Private ruling: Proposed return of capital - in-specie distribution of shares
Date of advice: 1 September 2015
Published: September 2015
Ruling period: 01 July 2015 - 30 June 2016
Date scheme commenced: 01 July 2015

Ruling: Q1: Will any part of the proposed return of capital by Company X to Company Y be a dividend within the meaning of subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: No. | Q2: Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed return of capital, deeming the capital benefits to be a dividend and hence assessable for income tax purposes? | A2: No.

Relevant facts and circumstances: The capital return will involve a distribution in-specie of shares by Company X to its shareholder, Company Y. Company Y is a non-resident company. Company Y acquired Company X through a Scheme of Arrangement. Company Y holds all of the shares in Company X. Company X is an Australian incorporated company. Company X holds shares in a number of resident and non-resident companies (Subsidiary Companies). Company X will debit the entire amount of the capital return to its share capital account. There are no accrued or unrealised profits in respect of any of Company X's assets, nor are there expected to be any accrued or unrealised profits in any of its subsidiaries at the date of the return of capital. Company X's only funding is equity funding (ie. share capital). The share capital in Company X is represented by its indirect investment in its subsidiaries. The entire amount of the in-specie distribution is expected to be the money value of the property at the time it is distributed. The money value of the property of the in-specie distribution will not exceed the amount debited to Company X's share capital account. Company X has never returned an accounting profit in respect of a financial year and does not have any profit reserves on its balance sheet. Company X is in an accumulated accounting loss position. Company X has never made a dividend distribution. Company X has never made a return of capital to Company Y. Company X's share capital account is untainted for the purpose of Division 197 of the ITAA 1997. The assets distributed by Company X to Company Y are not "taxable Australian property" as defined in Division 855 of the Income Tax Assessment Act 1997 (ITAA 1997).

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 6(1) | Income Tax Assessment Act 1936 subsection 44(1) | Income Tax Assessment Act 1936 section 45B | Income Tax Assessment Act 1936 section 45C | Income Tax Assessment Act 1936 subsection 177D(2) | Income Tax Assessment Act 1997 Division 197 | Income Tax Assessment Act 1997 section 197-50 | Income Tax Assessment Act 1997 section 975-300 | Income Tax Assessment Act 1997 subsection 975-300(3)

Reasons for decision: Summary: The proposed return of capital by Company X to Company Y will not be a dividend as defined in section 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, as defined in subsection 6(1) of the ITAA 1936, paid to the shareholders 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). The term 'dividend' in subsection 6(1) of the ITAA 1936 includes any distribution made by a company to any of its shareholders. However, paragraph (d) specifically excludes a distribution from the definition of 'dividend' if the amount of the distribution 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 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 applies is transferred to the account and the account is not already tainted. The proposed return of capital to Company Y will be debited entirely against the amount standing to the credit of Company X's share capital account. Company X has confirmed no amount has been transferred to the share capital account from another account. As the share capital account of Company X 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 will apply. Accordingly, the proposed return of capital will not be a dividend as defined in subsection 6(1). | Summary: The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the proposed return of capital, deeming the scheme to be a dividend and hence assessable for income tax purposes. | Detailed Reasoning - Detailed reasoning: Section 45B of the ITAA 1936 is an anti-avoidance provision which applies where certain capital payments, including a return of capital, are paid to shareholders in substitution for dividends. It allows the Commissioner to make a determination that section 45C of the ITAA 1936 applies to a capital benefit. Specifically, the provision 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)); and • having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into the scheme or carried out the scheme or any part of the scheme for a purpose, other than an incidental purpose, of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c)). The in-specie return of capital by Company X is a scheme within the broad meaning of that term. Provided with a capital benefit The phrase 'provided with a capital benefit' is defined in subsection 45B(5) of the ITAA 1936. It states 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. As the proposed return of capital will be debited to Company X's share capital account in relation to the distribution of shares, Company X will provide its shareholder with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936. Tax benefit In addition to being provided with a capital benefit, paragraph 45B(2)(b) of the ITAA 1936 also requires that the shareholder obtains a 'tax benefit' as defined in subsection 45B(9) where: • the amount of tax payable; or • any other amount payable under the ITAA 1936 or the ITAA 1997 would, apart from the operation of section 45B of the ITAA 1936, • be less than the amount that would have been payable; or • be payable at a later time than it would have been payable, if the capital benefit had instead been a dividend. Ordinarily, a return of capital would be subject to the CGT provisions under the income tax law. Unless the amount of the distribution exceeds the cost base of the shares, there will only be a cost base reduction under CGT event G1 (section 104-135 of the ITAA 1997). It is only to the extent (if any) that the distribution exceeds the cost base of the shares that a capital gain arises. A capital gain may not arise at all for certain foreign shareholders. By contrast, a dividend would generally be included in the assessable income of a resident shareholder or, in the case of a non-resident, would potentially be subject to dividend withholding tax. Therefore, Company Y will obtain a tax benefit from the capital return. Relevant circumstances For the purposes of paragraph 45B(2)(c) of the ITAA 1936, the Commissioner is required to consider the 'relevant circumstances' set out in subsection 45B(8) to determine whether any part of the scheme would be entered into for a purpose, other than an incidental purpose, of enabling a relevant taxpayer (Company Y as a shareholder in Company X) to obtain a tax benefit. However, the list of relevant circumstances in subsection 45B(8) is not exhaustive and regard may be had to other circumstances on the basis of their relevance. Each of the circumstances must be considered in order to determine whether or not, individually or collectively, they reveal the existence of the requisite purpose. The test of purpose is an objective one. The question is whether it would be concluded that a person who enters into or carries out the scheme does so for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. The requisite purpose does not have to be the most influential or prevailing purpose, but it must be more than an incidental purpose. The relevant circumstances contained in subsection 45B(8) of the ITAA 1936 cover the circumstances of Company X and the tax profile of Company Y. In this instance, it is considered that the matters covered by paragraphs 45B(8)(a), (b), and (k) of the ITAA 1936, are the most relevant. Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital and profits (realised and unrealised) of Company X or its associates. Company X does not have any prior year profits and that the investment in Company X was entirely sourced out of share capital. The attribution under the scheme correctly reflects the extent of share capital and profit in the distribution to Company Y. Paragraph 45B(8)(b) of the ITAA 1936 covers the relevant circumstance that includes the pattern of distributions of dividends and return of capital by the company. Company X has never generated an accounting profit in the previous financial years and therefore has not been in a position under the Corporations Act 2001 to declare and distribute a dividend to Company X shareholders. Therefore the in-specie distribution cannot be said to be in any way a substitute for any distribution of Company X, nor can it be viewed as a substitute for the absence of such distributions. Paragraph 45B(8)(k) refers to matter in paragraphs 177D(2)(a) to (h) of the ITAA 1936. These are matters by reference to which a scheme is able to be examined from a practical perspective in order to identify and compare its tax and non-tax objectives. The matters include the manner in which the scheme is carried out, its form and substance, and its financial and other implications for the parties involved. Having regard to the relevant circumstances of the scheme, set out in subsection 45B(8) of the ITAA 1936, it cannot be concluded that any of the parties to the scheme entered into or carried out the scheme for more than an incidental purpose of obtaining a tax benefit. Accordingly, the Commissioner will not make a determination pursuant to subsection 45B(3)(b) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the in-specie capital return provided to Company Y under the proposed scheme.