Private ruling: Proposed capital return
Date of advice: 14 October 2022
Published: 16 January 2023
Ruling period: Year ending 30 June 2022 | Year ending 30 June 2023
Date scheme commenced: 1 July 2021

Ruling: Q1: Will the Proposed Capital Return satisfy the ordinary definition of "dividend" in subsection 6(1) of the ITAA 1936? | A1: No | Q2: Will the Commissioner of Taxation ("Commissioner") make a determination in relation to the Proposed Capital Return pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies? | A2: No | Q3: Will the Commissioner make a determination in relation to the Proposed Capital Return pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies? | A3: No | Q4: Will section 104-135 of the ITAA 1997 apply to XYZ Pty Ltd, as a shareholder of ABC Pty Ltd in relation to the payment that implements the capital reduction? | A4: Yes

Relevant facts and circumstances: General group structure ABC Pty Ltd ABC Pty Ltd is an Australian tax resident and an Australian private limited company. Its taxable income is taxed at the corporate tax rate. The shareholding in ABC Pty Ltd in the 2022 income year is specified in the table below: Shareholder % shareholding XYZ Pty Ltd 50% M Trust 25% U Trust 25% Total 100% All the shareholders acquired their shares after 19 September 1985. In respect of the shareholders: • XYZ Pty Ltd and its controlled entities (the XYZ Group ) are involved in the business of providing finance. • M Trust and U Trust are Australian residents and are not foreign-controlled entities. ABC Pty Ltd offers retail financing to customers through the dealer networks of retail stores. The financing is for these customers to purchase assets from those outlets. ABC Pty Ltd holds an Australian Credit Licence ( ACL ) in order to conduct its business. Further, ABC Pty Ltd is required to register under the Financial Sector (Collection of Data) Act 2001 (Cth). The ABC Trust The ABC Trust was formed through a subscription of units from ABC Pty Ltd. 100% of the income and capital units of the ABC Trust are owned by ABC Pty Ltd. ABC Trust is a securitisation (' warehouse ') trust and is an Australian tax resident unit trust. It is not a corporate unit trust nor a public trading trust for income tax purposes. The central management and control of ABC Trust is situated in Australia. The trustee of ABC Trust is A Trustees Pty Ltd, an Australian resident company. On the last day of each financial year, ABC Pty Ltd, as sole unit holder of ABC Trust, is presently entitled to the net trust income of the trust for that financial year. The Term Out Trusts ABC Pty Ltd, along with other entities in which XYZ Pty Ltd had at least 50% shareholding, participated in the first of a series of rated term-out transactions that were organised by XYZ Pty Ltd. The form of the first transaction was the establishment of Term Out Trust 1. Term Out Trust 2 was similarly set up. ABC Pty Ltd holds a proportion of units in the Term Out Trusts. ABC Pty Ltd currently holds one income unit in Term Out Trust 1 for an amount of $10; and one income unit in Term out Trust 2 for an amount of $10. The Trustee of both Term Out Trust 1 and Term Out Trust 2 is A Trustees Pty Limited. ABC Pty Ltd in detail Share Capital Account Since the date of its incorporation, a total of $XXX has been credited to ABC Pty Ltd's share capital account. The amount in the share capital account remains the same as at 28 February 2022. In respect of the above: • XYZ Pty Ltd initially owned 100% of the shares in ABC Pty Ltd upon ABC Pty Ltd's incorporation. • In August 2016, ABC Pty Ltd issued additional shares to XYZ Pty Ltd, M Trust and U Trust. Following the issue of these shares, ABC Pty Ltd was subsequently 50% held by XYZ Pty Ltd, and 25% held by each of M Trust and U Trust. • ABC Pty Ltd continues to be 50% held by XYZ Pty Ltd, and 25% held by each of M Trust and U Trust. The only amounts recognised in the share capital account of ABC Pty Ltd since its incorporation are amounts subscribed for the issue of share capital. That is, no amounts have been transferred into the share capital account from other accounts, including, in particular, the retained profits account. Accordingly, the share capital account of ABC Pty Ltd is not a ' tainted share capital account ' as defined in section 197-50 of the Income Tax Assessment Act 1997 (Cth) ( ITAA 1997 ). Retained earnings On both a consolidated and standalone basis, ABC Pty Ltd earned profits after tax in the amount of $xxx for the period between 1 July 2021 to 28 February 2022. In 2022, ABC Pty Ltd paid a $xxx fully franked dividend to its