Private ruling: Return of share capital
Published: May 2012
Ruling period: XX/ XX/ XXXX to XX /XX/ XXXX
Date scheme commenced: XX/XX/XXXX

Ruling: Q1: Will the Commissioner confirm that the distribution by Company C to its shareholder, B (totalling $X million) in the form of a pro-rata return of share capital without cancellation of shares will not constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | A1: Yes | Q2: Will the Commissioner confirm that he will not make a determination under section 45C of the ITAA 1936 because subsection 45A(2) of the ITAA 1936 will not apply in relation to the whole or any part of the return of share capital? | A2: Yes | Q3: Will the Commissioner confirm that he will not make a determination under section 45C of the ITAA 1936 because subsection 45B(3) of the ITAA 1936 will not apply in relation to the whole or any part of the return of share capital? | A3: Yes

Relevant facts and circumstances: Description of the group Structure A non-resident Shareholder B, is the parent of the Australian Company C Shareholder B is the sole shareholder of Company C. Proposed Transaction Return of share capital Company C raised $XXX amounts of share capital in the 2009 and 2010 income years from Shareholder B to fund its objective of expanding its business operations and acquisition of suitable land or properties. Shareholder B funded its investment through debt borrowed from various foreign financial institutions. Company C proposes to return share capital to Shareholder B during this income year. The return of share capital is proposed to be implemented by way of a pro-rata reduction of capital on all shares issued by Company C to Shareholder B without a cancellation of shares. That is, there will be no change in the number ordinary shares on issue and held by Shareholder B in Company C. The commercial reasons for the return of share capital are to meet the financial requirements and achieve efficient utilisation of funds at Shareholder B. Dividend policy Company C has not paid any dividends nor return any share capital since incorporation. Company C has no formal dividend or capital distribution policy. Other information Shareholders B's CGT cost base in each share in Company B is $X. The applicant contends that the cash position of Company C will not be materially affected by the transfer of share capital to Shareholder B. The applicant advises that the share capital account of Company C (as defined in section 975- 300 of the ITAA 1997) is not tainted (within the meaning of Division 197 of the ITAA 1997). The applicant advises that Division 855 of the ITAA 1997 would not apply to exempt Shareholder B from any Australian Capital Gains Tax given the current asset profile of Company C.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 6(1), | Income Tax Assessment Act 1936 subsection 6(1)(d), | Income Tax Assessment Act 1936 subsection 44(1), | Income Tax Assessment Act 1936 section 45A, | Income Tax Assessment Act 1936 subsection 45A(2), | Income Tax Assessment Act 1936 paragraph 45A(3)(b), | Income Tax Assessment Act 1936 section 45B, | Income Tax Assessment Act 1936 paragraph 45B(1)(a), | Income Tax Assessment Act 1936 paragraph 45B(1)(b), | 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 paragraph 45B(3)(b) | Income Tax Assessment Act 1936 subsection 45B(5), | 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 section 45C, | Income Tax Assessment Act 1936 paragraph 128B(3)(ga), | Income Tax Assessment Act 1936 section 318, | Income Tax Assessment Act 1936 subsection 177(D)(b), | Income Tax Assessment Act 1997 Division 197, | Income Tax Assessment Act 1997 section 197-50, | Income Tax Assessment Act 1997 Division 855, | Income Tax Assessment Act 1997 section 855-15, | Income Tax Assessment Act 1997 section 975-300, | Income Tax Assessment Act 1997 subsection 975-300(3) and | Income Tax Assessment Act 1997 subsection 995-1(1). Does Part IVA apply to this ruling? | Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable. | We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part. | If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply. | For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision: Summary: Question 1 The proposed return of share capital to shareholder B will not be a dividend as defined in subsection 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), paid to the shareholder 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. '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 generally taken not to be a share capital account 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 of the ITAA 1997 applies, is transferred to the account and the account is not already tainted. The return of share capital was debited against Company C's share capital account. The applicant advises that there have been no transfers into Company C's share capital account as defined in section 975-300 of the ITAA 1997. Therefore, paragraph (d) of the definition of 'dividend' in subsection 6(1) of the ITAA 1936 applies and the return of share capital will not constitute a dividend. | Summary: The Commissioner will not make a determination under section 45C of the ITAA 1936 because subsection 45A(2) of the ITAA 1936 will not apply to any of the proposed return of share capital to the shareholder B. | Detailed Reasoning - Detailed reasoning: Section 45A of the ITAA 1936 will apply where a company streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that: · The capital benefits are, or apart from section 45A of the ITAA 1936 would be, received by shareholders who would, in the year of