Private ruling: Share capital tainting
Date of advice: 24 August 2017
Published: December 2017

Ruling: Q1: Will the assignment or forgiveness of the intercompany loans constitute an amount that is transferred to the Company B, or in the case of an assignment of the intercompany loan, an amount transferred to the share capital account of Company Z for the purposes of section 197-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will the assignment or forgiveness of the intercompany loans cause a franking debit to arise in the franking account of Company A in accordance with subsection 709-75(2) of the ITAA 1997? | A2: No. | Q3: Will the assignment or forgiveness of the intercompany loans give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002 ? | A3: No.

Relevant facts and circumstances: Limitation of scope The Commissioner’s opinion on the effect of the assignment or forgiveness under the commercial debt forgiveness rules contained in Division 245 of the ITAA 1997 is neither sought nor provided. Background Company A is the head company of an income tax consolidated group (the group) with its wholly owned subsidiary entities, which include Company B, Company C, Company D and Company Z. As part of the group’s operations, Company D (Creditor Company) provided a loan to Company B (Debtor Company) and Company C (Creditor Company) provided a loan to Company D (Debtor Company). Company D will forgive the loan amount owed by Company B. Company A will assign the loan amount Company D owed to Company C to Company Z (Assignee Company). The accounting entries Company A will account for the assignment or forgiveness of these loans as follows: Creditor Company Assignee Company or Debtor Company Dr Retained Earnings Dr Intercompany payable Cr Intercompany receivable Cr Retained earnings The credit entry in the accounts of the Creditor Company recognises that it will cease to have an asset. It will therefore reduce its assets (i.e. the intercompany loan that was forgiven or assigned). This loss of value will be recognised as a debit to retained earnings and this debit will not be treated as an expense through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact). The debit entry in the accounts of the Debtor Company will recognise that the debtor has ceased to have a liability (i.e. the intercompany loan that was forgiven). This decrease in its liabilities will be recognised as a credit to the retained earnings account and this credit will not be treated as an income amount through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact). The debit entry in the accounts of the Assignee Company will recognise that Company Z will be assigned an asset (i.e. the intercompany loan that was assigned). This increase in its assets will be recognised as a credit to the retained earnings account and this credit will not be treated as an income amount through the profit and loss, but rather affects the accumulated retained earnings balance (i.e. this will have a balance sheet impact).

Relevant legislative provisions: Income Tax Assessment Act 1997 Division 197. | Income Tax Assessment Act 1997 Subdivision 197-A. | Income Tax Assessment Act 1997 Subsection 197-5. | Income Tax Assessment Act 1997 Subsection 197-5(1). | Income Tax Assessment Act 1997 Subsection 197-5(2). | Income Tax Assessment Act 1997 Subsection 197-45(1). | Income Tax Assessment Act 1997 Section 205-45. | Income Tax Assessment Act 1997 Section 205-45(2). | Income Tax Assessment Act 1997 Section 205-45(3). | Income Tax Assessment Act 1997 Subsection 709-75(1). | Income Tax Assessment Act 1997 Subsection 709-75(2). | Income Tax Assessment Act 1997 Subsection 709-75(3). | Income Tax Assessment Act 1997 Section 975-300. | Income Tax Assessment Act 1997 Subsection 975-300(1). | Income Tax Assessment Act 1997 Subsection 975-300(2). | Income Tax (Transitional Provisions) Act 1997 Section 205-20. | Income Tax (Transitional Provisions) Act 1997 Subsection 205-20(2). | Income Tax (Transitional Provisions) Act 1997 Section 205-25. | New Business Tax System (Franking Deficits Tax) Act 2002 Section 3. | New Business Tax System (Franking Deficits Tax) Act 2002 Section 4.

