Private ruling: Share capital tainting
Date of advice: 20 November 2015
Published: February 2016
Ruling period: 1 April 2015 to 31 March 2016.
Date scheme commenced: 1 April 2015.

Ruling: Q1: Will any of the Proposed Accounting Entries constitute a transfer to which section 197-5 of the Income Tax Assessment Act 1997 (ITAA 1997) applies? | A1: No. | Q2: If the answer to Question 1 is yes, will the exclusion in section 197-10 of the ITAA 1997 apply to the transfer? | A2: Not applicable.

Relevant facts and circumstances: 1. The Company X group of legal entities (Company X Group) maintains stand-alone general ledger accounts for each legal entity in the Company X Group and consolidated accounts for the Company X Group. 2. Company X Group operates by way of business units. Management tracks the financial performance of the various business units within the Company X Group by requiring each journal booked in the general ledger to contain a separately identifiable business unit code to indicate allocation to a business unit. Journals not otherwise allocated to a particular business unit are allocated to a generic business unit code. 3. Company X Group's general ledger system enforces double-entry accounting bookkeeping, which means that all journals posted for a legal entity must net to nil. All journals posted for a business unit must also net to nil. 4. Currently, when one Company X Group legal entity subscribed for shares in another Company X Group legal entity, the resulting journal entries were assigned to a particular business unit. Subsequent share subscriptions may have been assigned to a different business unit. 5. To simplify this, it is proposed to centralise the accounting allocation for the majority of these journal entries so that they have the generic code in the business unit informational field. 6. This business code redesignation process will be implemented for a number of Australian resident companies in the Company X Group, most (but not all) of which will be subsidiary members of the Company X income tax consolidated group. 7. To conform with the Company X accounting system, the redesignation process will be done by effectively reversing the original journal entries containing the existing business unit informational field and record journal entries with the generic code in the business unit informational field. 8. The proposed accounting entries (Proposed Accounting Entries) will rebook the journal entries from the existing business unit code to the generic unit code. In order for the journals to net to nil for each business unit, this will be done via a balancing account. 9. There is no overall net increase or decrease in assets, liabilities or equity of the relevant legal entities as a result of the Proposed Accounting Entries.

Relevant legislative provisions: Income Tax Assessment Act 1997 subsection 197-5(1)

Reasons for decision: Summary: The Explanatory Memorandum (EM) to Tax Laws Amendment (2006 Measures No. 3) Bill 2006 provides the context of Division 197 of the ITAA 1997. At paragraph 4.4, it states: The share capital tainting rules are integrity rules designed to prevent a company from disguising a distribution of profits as a tax-preferred capital distribution by transferring profits into its share capital account and subsequently making distributions from that account. In that context, subsection 197-5(1) of the ITAA 1997 provides: Subject to subsection (2), this Division applies to an amount (the transferred amount ) that is transferred to a company's *share capital account from another of the company's accounts, if the company was an Australian resident immediately before the time of the transfer. The term 'transferred amount' is not defined in the income tax legislation. However, guidance on its meaning is provided in the EM: 4.12 An amount is transferred from one account to another where that amount is moved from one account to another. This, in turn, requires the balance of the first account to be reduced, while the balance on the second account is increased by the same amount. 4.13 An amount is not transferred from one account to another where the particular accounting entries result in the balances of both accounts increasing in size… One of the Proposed Accounting Entries, involving a debit to the balancing account and a credit to issued capital, could prima facie, be considered to effect a transfer of an amount to a share capital account, as it involves the decrease of one account (the balancing account) and an increase in share capital. However, a contemporaneous journal entry reverses this, such that the journal entry in the balancing account is effectively a 'balancing' entry facilitating the recoding of the original journal entry with the generic business unit code. The redesignation takes place within the legal entity, such that the attributes of the relevant business unit code changes, whilst the actual quantum of the balancing account and share capital of the entity does not change. The redesignation is done in this manner so as to conform with Company X's accounting system. Accordingly, there is no transfer to the share capital account within the meaning defined in paragraph 4.12 of the EM, as there is no actual decrease in the balance of one account with a corresponding increase in the share capital account. Further, the Proposed Accounting Entries do not effect the transfer of profits to share capital account under the Proposed Accounting Entries, to which Division 197 was enacted to target. As there is no amount transferred within the meaning of subsection 197-5(1) of the ITAA 1997, Division 197 of the ITAA 1997 does not apply to deem the share capital account of the relevant subsidiary as being tainted. As the answer to Question 1 is in the negative, this question is not applicable.