Private ruling: Return of capital
Published: May 2014
Ruling period: Year ending xx/xx/xxxx
Date scheme commenced: xx/xx/xxxx

Ruling: Q1: Will the distribution to Shareholder B by Company H in the form of the proposed capital return constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No. | Q2: Will the Commissioner make a determination pursuant to subsection 45A(2) of the ITAA 1936 that section 45C ITAA 1936 applies to the proposed capital return by Company H? | A2: No. | Q3: Will the Commissioner make a determination pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return by Company H? | A3: No.

Relevant facts and circumstances: 1. Company H is the head company of an Australian consolidated group. 2. Company H has not conducted any previous returns of capital, share buy-backs or bonus share issues since its inception. There have not been any capital injections into Company H since its inception. Capital management proposal 3. Company H intends to pay a dividend to shareholders (the proposed dividend) and to immediately thereafter undertake a return of capital (the proposed capital return) to shareholders. It is expected that the proposed dividend will be fully franked. The capital return is proposed to be undertaken by way of a pro-rata capital reduction. 4. The proposed dividend and 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). 5. Company H will source the entire amount of cash for the proposed capital return from a capital return to be made to Company H by one of its subsidiaries. Proposed dividend 6. Company H expects to declare the proposed dividend in xx/xx/xxxx with payment to be made no later than xx/xx/xxxx. 7. The proposed dividend will be funded from current year profits of Company H arising as a result of receipt of a dividend from its subsidiaries. The dividend received by Company H will not be offset in the accounting records of Company H against any accumulated losses of Company H prior to the proposed dividend being declared and paid. 8. Company H will source the dividend proposed to be paid to its shareholders from available current year period profits, which will be evidenced by appropriate directors' resolutions and the way in which the accounts are prepared and approved by the directors of Company H. 9. Company H will satisfy all of the requirements of section 254T of the Corporations Act which stipulates the circumstances in which a company may pay a dividend in relation to the payment of the proposed dividend. Company H will also satisfy all provisions of its Constitution in relation to the declaration and payment of the proposed dividend. 10. The proposed dividend will not be sourced directly or indirectly from the share capital of Company H or any other entity in the Company H Group. 11. Company H has a sufficient franking credit balance in its franking account to frank the proposed dividend to 100%. Proposed capital return 12. Company H's management is of the view that it has a surplus of capital. 13. As at xx/xx/xxxx, the Company H Group's cash balance exceeded its total liabilities balance. 14. Therefore the excess cash is surplus to its on-going business needs. Company H's strong cash flow generating ability is expected to add further to this surplus position. 15. Additionally, no significant investment opportunities have been identified in the immediate or foreseeable future to which the surplus capital could be applied. 16. The proposed dividend will result in Company H paying out majority of its available distributable retained profits balance. A minor amount of retained profits will not be paid out at this time for various commercial and business reasons. 17. Company H paid a dividend in the year ended xx/xx/xxxx. Company H expects to pay a dividend in later income years when circumstances allow for a dividend to be paid. 18. The proposed capital return is considered to be the most efficient mechanism to return surplus capital to shareholders. 19. As at xx/xx/xxxx, Company H, as head Company of the Company H tax consolidated group had a balance of franking credits that can be used to pay fully franked dividends. 20. The share capital account of Company H is not a "tainted" share capital account as defined in section 197-50 of the ITAA 1997. 21. There is no arrangement whereby the share capital account of Company H will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction. 22. A majority of the consolidated surplus cash has been generated from operating activities of the Company H group. 23. Company H and its "associate" subsidiaries (as defined in section 318 of the ITAA 1936 do not have any unrealised profits or gains (either recorded or unrecorded).

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1); | Income Tax Assessment Act 1936 paragraph 6(1)(a) | Income Tax Assessment Act 1936 paragraph 6(1)(d) | Income Tax Assessment Act 1936 subsection 6(4); | Income Tax Assessment Act 1936 subsection 44(1); | Income Tax Assessment Act 1936 section 45A | Income Tax Assessment Act 1936 subsection 45A(2); | Income Tax Assessment Act 1936 paragraph 45A(3)(b); | Income Tax Assessment Act 1936 subsection 45A(4); | Income Tax Assessment Act 1936 section 45B; | Income Tax Assessment Act 1936 paragraph 45B(1)(a); | Income Tax Assessment Act 1936 paragraph 45B(1)(b); | Income Tax Assessment Act 1936 subsection 45B(2); | Income Tax Assessment Act 1936 paragraph 45B(2)(a); | Income Tax Assessment Act 1936 paragraph 45B(2)(b); | Income Tax Assessment Act 1936 paragraph 45B(2)(c); | Income Tax Assessment Act 1936 subsection 45B(3); | Income Tax Assessment Act 1936 paragraph 45B(3)(b); | Income Tax Assessment Act 1936 subsection 45B(5); | Income Tax Assessment Act 1936 subsection 45B(8); | Income Tax Assessment Act 1936 paragraphs 45B(8)(a) | Income Tax Assessment Act 1936 paragraphs 45B(8)(b) | Income Tax Assessment Act 1936 subsection 45B(9); | Income Tax Assessment Act 1936 section 45C; | Income Tax Assessment Act 1936 Section 318; | Income Tax Assessment Act 1997 section 197-50; | Income Tax Assessment Act 1997 section 701-1; | Income Tax Assessment Act 1997 Subdivision 705D; | Income Tax Assessment Act 1997 section 975-300; | Income Tax Assessment Act 1997 subsection 975-300(3); | Income Tax Assessment Act 1997 subsection 995-1(1); and | Corporation Act 2001 section 254T.

