Private ruling: Dividend distribution and capital return
Published: June 2015
Ruling period: Year ending xx/xx/xxxx
Date scheme commenced: During the year ending xx/xx/xxxx

Ruling: Q1: Will the proposed dividend to be declared and paid by Company N, and to be debited against the amounts standing to the credit of the profits account of Company N be unfrankable pursuant to paragraph 202-45(e) of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will Company N be required to withhold an amount from the proposed capital return in accordance with section 12-210 of Schedule 1 to the Taxation Administration Act 1953 (TAA 1953)? | A2: No. | Q3: Will the Commissioner make a determination in relation to the proposed capital return pursuant to subsection 45C(3) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A3: No. | Q4: On the basis that the proposed capital return will not be a dividend for income tax purposes, will a franking debit arise in the franking account of Company N pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of the ITAA 1936 or ITAA 1997? | A4: No.

Relevant facts and circumstances: 1. Company N is the head company of an Australian tax consolidated group. 2. Company N has not conducted any share buy-backs or bonus share issues, and there has not been any capital injection into Company N since its inception. 3. Company N proposes to pay a dividend to shareholders (the proposed dividend) and immediately thereafter to undertake a capital return (the proposed capital return). 4. The proposed dividend and the proposed capital return will be distributed equally to each shareholder of Company N as at the nominated relevant entitlement date. 5. The proposed dividend will be funded from current year profits of Company N arising as a result of receipt of a dividend from one of its subsidiaries. The dividend received by Company N will not be offset in the accounting records of Company N against any accumulated losses of Company N prior to the proposed dividend being declared and paid. 6. It is expected that the proposed dividend will be fully franked. Company N had previously paid fully franked dividends and returned share capital to its shareholders. 7. Company N has a sufficient franking credit balance in its franking account to frank the proposed dividend to 100%. 8. The proposed dividend will not be sourced, directly or indirectly, from the share capital of Company N or any other entity in the Company N Group. 9. Company N will source the entire amount of cash for the proposed capital return from a capital return to be made to Company N by one of its subsidiaries. 10. The share capital account of Company N is not a 'tainted' share capital account for the purposes of section 197-50 of the ITAA 1997. 11. Company N's management is of the view that it has a surplus cash. 12. The excess cash is surplus to its on-going business needs. Company N's strong cash flow generating ability is expected to add further to this surplus position. 13. Additionally, no significant investment opportunities have been identified in the immediate or foreseeable future to which the surplus cash could be applied. 14. The proposed dividend will result in Company N paying out the majority of its available distributable profits balance. A minor amount of profits will not be paid out at this time for various commercial and business reasons. 15. The proposed capital return is considered to be the most efficient mechanism to return surplus capital to shareholders. 16. There is no arrangement whereby the share capital account of Company N will be credited in connection with the proposed debiting of the share capital account required to effect the capital return by the company. 17. The proposed capital return represents the surplus capital remaining that was not previously distributed. Following the distribution of the proposed capital return, Company N does not have further surplus capital to return to shareholders. 18. Apart from a small unrealised gain recorded in one of Company N's subsidiaries, Company N 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). 19. Shareholder B, being one of the shareholders in Company N, is a foreign resident. 20. Company N advised that the company will satisfy all the requirements in section 254T of the Corporations Act for the declaration and payment of the proposed dividend.

