Private ruling: Capital return
Date of advice: 30 June 2022
Published: October 2022
Ruling period: Year ended 31 December 20XX
Date scheme commenced: 1 January 20XX

Ruling: Q1: Is the capital return a dividend and so assessable under section 44 of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No. | Q2: Is the capital return assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A2: No. Issue 2 | Q3: Will the Commissioner make a determination under section 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in respect of the capital return? | A3: No. | Q4: Will the Commissioner make a determination under section 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies in respect of the capital return? | A4: No. Issue 3 | Q5: Will any capital gain under CGT Event G1, in relation to the capital return, for shares be disregarded under section 855-10 of the ITAA 1997 for XCo because the shares are not taxable Australian property? | A5: Yes.

Relevant facts and circumstances: Background ACo is an Australian resident company which was incorporated prior to 20 September 1985. ACo is the provisional head company (PHC) of a multiple entry consolidated (MEC) group. ACo is wholly owned by XCo which is a non-resident of Australia. ACo and XCo are members of the YCo group. ACo was engaged in a contract from which it made losses. The losses from the contract were initially funded by loans from YCo and ZCo. ACo entered into a contract to acquire SubCo from XCo at XCo's net book value for SubCo. The acquisition was financed by an equity injection. At the date of acquisition SubCo's equity included retained earnings. YCo group borrowings from ZCo were refinanced following the establishment of a group finance company, FCo. As part of the refinancing: • ACo's share capital was increased • ACo used the funds from the share issue to repay the amounts owing to YCo and ZCo, which had been used to fund the losses from the contract. ACo received a number of payments in relation to the loss making contract. The cash received was applied to repay amounts borrowed from FCo and any additional cash was lent to FCo. Prior to the payments, ACo had estimated the amount it would receive as a receivable and booked expected losses from the contract. On receipt of the payments, an accounting profit was recorded as, under accounting standards, ACo was required to make a conservative assessment of the amount that would be received in relation to the contract, with only that amount being recorded as a receivable. ACo has accumulated losses of $X. SubCo After acquisition by ACo, SubCo sold its business to a third party. SubCo distributed a dividend to ACo. ACo recognised an amount as equity in its consolidated accounts in respect to its investment in SubCo. The amount recognised represents the excess of SubCo's net book assets over the share price paid by ACo on acquisition of SubCo. A liquidator was appointed to SubCo. The liquidator made a final liquidator's distribution and SubCo's ordinary shares were cancelled with ACo's financial statements showing dividends received in relation the the liquidation and a net loss from investment. The amount recognised in ACo's financial statements, representing the excess of ACo's net book value of SubCo's assets and liabilities over ACo's cost of investment in SubCo on acquisition will remain in ACo's consolidated accounts. Cash pooling arrangement The YCo group has a cash pooling arrangement under which group companies lend cash to FCo and borrow funds from FCo. The dividend paid by SubCo was funded through the repayment of a receivable by FCo, with ACo using the funds to repay a part of an amount it owed to FCo. Proposed return of capital Part of the payments received by ACo in respect of the contracts is surplus to ACo's needs. ACo proposes to make a return of capital to XCo. The return of capital will be debited against ACo's share capital account. The amount recorded in equity following the liquidation of SubCo will not play any part in the proposed return of capital. ACo's share capital account ACo has only ordinary shares on issue. All ordinary shares rank equally for dividend and capital distributions. ACo has confirmed that its 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). ACo has not paid a dividend in the last X years. Other ACo does not hold any assets that are taxable Australian real property, other than office leases on market terms. ACo shares are not held, and have never been held, in carrying on a business through a permanent establishment in Australia. ACo has $X of franking credits. ACo has undertaken work for a project and reached an agreement for the development of another project with respect to which negotiations are ongoing.


