Edited version of your private ruling

Authorisation Number: 1012520828068

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Ruling

Subject: Off market selective share buy-back

Question 1

Will the portion of the buy-back purchase price exceeding the capital component be a dividend for the purposes of section 159GZZZP of the Income Tax Assessment Act 1936 (ITAA 1936)?

Advice/Answers

Yes

Question 2

Will the Commissioner make a determination under either section 45A or section 45B of the ITAA 1936 that section 45C of the ITAA 1936 will apply to the proposed selective buy-back?

Advice/Answers

No

Question 3

Will the Commissioner confirm that section 204-30 of the Income Tax Assessment Act 1997 (ITAA 1997) will not apply to the proposed selective buy-back?

Advice/Answers

Yes

Question 4

Will the Commissioner confirm that the general anti-avoidance rule in subsection 177EA(5) of the ITAA 1936 will not apply to the proposed selective buy-back?

Advice/Answers

Yes

This ruling applies for the following period

Year ended 30 June 2014

The scheme commenced on

1 July 2013

Relevant facts

1. Company V is a private limited company.

2. The shareholders of Company V are Company X, Taxpayer Y and Taxpayer Z.

3. All shareholders of Company V are Australian tax residents.

4. Company X is a private limited company.

5. The shareholder of Company X is Taxpayer Z.

6. Company V is proposing to undertake a selective off market buy-back (the proposed buy-back) of a number of shares from Company X which will indirectly reduce the shareholding of Taxpayer Z.

7. The consideration for the Company V shares bought back will be their market value.

8. The capital component of the proposed buy-back has been determined in accordance with the average capital per share methodology.

9. Company V and Company X both have a single class of ordinary shares on issue without any special rights or obligations attached.

10. It is expected that Company V will have sufficient franking credits to attach to any dividend paid as part of the proposed buy-back.

11. The share capital account of Company V is not tainted within the meaning of section 197-50 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 Section 45A.

Income Tax Assessment Act 1936 Section 45B.

Income Tax Assessment Act 1936 Subsection 45B(1).

Income Tax Assessment Act 1936 Subsection 45B(2).

Income Tax Assessment Act 1936 Paragraph 45B(2)(a).

Income Tax Assessment Act 1936 Paragraph 45B(2)(b).

Income Tax Assessment Act 1936 Subsection 45B(3)

Income Tax Assessment Act 1936 Subsection 45B(9).

Income Tax Assessment Act 1936 Section 45C.

Income Tax Assessment Act 1936 Paragraph 159GZZZK(a).

Income Tax Assessment Act 1936 Paragraph 159GZZZK(b).

Income Tax Assessment Act 1936 Paragraph 159GZZZK(d).

Income Tax Assessment Act 1936 Paragraph 159GZZZM(a).

Income Tax Assessment Act 1936 Subsection 159GZZZP(1).

Income Tax Assessment Act 1936 Subsection 159GZZZQ(2).

Income Tax Assessment Act 1936 Section 159GZZZP.

Income Tax Assessment Act 1936 Subsection 177D(b).

Income Tax Assessment Act 1936 Section 177EA.

Income Tax Assessment Act 1936 Subsection 177EA(3).

Income Tax Assessment Act 1936 Paragraph 177EA(3)(a).

Income Tax Assessment Act 1936 Paragraph 177EA(3)(d).

Income Tax Assessment Act 1936 Paragraph 177EA(3)(e).

Income Tax Assessment Act 1936 Subsection 177EA(5).

Income Tax Assessment Act 1936 Subsection 177EA(17).

Income Tax Assessment Act 1997 Section 197-50.

Income Tax Assessment Act 1997 Subsection 202-40(1).

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 Subsection 204-30(3).

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).

Reasons for decision

All legislative references are to the ITAA 1936 unless otherwise indicated.

Question 1

Summary

The portion of the buy-back purchase price exceeding the capital component will be a dividend for the purposes of section 159GZZZP?

Detailed reasoning

Subsection 159GZZZP(1) provides that where the buy-back of a share is an 'off-market purchase', the difference between the purchase price and the part (if any) of the purchase price which is debited against amounts standing to the credit of the company's share capital account is taken to be a dividend paid by the company, to the seller as a shareholder in the company, out of profits derived by the company, and on the day the buy-back occurs.

An 'off-market purchase' occurs when a company that is not listed on any official stock exchange buys a share in itself from a shareholder in the company (paragraph 159GZZZK(d)). When the off-market purchase occurs, it is a 'buy-back' and the shareholder is the seller (paragraphs 159GZZZK(a) and 159GZZZK(b)). Accordingly, as Company V is not listed on any official stock exchange, the proposed purchase of shares in itself from the participating Company V shareholder (Company X) is an off-market buy-back.

The purchase price for the purposes of the off-market buy-back provisions is defined in paragraph 159GZZZM(a) to include the amount of money that the seller has received or is entitled to receive as a result of or in respect of the buy-back. However, the amount of the purchase price that is treated as a dividend under section 159GZZZP is only the amount that is not debited against the company's share capital account. The amount of the purchase price that is debited against the share capital account is essentially a 'split' between the return of capital and dividend paid to the shareholder.

