ATO Interpretative Decision
ATO ID 2004/654
Income Tax
Return of Capital - section 45B appliesFOI status: may be released
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If you reasonably apply this decision in good faith to your own circumstances (which are not materially different from those described in the decision), and the decision is later found to be incorrect you will not be liable to pay any penalty or interest. However, you will be required to pay any underpaid tax (or repay any over-claimed credit, grant or benefit), provided the time limits under the law allow it. If you do intend to apply this decision to your own circumstances, you will need to ensure that the relevant provisions referred to in the decision have not been amended or repealed. You may wish to obtain further advice from the Tax Office or from a professional adviser.
Issue
Does section 45B of the Income Tax Assessment Act 1936 (ITAA 1936) apply such that the Commissioner is able to make a determination under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat the amount of the return of capital as an unfranked dividend paid out of the profits of the company?
Decision
Yes. Section 45B of the ITAA 1936 applies to treat the amount of the capital reduction as an unfranked dividend paid out of the profits of the company.
Facts
The company distributed funds to its shareholders as a return of capital in proportion to their shareholding and additional to an ordinary dividend which it regularly paid at half-yearly intervals.
The return of capital was debited to the company's share capital account and funded out of the company's existing borrowing facilities.
The company had generated greater than usual profits in the preceding year and had used surplus cash to repay borrowings. The distribution would restore the company's gearing to a normal level.
Reasons for Decision
The purpose of section 45B of the ITAA 1936 is to ensure that amounts paid in substitution for dividends are treated as unfranked dividends for income tax purposes.
Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 applies. This section applies if:
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- there is a scheme under which a person is provided with a capital benefit by a company; and
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- 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; and
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- 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.
The distribution is a 'scheme' within the broad meaning of that term, for the purposes of section 45B of the ITAA 1936.
The meaning of 'provided with a capital benefit' is found in subsection 45B(5) of the ITAA 1936. A person is provided with a capital benefit if:
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- shares in a company are issued to the person;
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- there's a distribution to the person of share capital; or
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- the company does something in relation to shares that has the effect of increasing the value of shares held by that person.
As the distribution is debited against the company's share capital account, there is a provision of a capital benefit as defined by subsection 45B(5) of the ITAA 1936.
A further requirement of subsection 45B(2) of the ITAA 1936 is that a taxpayer (the relevant taxpayer) must obtain a tax benefit. The relevant taxpayer need not be the person who is provided with the capital benefit. Obtaining a tax benefit is defined in subsection 45B(9) of the ITAA 1936 to mean circumstances where the amount of tax payable, or any other amount payable under the income tax law 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 capital benefit had been a dividend.
Shareholders would obtain a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936, as the amount of tax payable from treatment of a return of capital distribution under the capital gains and losses provisions would, apart from the operation of section 45B, be less than the amount that would be payable if the distribution had instead been a dividend.
Subsection 45B(8) of the ITAA 1936 sets out circumstances that are relevant to determining whether any person has the requisite degree of purpose of enabling a taxpayer to obtain a tax benefit.
Paragraph 45B(8)(a) of the ITAA 1936 refers to the extent to which the distribution is attributable to the profits of the company. The distribution is effectively sourced from profits. Although the distribution is to be funded directly by drawing from existing borrowing facilities, the ultimate source of the surplus is the profits that had produced surplus funds to repay earlier borrowings.
The company's business structure had remained intact and its recent operations had not included any significant divestment. This suggests that no surplus equity capital had been generated.
Borrowings to fund the distribution would not result in a substantial change to gearing levels having regard to the variation in those levels in the preceding 18 month period.
Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions. Although the company had a regular pattern of dividend payments, the company had recently accumulated substantial retained profits. The ordinary half-year dividend was not commensurate with the increased level of profits. The regularity of dividend payments was therefore not sufficient to indicate that the requisite degree of purpose was not present.
Paragraphs 45B(8)(c) to (g) of the ITAA 1936 concern the particular taxation status of shareholders. As the company has a diverse range of shareholders, these factors tend neither toward nor against the existence of the requisite degree of purpose.
Paragraph 45B(8)(h) of the ITAA 1936 requires a comparison of the respective interests held by shareholders after the distribution. As the distribution is proportional, to all shareholders, it is indicative of being in substitution for a dividend.
Paragraphs 45B(8)(i) and (j) of the ITAA 1936 refer to factors that are not relevant to the distribution.
Paragraph 45B(8)(k) of the ITAA 1936 refers to matters listed in section 177D of the ITAA 1936.
Having regard to the 'relevant circumstances' in paragraph 45B(8)(a), (b) and (h) of the ITAA 1936 it is concluded that the requisite degree of purpose of enabling a shareholder to obtain a tax benefit exists.
Paragraph 45B(8)(k) of the ITAA 1936 circumstances have therefore not been separately considered.
As all the conditions of subsection 45B(2) of the ITAA 1936 have been satisfied, section 45B applies to the distribution. Subsection 45B(3) of the ITAA 1936 permits the Commissioner to make a determination that section 45C of the ITAA 1936 applies to treat the distribution as an unfranked dividend.
Date of decision: 08 April 2004Year of income: Year ended 30 June 2004
Legislative References:
Income Tax Assessment Act 1936
section 45B
section 45C
ATO ID 2002/788 ATO ID 2002/858
Keywords
Capital benefits
Share capital
Capital reductions
Return of capital on shares
ISSN: 1445-2782
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