Edited version of private advice

Authorisation Number: 1051666833157

Date of advice: 7 May 2020

Ruling

Subject: Distribution from a company in liquidation

Question 1

Will the amount be received by you be "capital proceeds" arising from a CGT event and limited to the extent as provided in the applicable CGT event?

Answer

Yes

Question 2

Will CGT event A1 occur at the time of the distribution?

Answer

No

Question 3

Will CGT event C2 happen at the time of deregistration?

Answer

Yes

Question 4

Will the capital gain that occurs as a result of CGT event C2 be disregarded?

Answer

Yes

Question 5

Will CGT event K6 occur at the time of deregistration?

Answer

No

Question 6

Will the distribution to shareholders in the course of the member's voluntary winding up included in the assessable income of the shareholders in the form of a dividend under subsection 47(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 of the ITAA 1936?.

Answer

No

This ruling applies for the following periods:

Year ended 30 June 20XX

Year ended 30 June 20XX

Year ending 30 June 20XX

Year ending 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

Company X's land and building

Company X acquired land and a building (the Property) pre-CGT.

The Property comprised land and a commercial building.

The Property was used for the purpose of producing rental income at all times from the date of acquisition by you up until the commencement of the post-CGT Refurbishment. Over the years, portions of the building were leased to various arm's length tenants.

Company X commenced the major refurbishment of the building situated on the land owned by Company X.

The building was vacated so as to permit construction of the Refurbishment.

After completion of the Refurbishment, the building was reopened for the leasing of the redeveloped floors or parts thereof to third party tenants.

New third party leases for separate portions of the new building were entered into.

On or about XX XXXX XXXX, Company X acquired the Laneway post-CGT adjoining the Property (excluding GST and other settlement adjustments). No capital improvement was made to the laneway. The laneway provided access to the Property.

By contract of sale dated XX XXXX XXXX, made between you (as Vendor) and purchaser and settled on XX XXXX XXXX, Company X sold each of

·         the Property as a going concern.

·         The laneway as a taxable supply.

The laneway was an asset used by Company X in carrying on the commercial leasing business within the Property. It was supplied to the Purchaser to enable the purchaser to continue the operation of the business acquired from Company X.

After the completion of the Refurbishment, Company X continuously carried on the business of renting out the building on the Property under commercial leases to third parties until the date of settlement of the sale.

The post-CGT Contract of Sale provides for the sale to be subject to existing tenancies.

At settlement, all the building levels were occupied by tenants.

The refurbishment is to be considered a separate asset and is deemed to have been acquired by Company X on the date the construction contract was executed (section 100-20(3) ITAA 1997).

Shareholdings

The issued capital of Company X comprises X ordinary shares each fully paid to $X per share.

The Company X's issued capital has, at all material times since a date pre-CGT, been beneficially owned by you.

Your issued capital comprises X Ordinary Shares each fully paid to $X per share.

Your issued capital has at all material times been held by Company Z in its capacity as Trustee of the W Trust created by deed dated pre-CGT

Trust deed

The list of beneficiaries has not been changed since the creation of the W Trust.

There is no person existing capable of appointing additional beneficiaries in terms of the Trust Deed; so the range of Beneficiaries as detailed in the Schedule to the Trust Deed has been locked in since XX XXXX XXXX.

The directors of Company Z have decided that all distributions of capital from the W Trust are to be made in a manner consistent with the provisions of the Will of their mother, and in the proportions stated in that Will (the Will Concept).

Company Z has, at all relevant times since the creation of the W Trust, administered the W Trust solely for the benefit of the same family.

Distribution to Company X

The liquidator proposes to distribute, by way of a specific liquidator's capital distribution, the amount of $X out of the Capital Profit Reserve Pre 1985 account to you.

You will be deregistered in terms of subsection 509(5) of the Corporations Act 2001.

This distribution from Company X will not be considered to be an assessable dividend as it comprises the profits from the sale of a pre-CGT asset.

