Private ruling: Liquidator distributions
Date of advice: 8 July 2021
Published: October 2021
Ruling period: 1 July 20XX to 30 June 20XX
Date scheme commenced: Before 20 September 1985

Ruling: Q1: Will section 47 of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the pre-CGT retained profits held in the 20XX financial year accounts of Company A, when CGT event C2 happens to the company shares and the retained profits are distributed to its shareholder, Company B, by the liquidator? | A1: No | Q2: What is the cost base of Company B's shares when CGT event C2 occurs and the pre-CGT retained profits are distributed to Company B's shareholders? | A2: $XXXX | Q3: Will section 47 of the ITAA 1936 apply to the distribution of $YYYY from Company B to its shareholders by a liquidator on cancellation of its shares when CGT event C2 happens? | A3: No

Relevant facts and circumstances: Companies A, B and C own a property and have run a business on it since prior to 20 September 1985. The property includes a main building and a large parking area. Shareholdings Company B was established prior to 1985 with Class A shareholders. According to the Articles of Company B, Class A shares had voting, dividend and capital rights and provided that if Class A shares were transferred to any other shareholder, the Class A shares became Class B shares which had rights to capital and dividends only. Subsequently a number of Class C redeemable preference shares were issued to members of a family that were later redeemed. [1] An original Class A shareholder subsequently acquired the other Class A shares leaving him the only remaining Class A share and the owner of Class B shares. After 20 September 1985 a C class share was allotted to the spouse on bare trust for the shareholder. Upon the shareholder's death in 20XX all the shares held in Company B passed to the spouse resulting in the remaining Class A share converting to a Class B share. Subsequently, the four Class B shares and one Class C share were converted into five ordinary shares. [2] Company C and G Company A were both incorporated prior to 1985. Company B owned 100% of each entity, apart from one share owned by the spouse on trust for Company B in both Company C and Company A. Company C has XXXX shares of which one was held by the spouse and the remainder by Company B. Company A has XXXX shares of which one was held by the spouse and the remainder by Company B. The spouse died in 20XX. On the spouse's death, all shares previously held by the spouse were then held by the legal personal representatives in their capacity as trustees of the estate. Subsequently the two shares in Company A and Company C that were held by the spouse before the spouse's death were transferred by the executors of the estate to Company B. On the same date, the beneficiaries of the Estate were each allocated ordinary shares in Company B in accordance with the Will. Sale of land Company B and a Trust entered into a Joint Venture on a 50/50 basis to develop and sell certain land around the property. The financial statements for Company A note it sold approximately 40% of its pre-CGT land to the Joint Venture. The retained profit in the shareholders equity jumped from a debit to a credit. Certificate of Title documents provided established land owned by Company B. A contract for the sale of the land was entered into. A private ruling issued advising that the sale proceeds from the land was considered exempt income in the hands of the beneficiaries of the spouse's estate who qualified as CGT concession stakeholders. A registered valuer valued the property as at the date of death of the original shareholder. The valuer considered the land, its facilities of buildings and landscaping, residual land from the earlier subdivision and easements. The valuation did not include plant and equipment.

Relevant legislative provisions: Income Tax Assessment Act 1936 section 47 | Income Tax Assessment Act 1936 subsection 47(1) | Income Tax Assessment Act 1936 subsection 47(1A) | Income Tax Assessment Act 1936 paragraph 47(1A)(b) | Income Tax Assessment Act 1997 paragraph 104-10(5)(a) | Income Tax Assessment Act 1997 paragraph 104-25(1)(a) | Income Tax Assessment Act 1997 subsection 104-25(3) | Income Tax Assessment Act 1997 paragraph 104-25(5)(a) | Income Tax Assessment Act 1997 s ection 106-35 | Income Tax Assessment Act 1997 subsection 128-15(2) | Income Tax Assessment Act 1997 subsection 128-15(4) | Income Tax Assessment Act 1997 Division 152 | Income Tax Assessment Act 1997 section 152-125

