Private ruling: CGT - returns
Date of advice: 28 September 2023
Published: 13 November 2023
Ruling period: Year ended X 20XX
Date scheme commenced: X 20XX

Ruling: Q1: Will the return of paid up share capital by ACo to BCo constitute a 'dividend' within the definition of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936) for the purposes of section 44 and 128B of the ITAA 1936? | A1: No. | Q2: Will the return of paid up capital by ACo to BCo constitute a scheme to provide a capital benefit for the purposes of section 45B of the ITAA 1936? | A2: es. | Q3: Would the Commissioner make a determination that section 45C of the ITAA 1936 applies to treat the amount of the payment, or any part of that payment, made by ACo to BCo as the payment of an unfranked dividend? | A3: Yes. | Q4: Will CGT event G1 happen to BCo under section 104-135 of the Income Tax Assessment Act 1997 (ITAA 1997) such that there is nil capital gain for BCo and the cost base in each of its shares in ACo will be reduced by the amount of the capital returned in respect of each share? | A4: No. CGT event G1 will happen such that there is nil capital gain and the cost base in each of its shares in Ecom will be reduced by the amount of the capital returned in respect to each share which is not treated as an unfranked dividend under section 45C.

Relevant facts and circumstances: ACo is a registered as a proprietary company limited by shares. ACo is a resident of Australia for income tax purposes. ACo's income tax reporting year is from X to X. ACo carries on a business. ACo focused on: • during 20XX and 20XX on A and B • from 20XX onwards A, with ACo deciding to re-establish its presence in the A industry and exit the B industry after experiencing disappointing results for several years. ACo has x fully paid-up ordinary shares on issue. ACo is a wholly owned subsidiary of BCo, a non-resident. BCo paid for shares in ACo, which were valued in Australian Dollars (A$), using United States Dollars ($). From X 20XX to X 20XX, the share capital account of ACo shows relevant transactions. Effective X 20XX, ACo's functional currency was changed from A$ to $. Following the adoption of $ as its functional currency, as at X 20XX, ACo had x fully paid-up ordinary shares on issue with total equity of x. For the years ended X 20XX to X 20XX, ACo's financial statements show movement in total equity of x. During the year ended X 20XX ACo traded A and B. On X 20XX, ACo issued, and BCo subscribed to, x ordinary shares at A$x each: • to strengthen ACo's balance sheet • in order for BCo to provide continued financial support (via recapitalising ACo) as ACo made a loss before tax of $x, with total current assets of $x over total current liabilities of $x as at the year end. As at X 20XX, ACo held an investment of $x in one wholly owned subsidiary, CCo. The principal activity undertaken by CCo involved B. ACo's investment in DCo was brought to account at cost and subsequently measured at cost less provision for permanent impairment as determined by the board of directors. Impairment losses are recognised in ACo's Income Statement. As at X 20XX, no impairment had been recognised for any of ACo's assets. After experiencing disappointing results from its B operations for several years: • ACo decided • to exit B • renew its focus on A. • ACo began the process of liquidating B and all major B related assets during the year ended X 20XX • the focus for the year ended X 20XX was to gradually phase out of B • management estimated that ACo would be completely phased out of the B business during 20XX • as a growth strategy the phasing out of B meant that ACo would be able to free up capital and invest in the core business of A. For the year ended X 20XX, ACo's financial statements showed a loss of $x. The loss arose from a substandard performance in B. The loss was attributed to a decision to write-off ACo's investment of $x in CCo and the write-down of $x of a deferred tax asset. At X 20XX, ACo's trade in A returned a profit of $x. During X 20XX, ACo issued, and BCo subscribed to, x ordinary shares at A$x each: • to offset the equity shortfall which occurred as a result of the substandard performance of ACo's B business • as part of ACo's growth strategy • to strengthen ACo's balance sheet. As at X 20XX, ACo's financial statements show a further impairment of $x to its investment in CCo. The purpose of the capital injections between X 20XX and X 20XX was to manage market volatility. For the years ended X 20XX to X 20XX, ACo's financial statements show a reduction in total equity as a result of retained losses. As at X 20XX, ACo's accounts show an increase in total equity as a result of retained earnings. ACo has not paid dividends to its shareholder. ACo's Board of Directors has taken the view that the company has generated insufficient profits to support the payment of a dividend. ACo has not been in a tax payable position and accordingly has a nil franking account balance as at X 20XX. During the periods ended X 20XX to X 20XX, ACo's net assets increased. ACo's assets are marked-to-market. Proposed return of capital The conditions that required the capital injections between X 