Edited version of private advice

Authorisation Number: 1052119959392

Date of advice: 6 June 2023

Ruling

Subject: Proposed return of capital

Question 1

Will the Proposed Capital Return satisfy the ordinary definition of 'dividend' in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

No.

Question 2

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

Answer

No.

Question 3

On the basis that the Proposed Capital Return will not be a dividend for income tax purposes, will a franking debit arise in the franking account of Company A under section 205-30 of the Income Tax Assessment Act 1997 (ITAA 1997) on the day the distribution is made?

Answer

No.

This ruling applies for the following period:

Year ending 30 June 2023 and

Year ending 30 June 2024

The scheme commenced on:

1 July 2022

Relevant facts and circumstances

Company A is an Australian tax resident and private limited company. Its taxable income is taxed at the corporate tax rate.

The shares in Company A are held 50% each by Company B and Company C. The two shareholders have equal holdings and have equally invested at each point since Company A's incorporation.

Company B and its controlled entities are involved in the business of providing finance in various industries. Company B is resident in Australia for tax purposes.

Company C is non-resident of Australia for tax purposes but is registered as a foreign company with the Australian Securities and Investments Commission and has operations and an office in Australia. The shareholding that Company C holds in Company A has been attributed to an Australian permanent establishment of Company C.

Company A offers retail finance and commenced operations in 2013. Company A holds an Australian Credit Licence (ACL) in order to conduct its business and is also required to register under the Financial Sector (Collection of Data) Act 2001.

When Company A's operations commenced, the funding base was a mixture of issued share capital and a corporate loan from a bank to fund loans that it originated.

Company A's most recent equity capital raising occurred in 2018. This capital raising was undertaken to support ongoing growth of the business at the time.

The only amounts recognised in Company A's share capital account since incorporation are amounts subscribed to for the issue of share capital. Accordingly, the share capital account of Company A is not a 'tainted share capital account' as defined in section 197-50 of the ITAA 1997.

In 2020 and 2021, Company A participated in a series of securitisation trusts which raised debt finance and used the proceeds to acquire the equitable assignment of customer loans from Company A and other similar finance companies.

Under the securitisation trusts, Company A is required to fund a lesser amount of loan originations than previously. As a result, the assignment of customer loans by Company A to the securitisation trusts has liberated surplus share capital, after paying down the bank corporate loan and paying the set-up costs of the new funding arrangements.

Due to this and other factors, Company A has calculated that at least $X of share capital is now surplus to ongoing business requirements. Company A has determined it would be prudent to return this to shareholders.

Company A intends to undertake, subject to shareholder approval, a return of capital (Proposed Capital Return) to its shareholders in the June 2023 quarter. Company A is also proposing to pay a $X fully franked dividend to its shareholders prior to the Proposed Capital Return.

The Proposed Capital Return will be applied equally to each fully paid ordinary share at the nominated entitlement date (Record Date). No shares will be cancelled or bought back in connection with the Proposed Capital Return. Company A will debit the issued capital account for the capital payment.

Company A, to date, has never paid a dividend or undertaken any capital reductions in relation to its share capital since incorporation.

Company B does not have unrecouped capital losses that would be available to use against any capital gain from the Proposed Capital Return. It is not known whether Company C has any unrecouped capital losses available. The amount of the Proposed Capital Return should be less than the cost base that shareholders should have in their shares in Company A on the basis that the cost base reflects the amounts subscribed for those shares.

The decision to return capital and the amount to be returned has not been set with regard to shareholder tax preference.

Relevant legislative provisions

Income Tax Assessment Act 1936 subsection 6(1)

Income Tax Assessment Act 1936 paragraph 6(1)(a)

Income Tax Assessment Act 1936 paragraph 6(1)(d)

Income Tax Assessment Act 1936 subsection 6(4)

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 subsection 45B(2)

Income Tax Assessment Act 1936 paragraph 45B(2)(a)

Income Tax Assessment Act 1936 paragraph 45B(2)(b)

Income Tax Assessment Act 1936 paragraph 45B(2)(c)

Income Tax Assessment Act 1936 subsection 45B(3)

Income Tax Assessment Act 1936 paragraph 45B(3)(b)

Income Tax Assessment Act 1936 paragraph 45B(5)(b)

Income Tax Assessment Act 1936 subsection 45B(8)

Income Tax Assessment Act 1936 paragraph 45B(8)(a)

Income Tax Assessment Act 1936 paragraph 45B(8)(b)

Income Tax Assessment Act 1936 paragraph 45B(8)(c)

Income Tax Assessment Act 1936 paragraph 45B(8)(d)

Income Tax Assessment Act 1936 paragraph 45B(8)(e)

Income Tax Assessment Act 1936 paragraph 45B(8)(f)

Income Tax Assessment Act 1936 paragraph 45B(8)(h)

Income Tax Assessment Act 1936 paragraph 45B(8)(i)

Income Tax Assessment Act 1936 paragraph 45B(8)(j)

Income Tax Assessment Act 1936 paragraph 45B(8)(k)

Income Tax Assessment Act 1936 subsection 45B(9)

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1997 section 104-135

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 subsection 202-45(e)

Income Tax Assessment Act 1997 section 205-10

Income Tax Assessment Act 1997 section 205-30

Income Tax Assessment Act 1997 section 960-115

Income Tax Assessment Act 1997 section 960-120

Income Tax Assessment Act 1997 section 975-300

Income Tax Assessment Act 1997 subsection 975-300(3)

Income Tax Assessment Act 1997 subsection 995-1(1)

Reasons for decision

Question 1

The Proposed Capital Return will not satisfy the ordinary definition of 'dividend' in subsection 6(1) of the ITAA 1936.

Detailed reasoning

Under subsection 6(1) of the ITAA 1936 the definition of a dividend includes:

(a) any distribution made by a company to any of its shareholders, whether in money or other property; and

...

but does not include:

(d) moneys paid or credited by a company to a shareholder or any other property distributed by a company to shareholders (not being moneys or other property to which this paragraph, by reason of subsection (4), does not apply or moneys paid or credited, or property distributed for the redemption or cancellation of a redeemable preference share), where the amount of the moneys paid or credited, or the amount of the value of the property, is debited against an amount standing to the credit of the share capital account of the company; or ...

The Proposed Capital Return will be a distribution of money to all shareholders which satisfies paragraph 6(1)(a) of the ITAA 1936. However, paragraph 6(1)(d) excludes the distribution, subject to an exception in subsection 6(4), as this amount of money will be debited against an amount standing to the credit of the share capital account of Company A.

The term 'share capital account' is defined in section 975-300 of the ITAA 1997 broadly as an account which the company keeps of its share capital. Subsection 975-300(3) provides that an account is generally not taken to be a share capital account if it is tainted. Company A has confirmed that its share capital account is not tainted within the meaning of Division 197.

Subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph 6(1)(d) does not apply if:

... under an arrangement:

(a) a person pays or credits any money or gives property to the company and the company credits its share capital account with the amount of the money or the value of the property; and

(b) the company pays or credits any money, or distributes property to another person, and debits its share capital account with the amount of the money or the value of the property so paid, credited or distributed.

Company A's most recent capital raising occurred in 2018 when additional capital was required to fund growth in loan originations. The capital raising was subscribed to by both shareholders equally.

Since then, the securitisation transactions have reduced the level of share capital that Company A requires. The Proposed Capital Return will be sourced from this surplus share capital and will be distributed to both shareholders equally.

On this basis and given the substantial time between the last capital raising and the Proposed Capital Return, there is no arrangement to which subsection 6(4) of the ITAA 1936 would apply. As such, paragraph (d) of the definition of dividend in subsection 6(1) applies and the Proposed Capital Return is not a dividend.

Question 2

The Commissioner will not make a determination in relation to the Proposed Capital Return under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies.

