FACULTY OF LAW

READING TIME: 20 MINUTES

WRITING TIME: 2 HOURS

CANDIDATES MUST ATTEMPT TWO QUESTIONS

OPEN BOOK EXAMINATION: CANDIDATES MAY TAKE INTO THE EXAMINATION ROOM ANY MATERIALS EXCEPT UNIVERSITY OF SYDNEY LIBRARY BOOKS

What are the distribution, imputation and CGT treatments of bonus shares that capitalise profits that are issued out of existing capital (being effectively equivalent to share splits if pro rata)? Does it make any difference if capitalised profits are directly capitalised or indirectly capitalised through the declaration of a dividend and crediting of that amount to the newly issued shares? If the bonus shares are fully or partly paid? If the recipient is an Australian resident company? If the bonus issue is pro rata? What happens when the bonus shares are sold?

Glumville Pastoral Pty Ltd holds a pastoral property in western New South Wales and is owned by Mrs Glumville as to 60% and her two daughters as to 20% each. The company acquired the property in the 1960s for $4,000, which is also the time that Mrs Glumville acquired her interest in the company. The daughters acquired their shares in the company from their father in 1998. Each daughter has a cost base in the shares of $1m. The company has $100,000 in its share capital account. Mrs Glumville has decided to sell the property and move to the "big smoke" of Sydney. A purchaser has been found that is willing to buy the property for $6m. The company has retained profits of $3m which are reflected in its franking account.

Advise as to the income tax consequences of this proposal. Should the Glumvilles simply sell their shares in the company to the buyer of the property instead? Would it make any difference if Mrs Glumville held a special class of share that entitled her to receive a distribution equal to the proceeds from any sale of the property?

A Pty Ltd, B Pty Ltd, C Pty Ltd and D Pty Ltd hold respectively 10%, 10%, 40% and 40% of the shares in Divest Pty Ltd which has a history of tax losses on capital and revenue account in recent times. All the shares have the same voting, dividend and capital rights. Divest conducts a hardware business in Grafton and a toy retail business in Port Macquarie. Divest acquired the premises from which the Grafton business is run in 1984. It leases the premises from which the Port Macquarie business is run. The directors of A and B consider that Divest's problems arise from the poor management of the Port Macquarie business. Accordingly, A purchases a 30% interest from C and B a 30% interest from D for $1m each. The directors of A and B take over active management of Divest and cause it to-

(1) sell the Port Macquarie business;

(2) change the name of the company to Hardware Pty Ltd;

(3) add new lines that have not before been run by the hardware business; and

Discuss the income tax issues arising for Divest/Hardware from the above facts in respect of the tax losses and the premises.

How would your answer differ in each of the following cases:

ABC Ltd is an Australian company that has issued preference shares requiring dividend payments of $50,000 each to be paid quarterly on the last day of each quarter. By the articles the preference shares are cumulative, that is, in the event that a dividend cannot be paid in any particular quarter the dividend will be paid in the following quarters in priority to the ordinary shareholders. The preference shares are held by resident financial institutions. The directors of ABC Pty Ltd would also like to pay a dividend of $200,000 to the ordinary shareholders during the current year of income. The ordinary shares are predominantly held by non-resident shareholders.

ABC's franking surplus as at the start of the current year of income is $66,000. Due to the use of losses, ABC had no tax liability for the 1999/2000 year. It expects a tax liability for the current year of $100,000 and its quarterly instalments under the PAYG system are based on this figure. The directors wish to maximise the level of franked dividends, particularly those paid to the preference shareholders, but do not wish to incur any franking deficit tax or deficit deferral tax if such tax would give rise to additional tax by way of penalty under Pt IIIAA Div 11.

The directors seek your advice as to the franking of dividends distributed during the year. In particular, they would like advice as to an appropriate timing for the payment of the ordinary dividend? Assume that none of the dividends are debt dividends within s. 46D and that the company tax rate is 34%. How would your answer differ if the Ralph proposals regarding the franking of dividends become law. What problems might ABC have under these proposals if it unexpectedly has a severe down turn in the second half of the year and its estimate of company tax liability for the year is revised to $30,000?

Conglomerate Ltd acquired all the shares in Baker Pty Ltd in 1996 for $20m. The accounts of Baker at the time disclosed profit reserves of $15m and share capital of $5m. Since its acquisition the assets of Baker have either been sold or transferred to other companies in the Conglomerate group so that all Baker’s assets are now loans of $25m to other members of the group. Conglomerate wishes to liquidate or otherwise dispose of Baker but to ensure that it will not suffer any unexpected tax consequences. Conglomerate seeks you advice especially as to any issues arising for dividend stripping and rebatable dividend adjustments.