20XX and X 20XX are no longer applicable. Management of ACo has determined that $x is surplus to ACo's capital requirements and can be returned to the shareholder without prejudicing the company's ability to pay its creditors. ACo proposes to return $x of capital to its shareholder, being $x per ordinary share (Capital Return). The return of surplus capital is required to ensure that the company maintains an efficient capital structure. In 20XX, ACo held an average excess cash position of $x for the period X to X 20XX. There were no bank loans throughout this period. As at X 20XX, ACo had cash and cash equivalents and third-party trade receivable balances totalling $x. As at X 20XX, ACo had cash and cash equivalents and third-party trade receivable balances totalling $x. As at X 20XX, ACo had cash and cash equivalents and trade receivables balances totalling $x. ACo participates in a cash pooling arrangement with its affiliate. As at X 20XX, ACo had approximately $x of cash deposited in the cash pool. ACo's capital requirements are reduced due to: the current strategy for 20XX and 20XX and the current A market. The proposed return of capital will be made equally to ACo's shareholder and will be wholly debited against ACo's share capital account. The accounting entries to be made by ACo on the proposed Capital Return are: DR Contributed equity $x CR Cash/Interco debt $x After the return of capital, ACo will retain substantial share capital, together with access to significant third-party loan funds, and will continue to provide sufficient funds for expected capital requirements going forward. As at X 20XX, ACo had a market value of $x with x shares on issue, equating to a share price of $x. After the return of capital, ACo's total equity will be reduced by the sum of $x. ACo's share capital account (as defined in section 975-300 of the ITAA 1997) is not tainted (within the meaning of Division 197 of the ITAA 1997). Funding As at X 20XX, ACo had $x of cash and cash equivalents. The proposed Capital Return will be funded from cash reserves. Constitution Clause X of the Constitution provides that the directors may determine that a dividend is payable and fix the amount, the time for payment and the method of payment. Clause X of the Constitution provides that no dividend shall be declared or paid to members otherwise than in accordance with section 254T of the Corporations Law. Other The amount to be returned in respect of each share that BCo holds in ACo will be less than BCo's cost base and reduced cost base in each share. The sum of the market values of ACo's assets that are taxable Australian real property do not exceed the sum of the market values of their other assets for the purposes of section 855-30 of the ITAA 1997.


Reasons for decision: Summary: The proposed Capital Return will not be a dividend as defined in subsection 6(1) for the purposes of section 44 and 128B. | Detailed Reasoning - Detailed reasoning: Subsection 44(1) includes in a shareholder's assessable income any dividends, as defined in subsection 6(1), paid to the shareholder out of profits derived by the company from any source (if the shareholder is a resident of Australia) and from an Australian source (if the shareholder is a non-resident of Australia). Section 128B provides that a non-resident shareholder who derives income consisting of a dividend from an Australian resident company is liable to pay withholding tax on the dividend. Section 12-210 of Schedule 1 to the Taxation Administration Act 1953 (TAA) requires an Australian resident company to withhold an amount from a dividend it pays where the entity to whom the dividend is paid has an address outside of Australia. Under section 12-300 of Schedule 1 to the TAA, an entity is not required to withhold and amount from a dividend if no withholding tax is payable in respect of that dividend or otherwise withhold more than the withholding tax that is payable in respect of that dividend. The note to section 12-300 states that section 128B deals with withholding tax liability. The term dividend as defined in subsection 6(1) includes any distribution made by a company to any of its shareholders. However, paragraph 6(1)(d) excludes from the definition of a dividend any: 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... Subsection 6(4) provides that paragraph 6(1)(d) of the definition of dividend in subsection 6(1) 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. The term share capital account is defined in section 975-300 as an account which the company keeps of its share capital, or any other account created on or after 1 July 1998 where the first amount credited to the account was an amount of share capital. Subsection 975-300(3) states that an account is taken not to be a share capital account, except for certain limited purposes, if it is tainted. Section 197-50 states that a share capital account is tainted if an amount to which Division 197 applies is transferred to the account and the account is not already tainted. ACo's share capital account consists solely of ordinary shares. The proposed Capital Return will be recorded as a debit against an amount standing to the credit of