Reasons for decision: Detailed Reasoning - Question 1: Will the distribution to Shareholder B by Company H in the form of the proposed capital return constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | Summary: No. The distribution to Shareholder B by Company H in the form of the proposed capital return will not constitute a dividend as defined in subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Detailed reasoning: Subsection 44(1) of the ITAA 1936 includes in a shareholder's assessable income any dividends 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). Subsection 6(1) of the ITAA 1936 defines a "dividend" (subject to certain exclusions) to include the following: a) any distribution made by a company to any of its shareholders, whether in money or other property. The proposed return of capital will be a distribution of money to shareholders in proportion to the number of shares held at the Record Date, thus satisfying paragraph 6(1)(a) of the ITAA 1936. Paragraph (d) of the definition of 'dividend' contained in subsection 6(1) of the ITAA 1936, excludes the following distributions from the definition: 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. The term 'share capital account' is defined in section 975-300 of the ITAA 1997 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) of the ITAA 1997 states that an account is not a share capital account, except for certain limited purposes, if it is tainted. Section 197-50 of the ITAA 1997 states that a share capital account is tainted if an amount to which Division 197 of the ITAA 1997 applies, is transferred to the account and the account is not already tainted. The proposed return of capital will be debited against Company H's share capital account. As the share capital account of Company H is not tainted within the meaning of Division 197 of the ITAA 1997, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 applies. However, subsection 6(4) of the ITAA 1936 provides that the exclusion in paragraph (d) of the definition of "dividend" in subsection 6(1) of the ITAA 1936 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 property so paid, credited or distributed. The applicant has submitted that the return of capital will be sourced from the cash reserves of the Company H group. There is no arrangement whereby the share capital account of Company H will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction. In particular, it should be noted that on receipt of the cash from the capital return by one of its subsidiaries, Company H will credit its Investment in that subsidiary's account (an asset account) and not its share capital account (an equity account). Accordingly, there is no arrangement whereby the share capital account of Company H will be credited in connection with the proposed debiting of the share capital account required to effect the capital reduction. Therefore, it is concluded that the distribution to Shareholder B by Company H in the form of the proposed capital return will not constitute a dividend as defined in subsection 6(1) of the ITAA 1936. | Detailed Reasoning - Question 2: Will the Commissioner make a determination pursuant to subsection 45A(2) of the ITAA 1936, that section 45C of the ITAA 1936 applies to the proposed capital return? | Summary: No. The Commissioner will not make a determination pursuant to subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return. | Detailed Reasoning - Detailed reasoning: Section 45A of the ITAA 1936 applies if: • a company streams the provision of capital benefits and the payment of dividends to its shareholders: • this is done in such a way that the capital benefits are received by shareholders (the advantaged shareholders) who would in the year of income the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders; and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received, or will receive, dividends. According to paragraph 45A(3)(b) of the ITAA 1936 , the meaning of the "provision of capital benefits" is any of the following: (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 It has been submitted by the applicant that: • Company H is not providing shares to its shareholders in relation to the capital reduction. • Company H is distributing part of the balance standing to the credit of its share capital account to its shareholders. • Nothing is proposed to be "done" by Company H that has the effect of increasing the value of shares held by its shareholders. As the distribution to the shareholders of share capital is a provision of capital benefit as specifically defined in paragraph 45A(3)(b) of the ITAA 1936, the proposed capital return by Company H will constitute the provision of capital benefits for the purposes of section 45A of the ITAA 1936. Company H proposes to provide a 'capital benefit' as defined in paragraph 45A(3)(b) of the ITAA 1936 to all of its shareholders in the same proportion as their share holdings. In order for the Commissioner to be able to make a determination under subsection 45A(2) of the ITAA 1936, it must be the case that Company H "streams the provision of capital benefits and the payment of dividends" to shareholders in such a way that: "..the capital benefits are, or apart from this section would be, received by shareholders (the advantaged shareholders) who would, in the year of income the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders." The circumstances in which a shareholder would in a year of income, derive a greater benefit from capital benefits than another shareholder include, but are not limited to, any of the circumstances set out in subsection 45A(4), some of which exist in relation to the shareholders of Company H. In the present circumstances, because the capital reduction is being made on a pro-rata basis equally across all shareholders and there is no anticipated change to the dividend policy of Company H, the applicant has submitted that there will be no "advantaged shareholders" and no "other shareholders". On