Issue
Will a return of capital to a shareholder whose equity interest is reduced trigger the application of section 45B of the Income Tax Assessment Act 1936 (ITAA 1936) to enable the Commissioner to treat the distribution as a dividend for taxation purposes?
Decision
No. Section 45B of the ITAA 1936 will not apply in respect of the return of capital component of the buy-back consideration paid to a shareholder whose equity interest is reduced. The distribution of share capital will not be treated as a dividend for income tax purposes.
Facts
Company A is equally owned by family companies B and C. Both companies B and C are Australian resident companies. Most of the company A shares were issued pre-CGT, that is, before 20 September 1985. The original owner of shares in company B died and ownership of the shares passed to that shareholder's children. Company A is primarily operated and managed by persons associated with company C. The shareholders in company B wish to reduce company B's equity interest in company A.
Company A proposes to undertake a selective share buy-back of almost all the shares held by company B at the price of $3.85 per share. A nominal shareholding is to be retained by company B. The buy-back is to consist entirely of pre-CGT shares.
The buy-back consideration is to be debited to the share capital account at $2 per share (the original subscription price) with the remaining balance of $1.85 debited against retained profits. Company A has confirmed that there have not been any transfers to share capital account that would constitute to the tainting of the share capital account for the purposes of Division 7B of Part IIIAA of the ITAA 1936.
Reasons for Decision
A 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. Section 45B of the ITAA 1936 applies if: • there is a 'scheme' under which a person is 'provided with a capital benefit' by a company; and • a taxpayer (whether receiving the capital benefit or not) '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, 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 to 'obtain a tax benefit'.
The proposed share buy-back is a 'scheme' contemplated by section 45B of the ITAA 1936 that provides a shareholder (company B), with a capital benefit, as defined by subsection 45B(5) of the ITAA 1936.
As part of the buy-back consideration consists of a distribution of a capital on which no tax is payable, company B would 'obtain a tax benefit' (within meaning of the phrase in subsection 45B(9) of the ITAA 1936).
Subsection 45B(8) of the ITAA 1936 lists the circumstances that are relevant to determining whether any person has a more than incidental purpose of enabling a person to obtain a tax benefit.
Significantly, under the proposed share buy-back: • the buy-back price consists of dividend and return of capital components - but as the return of capital corresponds to the capital originally contributed the capital benefit is not attributable to the profits of the company • company A had not paid dividends regularly, but the buy-back consideration consists of a franked dividend component that reflected company B's underlying share of retained profits • the shares to be bought back were acquired by company B before 20 September 1985 • company B's equity interest in company A would be substantially reduced in accordance with commercial objective of the shareholders and • the scheme effects a change in the financial position of the shareholders reflecting the intended reduction in company B's equity interest in company A.
After considering all the relevant circumstances, it cannot reasonably be concluded that there exists the requisite level of purpose of providing a tax benefit to company B by way of the capital reduction.
Therefore, section 45B of the ITAA 1936 does not apply to deem the return of capital under the proposed share buy-back to be a dividend.