ACo's share capital account when paid. As ACo's share capital account is not tainted within the meaning of Division 197, paragraph (d) of the definition of dividend in subsection 6(1) will apply. Further, subsection 6(4) will have no application in respect of the proposed Capital Return as there is no such arrangement in place. Accordingly, the proposed Capital Return will not constitute a dividend for the purposes of subsection 6(1). | Summary: The return of paid up capital by ACo to BCo will constitute a scheme to provide a capital benefit for the purposes of section 45B. | Detailed Reasoning - Detailed reasoning: Section 45B applies where certain capital payments are paid to shareholders in substitution for dividends. Section 45B applies where: • there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a)) • 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 (paragraph 45B(2)(b)) • 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 the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)). Where section 45B applies, the Commissioner may make a determination under 45C that all or part of the capital benefit is taken to be an unfranked dividend paid by the company for income tax purposes. Law Administration Practice Statement PS LA 2008/10 Application of section 45B of the Income Tax Assessment Act 1936 to share capital reductions (PS LA 2008/10) provides instruction and practical guidance to tax officers on the application of section 45B to a share capital reduction by a company. PS LA 2008/10 provides the Commissioner's view as to the meaning of relevant definitions and the application of the key provisions within 45B, such as 'scheme', 'capital benefit', 'obtaining a tax benefit', 'a more than incidental purpose' and the making of a section 45B determination. PS LA 2008/10 makes clear that section 45B does not premise that a dividend would have been paid if the share capital had not been distributed. Rather, the reference in section 45B to dividend substitution is a reference to the distribution being more readily attributable to the company's profits as opposed to its share capital (Paragraph 31 of PS LA 2008/10). PS LA 2008/10 explains that profits are a gain to the company, which, when surplus to the company's needs, are to be divided amongst shareholders - whereas share capital is the money contributed by the company's members for carrying out its objects until some event or circumstance renders its retention unnecessary, whereupon it may be returned (Paragraph 34 of PS LA 2008/10). Each condition set out in subsection 45B(2) is considered below. | Detailed Reasoning - A scheme under which a person is provided with a capital benefit: Subsection 45B(10) provides that the term 'scheme' for the purposes of section 45B has the same meaning as given by subsection 995-1(1). That term means any arrangement (Paragraph 995-1(1)(a) of the definition of 'scheme'), or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise (Paragraph 995-1(1)(b) of the definition of 'scheme'). The proposed Capital Return of $x by ACo to its sole shareholder BCo would be a scheme for the purposes of section 45B. Paragraph 45B(2)(b) provides that a person has to be provided with a capital benefit under the scheme. The phrase 'provided with a capital benefit' is defined in subsection 45B(5) as: (a) the provision of ownership interests in a company to a person, (b) the distribution to the person of share capital or share premium, or (c) something that is done 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 be the person. As the proposed Capital Return would be recorded as a debit in the share capital account of ACo and BCo would receive a distribution of share capital, ACo will be providing BCo with a capital benefit under paragraph 45B(5)(b). | Detailed Reasoning - Obtains a tax benefit: A taxpayer must also obtain a tax benefit to satisfy paragraph 45B(2)(b). Under subsection 45B(9), a 'tax benefit' will be obtained from a capital benefit if the amount of tax payable by the relevant taxpayer would, apart from section 45B, be less than the amount that would have been payable if the capital benefit had been a dividend (Paragraph 48 of PS LA 2008/10). Where there is a distribution of share capital, a tax benefit would arise where a shareholder or the relevant taxpayer, would pay less tax on the distribution than they would have if the amount had been a dividend. Generally, a return of capital on shares acquired post-CGT would be subject to CGT. A taxpayer makes a capital gain from CGT event G1 if the amount of the proceeds returned is more than the cost of the share. Therefore, to the extent that the return of capital exceeds the cost base of BCo's post-CGT shares in ACo, a capital gain would arise. Fully franked dividends paid by ACo to BCo, as a non-resident, would not be subject to withholding tax (Paragraph 128B(3)(ga)). However, it is understood that ACo's franking account balance is nil and would continue to be so at the time the distribution is made such that the full amount of the distribution, if it were paid as a dividend, would not be exempt from withholding tax. However, an unfranked dividend paid by ACo to BCo would