The provisions of the ITAA 1936 do not prescribe how the company is to allocate the buy-back purchase price against the share capital account. However, the average capital per share method (ACPS) is the preferred methodology for determining the dividend / capital split in an off-market share buy-back (see paragraph 12 of Law Administration Practice Statement PS LA 2007/9 Share buy-backs (PS LA 2007/9)).This is obtained by dividing a company's ordinary issued capital by the number of shares on issue.

In this case Company V will debit an amount to its untainted share capital account for each share bought back (based on ACPS). Therefore the dividend component will be the difference between the buy-back purchase price and the dividend component.

In this case the buy-back purchase price will be the market value of the Company V shares.

Provided the purchase price of each Company V share bought back equals market value, no adjustment will be required under the market value rule in subsection 159GZZZQ(2).

The dividend component of the proposed buy-back is frankable but only to the extent that the buy-back purchase price does not exceed the market value of the share at the time of the buy-back if the buy-back did not occur and was never proposed to occur (paragraph 202-45(c) of the ITAA 1997).

Based on the information provided by the Applicant, it is expected that Company V will have sufficient franking credits to attach to any dividends paid as part of the proposed buy-back.

Question 2

Summary

The Commissioner will not make a determination under either section 45A or section 45B that section 45C will apply to the proposed buy-back.

Detailed reasoning

Section 45B applies 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)); or

(b) certain payments, allocations and distributions are made in substitution for dividends (paragraph 45B(1)(b)).

Subsection 45B(2) provides (relevantly) that the section applies if:

(a) there is a scheme under which a person is provided with a demerger benefit or a capital benefit by a company;

(b) under the scheme the taxpayer (the relevant taxpayer) obtains a tax benefit as defined in subsection 45B(9); and

(c) having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into or carried out for a more than incidental purpose of enabling the taxpayer to obtain the tax benefit.

Where the requirements of subsection 45B(2) are met, subsection 45B(3) empowers the Commissioner to make a determination that section 45C applies in relation to a capital benefit.

In this case, while the conditions of paragraphs 45B(2)(a) and 45B(2)(b) are met, the requisite purpose of enabling the participating Company V shareholder (Company X) to obtain a tax benefit (by way of a capital benefit) is not present.

Accordingly, the Commissioner will not make a determination under paragraph 45B(3) that section 45C applies to treat all or part of the capital component of the buy-back purchase price as an unfranked dividend paid by Company V.

Question 3

Summary

The Commissioner will not make a determination under section 204-30 of the ITAA 1997 to deny the whole, or any part, of the imputation benefits received in relation to the dividend component of the proposed buy-back.

Detailed reasoning

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));

(b) the member would derive a greater benefit from franking credits than another member of the entity (paragraph 204-30(1)(b)); 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)).

Relevantly, if section 204-30 of the ITAA 1997 applies, the Commissioner is vested with the 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)); or

(b) that no imputation benefit is to arise in respect of any streamed distribution made to a favoured member and specified in the determination (paragraph 204-30(3)(c)).

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 'derive 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.

Given Company V is the only shareholder participating in the proposed buy-back they derive a greater benefit from imputation benefits than the shareholders who are not participating in the buy-back.

However, the proposed buy-back is being undertaken for the purpose of diluting Taxpayer Z's interests in Company V. Therefore, it is considered that even if Company X derives a greater benefit than shareholders who do not participate in the proposed share buy-back this is purely an incidental consequence of the transaction.

In addition, following the franking of the dividend component of the buy-back purchase price, Company V's franking account will have sufficient franking credits to enable it to frank distributions to remaining shareholders in the future.

Accordingly, the Commissioner will not make a determination under paragraph 204-30(3)(c) of the ITAA 1997 to deny the whole, or any part, of the imputation benefits received in relation to the dividend component of the buy-back purchase price by Company X.

Question 4

Summary

The general anti-avoidance rule in subsection 177EA(5) will not apply to the proposed buy-back.

Detailed reasoning

Section 177EA is a general anti-avoidance provision that applies to a wide range of schemes to obtain a tax advantage in relation to franking credits or tax offsets. In essence, it applies to schemes for the disposition of shares, or an interest in shares where a franked dividend is paid or payable in respect of the shares. This would include a buy-back with a frankable distribution (franked distribution) component.

Specifically, subsection 177EA(3) provides that section 177EA applies if:

(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 frankable 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 the interest in 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, the 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 of paragraphs 177EA(3)(a) to 177EA(3)(d) are satisfied. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of Company V, its participating shareholders or any other relevant party, there is a more than merely incidental purpose, of obtaining an imputation benefit under the scheme.

With regard to paragraph 177EA(3)(e), the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that there is a more than incidental purpose of providing a franking credit benefit under the scheme.

In considering the purpose issue of paragraph 177EA(3)(e), the Commissioner must also consider the relevant circumstances outlined in subsection 177EA(17). 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.

From consideration of the factors contained in subsection 177EA(17), the Commissioner has come to the view that subsection 177EA(5) 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). Among the relevant circumstances present in the proposed arrangement is the fact that there are no non-resident shareholders in Company V, the buy-back purchase price is based on market value and the allocation of the buy-back purchase price between share capital and retained earnings is determined using the ACPS method.

Therefore, the general anti-avoidance rule in subsection 177EA(5) will not apply to the proposed buy-back.

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