Following the receipt by you of the distribution above, you propose to make a specific capital distribution(s) comprising all, or a part, of the balance remaining in Company X's Liquidator's Distribution Reserve Account to Company Z as trustee of the W Trust.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 subsection 47(1)

Income Tax Assessment Act 1997 section 102-20

Income Tax Assessment Act 1997 subsection 102-25(2)

Income Tax Assessment Act 1997 subsection 104-10(1)

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 subsection 104-25(2)

Income Tax Assessment Act 1997 paragraph 104-25(5)(a)

Income Tax Assessment Act 1997 section 104-230

Income Tax Assessment Act 1997 subsection 104-230(1)

Income Tax Assessment Act 1997 subsection 104-230(2)

Income Tax Assessment Act 1997 section 108-5

Income Tax Assessment Act 1997 subsection 118-20(1)

Income Tax Assessment Act 1997 subsection 118-20(1A)

Reasons for decision

CGT event A1

CGT event A1 occurs when there is disposal of a CGT asset (subsection 104-10(1) of the Income Tax Assessment Act 1997 (ITAA 1997)). You are taken to dispose of a CGT asset if a change of ownership occurs from you to another entity, whether because of some act or event or by operation of law.

In this instance, there is no change of ownership of a CGT asset. The asset in question has already been sold by another entity. The distribution of the proceeds of this disposal to another entity through the liquidation process does not represent a change of ownership for the purposes of CGT event A1.

CGT event C2

Under section 108-5, an asset for CGT purposes is any form of property or a legal or equitable right that is not property. Under section 102-20, you make a capital gain or capital loss as a result of a CGT event. Section 104-25 provides that CGT event C2 happens if your ownership of an intangible CGT asset ends by the asset:

a)    being redeemed or cancelled

b)    being released, discharged or satisfied

c)    expiring; or

d)    being abandoned, surrendered or forfeited; or

....

The time of the event is when you enter into the contract that results in the asset ending or if there is no contract, when the asset ends: subsection 102-25(2).

Taxation Determination TD 2001/27 Income tax: capital gains: how do Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 ('ITAA 1997') treat:

a)    a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the Income Tax Assessment Act 1936 ('ITAA 1936') to be a dividend; and

b)    an interim liquidation distribution to the extent it is not deemed to be a dividend by subsection 47(1)? (TD 2001/27)

considers how Parts 3-1 and 3-3 of the ITAA 1997 treat a final liquidation distribution, including where all or part of it is deemed by subsection 47(1) of the ITAA 1936) to be a dividend. Paragraph 1 of the ruling states that:

The full amount of a final distribution made by a liquidator on the winding-up of a company constitutes capital proceeds from the ending of the shareholder's shares in the company for the purposes of capital gains or capital losses made on the happening of CGT event C2 (about cancellation, surrender and similar endings) in section 104-25 of the ITAA 1997. After the winding-up of a company, CGT event C2 happens to the shares when the company ceases to exist in accordance with the Corporations Act 2001 (see Taxation Determination TD 2000/7 paragraphs 3 and 4).

If all or part of a final distribution made by a liquidator of a company is deemed by subsection 47(1) of the ITAA 1936 to be a dividend paid out of profits, and to be assessable income of a shareholder under subsection 44(1) of the ITAA 1936, this does not alter the position stated in paragraph 1 of TD 2001/27. However, subsection 118-20(1) of the ITAA 1997, when read with subsection 118-20(1A), ensures that no part of the final liquidator's distribution is taxed both as a dividend and as a capital gain.

Subsection 118-20(1) of the ITAA 1997 states that a capital gain you make from a CGT event is reduced if, because of the event, a provision of this Act (outside of this part) includes an amount (for any income year) in:

a)    you assessable income or exempt income; or

b)    if you are a partner in a partnership, the assessable income or exempt income of the partnership.

Subsection 118-20(1A) of the ITAA 1997 states that subsection (1) applies to an amount that, under a provision of this Act (outside of this part), is included in:

a)    your assessable income or exempt income; or

b)    if you are a partner in a partnership, the assessable income or exempt income of the partnership;

in relation to a CGT asset as if it were so included because of the CGT event referred to in that subsection if the amount would also be taken into account in working out the amount of a capital gain you make.