Reasons for decision: Summary: The capital return is not assessable under section 44 as it is not a dividend. | Detailed Reasoning - Detailed reasoning: Subsection 44(1) includes in a shareholder's assessable income any dividends paid to the shareholder out of profits derived by the company from any source (if a resident of Australia) and from an Australian source (if a non-resident). The term dividend in subsection 6(1) includes any distribution made by a company to any of its shareholders. However, paragraph (d) of the definition of dividend of subsection 6(1) excludes a distribution from the meaning of dividend if the amount of a distribution is debited against an amount standing to the credit of the company's share capital account. 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 not a share capital account if it is tainted. The proposed return of capital will be recorded as a debit to ACo's share capital account. As the share capital account of ACo is not tainted within the meaning of Division 197, paragraph (d) of the definition of dividend in subsection 6(1) applies. Accordingly, the proposed capital return will not constitute a dividend. | Summary: The capital return is not assessable under section 6-5. | Detailed Reasoning - Detailed reasoning: Subsection 6-5(1) provides that the assessable income of a taxpayer includes income according to ordinary concepts, which is called ordinary income. Ordinary income includes income from property. XCo will receive the proposed capital return because it holds shares in ACo. The proposed capital return will not be paid by ACo to XCo out of profits but will be a partial distribution of the share capital of ACo. Accordingly, the distribution to XCo under the proposed capital return will not constitute ordinary income. The distributions to XCo will not be assessable under section 6-5. | Summary: The Commissioner will not make a determination under section 45A(2) that section 45C applies in respect of the capital return. | Detailed Reasoning - Detailed reasoning: Section 45A applies in circumstances where a company streams 'capital benefits' to certain shareholders who derive a greater benefit from the receipt of capital (the advantaged shareholders) and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends. ACo will be providing XCo with a 'capital benefit' (as defined in paragraph 45A(3)(b)). The capital benefit, being $x.x per share or $X in total, is to be provided to ACo's sole shareholder. As XCo is ACo's sole shareholder, it is not possible for ACo to engage in a scheme under which ACo could 'stream' capital benefits to advantaged shareholders and dividends to disadvantaged shareholders. Accordingly, section 45A will not apply to the proposed capital return and the Commissioner will not make a determination under subsection 45A(2) that section 45C applies to the proposed capital return. | Summary: The Commissioner will not make a determination under section 45B(3)(b) that section 45C applies in respect of the capital return. | Detailed Reasoning - Section 45B - schemes to provide capital benefits in substitution for dividends: Section 45B applies where certain capital payments are paid to shareholders in substitution for dividends. Section 45B concerns the relationship between company and shareholder. It is an anti-avoidance provision which seeks to ensure that certain payments, allocations and distributions made in substitution for a dividend by a company to its shareholder, relevantly referred to in subsection 45B(5) as the 'provision of a capital benefit', are instead treated as a dividend for taxation purposes. Section 45B sets out threshold and definitional matters which, if met, empower the Commissioner to make a determination, the effect of which is to deem, pursuant to section 45C, the return of capital to be an unfranked dividend. The section does not premise that a dividend would otherwise have been paid by the company if the 'capital benefit' had not been provided. Rather, the reference in subsection 45B(1) to dividend substitution is a reference to the 'capital benefit' or a part of it being in substance attributable to the company's profits. Subsection 45B(2) sets out the conditions under which the Commissioner will make a determination under subsection 45B(3) that section 45C applies. In broad terms, 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)). Each condition set out in subsection 45B(2) is considered below. However, it is pertinent to note that subsection 45B(2) expressly contemplates the application of section 45B to a scheme which involves the provision of a capital benefit to one person in order to enable another person, the 'relevant taxpayer', to obtain a tax benefit. | 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) which is: scheme means: (a) any arrangement; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. 