ATO ID 2003/486: Selective capital reduction: application of section 45B
Date of decision: 9 December 2002
Year of income: Year ended 30 June 2003
Business line: Public Groups and International

Issue
Will section 45B of the Income Tax Assessment Act 1936 (ITAA 1936) apply to treat as a dividend any part of the selective reduction of capital undertaken to restructure the shareholdings in a company?

Decision
No. Section 45B of the ITAA 1936 will not apply to treat any part of the selective capital reduction as a dividend. Although there is a scheme that provides a capital benefit to a person, and a person obtains a tax benefit under the scheme, it cannot be concluded that any person who enters into or carries out the proposed selective capital reduction does so for a more than incidental purpose of enabling a taxpayer to obtain a tax benefit.

Facts
All the dividend-bearing shares in a company resident in Australia are held in equal proportion by a number of 'principals' or their associated entities. The principals are also employed by the company. The principals have reached agreement with an unrelated company to acquire their shares in the company. The principals have recognised that there are differences in the price considered appropriate for the sale of their respective shares in the company. To facilitate the takeover, a restructuring of the shareholdings is needed to even out differences in the value of the shares. In order to alter their shareholdings in the agreed proportions, the principals agreed to restructure their shareholdings through a selective capital reduction. The shareholders' equity in the company currently consists entirely of capital subscribed either as paid-up capital or share premium. All profits generated by the company have been distributed as dividends to the shareholders. Distributions to shareholders whose shares are cancelled will consist of amounts equal to the amount paid-up together with any former share premium contributed at the time of subscription for the shares to be cancelled.

Reasons for decision
Summary: A purpose of section 45B of the ITAA 1936 is to ensure that amounts paid in substitution for dividends are treated as unfrankable dividends for income tax purposes. Section 45B of the ITAA 1936 applies if there is a 'scheme' under which: The selective capital reduction is a 'scheme' contemplated by section 45B of the ITAA 1936. To the extent the amount paid to the shareholders whose shares are cancelled under the selective capital reduction is not a dividend, it will be a distribution of share capital. That distribution would constitute the 'provision of a capital benefit' to the shareholders. The shares to be cancelled were all acquired after 19 September 1985. As capital gains tax treatment ordinarily results in less tax payable than an equivalent distribution consisting of dividend income, the requirement that there must be a person who would 'obtain a tax benefit' under the scheme would be satisfied. It cannot be concluded that any person who enters into or carries out this selective capital reduction does so for a more than incidental purpose of enabling a taxpayer to 'obtain a tax benefit' having regard to:

Legislative references: Income Tax Assessment Act 1936 Section 45B
Subject references: Capital benefit Capital reductions Deemed dividends Return of capital on shares