Edited version of your written advice

Authorisation Number: 1051287234670

Date of advice: 13 October 2017

Ruling

Subject: Assessable income - Investments - Liquidating dividends

Question 1:

Will your share of the Profits Amount Distribution be assessable to you as a dividend under sections 44 and 47 of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer:

Yes.

Question 2:

Will your share of the Pre-CGT Amount Distribution be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936?

Answer:

No.

Question 3:

Will your share of the Frozen Indexation Amount Distribution be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936?

Answer:

Yes.

Question 4:

Will your share of the Pre-CGT Amount Distribution be included as part of the capital proceeds in respect of the cancellation of your shares?

Answer:

Yes.

Question 5:

Will your share of the Frozen Indexation Amount Distribution be included as part of the capital proceeds in respect of the cancellation of your shares?

Answer:

Yes.

This ruling applies for the following period

2017-18 income year.

The scheme commences on

1 July 2002.

Relevant facts and circumstances

You are the shareholders of the Company (a private company).

History of the Company

The Company was established before 1980 by two relatives who held one share each.

One relative passed away about 20 years ago and gifted their one share to the other relative.

The Company’s historical assets

The Company owned a retail business that was established by the relatives before 1985 and then the First Property when it was purchased. This business was sold about 25 years ago.

The First Property was purchased just after 1985 and sold about 12 years ago.

The capital gains worksheet was provided with your request.

The capital gain from the sale of the First Property was worked out using the frozen indexation method.

The Second Property was purchased about 30 years ago and sold recently. It was rented out for the majority of the Company’s ownership period.

Another property was purchased and sold about 30 years ago.

The Company’s financial statements

The Company’s financial statements and income tax returns show the ending of the retail business and an addition Capital Profits Reserve reflecting sales of Pre-CGT assets.

In the 2006-07 income year financial statements, the Capital Profits Reserve was re-named as the Pre-CGT Profits Reserve and the Indexation Profit was separately recorded in the Indexation Profits Reserve.

The Company’s current assets

The Company currently has assets of $x,xxx,xxx comprising primarily cash (and some minor depreciated equipment).

The franking account balance is $yyy,yyy, allowing for some franked dividends to be paid.

The accounts of the Company record the assets as being attributable to the following sources:

The Second Relative’s Estate

The Second Relative passed away about 15 years ago owning both of the shares.

The Second Relative was survived by various beneficiaries including you.

The Second Relative’s estate was divided into three parts:

● One part to the spouse

● One part to the parents (one parent died and the other inherited their share)

● One part on trust for the children (as shall attain the age of 21 years) in equal shares

Around 200X, as part of the administration of The Second Relative’s estate, the two shares were split into a larger number of ordinary shares. These shares were then distributed in accordance with the Will.

The Second Relative’s Will Trust

The terms of this Will Trust are governed by the Will. For accounting purposes, a separate Will Trust has been created for each child.

The Parent’s Will Trust

The Other Parent passed away some five years ago.

The terms of this Will provided that the shares were to be held on trust for such of the Second Relative’s children as shall attain the age of 18 years.

The terms of this Will Trust are governed by the Will. For accounting purposes, a separate Will Trust has been created for each child.

Two of the children have attained 18 years of age and shares have been transferred from the Parent’s Will Trust to them.

It is proposed that the Company be liquidated and deregistered in the 2017-18 income year and distribute its assets to its shareholders by liquidator’s distribution.

It is expected the Liquidator will make the distributions to the shareholders by appropriation from each of the sources of funds mentioned above, namely:

● The Pre-CGT Profit Amount

● The Frozen Indexation Amount

● Company’s Profits Amount

It is expected that the distributions by the Liquidator will be made no earlier than 18 months before the shares cease to exist.

Assumption

For the purpose of this ruling, the proposed actions will occur during the 2017-18 income year.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 47

Income Tax Assessment Act 1997 Part 3-1

Reasons for decision

Question 1

Summary

Your share of the Profits Amount Distribution will be assessable to you as a dividend under sections 44 and 47 of the Income Tax Assessment Act 1936 (ITAA 1936).

Detailed reasoning

Section 44 of the ITAA 1936 includes dividends you receive in your assessable income if they are paid by a company out of profits derived by it from any source.

Subsection 47(1) of the ITAA 1936 defines the profits derived by a company in relation to distributions by liquidators as being a reference to income derived by the company (whether before or during the liquidation).