Relevant legislative provisions: Income Tax Assessment Act 1936 subsection 45C(3) | Income Tax Assessment Act 1997 paragraph 202-45(e) | Income Tax Assessment Act 1997 section 205-30 | Taxation Assessment Act 1953 section 12-210 of Schedule 1

Reasons for decision: Detailed Reasoning - Detailed reasoning: An entity can frank a distribution if certain conditions are satisfied. Section 202-5 of the ITAA 1997 sets out the conditions under which an entity can frank a distribution and it states: An entity franks a distribution if: (a) the entity is a franking entity that satisfies the residency requirement when the distribution is made; and (b) the distribution is a frankable distribution; and (c) the entity allocates a franking credit to the distribution. A 'franking entity' is defined in section 202-15 of the ITAA 1997 to include a 'corporate tax entity'. A 'corporate tax entity', pursuant to section 960-115 of the ITAA 1997, includes a company. Company N is a company incorporated in Australia and an Australian resident for tax purposes. At the time of the distribution to be made by Company N, it will remain an Australian resident under paragraph 202-20(a) of the ITAA 1997. Thus, Company N will be a franking entity for the purposes of paragraph 202-5(a) of the ITAA 1997. The distribution also needs to be a frankable distribution (paragraph 202-5(b) of the ITAA 1997). The kinds of distributions that can be franked are defined in section 202-40 of the ITAA 1997 as distributions and non-share dividends, unless it is specified that they are unfrankable under section 202-45 of the ITAA 1997. Subsection 202-40(1) of the ITAA 1997 provides that: (1) A *distribution is a frankable distribution, to the extent that it is not unfrankable under section 202-45. Paragraph 202-45(e) of the ITAA 1997 specifically makes the following unfrankable: a distribution that is sourced, directly or indirectly, from a company's *share capital account. A 'distribution' is defined in section 960-120 of the ITAA 1997 as: a dividend, or something that is taken to be a dividend, under this Act. Subsection 6(1) of the ITAA 1936 provides the definition of 'dividend' and it states: dividend includes: (a) any distribution made by a company to any of its shareholders, whether in money or other property; and (b) any amount credited by a company to any of its shareholders as shareholders; … but does not include: (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' in the above definition has the meaning given in subsection 975-300(1) of the ITAA 1997 as 'an account that the company keeps of its share capital' or 'any other account … the first amount credited to the account was an amount of share capital'. The share capital account included in the Company N's stand-alone financial statements is the share capital of Company N for tax purposes. The proposed dividend will not be debited against the share capital account of Company N. It will be debited against the profits account of Company N. The proposed dividend payment to be made by Company N will constitute an amount of money to be paid to its shareholders. Further, the applicant has also confirmed that the whole amount of the proposed dividend will be debited in full to the current year profit account of Company N and not against any amounts standing to the credit of its share capital account. Hence the distribution to be made by Company N will be a dividend pursuant to subsection 6(1) of the ITAA 1936, and therefore a 'distribution' as defined in section 960-120 of the ITAA 1997. As set out above, paragraph 202-45(e) of the ITAA 1997 makes a distribution 'sourced, directly or indirectly, from a company's share capital account' unfrankable. The question of whether a distribution is 'sourced, directly or indirectly, from a company's share capital account' is one based on fact. In the present scheme, Company N expects to declare the proposed dividend in the current year. Company N advised that the company will satisfy all the requirements in section 254T of the Corporations Act for the declaration and payment of the proposed dividend. The proposed dividend will not be sourced, directly or indirectly, from the share capital account of Company N but will be funded from current profits. The applicant has confirmed that the current year profits will not be offset in the accounting records of Company N against the prior year accumulated losses of Company N prior to the proposed dividend being declared and paid. Company N has sufficient franking credits to fully frank the proposed dividend, thereby completing the requirements in section 202-5 of the ITAA 1997. Therefore, the proposed dividend would not be a type of distribution identified within paragraph 202-45(e) of the ITAA 1997 as being unfrankable. Accordingly, the proposed dividend to be declared and paid by Company N and to be debited against the amount standing to the credit of Company N's profits account will not be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Company N proposes to make a capital return of $13 million to be sourced from a capital return to be made by a subsidiary of Company N. Section 12-210 of Schedule 1 to the TAA 1953 provides that a company that is an Australian resident must withhold an amount from a dividend it pays if: (a) according to the register of the company's members, the entity, or any of the entities, holding the *shares on which the dividend is paid has an address outside Australia; or (b) that entity, or any of those