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Edited version of your written advice

Authorisation Number: 1012690741798

Ruling

Subject: Income tax exemption and refund of franking credits

Question 1

Are the proceeds received by the entity under the arrangement exempt from income tax under section 50-1 of the Income Tax Assessment Act 1997 (ITAA 1997) if the entity is endorsed under section 50-110 of the ITAA 1997?

Answer

Yes

Question 2

If the proceeds are exempt, is the entity eligible to obtain a refund of any imputation credits received from the arrangement under section 207-117 of the ITAA 1997?

Answer

Yes

This ruling applies for the following periods:

1 July 2013 - 30 June 2014

1 July 2014 - 30 June 2015

The scheme commences on:

1 July 2013

Relevant facts and circumstances

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 50-1

Income Tax Assessment Act 1997 Section 50-5

Income Tax Assessment Act 1997 Section 50-110

Income Tax Assessment Act 1997 Section 207-115

Income Tax Assessment Act 1936 Subsection 160APHM(2)

Income Tax Assessment Act 1936 Subsection 160APHM(3)

Income Tax Assessment Act 1936 Section 160APHO

Reasons for decision

Question 1

Section 50-1 of the ITAA 1997 provides that the total ordinary and statutory income of the entities covered in the tables in section 50-5 to 50-45, are exempt from income tax.

In this case, the entity is a registered charity and has satisfied the endorsement conditions in section 50-110. That is, the Society:

Therefore, the proceeds from the sale of the shares pursuant to the share buy-back agreement with AAA company is exempt from income tax under section 50-1 of the ITAA 1997.

Question 2

Under section 207-115 of the ITAA 1997 an entity, referred to in the legislation as an 'exempt institution that is eligible for a refund', is eligible for tax offsets for franking credits attached to the franked distributions that they receive. These tax offsets are refundable under Division 67 of the ITAA 1997. The eligible institutions are:

The entity falls under two of the above eligible institutions as it is both a tax exempt charity and a deductible gift recipient.

The entity was bequeathed the residual of a deceased estate. The deceased owned AAA shares. AAA company and the entity reached an agreement on W date. The AAA shares would be transferred to the entity and AAA company would buy-back the shares through a share buy-back arrangement.

Share buy-backs are mainly governed by Division 16K of Part 111 of the Income Tax Assessment Act 1936 (ITAA 1936). The Division applies where a company buys a share in itself from a shareholder. On-market buy backs are defined in section 159GZZZK of the ITAA 1936. If the share is listed on the stock exchange and the purchase is made in the ordinary course of business of that stock exchange, the buy-back will be an on-market purchase. All other buy-backs are treated as off-market purchases.

In the entity's case, as the AAA shares are not listed on the stock exchange it is an off-market buy-back in accordance with section 159GZZZK of the ITAAA 1936.

Law Administration Practice Statement (PSLA) 2007/9 Share buy-backs, provides at paragraph 32:

AAA company has provided the entity with a share buy-back distribution statement for the period ending 30 June 2014. The return of capital component is $C and the dividend component is $D. The dividend has been franked.

Paragraphs 75-79 of PSLA 2007/9 provide guidance on the 'holding period rule' and how it interacts with share buy-back arrangements. The holding period must be satisfied to enable the shareholder to receive a tax offset in relation to the franking credits:

Section 160APHO was repealed and has not yet been re-enacted but the these rules still have application via the anti-manipulation rule in paragraph 207-145(1)(a) of the ITAA 1997 (Taxation Determination TD 2007/11 Income tax: imputation: franked distributions: qualified persons…)

The AAA shares were transferred into the entity's name on X date. The share buy-back was approved by the shareholders on Y date and the AAA company bought-back the shares on Z date. Therefore, the entity has held the shares for at least 45 days.

However, the shares must be held 'at risk' to satisfy the holding period, paragraph 83-84 of PSLA 2007/9 states:

Subsection 160APHM(2) of the ITAA 1936 defines when a taxpayer has materially diminished risk in respect of their shares:

According to subsection 160APHM(3) of the ITAA 1936, a taxpayer's net position is worked out by reference to 'delta'.

Taxation Determination TD 2007/29 Income tax: holding period rule: is an embedded share option a position… states at paragraph 10 that 'delta' is a financial concept that measures the change in price of a derivative for a given small change in the price of an underlying asset. If a derivative has a delta in relation to an equity interest it can be used to diminish the risks of loss or opportunities for gain associated with owning the interest.

According to paragraph 4.50 and 4.63 of the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 2) 1999:

On W date the entity and AAA company signed the share buy-back agreement, where AAA company agreed to buy the AAA shares from the entity for a certain price. However, the share buy-back agreement was subject to shareholder's approval.

Shareholder approval was given on Y date. It is considered that until the shareholders approved the share buy-back, AAA company was not obligated to purchase the AAA shares from the entity and the entity was subject to risk.

Therefore for the period X date until the day before the shareholder's approved the share buy-back on Y date, the entity held the shares 'at risk'. This is greater than 45 days and the entity will satisfy the holding period rule.

Consequently, the entity is entitled to a refund of imputation credits under section 207-117 of the ITAA 1997.


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