Edited version of your written advice

Authorisation Number: 1051197453727

Date of advice: 8 March 2017

Ruling

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

Question 1

Will the Commissioner confirm that the share buy-back will not give rise to an assessable or deductible amount for Foreign Co pursuant to either Division 230 of the ITAA 1997 or section 26BB of the ITAA 1936?

Answer

Yes

Question 2

Will the Commissioner confirm that Division 855 of the ITAA 1997 will apply to the share buy-back such that any capital gain or loss arising for Foreign Co will be disregarded?

Answer

Yes

Question 3

Will the Commissioner confirm that the share buy-back will not trigger the MEC cost base pooling rules in subdivision 719-K of the ITAA 1997?

Answer

Yes

Question 4

Will the Commissioner confirm that he will not make a determination under sections 45A and 45B of the ITAA 1936 that section 45C applies in relation to the share buy-back?

Answer

Yes

Question 5

Will the Commissioner confirm that sections 177EA and 128B of the ITAA 1936 and sections 202-45 and 204-30 of the ITAA 1997 will not apply to the share buy-back?

Answer

Yes

This ruling applies for the following periods:

Financial year 20XX

The scheme commences on:

Financial year 20XX

Relevant facts and circumstances

1. Foreign Co is incorporated in a foreign jurisdiction and is a non-resident for Australian tax purposes.

2. Company D is also a non-resident for Australian tax purposes.

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

4. Foreign Co holds X% of the ordinary shares and X% of the Redeemable Preference Shares (RPS) in Company A.

5. Company D holds the remaining X% of the ordinary shares in Company A.

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

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

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

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

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

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

12. The Company A share capital account is untainted.

13. 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 by Company A.

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. Company A has paid fully franked dividends on its ordinary shares in the past.

18. Company A has paid RPS dividends each year since the RPS were issued.

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

20. 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.

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

22. The purpose of the buy-back of the RPS is to effectively make an early repayment of the intercompany debt (for accounting and tax purposes), represented by all of the RPS on issue, prior to the Mandatory Redemption Date.

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

24. The purchase price will be paid in Australian dollars and will be settled in cash.

25. The original issue price and share buy-back price (purchase price) is equal to market value of the RPS at the share buy-back date.

Relevant legislative provisions

● section 26BB of the ITAA 1936

● subsection 26BB(1) of the ITAA 1936

● section 45A of the ITAA 1936

● section 45B of the ITAA 1936

● section 45C of the ITAA 1936

● section 70B of the ITAA 1936

● section 128B of the ITAA 1936

● subsection 159GP(1) of the ITAA 1936

● section 177EA of the ITAA 1936

● section 104-10 of the ITAA 1997

● section 202-45 of the ITAA 1997

● Division 230 of the ITAA 1997

● subdivision 719-K of the ITAA 1997

● section 719-560 of the ITAA 1997

● Division 855 of the ITAA 1997

● section 855-25 of the ITAA 1997

● section 960-130 of the ITAA 1997

● subsection 960-130(3) of the ITAA 1997

● section 960-135 of the ITAA 1997

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

Reasons for decision

Question 1

Taxation of Financial Arrangement (TOFA)

Division 230 of the ITAA 1997 contains the rules for the taxation of gains and losses arising from certain financial arrangements entered into on or after 1 July 2010, unless the taxpayer made an election to bring financial arrangements that pre-dated the TOFA rules into the TOFA regime.

As the RPS were issued prior to the introduction of the TOFA regime they are not subject to the TOFA rules in Division 230 of the ITAA 1997. Further there have been no changes to the RPS Terms since their issue which may give rise to a change in the financial arrangement nor which bring the RPS into the TOFA regime.

Traditional security gain or loss

Where a taxpayer makes a gain in relation to the disposal or redemption of a traditional security, section 26BB of the ITAA 1936 operates to include the amount of any gain in the assessable income of the taxpayer, whilst section 70B of the ITAA 1936 operates to allow the taxpayer a deduction for the amount of any loss from their assessable income.

A traditional security is defined in subsection 26BB(1) of the ITAA 1936 as a security held by the taxpayer which the taxpayer acquired after XXXX, is not trading stock of the taxpayer, and either:

● does not have an eligible return, or

● has an eligible return that satisfies the conditions listed in subparagraph (b)(ii) of the definition of traditional security in subsection 26BB(1) of the ITAA 1936.

The term 'security' is defined in subsection 26BB(1) of the ITAA 1936 to have the same meaning as set out in Division 16E of the ITAA 1936. Relevantly, subsection 159GP(1) of the ITAA 1936 provides that 'security' means:

(a) stock, a bond, debenture, certificate of entitlement, bill of exchange, promissory note or other security;

(b) a deposit with a bank or other financial institution;

(c) a secured or unsecured loan; or

(d) any other contract, whether or not in writing, under which a person is liable to pay an amount or amounts, whether or not the liability is secured.