Subsection 47(1A) of the ITAA 1936 includes the following amounts within the definition of income for this purpose:

● Amounts (other than net capital gains) included in the company’s assessable income, and

● Net capital gains (calculated in a modified way).

The Commissioner accepts the application of the Archer Brothers principle to distributions by liquidators. The principle is that if a liquidator appropriates (or ‘sources’) a particular fund of profit or income in making a distribution (or part of a distribution), that appropriation ordinarily determines the character of the distributed amount for the purposes of section 47 and other provisions of the ITAA 1936. (See Taxation Determination TD 95/10)

The Profits Amount represents the ordinary income amounts earned by the Company that are yet to be distributed to shareholders. It will be distributed to the shareholders (including you) as part of the liquidation of the Company.

Therefore, your share of the Profits Amount Distribution will be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936.

Question 2

Summary

Your share of the Pre-CGT Amount Distribution will not be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936.

Detailed reasoning

This question follows on from Question 1 and considers the Pre-CGT Amount Distribution.

The Pre-CGT Amount did not arise from a receipt that was income in nature. Nor does it relate to a receipt that was assessable to the Company (as a net capital gain or otherwise). It will be distributed to the shareholders (including you) as part of the liquidation of the Company.

Therefore, your share of the Pre-CGT Amount Distribution will not be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936.

Question 3

Summary

Your share of the Frozen Indexation Amount Distribution will be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936.

Detailed reasoning

This question also follows on from Question 1 and considers the Frozen Indexation Amount Distribution.

The Frozen Indexation Amount did not arise from a receipt that was income in nature. Nor does it relate to a receipt that was assessable to the Company (otherwise than as a net capital gain).

However, the Frozen Indexation Amount Distribution has arisen from a capital gain that was not disregarded.

Net capital gains are calculated in a modified way when applying subsection 47(1A) of the ITAA 1936. Step 1 of the Method Statement requires the effect of indexation of the cost base of an asset to be removed from the calculation of the amount of the capital gain.

Consequently, the indexation benefit is added back into the amount that is considered to be the capital gain from that particular CGT event. (See for instance the example in Taxation Determination TD 2000/5 and the example in Taxation Determination TD 2001/14.)

Therefore, while the amount of the capital gain calculated for the sale of the First Property was calculated as capital proceeds less indexed cost base, for section 47 purposes, the amount of this capital gain is calculated as capital proceeds less cost base.

In effect, the indexation benefit is included in the calculation of the adjusted amount of the capital gain meaning the Frozen Indexation Amount represents another income amount earned by the Company that is yet to be distributed to shareholders. It will be distributed to the shareholders (including you) as part of the liquidation of the Company.

Therefore, your share of the Frozen Indexation Amount Distribution will be assessable to you as a dividend under sections 44 and 47 of the ITAA 1936.

Question 4

Summary

Your share of the Pre-CGT Amount Distribution will be included as part of the capital proceeds in respect of the cancellation of your shares.

Detailed reasoning

CGT event C2 will happen when the shares are cancelled.

Capital proceeds is the total of the money and other property you receive or that is receivable in respect of the shares being cancelled.

The whole of the distribution (including the part that is sourced from the Pre-CGT Amount) is a payment that you will receive due to the cancellation of the shares.

Therefore, the whole of the distribution (including the part that is sourced from the Pre-CGT Amount) is treated as capital proceeds for capital gains purposes. (See Taxation Determination TD 2001/27)

CGT event G1 will not happen due to the distribution as the company will cease to exist within 18 months of the payment being made.

Question 5

Summary

Your share of the Frozen Indexation Amount Distribution will be included as part of the capital proceeds in respect of the cancellation of your shares.

Detailed reasoning

CGT event C2 will happen when the shares are cancelled.

Capital proceeds is the total of the money and other property you receive or that is receivable in respect of the shares being cancelled.

The whole of the distribution (including the part that is sourced from the Frozen Indexation Amount) is a payment that you will receive due to the cancellation of the shares.

Therefore, the whole of the distribution (including the part that is sourced from the Frozen Indexation Amount) is treated as capital proceeds for capital gains purposes. (See Taxation Determination TD 2001/27)

CGT event G1 will not happen due to the distribution as the company will cease to exist within 18 months of the payment being made.

Note: section 118-20 of the Income Tax Assessment Act 1997 ensures that no part of the final liquidator’s distribution is taxed as both a dividend and as a capital gain by reducing the amount of the capital gain.