Private ruling: Return of share capital
Published: November 2014
Ruling period: Income year ended 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the Commissioner exercise his discretion under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) to apply section 45C of the ITAA 1936 to the Private Company's proposed return of share capital to the Taxpayer? | A1: No

Relevant facts and circumstances: The Taxpayer is the sole shareholder and director of the Private Company, which is a resident private company that was incorporated in 2004. As at 30 June 2014, the Private Company's shareholder funds were wholly comprised of issued share capital due to accumulated losses and negative unrealised losses (representing the decrease in market value of the Private Company's assets over a period of time). As the sole shareholder and director of the Private Company, the Taxpayer would like to take steps to winding up the affairs of the Private Company and eventually have it deregistered in accordance with section 601AA of the Corporations Act 2001 (Corporations Act). It is proposed to commence the process of winding up the Private Company's affairs by: • assigning (or transferring) out its assets • paying a small fully franked dividend, and • returning the share capital to the Taxpayer in accordance with the requirements of the Corporations Act. The Private Company has paid the Taxpayer fully franked dividends for the income years ended 30 June 2009 to 30 June 2014, during which they have either gradually or steeply declined. The Taxpayer has no carried forward capital losses. The Taxpayer is a resident taxpayer. There is no intention for the Private Company to become presently entitled to trust distributions from any associated trust in the income year ended 30 June 2015.

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 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 Subsection 45B(5), | Income Tax Assessment Act 1936 Paragraph 45B(5)(b), | Income Tax Assessment Act 1936 Subsection 45B(8), | Income Tax Assessment Act 1936 Paragraph 45B(8)(a), | Income Tax Assessment Act 1936 Paragraph 45B(8)(b), | Income Tax Assessment Act 1936 Paragraph 45B(8)(c), | Income Tax Assessment Act 1936 Paragraph 45B(8)(d), | Income Tax Assessment Act 1936 Paragraph 45B(8)(e), | Income Tax Assessment Act 1936 Paragraph 45B(8)(f), | Income Tax Assessment Act 1936 Paragraph 45B(8)(h ), | Income Tax Assessment Act 1936 Paragraph 45B(8)(k) , | Income Tax Assessment Act 1936 Subsection 45B(9), | Income Tax Assessment Act 1936 Subsection 45B(10), | Income Tax Assessment Act 1936 Section 45C, | Income Tax Assessment Act 1936 Subparagraph 177D(b)(i), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(ii), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(iii ), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(iv), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(v), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(vi), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(vii), | Income Tax Assessment Act 1936 Subparagraph 177D(b)(viii), | Income Tax Assessment Act 1997 Section 104-135, | Income Tax Assessment Act 1997 Subdivision 115-A, | Income Tax Assessment Act 1997 Subdivision 115-B and | Income Tax Assessment Act 1997 Subsection 995-1(1).

Reasons for decision: Summary: The Commissioner will not exercise his discretion under subsection 45B(3) of the Income Tax Assessment Act 1936 (ITAA 1936) to apply section 45C of the ITAA 1936 to the Private Company's proposed return of share capital to The Taxpayer. | Detailed Reasoning - Detailed reasoning: The purpose of section 45B of the ITAA 1936 is to ensure relevant amounts are treated as dividends for taxation purposes where certain distributions are made to shareholders in substitution of dividends. If section 45B of the ITAA 1936 applies, the Commissioner may make a determination that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the distribution to the shareholders. Under section 45C of the ITAA 1936, the whole, or a part, of the distribution is taken to be an unfranked dividend paid by the company to its shareholders. Subsection 45B(2) of the ITAA 1936 sets out the requirements for section 45B of the ITAA 1936 to apply. These requirements are that: • there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); • 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) of the ITAA 1936); and • 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) of the ITAA 1936). Each of these requirements is considered below. | Detailed Reasoning - A scheme: Subsection 45B(10) of the ITAA 1936 states that for the purposes of section 45B of the ITAA 1936, 'scheme' has the meaning given by subsection 995-1(1) of the Income Tax Assessment Act 1997 (ITAA 1997), which defines it to mean any arrangement; or any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The arrangement involving the proposed return of share capital by the Private Company to the Taxpayer is 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 1936, and paragraph (b) includes a distribution by a company to a person of share capital. The arrangement involving the proposed return of share capital by the Private Company to the Taxpayer, means that they will be provided with a capital benefit under paragraph 45B(5)(b) of the ITAA 1936. | Detailed Reasoning - Tax benefit: A taxpayer 'obtains a tax benefit', as defined in subsection 45B(9) of the ITAA 1936, if: • 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 been an assessable dividend. The relevant taxpayer in the present case is the Taxpayer. But for section 45B of the ITAA 1936, the