Edited version of your written advice

Authorisation Number: 1051197417750

Date of advice: 8 March 2017

Ruling

Subject: Off market share buy-back of Redeemable Preference Shares

Question 1

Will the Commissioner confirm that section 159GZZZN of the Income Tax Assessment Act 1936 (ITAA 1936) will apply to the share buy-back such that no capital gain or loss, nor any assessable income or deduction will arise for Company A?

Answer

Yes

Question 2

Will the Commissioner confirm that no part of the purchase price in respect of the proposed share buy-back will be a dividend under either section 159GZZZP or the definition of dividend in section 6(1) of the ITAA 1936?

Answer

Yes

Question 3

Will the Commissioner confirm that paragraph (e) of the definition of dividend in section 6(1) of the ITAA 1936 (dealing with the redemption or cancellation of a redeemable preference share) will not apply to the proposed share buy-back?

Answer

Yes

Question 4

Will the Commissioner confirm that there will be no tainting of Company A's share capital account (as defined in Division 197 of the Income Tax Assessment Act 1997 (ITAA 1997)) as a result of the proposed share buy-back?

Answer

Yes

Question 5

Will the Commissioner confirm that no implications will arise for Company A under the commercial debt forgiveness provisions in Division 245 of the ITAA 1997 as a result of the proposed share buy-back?

Answer

Yes

Question 6

Will the Commissioner confirm that section 14-200 of Schedule 1 to the Tax Administration Act 1953 (TAA) will not apply to require an amount to be withheld by Company A from the purchase price payable to Foreign Co in respect of the share buy-back?

Answer

Yes

This ruling applies for the following period:

Financial year 20XX

The scheme commences on:

Financial year 20XX

Relevant facts and circumstances

1. Foreign Co is a non-resident for Australian tax purposes and holds X% of the ordinary shares and X% of the Redeemable Preference Shares in Company A.

2. Company A is incorporated and a tax resident in Australia.

3. Company A is the head company of the a multiple entry tax consolidated (MEC) group

4. Foreign Co does not have any Australian tax or capital losses.

5. Company A has no carried forward tax or capital losses

6. In XXXX Company A issued RPS to Foreign Co denominated in Australian dollars.

7. The RPS 'Terms and Conditions' (the RPS Terms) set out the key terms and conditions of the RPS.

8. The RPS are not convertible into ordinary shares in Company A (or any other company).

9. The RPS do not constitute an option or a right to acquire an asset that is Taxable Australian Real Property (TARP).

10. The account in which Company A records its ordinary share capital is a separate general ledger account titled 'Contributed equity - ordinary share capital' account.

11. The subscription funds which was received by Company A for the issue of the RPS was in cash, and was initially credited to the 'Contributed equity - ordinary share capital' account.

12. Although the RPS are legal form shares, they were treated as borrowings and classified as a financial liability in accordance with AASB 132 for statutory accounting purposes. During the year ended XXXX, the subscription funds were 'transferred' to a newly created general ledger account titled 'Borrowings - Redeemable Preference Shares'. There were no changes in the accounting treatment of the RPS to date.

13. There were no transfers of any amounts to the 'Borrowings - Redeemable Preference Shares' account from any other accounts of Company A, and similarly there were no transfers of any amounts to the 'Contributed equity - ordinary share capital' account.

14. The RPS are 'debt interests' for Australian income tax purposes under Division 974 of the ITAA 1997.

15. Foreign Co does not hold the RPS as trading stock or otherwise on revenue account. .

16. The accounting carrying value of the RPS is equal to their issue price.

17. The RPS were issued prior to the commencement of the Taxation of Financial Arrangements regime (TOFA). Further, Company A did not make a TOFA election to bring the RPS into the TOFA regime nor was there any change to the RPS Terms since their issue which may give rise to a change in the financial arrangement and bring the RPS into the TOFA regime.

18. Company A has paid fully franked dividends on its ordinary shares each year of income.

19. Company A has paid RPS dividends since the RPS were issued.

20. Company A proposes to undertake a selective buy-back of the RPS in accordance with the Corporations Act 2001 (Corporations Act).