An RPS is not 'stock, a bond, debenture, certificate of entitlement, bill of exchange, or a promissory note'.

The term 'or other security' in paragraph (a) of the definition of 'security' encompasses instruments that evidence an obligation on the part of the issuer or drawer to pay an amount to the holder or acceptor, whether during the term of the instrument or at its maturity. The types of securities referred to in paragraph (a) of the definition of security will generally be recognised as debt instruments (Taxation Ruling TR 96/14 Income tax: traditional securities). Therefore, the RPS are not 'securities' within the meaning of paragraph (a) of the definition.

Paragraphs (b) and (c) of the definition of 'security' do not apply because the RPS are neither a deposit with a bank or other financial institution, nor secured or unsecured loans.

Contracts that have debt like obligations may fall under paragraph (d) of the definition of security (TR 96/14).

We note that the Explanatory Memorandum to the Taxation Laws Amendment Bill (No. 3) 1989, which introduced the traditional security rules, relevantly states as follows:

… security in subsection 159GP(1) refers to items that are usually taken to be a security. Shares in the issued capital of a company are not included in this definition…

The Commissioner considers that RPS do not meet the requirements of paragraph (d) of the definition of 'security' and therefore sections 26BB and 70B of the ITAA 1936 will not apply in respect of any gain or loss made on the disposal of the RPS by Foreign Co.

Question 2

The RPS are CGT assets pursuant to section 108-5 of the ITAA 1997.

At the time of the buy-back, Foreign Co will dispose of CGT assets (RPS) and CGT Event A1 in section 104-10 of the ITAA 1997 will happen to Foreign Co as there will be a change in legal and beneficial ownership of the RPS from Foreign Co to Company A.

However, under section 855-10 of the ITAA 1997, an entity disregards a capital gain or capital loss from a CGT event if they are a foreign resident just before the CGT event happens to a CGT asset that is not 'taxable Australian property' as defined in the table in section 855-15 of the ITAA 1997.

For 'taxable Australian property', the Commissioner considers that the RPS are not 'taxable Australian real property' (TARP) 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, and therefore the RPS are not an indirect Australian real property interest.

As set out in the Relevant facts and circumstances the RPS are not, and have not been, used in carrying on a business at or through a permanent establishment in Australia by Foreign Co or any other foreign resident entity.

Further, the RPS do not constitute an option or right to acquire an asset that is TARP, a TARP interest or used by an Australian permanent establishment.

Therefore, any capital gain or capital loss that Foreign Co may make as a result of the buy-back of the RPS will be disregarded under Division 855 of the ITAA 1997.

Question 3

Subdivision 719-K of the ITAA 1997 contains the cost setting rules for membership interests held in eligible tier-1 companies that are members of a MEC group where those interests are not held by members of the group. The pooling rules in subdivision 719-K of the ITAA 1997 allow the foreign shareholders of either the provisional head company or of another eligible tier-1 company of a MEC group to determine the cost base of their shares for Australian CGT purposes on the disposal of those membership interests.

Broadly, the membership interests in eligible tier-1 companies, including the provisional head company, that are held by entities that are not members of the MEC group (section 719-560 of the ITAA 997) are taken into account as a pool ('pooled interests').

Under the pooling rules, the original cost bases of all pooled interests form a single cost base pool. Upon the occurrence of certain CGT events including CGT event A1, the cost base of all pooled interests are 'reset' by reallocating the original cost base of the pooled interests to shares in each eligible tier-1 company by reference to each company's market value relative to other eligible tier-1 companies at the time of the CGT event.

Company A is the provisional head company of a MEC group, and as such the MEC cost base pooling rules may apply if the RPS formed part of the pooled interests.

However, as discussed in the Detailed reasoning for Question 2 above, the RPS do not constitute membership interests and as such are not pooled interests, and therefore the MEC cost base pooling rules will not apply as a result of the buy-back of the RPS.

Question 4

Section 45A of the ITAA 1936

Section 45A of the ITAA 1936 is an anti-avoidance rule that applies where a company streams 'capital benefits' to shareholders who derive a greater benefit from the receipt of capital benefits (advantaged shareholders), and it is reasonable to assume that other shareholders (disadvantaged shareholders) have received or will receive dividends.

Paragraph 45A(3) states that a reference to 'provision of capital benefit' is a reference to:

…

(b) the distribution to the shareholder of share capital or share premium

...

Subsection 45A(4) provides a non-exhaustive list of circumstances in which a shareholder would derive a greater benefit from capital benefits than another shareholder.

Foreign Co is the only shareholder of the RPS (which are governed by separate terms and conditions) and is also a shareholder of X% of the ordinary shares in Company A. The remaining X% of the ordinary shares of Company A are held by Company D.

Pursuant to paragraph 45A(3)(b), the buy-back price received by Foreign Co will constitute the 'provision of a capital benefit' as the whole of the buy-back price will be debited to Company A's share capital account.