amount of tax payable by the Taxpayer on the proposed return of share capital by the Private Company will be less than the amount that would have been payable if the capital benefit had been an assessable fully franked dividend. For a resident shareholder, a return of capital would be subject to the CGT provisions rather than assessed as a dividend under subsection 44(1) of the ITAA 1936. Unless the return of capital amount exceeds the shareholder's 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 return of share capital exceeds the shareholder's cost base of the shares that a capital gain arises. Even then, the amount of tax payable by the Taxpayer as a result of any such capital gain is likely to be less than the amount that would have been payable on an assessable fully franked dividend, due to the availability, under Subdivisions 115A and 115-B of the ITAA 1997, of the 50% discount to individuals who own a CGT asset for at least 12 months. Therefore, the Taxpayer will obtain a tax benefit under subsection 45(9) of the ITAA 1936. | Detailed Reasoning - A more than incidental purpose of enabling a taxpayer to obtain a tax benefit: Under paragraph 45B(2)(c) of the ITAA 1936, the purpose of the person, or one of the persons, who entered into or carried out the scheme, or any part of the scheme, is determined having regard to the 'relevant circumstances of the scheme'. Subsection 45B(8) of the ITAA 1936 provides a (non-exhaustive) list of the relevant circumstances. The test of purpose is an objective one. The question is whether 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 the purpose of enabling a taxpayer to obtain a tax benefit. The requisite purpose need not be the dominant purpose, but it must be more than an incidental purpose. The relevant circumstances of the scheme in the present case are discussed below (insofar as they are relevant). | Detailed Reasoning - Paragraph 45B(8)(a) of the ITAA 1936: Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the capital benefit is attributable to capital or attributable to profits (realised and unrealised) of the company or an associate of the company. As at 30 June 2014 the Private Company's shareholder funds were wholly comprised of issued share capital due to accumulated losses and negative unrealised losses. As the Private Company has no realised or unrealised profits, and will not become presently entitled to any trust distributions from any associated trust for the income year ended 30 June 2015, the capital benefit will be 100% attributable to the share capital of the Private Company. This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(b) of the ITAA 1936: Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distribution of dividends, bonus shares and returns of capital or share premium. Over the income years ended 30 June 2009 to 30 June 2014, the fully franked dividends the Private Company has paid to the Taxpayer have either gradually or steeply declined. However, offsetting this is the fact that as at 30 June 2014 the money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This circumstance neither points toward or away from the requisite purpose in paragraph 45(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(c) of the ITAA 1936: Paragraph 45B(8)(c) of the ITAA 1936 refers to whether the relevant taxpayer has capital losses that, apart from the scheme, would be carried forward to a later year of income. The Taxpayer has no carried forward capital losses. This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(d) of the ITAA 1936: Paragraph 45B(8)(d) of the ITAA 1936 refers to whether some or all of the ownership interests in the company held by the relevant taxpayer were acquired, or taken to have been acquired, by the relevant taxpayer before 20 September 1985. Where taxpayers receive a capital distribution in respect of a pre-CGT asset there would ordinarily be no CGT implications for the shareholders and this could influence the company's decision to return capital to shareholders. The Private Company was incorporated in 2004, meaning that the Taxpayer did not acquire their 100% ownership interest in the Private Company before 20 September 1985. This circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(e) of the ITAA 1936: Paragraph 45B(8)(e) of the ITAA 1936 refers to whether the relevant taxpayer is a non-resident. The Taxpayer is a resident, meaning that this circumstance points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(f) of the ITAA 1936: Paragraph 45B(8)(f) of the ITAA 1936 refers to whether the cost base of the relevant ownership interest is not substantially less than the value of the applicable capital benefit. Where the cost base of the ownership interest is similar or greater in value than the capital benefit provided, the capital distribution will not expose the relevant taxpayer to a capital gain under CGT event G1 as the return of share capital will not exceeds the shareholder's cost base of the shares. The cost base of the Taxpayer's 100% ownership interest in the Private Company is substantially more than the return of share capital. However, offsetting this is the fact that as at 30 June 2014 the money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This circumstance tends neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(h) of the ITAA 1936: Paragraph 45B(8)(h) of the ITAA 1936 refers to whether the interest held by the relevant taxpayer after the distribution is the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of share capital. The Taxpayer would have a 100% ownership interest in the Private Company if