Private ruling: Return of capital
Date of advice: 12 September 2018
Published: October 2018
Ruling period: XXXX
Date scheme commenced: XXXX

Ruling: Q2: Will the Commissioner make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit for the return of capital? | A1: No | Q3: Will the Commissioner make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies in relation to the whole, or a part, of the capital benefit for the return of capital? | A2: No

Relevant facts and circumstances: 1. Entities A, B and C are Australian residents for income tax purposes. 2. Entity B is wholly owned by Entity A and Entity C is wholly owned by Entity B. 3. Entity B will return capital to Entity A in accordance with section 256B of the Corporations Act 2001 (Cth) (Corporations Act). The return of capital is intended to be an extraordinary distribution. 4. To fund the return of capital, Entity C, will return its capital to Entity B. 5. To effect these capital returns, Entity B and Entity C will each debit the full amount of the capital return against their respective untainted share capital accounts. 6. Entity B and Entity C’s share capital account is ‘untainted’ for the purposes of the share capital tainting provisions in Division 197 of the Income Tax Assessment Act 1997 (ITAA 1997).

Relevant legislative provisions: Income Tax Assessment Act 1936 section 6(1) | Income Tax Assessment Act 1936 section 45A(2) | Income Tax Assessment Act 1936 section 45B(3) | Income Tax Assessment Act 1936 section 45C

Reasons for decision: Summary: Pursuant to subsection 6(1), the term dividend includes any distribution made by a company to its shareholder. However, paragraph 6(1)(d) excludes from the definition of dividend any: 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… Subsection 6(4) provides that paragraph 6(1)(d) of the definition of dividend in subsection 6(1) does not apply if, under the agreement: (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 the property so paid, credited or distributed. Entity B and C will effect the return capital by debiting the whole amount against their respective untainted share capital account. The definition of share capital account is provided in section 975-300 of the ITAA 1997 and it means an account that the company keeps of its share capital, or any other account, that was created on or after 1 July 1998 and the first amount credited to the account was an amount of share capital. However, if a company's share capital account is tainted, then the account is generally taken not to be a share capital account for the purposes of the ITAA 1936 and the ITAA 1997. Based on the facts provided, paragraph 6(1)(d) will exclude the return of share capital from the definition of dividend in subsection 6(1). Further, subsection 6(4) will have no application in respect of the return of capital. Therefore the return of capital will not constitute a dividend as defined in subsection 6(1). Subsection 45A(1) states that this section applies in respect of a company that streams the provision of capital benefits and the payment of dividends to its shareholders in such a way that: (c) the capital benefits are, or apart from this section would be, received by shareholders (the advantaged 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, and (d) it is reasonable to assume that the other shareholders (the disadvantaged shareholders ) have received, or will receive, dividends. Implicit in operation of 45A is the 'streaming' of benefits, that is, the provision of different benefits to different shareholders. Subsection 45A(2) states that the Commissioner may make, in writing, a determination that section 45C applies in relation to the whole, or a part, of the capital benefits. Entity B is a wholly owned subsidiary of Entity A. Entity B will return capital to Entity A. In the present case, Entity A is the sole shareholder of Entity B who will receive a capital benefit (as defined in subsection 45A(3)). Therefore, there is no streaming of capital benefits and dividends among different shareholders of Entity B. Accordingly, the Commissioner will not make a determination under subsection 45A(2) that section 45C applies to the return of capital. Section 45B is a specific anti-avoidance provision. The section is designed to prevent companies from effectively distributing company profits as preferentially taxed capital rather than taxable dividends. Subsection 45B(2) sets out the conditions under which the Commissioner will make a determination under subsection 45B(3) that section 45C applies. These conditions are: ● there is a scheme under which a person is provided with a capital benefit by a company, and ● under the scheme a person (the relevant taxpayer), who may or may not be the person provided with the capital benefit, obtains a tax benefit, and ● having regard to the relevant circumstances of the scheme, it would be concluded that the person, or one of the persons, entered into 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. Scheme The term ‘scheme’ is defined widely and includes any agreement, arrangement, understanding, promise, undertaking, scheme, plan or proposal (subsections 45B(10) and 995-1(1) of the ITAA 1997). Accordingly, a return of share capital would normally constitute a scheme for the purposes of section 45B. Therefore, the return of share capital constitute a scheme for the purposes of paragraph 45B(2)(a), because the return of capital will provide shareholders with a capital benefit. Tax benefit Under subsection 45B(9) 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. Ordinarily, a return of capital would be subject to the CGT provisions of 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. By contrast, a dividend would generally be included in the assessable income of a resident shareholder. In this case, the shareholder of Entity B would obtain a tax benefit from a capital distribution. Purpose Subsection 45B(8) lists the relevant circumstances of the scheme which the Commissioner must have regard to when determining whether or not the requisite purpose exists. The list of circumstances is not exhaustive and the Commissioner may have regard to other circumstances which he regards as relevant. Based on the facts provided, the relevant circumstances in subsection 45B(8) do not point to a significant purpose on the part of Entity B for carrying out the scheme for a more than incidental purpose of enabling Entity A to obtain a tax benefit. Accordingly, the Commissioner will not make a determination under subsection 45B(3) that section 45C applies in relation to return of capital.

Question 1: Will the return of capital constitute a dividend as defined in subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)? | Reasons for decision: All legislative references are to the ITAA 1936 unless otherwise indicated.