Edited version of your written advice

Authorisation Number: 1051203690461

Date of advice: 22 March 2017

Ruling

Subject: Tax treatment of liquidator distributions

Question 1

Will the proceeds from the sale of land by Company X be a deemed dividend under section 47 of the ITAA 1936 and assessable under section 44 of the ITAA 1936 when the sale proceeds are distributed to Trust Y, a shareholder of Company X, in the course of winding up the company?

Answer

No

Question 2

Will the distribution by a Liquidator from Company X to Trust Y result in CGT event C2 happening under section 104-25 of the ITAA 1997?

Answer

Yes

Question 3

Will the capital distribution made to Company Z when Trust Y ends, be assessable as a capital gain under CGT event K6 (section 104-230 of the ITAA 1997)?

Answer

Yes

Question 4

Will the capital distribution made to Company Z when Trust Y ends, that is distributed to the shareholders of Company Z as part of the liquidation of Company Z, be a deemed dividend under section 47 of the ITAA 1936 and assessable under section 44 of the ITAA 1936?

Answer

Yes

Question 5

Will Part IVA of the ITAA 1936 apply to a dividend paid to Company Z shareholders, sourced from the capital gain it derived on the ending of Trust Y, as part of the liquidation of Company Z?

Answer

No

This ruling applies for the following period

Income year ended 30 June 2017

Income year ended 30 June 2018

The scheme commenced on

1 July 2016

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

Company Z is an Australian Resident Company. In 1984 Trust Y was established as a unit trust. Company Z was an original subscriber on the establishment of Trust Y and subscribed for all of the units in that trust. The units are beneficially held by Company Z is its own right.

The shareholders of Company Z include resident and non-resident companies, trusts and individuals.

Sometime before 20 September 1985, Company X acquired land.

Company X used the land in operating a farming business either by the Company or as lessor of the land to a related entity.

After 20 September 1985, Company W as trustee of Trust Y acquired shares in Company X which represents the sole asset held by Trust Y. The shares acquired by Trust Y represent 100% of the net value of the Trust Y.

The acquisition of Company X shares by Trust Y was funded nearly entirely by debt borrowed from Company Z.

Under subsection 149-30(1) of the ITAA 1997, the Land stopped being a pre-CGT asset at the earliest time when the majority underlying interests in the Land were not held by the ultimate owners who held the majority underlying interest in the asset immediately before 20 September 1985.

In accordance with Section 149-35 of the ITAA 1997 the first element of the cost base of the Land is the market value at the time referred to in subsection 149-30(1).

Company X obtained a valuation of the land. The valuation was signed off by registered members of the Australian Property Institute.

The difference between the historical cost price for the acquisition of the land and the market value under the valuation was allocated in the accounts of Company X to a "pre-CGT Reserve".

There were two prior disposals of part of the land. The first was a partial sale of the land. The second occurred at a later date. A portion of the gain was treated as a disposal of a post CGT asset by reason of the operation of Division 149 of the ITAA 1997 and included in the assessable income of Company X.

Company X executed a Contract for the sale of the remaining land. The Contract indicated that the sale was of a farming business and GST going concern.

At the time of the sale, there was no development undertaken on the land. No capital works, no registered plan of subdivision obtained as a precursor to a sale of individual smaller blocks of land. The land was sold "as is" with a farming business and going concern.

The Directors, with the consent of the Shareholders of Company X, intend to wind up Company X. Consequently, a Liquidator will be appointed as part of a member's voluntary wind up.

The total pre CGT reserve after the sale of the land will be distributed to the Shareholders by the Liquidator.

The Shareholders wish to wind up Company X and realise their investment. Company X has no substantial assets other than cash or debtors. The Shareholders do not wish to conduct any further business venture in Company X.

Under the Voluntary Wind Up process a Liquidator will be appointed who will collect and call in the assets and distribute the amounts to the Shareholders.

When the distribution is received by Trust Y from the Liquidator of Company X, Trust Y will make a capital distribution to Company Z, and the trust will end.

Under clause 13(h) of the Trust Deed:

'…upon realisation of the trust fund the trustee shall distribute to the unitholders all of the cash proceeds derived from the realisation of the trust fund and available for the purpose for such distribution and all unit shall rank equally for the distribution of cash proceeds derived by the realisation of trust fund...'

When Trust Y ends, and after the payment of any liabilities of Trust Y, the net cash proceeds will be paid to Company Z as the sole unit holder of Trust Y. The funds paid by Trust Y will comprise entirely of the proceeds from the liquidation of Company X.