entities, has authorised or directed the company to pay the dividend to an entity or entities at a place outside Australia. According to the register of members of Company N, Shareholder B has an address outside 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. (b) Any amount credited by a company to any of its shareholders as shareholders. But excludes: (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 proposed capital return will be debited against the amount standing to the credit of the untainted share capital account of Company N. In this regard, the exclusion contained in paragraph (d) is prima facie applicable to the proposed capital return to be undertaken by Company N. Subsection 6(4) of the ITAA 1936 also 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 proposed capital return will be sourced from the cash reserves of the Company N group. There is no arrangement whereby the share capital account of Company N will be credited in connection with the proposed debiting of the share capital account required to effect the capital return. Accordingly, there is no arrangement whereby the share capital account of Company N will be credited in connection with the proposed debiting of the share capital account required to effect the proposed capital return. As such, the present scheme is not one that triggers the operation of paragraphs 6(4)(a) and (b) of the ITAA 1936. Thus, paragraph (d) exclusion still applies. Further for the reasons given under Question 3 below the Commissioner will not make a determination under either subsection 45A(2) or subsection 45B(3) of the ITAA 1936 that section 45C applies to treat the capital benefit under the proposed capital return as an unfranked dividend. In view of the above, Company N will have no obligation to withhold an amount from the payment of the proposed capital return to Shareholder B for the purposes of section 12-210 of Schedule 1 to the TAA 1953. | Detailed Reasoning - Detailed reasoning: Subsection 45C(3) of the ITAA 1936 provides that: If the Commissioner has made a determination under section 45B in respect of the whole or a part of a capital benefit and the Commissioner makes a further written determination that the capital benefit, or the part of the capital benefit, was paid under a scheme for which a purpose, other than an incidental purpose, was to avoid franking debits arising in relation to the distribution from the company: (a) on the day on which notice of the determination is served in writing on the company, a franking debit of the company arises in respect of the capital benefit; and (b) the amount of the franking debit is the amount that, if the company had: (i) paid a dividend of an amount equal to the amount of the capital benefit, or the part of the capital benefit, at the time when it was provided; and (ii) fully franked the dividend; would have been the amount of the franking credit of the company that would have arisen as a result of the dividend. In considering whether subsection 45C(3) of the ITAA 1936 is satisfied in respect of the proposed capital return, it is necessary for the Commissioner to make a determination under section 45B of the ITAA 1936 in respect of the whole or part of the capital benefit. Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if 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; 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; 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. | Detailed Reasoning - 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 (subsection 45B(10) of the ITAA 1936). A scheme is defined in subsection 995-1(1) of the ITAA 1997 to mean: (a) any arrangement; or (b) any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. Paragraph 41 of 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 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 capital return by Company N is considered to be a 'scheme' for the purposes of section 45B of the ITAA 1936. | Detailed Reasoning - Capital benefit: Subsection 45B(5) of the ITAA 1936 defines 'provided with a capital benefit' as a reference to a person being provided with a capital benefit to any of the following: (a) the provision of ownership interest in a company to the person; (b) the distribution to the person of share capital or share premium; (c) something that is done 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) that is held by the person. Under the present scheme, Company N proposes to make a capital distribution to each of its shareholders by debiting its share capital account. Thus, Company N will be providing its shareholders with a 'capital benefit' as defined in paragraph 45B(5) of the ITAA 1936. | Detailed Reasoning - Does the relevant taxpayer obtain a tax benefit?: For paragraph 45B(2)(b) of the ITAA 1936 to be satisfied, 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 had been a dividend. Accordingly, the tax effect of paying the amount as a dividend must be considered when determining whether the taxpayer has obtained a tax benefit or not. 