the basis that all shareholders will receive the same amount of capital per share, Company H cannot be said to be 'streaming' capital benefits to some shareholders to the exclusion of other shareholders. Therefore, section 45A of the ITAA 1936 will have no application in respect of the return of capital. Accordingly, the Commissioner will not make a determination pursuant to subsection 45A(2) of the ITAA 1936, that section 45C of the ITAA 1936 applies to the proposed capital return. | Detailed Reasoning - Question 3: Will the Commissioner make a determination pursuant to subsection 45B(3) of the ITAA 1936, that section 45C of the ITAA 1936 applies to the proposed capital return? | Summary: No. The Commissioner will not make a determination pursuant to subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed capital return. | Detailed Reasoning - Detailed reasoning: Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if: • Components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger (paragraph 45B(1)(a) of the ITAA 1936); or • Certain payments, allocations and distributions are made in substitution for dividends (paragraph 45B(1)(b) of the ITAA 1936). Where the requirements of subsection 45B(2) of the ITAA 1936 are satisfied, paragraph 45B(3)(b) of the ITAA 1936 empowers the Commissioner to make a determination that section 45C of the ITAA 1936 will apply in relation to the whole, or a part, of the capital benefit. Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if: (a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); 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 (paragraph 45B(2)(b) of the ITAA 1936); 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 (paragraph 45B(2)(c) of the ITAA 1936). | Detailed Reasoning - (a) Is there a relevant scheme under which a person is provided with a capital benefit?: "Relevant scheme" A scheme for the purposes of section 45B of the ITAA 1936 has the meaning given by subsection 995-1(1) of the ITAA 1997. A scheme is defined in subsection 995-1(1) of the ITAA 1997 to mean; (a) any arrangement, agreement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Practice Statement Law Administration PS LA 2008/10 (PS LA 2008/10) provides guidance on the application of section 45B of ITAA 1936 to share capital reductions. At paragraph 41 it is stated that a share capital reduction would normally constitute either a scheme or part of a scheme for the purposes of section 45B. Accordingly, the proposed return of capital by Company H is considered to be a "scheme" for the purposes of section 45B of the ITAA 1936. | Detailed Reasoning - "Capital benefit": The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It provides that a person is provided with a capital benefit if: • An ownership interest in a company is issued to the person; • There is a distribution to the person of share capital; or • The company does something in relation to an ownership interest that has the effect of increasing the value of the ownership interest (which may or may not be the same interest) held by that person. Under the present scheme, Company H proposes to make a capital distribution to each of its shareholders by debiting its share capital account. Accordingly, Company H will be providing its shareholders with a 'capital benefit' as defined in subsection 45B(5) of the ITAA 1936. (b) Does a taxpayer (the relevant taxpayer) who may or may not be the person provided with the demerger benefit or the capital benefit, obtain a tax benefit? | Detailed Reasoning - "Does the relevant taxpayer obtain a tax benefit?": The relevant taxpayer is the taxpayer who obtains a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936. Under the present scheme, the shareholders of Company H are the entities who are being provided with a capital benefit. If paragraph 45B(2)(b) of the ITAA 1936 is to apply, the provision of the capital benefit must be accompanied by an associated tax benefit. The meaning of 'obtaining a tax benefit' is contained in subsection 45B(9) of the ITAA 1936. Essentially, the relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under the ITAA 1936 and ITAA 1997, by the relevant taxpayer would, apart from section 45B, 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 capital benefit has been a dividend. Accordingly, the tax effect of paying the amount as a dividend must be taken into account in determining whether the taxpayer has obtained a tax benefit or not. Generally, where there is a distribution of share capital, a tax benefit will arise as a shareholder or the relevant taxpayer will pay less tax on the distribution than they would have if the amount had instead been a 'dividend'. An assessable dividend is ordinarily a payment to a shareholder out of profits and included in their assessable income under subsection 44(1) of the ITAA 1936 or subject to withholding tax, in the case of non-resident shareholders. It is the applicant's contention that no tax benefit should arise in the circumstances of Company H's shareholders because even if the capital return amount was otherwise a dividend, it would be fully franked, such that no Australian income tax consequences should arise for either the resident or the non-resident shareholders. However, in addition to the general circumstances, the relevant taxpayer also obtains a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends. This scenario is identified by the Explanatory Memorandum to the Bill enacting section 45B of the ITAA 1936: For example, obtaining a tax benefit would include circumstances where the amount of tax assessed as being payable by the relevant taxpayer in respect of the capital benefits is substantially the same as would have been the case had the relevant taxpayer received a dividend, but the relevant taxpayer has income losses, or the company providing the capital benefits has franking credits, which are preserved for future income years (and therefore reduce tax in those years). Preservation of franking credits