Reasons for decision: Summary: The retained capital held in Company A's accounts that is from the sale of pre-CGT land will not be deemed to be a dividend under section 47 of the ITAA 1936 when distributed by the liquidator to its sole shareholder, Company B. | Detailed Reasoning - Detailed reasoning: Company A was incorporated prior to 20 September 1985. Company A subsequently sold approximately 40% of its pre-CGT land to the Joint Venture after 1985. The proceeds from the disposal of a pre-CGT asset (the land) is disregarded pursuant to the operation of paragraph 104-10(5)(a) of the ITAA 1997. Company A put the sale proceeds into its retained profit account, which by the 20XX financial year had reduced. A contract for the sale of the property was executed in 20XX and sale proceeds of attributed to each landowner. A private binding ruling issued for this sale determined that as the capital gain made would be disregarded under the 15 year exemption in Division 152 of the ITAA 1997, the total payments made to the shareholders are considered to be an exempt amount under section 152-125 of the ITAA 1997. Company A will go into voluntary liquidation and its shares cancelled that will result in CGT event C2 happening. [3] As the sole shareholder, Company B will receive all the money that is left when Company A is liquidated. Company B shares in Company A are post-CGT shares, but any capital gain made by Company B from CGT event C2 happening will be disregarded. [4] Liquidator distributions sourced from assets acquired prior to 20 September 1985 are, in some circumstances, not taxable as either a deemed dividend under section 47 of the ITAA 1936, or a net capital gain made from CGT event C2 happening. If the assets were acquired prior to 20 September 1985 and a capital gain is disregarded, then these assets maintain the tax-free status of the distribution from the retained profits account. Archer Bros Pty Ltd (In Vol Liq) v. FCT (1953) 90 CLR 140; 27 ALJ 353; 10 ATD 192 ( Archers Case ) discusses distributions. In a joint judgement, the Full High Court of Australia in Archers Case observed by way of obiter dicta: By a proper system of bookkeeping the liquidator, in the same way as the accountant of a private company which is a going concern, could so keep his accounts that...distributions could be made wholly and exclusively out of...particular profits...or income...' Taxation Ruling TR 95/10 discusses the significance of the 'Archer Brothers principle' in the context of liquidation distributions: The observations in Archers Case have given rise to what is known as the Archer Brothers principle. The principle is that if a liquidator appropriates a particular fund of profit or income in making a distribution, that appropriation ordinarily determines the character of the distributed amount for the purposes of the Income Tax Assessment Act. Generally, a liquidator may rely on the Archer Brothers principle, except where a specific provision produces a different result. Archers Case refers to 'profits' or 'income'. However, if a liquidator ostensibly distributes an amount representing capital actually contributed by shareholders, we accept that the distribution is treated as a non-dividend return of capital. Provided the liquidator is able to identify the source from which a particular distribution is made, we will accept a liquidator's nominated appropriation. For example, identifying pre-CGT non-assessable profits separately to post-CGT capital gains. If a liquidator can identify the source of funds distributed, then those funds retain the character of the source. So, any capital gain made from disposal of a pre-CGT asset will retain that character when it was distributed and would therefore be tax free to the shareholders. Section 47 of the ITAA 1936 specifically deems certain amounts to be dividends paid to the shareholders out of the profits derived by the company. Specifically, subsection 47(1) of the ITAA 1936 states: Distributions to shareholders of a company by a liquidator in the course of winding-up the company, to the extent to which they represent income derived by the company (whether before or during liquidation) other than income which has been properly applied to replace a loss of paid-up share capital, shall, for the purposes of this Act, be deemed to be dividends paid to the shareholders by the company out of profits derived by it. The use of the term 'income' in the context of subsection 47(1) of the ITAA 1936 has been interpreted in Gibb v FCT (1966) 118 CLR 628 as meaning income according to ordinary concepts, rather than ' assessable income'. Hence, amounts that are deemed to be assessable income but are not of an income or revenue character are not considered, for the purposes of subsection 47(1) to be ' income'. Subsection 47(1A) of the ITAA 1936 provides a reference in subsection (1) to income derived by a company includes a reference to an amount included in the company's assessable income or a net capital gain that would be included in the company's assessable income if the required net capital gain is worked out