After Company Z receives funds relating to the liquidation of Company X, the shareholders wish to wind up Company Z and realise their investment. At that point in time Company Z is not expected to hold substantial assets other than cash or debtors. The shareholders do not wish to conduct any further business venture in Company Z and therefore have decided to wind up Company Z by way of a Members Voluntary Wind Up.

Under this process, a Liquidator will be appointed who will collect and call in the assets and distribute the amounts to the shareholders of Company X. It is expected any distribution will consist primarily of fully franked dividends and a repayment of debt and a return of capital.

Company Z will subsequently pay a franked dividend sourced from the proceeds received when Trust Y ends to its shareholders that it expects will be fully franked.

Subsequent to the payment of that franked dividend, Company Z will be placed into liquidation. It is expected that Company Z will retain sufficient cash proceeds to pay any liabilities (including income tax), if any, leaving only a nominal amount available for distribution to the shareholders of Company Z by reason of the liquidation.

Assumptions

Since 19 September 1985, the shareholding of Company X changed on several occasions, and an analysis undertaken of the shareholding indicated that the majority underlying interest in the land for the purposes of Section 149-15 of the ITAA 1997 changed.

Company X sustained trading losses from farming, and capital losses from the sale of the land. Further, Company X also incurred capital losses from the sale of post-CGT improvements to the land. As a consequence of trading and other issues, as well as the effect of the second, third, fourth and fifth elements of the cost base of the land that arose after the change in majority underlying interest, no capital gain was realised when the sale of the remaining land was completed.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 47

Income Tax Assessment Act 1936 Section 95

Income Tax Assessment Act 1936 Part IVA

Income Tax Assessment Act 1936 Section 177A

Income Tax Assessment Act 1997 Section 104-25

Income Tax Assessment Act 1997 Section 104-230

Reasons for decision

Question 1

Summary

The proceeds from the sale of the land by Company X will not be a deemed dividend under section 47 of the ITAA 1936 and will not be assessable under section 44 of the ITAA 1936 when the sale proceeds are distributed to Trust Y, a shareholder of Company X, in the course of winding up the company.

Detailed reasoning

Section 47 of the ITAA 1997 specifically deems certain amounts to be dividends paid to the Shareholders out of the profits derived by the Company.

Specifically, subsection 47(1) of the ITAA 1936 provides that:

Distributions to shareholders of a company by a liquidator in the course of winding up a company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

The use of the term "income" in the context of subsection 47(1) of the ITAA 1997 has been interpreted in Gibb v FCT (1966) 118 CLR 628 as meaning income according to ordinary concepts rather than "assessable income". Hence, amounts that are deemed to be assessable income but are not of an income or revenue character are not considered, for the purposes of subsection 47(1) to be "income".

As the land sold by Company X was the principal asset of the Company since its acquisition, it is considered that the gain made on the disposal of the land was not income according to ordinary concepts. There is no suggestion that the land was ventured into a profit making undertaking or scheme. There was no development on the land. It was land that was leased or used in a farming business. It was the profit yielding subject as that term was used in the Sun Newspapers Ltd v FCT(1938) 61 CLR 337 decision per Dixon J. It was of an enduring character.

Subsection 47(1A) of the ITAA 1997 includes in the reference in subsection 47(1) to income derived by a Company a reference to an amount included in the Company's assessable income or a net capital gain that would be included in the Company's assessable income if the required net capital gain is worked out in accordance with the method statement contained in paragraph 47(1A)(b) of the ITAA 1997.

The effect of subsection 47(1A) of the ITAA 1997 is that it only includes in income the net capital gains that are included in assessable income (without indexation) under Part 3-3 of the ITAA 1997. Capital gains that are disregarded or otherwise not within the concept of a net capital gain included in the assessable income of the Company are also not within the meaning of the word "income".

In the case of a pre-CGT asset held by a Company at a time when the majority underlying ownership changes, subsection 149-30(1) of the ITAA 1997 specifies that the pre-CGT asset stops being a pre-CGT asset at the earliest time when the majority underlying interests in the asset were not held by the ultimate owners who had majority underlying interests in the asset immediately before 20 September 1985.

Subsection 149-30(1A) of the ITAA 1997 treats the asset as having been acquired at that earliest time within subsection 149-30(1). Under section 149-35 of the ITAA 1997, the first element of the cost base of the asset is the market value at the time referred to in subsection 149-30(1) (i.e. the earliest time the majority underlying ownership ceased).

On the basis that the gain made on the disposal of the land was not income, then subsection 47(1A) only includes as "income" within subsection 47(1), an amount of a net capital gain that will be included in the Company's assessable income for year of income. The net capital gain that would be included is the difference between the capital proceeds and the cost base of the land.

The first element of that cost base as specified in section 149-35 of the ITAA 1997 is the market value of the property at the time the majority underlying interest changed. Hence, the difference between the selling price under the Contract (less the market value of the land sold at the time of the change of majority underlying ownership) is the amount that is included in "income" by reason of the extension of that concept made under subsection 47(1A) of the ITAA 1997.

It is also assumed that Company X sustained trading losses from farming, and capital losses from the sale of the land. Further, that Company X also incurred capital losses from the sale of post-CGT improvements to the land. Therefore, there is no capital gain that will be included as income within subsection 47(1A) of the ITAA 1997 by reason of the respective losses Company X sustained as well as the effect of the second, third, fourth and fifth elements of the cost base of the land that arose after the change in majority underlying interest.

It is therefore considered that the proceeds from the sale of the land by Company X will not be a deemed dividend under section 47 of the ITAA 1936 when the sale proceeds are distributed to Trust Y in the course of winding up the company.

Question 2

Summary

The distribution by a Liquidator from Company X to Trust Y will result in CGT event C2 happening under section 104-25 of the ITAA 1997.

Detailed reasoning

As the ownership of shares in Company X by the Trustee of Trust Y will end by the shares being cancelled on the winding up and deregistration of Company X, CGT event C2 will happen (paragraph 104-25(1)(a) of the ITAA 1997).

Subsection 104-25(2) of the ITAA 1997 states that the time at which CGT event C2 happens is:

a) when you enter into the contract that results in the asset ending; or

b) if there is no contract - when the asset ends.

In this case, the time at which CGT event C2 will happen is when the shares in Company X are cancelled on the deregistration of the company.

Subsection 104-25(5) of the ITAA 1997 provides that a capital gain that is made in relation to CGT event C2 is disregarded if the asset was acquired before 20 September 1985. In this case, the Trustee of Trust Y acquired its shares in Company X after 20 September 1985. Therefore, while the distribution from Company X related to proceeds from the sale of land that was acquired prior to 20 September 1985, the asset acquired by Trust Y (the shares in Company X), was a post CGT asset for the purposes of the CGT regime. As a result, any capital gain that arises in relation to the ownership by the Trustee of Trust Y of the shares in Company X will not be disregarded under subsection 104-25(5) of the ITAA 1997.

The assessable capital gain will be the capital proceeds from the Liquidator distribution less the cost base of the shares.

Question 3

Summary

The capital distribution made to Company Z when Trust Y ends, will be assessable as a capital gain under CGT event K6 (section 104-230 of the ITAA 1997).

Detailed reasoning

CGT event K6 is an anti-avoidance measure designed to prevent the possible avoidance of CGT where the owners of interests in a company or trust, acquired prior to 20 September 1985, dispose of these interests, rather than actual property of the company or trust acquired after 20 September 1985.

Specifically under subsection 104-230(1) of the ITAA 1997, CGT event K6 happens when:

● you own shares in a company or an interest in a trust you acquired before 20 September 1985,

● CGT event A1, C2, E1, E2, E3, E5, E6, E7, E8, J1 or K3 (the Other CGT Event) happens in relation to the shares or interest in the trust,

● there is no roll-over for the Other CGT Event, and

● the 75% test in subsection 104-230(2) of the ITAA 1997 is satisfied.

The 75% test in subsection 104-230(2) of the ITAA 1997 is satisfied when just before the Other CGT Event happened:

● the market value of property of the company or trust (that is not trading stock) that was acquired on or after 20 September 1985, or

● the market value of interests in the company or trust owned through interposed companies or trusts in property (except trading stock) that was acquired on or after 20 September 1985, must be at least 75% of the net value of the company or trust.

As the ownership by Company Z of the units of the Trust will end when Trust Y ends, CGT event C2 will happen (paragraph 104-25(1)(a) of the ITAA 1997).

Subsection 104-25(2) of the ITAA 1997 states that the time at which CGT event C2 happens is:

c) when you enter into the contract that results in the asset ending; or

d) if there is no contract - when the asset ends.

In this case, the time at which CGT event C2 will happen is when Trust Y ends.

For CGT purposes, shares in a company or units in a unit trust are treated in the same way as any other assets. Shares and units acquired on or after 20 September 1985 are a CGT asset. A unit in a unit trust is an intangible CGT asset.