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. However, Explanatory Memorandum to the Taxation Laws Amendment (Company Law Review) Bill 1998 identifies a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends as stated below: 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). In the present scheme, the applicant has confirmed that Company N has sufficient franking credits to fully frank the entire distribution, were the capital component to be paid instead as a dividend. However, 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 would constitute the obtaining of a tax benefit. | Detailed Reasoning - 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'. The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. Under the proposed scheme paragraphs 45B(8)(a), 45B(8)(b) and 45B(8)(k) of the ITAA 1936 are relevant for the purposes of determining the requisite purpose pursuant to paragraph 45B(2)(c) of the ITAA 1936. Paragraph 45B(8)(a) of the ITAA 1936 This paragraph refers to 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. 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. The applicant contends that no part of the proposed capital return is attributable to the profits of Company N or an associate of Company N because substantially all of the available profits will have been distributed to the shareholders of Company N 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. The surplus cash of the group remaining after the proposed dividend represents surplus share capital of the group. The management of the business have determined that this share capital is surplus to its needs. Paragraph 72 of PS LA 2008/10 states that: … The mere existence of profits will not automatically trigger application of section 45B; rather, the availability of profits is but one matter to be considered in the attribution inquiry posed by paragraph 45B(8)(a). This means that the mere fact that some profits may be available in subsidiaries should not automatically mean that section 45B of the ITAA 1936 is triggered. In the present case, there will be some amounts of profits of Company N 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. Paragraph 45B(8)(b) of the ITAA 1936 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 N had previously paid fully franked dividends and returned share capital. 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 N will distribute substantially all of its profit prior to making the return of capital. Therefore, there is no indication that the proposed capital return by Company N is being used to replace standard profit distributions. The Company N Group has surplus capital due to strong operating cash flows and is returning share capital that was not previously returned to shareholders. Company N does not have further surplus capital to return to shareholders following the distribution of the proposed capital return. Given the above circumstances, the pattern of distributions does not indicate that the requisite purpose exists. Paragraph 45B(8)(k ) This paragraph refers to the matters in subparagraphs 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. These matters include, among other things, the form and substance of the scheme and its financial implications for the parties involved. In this case, the practical implications of the scheme for Company N and its shareholders are consistent with it being, in form and substance, a return of share capital. | Detailed Reasoning - Conclusion: In view of the above, the Commissioner will not make a determination pursuant 45C (3) of the ITAA 1936 as section 45B of the ITAA 1936 will not apply to the scheme. | Detailed Reasoning - Detailed reasoning: Section 205-10 of the ITAA 1997 provides that each entity that is a corporate tax entity has a franking account. Company N as a corporate entity has a franking account. Subsection 202-40(1) of the ITAA 1997 states: (1) A distribution is a frankable distribution , to the extent that it is not unfrankable under section 202-45. The table contained in subsection 205-30(1) of the ITAA 1997 sets out when a debit will arise in the franking account of an entity and the amount of the debit. The amount is called a franking debit. Item 3 of the table contained in subsection 205-30(1) of the ITAA 1997 provides that a franking debit arises for an entity in circumstances where the entity franks a 'distribution' in contravention of the franking benchmark rule. Subsection 995-1(1) of the ITAA 1997 refers to section 960-120 of the ITAA 1997 for the meaning of distribution. Item 1 of the table in section 960-120 of the ITAA 1997 states that a company will be taken to have made distribution where it pays a dividend or something taken to be a dividend under either the ITAA 1936 or ITAA 1997. As discussed in question 2 above, the proposed capital return to be undertaken by Company N will not constitute a 'dividend' as defined in subsection 6(1) of the ITAA 1936. Therefore, the amount of capital to be returned by Company N will not be a 'distribution' for these purposes. Accordingly, the proposed capital return amount will not be a frankable distribution in accordance with subsection 202-40(1) of the ITAA 1997. Paragraph 202-45(e) of the ITAA 1997 states that a distribution will be unfrankable to the extent that it is sourced, directly or indirectly, from a company's share capital account. In the current circumstances, the proposed capital return will be debited against the amount standing to the credit of the untainted share capital account of Company N and will therefore be unfrankable pursuant to paragraph 202-45(e) of the ITAA 1997. Accordingly, on the basis that the proposed capital return will not be a dividend for income tax purposes, a franking debit will not arise in the franking account of Company N pursuant to section 205-30 of the ITAA 1997 on the day the distribution is made, or from the application of any other provision of the ITAA 1936 or ITAA 1997.