the money is paid as either a return of share capital or as a fully franked dividend. However, offsetting this is the fact that as at 30 June 2014 the money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This circumstance tends neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Paragraph 45B(8)(k) of the ITAA 1936: Paragraph 45B(8)(k) of the ITAA 1936 refers to the Part IVA matters in subparagraphs 177D(b)(i) to 177D(b)(viii) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(i) of the ITAA 1936: This matter refers to the manner in which the scheme was entered into and carried out. The proposed scheme involves the Private Company paying a return of share capital to the Taxpayer on or before 30 June 2015 after paying the Taxpayer a small fully franked dividend and assigning (or transferring) out all of the assets. The money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(ii) of the ITAA 1936: This matter looks to the form and substance of the scheme. The legal form of the scheme will be a return of share capital to the Taxpayer in accordance with the requirements of the Corporations Act. Due to the Private Company having no realised or unrealised profits as at 30 June 2014, the substance of the scheme will align with its form, as the proposed payment to the Taxpayer will sourced entirely from the Private Company's share capital. This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(iii) of the ITAA 1936: This matter refers to the time at which the scheme was entered into and the length of the period during which the scheme was carried out. In particular, it enables consideration of the extent to which the timing and duration of the scheme go towards delivering the relevant tax benefit or is related to commercial opportunities or requirements. The scheme will be entered into and carried out on or before 30 June 2015 as part of the Taxpayer's intention to wind up the affairs of the Private Company and eventually have it deregistered after that date. This matter points away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(iv) of the ITAA 1936: This matter refers to the result the scheme would achieve under the ITAA 1936 and the ITAA 1997 but for the application of section 45B of the ITAA 1936. But for section 45B of the ITAA 1936, the proposed return of share capital will not be a dividend as defined in subsection 6(1) of the ITAA 1936 and will not be assessable income for the Taxpayer under subsection 44(1) of the ITAA 1936. Furthermore, CGT event G1 happens for the Taxpayer when the return of share capital is paid, however no capital gain will be made as this amount will be less than the Taxpayer's cost base for the Private Company's shares. But for section 45B of the ITAA 1936, the return of share capital is preferable to a fully franked dividend (i.e. less tax payable) for the Taxpayer. This matter points toward the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(v) of the ITAA 1936: This matter refers to any change in the financial position of the relevant taxpayer. Whilst the Taxpayer's 100% ownership in the Private Company will remain unchanged after the proposed return of share capital, this payment is only part of the Taxpayer's intention to wind up the affairs of the Private Company and eventually have it deregistered. This matter neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(vi) of the ITAA 1936: This matter refers to the change in the financial position of any person connected with the relevant taxpayer. The Private Company's financial position will be reduced by the return of share capital payment, which will be no different to the effect that paying an equivalent dividend would have had on the Private Company. However, offsetting this is the fact that as at 30 June 2014 the money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This matter neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(vii) of the ITAA 1936: This matter requires consideration of any other consequences of the scheme for the relevant taxpayer or any person connected with the relevant taxpayer. Other than the proposed return of share capital being part of the Taxpayer's intention to wind up the affairs of the Private Company and eventually have it deregistered, there are no other consequences of the scheme being entered into or carried out for either the Private Company or the Taxpayer. This matter neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Subparagraph 177D(b)(viii) of the ITAA 1936: This matter looks to the nature of any connection between the relevant taxpayer and any other person connected with the relevant taxpayer. The connection between the relevant parties is the relationship of shareholder and company. As the Taxpayer is the sole shareholder and director of the Private Company, it may be argued that the proposed return of share capital is for their benefit at the detriment of the Private Company. However, offsetting this is the fact that as at 30 June 2014 the money used to make the return of share capital to the Taxpayer will be sourced solely from its share capital as the Private Company had no realised or unrealised profits as at 30 June 2014. This matter neither points toward or away from the requisite purpose in paragraph 45B(2)(c) of the ITAA 1936. | Detailed Reasoning - Conclusion on purpose under paragraph 45B(2)(c) of the ITAA 1936: Having regard to the relevant circumstances of the scheme, it is concluded that the Private Company will not be entering into or carrying out the scheme, or any part of the scheme, for a more than incidental purpose of enabling the Taxpayer to obtain a tax benefit.