Edited version of private advice

Authorisation Number: 1052090528446

Date of advice: 23 February 2023

Ruling

Subject: Attributable income - liquidator distributions

Question 1

Will the Taxpayer be taxed on an accrued basis in respect of the capital gain on the sale of business goodwill by the Company under the controlled foreign company rules?

Answer

No

Question 2

Will the distributions made to the Taxpayer out of the capital gain on the sale of business goodwill be treated as liquidator's distributions for the purpose of subsection 47(2A) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No

Question 3

If the answer to Question 2 is No, will the distributions made to the Taxpayer out of the capital gain on the sale of business goodwill be treated as liquidator's distributions for the purposes of subsection 47(1) of the ITAA 1936?

Answer

Yes

Question 4

If the answer to Question 3 is Yes, will the capital gain on the sale of business goodwill be considered income derived by the Company under subsection 47(1) and 47(1A) of the ITAA 1936?

Answer

No

Question 5

If the answer to Question 4 is Yes, will CGT event G1 or CGT event C2 happen in relation to the non-assessable payments to the Taxpayer?

Answer

Yes

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

1 July 20XX to 30 June 20XX

The scheme commenced on:

XX December 20XX

Relevant facts and circumstances

The Taxpayer is a resident trust.

The Company was incorporated in Country A on XX XXX 20XX. The Company operated a business in Country A until the business was sold in 20XX. The Company's business was operated entirely in Country A and was centrally managed solely from its Country A office.

The Company is a non-resident of Australia for Australian tax purposes.

The Company has X shares on issue. The Taxpayer acquired X shares on XX XXX XXXX for $XX,XXX. The other X shares are owned by a Country A resident company.

The Company sold its business to a third party on XX XXX 20XX and made a capital gain of approximately Country A $X million on the sale of business goodwill. The business sale was agreed to on a deferred settlement basis, payable on a monthly basis, determined by the amount of sales achieved by the Company, subject to adjustments to the revenue target, with the final payment to be made in XXX 20XX.

The Company derived income from sale of goods and capital profits from the sale of its business for the income year ended 20XX. There were no inter-company sales between Australia and Country A companies or related parties and there was no services income derived by the Company for the income year ended 20XX.

The taxpayer has stated that under the Country A tax law, the entire capital gain to the Company was not subject to taxation in Country A at the company level. However, under Country A's Income Tax Act 2007 the capital gain of the Company may still be subject to Country A income tax depending on how and to whom it is distributed.

The Company ceased trading after the business was sold. It has no functions or activities. The Company merely holds a bank account to receive the sale proceeds from the sale of the business under the terms of the sale contract.

Following the cessation of the business the shareholders of the Company wish to access the funds of the Company. A Special Resolution of Shareholders was passed on XX XXX 20XX to wind up the Country A Company.

The Special Resolution states that since the Company has ceased to carry on any business, has discharged its liabilities and upon completion of distributing its surplus assets, the Companies Office Registrar be requested to remove the Company from the Companies Registry. No formal liquidator will be appointed. A Country A accountant has been engaged to assist with applying for deregistration of the Company.

It is anticipated that the Company will be deregistered around February 20XX soon after the final payment of the sale proceeds is received in January 20XX.

The capital gain will be paid to the shareholders on the winding up of the Company. Each shareholder will be entitled to a payment of Country A $XX million.

It is expected that there will be a series of distributions to be made to the shareholders during the winding up process. The first distribution was made to the Taxpayer in XX XXX 20XX.

The taxpayer has stated that Non- Resident Withholding Tax has been applied under Country A law at a rate of X% and will be withheld from all distributions from the Company to the Taxpayer. This is because under Country A's Income Tax Act 2007 some non-resident entity shareholders are required to have Non-Resident Withholding Tax applied to distributions.