shareholders. Following this distribution, ABC Pty Ltd had accumulated accounting profits of approximately $xxx on both a consolidated and standalone basis. These profits were retained for unforeseen circumstances or unexpected losses. ABC Pty Ltd is entitled to monthly income distributions from the Term Out Trusts, if available in accordance with the cashflow waterfall rules. As such, in ABC Pty Ltd's monthly accounting revenue, the amount received for the previous month from the securitisation trusts is recorded as accounting revenue along with an accrual for the current month. That is, income from the Term Out Trusts is recognised by ABC Pty Ltd monthly in its accounting profit and loss statement and any such profit is available for distribution to shareholders in accordance with the constitution of ABC Pty Ltd and the requirements of the Corporations Act 2001 (Cth). On the last day of each financial year, ABC Pty Ltd, as a unit holder of both of the Term Out Trusts, is presently entitled to a share of the net trust income of the relevant trust for that financial year commensurate to the proportion of distributions from the total available income (as defined in the trust documents) paid to ABC Pty Ltd during the financial year compared to the total. Proposal Context and background Current funding arrangements The funding arrangements for ABC Pty Ltd, ABC Trust and the Term Out Trusts are as follows: • ABC Pty Ltd provides a loan to a customer when a customer seeks financing to purchase the relevant product. • The loans originated by ABC Pty Ltd which meet the relevant eligibility criteria are equitably assigned to ABC Trust, as well as the rights to future interest on these loans. ABC Trust is funded: − by third-party banks; and − by subordinated loan notes issued from ABC Pty Ltd. The loan notes are debt interests for the purposes of Division 974 of the ITAA 1997. The loans are assigned to ABC Trust for a cash payment equal to the principal value of the loan (plus accrued interest, if relevant). • ABC Trust uses the funding received from the banks and subordinated loan notes to acquire loan receivables from ABC Pty Ltd. However, ABC Pty Ltd retains all credit risk associated with the loans subsequently assigned to ABC Trust. Since ABC Pty Ltd maintains "substantially all the risks and rewards", the recognition of the loan receivables for accounting purposes remains in ABC Pty Ltd's standalone company accounts. • When there is a sufficient pool of loans in ABC Trust which meet the relevant eligibility criteria, these loans are equitably assigned to the Term Out Trusts, as well as the rights to future interest on these loans, from ABC Trust. The loans are assigned to the Term Out Trusts for a cash payment equal to the principal value of the loan (plus accrued interest, if relevant). • The Term Out Trusts raise debt finance and use the proceeds to acquire the equitable assignment of customer receivables from ABC Trust (as well as other XYZ Pty Ltd owned and joint venture finance company entities and securitisation trusts) on a larger scale than ABC Trust does on a standalone basis with ABC Pty Ltd as described above. Proposal The board of ABC Pty Ltd resolved to reduce equity in the company in an amount considered to be unnecessary to its needs, being the total amount of $xxxx. Pursuant to this objective, a strategy was adopted by the board to issue the following returns to the shareholders by 30 June 2023: • A dividend distribution of $xxx. As mentioned, this was implemented in 2022, on which ABC Pty Ltd paid a $xxx fully franked dividend to its shareholders. Prior to the dividend, ABC Pty Ltd had not previously paid any other dividends to shareholders. ABC Pty Ltd had a $xxx credit franking account balance following the distribution. • A $xxx return of capital. This has not yet been carried out. ABC Pty Ltd proposes to make, subject to shareholder approval, a return of share capital of $xxx to its shareholders by 30 June 2023 (the Proposed Capital Return ). ABC Pty Ltd has not previously undertaken any capital reductions in relation to its share capital. The amount of equity, which has been considered to be excess to the needs of ABC Pty Ltd, has been determined with reference to what ABC Pty Ltd describes as its 'target capital levels '. The return of equity has been determined with reference to its ' target capital levels' . The Proposed Capital Return will reduce the value of all the shares on issue by the same pro-rata amount and returns to the shareholders the cash value of that reduction. The Proposed Capital Return will be applied equally to each holder