income in which the capital benefits are provided, derive a greater benefit from the capital benefits than other shareholders (the advantaged shareholders). · It is reasonable to assume that the other shareholders have received, or will receive, dividends (the disadvantaged shareholders). · The streaming does not have to occur within the same income year. It can occur in different income years. The Explanatory Memorandum (Senate) to the Taxation Laws Amendment (Company Law Review) Bill 1998 which inserted section 45A of the ITAA 1936 explains that the section "applies in circumstances where capital benefits are streamed to shareholders (advantaged shareholders) who gain a tax benefit from the receipt of capital while dividends are paid to those who would not gain such a benefit (disadvantaged shareholders)". Shareholder B will be provided with a capital benefit because share capital will be distributed to it (paragraph 45A(3)(b) of the ITAA 1936). However, for section 45A of the ITAA 1936 to apply, Company C must stream the provision of capital benefits and dividends to its shareholders in the way prescribed by the section. Company C has a single class share capital structure consisting solely of ordinary shares which all have the same rights and are all owned by Shareholder B. The return of share capital will be paid to Shareholder B as the holder of all fully paid ordinary shares on XX/XX/XXXX (proposed date of return of share capital). Given that there is only one shareholder, there is no other shareholder that will derive a greater benefit from the capital benefit. As a result, there is no streaming of capital benefits by Company C to Shareholder B as the holder of fully paid ordinary shares on XX/XX/XXXX will receive the same capital benefit in respect of each share held. Accordingly, section 45A of the ITAA 1936 does not apply to the return of capital and the Commissioner will not make a determination under section 45C of the ITAA 1936 because subsection 45A(2) of the ITAA 1936 will not apply in relation to the return of share capital. | Summary: The Commissioner will not make a determination under section 45C of the ITAA 1936 because subsection 45B(3) of the ITAA 1936 will not apply to any of the proposed return of share capital to the shareholder B. | Detailed Reasoning - Detailed reasoning: Section 45B of the ITAA 1936 applies to ensure that relevant amounts are treated as dividends for taxation purposes if: Components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger (paragraph 45B(1)(a) of the ITAA 1936; or 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 will apply in relation to the whole, or a part, of the capital benefit. The effect of section 45C applying to a capital benefit is that the amount of the capital benefit, or part of the benefit, is taken to be an unfranked dividend that is paid by the company to the shareholder or relevant taxpayer at the time at which they are paid the capital benefit. Subsection 45B(2) of the ITAA 1936 provides that section 45B of the ITAA 1936 applies if: · there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936); and · 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 (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 a taxpayer (the relevant taxpayer) to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936). | Detailed Reasoning - (a) Is there a relevant scheme under which a person is provided with a capital benefit?: "Relevant scheme" A scheme for the purposes of section 45B has the meaning given by subsection 995-1(1) of the ITAA 1997. A scheme is defined in subsection 995-1(1) to mean; · any arrangement, agreement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; or · any scheme, plan, proposal, action, course of action or course of conduct, whether unilateral or otherwise. The proposed return of share capital is considered to be a "scheme" within the broad meaning of that term. "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 distribution will be debited to Company C's share capital account, Company C will provide Shareholder B with a 'capital benefit' as defined within the subsection. (b) Does a taxpayer (the relevant taxpayer) who may or may not be the person provided with the demerger benefit or the capital benefit, obtain a tax benefit "The relevant taxpayer" The relevant taxpayer is the taxpayer who obtains a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936. Under the present scheme, the shareholder B is entity that will be provided with the capital benefit. "Obtain a tax benefit" If the section is to apply, the provision of the capital benefit must be accompanied by an associated tax benefit. A tax benefit is defined by subsection 45B(9) of the ITAA 1936 as follows: "A relevant taxpayer obtains a tax benefit if an amount of tax payable, or any other amount payable under this Act, by the relevant taxpayer would, apart from this section, 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 demerger benefit had been an assessable dividend or the capital benefit had been an assessable dividend ". Generally, where there is a distribution of share capital, a tax benefit will arise as a shareholder or the relevant taxpayer will pay less tax on the distribution than they would have if the amount had instead been a 'dividend'. In addition to this general circumstance, the relevant taxpayer also obtains a tax benefit where the distribution of share capital by the company forestalls the distribution of franked dividends. This scenario is identified by the Explanatory Memorandum to the Bill enacting section 45B of the ITAA 1936: 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). The applicant advises that Company C has never paid a franked dividend to Shareholder B, nor does Company C intends to make such a distribution within the foreseeable future. Based on the facts of this scheme, paragraph 45B(2)(b) of the ITAA 1936 is satisfied. | Detailed Reasoning - (c) 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'. 