Detailed reasoning

The purpose of section 45B of the ITAA 1936 is to ensure that capital benefits are treated as dividends for taxation purposes if they are provided in substitution for dividends. When applied, the Commissioner may make a determination in accordance with paragraph 45B(3)(b) that section 45C applies in relation to the whole, or a part, of the capital benefit.

Under subsection 45B(2) of the ITAA 1936, section 45B applies when:

(a) there is a scheme under which a person is provided with a... capital benefit by a company; and

(b) 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; and

(c) 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.

For section 45B of the ITAA 1936 to apply, each of the requirements set out in paragraphs (a) to (c) of subsection 45B(2) of the ITAA 1936 must be present.

The Proposed Capital Return constitutes a 'scheme' within the meaning given by subsection 995-1(1) of the ITAA 1997. Company B and Company C will be 'provided with a capital benefit' under the Proposed Capital Return as share capital will be distributed to them (paragraph 45B(5)(b) of the ITAA 1936). Therefore, paragraph 45B(2)(a) of the ITAA 1936 will be satisfied.

Under paragraph 45B(2)(b) and subsection 45B(9) of the ITAA 1936, a taxpayer will obtain a tax benefit if the amount of tax payable by the taxpayer would be less than the amount of tax that would have been payable if the capital benefit had instead been an assessable dividend. The determination of whether a taxpayer obtains a tax benefit under a scheme depends on each shareholder's particular circumstances and needs to be considered on a case-by-case basis.

Company B and Company C's circumstances are such that the tax payable in respect of a capital benefit would be less than the amount of tax that would be payable if that capital benefit were instead an assessable dividend. This is because it is expected that the Proposed Capital Return will be applied to reduce the cost base in their respective shares while a dividend would ordinarily be assessable income. The ability to preserve tax losses or franking credits that could eliminate the tax payable on such a dividend is itself a tax benefit within the meaning of subsection 45B(9) of the ITAA 1936. As such, the requirement of paragraph 45B(2)(b) is satisfied.

Paragraph 45B(2)(c) of the ITAA 1936 provides that it is necessary to have regard to the 'relevant circumstances' of the capital benefit to determine whether Company A, Company B or Company C entered into or carried out the Proposed Capital Return for a more than incidental purpose of enabling Company B or Company C to obtain a tax benefit.

The relevant circumstances to be considered include the non-exhaustive factors set out in subsection 45B(8) of the ITAA 1936 and include any of the matters listed in subsection 177D(2) of the ITAA 1936:

•         The extent to which the capital benefit is attributable to profits of the company (paragraph 45B(8)(a)) - the source of the Proposed Capital Return is the surplus share capital resulting from the securitisation transactions. It is a distribution to shareholders in addition to the distribution of available profits by way of dividend.

The separate dividend payment has the effect that the available profits of Company A, less a buffer for unforeseen circumstances or unexpected losses, will be distributed prior to the Proposed Capital Return. The calculation of Company A's surplus share capital has factored in the impact of the securitisation transactions and other factors.

This circumstance does not point towards the requisite purpose.

•         The pattern of distributions of dividends and returns of capital by the company (paragraph 45B(8)(b)) - Company A will pay a dividend to shareholders from accumulated profits, less a buffer for unforeseen circumstances or unexpected losses, prior to the Proposed Return of Capital.

However, as Company A has not previously paid a dividend or undertaken any capital reductions since incorporation there is no pattern of distributions.

This circumstance does not point towards the requisite purpose.

•         Whether the relevant taxpayer has capital losses (paragraph 45B(8)(c)) - Company B does not have capital losses available while Company C's position is unknown.

This circumstance does not point towards the requisite purpose.

•         Whether the shares held by the relevant taxpayer are pre-CGT shares (paragraph 45B(8)(d)) - as all shares held by Company B and Company C are post-CGT shares, this circumstance is not relevant.

•         Whether the relevant taxpayer is a non-resident (paragraph 45B(8)(e)) - Company B is resident in Australia for tax purposes while Company C, which is non-resident of Australia for tax purposes, attributes its shareholding in Company A to an Australian permanent establishment.