21. As a result of the buy-back, Foreign Co will transfer all of the RPS to Company A in return for an agreed consideration amount.

22. All RPS bought back by Company A will be cancelled immediately after registration of the transfer of the shares to Company A.

23. The purchase price for the RPS will be equal to the original issue price (being the face value of the RPS), and is equal to market value. Company A will not pay any additional amounts to Foreign Co.

24. A RPS dividend was paid in respect of the period ended XXXX in accordance with the RPS Terms. No dividend will be declared following this dividend payment and the date the share buy-back takes place.

Relevant legislative provisions

● subsection 6(1) of the Income Tax Assessment Act 1936 (ITAA 1936)

● subsection 6(4) of the ITAA 1936

● Division 16K of the ITAA 1936

● section 159GZZZK of the ITAA 1936

● section 159GZZZM of the ITAA 1936

● section 159GZZZN of the ITAA 1936

● section 159GZZZP of the ITAA 1936

● Division 197 of the Income Tax Assessment Act 1997 (ITAA 1997)

● section 197-5 of the ITAA 1997

● section 197-10 of the ITAA 1997

● Division 245 of the ITAA 1997

● section 245-10 of the ITAA 1997

● section 245-15 of the ITAA 1997

● section 245-35 of the ITAA 1997

● section 855-10 of the ITAA 1997

● section 855-15 of the ITAA 1997

● section 855-20 of the ITAA 1997

● section 855-25 of the ITAA 1997

● Division 974 of the ITAA 1997

● section 975-300 of the ITAA 1997

● subsection 995-1(1) of the ITAA 1997

● Subdivision 14-D of Schedule 1 to the Taxation Administration Act 1953 (TAA), and

● section 14-200 of Schedule 1 to the TAA

Reasons for decision

All legislative references are to provisions of the Income Tax Assessment Act 1936 unless otherwise stated.

Question 1

Division 16K sets out the income tax consequences of share buy-backs.

For the purposes of Division 16K, where a company buys a share in itself from a shareholder, the purchase is a 'buy-back' (paragraph 159GZZZK(a)).

Division 16K categorises a buy-back as either an 'on-market purchase' or an 'off-market purchase'. As Company A shares are not listed on any stock exchange, the buy-back will be an off-market purchase (paragraph 159GZZZK(d)).

Company A will buy-back its shares within the meaning given by paragraph 159GZZZK(a). Accordingly, the share buy-back and the subsequent cancellation of the shares will be disregarded for the purposes listed in section 159GZZZN. That is, for the purposes of determining whether Company A:

● includes an amount in its assessable income under a provision of the ITAA 1936 or the ITAA 1997 (other than a provision of Part 3-1 or 3-3 of the ITAA 1997 (about CGT))

● is entitled to an allowable deduction under the ITAA 1936 or the ITAA 1997, and

● makes a capital gain or a capital loss under Part 3-1 or 3-3 of the ITAA 1997.

Accordingly, section 159GZZZN will apply to the share buy-back such that Company A will not make a capital gain or loss, nor generate any assessable income nor be entitled to a deduction.

Question 2

In an off-market share buy-back, the difference between the purchase price and the part of the purchase price which is debited to the company's share capital account is taken to be a dividend paid by the company to the seller (subsection 159GZZZP(1)).

Purchase price

The purchase price paid by the company to the shareholder is the amount of money and/or the market value of any property that the shareholder receives as consideration for the buy-back (section 159GZZZM).

Share capital account

The Commissioner accepts that the subscription funds for the RPS which is recorded in the 'Borrowings - Redeemable Preference Shares' account constitutes part of Company A's share capital account in accordance with paragraph 975-300(1)(b) of the ITAA 1997 on the basis that:

● the account was created on or after 1 July 1998, and

● the first amount credited to the account was an amount of share capital, being the amount of subscription funds paid by Foreign Co to subscribe for the RPS..