be subject to withholding tax under section 128B at a rate of x% as BCo is a tax resident of XX. It follows that BCo will obtain a tax benefit when the return of capital is paid as the amount of tax payable by BCo would, apart from section 45B, be less than the amount that would have been payable if the capital benefit had been paid as a dividend. | Detailed Reasoning - Relevant circumstances of the scheme: Paragraph 45B(2)(c) states that section 45B applies if, having regard to the relevant circumstances of the scheme, as set out in paragraph 45B(8) it would be concluded that person, or one of the persons, who entered into or carried out the scheme or any part of the scheme did so for the purpose (whether or not the dominant purpose but not including an incidental purpose) of enabling the relevant taxpayer to obtain a tax benefit. Each of the relevant circumstances listed in subsection 45B(8) is addressed below. | Detailed Reasoning - Paragraph 45B(8)(a): the extent to which the capital benefit is attributable to capital and profits (realised and unrealised) of the company: The inquiry contemplated by the words 'attributable to' is 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 ( Paragraph 61 of PS LA 2008/10). If the composition of the capital benefit is inconsistent with the substance of the benefit (that is, the capital and profit it is attributable to), this would support a conclusion that the requisite purpose exists. A capital distribution that is attributable to share capital generally represents share capital that is genuinely surplus to the company's needs and not merely a distribution debited against share capital on the basis of shareholder tax preference (Paragraph 63 of PS LA 2008/10). A distribution of profit would normally be expected to be a relatively ordinary business occurrence, whereas a distribution of capital would be a relatively extraordinary one (Paragraph 68 of PS LA 2008/10). For instance, the capital distribution may coincide with the disposal of a significant part of the business structure which can identified as releasing share capital. However, if the disposal also releases profit the ensuring distribution should, subject to all the other relevant circumstances, be considered in terms of attribution to both share capital and the profit from the disposal (Paragraph 63 of PS LA 2008/10). Based on the facts presented by the applicant, this is not the circumstance in which ACo is considering its capital return. There is no indication that there is a contemporaneous asset disposal or other structural change to ACo's business, which is coinciding with or driving, the proposed Capital Return. Rather, the applicant contends that the management of ACo has determined that $x million is surplus to ACo's capital requirements and can be returned to the shareholder and that such a distribution is entirely attributable to capital. The applicant's reasons for this conclusion are as follows: • the company considers that it has insufficient profits from which to source the payment, given the significant losses in its earlier period of operation • the injections of capital into the company in 20XX and 20XX were made specifically to address the prevailing business conditions that are no longer applicable • the company's strategy has changed such that its need for capital has reduced substantially • the company will after the return of capital retain substantial share capital that, together with access to significant third-party funds, will continue to provide sufficient funding for expected capital requirements going forward • no part of the return is attributable to specific profits, realised or unrealised of ACo. The share capital is genuinely surplus to its needs. In the absence of identifying an asset disposal or other key structural event within the business which could be said to 'free-up' capital invested in the business, the applicant contends that it can trace the amount of the Capital Return to the capital contributed by BCo in X 20XX and X 20XX. As detailed above, the applicant states that both tranches of share capital injections were primarily used by ACo as working capital within its business, to amongst other things: • strengthen its balance sheet • cover losses and other equity shortfalls that ACo was experiencing at the time due to poor business conditions. The Commissioner's view is that it would be difficult for ACo to directly trace the share capital it suggests are attributable to the share capital raisings of X 20XX and X 20XX, given the nature of the capital expenditure. Furthermore, there has been no attempt by the applicant to actually do this. It is also unclear to the Commissioner why the applicant is of the view that 'the company considers that it has insufficient profits from which to source the distribution (or at least part of the distribution), given the significant losses in its earlier period of operation. The key question is not what ACo's historical position has been in relation to losses, but whether ACo is currently in a position to source at least some of the proposed distribution out of profits. Notwithstanding ACo was in a loss position when the share capital