of fully paid ordinary shares as at the nominated relevant entitlement date ( the Record Date ). That is, under the Proposed Capital Return, xx cents will be paid per ordinary share. No shares will be cancelled or bought back in connection with the Proposed Capital Return. The decision to return capital and the amount to be returned has not been set with regard to shareholder tax preference. Reasons for the Proposed Capital Return The proposed return is made of an amount of which ABC Pty Ltd regards as unnecessary to its needs. Subsequent to ABC Pty Ltd ' refinancing ' a substantial portion of its outstanding customer loans through the establishment of the ABC Trust and the Term Out Trusts, ABC Pty Ltd is no longer required to hold the same level of equity capital against customer loans and subordinated loan notes. These events reduced ABC Pty Ltd's liquidity needs, cost of funds and ultimately its equity capital. In earlier years during which the business was expanding, it was the view of ABC Pty Ltd management that the relevant amount could not be returned to the shareholders. However, ABC Pty Ltd management is of the view that now is an appropriate time to return an amount that is surplus to ABC Pty Ltd's business needs to shareholders. ABC has forecasted limited growth in the short to medium term for the business. At this point in time, there is no expectation of any equity injections.

Relevant legislative provisions: Income Tax Assessment Act 1936 (ITAA 1936) - subsection 6(1) | Income Tax Assessment Act 1936 (ITAA 1936) - subsection 6(4) | Income Tax Assessment Act 1936 (ITAA 1936) - section 6BA(5) | Income Tax Assessment Act 1936 (ITAA 1936) - section 45A | Income Tax Assessment Act 1936 (ITAA 1936) - section 45B | Income Tax Assessment Act 1936 (ITAA 1936) - section 45C | Income Tax Assessment Act 1936 (ITAA 1936) - section 47 | Income Tax Assessment Act 1936 (ITAA 1936) - section 84L | Income Tax Assessment Act 1936 (ITAA 1936) - subsection 177D(2) | Income Tax Assessment Act 1997 (ITAA 1997) - section 104-135 | Income Tax Assessment Act 1997 (ITAA 1997) - section 197-50 | Income Tax Assessment Act 1997 (ITAA 1997) - section 205-30 | Income Tax Assessment Act 1997 (ITAA 1997) - section 995-1

Reasons for decision: Summary: The Proposed Capital Return does not satisfy the ordinary definition of "dividend" in subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Subsection 6(1): 'Dividend': Subsection 6(1) of the ITAA 1936 states: "dividend" includes: (a) any distribution made by a company to any of its shareholders, whether in money or other property; and (b) any amount credited by a company to any of its shareholders as shareholders; 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......." ' Share Capital Account ' is, in turn, defined in section 975-300 of the ITAA 1997. With limited exceptions, an account that is ' tainted ' within the meaning of section 197-50 of the ITAA 1997 is not a ' share capital account '. In this case: • The Proposed Capital return is a cash payment to the shareholders of ABC Pty Ltd, therefore subsection 6(1)(a) of the ITAA 1936 is satisfied. • However, under the Proposed Capital Return, the $xxx paid to shareholders will be debited against the share capital account of ABC Pty Ltd. The share capital account of ABC Pty Ltd is not a " tainted share capital account " as defined under section 197-50. Specifically, it is taken as a fact in this ruling that the only amounts recognised in the share capital account of ABC Pty Ltd since its incorporation are amounts subscribed for the issue of share capital; that no amounts have been transferred into the share capital account from other accounts; and, accordingly, the share capital account of ABC Pty Ltd is not a ' tainted share capital account ' as defined in section 197-50. | Detailed Reasoning - Subsection 6(4): exception: Subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph (d) of the definition of " dividend " in subsection 6(1) will not apply where, " 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." It is accepted that the Proposed Capital Return is made pursuant to the objective of reducing equity in ABC Pty Ltd in an amount considered to be unnecessary to its needs, following the changes to the funding structure and funding requirements of the ABC Pty Ltd business after the establishment of the ABC Trust and the Term Out Trusts. As such, the Proposed Capital Return does not fall within the scope of the arrangement contemplated by subsection 6(4). | Detailed Reasoning - Conclusion: The Proposed Capital Return is not a ' dividend ' under subsection 