That is, the Commissioner accepts that the 'transfer' to the 'Borrowings - Redeemable Preference Shares' account more accurately reflects the subscription funds for the RPS, in effect the account is a sub-account of Company A's share capital account and does not represent retained earnings or other reserves of Company A.

Notwithstanding the RPS were classified as borrowings (a financial liability) for Australian statutory reporting / accounting purposes and constitute 'debt interests' for Australian income tax purposes, the RPS are legal form shares.

Subsection 975-300(2) of the ITAA 1997 provides that where a company has more than one share capital account the accounts are taken to be a single account. In this case, then, the 'Borrowings - Redeemable Preference Shares' and the 'Contributed equity - ordinary share capital' accounts are taken to be one share capital account of Company A.

Further, there have been no changes in the accounting treatment of the RPS and no amounts have been transferred from any other account to the 'Borrowings - Redeemable Preference Shares' account, or to the 'Contributed equity - ordinary share capital' account which would otherwise have triggered the share capital tainting rules under Division 197, and therefore the Commissioner accepts that Company A's share capital account is untainted.

Allocation between the capital and dividend components

Company A will buy-back and cancel all of the RPS on issue at a purchase price equal to the original issue price / face value of the RPS. Company A will debit the entire purchase price against its untainted share capital account (as discussed above). Therefore section 159GZZZP will not apply to treat any part of the purchase price as a dividend, paid to Foreign Co as shareholder.

Dividend pursuant to subsection 6(1)

'Dividend' is defined in paragraph 6(1)(a) to include any distribution made by a company to its shareholders, whether in money or other property. The buy-back of the RPS will be a distribution of money to Foreign Co, therefore, this element of the definition would be satisfied.

However, paragraph 6(1)(d) of the definition excludes amounts debited against the share capital account of a company from constituting a dividend, provided that no amounts are credited to the share capital account which was contributed by another shareholder and under an arrangement in order to effect the buy-back (subsection 6(4)).

The buy-back of the RPS will be debited against the amount standing to the credit of Company A's untainted share capital account and there is no arrangement where the share capital account of Company A will be credited in connection with the debiting of the share capital account required to effect the share buy-back. Therefore, subsection 6(4) will not apply as an exception to paragraph (6)(1)(d) of the definition of dividend, and as such, the buy-back of the RPS will not constitute a dividend as defined in subsection 6(1).

Further, Company A will not declare a dividend or determine that a dividend is to be paid on the RPS for the period from Dividend Date (as defined in RPS Terms) of XXXX which immediately precedes the share buy-back and up to the buy-back date.

Therefore no part of the purchase price in respect of the share buy-back will be a dividend under either section 159GZZZP or the definition of dividend in subsection 6(1).

Question 3

The definition of 'dividend' in subsection 6(1) does not include:

(e) moneys paid or credited, or property distributed, by a company for the redemption or cancellation of a redeemable preference share if:

(i) the company gives the holder of the share a notice when it redeems or cancels the share; and

(ii) the notice specifies the amount paid-up on the share immediately before the cancellation or redemption; and

(iii) the amount is debited to the company's share capital account;

...

As discussed in Question 1 above, the buy-back of the RPS will constitute a buy-back within the meaning given by paragraph 159GZZZK(a), and will not constitute a redemption of the RPS. The notice referred to in paragraph (e)(i) applies where there is a redemption of shares.

The amount paid will be the consideration for the purchase of the RPS and not for the redemption of the RPS. Once the RPS are purchased by Company A they will be transferred from Foreign Co to Company A and entered into Company A's share register, and subsequently cancelled.

Therefore paragraph 6(1)(e) will not apply to the buy-back of the RPS.

Question 4

Section 197-5 of the ITAA 1997 states that the share capital tainting rules contained in Division 197 will apply where an amount is transferred to a company's share capital account from another of the company's accounts. Section 197-10 of the ITAA 1997 provides an exclusion for amounts that at all times before the transfer could be identified as an amount of share capital.