As both Foreign Co and Company D are non-residents, Foreign Co will not derive a greater benefit from the receipt of a capital benefits for the purposes of subsection 45A(4) of the ITAA 1936. Both Foreign Co and Company D have historically received fully franked dividends from Company A which are not subject to dividend withholding tax and both shareholders are non-resident entities. Further, both shareholders do not have any Australian tax or capital losses and the cost base of the shares held by Foreign Co and Company A are subject to the Australian CGT regime (unless an exemption applies such as under the non-resident CGT rules discussed at question 2 above).

Accordingly, section 45A of the ITAA 1936 will not apply to the buy-back of the RPS.

Section 45B of the ITAA 1936

The purpose of section 45B is to ensure that capital benefits are treated as dividends for taxation purposes if they are provided in substitution for dividends.

Subsection 45B(2) states that section 45B applies if:

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

(b) 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; and

(c) 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 a taxpayer (the relevant taxpayer) to obtain a tax benefit.

Scheme

The buy-back constitutes a 'scheme' within the meaning given by subsection 995-1(1) of the ITAA 1997 under which a capital benefit (discussed below) is provided to Foreign Co, a person, where 'person' is defined to include a company.

Capital Benefits

Foreign Co will be 'provided with a 'capital benefit' by Company A as the proceeds for the buy-back of the RPS will be a distribution to Foreign Co of share capital by Company A (paragraph 45B(5)(b) of the ITAA 1936). Therefore the paragraph 45B(2)(a) requirement will be satisfied, in respect of the buy-back

Tax benefit

Pursuant to paragraph 45B(2)(b) and subsection 45B(9), a person will obtain a tax benefit where the amount of tax payable (or another amount payable under the Act) would be less than the amount of tax (or other amount) that would have been payable had the capital benefit instead been an assessable dividend.

The buy-back of the RPS provides Foreign Co with a 'tax benefit', as the Australian tax payable on the distribution of the share capital is less than what would be payable if an assessable dividend was paid by Company A to Foreign Co, as such a dividend would be subject to Australian dividend withholding tax (to the extent it was not franked by Company A).

Purpose

Paragraph 45B(2)(c) provides that 45B only applies if, having regard to the relevant circumstances of the scheme, it would be concluded that the scheme was entered into for a purpose (for a non-incidental purpose) of enabling a taxpayer to obtain a tax benefit. The relevant circumstances are inexhaustively listed in subsection 45B(8) and also include the matters set out in subsection 177D(2) of the ITAA 1936.

Having regard to the relevant circumstances of the buy-back as set out in the Relevant facts and circumstances, the Commissioner concludes that the buy-back of the RPS will not be undertaken, for a purpose which is more than incidental of enabling Foreign Co or another taxpayer to obtain a tax benefit. As the paragraph 45B(2)(c) of the ITAA 1936 requirement will not be satisfied, section 45B of the ITAA 1936 will in turn not apply to the buy-back of the RPS.

Accordingly, the Commissioner will not make a determination under subsections 45A(2) and  45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat any of the Buy-Back Price as an unfranked dividend paid by Company A to Foreign Co.

Conclusion

The Commissioner will not make a determination under sections 45A and 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies to the buy-back price received by Foreign Co.

Question 5

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 franking credits. 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.

Section 128B of the ITAA 1936 imposes withholding tax on dividends paid or credited to a non-resident shareholder to the extent the dividend is not franked.

Section 202-45 of the ITAA 1997 provides a list of distributions that are unfrankable. Paragraph 202-45(c) is relevant to off-market share buy-backs and provides that part of the dividend component of the buy-back price is unfrankable if the buy-back price exceeds the market value of the share at the time of the buy-back if the buy-back did not take place and were never proposed to take place.

Section 204-30 of the ITAA 1997 applies where a corporate tax entity 'streams' the payment of distributions, or the payment of distributions and the giving of other benefits, to its shareholders in such a way so as to provide franking credit benefits to shareholders who benefit most, in preference to other shareholders

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. The Commissioner accepts that section 159GZZZP of the ITAA 1936 will not apply to treat any part of the purchase price as a dividend.

Since no part of the buy-back price for the RPS will be a dividend, paragraph 202-45(c) of the ITAA 1997 will not apply.

The Commissioner accepts that as both Foreign Co and Company D are non-residents, that neither Foreign Co nor Company D obtains a greater benefit from imputation credits than the other (regardless of whether Foreign Co obtains 'other benefits' for the purposes of paragraph 204-30(1)(c) and regardless of whether franked dividends were or continue to be paid on ordinary shares in Company A). Therefore, neither section 177EA of the ITAA 1936 nor section 204-30 of the ITAA 1997 will apply to the buy-back.

For the above reasons, section 128B of the ITAA 1936 will not apply to the buy-back.

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