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Edited version of private ruling
Authorisation Number: 1011567478196
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Ruling
Subject: Share buy-back
Question 1
Will Division 16K of Part III of Subdivision C of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed transaction?
Yes.
Question 2
Will the average capital per share methodology (ACPS) be the most appropriate method of determining the capital and dividend components of the off-market share buy-back purchase price under section 159GZZZP of the ITAA 1936?
Yes.
Question 3(a) (applies to the shareholders only)
Will the anti-avoidance provisions contained within sections 45A and 45B of the ITAA 1936 apply to the proposed transaction?
No.
Question 3(b) (applies to the company only)
Will the Commissioner make a determination under subsection 45C(3) of the ITAA 1936 in relation to the company's off-market share buy-back?
No.
Question 3(c)
Will the anti-avoidance provisions contained within section 177EA of the ITAA 1936 and section 204-30 ,Division 725 and Division 727 of the Income Tax Assessment Act 1997 (ITAA 1997) apply to the proposed transaction?
No.
Question 4
Can the company allocate franking credits to that part of the purchase price which is taken to be the dividend component to the extent that the purchase price does not exceed the market value of the shares at the time of the buy-back if the buy-back did not take place and was never proposed to take place by virtue of section 202-45(c) of the ITAA 1997?
Yes.
Question 5
Apart from the debit entry which the company may be required to make to its franking account under section 205-30 of the ITAA 1997, are there any other income tax or capital gains tax consequences for the company as a result of the proposed transaction?
No.
Question 6
Is each shareholder a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936?
Yes.
This ruling applies for the following period
1 July 2010 to 30 June 2011
The scheme commenced on
1 July 2010
Relevant facts
The parties to the proposed transaction are:
a) The shareholders
b) The company
The company proposes conducting an equal access off-market buy back and cancellation of its shares during an income year.
The shareholders each hold an equal percentage of the ordinary shares in the company. The shareholders are Australian residents and none of the shareholders has carry forward revenue or capital losses.
The shareholders are currently in the process of structuring their estate to facilitate an equitable distribution of assets. As part of this broader estate planning exercise, there are a number of objectives to be undertaken in relation to the company.
It is the shareholders' intention that the company operates as a stand-alone company, the shares in which can then be distributed to a specific person at the instigation of the shareholders.
The company intends to return capital to the shareholders so that the company's shares will represent broadly the value of the assets that the company owns. The market value and purchase price of the shares to be purchased under the off-market buy-back have been determined.
The company's market value at the time of the proposed transaction is substantially in excess of the value of the assets. The company has retained earnings and a franking account balance.
For the purposes of determining the appropriate capital and dividend components of the purchase price, the applicant has agreed that ACPS will be used.
Relevant legislative provisions
Income Tax Assessment Act 1936, Section 45A
Income Tax Assessment Act 1936, Paragraph 45A(3)(b)
Income Tax Assessment Act 1936, Section 45B
Income Tax Assessment Act 1936, Paragraph 45B(2)(a)
Income Tax Assessment Act 1936, Paragraph 45B(2)(b)
Income Tax Assessment Act 1936, Paragraph 45B(2)(c)
Income Tax Assessment Act 1936, Subsection 45B(3)
Income Tax Assessment Act 1936, Subsection 45B(8)
Income Tax Assessment Act 1936, Section 45C
Income Tax Assessment Act 1936, Subsection 45(3)
Income Tax Assessment Act 1936, Section 159GZZZK
Income Tax Assessment Act 1936, Paragraph 159GZZZK(d)
Income Tax Assessment Act 1936, Section 159GZZZN
Income Tax Assessment Act 1936, Section 159GZZZP
Income Tax Assessment Act 1936, Subsection 159GZZZP(1)
Income Tax Assessment Act 1936, Section 160APHO
Income Tax Assessment Act 1936, Section 177EA
Income Tax Assessment Act 1936, Subsection 177EA(3)
Income Tax Assessment Act 1936, Subsection 177EA(17)
Income Tax Assessment Act 1997, Section 202-40
Income Tax Assessment Act 1997, Subsection 202-40(1)
Income Tax Assessment Act 1997, Section 202-45
Income Tax Assessment Act 1997, Paragraph 202-45(c)
Income Tax Assessment Act 1997, Section 204-30
Income Tax Assessment Act 1997, Paragraph 204-30(1)(a)
Income Tax Assessment Act 1997, Paragraph 204-30(1)(b)
Income Tax Assessment Act 1997, Paragraph 204-30(1)(c)
Income Tax Assessment Act 1997, Paragraph 204-30(3)(a)
Income Tax Assessment Act 1997, Paragraph 204-30(3)(c)
Income Tax Assessment Act 1997, Subsection 204-30(8)
Income Tax Assessment Act 1997, Section 205-30
Income Tax Assessment Act 1997, Section 725-55
Income Tax Assessment Act 1997, Section 725-65
Income Tax Assessment Act 1997, Section 725-70
Income Tax Assessment Act 1997, Section 725-85
Income Tax Assessment Act 1997, Section 725-90
Income Tax Assessment Act 1997, Section 725-145
Income Tax Assessment Act 1997, Paragraph 727-100(a)
Income Tax Assessment Act 1997, Paragraph 727-100(b)
Income Tax Assessment Act 1997, Section 727-105
Income Tax Assessment Act 1997, Section 727-110
Income Tax Assessment Act 1997, Subsection 727-150(3)
Income Tax Assessment Act 1997, Section 727-215
Income Tax Assessment Act 1997, Section 727-260
Income Tax Assessment Act 1997, Subsection 960-120(1)
Corporations Act 2001, Division 2 of Part 2J.1
Reasons for Decision
Detailed reasoning
Question 1
Will Division 16K of Part III of Subdivision C of the Income Tax Assessment Act 1936 (ITAA 1936) apply to the proposed transaction?