The Company's shareholder equity account is set out below as at XX XXX 20XX.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 section 44

Income Tax Assessment Act 1936 section 47

Income Tax Assessment Act 1936 section 317

Income Tax Assessment Act 1936 section 446

Income Tax Assessment (1936 Act) Regulation 2015

Income Tax Assessment (1936 Act) Regulation 2015 regulation 17

Income Tax Assessment (1936 Act) Regulation 2015 regulation 19

Income Tax Assessment Act 1997 section 104-25

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 section 118-20

Income Tax Assessment Act 1997 section 855-10

Income Tax Assessment Act 1997 section 770-10

Income Tax Assessment Act 1997 subsection 770-15

Income Tax Assessment Act 1997 section 770-130

Reasons for decision

Question 1

Will the Taxpayer be taxed on an accrued basis in respect of the capital gain on the sale of business goodwill by the Company under the controlled foreign company rules?

Summary

No, the gain on sale of the business goodwill will not be attributable income of a controlled foreign company to the Taxpayer.

Detailed reasoning

The controlled foreign company (CFC) provisions are contained in Part X of the Income Tax Assessment Act 1936 (ITAA 1936). The accruals system applies to Australian residents who have a substantial interest in a foreign company controlled by Australians. The system operates to include a taxpayer's share of specified income and gains of a CFC in the taxpayer's assessable income as 'attributable income'. This is achieved by attributing tainted income to the Australian resident controllers of the CFC.

There are modifications to the attributable income where the CFC is located in a country that taxes income in a similar way to Australia. The attributable income is also modified where the CFC has significant income from actively carrying on business.

Is the company a CFC?

Pursuant to section 340 of the ITAA 1936, a company is a CFC at a particular time if, at that time, the company is a resident of a listed country or of an unlisted country and any of the following paragraphs applies:

(a)  at that time, there is a group of 5 or fewer Australian 1% entities the aggregate of whose associate-inclusive control interests in the company is not less than 50%;

(b)  both of the following subparagraphs apply:

(i)    at that time, there is a single Australian entity (in this paragraph called the "assumed controller'') whose associate-inclusive control interest in the company is not less than 40%;

(ii)   at that time, the company is not controlled by a group of entities not being or including the assumed controller or any of its associates;

(c)   at that time, the company is controlled by a group of 5 or fewer Australian entities, either alone or together with associates (whether or not any associate is also an Australian entity).

Listed country

Regulation 19 of the Income Tax Assessment (1936 Act) Regulation 2015 specifies the countries that are listed countries. The countries that are listed countries are Canada, France, Germany, Japan, New Zealand, United Kingdom of Great Britain and Northern Ireland and the United States of America.

As the Company is a Country A resident company, owned X% by the Australian resident Taxpayer and X% by a third party, it is a CFC.

Is the Australian entity an attributable taxpayer in relation to the CFC?

Pursuant to section 361 of the ITAA 1936, an entity (the test entity) is an attributable taxpayer in relation to a CFC at a particular time if, at that time:

(a)  the test entity is an Australian entity whose associate-inclusive control interest in the CFC is at least 10%; or

(b)  all of the following subparagraphs apply:

(i)    the CFC is a CFC at that time only because of paragraph 340(c);

(ii)   the CFC is controlled by any group of 5 or fewer Australian entities, either alone or together with associates (whether or not any associate is also an Australian entity);

(iii)  the test entity is an Australian 1% entity and is included in that group of 5 or fewer Australian entities.

As the Taxpayer's interest in the CFC, being the Company, is X%, it satisfies section 361(a) of the ITAA 1936 and will be considered an attributable taxpayer in relation to the Company. Broadly, attributable income is calculated on the basis that the CFC is a resident Australian company with some modifications.

What is the attributable taxpayers attributable income?

The attributable income of a CFC is calculated under Division 7 of Part X of the ITAA 1936. The income taken into account in the calculation of attributable income depends on whether the CFC is resident in a listed country or in an unlisted country and whether or not the CFC passes the active income test.

As the Company is resident of a listed country, pursuant to section 385(2) of the ITAA 1936, where it does not pass the active income test, the Company's notional assessable income would be its adjusted tainted income that is eligible designated income.

Eligible designated income is income or profits of a kind specified in the Table in Part 8 of the Income Tax Assessment (1936 Act) Regulation 2015.

For a Country A resident company, such income or profits would be ordinary capital gains in respect of tainted assets, derived by a company that is not subject to tax in Country A during the relevant period.

Tainted asset is defined by subsection 317(1) of the ITAA 1936 and includes:

...