was raised in X 20XX and X 20XX, the financial information provided by the applicant indicate ACo has become increasingly profitable. By the year ended X 20XX it was no longer in a loss position and reported retained profits/earnings in the amount of $x. Section 45B does not apply on a profits first basis, however by implication it does presuppose some objective non-tax basis for distributing capital rather than profits, where both are available (Paragraph 33 of PS LA 2008/10). Further, the generation of surplus funds from carrying on a business in the ordinary way is the occasion for the distribution of a dividend, not a return of capital (Paragraphs 35 and 65 of PS LA 2008/10). In the absence of being able to comprehensively trace the share capital it is intending to return and as there are clearly profits available for distribution by ACo, the proposed capital distribution is considered to be attributable in part, to profits generated by ACo in the ordinary course of carrying on its business. This factor therefore points towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(b): Pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or by an associate: The inference in paragraph 45B(8)(b) is that an interruption to the normal pattern of profit distribution and its replacement with a distribution of capital distribution may suggest dividend substitution (Paragraph 77 of PS LA 2008/10). ACo has never paid a dividend. The absence of a pattern of distributions in itself does not indicate that the return of capital is in substitution for a dividend. ACo has disclosed Comprehensive income of $x for the year ended X 20XX and net income after tax of $x for the six months to X 20XX. Further, as at X 20XX ACo's financial statements disclosed total retained earnings of $x from which ACo was able to pay a dividend. ACo's net income after tax for the six months to X 20XX resulted in ACo's retained earnings increasing to $x. ACo has not previously undertaken a return of capital. However, once ACo had determined the amount of $x was surplus to its needs and evaluated whether to make an ordinary dividend distribution or return of capital to BCo, factors such as insufficient franking credits and BCo's non-residency status may have influenced ACo's decision to propose a return of capital rather than pay a dividend. This factor points towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(c): capital losses that, apart from the scheme would be carried forward to a later year of income: This factor considers whether a shareholder of a company receiving a capital benefit has any capital losses it could apply to the capital benefit as this would result in reduced or no CGT implications for the shareholder. Where a shareholder has a capital loss that can applied against the capital benefit, it would suggest that the capital benefit was provided for the purpose of securing a tax benefit (Paragraph 85 of PS LA 2008/10). The sum of the market values of ACo's assets that are taxable Australian real property do not exceed the sum of the market values of their other assets for the purposes of section 855-30. As BCo is a non-resident, it would be entitled to disregard any capital gains or capital losses made. This factor does not point towards the requisite purpose. Paragraph 45B(8)(d): whether some or all of the ownership interests in the company or an associate (within the meaning of section 31) of the company held by the relevant taxpayer were acquired, or are taken to have been acquired, by the relevant taxpayer before 20 September 1985 ACo was incorporated on or about X 19XX. This factor does not point towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(e): where the relevant taxpayer is a non-resident: Paragraph 45B(8)(e) requires consideration of whether the shareholders of a company are non-residents. The implication of non-residency is that it would normally point towards a tax preference for a distribution of capital over profit. Non-residents are normally taxed on dividends (via the withholding tax regime) but they are not exposed to capital gains on the disposal of shares unless those shares are 'indirect Australian real property interests as defined in section 855-25 (Paragraph 87 of PS LA 2008/10). As BCo is non-resident taxpayer and a tax resident of X country, it is subject to dividend withholding tax of 5% on any unfranked dividends received. This suggests there is a purpose which is more than incidental for BCo to prefer a distribution of capital over profit in view of the preferable tax treatment it would otherwise receive under the CGT regime. This factor points towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(f): cost base of shares: Paragraph 45B(8)(f) relates to whether the cost of the relevant ownership interest is not substantially less than the value of the applicable capital benefit. The opportunity to defer the CGT taxing point may incline towards a conclusion that the purpose of the return of capital is to access the tax concession as an end in itself, rather than to increase business efficiency. The cost base of BCo's shares at the time they were issued was A$x. Where CGT event G1 applies to