Division 16K of Part III of the ITAA 1936 modifies the application of the relevant provisions of the ITAA 1936 and the ITAA 1997 (including the capital gains provisions) relating to the acquisition of shares under a buy-back.
The buy-back will be conducted in accordance with the requirements of Division 2 of Part 2J.1 of the Corporations Act 2001.
Section 159GZZZK of the ITAA 1936 explains whether a buy-back will be considered to be an on-market or off-market share buy-back. As the proposed buy-back will not be made in the ordinary course of trading on a stock exchange, it will be an off-market share buy-back for the purposes of paragraph 159GZZZK(d) of the ITAA 1936. Division 16K of the ITAA 1936 will apply to the proposed transaction.
Question 2
Will the average capital per share methodology (ACPS) be the most appropriate method of determining the capital and dividend components of the off-market share buy-back purchase price under section 159GZZZP of the ITAA 1936?
Where a company buys back its own shares by way of an off-market share buy-back, subsection 159GZZZP(1) of the ITAA 1936 applies to treat the difference between the purchase price and that part of the purchase price that is debited against the company's share capital account as a dividend.
Law Administration Practice Statement PS LA 2007/9 discusses acceptable methodologies which may be used for calculating the capital and dividend components. Paragraphs 12 and 62 explain that ACPS is the preferred methodology for calculating the split. The applicant, on behalf of the rulees, has agreed that ACPS will be used to determine the capital and dividend components of the purchase price.
The purchase price in respect of the buy-back will be amount per ordinary share which equates to the market value of the shares at the time of the buy-back. The total market value of shares to be purchased under the buy-back will be as per the amount determined.
Question 3(a) (applies to the shareholders only)
Will the anti-avoidance provisions contained within sections 45A and 45B of the ITAA 1936 apply to the proposed transaction?
Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if they apply, allow the Commissioner to make a determination that section 45C of the ITAA 1936 applies.
The effect of such a determination is that all or part of the distribution of capital received by the shareholders under the buy-back is treated as an unfranked dividend. Accordingly, the application of these two provisions to the buy-back must be considered.
Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.
Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided to participating shareholders under the buy-back, the circumstances of the buy-back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders. Accordingly, section 45A of the ITAA 1936 has no application to the buy-back.
Section 45B of the ITAA 1936 applies where certain capital payments are paid to shareholders in substitution for dividends. In broad terms, section 45B applies where:
· there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a) of the ITAA 1936);
· 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 (paragraph 45B(2)(b) of the ITAA 1936); 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 purposes but not including an incidental purpose), of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).
In the case of the proposed buy-back, whilst the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 have been met, the requisite purpose of enabling the shareholder to obtain a tax benefit - by way of capital distribution - is not present.
Having regard to the relevant circumstances of the proposed scheme, as set out in subsection 45B(8) of the ITAA 1936, it is apparent that the inclusion of a capital component as part of the buy-back price is not inappropriate. Further, the capital component cannot be said to be attributable to the profits of the company. Accordingly, section 45B of the ITAA 1936 has no application to the buy-back.
Question 3(b) (applies to the company only)
Will the Commissioner make a determination under subsection 45C(3) of the ITAA 1936 in relation to the company's off-market share buy-back?
The Commissioner will not make a determination under subsection 45B(3) of the ITAA 1936 in relation to the company's off-market share buy-back.
As a determination under subsection 45C(3) of the ITAA 1936 will not be made, a determination under subsection 45C(3) of the ITAA 1936 cannot be made.
Question 3(c)
Will the anti-avoidance provisions contained within 177EA of the ITAA 1936 and section 204-30, Division 725 and Division 727 of the ITAA 1997 apply to the proposed transaction?
