Edited version of private advice

Authorisation Number: 1051541075039

Date of advice: 26 July 2019

Ruling

Subject: Off-market share buy-back

Question 1

Can the Commissioner make a determination that section 204-30 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to the share buy-back scheme?

Answer

No.

Question 2

Can the Commissioner make a determination under section 45A or 45B of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies in relation to the share buy-back scheme?

Answer

No.

Question 3

Can the Commissioner make a determination that section 177EA of the ITAA 1936 applies to the share buy-back scheme?

Answer

No.

This ruling applies for the following period:

1 July 2018 to 30 June 2019

The scheme commences on:

June 2019

Relevant facts and circumstances

This ruling is based on the facts stated in the description of the scheme that is set out below. If your circumstances are materially different from these facts, this ruling has no effect and you cannot rely on it. The fact sheet has more information about relying on your private ruling.

1.     A Pty Ltd is an Australian-incorporated private company with share capital of fully paid ordinary shares issued at $1.00 each.

2.     A Pty Ltd was incorporated in 20XX.

3.     50% of the ordinary shares are owned by Family Trust. The other 50% of ordinary shares are owned by a non-resident company.

4.     A Pty Ltd will buy-back and subsequently cancel the ordinary shares owned by Family Trust.

5.     The buy-back will be a selective buy-back that meets the provisions under section 257B of the Corporations Act 2001.

6.     The purchase price for the buy-back will be the market value of the shares.

7.     The dividend paid under the scheme, to the Family Trust, will be out of an unrealised capital profit of a permanent character recognised A Pty Ltd's accounts and available for distribution. A Pty Ltd's net assets will exceed its share capital by at least the amount of the dividend, and the dividend will be paid in accordance with the company's constitution and without breaching section 254T or Part 2J.1 of the Corporations Act 2001.

8.     To determine the appropriate split between the capital component and dividend component of the consideration paid to the Family Trust, the average capital per share methodology described in paragraph 62 of PS LA 2007/9 has been used.

9.     The dividend component of the consideration for the share buy-back will not be franked.

10.  The Family Trust or beneficiaries will not be in a position to utilise any capital losses as a result of the share buy-back and as such any unutilised capital losses will remain so at the end of the relevant year of income, as far as the share buy-back transaction is concerned.

11.  The cost base of the shares is not substantially less than the applicable capital benefit.

Reasons for decision

These reasons for decision accompany the Notice of private ruling for A Pty Ltd.

While these reasons are not part of the private ruling, we provide them to help you to understand how we reached our decision.

Question 1

Can the Commissioner make a determination that section 204-30 of the Income Tax Assessment Act 1997 (ITAA 1997) applies to the share buy-back scheme?

Summary

As the dividend will not be franked, there will be no imputation benefit for the purposes of section 204-30 of the ITAA 1997 to allow the Commissioner to make a determination to either impose a franking debit or deny an imputation benefit where distributions with imputation benefits are streamed to a member in preference to another member.

Detailed reasoning

Dividend streaming

Subdivision 204-D of the ITAA 1997 deals with the streaming of distributions with imputation benefits.

In broad terms, it is an anti-avoidance measure to deal with the inappropriate streaming of distributions with imputation benefits. Streaming is not defined for the purposes of Subdivision 204-D of the ITAA 1997. However, having regard to paragraph 3.28 of the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002, the Commissioner understands it to refer to a company 'selectively directing the flow of franked distributions to those members who can most benefit from the imputation credits'.

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 members in such a way that:

a)     an imputation benefit is, or apart from section 204-30 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 (the favoured 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 (the disadvantaged 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)).

If section 204-30 of the ITAA 1997 applies, the Commissioner has a discretion, under subsection 204-30(3), to make a determination 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)),

b)     that a specified exempting debit arises in the exempting account of the entity, for a specified distribution or other benefit to a disadvantaged member (paragraph 204-30(3)(b)), or

c)     that no imputation benefit is to arise in respect of a distribution that is 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, shareholders who participated in the buy-back to whom distributions are streamed must derive a greater benefit from franking credits than other shareholders of A Pty Ltd who did not participate in the buy-back. Some of the cases in which a member of an entity 'derives a greater benefit from franking credits' are listed in subsection 204-30(8) by reference to the ability of a member to fully utilise franking credits.

The requirements of subsection 204-30(1) of the ITAA 1997 are not satisfied in respect of the buy-back in this case because the beneficiaries of the Family Trust will not receive an imputation benefit (within the meaning given by subsection 204-30(6) of the ITAA 1997) as the dividend component of the buy-back price will not be franked.

Accordingly, the conditions in subsection 204-30(1) of the ITAA 1997 are not met and the Commissioner cannot make any of the determinations allowed under subsection 204-30(3) of the ITAA 1997 - including under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in the franking account of A Pty Ltd for a specified distribution or other benefit to a disadvantaged shareholder.

Question 2

Can the Commissioner make a determination under section 45A or 45B of the Income Tax Assessment Act 1936 (ITAA 1936) that section 45C of the ITAA 1936 applies in relation to the share buy-back scheme?

Summary

There is no streaming of capital benefits to certain shareholders and dividends to others. Nor are any payments being made in substitution for a dividend. As such, it cannot be concluded the entity or shareholders will enter into or carry out a scheme for the purpose of enabling the shareholders to obtain a tax benefit to which sections 45A or 45B of the ITAA 1936 would apply.

Detailed reasoning

Capital streaming

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 capital component you received under the buy-back would be treated as an unfranked dividend.