BCo, it is likely the cost base of shares will exceed the amount of the capital benefit received such that no capital gain should arise to the relevant taxpayer. The proposed Capital Return will be an amount which is less than the amount of paid-up capital of BCo's ownership interest in ACo. However, the proposed Capital Return is exempt from Australian income tax given that it will be made to a non-resident shareholder in respect of shares which are not taxable Australian property. This factor neither points towards or against the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(h): nature of interest after the return of capital: This factor proceeds from the premise that when a dividend is paid, the shareholder's interest remains unchanged and that a distribution of capital made in similar circumstances may be performing the same function as a dividend and be made in substitution for it. The factor has regard not only to whether there has been a cancellation or variation of the shareholder's interest, but also to whether the shareholder's interest has remained the same comparative to other shareholders (Paragraph 90 of PS LA 2008/10). An equal share capital reduction under which no shares are cancelled does not affect a shareholder's substantive interests, either individually or inter se and thus the interests remain the same as if a dividend had been paid instead. From a shareholder's perspective a reduction of capital without a cancellation of shares is not dissimilar economically to a special dividend, in that cash is distributed to them while they retain the share with all of its rights intact (Paragraph 91 of PS LA 2008/10). The proposed return of capital by ACo will not involve the cancellation of shares and there will be no impact on BCo's substantive interests or the proportion of its interest in ACo. This factor points towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(i): scheme involves the provision of ownership interests and the later disposal of those interests: The scheme does not involve a subsequent disposal of the ordinary shares in ACo. This factor would not point towards the requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(k): any other matters referred to in subsection 177D(2): The matters referred to in these subparagraphs are matters of reference to '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. Furthermore, they are matters by reference to which one is able to examine a return of capital from a broad, practical perspective in order to identify and compare its tax and non-tax objectives (Paragraph 98 of PS LA 2008/10). The paragraph 177D(2)(a) to (h) matters operate together to direct attention to the means by which the tax benefit has been obtained. | Detailed Reasoning - Paragraph 177D(2)(a): manner in which the scheme was entered into or carried out: This factor looks at the method or procedure by which the scheme was established or carried out - that is, the decisions, steps and events that combine to make up the scheme. This is an objective inquiry into the reasons a person had for entering into the scheme. The steps and events that combine to make up the scheme do not suggest that it is being entered into in a contrived or artificial way. The proposed Capital Return has been considered by the management of ACo to be in excess of its current needs and will represent a repatriation of that capital and will be treated as such for accounting, legal and tax purposes. This factor is neutral as to the requisite purpose. | Detailed Reasoning - Paragraph 177D(2)(b): the form and substance of the scheme: The form of the scheme is one that accords with the description of a return of capital. However, despite the proposed distribution taking the form of a return of capital, it can nonetheless, in substance, be attributable in part to the retained earnings currently held by ACo (see the discussion above in respect of the application of paragraph 45B(8)(a)). The practical implications of the scheme are consistent with it being, in form and substance, a distribution of both share capital and profit. Accordingly, there is a discrepancy between the form and substance of the scheme. This factor points towards the requisite purpose. | Detailed Reasoning - Paragraph 177D(2)(c): the at which the scheme was entered into and the length or the period during which the scheme was carried out: This factor requires not only reference to time measurement but also reference to the timing of the scheme from the point of view of the scheme's coincidence with events or circumstances beyond the scheme itself. In particular, it enables consideration of the extent to which the timing and the duration of the scheme go towards delivering the relevant tax benefit or are related to commercial opportunities and requirements. Whilst there have been changes to ACo's capital requirements since the last two tranches of share capital raising it undertook in X 20XX and X 20XX - the timing of the proposed Capital Return follows a number of years in which ACo has made significant profits from its ordinary business operations. The proposed Capital Return also coincides with a time ACo does not have franking