Section 177EA of the ITAA 1936
Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes to obtain a tax advantage in relation to imputation benefits. In essence, it applies to schemes for the disposition of shares or an interest in shares where a franked distribution is paid or payable in respect of the shares or an interest in shares. This would include a buy-back with a dividend component.
Specifically, subsection 177EA(3) of the ITAA 1936 provides that section 177EA of the ITAA 1936 applies where:
(a) there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity; and
(b) either:
(i) a franked distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests; or
(ii) a frankable distribution has flowed indirectly, or flows indirectly or is expected to flow indirectly, to a person in respect of membership interests, as the case may be; and
(c) the distribution was, or is expected to be, a franked distribution, or a distribution franked with an exempting credit; and
(d) except for this section, a person (the relevant taxpayer) would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; and
(e) 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 an imputation benefit.
In the present case, the conditions in paragraphs 177EA(3)(a) to (d) of the ITAA 1936 will be satisfied. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the company, the shareholders or any other relevant party, there is a more than merely an incidental purpose, of obtaining an imputation benefit under the scheme. Under this scheme, the relevant taxpayer is a company shareholder and the scheme comprises the circumstances surrounding the buy-back.
In arriving at a conclusion, the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17) of the ITAA 1936. The listed circumstances there encompass a range of circumstances which, taken individually or collectively, indicate the requisite purpose. Due to the diverse nature of these circumstances, some may not be present at any one time in any one scheme.
The Commissioner has come to the view that section 177EA of the ITAA 1936 does not apply in relation to the proposed buy-back. In coming to this conclusion, the Commissioner had regard to all relevant circumstances of the arrangement, as outlined in subsection 177EA(17) of the ITAA 1936. Among the circumstances present in this proposed arrangement is the fact that there are no non-resident shareholders in the company and the allocation of the buy-back price between share capital and retained earnings using the ACPS method.
Section 204-30 of the ITAA 1997
Section 204-30 of the ITAA 1997 applies where a corporate tax entity streams the payment of dividends, or the payment of dividends and the giving of other benefits, to its members in such a way that:
(a) an imputation benefit is, or apart from this section would be, received by a member of the entity as a result of the distribution or distributions (paragraph 204-30(1)(a) of the ITAA 1997);
(b) the member would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b) of the ITAA 1997); and
(c) the other member of the entity will receive lesser imputation benefits, or will not receive any imputation benefits, whether or not the other member receives other benefits (paragraph 204-30(1)(c) of the ITAA 1997).
Relevantly, if section 204-30 of the ITAA 1997 applies the Commissioner is vested with discretion under subsection 204-30(3) of the ITAA 1997 to make a determination in writing either:
(a) that a specified franking debit arises in the franking account of the entity, for a specified distribution or other benefit to a disadvantaged member (paragraph 204-30(3)(a) of the ITAA 1997); or
(b) that no imputation benefit is to arise in respect of any streamed distributions made to a favoured member and specified in the determination (paragraph 204-30(3)(c) of the ITAA 1997).
For section 204-30 of the ITAA 1997 to apply, members to whom distributions are streamed must derive a greater benefit from imputation benefits than the members who do not participate in the buy-back. The words 'derives a greater benefit from franking credits' (imputation benefits) are defined in subsection 204-30(8) of the ITAA 1997 by reference to the ability of the members to fully utilise imputation benefits.
The conditions in subsection 204-30(1) of the ITAA 1997 will not be met as the company will pay equivalent dividends to each shareholder, rather than to one in preference to the other (paragraph 204-30(1)(b) of the ITAA 1997).
Divisions 725 and 727 of the ITAA 1997
Division 725 of the ITAA 1997 deals with a direct value shift which occurs under a scheme involving equity or loan interests in an entity where there is a decrease in the market value of some equity or loan interest and an increase or issue at a discount of other equity or loan interests. The decreases, increases and issues at a discount must be reasonably attributable to things done under the scheme (section 725-145 of the ITAA 1997).
· there are threshold conditions which apply to a direct value shift. A direct value shift under a scheme will not have any consequences unless all of the following conditions are satisfied:-
· the controlling entity test in section 725-55 of the ITAA 1997 is satisfied;
· the causal nexus test in section 725-65 of the ITAA 1997 is satisfied;
· there are affected owners of interests in the target entity (sections 725-70 to 725-85 of the ITAA 1997) and
· there are no exceptions (sections 725-70 and 725-90 of the ITAA 1997).
The facts in this instance involve a private company with a single class of shares on issue and a small number of individual and related shareholders. The proceeds of the buy-back are based on a directors' valuation and resulting in a buy-back of the shares by the company from the shareholders on exactly the same terms and in accordance with the ACPS methodology. Taking into account these facts, the proposed arrangement does not give rise to any direct value shift for which there are consequences under Division 725 of the ITAA 1997.
Division 727 of the ITAA 1997 deals with an indirect value shift which involves an unequal exchange of economic benefits between two entities - the losing entity and gaining entity (subsection 727-150(3) of the ITAA 1997).