6(1) of the ITAA 1936, as it is a distribution to the shareholders from an untainted share capital account and does not fall within the scope of the exclusion in subsection 6(4). | Detailed Reasoning - Question 2: Will the Commissioner make a determination in relation to the Proposed Capital Return pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies? | Summary: The Commissioner will not make a determination in relation to the Proposed Capital Return pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies. | Detailed Reasoning - Detailed reasoning: Subsection 45A(2) of the ITAA 1936 states: "(2) The Commissioner may make, in writing, a determination that section 45C applies in relation to the whole, or a part, of the capital benefits. A determination does not form part of an assessment." Subsection 45A(1) of the ITAA 1936 states: " (1) This section applies in respect of a company that, whether in the same year of income or in different years of income, streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that: (a) the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and (b) it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends." Therefore, section 45A of the ITAA 1936 applies where: • a company streams the provision of capital benefits and the payment of dividends to its shareholders; and • the capital benefits are received by shareholders who derive a greater benefit from receiving them than the other shareholders would (the " advantaged shareholders ") and it is reasonable to assume that the other shareholders (the " disadvantaged shareholders ") would have received, or will receive, dividends. These elements are considered in turn below. | Detailed Reasoning - Provision of a capital benefit to a shareholder: Pursuant to subsection 45A(3) of the ITAA 1936, the meaning of " provision of a capital benefit to a shareholder in a company " is as follows: "(a) the provision to the shareholder of shares in the company; (b) the distribution to the shareholder of share capital or share premium; (c) something that is done in relation to a share that has the effect of increasing the value of a share (which may or may not be the same share) held by the shareholder." ABC Pty Ltd will distribute $xxxx to its shareholders from its share capital account by 30 June 2023, under the Proposed Capital Return. Therefore, paragraph 45A(3)(b) is satisfied. | Detailed Reasoning - Advantaged and disadvantaged shareholders: The Proposed Capital Return will reduce the value of all the shares on issue by the same pro-rata amount. A pro-rata dividend payment to shareholders has also been made. As the share capital reduction and dividend payment are being pro-rated equally across all shareholders, no one shareholder will derive a greater benefit than any other shareholder. As there are no advantaged or disadvantaged shareholders, subsection 45A(1) of the ITAA 1936 is not satisfied. As such, the Commissioner will not make a determination under subsection 45A(2). | Detailed Reasoning - Question 3: Will the Commissioner make a determination in relation to the Proposed Capital Return pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies? | Summary: The Commissioner will not make a determination in relation to the Proposed Capital Return pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies. | Detailed Reasoning - Subsection 45B(3): Subsection 45B(3) of the ITAA 1936 states the following: "(3) The Commissioner may make, in writing, a determination that: ...... (b) section 45C applies in relation to the whole, or a part, of the capital benefit." | Detailed Reasoning - Subsection 45C(3): Subsection 45C(3) provides the following: "(3) If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or the part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company: (a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and (b) the amount of the franking debit is the amount that, if the company had: (i) paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and (ii) fully franked the dividend; would have been the amount of the franking credit of the company that would have arisen as a result of the dividend." For the reasons expressed below, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies in relation to the whole, or a part, of the capital benefit paid by ABC Pty Ltd to its shareholders under the scheme. Consequently, the Commissioner will not make a determination under subsection 45C(3), whereby the whole (or part) of the capital benefit will be treated as an unfranked dividend. | Detailed Reasoning - Section 45B: The purpose of Section 45B is set out in