Dividends: return of capital - application of section 45B

Can the Commissioner make a determination under subsection 45B(3) of the Income Tax Assessment Act 1936 (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?

Yes. The Commissioner may 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 capital return as an unfranked dividend, paid out of the profits of the company.

The company purchased a group of assets prior to 1985. The company recently sold one of those assets and made a significant profit on the sale. The asset was never used in the business.

After making a profit from the sale of the asset, the company made a capital return to its shareholders by debiting its share capital account.

Many of the company's shareholders hold pre-CGT shares.

The company has been profitable for a number of years. The company's franking policy has been to pay dividends to its shareholders to the extent it can fully frank those dividends. It always paid sufficient dividends to exhaust its franking credits.

The company has significant assets on its balance sheet. Despite this, the company distributed the majority of its paid-up share capital under the capital return.

The company also has significant retained profits.

The purpose of section 45B of the ITAA 1936 is to ensure that relevant amounts are treated as dividends for taxation purposes if: (a) components of a demerger allocation as between capital and profit do not reflect the circumstances of the demerger (paragraph 45B(1)(a) of the ITAA 1936); or (b) certain payments, allocations and distributions are made in substitution for dividends (paragraph 45B(1)(b) of the ITAA 1936).

This ATO Interpretative Decision is concerned only with part (b) of this purpose.

Subsection 45B(2) of the ITAA 1936 sets out the conditions under which section 45B of the ITAA 1936 applies. With regard to payments made in substitution for dividends, this section applies if: • there is a scheme under which a person is provided with a capital benefit by a company; and • 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 • 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 of the amount referred to in the Facts is a 'scheme' within the broad meaning of that term, for the purposes of section 45B of the ITAA 1936.

As the distribution is debited against the company's share capital account, there is a provision of a capital benefit for the purposes of 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, as defined in subsection 45B(9) of the ITAA 1936.

Shareholders would obtain a tax benefit, within the meaning of subsection 45B(9) of the ITAA 1936, as the amount of tax payable from the treatment of a return of capital distribution under the capital gains and losses provisions would, apart from the operation of 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 in determining whether, in relation to the scheme, any person has more than an incidental 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. Although the distribution is made out of the share capital account, it reflects the profit on the sale of the asset in question. The amount distributed does not reflect the amount invested in that asset when it was purchased.

Paragraph 45B(8)(b) of the ITAA 1936 refers to the pattern of distributions. The company's dividend policy is to pay dividends to the extent that it has available franking credits to fully frank those dividends. Accordingly, if this distribution were a special dividend, the company would not be able to frank it.

Paragraphs 45B(8)(c) to (g) of the ITAA 1936 concern the particular tax status of shareholders. Many of the company's shareholders hold pre-CGT shares.

Paragraph 45B(8)(h) of the ITAA 1936 requires a comparison of the respective interests held by shareholders after the distribution. The distribution is made proportionally to all shareholders, and their interest in the company remains unchanged after the distribution.

Having regard to the relevant circumstances of the scheme, it can be concluded that the scheme was entered into for more than an incidental purpose of enabling the relevant taxpayers to obtain a tax benefit. Accordingly 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 paid out of the profits of the company.