Edited version of private advice

Authorisation Number: 1052005034291

Date of advice: 14 July 2022

Ruling

Subject: Share capital

Question 1

Will any part of the Proposed Share Capital Return that is debited to Company A's share capital account constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) and for the purposes of subsection 44(1) of the ITAA 1936?

Answer

No

Question 2

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

Answer

No

This ruling applies for the following period:

XXXX

Relevant facts and circumstances

Company A is the holding company for a number of subsidiaries (the Group).

Company A has only one class of shares on issue, being ordinary shares. All ordinary shares rank equally in all respects.

Company A completed the sale of all of its shares in one of its wholly owned subsidiaries, Company B (the Transaction).

No accounting profit has been recognised by Company A in connection with the Transaction.

As a consequence of the Transaction, the Group effected the disposal of a business (the Business) given all of the assets necessary to conduct this business were held by Company B at completion.

Some portion of the proceeds from the Transaction is considered to be in excess of the overall business requirements of the Group, noting the overall business is now substantially smaller following the divestment of the Business.

Accordingly, Company A proposes to distribute the excess cash to its shareholders by way of a return of capital (the Proposed Share Capital Return).

The Proposed Share Capital Return will be undertaken on a pro-rata basis based on the number of shares respectively held by each of Company A's shareholders. No shares will be cancelled in connection with the proposed share capital return.

Company A will debit the whole amount of the Proposed Share Capital Return against the amount standing to the credit of Company A's share capital account. (Share capital sources are in the one share capital account.)

Company A can trace share capital invested in Company B for the purposes of funding the development of the business.

From incorporation to date, Company B has not previously returned capital or made any dividend distributions to its shareholders (i.e Company A): Company B has not made any accounting profits and, as such, has been consistently in a negative retained earnings position. Accordingly, at completion of the Transaction, the aggregate amount of share capital received by Company B, net of any associated costs, is represented by Company B's share capital account balance on completion, being an amount greater than the excess cash from the Transaction.

Company A has accumulated losses. Company A has not had and does not have any retained earnings and no franking account balance.

Company A has never paid a dividend or returned capital to its shareholders

None of the entities comprising the Group are members of a tax consolidated group for Australian income tax purposes.

Each of the entities within the Group are solely resident of Australia for tax purposes.

Company A has one share capital account.

Company A's share capital account (as defined in section 975-300 of the ITAA 1997) is not tainted within the meaning of Division 197 of the ITAA 1997

Assumption

The transactions between all entities are conducted at arm's length.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 44

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1997 Section 6-5

Reasons for decision

Issue 1

Question

Summary

The payments to shareholders in respect of the Proposed Share Capital Return will be distributions made by the company that is sourced entirely from the company's share capital account. Consequently, no part of the distributions will be a dividend for tax purposes as a dividend for purposes of subsection 44(1) of the ITAA 1936 does not include distributions sourced from the company's share capital account (paragraphs (a) and (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936).

Detailed reasoning

A dividend includes any distribution made by a company to any of its shareholders, whether in money or other property, and any amount credited by a company to any of its shareholders as shareholders.

Relevantly, subsection 44(1) of the ITAA 1936 provides that the assessable income of a shareholder of a company (whether resident or non-resident) includes:

•         if the shareholder is a resident, dividends paid to the shareholder by the company out of profits derived by it from any source; or

•         if the shareholder is a non-resident, dividends paid to the shareholder by the company to the extent to which they are paid out of profits derived by it from sources in Australia.

A dividend does not include moneys paid or credited, or property distributed, by a company to shareholders where the amount of the money or the value of the property is debited against an amount standing to the credit of the company's share capital account (subsection 6(1) of the ITAA 1936).

'Share capital account' is defined in section 975-300 of the ITAA 1997 as an account in which the company keeps its share capital, or any other amount created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. Subsection 975-300(2) further provides that where a company has more than one account covered in subsection (1), the accounts are taken, for the purposes of the ITAA 1997, to be a single account.

Taxation Ruling TR 2003/8 Income tax: distributions of property by companies to shareholders - amount to be included as an assessable dividend, in explaining when dividends are paid or taken to be paid out of profits, confirms that a distribution that is sourced from the company's share capital account does not fall within the ambit of subsection 44(1) of the ITAA 1936:

13. In most cases a company which distributes property to its shareholders and debits part of the value of that property to its share capital account would debit the remaining part to another account or reserve. Where that account or reserve does not represent share capital, it would, for subsection 44(1) purposes, represent profits derived by the company so that the amount debited to it would be included in the shareholder's assessable income under that subsection.

Consequently, any part of the payments to Company A's shareholders under the Proposed Share Capital Return that is debited company's share capital account does not constitute a dividend as defined in subsection 6(1) and for the purposes of subsection 44(1) of the ITAA 1936.

As the share capital account of the company 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 applies. Accordingly, the Proposed Share Capital Return payments will not constitute a dividend.

Issue 2

Question

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 Share Capital Return payments.

Detailed reasoning

Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies. The effect of such a determination is that all or part of the capital component received under the Proposed Share Capital Return would be treated as an unfranked dividend.

Section 45A of the ITAA 1936 applies where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the capital benefits than other shareholders, and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Although the distribution of share capital per share is the 'provision of a capital benefit' to shareholders under the Proposed Share Capital Return, the circumstances of the Proposed Share Capital Return indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders - as The Proposed Capital Return will be undertaken on a pro-rata basis based on the number of shares respectively held by each of Company A's shareholders and no shares will be cancelled in connection with the Proposed Share Capital Return.

Accordingly, section 45A of the ITAA 1936 does not apply to the Proposed Share Capital Return.

The Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat all or part of the distribution of share capital per share as an unfranked dividend paid by the company.

Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B of the ITAA 1936 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, who entered into or carried out the scheme or any part of the scheme did so for a purpose (whether or not the dominant purpose, but not including an incidental purpose) of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(a) of the ITAA 1936).

Scheme

A 'scheme' for the purposes of section 45B of the ITAA 1936 is taken to have the same meaning as provided in subsection 177A(1) of Part IVA of the ITAA 1936. That definition is widely drawn and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan, or proposal. In particular, a scheme is anything that satisfies any of the terms in the statutory definition.

The Proposed Share Capital Return would constitute a scheme for the purposes of section 45B of the ITAA 1936.

Tax benefit

Subsection 45B(9) of the ITAA 1936 provides that a relevant taxpayer 'obtains a tax benefit' if an amount of tax payable by that taxpayer would, apart from the operation of section 45B, be less than the amount that would have been payable if the 'demerger benefit' had been an assessable dividend or the capital benefit had been a dividend.

As a result of the Proposed Share Capital Reduction, the tax payable by shareholders may be lower than if the payment was an assessable dividend. Accordingly, depending on their circumstances, shareholders may obtain a tax benefit for the purposes of section 45B.

It is noted that the operation of CGT Event G1 in relation to the Proposed Share Capital Return may result in certain shareholders making a taxable capital gain where the capital proceeds received by that shareholder exceed the shareholder's cost base in their shares.

More than incidental purpose

However, having regard to the 'relevant circumstances' of the Proposed Share Capital Return, the Commissioner considers that the scheme consisting of the Proposed Share Capital Return was not entered into or carried out for a more than an incidental purpose of enabling the shareholders to obtain a tax benefit. Some of the key factors in determining that the capital distribution will not be made in substitution for dividends are:

•         No portion of the Proposed Capital Return represents profits.

•         Having regard to Company A's (and the Group's) overall funding requirements, the Proposed Share Capital Return represents funds which are no longer required to carry out the Group's corporate objectives of owning and contributing to Company B and the business.

•         The payments under the Proposed Share Capital Return that is attributable to the disposal of Company B can be traced to Company A share capital that was invested in Company B.

•         Company A has no retained earnings.

It is reasonable to assume the transactions between all entities are conducted at arm's length. The distribution culture and the characteristics of the shareholders (having regard to the nature of the Group and that all transactions are conducted at arm's length) are neutral factors in these circumstances - as Company A has not made any dividend distributions in the past and the Proposed Share Capital Return applies to all shareholders on a pro rata basis.

Accordingly, section 45B of the ITAA 1936 would not apply to the Proposed Share Capital Return.

The Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat all or part of the distribution of share capital per share as an unfranked dividend paid by Company A.