subsection 45B(1) as follows: "(1) The purpose of this section is to ensure that relevant amounts are treated as dividends for taxation purposes if: ......... (b) certain payments, allocations and distributions are made in substitution for dividends." Subsection 45B(2) states the following: "(2) This section applies if: (a) there is a scheme under which a person is provided with a demerger benefit or 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 demerger benefit or 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. Commissioner to determine that section 45BA or 45C applies" The application of the conditions in each of the above paragraphs is considered below. | Detailed Reasoning - Paragraph 45B(2)(a): 'Scheme' is defined in section 995-1 of the ITAA 1997 as 'any arrangement' or 'any scheme, plan, proposal, action, course of action, or course of conduct, whether unilateral or otherwise' . ABC Pty Ltd board's strategy to return $xxxx of equity to its shareholders, implemented by the payment of a $xxxx dividend and the Proposed Capital Return of $xxxxx by 30 June 2023, will be considered a 'scheme' under the terms of the prescribed definition . Pursuant to subsection 45B(5), the meaning of ' provided with a capital benefit ' is as follows: "(a) the provision of ownership interests in a company to the person; (b) the distribution to the person of share capital or share premium; (c) something that is done in relation to an ownership interest that has the effect of increasing the value of an ownership interest (which may or may not be the same interest) that is held by the person." Under the Proposed Capital Return, ABC Pty Ltd will distribute part of the balance of its share capital account to its shareholders. Therefore, the Proposed Capital Return will result in the " provision of a capital benefit " to the shareholders of ABC Pty Ltd. | Detailed Reasoning - Paragraph 45B(2)(b): Subsection 45B(2)(9) provides as follows: "(9) A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, be less than the amount that would have been payable, or would be payable at a later time than it would have been payable, if the demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend." Paragraph 49 of Practice Statement Law Administration PSLA 2008/10 ( PSLA 2008/10 ) states in relation to obtaining a tax benefit: "....the preservation of tax losses or franking credits for use in the future would ordinarily mean that a tax benefit is obtained within the meaning of subsection 45B(9)" It is expected that the shareholders of ABC Pty Ltd, all of whom are Australian residents for income tax purposes, will have their cost base in their ABC Pty Ltd shares reduced by the amount of the Proposed Capital Return pursuant to the application of section 104-135 of the ITAA 1997 (CGT event G1). Had a dividend (the Notional Dividend ), instead been paid to ABC Pty Ltd's shareholders in the equivalent amount, it would be expected that the whole (or some part) of that Notional Dividend could be franked based on the franking account balance of ABC Pty Ltd. Therefore, a tax benefit will arise under the scheme as the franking credits are ' preserved' by ABC Pty Ltd undertaking the Proposed Capital Return, as opposed to paying the Notional Dividend. | Detailed Reasoning - Paragraph 45B(2)(c): The relevant circumstances which must be considered in the assessment of whether there exists a more-than-incidental purpose of enabling a taxpayer to obtain a tax benefit are outlined in subsection 45B(8). They are considered in turn below. | Detailed Reasoning - Paragraph 45B(8)(a): Paragraph 45B(8)(a) prescribes the following ' relevant circumstance ': "the extent to which the demerger benefit or capital benefit is attributable to capital or the extent to which the demerger benefit or capital benefit is attributable to profits (realised and unrealised) of the company or of an associate (within the meaning in section 318) of the company;" In respect of the ' relevant circumstance ' specified in paragraph 45B(8)(a), PSLA 2008/10 states the following: "61. The inquiry contemplated by the words 'attributable to' is essentially a practical one concerned with determining whether there is a discernible connection between the amount distributed as share capital and the share capital and profits that are realistically available for distribution, including the profits of an associate of the company. The connection need not be that of a sole, dominant, direct or proximate cause and effect; a contributory causal connection is sufficient. 