The distribution made to you in the course of the voluntary liquidation, to the extent to which it is made out of a reserve that represents a capital gain that has been reduced to nil (due to it being profits from the sale of a pre-CGT asset), will not be deemed a dividend paid by the company out of profits under subsection 47(1) of the ITAA 1936. It will instead form part of the capital proceeds for the ending of your shares on liquidation. As per TD 2000/7 at paragraph 4, it is considered that when a company is deregistered under subsection 509(5) of the Corporations Act 2001, a CGT event (usually being C2) happens to the member's shares. In this case C2 occurs when the company is deregistered. This deregistration occurs three months after the liquidator lodges a return of the holding of the final meeting of members or of members and creditors.

Will the capital gain that results from CGT event C2 happening be disregarded?

Under paragraph 104-25(5)(a) of the ITAA 1997, a capital gain or loss you make as a result of CGT event C2 is disregarded if you acquired the asset before 20 September 1985.

All the shares were acquired pre-CGT and they have remained pre-CGT. Therefore any capital gain that results from CGT event C2 occurring will be disregarded.

CGT Event K6

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 detailed above, CGT event C2 occurs at the time of deregistration.

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.

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.

The principal asset was purchased pre-CGT and this asset has remained pre-CGT. The asset was sold prior to deregistration, leaving only cash at bank. No other property was acquired by the entity post 20 September 1985. No other interests were acquired by interposed companies post 20 September 1985. Therefore the 75% test in subsection 104-230(2) of the ITAA 1997 is not satisfied and CGT event K6 does not apply.

Liquidator Distribution

At common law, a distribution to a shareholder by a liquidator is capital, not income, in the hands of the shareholder since it is a realisation of the shareholder's interest in the company: FC of T (NSW) v Stevenson (1937) 4 ATD 415; (1937) 59 CLR 80; FC of T v Blakely (1951) 9 ATD 239 at 245, 247; (1951) 82 CLR 388 at 402, 407; FC of T v Brewing Investments Ltd [2000] FCA 920; 2000 ATC 4431 per Hill J at 18 - 19

Liquidator distributions from the capital reserve account sourced from assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of the ITAA 1936, or a net capital gain under section 104-25 of the ITAA 1997. If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets maintain the tax-free status of the distribution from the capital profits reserve account.

Archer Bros Pty Ltd (In Vol Liq) v. FCT (1953) 90 CLR 140; 27 ALJ 353; 10 ATD 192 (Archers Case) discusses distributions. In a joint judgement, the Full High Court of Australia in Archers Case observed by way of obiter dicta:

By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that...distributions could be made wholly and exclusively out of...particular profits...or income...'

Taxation Determination TD 95/10 Income tax: what is the significance of the Archer Brothers principle in the context of liquidation distributions? discusses the significance of the "Archer Brothers principle" in the context of liquidation distributions:

The observations in Archers Case have given rise to what is known as the Archer Brothers principle. The principle is that if a liquidator appropriates a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of the Income Tax Assessment Act. Generally, a liquidator may rely on the Archer Brothers principle, except where a specific provision produces a different result.

Archers Case refers to 'profits' or 'income'. However, if a liquidator ostensibly distributes an amount representing capital actually contributed by shareholders, we accept that the distribution is treated as a non-dividend return of capital.

Provided the liquidator is able to identify the source from which a particular distribution is made, we will accept a liquidators nominated appropriation. For example, identifying pre-CGT non-assessable profits separately to post-CGT capital gains.

If a liquidator can identify the source of funds distributed, then those funds retain the character of the source. So, a pre-CGT gain on disposal of a building would remain pre-CGT when it was distributed and would therefore be tax free to the shareholders.

Section 47 of the ITAA 1936 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 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.

The use of the term "income" in the context of subsection 47(1) of the ITAA 1936 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".

You received a capital distribution from Company X that was sourced from pre-CGT profits. This amount was not considered to be a dividend in your hands. You are going to distribute this amount to your shareholders. It is considered that this amount has retained its character when it is distributed through to your shareholders and therefore will be considered to be pre-CGT profits. You have designated those profits as such as per the Archer Brothers principle. Therefore the amount will not be considered to be a deemed dividend under section 47 of the ITAA 1936 as the amount distributed does not represent income derived by the company.