Edited version of private advice

Authorisation Number: 1051599593159

Date of advice: 28 October 2019

Ruling

Subject: Off-market share buy-back

Question 1

Does the Buy-Back constitute an off-market share buy-back for the purposes of Division 16K of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Is $XXXX per share taken to be a dividend paid by the company to Participating Shareholders out of profits derived by the company on the day the Buy-Back occurs, in accordance with section 159GZZZP of the ITAA 1936?

Answer

Yes

Question 3

Will paragraph 202-45(c) of the Income Tax Assessment Act 1997 (ITAA 1997) apply in respect of the Dividend Component of the Buy-Back?

Answer

No

Question 4

Will the Dividend Component of the Buy-Back and the amount of the franking credit attached be assessable in the hands of Participating Shareholders under subsection 44(1) of the ITAA 1936 and subsection 207-20(1) of the ITAA 1997?

Answer

Yes

Question 5

Are the Participating Shareholders qualified persons in relation to the Dividend Component paid in respect of the Buy-Back?

Answer

Yes

Question 6

Will the Commissioner make a determination under section 45A of the ITAA 1936 or section 45B of the ITAA 1936 that subsection 45C(3) of the ITAA 1936 will apply in respect of the Capital Component of the Buy-Back?

Answer

No

Question 7

Will the Commissioner make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in respect of the Buy-Back?

Answer

No

Question 8

Will the Commissioner make a determination under paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the Buy-Back?

Answer

No

Question 9

Will Capital Gains Tax (CGT) Event A1 happen to Participating Shareholders upon entering the Buy-Back contract pursuant to section 104-10 of the ITAA 1997?

Answer

Yes

Question 10

Will subsection 159GZZZQ(2) of the ITAA 1936 apply in respect of the Buy-Back?

Answer

No

Question 11

Is $XXXX the reduction amount per share for Participating Shareholders in respect of the Buy-Back pursuant to subsection 159GZZZQ(3) of the ITAA 1936 and subsection 159GZZZQ(4) of the ITAA 1936?

Answer

Yes

This ruling applies for the following period:

Year ending 30 June 2020

The scheme commenced on:

1 July 2019

Relevant facts and circumstances:

Company background

The Company proposes to undertake an off-market share buy-back of ordinary shares currently held by the Participating Shareholders (the Buy-Back).

The Company is an Australian resident for tax purposes.

The shareholders of the Company include resident individuals and other resident entities.

The Buy-Back

A Selective Share buy-back Agreement was executed between the Company and the Participating Shareholders.

The purpose of the Buy-Back was to offer the Participating Shareholders a means to exit the Company.

The Participating Shareholders each agreed to sell and the Company agreed to purchase the Buy-back Shares held by the Participating Shareholders at market value, and in accordance with the terms of the Agreement.

The purchase price comprised a dividend component (Dividend Component) and capital component (Capital Component).

The Average Cost Per Share method (ACPS method) was used to determine the Capital Component and Dividend Component of the purchase price.

The Capital Component was debited to share capital.

The Dividend Component was debited to retained earnings.

The Company fully franked the Dividend Component of the Participating Shareholders purchase price, and had sufficient franking credits to frank the Dividend Component to that extent.

Upon completion of the sale and purchase of the Buy-Back Shares contemplated by the Agreement, legal and beneficial ownership in those shares passed to the Company.

The Company cancelled the Buy-Back shares.

Other

The Company has a history of paying fully franked dividends to the Company shareholders.

The Company has only one class of ordinary share on issue.

The Participating Shareholders held their shares in the Company for a significant period of time prior to the Buy-Back.

The share capital account of the Company is not tainted for income tax purposes in accordance with Division 197 of the ITAA 1997.

Relevant legislative provisions

Income Tax Assessment Act 1936 Division 16K

Income Tax Assessment Act 1936 subsection 44(1)

Income Tax Assessment Act 1936 section 45A

Income Tax Assessment Act 1936 section 45B

Income Tax Assessment Act 1936 section 45C

Income Tax Assessment Act 1936 section 159GZZZK

Income Tax Assessment Act 1936 section 159GZZZP

Income Tax Assessment Act 1936 section 159GZZZQ

Income Tax Assessment Act 1936 section 160APHN

Income Tax Assessment Act 1936 subsection 177A(1)

Income Tax Assessment Act 1936 subsection 177D(2)

Income Tax Assessment Act 1936 section 177EA

Income Tax Assessment Act 1997 section 104-10

Income Tax Assessment Act 1997 section 202-5

Income Tax Assessment Act 1997 section 202-40

Income Tax Assessment Act 1997 section 202-45

Income Tax Assessment Act 1997 section 204-30

Income Tax Assessment Act 1997 Division 207

Income Tax Assessment Act 1997 section 207-20

Income Tax Assessment Act 1997 section 207-35

Income Tax Assessment Act 1997 section 207-45

Income Tax Assessment Act 1997 section 207-145

Income Tax Assessment Act 1997 subsection 975-300(1)

Reasons for Decision

Question 1

Summary

The Buy-Back constitutes an off-market share buy- back for the purposes of Division 16K of the ITAA 1936.

Detailed reasoning

Broadly, Division 16K of the ITAA 1936 outlines the income tax consequences of share buy-backs. This division applies where a company buys a share in itself from its shareholders and as a result cancels the share. Accordingly, Division 16K should apply in the context of the proposed Buy-Back.