in accordance with the method statement contained in paragraph 47(1A)(b) of the ITAA 1936. The effect of subsection 47(1A) of the ITAA 1936 is that it only includes in income the net capital gains that are included in assessable income (without indexation). Capital gains that are disregarded or otherwise not within the concept of a net capital gain included in the assessable income of the company are also not within the meaning of the word 'income'. The distribution of the retained profits still in Company A at the time of liquidation that is sourced from a pre-CGT capital gain made will not considered as 'income' and therefore will not be deemed to be a dividend under section 47 of the ITAA 1936. While the distribution of the pre-CGT capital gain will not be treated as an assessable liquidator's dividend, it will still be included as consideration for the cancellation of a shareholder's shares in Company A under CGT event C2. However, as determined in the previous private ruling, any capital gain that Company B will make when CGT event C2 happens on cancellation of the shares by the liquidator will be disregarded under the 15 year exemption in Division 152 of the ITAA 1997 and the total payments made to the shareholders are considered to be an exempt amount under section 152-125 of the ITAA 1997. Therefore, as the capital gain made will be disregarded this amount will not be deemed to be dividend under section 47 of the ITAA 1936. However, any amount that is income, e.g. from the sale of the plant and equipment, will be deemed a dividend under section 47 of the ITAA 1936. Section 106-35 of the ITAA 1997 provides that an act done by a liquidator for CGT purposes is the same as if the act was performed by the company. Therefore, the distribution of the disregarded capital gain by the liquidator will be the same as if Company A had distributed the amount to its shareholder directly. | Detailed Reasoning - Question 2: What is the cost base of Company B's shares when CGT event C2 occurs on liquidation and the pre-CGT retained profits are distributed to Company B's shareholders? | Summary: The cost base of Holdings shares is $XXXX. | Detailed Reasoning - Detailed reasoning: When the original shareholder died in 20XX, all his pre-CGT shares in Company B passed to his spouse. Subsection 128-15(2) of the ITAA 1997 provided that, as beneficiary, the spouse was taken to have acquired the asset on the day the original shareholder died. Item 4 of subsection 128-15(4) establishes the cost base for the shares as their market value as at the date of death. As Company B's assets are its shares in Company A and its share of the land, it has to be determined what is the market value of Company B's shares at the time the original shareholder died. A retrospective market valuation was issued. The independent valuer valued the facilities of buildings and landscaping, residual land from the earlier subdivision and easements at $XXXX. Whilst Company A had other assets and liabilities, Company B is asking the Commissioner to accept the value of Company B's shares as $XXXX. The Commissioner has agreed to accept this value, given that the value of Company B's shares is likely to be greater than the assets valued by the valuer. | Detailed Reasoning - Question 3: Will section 47 of the ITAA 1936 apply to the distribution of $YYYY from Company B to its shareholders by a liquidator on cancellation of its shares when CGT event C2 happens? | Summary: Section 47 of the ITAA 1936 will not apply to the distribution by a liquidator to Company B's shareholders that originated from the pre-CGT gain made by Company A. However, the amount distributed will need to be included as consideration for the cancellation of a shareholders shares in Company B under CGT event C2. | Detailed Reasoning - Detailed reasoning: The shareholders acquired their shares in Company B in 20XX. The shares will be cancelled when the company enters voluntary liquidation. As determined in Question 1, the retained profits from Company A's pre-CGT sale of land that will be distributed by the liquidator to Company B will not be considered to be 'income' and therefore not assessable as a dividend under section 47 of the ITAA 1936. The consequence of Company B receiving this amount not as income derived by the company, means the amount will not be a deemed to be a dividend under section 47 of the ITAA 1936. While the amount distributed will not be treated as an assessable liquidator's dividend, it will still be included as consideration for the cancellation of a shareholders shares in Company B under CGT event C2. [1] As redeemable shares are not taken into account for the purposes of determining the small business participation percentage, no further reference will be made in this ruling: refer subsection 152-70(2). [2] Note, two Notification of division or conversion of classes of shares - ASIC Form 211 - were provided: one with a date of 6/3/2003 and another 1/11/2006. [3] Paragraph 104-25(1)(a) of the ITAA 1997. [4] Refer previous private ruling issued.

This ruling applies for the following period: