ATO ID 2002/858: Proposed share capital reduction
Date of decision: 29 June 2001
Year of income: Year ended 30 June 2001
Business line: Public Groups and International

Issue
Will a return of capital trigger the application of section 45B of the Income Tax Assessment Act 1936 ('ITAA 1936') to enable the Commissioner to regard the capital reduction as paid in substitution for dividends that would be treated as dividends for taxation purposes?

Decision
No. It is accepted that section 45B will not apply in respect of the return of capital and the distribution will not be treated as a dividend for income tax purposes.

Facts
The sole shareholder had acquired all the issued share capital from a company incorporated and resident in the USA. Following the acquisition the company was subsequently "migrated" to Australia and is now an Australian resident. Additional capital had resulted from earlier conversions to equity of all debt resulting in the company being 100% financed by equity. Retained earnings have been accumulated since incorporation in the USA and there is no pattern of distribution of dividends The financing profile of the company was considered to be undergeared so that the company wished to obtain additional debt financing to increase its gearing levels to an optimum commercially acceptable level. The company proposed to borrow funds to undertake a distribution of share capital by way of a capital reduction and the return of capital has clearly been established as by way of borrowings and has not been paid out of profits.

Reasons for decision
Summary: The distribution paid out of capital had been motivated by commercial objectives and was achieved by way of specific borrowings for that purpose. While mutually accepted that a scheme exists in respect of the capital benefit paid to the sole shareholder and a tax benefit would result in the year ended 30 June 2001, para.45B(2)(c ) was not applied in view of the dominant purpose of the capital reduction ie. to introduce commercial debt levels into the company. The Commissioner will not make a determination in terms of subsection 45B(3) that section 45C applies in relation to the capital benefit.

Legislative references: Income Tax Assessment Act 1936 Section 45B Section 45C
Related ATO interpretative decisions: ATO ID 2002/857 | ATO ID 2002/859 | ATO ID 2002/860
Subject references: Share capital Capital reduction