Income tax: Transfer from a share capital account - excluded transfer - sale of an asset

Will a transfer from a company's share capital account to write-off the loss realised on the sale of an asset be an 'excluded transfer' for the purposes of subsection 46J(2) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Yes. Where a company makes a transfer out of its share capital account to reflect the loss realised upon the sale of an asset, and there is no opportunity for recovery of that loss, the transfer will be an 'excluded transfer' for the purposes of subsection 46J(2) of the ITAA 1936.

A company sells an asset and realises a loss upon that sale. After the sale is settled, the company transfers an amount from its share capital account to its Retained Earnings/Accumulated Losses account to reflect the value that has ceased to be represented by assets, pursuant to section 258F of the Corporations Act 2001. The transfer does not facilitate the payment of a dividend. Neither does it replace funds used to pay a dividend.

Section 46M of the ITAA 1936 operates to deny frankability to dividends to the extent that they are: • debited from a company's disqualifying account, or • debited from a company's non-disqualifying account to the extent that there is a debit to its notional disqualifying account.

The company's share capital account is a 'disqualifying account' (subsection 46H(1) of the ITAA 1936). A 'non-disqualifying account' is any account that is not a disqualifying account (subsection 46H(3) of the ITAA 1936). The company's 'notional disqualifying account' is credited if the company has transferred money from its share capital account into a non-disqualifying account (subsection 46I(3) of the ITAA 1936). As a result, it will have a surplus in its notional disqualifying account.

When the company pays a dividend from a non-disqualifying account and the notional disqualifying account was in surplus immediately before that payment, there will be a debit to its notional disqualifying account (subsection 46I(5) of the ITAA 1936). To the extent that the dividend is debited from the company's notional disqualifying account, it will not be frankable (subsections 46M(3) and 46M(4) of the ITAA 1936).

Section 46M of the ITAA 1936 will not operate with this effect, however, if the transfer from the share capital account is an 'excluded transfer' (subsection 46I(3) of the ITAA 1936). In this event, the notional disqualifying account will not be credited by the transfer. A transfer will be an excluded transfer where the disqualifying account is a share capital account and the transfer 'gives effect to a reduction in paid-up share capital that has been permanently lost or has permanently ceased to be represented by assets' (subsection 46J(2) of the ITAA 1936).

A 'permanent loss' is one where the loss has been realised and there is no presently foreseeable prospect of its recovery ( Re Jupiter House Investments (Cambridge) Ltd [1985] 1 WLR 975 per Harman J at 979).

In this instance the company has realised a loss on the sale of the asset, and there is no reasonable prospect of recovering that loss. The loss is permanent.

The transfer from the share capital account did not facilitate the payment of a dividend by the company, nor did it replace funds used to pay a dividend. This means that the transfer did not take place as part of a 'dividend payment or replacement arrangement' and is not prevented from being an excluded transfer by subsection 46J(5) of the ITAA 1936. Accordingly, the transfer is an excluded transfer for the purposes of subsection 46J(2) of the ITAA 1936.