62. Therefore, in determining whether the distribution of share capital is attributable to either share capital or profits, tax officers should take account of the pertinent characteristics of share capital and profits and the availability of each in the circumstances of the company (including the availability of profits in associates) and in the context of the pertinent scheme.....Tax officers should also have regard to the occasion for the share capital reduction, that is, the circumstances surrounding the making of the capital distribution. 63. A capital distribution that is attributable to share capital should reflect circumstances which show that the share capital distributed is genuinely surplus to the company's need of it and that it is not merely a cash distribution debited against share capital on the basis of shareholder tax preference." Paragraph 68 of PSLA 2008/10 indicates that the occasion for the share capital reduction include circumstances such as where capital is reduced and replaced with debt where it is shown to be more profitable for shareholder: "68. Therefore, a distribution of profit would normally be expected to be a relatively ordinary corporate event and a distribution of capital a relatively extraordinary one. A decision to reduce capital would generally be expected to coincide with and be influenced by some other commercial circumstance. ...... some other business structural change, or in some circumstances its replacement with debt capital where it is shown to be more profitable for shareholders. It should be noted, however, that the fact that the capital distribution has been funded from debt does not preclude it from being attributable to profits.." The Commissioner accepts that $xxxx of equity - including the $xxxx of share capital constituting the Proposed Capital Return - is considered by ABC Pty Ltd to be surplus to its needs, and that there is a reasonable basis for this view. It is also accepted that ABC Pty Ltd considers that it would be appropriate for this amount to be returned to shareholders by 30 June 2023. The return has been determined with reference to what it describes as its ' target capital levels '. Specifically, the Commissioner accepts the following submissions: • Subsequent to ABC Pty Ltd ' refinancing ' a substantial portion of its outstanding customer loans though the establishment of the ABC Trust and the Term Out Trusts, ABC Pty Ltd is no longer required to hold the same level of equity capital against customer loans and subordinated loan notes. These events reduced ABC Pty Ltd's liquidity needs, cost of funds and ultimately its equity capital. • ABC Pty Ltd is currently forecasting limited (if any) growth in its originated loan portfolio in the short to medium term due to market and economic factors. • ABC Pty Ltd management has not identified any appropriate future investment opportunities. • The amount of capital, which is excess to the needs of ABC Pty Ltd, has been determined with reference to ABC Pty Ltd's ' target capital levels '. While the above reflects circumstances which show genuine, commercial reasons for the return of the equity to shareholders, and therefore that there is ' occasion for' a share capital reduction as a part of that return, the issue arises as to what portion of the overall return should be attributable to profits; and, in particular, whether any portion of the Proposed Capital Return itself should be attributable to profits. In this regard, paragraph 74 of PSLA 2008/10 states the following: "74. Similarly, if the occasion for the share capital reduction is to increase the company's gearing ratio (the debt to equity ratio) it should be borne in mind that equity includes both retained profits and share capital and that this is an occasion that affects both. This means that an increase in the gearing ratio can be achieved just as effectively by returning profits as reducing share capital, including by way of dividend. Generally, in the absence of other relevant factors which indicate otherwise, tax officers should regard the capital distribution as being attributable to the share capital and retained earnings on a proportionate basis." Paragraph 74 of PSLA 2008/10 describes analogous circumstances to this case, whereby the circumstance described at paragraph 74 is, as in this case, a decision to change a company's capital structure, resulting in a change to the company's debt to equity ratio. In the absence of other relevant factors which indicate otherwise,paragraph 74 states: " tax officers should regard the capital distribution as being attributable to the share capital and retained earnings on a proportionate basis". Whilst this may