ATO ID 2004/318: Reduction in a shareholder's equity interest by the way of share buy-back: section 45A does not apply
Date of decision: 29 October 2003
Year of income: Year ended 30 June 2004
Business line: Public Groups and International

Issue
Will the return of capital to a shareholder whose equity interest is reduced trigger the application of section 45A of the Income Tax Assessment Act 1936 (ITAA 1936) to enable the Commissioner to treat the distribution as a dividend for income tax purposes?

Decision
No. Section 45A of the ITAA 1936 will not apply to a shareholder whose equity interest in the company is reduced.

Facts
Company A is equally owned by family companies B and C. Both companies B and C are Australian resident companies. Most of the company A shares were issued pre-CGT, that is, before 20 September 1985. The original owner of shares in company B died and ownership of the shares passed to that shareholder's children. Company A is now primarily operated and managed by persons associated with company C. The shareholders in company B wish to reduce company B's equity interest in company A. Company A proposes to undertake a selective share buy-back of almost all the shares held by company B at the price of $3.85 per share. A nominal shareholding is to be retained by company B. The buy-back is to consist entirely of pre-CGT shares. The buy-back consideration is to be debited to the share capital account at $2 per share (the original subscription price) with the remaining balance of $1.85 debited against retained profits. Company A has confirmed that there have not been any transfers to share capital account that would constitute to the tainting of the share capital account for the purposes of Division 7B of Part IIIAA of the ITAA 1936.

Reasons for decision
Summary: Section 45A of the ITAA 1936 applies in circumstances where capital benefits are streamed to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or would receive dividends. By distributing share capital as part of the buy-back consideration, the company will provide one shareholder with a 'capital benefit', as defined in paragraph 45A(3)(b) of ITAA 1936. However, there is nothing in the proposed arrangement to indicate that there is a 'streaming' of capital benefits to one shareholder and dividends to the other shareholder. Therefore, section 45A of the ITAA 1936 does not apply to treat the proposed return of capital as a dividend.

Legislative references: Income Tax Assessment Act 1936 section 45A
Related ATO interpretative decisions: ATO ID 2002/857
Subject references: Share capital Capital reduction