Section 45A of the ITAA 1936

Section 45A of the ITAA 1936 applies where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the capital benefits than other shareholders, and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

Although the distribution of share capital is the 'provision of a capital benefit' (paragraph 45A(3)(b) of the ITAA 1936) to the Family Trust under the buy-back, the circumstances of the buy-back are that there is no streaming of capital benefits to some shareholders and dividends to other shareholders. There is only one shareholder that participated in the buy-back.

Accordingly, section 45A of the ITAA 1936 does not apply to the buy-back. The Commissioner cannot make a determination under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 applies to treat all or part of the distribution of share capital as an unfranked dividend paid by A Pty Ltd.

Section 45B of the ITAA 1936

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 purpose, but not including an incidental purpose) of enabling the relevant taxpayer to obtain a tax benefit (paragraph 45B(2)(c) of the ITAA 1936).

The conditions of paragraphs 45B(2)(a) and (b) of the ITAA 1936 were met in respect of the

buy-back. However, having regard to the 'relevant circumstances' (subsection 45B(8) of the ITAA 1936) of the buy-back, the Commissioner considers that the scheme consisting of the buy-back was not entered into or carried out for a more than incidental purpose of enabling the shareholders who participated in the buy-back to obtain a tax benefit - relevantly:

·        the capital component (a distribution of share capital) accords with the average capital per share methodology and could not be said to be attributable to the profits of A Pty Ltd.

·        the interest held by A Pty Ltd after the distribution is not the same as the interest would have been if an equivalent dividend had been paid instead of the distribution of the share capital (i.e. a dividend is not disguised as a capital payment).

·        the realised and unrealised profits of the company are being paid out as the dividend component of the distribution, not as a capital benefit;

·        the taxpayer receiving the payment will not be in a position to utilise any capital losses as a result of the share buy-back and as such any unutilised capital losses will remain so at the end of the relevant year of income, as far as the share buy-back transaction is concerned;

·        none of the ownership interests in the company are or are taken to have been acquired prior to 20 September 1985;

·        the relevant taxpayer is a resident trust and not a non-resident entity;

·        The cost base of the shares is not substantially less than the applicable capital benefit.

·        The interest held by the taxpayer after the share buy-back is not the same as if an equivalent dividend had been paid.

Therefore, section 45B of the ITAA 1997 will not apply to the buy-back and accordingly, the Commissioner cannot not make a determination under paragraph 45B(3)(b) that section 45C applies to the whole, or a part, of the capital benefit provided under the buy-back.

Question 3

Can the Commissioner make a determination that section 177EA of the ITAA 1936 applies to the share buy-back scheme?

Summary

As the dividend will not be franked, there will be no imputation benefit for the purposes of section 177EA of the ITAA 1936 to allow the Commissioner to make a determination to cancel a benefit.

Detailed reasoning

General imputation benefits anti-avoidance provisions

Section 177EA of the ITAA 1936 deals with the disposition of shares to obtain a franking credit benefit.

In broad terms, it is a general anti-avoidance provision that applies to franking credit trading schemes where one of the purposes (other than an incidental purpose) of the schemes is to obtain a franking credit benefit. The provision 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 which includes an off-market share buy-back with a franked dividend component.

Relevantly, subsection 177EA(3) of the ITAA 1936, provides that the following conditions must exist for the operation of the provision:

(a) there is scheme for the 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 the 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 section 177EA of the ITAA 1936, 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.

Circumstances which are relevant in determining whether any person had the requisite purpose include, but are not limited to, the factors listed in subsection 177EA(17) of the ITAA 1936 - such as:

·        the extent and duration of the risks of loss, and the opportunities for profit or gain, from holding shares in the company that are borne or accrue to the parties to the scheme;

·        whether the relevant taxpayer would derive a greater benefit from franking credits than other entities that hold shares in the company

·        whether, apart from the scheme, the company would have retained the franking credits or exempting credits or would have used the franking credits or exempting credits to pay a franked distribution to another entity; or

·        the period for which the relevant taxpayer held shares in the company.

In this case, A Pty Ltd will satisfy paragraph 177EA(3)(a) as there is a scheme for disposition of membership interests as defined in paragraphs 177EA(14)(b) and (d) as under the buy-back, A Pty Ltd will enter into a contract (or transactions) that affects the ownership of A Pty Ltd's ordinary shares held and disposed of by the Family Trust which will then subsequently be cancelled.

Paragraph 177EA(3)(b) will also be satisfied as a frankable distribution will be paid as part of the buy-back price pursuant to section 202-40 of the ITAA 1997.

However, paragraph 177EA(3)(c) will not be satisfied as, pursuant to section 995-1 of the ITAA 1997, a franked distribution arises if the distribution is franked in accordance with section 202-5 of the ITAA 1997. The dividend component of the buy-back price will not be franked.

Consequently, paragraph 177EA(3)(d) will not be satisfied as the Family Trust (i.e. the beneficiaries of the Family Trust) will not receive an imputation benefit (as set out under the note to subsection 177EA(16) and as defined in subsection 204-30(6) of the ITAA 1997).

Paragraph 177EA(3)(e) requires a conclusion that A Pty Ltd, its participating shareholders or any other relevant party entered into the buy-back with a more-than-incidental-purpose of enabling the participating shareholders (each a relevant taxpayer) to obtain an imputation benefit.

As the dividend will not be franked, shareholders cannot obtain imputation benefits, incidental or otherwise. Accordingly, the Commissioner cannot make a determination under section of 177EA of the ITAA 1936 to deny the whole, or part, of any imputation benefit attaching to the shares. - i.e. the Commissioner cannot make a determination in respect of an imputation benefit that does not exist.

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