Authorisation Number: 1013137539297

Date of advice: 2 March 2017

Ruling

Subject: Return of capital

Question 1

Is the Proposed Return of Capital a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and hence assessable under subsection 44(1) of the ITAA 1936?

Answer

No.

Question 2

Will the Commissioner make a determination under subsection 45A(2) of the ITAA 1936 or subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole or part of the Proposed Return of Capital?

Answer

No.

This ruling applies for the following period

Income year ended 30 June 20XX

The scheme commenced

During the income year ended 30 June 20XX

Relevant facts and circumstances

Background

Company X

Company X is a company that was incorporated in Australia.

Company X directly and indirectly owns all of the issued share capital in a number of subsidiaries (the Subsidiaries). The Subsidiaries own assets and operate trading businesses. Company X is the head company of a consolidated group for Australian taxation purposes (the Company X Group) which includes all the Subsidiaries.

Capital structure

Company X has a single class of share on issue consisting of fully paid ordinary shares.

Company X's share capital account, as defined in section 975-300 of the Income Tax Assessment Act 1997 (ITAA 1997), is not a tainted share capital account within the meaning of Division 197 of the ITAA 1997.

The Shareholder owns all of the issued share capital of Company X. The Shareholder is a non-resident for Australian taxation purposes and is a resident, for taxation purposes, in its country of residence. That country has a taxation agreement with Australia (the International Agreement).

All of the shares issued by Company X, and held by the Shareholder, are post-CGT assets.

Sale of assets and repatriation of funds

Pursuant to an agreement for sale and purchase of business and assets, a purchaser agreed to acquire the business assets held by the Company X Group and assume certain liabilities (the Company X Asset Sale).

The proceeds from the Company X Asset Sale (the Proceeds) will be returned to the Shareholder by Company X after the discharge of bank, taxation, employee and other liabilities.

The distributions made to the Shareholder will include a return of capital amount, which will be debited to Company X's share capital account (the Proposed Return of Capital) and a dividend (the Dividend).

Other matters

The Relevant Australian Authority has made a determination under the International Agreement which means that the rate of withholding tax on any unfranked dividend paid by Company X to the Shareholder is reduced to nil.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 Division 197

Income Tax Assessment Act 1997 section 975-300

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 and is not included in assessable income under subsection 44(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).

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 subsection 975-300(1) 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(2) of the ITAA 1997 further explains that if a company has more than one share capital account, the accounts are taken for the purposes of the ITAA 1997 to be a single account.

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.

Following the completion of the Company X Asset Sale, Company X will distribute the proceeds to the Shareholder. The distribution to the Shareholder will comprise of a capital component, representing the Proposed Return of Capital, and a Dividend. The Proposed Return of Capital will be debited to Company X's share capital account.

As the share capital account of Company X 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 and is not included in assessable income under subsection 44(1) of the ITAA 1936.

Question 2

Summary

The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 or subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole or any part of the Proposed Return of Capital received by Shareholder, deeming the capital benefits to be a dividend and hence assessable for income tax purposes.

Detailed reasoning

Subsection 45A(2) of the ITAA 1936

Section 45A of the ITAA 1936 applies where capital benefits are streamed to some shareholders (the Advantaged Shareholders), who would derive a greater benefit from the receipt of capital than other shareholders (the Disadvantaged Shareholders) and these Disadvantaged Shareholders receive, or are likely to receive, dividends.

A reference to the 'provision of a capital benefit to a shareholder in a company' is defined in paragraph 45A(3)(b) of the ITAA 1936 to include the distribution to the shareholder of share capital. Company X will provide its shareholder with a 'capital benefit' as defined in paragraph 45A(3)(b) of the ITAA 1936.

As the Shareholder is the only shareholder in Company X at the time the capital is returned, subsection 45A(1) of the ITAA 1936 will not apply as there are no advantaged or disadvantaged shareholders.

Therefore, section 45A of the ITAA 1936 will not apply to the Proposed Return of Capital. Accordingly, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the Proposed Return of Capital.

Subsection 45B(3) of the ITAA 1936

Section 45B of the ITAA 1936 applies where certain capital payments, including a return of capital, are paid to shareholders in substitution for dividends. It allows the Commissioner to make a determination that section 45C of the ITAA 1936 applies to a capital benefit. Specifically, the provision applies where:

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

● 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 (paragraph 45B(2)(b) of the ITAA 1936); and

● having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

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) of the ITAA 1936). That definition is widely drawn and includes any arrangement, scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Company X's Proposed Return of Capital would be captured within this broad definition.

The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It states 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.

Following the completion of the Company X Asset Sale, Company X will distribute the proceeds to the Shareholder. The distribution to the Shareholder will comprise of a capital component, representing a return of capital, and a dividend component. The Proposed Return of Capital will be debited to Company X's share capital account, meaning Company X will provide the Shareholder with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936 in the form of distributions of share capital.

Accordingly, the requirements of paragraph 45B(2)(a) of the ITAA 1936 will be met in relation to the Proposed Return of Capital.

Tax benefit

A relevant taxpayer 'obtains a tax benefit' as defined in subsection 45B(9) of the ITAA 1936 if:

● the amount of tax payable; or

● any other amount payable under the ITAA 1936 or the ITAA 1997,

would, apart from the operation of section 45B, be less than the amount that:

● would have been payable; or

● be payable at a later time than it would have been payable,

if the capital benefit had instead been a dividend.

Ordinarily, a return of capital would be subject to the CGT provisions of the income tax law. Unless the amount of the distribution exceeds the cost base of the shares, there will only be a cost base reduction under CGT event G1 (section 104-135 of the ITAA 1997). It is only to the extent (if any) that the distribution exceeds the cost base of the shares that a capital gain arises. By contrast, a dividend would generally be included in the assessable income of a resident shareholder or in the case of a non-resident, be subject to dividend withholding tax.

Paragraph 49 of Practice Statement Law Administration PS LA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions addresses the scope of any tax benefits that should be considered for the purpose of applying section 45B of the ITAA 1936 and includes the following guidance:

…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. In this regard, the tax payable (or any other amount payable under the Act) on the notional dividend is ascertained in a continuum and not just for the year in which the dividend is received.

In the current circumstances, the Relevant Australian Authority has made a determination under the International Agreement which means that the rate of withholding tax on any unfranked dividend paid by Company X to the Shareholder is reduced to nil.

Consequently, the tax position for the Shareholder under Australian taxation law is the same regardless of whether it receives a dividend or a return of share capital.

On these grounds, it is considered that, no tax benefit will be obtained (for the purpose of subsection 45B(9) of the ITAA 1936) by the sole Shareholder, from the distributions to be paid under the proposed scheme.

It therefore follows that because no tax benefit will be obtained by the Shareholder, the conditions in paragraph 45B(2)(b) of the ITAA 1936 are not satisfied and consequently section 45B of the ITAA 1936 will have no application.

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 Proposed Return of Capital.