suggest that the Proposed Capital Return should be subject to apportionment (such that a portion of the amount should be considered to be attributable to retained earnings in accordance with the existing proportion of retained earnings to total equity in ABC Pty Ltd), it would be reasonable to depart from the literal application of this rule in this case. Specifically, it is appropriate in the circumstances that apportionment be applied from a broader perspective, taking into account: • the total amount of equity considered excess to the company's needs; • the co-ordinated strategy to return this excess equity by way of both the Proposed Capital Return as well as a fully franked dividend distribution; and • the fact that the dividend distribution represents 12.5% of the total return to shareholders, which is in excess of the 6.3% (approximately) representing the proportion of retained earnings and cash flow hedge reserve to the total equity that existed prior to the dividend distribution. That is, in applying the apportionment approach, a reasonable proportion of the total return was (effectively) attributed to profit through the dividend distribution. In this regard, it is accepted that the dividend distribution forms an inseparable part of the broader commercial objective to effect a return of excess equity to shareholders (and is therefore distinguishable from, for example, a distribution made by a company pursuant to an established practice of distributing dividends). This takes into consideration the fact that ABC Pty Ltd had not previously made any dividend or share capital distributions to shareholders. | Detailed Reasoning - Paragraph 45B(8)(b): Paragraph 45(8)(b) specifies the following ' relevant circumstance ': "the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate (within the meaning in section 318) of the company;" Paragraph 77 of PSLA 2008/10 provides that: "The inference here is that an interruption to the normal pattern of profit distribution and its replacement with a distribution of capital may suggest dividend substitution." The Proposed Capital Return is preceded only by the dividend payment in 2022. No dividend or share capital distributions were made to shareholders prior to this time. There is consequently no ' pattern of distributions ' in this case that might suggest that the Proposed Capital Return is a substitution for a dividend distribution. As mentioned above, it is accepted that both the dividend payment and the Proposed Capital Return should be considered as together comprising the overall strategy to return excess equity to shareholders. | Detailed Reasoning - Paragraphs 45B(8)(c) to (f): These paragraphs require an examination of the tax characteristics of the particular shareholders in question in determining the relevant circumstances of the scheme. In general, the following characteristics of the taxpayer, and the provisions to which they relate, have been noted as follows: • In respect of paragraph 45B(8)(c), the taxpayer was unable to provide information regarding capital losses held by each of the shareholders. • The shares in this case were acquired after 20 September 1985: paragraph 45B(8)(d). • The relevant taxpayers in this case are residents: paragraph 45B(8)(e). • In respect of paragraph 45B(8)(f), based on shares issued and amounts subscribed for those shares since the company's incorporation, and the Proposed Capital Return to the shareholders, it is expected that no capital gain will arise under CGT event G1 (section 104-135). The shareholder characteristics as ascertained do not, taken together, themselves indicate that there is a tax preference for one form of distribution over another in a way that would suggest a more than incidental purpose of delivering a tax benefit. It is considered that the other factors considered in this ruling carry greater weight in this determination. | Detailed Reasoning - Paragraph 45B(8)(h): Paragraph 45B(8)(h) prescribes the following ' relevant circumstance ': "if the scheme involves the distribution of share capital or share premium--whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital or share premium;" In this case, the interest held by all taxpayers will be the same after the Proposed Capital Return. That is, their position after the return would be the same had a further dividend been distributed instead of the capital return. While this is a factor that may, in some cases, indicate that a capital reduction is made in substitution for a dividend (see paragraph 92 of the PSLA 2008/10), it is one consideration amongst several relevant factors that have