There are threshold conditions which apply to an indirect value shift. An indirect value shift under a scheme will not have any consequences unless all of the following conditions are satisfied:
· the losing entity is a company or trust (other than a superannuation entity) at the indirect value shifting time (paragraph 727-100(a) of the ITAA 1997);
· the losing entity and the gaining entity did not deal at arm's length in the provision of at least one of the economic benefits (paragraph 727-100(b) of the ITAA 1997);
· the losing entity and gaining entity satisfied the control test or the common ownership nexus test (sections 727-105 or 727-110 of the ITAA 1997), and
· no exclusion applies (sections 727-215 to 727-260 of the ITAA 1997).
As mentioned above the facts in this instance involve a private company with a single class of shares on issue and a small number of individual and related shareholders. The proceeds of the buy-back are based on a directors' valuation and resulting in a buy-back of the shares by the company from the shareholders on exactly the same terms and in accordance with the ACPS methodology. Taking into account these facts, the arrangement does not give rise to any indirect value shift for which there are consequences under Division 727 of the ITAA 1997.
Question 4
Can the company allocate franking credits to that part of the purchase price which is taken to be the dividend component to the extent that the purchase price does not exceed the market value of the shares at the time of the buy-back if the buy-back did not take place and was never proposed to take place by virtue of section 202-45(c) of the ITAA 1997?
The dividend component of the purchase price will be a distribution by the company under item 1 of the table in subsection 960-120(1) of the ITAA 1997. Pursuant to subsection 202-40(1) of the ITAA 1997, this distribution will be a frankable distribution to the extent that it is not unfrankable under section 202-45 of the ITAA 1997.
Section 202-45 of the ITAA 1997 lists those distributions that are unfrankable. Paragraph 202-45(c) of the ITAA 1997 provides that so much of the buy-back purchase price that exceeds the market value of the share at the time of the buy-back is an unfrankable distribution. If the price exceeds the market value, the excess cannot be a frankable distribution under section 202-40 of the ITAA 1997 (paragraph 202-45(c) of the ITAA 1997).
The Commissioner accepts the methodology the company has adopted to determine the market value of its shares. Given that there will be no difference between the purchase price and the market value of the company's shares at the time of the buy-back, no part of the dividend component will be unfrankable under paragraph 202-45(c) of the ITAA 1997.
Question 5
Apart from the debit entry which the company may be required to make to its franking account under section 205-30 of the ITAA 1997, are there any other income tax or capital gains tax consequences for the company as a result of the proposed transaction?
Section 205-30 of the ITAA 1997 contains a table which sets out when a debit may arise in the franking account of a corporate tax entity. A debit may arise in the franking account, notwithstanding that an entity has not made an actual frankable distribution.
Where the buy-back is an off-market share buy-back, the purchase of the interest will be a 'frankable distribution' but only to the extent that the consideration for the buy-back is not debited against the company's share capital account.
The company will debit an amount per share of the purchase price against its share capital account and the balance per share against its retained earnings. Accordingly, that part of the purchase price per share will be taken to be a 'dividend' and hence a 'frankable distribution' for the purposes of Part 3-6 of the ITAA 1997 (see section 159GZZZP of the ITAA 1936, section 202-40 of the ITAA 1997 and the definition of 'distribution' in section 960-120 of the ITAA 1997).
Accordingly, a franking debit will arise under section 205-30 of the ITAA 1997 as a consequence of the company's share buy-back. No other income tax or capital gains tax consequences will arise for the company as a result of the proposed transaction.
Question 6
Is each shareholder of the company a qualified person for the purposes of Division 1A of the former Part IIIAA of the ITAA 1936?
Division 1A of former Part IIIAA of the ITAA 1936 provides the statutory tests that must be satisfied for a taxpayer to be a 'qualified person' with respect to a franked distribution they have received and thus be entitled to a tax offset for the franking credit attached to the distribution.
The test of what constitutes a 'qualified person' is provided in former section 160APHO of the ITAA 1936. The section provides, in brief, that a taxpayer will be a qualified person in relation to a dividend paid on a share if they are not under an obligation to make a related payment in respect of the dividend and have held the share at risk for the required holding period.
Related payment rule
The applicant has advised that the company's shareholders are not under any obligation to make a related payment in respect of the dividend. Consequently the shareholders will have to satisfy the holding period requirement for the primary qualification period.
Holding period requirement
The holding period requirement requires a shareholder to hold the shares, or the interest in the shares, on which a dividend is paid, at risk for a continuous period of at least 45 days during the relevant qualification period. As each shareholder has held their company's shares for more than 45 days, the holding period requirement has been satisfied.
All of the company's shareholders are therefore considered qualified persons for the purposes of former section 160APHO of the ITAA 1936.
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