(a)  an asset other than:

(i)    trading stock; or

(ii)   any other asset used solely in carrying on a business;

but does not include a commodity investment.

As discussed in ATO Interpretative Decision ATO ID 2006/181 Income Tax Disposal of Goodwill: tainted asset, the Commissioner does not consider Goodwill to be a tainted asset for the purposes of Part X of the ITAA 1936.

Goodwill is inseparable from a business and cannot be used other than in connection with a business. In terms of the section 317 of the ITAA 1936, goodwill is used solely in carrying on a business and is not therefore a tainted asset.

Therefore, the capital gain on the sale of business goodwill by the Company will not be attributable income of a CFC of the Taxpayer.

Question 2

Will the distributions made to the Taxpayer out of the capital gain on the sale of business goodwill be treated as liquidator's distributions for the purpose of subsection 47(2A) of the ITAA 1936?

Summary

No, as the business of the company is in the course of being wound up under Country A law, it is not eligible to be treated under subsection 47(2A) of the ITAA 1936 as a liquidator's distribution and instead may be a liquidator's distribution under subsection 47(1) of the ITAA 1936.

Detailed reasoning

Subsection 47(2A) of the ITAA 1936 provides, where:

(a)  the business of a company has been, or is in the course of being, discontinued otherwise than in the course of a winding up of the company under any law relating to companies;

(b)  in connexion with the discontinuance, any moneys of the company have been or other property of the company has been, on or after 19 October 1967, distributed, otherwise than by the company, to shareholders of the company; and

(c)   the moneys or other property so distributed are not, for the purposes of this Act, dividends;

the distribution shall, subject to subsection (2B), be deemed to be, for the purposes of this section, a distribution to the shareholders by a liquidator in the course of winding up the company.

Application to your circumstances:

A formal resolution was made on XX XXX 20XX to wind up the Country A Company under a Section 318(1)(d) of the Companies Act 1993 (Country A), also known in Country A as a 'short-form liquidation'.

As the winding up will occur under a law relating to companies, specifically the Companies Act 1993 (Country A), the 'otherwise than in the course of a winding up' condition under paragraph 47(2A)(a) of the ITAA 1936 will not be satisfied.

Question 3

If the answer to Question 2 is No, will the distributions made to the Taxpayer out of the capital gain on the sale of business goodwill be treated as liquidator's distributions for the purposes of subsection 47(1) of the ITAA 1936?

Summary

Yes. As the Company has made a Shareholder's Resolution under Section 318(1)(d) of the Companies Act 1993 (Country A) to enter into a 'short-form liquidation' process, subsection 47(1) can apply to the distributions.

Detailed reasoning

Subsection 47(1) of the ITAA states:

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.

Section 6(1) of the ITAA 1936 defines liquidator as 'the person who, whether or not appointed as liquidator, is the person required by law to carry out the winding-up of a company'.

In accordance with Country A publications Questions We've Been Asked QB 20/03: First step legally necessary to achieve liquidation when a liquidator is appointed and Public Ruling BR Pub 14/09 Income Tax - Meaning of "Anything Occurring on Liquidation" When a Company Requests Removal From the Register of Companies, under Country A tax legislation, any distributions made after the passing of the relevant resolution is to be considered "on the liquidation of the company".

Application to your circumstances

As the shareholders of the Company have made a special resolution under Country A Corporations Law to wind up the company, we consider the distributions made after the making of the resolution to have been made in the course of winding up the company.

Therefore, the distributions are considered liquidator's distributions and section 47(1) of the ITAA 1997 can apply.

Question 4

If the answer to Question 3 is Yes, will the capital gain on the sale of business goodwill be considered income derived by the Company under subsection 47(1) and 47(1A) of the ITAA 1936?

Summary

No, the capital gain on the sale of business will not be considered income derived by the Company under section 47(1) and section 47(1A) of the ITAA 1936.

Detailed reasoning

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) of ITAA 1936 to be 'income'.

Subsection 47(1A) of the ITAA 1936 extends the ordinary definition of income referenced in subsection 47(1) as follows:

(1A) A reference in subsection (1) to income derived by a company includes a reference to:

(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'sassessable 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. Do so without indexing any amount used to work out the cost base of a CGTasset.