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) states at paragraph 40 that the 'scheme' defined must relate to the tax benefit obtained. Also at paragraph 41, a share capital reduction would normally constitute either a scheme or a part of a scheme for the purposes of section 45B. The proposed capital return, under which ACo will return a total of $X to its sole shareholder, XCo, would constitute a scheme for the purposes of paragraph 45B(2)(a). Paragraph 45B(2)(b) provides that a person has to be provided with a capital benefit under the scheme. Subsection 995-1(1) defines 'person' to include a company. As indicated above, the 'relevant taxpayer' in the context of section 45B, being the person who obtains the tax benefit, need not also be the person who is provided with the capital benefit. In other words, section 45B recognises that 'dividend substitution' can occur where the capital benefit is provided to a person other than the 'relevant taxpayer' (where the 'relevant taxpayer' is, ordinarily, a shareholder of the company providing the capital benefit). The phrase 'provided with a capital benefit' is defined in subsection 45B(5) and includes a distribution of share capital to a person. Under the present scheme, ACo proposes to make a return of share capital, which will be accounted for via a debit against its untainted share capital account. The proposed capital return would constitute the provision of a capital benefit by ACo to XCo as the return constitutes a distribution of share capital to ACo's shareholder in accordance with paragraph 45B(5)(b). | Detailed Reasoning - Obtains a tax benefit: Subsection 45B(9) provides that a relevant taxpayer obtains a tax benefit if an amount of tax payable; or any other amount payable under the Act, would apart from the operation of 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 had been an assessable dividend. In other words, subsection 45B(9) provides that the relevant taxpayer obtains a tax benefit if the tax payable by the relevant taxpayer would have been greater had the capital benefit been a dividend paid to them rather than a capital benefit provided to them or another person. A return of capital is ordinarily subject to the Capital Gains Tax (CGT) provisions under Parts 3-1 and 3-3 of the income tax law. A return of capital prima facie gives rise to CGT event G1 (section 104-135). To the extent the distribution exceeds the cost base of the shares, a capital gain is made. Where the distribution does not exceed the cost base of the shares, there will only be a cost base reduction under CGT event G1. For a foreign resident shareholder, provided that the relevant asset is not 'taxable Australian property', the provisions of Division 855 operate to disregard any capital gain or capital loss. By contrast, in the case of a foreign resident, a dividend under subsection 44(1) would generally be subject to dividend withholding tax. Once the proposed capital return occurs, XCo will prima facie obtain a tax benefit from the return of capital, being an amount of $x.x per share, when compared to the receipt of a dividend. In the present case, if the proposed capital return were provided to XCo as a dividend, or partly a dividend, and not as a capital benefit, XCo would become liable to dividend withholding tax pursuant to subsection 128B(1), subject to the application of any relevant Double Taxation Agreement (DTA). Subsection 128B(1) provides that the liability to withholding tax (subject to certain exclusions which are not applicable here), applies to income that is derived on or after 1 January 1968 by a non-resident and consists of a dividend paid by a company that is a resident. XCo is the non-resident parent company of ACo, a resident company, which proposes to provide a capital benefit to XCo. Subsection 128B(4) assigns liability to income tax on persons that derive dividend income as described in subsection 128B(1), in this case, being XCo. The applicable rate of withholding is x% as provided for under the relevant DTA. Therefore, pursuant to subsection 45B(9), it is likely that XCo will obtain a tax benefit. The relevant tax benefit will be attributable to the return of capital being assessed under the CGT regime, rather than being assessed as a dividend under subsection 44(1). | Detailed Reasoning - Relevant circumstances of the scheme: Paragraph 45B(2)(c) requires the Commissioner to consider whether any part of the scheme was entered into for a purpose, other than an incidental purpose, of enabling XCo (the relevant taxpayer) to obtain a tax benefit. The conclusion as to purpose is to be obtained with regard to the 'relevant circumstances' of a scheme which includes the non-exhaustive factors set out in subsection 45B(8).The purpose does not have to be the dominant purpose, but it must be a more than incidental, or substantial, purpose. 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 entire amount of $X proposed to be returned to XCo will be debited against ACo's share capital account. However, it is necessary to consider the source of the distribution and the extent to which the proposed distribution is attributable to profits. In the current case the applicant contends that no portion of the capital benefit may be attributable to profits. Paragraph 45B(8)(a) refers to the extent to which the capital benefit is attributable to profits (realised and unrealised) of the company or an associate (within the meaning of section 318) of the company. Paragraph 45B(8)(a) directs attention at the extent to which, despite the distribution taking the form of share capital, it can be ascribed as belonging to, or appropriate to, the company's share capital or the profits of the company or its associates. The term 'profits' takes its ordinary meaning and, as it is