The Commissioner accepts that the 'Borrowings - Redeemable Preference Shares' account always formed part of Company A's share capital account (as discussed Question 2 above). That is, no amount was previously transferred to Company A's share capital account which caused the account to be tainted.

To carry out the buy-back, Company A will debit the entire purchase price to the 'Borrowings - Redeemable Preference Shares' account, and as such, the entire price will be debited to Company A's share capital account.

Further, the debit to Company A's share capital account will not constitute a transfer which causes the account to be tainted.

Question 5

Division 245 of the ITAA 1997 applies to any commercial debt that was forgiven after XXXX. For the purposes of this Division, a debt is a commercial debt if the whole or any part of the interest (or of an amount in the nature of the interest), payable in respect of the debt, has been or could be deducted by the taxpayer (section 245-10 of the ITAA 1997).

The provisions also extend to 'non-equity shares' as if these were a debt to which section 245-10 of the ITAA 1997 applies (section 245-15). A 'non-equity share' is defined as a share that is not an equity interest in the company. A share will not be an equity interest if it is characterised as a debt interest under Division 974.

The RPS are debt interests under Division 974 for Australian tax purposes and accordingly these constitute 'non-equity shares' which are subject to the commercial debt forgiveness rules. Further, as the dividends on the RPS are treated as deductible 'interest' for tax purposes, the RPS are a 'commercial debt'.

Section 245-35 of the ITAA 1997 relevantly states that forgiveness of a debt occurs when the debtor's obligation to repay the debt is released or waived, or is otherwise extinguished other than by repayment of the debt.

As Company A will purchase all the RPS under the buy-back, it will repay the RPS 'debt' to Foreign Co in full. Therefore the debt will not be forgiven and as such the commercial debt forgiveness rules will not apply to Company A in relation to the RPS.

Further, the Board of Company A will not declare a dividend for the period between the last Dividend Date and the buy-back date. Under the RPS Terms, in the absence of the Board declaring a Dividend Date (other than XXXX or XXXX), Company A is not obliged to pay a dividend on the RPS.

The Commissioner accepts that Company A is not obliged to pay a dividend that 'accrued' between the last Dividend Date and the buy-back date, and therefore not paying that dividend, Company A is not forgiving that dividend payment in circumstances which attracts the operation of Division 245 of the ITAA 1997.

Accordingly, no implications will arise for Company A under the commercial debt forgiveness provisions in Division 245 of the ITAA 1997 as a result of the proposed share buy-back.

Question 6

Subdivision 14-D of Schedule 1 to the TAA requires a purchaser to withhold 10% of the purchase price for a CGT asset acquired from a foreign resident where relevantly and among other things the CGT asset is with a market value of $2 million or more.

The RPS are CGT assets and possess a market value of more than $2 million.

The RPS are not 'taxable Australian real property' as defined in section 855-20 of the ITAA 1997 (as the RPS are not real property situated in Australia (including land, leasehold interests, fixtures to land), nor Australian mining / exploration rights. In addition, the RPS are not options to acquire an interest that provides company title interests.

In the present circumstances, it is necessary to consider if the RPS constitute an indirect Australian real property interest' as defined in section 855-25 of the ITAA 1997 which requires that the RPS are membership interests in Company A.

A 'membership interest' in an entity is defined in section 960-135 of the ITAA 1997 as:

… an interest or rights to an interest in an entity of which you are a member; …

Note: In conjunction with subsection 960-130(3), this means that a debt interest is not a membership interest.

…

As set out in Item 1 of the table in subsection 960-130(1), and in subsection 960-130(3), both of the ITAA 1997, a member of a company is:

..,. a member of the company or a stockholder in the company …

however

… an entity is not a member of another entity just because the entity holds one or more interests … relating to the other entity that are *debt interests.

As the RPS constitute debt interests for Australian tax purposes, the RPS do not constitute membership interests in Company A.

Therefore section 14-200 of Schedule 1 to the TAA will not require Company A to withhold an amount from the purchase price payable to Foreign Co in respect of the buy-back of the RPS

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