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

The effect of subsection 47(1A) of the ITAA 1936 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'.

Disregarded capital gains

Subsection 47(1A) of the ITAA 1936 was introduced by the Taxation Laws Amendment (Company Distributions) Act 1987 No.58 of 1987. The Explanatory Memorandum to the Bill explained:

Subsection 47(1) of the Principal Act deems distributions to shareholders of a company by a liquidator in the course of winding up the company to be dividends paid to the shareholders out of profits to the extent to which they represent income derived by the company. For these purposes, income has its ordinary meaning and does not include amounts - such as certain capital profits - that are specifically included in assessable income of a taxpayer by various provisions of the income tax law.

Clause 8 proposes to insert a new subsection - subsection (1A) - in section 47 of the Principal Act to extend the meaning of the phrase "income derived by the company" for the purposes of subsection (1). By this extension, liquidator's distributions out of realised capital gains on taxable assets acquired after 19 September 1985, and out of all amounts (other than the assessable portion of such gains) which are assessable income of a company under the income tax law, are deemed to be dividends paid to shareholders out of profits of a company.

... these tests will ensure that a distribution to a shareholder by a liquidator in the course of winding up a company is also deemed to be a dividend paid to the shareholder by the company out of profits derived by it to the extent that the distribution is made out of an actual gain on disposal of a taxable asset to which Part IIIA of the Principal Act has application.

A further technical amendment was made by Taxation Laws Amendment Act (No.4) 2000 (114 of 2000) which inserted within the method statement in subsection 47(1A) of the ITAA 1936 after 'each capital gain' the words '(except a capital gain that is disregarded)'. The Explanatory Memorandum for this Bill said that this amendment:

Clarifies the method statement to ensure that capital gains that have been disregarded (e.g. under a rollover provision) are not income derived by the company. This correctly reflects the intention of the provision.

Foreign resident capital gains

Subsection 855-10 of the ITAA 1997 applies to disregard foreign resident capital gains as follows:

Disregarding a capital gain or loss from CGT events

(1)  Disregard a capital gain or capital loss from a CGT event if:

(a)  you are a foreign resident, or the trustee of a foreign trust for CGT purposes, just before the CGTevent happens; and

(b)  the CGT eventhappens in relation to a CGT asset that is not taxable Australian property.

Archer Brothers principle

The interpretation of subsection 47(1A) of the ITAA 1936 is predicated on the ability of the liquidator to attribute a portion of a distribution as having been sourced from that non-taxable capital gain. Taxation Determination 95/10 Income tax: what is the significance of the Archer Brothers principle in the context of liquidation distributions? (TD 95/10) explains the Commissioner's view on that same ability in the context of liquidation distributions under the Archer Brothers principle.

The Archer Brothers principle is 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 section 47 and other provisions of the Act. TD 95/10 provides the Commissioner will accept that a liquidator may rely on the Archer Brothers principle if:

(i)    a specific provision in the Act does not produce a different result;

(ii)   the company accounts have been kept so that a liquidator can clearly identify a specific profit or fund in making a distribution; and

(iii)  it is clear from either the accounts or statement of distribution that the liquidator has appropriated the specific profit or fund in making the distribution.

Application to your circumstances

As the capital gain from the sale of the business is capital in nature, it would not fall within the definition of ordinary income of the Company.

The capital gains derived by the Company from the sale of its Country A business, represented by the 'Capital Gain on Business Disposal' account, would be 'disregarded' under the Act and so are specifically excluded from the method statement in subsection 47(1A) of the ITAA 1936. Accordingly, the amounts included in the 'Capital Gain on Business Disposal' account, are not included in the extended definition of 'income' under subsection 47(1A) of the ITAA 1936.

Therefore, the capital gain on the sale of business goodwill will not be considered 'income' derived by the Company under subsection 47(1) and 47(1A) of the ITAA 1936.

The Company has kept accounts that clearly identify the capital profits from the sale of the Country A business as these have been separately accounted for in the company's equity accounts under its 'Capital Gain on Business Disposal' account. Accordingly, the liquidator would clearly be able to identify the Company's disregarded capital gains in the making of its distributions.