Under subsection 104-25(3) of the ITAA 1997, you will make a capital gain if the capital proceeds from the surrender or cancellation of the units is more than the asset's cost base. You will make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Subsection 104-25(5) of the ITAA 1997 provides that a capital gain or capital loss that is made in relation to CGT event C2 is disregarded if the asset was acquired before 20 September 1985. In this case, Company Z acquired its units in Trust Y before 20 September 1985. Therefore, any capital gain or capital loss that arises in relation to the ownership by Company Z of units in Trust Y would be disregarded under subsection 104-25(5) of the ITAA 1997.

However, as the sole asset held by Trust Y was acquired post CGT, section 104-230 of the ITAA 1997 (CGT event K6) is applicable.

CGT Event K6 applies as Company Z holds units that are pre CGT in Trust Y where the market value of property acquired by the Trust post CGT is at least 75% or more of the net value of the Trust. In this case, the post CGT shares represent 100% of the net value of the trust.

Therefore on a cancellation of the units held by Company Z, CGT Event K6 will apply to include a capital gain derived by Company Z that forms part of the capital proceeds reasonably attributed to the amount that the market value of the property that was acquired post CGT is more than the sum of the cost bases of that property (see subsection 104-230(6) of the ITAA 1997).

Consequently, apart from a return of capital subscribed for in the Trust, the capital gain realised when Trust Y ends, will be assessable in the hands of Company Z as a capital gain under CGT event K6 (section 104-230 of the ITAA 1997).

Question 4

Summary

The capital distribution made to Company Z when Trust Y ends, that is distributed to the shareholders of Company Z as part of the liquidation of Company Z, will be a deemed dividend under section 47 of the ITAA 1936 and assessable under section 44 of the ITAA 1936.

Detailed reasoning

Specifically, under Section 47 of the ITAA 1936:

"Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it.

Subsection 47(1A) of the ITAA 1936 provides an extension to the term 'income' to include:

(a) an amount (except a net capital gain) included in the company's assessable income for a year of income; or

(b) a net capital gain that would be included in the company's assessable income for a year of income if the Income Tax Assessment Act 1997 required a net capital gain to be worked out as follows:

Method Statement

Step 1: Work out each capital gain (except a capital gain that is disregarded) that the company made during that year of income without indexation.

Step 2: Total the capital gains worked out under step 1. The result is the net capital gain for that year of income.

As explained in the Reasons for Decision for Question 3, the capital distribution to Company Z when Trust Y ends will be assessable as a capital gain under CGT event K6 (section 104-230 of the ITAA 1997).

Therefore, if the Liquidator distributes the capital gain derived by Company Z to the shareholders of Company Z as part of the liquidation, it would be a deemed dividend under paragraph 47(1A)(b) of the ITAA 1936.

Section 6-1 of the ITAA 1936 provides the definition of a dividend and subsection 44(1) of the ITAA 1936 defines the assessability of dividends. Subsection 44(1) requires that dividends received by a resident or a non-resident of Australia issued by a company out of profits, are assessable income of a shareholder.

In this case, Company Z will pay a dividend sourced from the capital gain it derived when Trust Y ends. This payment will be made prior to Company Z being liquidated. Therefore, the payment will be assessable as a dividend under subsection 44(1) of the ITAA 1936.

Note: Dividends paid to non-resident shareholders are subject to PAYG withholding requirements.

Question 5

Summary

Part IVA of the ITAA 1936 will not apply to a dividend paid to Company Z shareholders, sourced from the capital gain it derived on the vesting of Trust Y, as part of the liquidation of Company Z.

Detailed reasoning

The main elements of Part IVA of the ITAA 1936 contained in section 177D are that there is a scheme that was entered into for a purpose of enabling a taxpayer to obtain a tax benefit. The relevant importance of "purpose" is that the purpose must be the dominant or most influential purpose of obtaining a tax benefit as part of the scheme (subsection 177A(5) of the ITAA 1936).

In this case, the scheme involves the decision to liquidate Company Z instead of choosing to pay a dividend to the shareholders of Company Z prior to liquidation.

The issue is whether the decision to liquidate had a dominant purpose of enabling a taxpayer to obtain a tax benefit. The reason for the liquidation is the desire of the shareholders to realise their investment. Further, the shareholders have no intention of conducting another business venture in Company Z. The primary asset of Company Z ended when Trust Y ended.

In this case, the liquidation of Company Z results in the distribution of payments to the Company Z shareholders that are assessable under section 47 of the ITAA 1936. It is not considered that any of the anti-avoidance provisions apply to the decision to liquidate the company.

Therefore, Part IVA of the ITAA 1936 will not apply to the distributions to Company Z shareholders on the liquidation of Company Z.