been taken into account in this case. As explained in these Reasons for Decision, It is the Commissioner's view that all relevant considerations, taken together, point away from the conclusion that the Proposed Capital Return is made in substitution for a dividend. | Detailed Reasoning - Paragraph 45B(8)(i): Paragraph 45B(8)(i) provides as follows: 'if the scheme involves 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: (i) the period for which the ownership interests are held by the holder of the interests; and (ii) when the arrangement for the disposal of the ownership interests was entered into;' The present scheme involves neither the provision of ownership interests nor an increase in the value of ownership interests, being schemes in which the subsequent disposal of those interests may provide the equivalent of a cash dividend in a more tax-effective form. Therefore, paragraph 45B(8)(i) has no application to this case. | Detailed Reasoning - Paragraph 45B(8)(j): Paragraph 45B(8)(j) is not relevant to the present case as it applies to demergers only. | Detailed Reasoning - Paragraph 45B(8)(k): This paragraph requires that regard be had to ' any of the matters referred to in subsection 177D(2) ', which are matters prescribed for the purposes of determining the ' dominant purpose ' test in Part IVA. In the context of section 45B, however, they are to be applied in determining the ' more than incidental ' test specific to the provision. The circumstances which the Commissioner considers relevant to the assessment of the scheme in this case, and the corresponding paragraphs in subsection 177D(2) to which they relate, are as follows: • Paragraph 177D(2)(a) - ABC Pty Ltd board's strategy was implemented by the payment of a dividend in 2022 and a proposed return of capital by 30 June 2023. The amount of equity in excess to the needs of ABC Pty Ltd has been determined with reference to ABC Pty Ltd's target capital levels. • Paragraph 177D(2)(b) - The form and substance of the scheme are consistent in this case. The substance of the scheme is characterised by ABC Pty Ltd's primary objective to return equity to its shareholders which it considers to be surplus to its needs. The form of the scheme gives effect to this objective. It is material that it an appropriate amount is returned to shareholders as profit under the terms of the scheme(through the dividend distribution). In light of the above considerations, paragraph 45B(2)(c) is not satisfied in this case; and consequently section 45B does not apply to the scheme; that is, having regard to the relevant circumstances of the scheme, it is not 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 of enabling the Taxpayer to obtain a tax benefit. | Detailed Reasoning - Question 4: Will section 104-135 of the ITAA 1997 apply to XYZ Pty Ltd, as a shareholder of ABC Pty Ltd in relation to the payment that implements the capital reduction? | Summary: Section 104-135 of the ITAA 1997 will apply to XYZ Pty Ltd, as a shareholder of ABC Pty Ltd in relation to the payment that implements the capital reduction. | Detailed Reasoning - Detailed reasoning: Section 104-135(1) of the ITAA 1997 states the following: "(1) CGT event G1 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 relevant conditions of section 104-135(1) are considered in turn below. | Detailed Reasoning - Payment in respect of shares owned: Shareholders of ABC Pty Ltd, including XYZ Pty Ltd, will receive a payment of xx cents in respect of each share held in ABC Pty Ltd as at the nominated Record Date. As the Proposed Capital Return does not involve a disposal of shares by the shareholders or a cancellation of shares by ABC Pty Ltd, CGT events A1 and C2 are not relevant. Therefore, paragraph 104-135(1)(a) will be satisfied. | Detailed Reasoning - Payment will not be a dividend: The Proposed Capital Return will not constitute a " dividend " as defined in subsection 6(1) and 6(4) of the ITAA 1936, for the reasons set out at Question 1. Subsection 6BA(5) and section 84L of the ITAA 1936 are not relevant. The Proposed Capital Return is not a distribution by a liquidator, therefore section 47 of the ITAA 1936 is not relevant. It follows that section 104-135 of the ITAA 1997 applies to XYZ Pty Ltd. | Detailed Reasoning - Payment not included in assessable income: Paragraph 104-135(1)(c) will be satisfied as the payment will not be included in XYZ Pty Ltd's assessable income. In particular the payment is not ordinary income, being derived from the share capital account and which, as discussed above, is in substance a return of capital to XYZ Pty Ltd.