UNIVERSITY OF SYDNEY FACULTY OF LAW

MASTER OF LAWS
MASTER OF TAXATION

CORPORATE TAXATION

SEMESTER `1 2002 INTENSIVE
TAKE HOME EXAM

AVAILABLE FRIDAY 3 MAY 2002
DUE 5.00 PM MONDAY 6 MAY 2002 (by delivery to the Law School, fax to Nancy Carrasco on 02 9351 0290 or e-mail to nancyc@law.usyd.edu.au)

ANSWER ALL FOUR QUESTIONS. YOUR ANSWER MUST BE YOUR OWN WORK AND MUST NOT EXCEED 10 PAGES (3,000 WORDS) IN LENGTH. EACH QUESTION IS OF EQUAL VALUE. THE ANSWER TO EACH QUESTION SHOULD THEREFORE BE OF TWO AND ONE HALF PAGES IN LENGTH (750 WORDS).

QUESTION 1

Would the following arrangements be debt interests or equity interests, or neither, under the debt/equity rules enacted by New Business Tax System (Debt and Equity) Act 2001? How would distributions under the arrangements in respect of the interests be treated for income tax purposes under the rules? [You are not required to consider the income tax and capital gains tax consequences of acquisition, conversion or termination of the interests under the arrangements.]

1. A Co Ltd makes an interest free loan of $10 million, repayable on demand, to its wholly-owned subsidiary, B Co Pty Ltd. Both are resident companies.

2. As in 2, except interest is charged at 8% per annum, and the loan has a fixed term of 5 years.

3. A Co Ltd issues a debenture which is on the same terms as the debenture stock which was the subject of DCT (WA) v Boulder Perseverance Ltd (1937) 58 CLR 223, 4ATD 389.

4. A Co Ltd issues a debenture which is on the same terms as the debenture stock which was the subject of FCT v The Midland Railway Co. of Western Australia Ltd (1951) 85 CLR 306, 9 ATD 372.

5. A Co Ltd subscribes $10 million for 10 million redeemable preference shares in C Co Pty Ltd. Both companies are resident, and unrelated. The shares are redeemable in 5 years, carry a right to a cumulative dividend of 8% per annum payable in priority to the ordinary shares, and have no voting rights. The amount payable on redemption is $10 million plus an amount equal to any unpaid annual dividend entitlement.

6. As in 5, except that the shares are non-redeemable convertible preference shares. At the end of 5 years the shares convert into ordinary shares in C Co Pty Ltd at the rate of 1 ordinary share for each preference share, plus an extra ordinary share for each dollar of unpaid annual dividend.

7. A Co Ltd employs Mr Smith as managing director. He is to be paid an annual salary of $100,000 plus a bonus equal to 10% of the company's annual net profit (before the bonus).

8. As in 7, except the salary is $1.00 per annum and the bonus is 20% of net profit.

QUESTION 2

1. What are the distribution, imputation and CGT treatments of-

(a) bonus shares that directly or indirectly capitalise profits;

(b) bonus shares that are issued out of existing capital - ie issued for no consideration and with no amount being transferred or credited to share capital (being effectively equivalent to share splits if pro rata);

Does it make any difference if the bonus shares are fully or partly paid? if the recipient is an Australian resident company? or if the bonus shares are held on revenue or capital account?

2. A listed company has a bonus plan whereby shareholders can elect in advance to forgo dividends and instead to receive bonus shares in accordance with a formula related to the amount of the dividend paid on other shares. Over half of its pre-CGT and non-resident shareholders elect to receive shares under the bonus plan. What are the consequences if:

(a) the dividends paid by the company are unfranked;

(b) the dividends paid by the company are franked 50%; or

How would your answer differ if the company had a dividend reinvestment plan whereby the shareholders elect to apply declared dividends to pay up an issue of shares to them?

QUESTION 3

A, B, C and D hold respectively 10%, 10%, 40% and 40% of the shares in Little 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. A and B consider that the problems arise from the poor management of C and D who have run the company during that time. Accordingly A purchases a 24% interest from C and B a 24% interest from D for $1m each. A and B take over active management of Little which commences to dispose of a number of existing businesses and to acquire new businesses. Little also disposes for $4m in that year of a commercial building that it acquired in 1984. The building cost $1m and was worth $6m when the shareholdings in the company changed. It disposes for $3m of another building that cost $5m three years ago and was worth $4m at the time of the share transfers.

The agreement for sale of the shares provides that the rights attached to the remaining shares of C and D will be changed so that they are entitled to a 10% cumulative preferential dividend with no further participation in profits and to a priority of return of capital in a winding up with no participation in surplus assets. The constitution of the company is altered to give effect to this agreement. The voting rights of the shares held by C and D are unaltered.

In the current year of income Little makes a profit which enables it to pay a dividend that just covers the preference dividend and it is likely to be some years before a dividend can be paid to A and B.

(a) Consider the tax treatment of Little in respect of the tax losses and of the sale of the buildings.

(b) What difference would it make if C and D sold 30% each to A and B, and C and D had acquired their shares in 1984?

(c) What difference would it make if instead of C and D, 80% of the shares were originally held by a discretionary trust, a charitable trust, a company wholly owned by the Commonwealth of Australia or a widely held Australian listed company?

QUESTION 4

Glumville Pastoral Pty Ltd holds a pastoral property and carries on business as a sheep station owner in western New South Wales. It 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 $100,000, 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.
A purchaser has been found that is willing to buy the property for $6m. The company has accumulated profits of $3m which are reflected in its franking account.

If Glumville sells the pastoral property to the buyer, what are the income tax consequences of then liquidating the company? What steps can be taken before or during liquidation to produce the best tax outcome for the shareholders.

What if, instead of accumulated profits and a credit in its franking account, Glumville has accumulated losses of $300,000? While in liquidation, it sells all of its cattle producing assessable income of $200,000 under s.70-90 and, on the sale of depreciated property, incurs a balancing charge of $100,000 under Division 40, in addition to the sale of the pastoral property for $6m.

END OF EXAMINATION

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