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. As the test of purpose is an objective test, the question is whether it would be concluded that a person who entered into or carried out the scheme did so, for the purpose of obtaining a tax benefit for the relevant taxpayer in respect of the capital benefit. For the purposes of this specific ruling the relevant circumstances to be considered under subsection 45B(8) of the ITAA 1936 covering the circumstances of the company and the tax profile of the shareholders are paragraphs 45B(8)(a)-(f), (h) and (k). Paragraph 45B(8)(a) of the ITAA 1936 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. Whether the proposed distribution of capital is 'attributable' to profit 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. Company C proposes to return of share capital which will be debited against the company's share capital account. In the context of attributing a distribution to the 'profit' of the company, the term 'profit' takes on its ordinary meaning and is not limited to the Corporation Act 2001 definition of the term: MacFarlane v. FCT 86 ATC 4477; (1986) 17 ATR 808. It extends beyond profits legally distributable by the company to profits which are available to be harvested by the company for distribution at that time or at a future time. Furthermore, for taxation purposes, the existence of profits does not depend on their recognition in the books of the company: Latham CJ in Dickson v. FCT (1940) 62 CLR 687 at 705 to 706 and Kitto J in FCT v. Uther (1965) 112 CLR 630 at 636 to 640. Taxation Ruling TR2003/8 provides guidance on the meaning of 'profits' in determining whether or not profits exist for the purpose of section 45B of the ITAA 1936. Paragraph 15 of Taxation Ruling TR 2003/8 states that: So long as the market value of the company assets exceeds the total amount (as shown in its books of account) of its liabilities and share capital what remains is profits. In this case the total market value of Company C exceeds its carried book value. Accordingly, Company C has available unrealised profits in the amount of $XX million. Prima facie, the existence of sufficient amounts of retained profits on the balance sheet confirms a source from which the proposed distribution of share capital by Company C could be attributed to. Having regard to the background facts of the scheme and the history of Company C, it has derived relatively small amounts of profit. In general and as explained in Law Administration Practice Statement PS LA 2008/10 , the Commissioner will have close regard to the circumstances where a company proposing to return share capital to its shareholders but which is not referable to an extraordinary event in the company to see whether the company is in fact substituting the role of share capital in the business with distributable profits. In this case, the applicant advises that the funds attributable to the recent increases of share capital were initially used for infrastructure development. However restricted investment opportunities have resulted in excess surplus cash. The applicant contends that Shareholder B is able to obtain a higher return if the surplus capital is invested elsewhere and therefore the source of the funds for the return of capital is referable to unutilised share capital previously raised by Company C. In the present case and notwithstanding the existence of retained and unrealised profits of Company C there is on balance no discernible connection to the proposed return of share capital. Therefore, for the purposes of this factor it is considered that the proposed distribution of capital is not attributable to profits. | Detailed Reasoning - Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions made by a company or an associate of the company.: The applicant submits that there have been no dividends, bonus shares, or return of share capital from the Company C to their shareholder since incorporation. The Commissioner has explained in paragraph 77 of PSLA 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. Furthermore, paragraph 78 of PSLA 2008/10 provides that "the fact that the company may not have made any distributions previously, whether of profit or share capital, does not point away from the requisite purpose." Considering the background of the applicant and their distribution history, it is concluded that this factor is neutral. | Detailed Reasoning - c) - e) whether the relevant taxpayer had capital losses, holds pre CGT shares or is a non-resident;: Capital losses Shareholder B does not have any capital losses. Accordingly the availability of capital losses is not considered to be a relevant factor in determining purpose under paragraph 45B(2)(c) of the ITAA 1936. Holds pre CGT shares All shares in Company C were issued in 199X, accordingly the availability of pre-CGT status is not considered to be a relevant factor. Non-resident The applicant submits that Company C shares are 'taxable Australian property' for the purpose of section 855-15 of the ITAA 1997. Accordingly the CGT exemption does not apply to the Shareholder B despite the fact that it is a foreign resident shareholder. Shareholder B is however exempted from withholding tax