Reasons for decision: Summary: The assignment or forgiveness of each intercompany loan will not constitute an amount that is transferred to the share capital account of the relevant debtor companies or in the case of an assignment of the intercompany loan, an amount that is transferred to the share capital account of Company Z for the purposes of section 197-5. | Detailed Reasoning - Detailed reasoning: Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75. Subsection 197-5(1) states: Subject to subsection (2), this Division applies to an amount (the transferred amount ) that is transferred to a company's *share capital account from another of the company's accounts, if the company was an Australian resident immediately before the time of the transfer. Note: If a company has 2 or more share capital accounts, those amounts are taken to be a single account (see subsection 975-300(2)). Subsection 197-45(1) provides that where an amount is transferred to a company’s share capital account, a franking debit arises in the company’s franking account immediately before the end of the franking period in which the transfer happened. The exclusions in subdivision 197-A (which are set out in sections 197-10 to 197-42) will not be relevant for the Company A group of companies. | Detailed Reasoning - Meaning of share capital account: The term ‘share capital’ is not defined in Australian income tax legislation. However, the Explanatory Memorandum to Tax Laws Amendment (2006 Measures No. 3) Bill 2006 which introduced section 975-300 into the ITAA 1997 states: 4.10 The concept of share capital is not defined in the ITAA 1997. Under its ordinary meaning, share capital includes amounts received by a company in consideration for the issue of shares. A company’s share capital comprises amounts received by a company as consideration for the issue of shares. The concept of share capital is discussed in paragraphs 32, 34 and 50 of Taxation Ruling TR 2012/1: Income tax: retail premiums paid to shareholders where share entitlements are not taken up or are not available which state: 32. It is the Commissioner’s view for the purposes of the income tax law that all amounts paid in consideration for the issue of shares by a company are share capital of the company (which should be credited to the company’s share capital account). 34. The ITAA 1936 and the ITAA 1997 use the concept of share capital without a statutory definition of the term (though share capital account has long been defined for income tax purposes, currently in section 975 300 of the ITAA 1997). The Corporations Act 2001 includes Chapter 2H-Shares and Chapter 2J-Transactions affecting share capital but also without a statutory definition of the term. The ordinary meaning of share capital applies. This meaning is supported by case law, which has also been reflected in discussions in legal text books and Explanatory Memoranda. 50. The amounts proffered in subscription for the issue of shares are share capital of the company and are properly credited by the company to its share capital account. | Detailed Reasoning - Transfer to a share capital account: Loans to be forgiven Under the current proposed arrangement, the following accounting entries will be recorded in the accounts of Company B to reflect Company D forgiveness of the intercompany loan: Dr Intercompany payable – Company D Cr Retained earnings The debit entry in the accounts of Company B recognises that it will cease to be liable for the loan amount payable to Company D that will be forgiven. The decrease in liabilities will be reflected as a credit to the retained earnings account of Company B. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings balance at the end of the financial period in which Company D forgives the loan amount owed by Company B. Although retained earnings are recorded under shareholder’s equity in the balance sheet of Company B, the account remains entirely separate from other shareholder’s equity accounts such as the ‘share capital account’. Loans to be assigned The following accounting entries will be recorded in the accounts of the assignee company, Company Z: Dr Intercompany Loan – Company C Cr Retained Earnings The credit entry above in Company Z’s account will recognise that Company Z will be entitled to receive the intercompany loan that Company C will assign to Company Z. The increase in the assets of Company Z will be reflected as a credit to the retained earnings / (accumulated losses) account. The credit entry will not be treated as an income amount through the profit and loss account, but instead will affect the retained earnings / (accumulated losses) balance at the end of the financial period in which Company C will assign the intercompany receivable to Company Z, due to the balance sheet impact of the accounting treatment. Although retained earnings / (accumulated losses) are recorded under shareholder’s equity in the balance sheet of Company Z, the retained earnings / (accumulated losses) account remains entirely separate from other shareholder’s equity accounts such as the share capital account. | Detailed Reasoning - Conclusion: Based on the above accounting entries, the Commissioner accepts that no part of the forgiveness of the intercompany loan will cause, or result in, the transfer of an amount to the share capital account of Company B from another shareholders’ equity account of Company B, nor will the forgiveness cause, or result in, an increase in the Company B’s share capital account. The Commissioner accepts that no part of the assignment of the intercompany loan will cause, or result in, the transfer of an amount of the share capital account of Company C from another shareholders’ equity account of Company C, nor will the assignment cause, or result in, an increase in Company Z’s share capital account. | Summary: The assignment or forgiveness of the intercompany loans will not cause a franking debit to arise in the franking account of Company A in accordance with subsection 709-75(2). | Detailed Reasoning - Detailed reasoning: Section 709-75 operates to debit the franking account of the head company of a consolidated group if a debit would otherwise arise in the franking account of a subsidiary member of the group. The consolidation single entity rule does not affect the operation of section 709-75. Subsection 197-45(1) provides that where an amount is transferred to a company’s share capital account, a franking debit arises in the company’s franking account immediately before the end of the franking period in which the transfer happened. As set out in the Reasons for Decision for Question 1 , the Commissioner accepts that there is no ‘transferred amount’ to the share capital account of each of Company B and Company Z. The Commissioner also notes that Company D will record the following accounting entries to reflect the forgiveness of the loan: Dr Retained earnings Cr Intercompany receivable The Commissioner also notes that Company C will record the following accounting entries to reflect the assignment of the loan: Dr Retained earnings Cr Intercompany Loan – Company D | Detailed Reasoning - Conclusion: The Commissioner accepts that there is no ‘transferred amount’ to Company B’s share capital account caused by, or as a result of Company D’s forgiveness of the loan. As the share capital account of Company B, or the share capital account of Company D, will not otherwise be tainted by Company D’s forgiveness of the loan, the forgiveness will not cause, nor result in, a debit arising in the franking account of Company A under section 709-75. The Commissioner also accepts that there is no ‘transferred amount’ to the share capital account of Company C caused by, or as a result of, Company A’s assignment of the intercompany loan. As the share capital account of Company C or the share capital account of Company D would not otherwise be tainted by the assignment of the intercompany loans, the assignment will not cause, nor result in, a debit to the franking account of Company A under section 709-75. | Summary: The assignment or forgiveness of the intercompany loans will not give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002 . | Detailed Reasoning - Detailed reasoning: Franking deficit tax (FDT) is imposed by section 4 of the New Business Tax System (Franking Deficits Tax) Act 2002 (the FDT Act). As set out in Section 3 of the FDT Act: franking deficit has the same meaning as in the Income Tax Assessment Act 1997 . franking deficit tax means: (a) franking deficit tax payable under section 205-45 of the Income Tax Assessment Act 1997 ; and (b) franking deficit tax payable under section 205-25 of the Income Tax (Transitional Provisions) Act 1997 . A liability to FDT arises where: ● An entity’s franking account is in deficit at the end of the income year (Subsection 205-45(2)) ● An entity’s franking account is in deficit immediately before the entity ceases to be a franking entity (Subsection 205-45(3)), or ● A late balancing company elects to have its FDT liability determined on 30 June under section 205-0 of the Income Tax (Transitional Provisions) Act 1997 (ITTPA 1997). The entity’s liability is therefore determined under sections 205-25 and 205-30 of the ITTPA 1997 (Subsection 205-20(2) of the ITTPA 1997). The Commissioner confirms that the assignment of the intercompany loan or the forgiveness of the intercompany loan will not of itself give rise to an amount of tax imposed under the New Business Tax System (Franking Deficits Tax) Act 2002 .

In these reasons for decision, all legislation references are to provisions of the Income Tax Assessment Act 1997 (ITAA 1997) unless specified otherwise.