credits to otherwise attach to dividends it could otherwise pay to its sole shareholder, BCo. This factor points towards the requisite purpose. | Detailed Reasoning - Paragraph 177D(2)(d): the result in relation to the operation of the Act that, but for this Part, would be achieved by the scheme: This factor requires consideration of all the relevant tax outcomes produced by the scheme if section 45B did not apply. The tax outcomes produced by the return of capital, assuming the non-application of section 45B, would be as follows: • the shareholders of ACo will receive a return of capital of $x per share (totalling $x) • a capital gain would only arise (under CGT event G1) to the extent that the amount of the capital proceeds exceed the cost base of the shares held, with any capital gain that arises in relation to shares being disregarded as the shares are held by foreign resident. ACo's franking account balance as at X 20XX is nil. The proposed Capital Return would result in BCo obtaining a tax benefit as the distribution will be excluded from the definition of dividend in subsection 6(1) and as a result, BCo would not be subject to dividend withholding tax under section 128B. This factor points towards the requisite purpose. Paragraph 177D(2)(e): any change in the financial position of the relevant taxpayer that has resulted, will result or may reasonably be expected to result from the scheme When the proposed Capital Return is made, BCo will continue to own the same number and proportion of shares in ACo in circumstances where it will be in receipt of a tax-free distribution equal to the return of capital, i.e. $x. BCo's financial position will therefore increase as a result of the scheme with its economic exposure to ACo remaining unchanged. This factor points towards the requisite purpose. Paragraph 177D(2)(f): any change in financial position of any other person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme The effect of the proposed Capital Return will be that ACo will be worth less than it was just before the return of capital as it will be divesting itself to the extent of $x which it will distribute to BCo. This factor does not point towards the requisite purpose. Paragraph 177D(2)(g): any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out This factor requires that regard be given to the nature of the company's business and how this impacts on its ability to pay dividends, as well as objective shareholder and 'market' expectations in relation to the company's distributions (Paragraph121 of PS LA 2008/10). ACo has not previously paid dividends to its shareholder. ACo does not have a formal dividend policy in place and does not intend to implement one following the capital reduction. The full impact of the return of capital cannot be predicted in advance and will depend on a number of other factors, including the commodity market. Whether or not the changes will have an overall impact on the applicant's future ability to pay a dividend is uncertain and remains to be seen. This factor does not incline towards or against the requisite purpose. Paragraph 177D(2)(h): the nature of any connection (whether of a business, family or other nature) between relevant taxpayer and any person in paragraph 177D(2)(f) The connection between the relevant taxpayer and ACo is the relationship of shareholder and company. The significance of this for tax purposes is that a distribution of corporate profit is ordinarily assessable income of the shareholder. This factor does not incline towards or against the requisite purpose. | Detailed Reasoning - Conclusion: On balance it can be concluded that: • a portion of the proposed Capital Return is attributable to the profits of ACo • the pattern of distributions and profile of the shareholder does indicate that the proposed Capital Return will be made in substitution of a dividend • the manner in which the proposed scheme will be carried out, and the form and substance of the proposed scheme, timing and result indicate that the proposed Capital Return will be made in substitution for dividend. Therefore, having regard to the relevant circumstances of the scheme, it would be concluded that ACo will enter into or carry out the scheme for a more than incidental purpose to enable BCo (its sole shareholder) to obtain a tax benefit for the purposes of paragraph 45B(2)(c). | Summary: The Commissioner would make a determination under paragraph 45B(3)(b) that section 45C applies to treat $x of the proposed Capital Return as the payment of an unfranked dividend. | Detailed Reasoning - Detailed reasoning: Based on the above analysis in Question 2, the requirement of paragraph 45B(2) will be satisfied in respect of the proposed Capital Return. The Commissioner would make a determination under paragraph 45B(3)(b), upon payment of the proposed return of capital, that section 45C applies in relation to the part of the capital benefit paid by ACo to BCo that is attributable to the retained earnings of ACo. In the circumstances, the Commissioner is of the view that the proposed Capital Return is attributable to the share capital and retained earnings of ACo on a proportionate basis (Paragraph 