for use in the future would ordinarily mean that a tax benefit is obtained within the meaning of subsection 45B(9). In the present scheme, the applicant has confirmed that Company H has sufficient franking credits to fully frank the entire distribution, were the capital component to be paid instead as a dividend. To the extent that franking credits are not needed to be used in respect of the capital component of the distribution, franking credits are thereby preserved for use in future years to reduce the income tax of resident shareholders, or the withholding tax of non-resident shareholders. Accordingly, the preservation of franking credits for future income years (because part of the distribution is in the form of a return of capital) will constitute the provision of a tax benefit. | Detailed Reasoning - (c) Relevant Circumstances: Paragraph 45B(2)(c) of the ITAA 1936 requires the Commissioner to objectively consider the 'relevant circumstances of the scheme' pursuant to subsection 45B(8) of the ITAA 1936 as to whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a taxpayer to obtain a 'tax benefit'. As the test of purpose is an objective test, the question is whether it would be concluded that a person who entered into or carried out the scheme did so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. Paragraphs 45B(8)(a) and 45B(8)(b) of the ITAA 1936, are relevant for the purposes of determining the requisite purpose pursuant to paragraph 45B(2)(c) of the ITAA 1936. a) Paragraph 45B(8)(a) of the ITAA 1936: the extent to which the capital benefit is attributable to capital or profits (realised and unrealised) of the company or an associate (within the meaning of section 318 of the ITAA 1936) of the company; | Detailed Reasoning - Attribution to capital or profits: Under this paragraph, it is necessary to consider the source of the distribution and whether it is properly attributable to capital or profit (realised and unrealised) of the company or an associate of the company. Whether the proposed distribution of capital is 'attributable' to profit is essentially a practical matter 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. As outlined in paragraph 71 of PS LA 2008/10, the notion of profits may be wider than that under the Corporations Act. The attribution inquiry extends beyond profits legally distributable by the company to profits which, as a practical matter of fact, are available to be harvested by the company for distribution at that time or at a future time. At paragraph 62 of PS LA 2008/10, the Commissioner of Taxation directs tax officers as follows in relation to assessing the extent to which the capital benefit is attributable to capital and profits: "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 have regard to the occasion for the share capital reduction, that is, the circumstances surrounding the making of the capital distribution" The applicant has claimed that no part of the proposed capital return is attributable to the profits of Company H or an associate of Company H because substantially all of the available profits will have been distributed to the shareholders of Company H as a result of the payment of the proposed dividend. The proposed capital return is a distribution to shareholders that is being made in addition to the distribution of available profits by way of dividend. Paragraph 61 of PS LA 2008/10 outlines that the inquiry contemplated by the words 'attributable to' involves 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. In the present case, there will be some minor amounts of retained and unrealised profits of Company H remaining after distribution of the proposed dividend, However on balance it is considered that no discernible connection is found between these remaining profits and the proposed return of share capital. It is considered that the proposed distribution of capital is not attributable to profits, and it can therefore be concluded that this circumstance does not incline towards the requisite purpose. b) Paragraph 45B(8)(b) of the ITAA 1936: the pattern of distributions made by a company or an associate of the company; This paragraph directs attention to the pattern of distributions of dividends, bonus shares and returns of capital or share premium by the company or an associate (within the meaning in section 318 of the ITAA 1936) of the company. The inference is that an interruption to the normal pattern of profit distribution and replacement with a distribution of capital may suggest dividend substitution. Company H paid a fully franked dividend in the year ended xx/xx/xxxx. The applicant has stated that this indicates a conservative approach to profit distribution, where a distribution occurred due to accumulated retained earnings being positive and surplus cash representing those profits being available to fund the distribution. The applicant has also submitted that Company H will distribute substantially all of its retained earnings prior to making the return of capital. Therefore there is no indication that the proposed capital return distribution by Company H is being used to replace standard profit distributions. It is therefore concluded that this circumstance does not indicate that the requisite purpose exists. | Detailed Reasoning - Conclusion: Having regard to the relevant circumstances of the scheme, it has been concluded that the proposed return of capital is not being implemented for a more than incidental purpose of enabling the relevant person to obtain a tax benefit for the purposes of paragraph 45B(2)( c) of the ITAA 1936. Therefore, the Commissioner will not make a determination under paragraph 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the capital benefit being provided to the shareholders of Company H under the scheme.

Does Part IVA apply to this ruling?: Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'. | Reasons for decision: These reasons for decision accompany the Notice of private ruling for Shareholder B.