generally understood, applies to a gain made by a business and disclosed by a comparison between the state of that business at one point and the state at another. Furthermore, such gain can only be characterised by a comparison of the assets of the business on the basis of valuation not merely enumeration at the two dates and would thus include realised and unrealised gainswhich the provision also expressly includes (PS LA 2008/10, paragraph 70). Paragraph 45B(a) requires careful consideration of the characteristics of share capital and profits and the availability of each in the particular circumstances of the company. This is illustrated in paragraph 1.35 of the Explanatory Memorandum to the Taxation Laws Amendment (Company Law Review) Bill 1998 (EM), which states: if a company makes a profit from a transaction, for example the disposal of business assets, and then returns capital to shareholders equal to the amount of the profit, that would suggest that the distribution of capital is a substituted dividend. On the other hand, if a company had disposed of a significant part of its business at a profit and distributed an amount of share capital which could reasonably be regarded as the share capital invested in that part of the business, the distribution of capital would not be seen as a substituted dividend because no amount would be attributable to profits. In MacFarlane v FCT 86 ATC 4477 at 4482 Fisher J stated: There are in my opinion a number of indications in the Act which confirm my view that there is no justification for attributing a narrow or accounting meaning to the word "profits". I consider that the circumstances here permit the application of the conventional rule. In the first instance it is pertinent to note that the thrust of subsec. 44(1) is primarily directed to the source of the profits out of which the dividend is paid i.e. a source within or without Australia. There is nothing to indicate that the legislature had in mind designating the nature of these profits, i.e. net profits, divisible profits, after tax profits, etc. As Kitto J. said in F.C. of T. v. Uther (1964 - 1985) 112 C.L.R. 630 at p. 639: "The criterion for the inclusion of a shareholder's receipts from the company is no longer the 'dividend' character of the receipts, that is to say their income character when considered from the shareholder's point of view; it is the profit character - from the company's point of view - of the source from which distributions should be made." The applicant contends that, as a result of ACo making an overall loss at the end of the contract, ACo does not have any profits from which to pay a dividend. Whilst ACo's financial statements show accumulated losses an amount has been recorded in its financial statements in equity in respect to the acquisition of SubCo. The amount recorded in ACo's accounts arose as a result of its acquisition of SubCo. XCo sold all of the issued shares in SubCo to ACo for consideration equal to their book value, which was an amount less than SubCo's net asset value. This was made possible because ACo, like SubCo, was a wholly owned subsidiary of XCo. The acquisition of SubCo by ACo at book value enabled the profit inherent in the SubCo shares to be transferred from XCo to ACo. The payment of a dividends by SubCo to ACo resulted in a reduction of intra-group amounts owing, without exposure to dividend withholding tax that would have otherwise arisen were the profits distributed to XCo. The transfer at book value consideration enabled the global group, via ACo, to acquire XCo's profit in the SubCo shares as a proxy for XCo, being the previous sole shareholder of SubCo. It is not without doubt that the economic gain which arose with respect to ACo's ownership of SubCo does not have the character of profit. As such, the contention that ACo does not have any profits from which to pay a dividend cannot be accepted. Subsection 45B(8)(a) is concerned with the extent to which the capital benefit is attributable to capital and profits of the company. Paragraph 61 of PS LA 2008/10 states: 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. A direct tracing of the funds is not necessary to demonstrate that the funds can be attributed to share capital. As ACo's consolidated accounts will continue to show an amount in equity following the liquidation of SubCo as well as paid-up capital from which the capital return could be made, the attribution question is not free from doubt. However, ACo has provided evidence which supports the conclusion that the share capital, which was contributed in order to fund the losses arising from the contract is surplus to ACo needs. The decision to reduce capital coincides with the circumstances arising as a result of the payments received in respect of the contract. This factor points away from the return of capital being for more than an incidental purpose of providing XCo with a tax benefit. | 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: Paragraph 45B(8)(b) refers to 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. The Commissioner has explained in paragraph 77 of PS LA 2008/10 that a pattern of making capital distributions (with the capital performing the function of dividends) may point towards the company engaging in dividend substitution. ACo has not paid dividends or made distributions