74 of PS LA 2008/10). As such, the relevant 'slice' of share capital to profit in relation to the $x would be as follows: (Share capital ÷ (Share capital + Retained earnings)) × Amount of the distribution Based on the most recent financial information contained in ACo's financial statements for the six months to X 20XX, the outcome of this 'slice' would be $x As such, $x of the $x would be considered attributable to the share capital of ACo, with $x attributable to profits. Accordingly, the Commissioner would make a determination under paragraph 45B(3)(b) that part of the proposed Capital Return, amounting to $x or $x for each ACo share held by BCo, will be taken under section 45C to be an unfranked dividend paid by ACo to BCo out of ACo's profits. | Summary: CGT event G1 (section 104-135) will apply to BCo, such that there is nil capital gain for BCo in respect of each ACo share. The cost base and reduced cost base of each of the shares BCo holds in ACo will be reduced by the amount of the proposed Capital Return which is not treated as an unfranked dividend under section 45C (subsection 104-135(4)). | Detailed Reasoning - Detailed reasoning: Subsection 104-135(1) states that CGT event G1 happens if: (a) a company makes a payment to 'you' in respect of a share you own in the company, other than where CGT event A1 or C2 happens in relation to the share (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 ( Section 47 of the ITAA 1936 deals with distributions by a liquidator), and (c) the payment is not included in your assessable income. The payment may include giving property, and to the extent that it does, the market value of the property is to be used in working out the amount of the payment (section 103-5). The time of the event is when the company makes the payment (subsection 104-135(2)). You make a capital gain if the amount of the non-assessable part exceeds the cost base of the share (subsection 104-135(3)). This is disregarded if: • you acquired the share before 20 September 1985 (subsection 104-135(5)) • you are a foreign resident and the share is not taxable Australian property (section 855-10), or • you are entitled to choose, and do choose, a roll-over under section 125-55 in the event of a demerger (subsection 125-80(1)). You cannot make a capital loss from the event (note 1 to subsection 104-135(3)). Where CGT event G1 happens other than as the result of a demerger (as defined in section 125-70), the share's cost base and reduced cost base is reduced under subsection 104-135(3) or (4) as applicable, that is to nil, where you make a capital gain and by the amount of the non-assessable part otherwise. Where the Commissioner makes a determination under subsection 45B(3) that section 45C applies to all or part of the payment referred to in paragraph 104-135(1)(a), that part is treated as an unfranked dividend and so does not form part of the non-assessable part. Under the proposed Capital Return, BCo will receive a distribution of $x, being $x in respect of each share it holds in ACo. The distribution will be a payment to BCo in respect of ACo shares BCo owns, therefore CGT event G1 will happened in respect of those shares. BCo will continue to hold the shares after this time, so the payment is not in respect of their disposal or cancellation. BCo contends that no part of the proposed Capital Return of $x is a dividend. As stated above in response to questions 2 and 3, $x of the proposed Capital Return in respect of each share will be taken to be an unfranked dividend paid by ACo to BCo under section 45C . In accordance with the detailed reasoning for questions 1, 2 and 3, $x ($x per share less $x per share taken under section 45C to be an unfranked dividend) of the proposed Capital Return (being the part of the total payment of $x per share attributable to the share capital of ACo) is not a dividend: • as defined in subsection 6(1) • under section 45C as the Commissioner will not make a determination under either subsection 45A(2) or 45B(3) in respect of that part of the distribution • under section 47, which relates to liquidator's dividends and is not relevant in the current circumstance. Finally, the amount of $x per share of the proposed Capital Return will not be included in BCo's assessable income. As such, the conditions are met for CGT event G1 to happen. Therefore, the non-assessable part of the proposed Capital Return will be $x per ACo share. BCo acquired ACo shares at an issue price of $x. BCo's cost base in the ACo shares it holds exceeds the non-assessable part of the proposed Capital Return per share of $x. Therefore, BCo will not make a capital gain in relation to ACo shares because of CGT event G1 happening at the time ACo distributes the proposed Capital Return to BCo. The cost base and reduced cost base of each ACo share will be reduced by $x under subsection 104-135(4).

Reasons for decision: These reasons for decision accompany the Notice of private ruling for ACo. | This is to explain how we reached our decision. This is not part of the private ruling. | All legislative references are to provisions of the ITAA 1936 or to provisions of the ITAA 1997, unless otherwise indicated.