Question 5

If the answer to Question 4 is No, will CGT event G1 or CGT event C2 happen in relation to the non-assessable payments to the Taxpayer?

Summary

Yes. Where the distributions have not been made within 18 months of liquidation of the company, then CGT Event G1 will apply. Where the distributions have been made within 18 months of liquidation of the company, then CGT Event C2 will apply.

Detailed reasoning

CGT Event G1

Section 104-135(1) provides that, CGT event G1 one happens if:

(a)  a company makes a payment to you in respect of a share you own in the company (except for CGT event A1 or C2 happening in relation to the share); and

(b)  some or all of the payment (the non-assessable part) is not a dividend, or an amount that is taken to be a dividend under section 47 of the Income Tax Assessment Act 1936; and

(c)   the payment is not included in your assessable income.

The Commissioner's view on the treatment of liquidator's distributions for capital gains tax purposes is outlined in Taxation Determination 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')

TD 2001/27 explains that CGT event G1 in subsection 104-135(1) of the ITAA 1997 may result in capital gains being made and (or) the need for cost base and reduced cost base reductions in respect of shares in a company in liquidation. However, it may do so only to the extent that the distribution made by the company's liquidator is not an amount that is deemed to be a dividend under subsection 47(1) of the ITAA 1936. The part that is not deemed to be a dividend under subsection 47(1) of the ITAA 1936 is called the 'non-assessable part'.

Generally, where a company is liquidated within 18 months of a liquidator's distribution, CGT event C2 will take precedence due to the exception within CGT event G1 in subsection 104-135(6) of the ITAA 1997 as follows:

(6)  You disregard a payment by a liquidator for the purposes of this section if the company ceases to exist within 18 months of the payment.

Note: The payment will be part of your capital proceeds for CGT event C2 happening when the share ends.

In the event that the Company does not cease to exist within 18 months of the first and final liquidator's distribution, CGT event G1 will be triggered for the Australian resident shareholders.

The effect of CGT event G1 in relation to the non-assessable part is to reduce the cost base and reduced cost base of the shareholder's share as at the time of the payment. The reduction amount is the non-assessable part of the distribution and, if the non-assessable part of the distribution is greater than the cost base (the difference being 'the excess'), the shareholder makes a capital gain equal to the excess at the time of the payment. The shareholder would take that capital gain into account in calculating their net capital gain or net capital loss for the income year in which the payment is made.

CGT Event C2

Section 104-25 of the ITAA 1997 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 per subsection 104-25(2) of the ITAA 1997.

TD 2001/27 explains that the full amount of a 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. Where the company is wound up within 18 months of the distribution, the relevant CGT event for the company's shareholders will be CGT event C2 in section 104-25 of the ITAA 1997.

If the Company is wound up within 18 months of the liquidator's distribution, CGT event C2 will be triggered for the Company's Australian resident shareholders and the liquidator's distribution will be included in the proceeds to work out any capital gain or loss from the event. The Australian resident shareholders will calculate their capital gain or loss as the difference between the capital proceeds from the liquidator's distribution and the cost base of their shares.

The anti-overlap provision in section 118-20 of the ITAA 1997 reduces any capital gain by amounts that are otherwise assessable as a result of the event. Accordingly, any component of the liquidator's distribution that would be a dividend under subsection 47(1) of the ITAA 1936 will reduce the capital gain for each shareholder, as the amount will be otherwise assessable as a dividend under section 44 of the ITAA 1936.

Application to your circumstances:

The non-assessable part of the liquidator's distribution made by the Company to the taxpayer, will consist of the amount distributed from the 'Capital Gain on Business Disposal' account.

CGT event G1 will occur to the extent that the distributions are not made within 18 months of the cessation of the Company.

The XXXXX 202X and later distributions will reduce the cost base of the shares. Once the cost base is exhausted, any excess in distributions over the cost base which are received but not within 18 months of the company ceasing to exist will be the taxpayers G1 capital gain.

Where the distributions occur and within 18 months of the distribution the Company ceases to exist, CGT event C2 will happen to the shares, where the excess of the distribution received over any remaining cost base is the C2 gain.