This circumstance does not point towards the requisite purpose.

•         Whether the cost base of the taxpayer's shares is not substantially less than the value of the capital benefit (paragraph 45B(8)(f)) - the amount of the Proposed Capital Return should be less than the cost base that Company B and Company C have in their shares in Company A which means Company B and Company C should not be exposed to a capital gain under CGT event G1 (section 104-135 of the ITAA 1997).

This circumstances points towards the requisite purpose.

•         Whether the interest held by the taxpayer after the distribution of capital is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital (paragraph 45B(8)(h)) - the Proposed Capital Return is equal for both Company B and Company C and does not involve dilution of their respective holdings.

In this instance, this circumstance does not point towards the requisite purpose.

•         Schemes that involve the provision of ownership interests and the later disposal of those interests, or an increase in the value of ownership interests and the later disposal of those interests (paragraph 45B(8)(i)) - the scheme does not involve the disposal of interests, so this circumstance is not relevant.

•         Schemes that involve a demerger and transactions with associates (paragraph 45B(8)(j)) - the scheme does not involve a demerger, so this circumstance is not relevant.

•         Any of the matters referred to in subsection 177D(2) (paragraph 45B(8)(k)) - the matters referred to in these subparagraphs are matters of reference for 'the dominant purpose' test in Part IVA. However, in the context of section 45B they facilitate the 'more than incidental purpose test' and do not introduce a different purpose test. They are matters by reference to which a return of capital is examined from a broad, practical perspective in order to identify and compare its tax and non-tax objectives.

While Company B and Company C obtain a tax benefit under the Proposed Capital Return, the main purpose is to return surplus capital. This is because Company A no longer has a requirement to maintain its existing level of capital to operate efficiently. Any tax benefit received is incidental to this purpose.

This circumstance does not point towards the requisite purpose.

On balance of the relevant circumstances to the Proposed Capital Return, it is considered that neither Company A, Company B or Company C entered into or carried out the Proposed Capital Return for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit.

The requirement of paragraph 45B(2)(c) of the ITAA 1936 will not be satisfied in respect of the Proposed Capital Return. The Commissioner will not make a determination under subsection 45B(3) that section 45C applies to treat all or part of the Proposed Capital Return as an unfranked dividend.

Question 3

On the basis that the Proposed Capital Return is not a dividend for income tax purposes, a franking debit will not arise in the franking account of Company A under section 205-30 of the ITAA 1997 on the day the distribution is made.

Detailed reasoning

Section 205-30 of the ITAA 1997 contains a table which sets out when a debit arises in the franking account of an entity and the amount of the debit. In particular:

•         Item 1 occurs where an entity franks a distribution.

•         Item 3 occurs where an entity franks a distribution in contravention of the benchmark rule.

Section 205-10 of the ITAA 1997 provides that each entity that is a corporate tax entity has a franking account. Company A is a corporate tax entity under section 960-115 of the ITAA 1997 and therefore has a franking account.

A distribution will be a frankable distribution to the extent that it is not unfrankable under section 202-40 of the ITAA 1997. An unfrankable distribution under subsection 202-45(e) includes a distribution that is sourced, directly or indirectly, from a company's share capital account.

Under section 975-300 of the ITAA 1997 a company's share capital account is an account that the company keeps of its share capital. However, under subsection 975-300(3), if the share capital account is tainted then it is not taken to be a share capital account.

Furthermore, section 960-120 of the ITAA 1997 contains a table which sets out what constitutes a distribution by various corporate tax entities. Under item 1 of this table, a company will be taken to have made a distribution when it pays a dividend, or something that is taken to be a dividend under the ITAA 1936 or ITAA 1997.

The Proposed Capital Return is not a dividend as defined in subsection 6(1) of the ITAA 1936. Company A will source it directly from its share capital account which is not a tainted share capital account.

Therefore, as the Proposed Capital Return is not frankable, nor is it a distribution, a franking debit cannot arise under section 205-30 of the ITAA 1997.