on fully franked dividends pursuant to paragraph 128B(3)(ga) of the ITAA 1936. Other than the preservation of franking credits, there is no immediate direct tax benefit to Shareholder B from receiving share capital rather than a dividend. f) whether the cost base (for the purposes of the Income Tax Assessment Act 1997) of the relevant ownership interest is not substantially less than the value of the applicable demerger benefit or capital benefit; The $X cost base of the share is not substantially less than the value of the capital benefit. h) if the scheme involves the distribution of share capital or share premium - 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 or share premium; As Shareholder B is the sole shareholder, the reduction of share capital in Company C and distribution to Shareholder B will not change either the legal and economic proportion of ownership or interest of Shareholder B. | Detailed Reasoning - k) any of the matters referred to in s177D(b)of the ITAA 1936 which call for a consideration of the following;: the manner in which the scheme was entered into or carried out; The proposed scheme for an equal reduction of share capital of Company C is consistent with the procedure at general law. the form and substance of the scheme; The form of the scheme is consistent with an equal reduction of share capital under the Corporations Act 2001 . Economically, the relevant taxpayer receives cash and an increase in assets whether the distribution is debited to profit or share capital. However, the advantage obtained is the tax preferential treatment in receiving share capital under the tax law as opposed to a dividend. The relevant taxpayer will receive cash to reflect the monetary decrease in their investment in the company. In this scheme the form equates to the substance of the transaction. the time at which the scheme was entered into and the length of the period during which the scheme was carried out; The proposed reduction of share capital will occur in this income year coinciding with the point in time in which the business operations are beginning to derive profits and increase in cash holdings. Having regard to the difficulties encountered in expanding the business, the opportunity for a higher return from investments elsewhere it is not unreasonable to conclude that the timing of the scheme is closely connected to commercial imperatives. the result in relation to the operation of this Act that, but for this Part, would be achieved by the scheme; This factor requires identifying the tax results of the scheme and consideration if section 45B did not apply. In the absence of this Part, the scheme results in the preservation of franking credits in Company C and the realisation of a foreign exchange gain. any change in the financial position of the relevant taxpayer that has resulted, will result, or may reasonably be expected to result, from the scheme; Shareholder B would record an exchange rate gain from the proposed scheme due to the appreciation of the AUD. Additional financial gains will accrue to Shareholder B because of preferential tax treatment under overseas tax laws from receiving the distribution of share capital rather than dividends. any change in the financial position of any person who has, or has had, any connection (whether of a business, family or other nature) with the relevant taxpayer, being a change that has resulted, will result or may reasonably be expected to result, from the scheme; The effect of the scheme is that it will preserve franking credits for future distribution of dividends. Shareholder B would also reduce their tax liability overseas. any other consequence for the relevant taxpayer, or for any person referred to in subparagraph (vi), of the scheme having been entered into or carried out; and None the nature of any connection (whether of a business, family or other nature) between the relevant taxpayer and any person referred to in subparagraph (vi) All entities that are involved in the proposed capital reduction are part of the group. | Detailed Reasoning - Conclusion: The applicant has submitted compelling factors supporting the commercial objectives for the equal reduction of share capital and distribution to Shareholder B. Principally, these can be summarised as follows: Company C has a very high ratio of contributed capital compared to retained profits, which is claimed to be excess to current investment requirements; Shareholder B will obtain a better utilisation and a higher return of its investment. The receipt of share capital will also produce a foreign exchange gain. The character of the receipt in this case attracts tax preferential treatment under relevant foreign tax laws; These objectives are considered against the factors that would incline towards the conclusion that the proposed scheme is being implemented for a more than incidental purpose for the relevant tax payer to obtain a tax benefit. Therefore, notwithstanding that subparagraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 are satisfied and having regard to the relevant circumstances of the scheme as stipulated within subsection 45B(8) of the ITAA 1936 it cannot be concluded that the proposed scheme will be implemented for a more than incidental purpose of enabling the relevant person to obtain a tax benefit for the purposes of paragraph 45B(2)(c) of the ITAA 1936. Accordingly, the Commissioner will not make a determination pursuant to section 45C of the ITAA 1936 because subsection 45B(3) of the ITAA 1936 will not apply to the scheme.

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