of share capital in the last X years. The absence of a previous pattern of distributions, whether profit or share capital, does not point towards or away from the requisite purpose. No conclusion is drawn in relation to this circumstance. Paragraph 45B(8)(c): capital losses that, apart from the scheme would be carried forward to a later year of income Paragraph 45B(8)(c) relates to whether a taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income. It concerns the availability of capital losses to offset any potential gain. ACo does not hold any assets that are taxable Australian real property, other than office leases on market terms. As XCo is a non-resident, it would be entitled to disregard any capital gains or capital losses made. This factor tends against a conclusion of requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(d): ownership interests acquired before 20 September 1985: Paragraph 45B(8)(d) requires an inquiry as to whether some or all of the ownership interests in the company or in an associate (within the meaning of section 318) of the company held by the relevant taxpayer were acquired, or taken to be acquired, before 20 September 1985, thus exempting any capital gain. Although ACo was incorporated before 20 September 1985, XCo acquired only a nominal number of shares before 20 September 1985, with the majority of ACo being issued shares after 20 September 1985. This factor tends against a conclusion of requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(e): non-resident shareholders: Paragraph 45B(8)(e) requires an inquiry as to whether the relevant taxpayer is a non-resident. When compared to an unfranked dividend, a foreign resident shareholder benefits from a capital distribution. This is mainly due to the provisions of section 855-10 which operates to disregard capital gains derived by a foreign resident from the disposal of shares held by it in an Australian resident company where the majority underlying assets of the Australian resident company are not real property. | 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. As outlined in question 5 below, Subdivision 719-K applied to reset the cost base of the shares which XCo held in ACo at the time that it acquired the membership interests in SubCo. The tax cost of those reset interests may be less than the value of the proposed capital return. The cost base of the majority of shares participating in the capital return would be substantially higher than the proposed capital return. Therefore, while the of $x.x capital return will result in a reduction in the cost base of each ACo Share, in the majority of cases no capital gain, either immediate or deferred will arise. Additionally, the return of capital 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. On balance, this circumstance does not incline towards a conclusion of requisite purpose. | Detailed Reasoning - Paragraph 45B(8)(h): nature of interest after the return of capital: Paragraph 45B(8)(h) requires a comparison of the respective interests held by shareholders after the distribution. 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. As the proposed capital return is to be proportional and will not result in the cancellation of any ACo Shares, XCo's substantive interests will remain the same as if a dividend was paid instead. In the circumstances of this arrangement, this factor tends towards the requisite purpose. Paragraph 45B(8)(i): if the scheme involves the later disposal of those interests Paragraph 45B(8)(i) applies if the scheme involves the provision of ownership interests or an increase in the value of ownership interests, and there is a later disposal of those interests. This circumstance is not relevant as the scheme does not involve a subsequent disposal of the ordinary shares in ACo. Therefore, this circumstance is not indicative as to purpose and no conclusion is drawn in relation to this circumstance. | Detailed Reasoning - Paragraph 45B(8)(k): the Part IVA matters: Paragraph 45B(8)(k) requires regard to be had to any of the matters referred to in paragraphs 177D(2). The paragraph 177D(2)(a) to (h) matters operate together to direct attention to the means by which the tax benefit has been obtained. Having regard to the matters raised in paragraphs 177D(2)(a) to 177D(2)(h) does not lead to a conclusion that a purpose, other than an incidental purpose, of obtaining a tax benefit exists in relation to the entering of the scheme. | Detailed Reasoning - Conclusion: While the matter is not free from doubt, on balance it cannot be said that the proposed capital return is attributable to the profits of ACo. The pattern of distributions does not indicate that the proposed capital return will be made in substitution for dividends. Similarly, the manner in which the proposed scheme will be carried out, and the form and substance of the proposed scheme, do not indicate that the proposed capital return will be made in substitution for dividends. Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies to treat the whole, or any part of the return of capital as an unfranked dividend for the purposes of the ITAA 1936 or of the ITAA 1997. | Summary: Any capital gain that arises under CGT Event G1, in relation to the capital return, for ACo Shares will be disregarded under section 855-10. | Detailed Reasoning - Detailed reasoning: CGT event G1 happens pursuant to section 104-135 if a company makes a payment to a shareholder in respect of a share they own in the company, 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, and the payment is not included in the shareholder's assessable income. The payment can include giving property. The time of the event is when the company makes the payment (subsection 104-35(2)). The shareholder makes a capital gain if the amount of the non-assessable part is more than the share's cost base. If a capital gain is made, the share's cost base and reduced cost base are reduced to nil (subsection 104-135(3)). Where the amount of the non-assessable part is not more than the share's cost base, that cost base and the share's reduced cost base are reduced by the amount of the non-assessable part (subsection 104-135(4)). Subsection 855-10(1) provides that you can disregard a capital gain or capital loss from a CGT event if: • you are a foreign resident just before the CGT event happens • the CGT event happens in relation to a CGT asset that is not taxable Australian property. What constitutes taxable Australian property is set out in the table in section 855-15. Item 2 of that table states that a CGT asset that is an indirect Australian real property interest is taxable Australian property. Under section 960-195, the non-portfolio interest test is satisfied if the sum of the interests in the company held by the foreign resident and its associates is 10% or more. The principal asset test under section 855-30 is satisfied if the sum of the market values of the test entity's taxable Australian real property assets exceeds the sum of the market values of its assets that are not taxable Australian real property. | Detailed Reasoning - CGT event G1: ACo proposes to make a return of capital of $x.x per share to its sole shareholder XCo. As explained at questions 1, 2 and 3 above, the amount of $x.x per share which ACo proposes to pay to XCo: • is not a dividend as defined in subsection 995-1(1) or an amount taken to be a dividend under section 47 • is not assessable to XCo. Therefore, CGT event G1 will happen at the time ACo pays the proposed return of capital amount in respect of Shares that XCo owns (subsections 104-135(1) and 104-135(2)). Subdivision 719-K contains the cost setting rules for membership interests held in eligible tier-1 companies that are members of a MEC group where those interests are not held by members of the group. Broadly, the membership interests in eligible tier-1 companies, including the PHC, that are held by entities that are not members of the MEC group (section 719-560) are taken into account as a pooled interest. Under the pooling rules, the original cost bases of all pooled interests form a single cost base pool. Upon the occurrence of certain CGT events including CGT event A1, the cost base of all pooled interests are 'reset' by reallocating the original cost base of the pooled interests to shares in each eligible tier-1 company by reference to each company's market value relative to other eligible tier-1 companies at the time of the CGT event (sections 719-565 and 719-570). As at 31 December 2015, SubCo was the PHC of a MEC group and ACo was an eligible tier-1 company of a MEC group. The interests which XCo held in ACo and SubCo were pooled interests. As such, the MEC cost base pooling rules applied to reset the cost base of the shares which XCo held in ACo and SubCo at the time that ACo acquired 100% of the membership interests in SubCo, (paragraph 719-555(b)(ii)). In the circumstances where the proposed return of capital is more than the cost base of the ACo shares XCo owns at the time of payment, XCo will make a capital gain (subsection 104-135(3)). If XCo makes a capital gain, the cost base and reduced cost base of the relevant ACo shares will be reduced to nil (subsection 104-135(3)). XCo cannot make a capital loss when CGT event G1 happens. Where the proposed return of capital is not more than the cost base of ACo shares held by XCo at the time of payment, the cost base and the reduced cost base of each of the shares will be reduced by the amount of the proposed return of capital (subsection 104-135(4)). | Detailed Reasoning - Application of Subdivision 855-A to a capital gain: As indicated above, XCo may make a capital gain if the proposed return of capital is more than the cost base of their ACo shares. The amount of the capital gain would be equal to the excess. As XCo will hold more than 10% of the interests in ACo at the time of the proposed capital return, it will satisfy the non-portfolio interest test in section 855-25. At no time during the proposed capital return will the sum of the market values of the assets of ACo that are taxable Australian real property (as defined in section 855-20) exceed the sum of the market values of its assets that are not taxable Australian real property. Therefore, the principal asset test in section 855-30 will not be satisfied. As the principal asset test in section 855-30 is not passed, XCo's shares in ACo will not be taxable Australian property as provided for under section 855-15. Consequently, any capital gain made by XCo as a consequence of CGT event G1 happening at the time ACo pays the proposed capital return would be disregarded under subsection 855-10(1).