Section 159GZZZK of the ITAA 1936 provides that share buy-backs take the form of an on-market purchase or an off-market purchase. In accordance with paragraph 159GZZZK(d) the share buy-back will be an off-market purchase where it is not an on-market purchase. Paragraph 159GZZZK(c) provides that an on-market purchase will arise if:

(i) the share is listed for quotation in the official list of a stock exchange in Australia or elsewhere; and

(ii) the buy-back is made in the ordinary course of trading on that stock exchange.

As the Company is not listed for quotation on the official list of a stock exchange in Australia or elsewhere, the buy-back cannot be made in the ordinary course of trading on that stock exchange. Therefore, in accordance with paragraph 159GZZZK(d) of the ITAA 1936, the proposed Buy-Back will constitute an off-market purchase for the purpose of Division 16K of the ITAA 1936.

Question 2

Summary

$XXXX per share is taken to be a dividend paid out of profits to Participating Shareholders on the day the Buy-Back occurs under subsection 159GZZZP(1) of the ITAA 1936.

Detailed reasoning

Section 159GZZZP of the ITAA 1936 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 the share capital account, is taken to be a dividend paid by the company to the seller on the day the buy-back occurs.

A company's 'share capital account' is defined in subsection 975-300(1) of the ITAA 1997 as an account that the company keeps of its share capital or any other account, whether or not called a share capital account, created on or after 1 July 1998, where the first amount credited to the account was an amount of share capital.

Practice Statement Law Administration PS LA 2007/9 Share buy-backs (PS LA 2007/9) provides the acceptable methodologies to calculate the dividend/capital split. The ACPS method is the preferred method and requires a company's ordinary issued capital to be divided by the number of shares on issue to give a reasonable estimation of the capital component of a purchase price (with any amount in excess reflecting the dividend component).

In the Company's case, the purchase price (Buy-Back Price) will be calculated in accordance with the ACPS and will be debited against the Company's share capital account (the Capital Component).

Accordingly, the difference between the Buy-Back Price and the Capital Component will be taken to be a dividend (the Dividend Component).

The Dividend Component will be taken to be a dividend paid by the Company to Participating Shareholders, out of profits derived by the Company on the day the Buy-Back occurs under subsection 159GZZP(1) of the ITAA 1936.

Question 3

Summary

Paragraph 202-45(c) of the ITAA 1997 will not apply to treat any part of the Dividend Component as an unfrankable dividend.

Detailed reasoning

Under subsection 202-40(1) of the ITAA 1997, a distribution is a frankable distribution to the extent it is not unfrankable under section 202-45 of the ITAA 1997.

Section 202-45 of the ITAA 1997 provides a number of instances in which distributions are unfrankable distributions.

In relation to paragraph 202-45(c) of the ITAA 1997, the Dividend Component of $XXXX per share is frankable but only to the extent that the Buy-Back Price does not exceed the market value of each Buy-Back share at the time of the Buy-Back if the Buy-back did not occur and was never proposed to occur.

It is considered that the Buy-Back Price does not exceed the market value of each Buy-Back share at the time of the buy-back if the buy-back did not occur and was never proposed to occur. Accordingly, paragraph 202-45(c) of the ITAA 1997 will not apply to treat any part of the Dividend Component as an unfrankable dividend.

As a result, the Dividend Component will be a frankable distribution under section 202-40 of the ITAA 1997 and therefore, capable of being franked in accordance with section 202-5 of the ITAA 1997.

Question 4

Summary

The Dividend Component of the Buy-Back and the amount of the franking credit attached will be assessable in the hands of Participating Shareholders under subsection 44(1) of the ITAA 1936 and subsection 207-20(1) of the ITAA 1997.

Detailed reasoning

Pursuant to subsection 44(1) of the ITAA 1936, the assessable income of a resident shareholder will include dividends that are paid to shareholders out of profits of the company. Section 159GZZZP of the ITAA 1936 provides that the difference between the purchase price and the part (if any) of the purchase price which is debited against the share capital account, is taken to be a dividend paid by the company to the seller on the day the buy-back occurs out of profits derived by the company. Applying this to the case at hand, with reference to the Buy-Back Agreement, the Buy-Back occurs on Completion and in applying section 159GZZZP of the ITAA 1936 the full Dividend Component will be taken to be paid by the Company in the income year ended 30 June 2020.

As the Dividend Component per share is paid in the income year ended 30 June 2020, subsection 44(1) of the ITAA 1936 will include this amount in the assessable income of the Individual for the income year ended 30 June 2020.

Subject to the 'qualified person' rule, an amount equal to the amount of the Franking Credit on the Dividend Component is included in the assessable income of Participating Shareholders under subsection 207-20(1) of the ITAA 1997 (gross-up).

Subject to the 'qualified person' rule, Participating Shareholders are entitled to a tax offset under subsection 207-20(2) of the ITAA 1997 equal to the amount of the Franking Credit on the Dividend Component.

Question 5

Summary

Participating Shareholders will be qualified persons in relation to the Dividend Component paid in respect of the Buy-Back.

Detailed reasoning

Paragraph 207-145(1)(a) of the ITAA 1997 provides that in relation to a franked dividend made by an entity, only a qualified person in relation to the distribution for the purposes of Division 1A of former Part IIIAA of the ITAA 1936 is entitled to a franking credit or tax offset. Broadly speaking, to be a 'qualified person' in relation to the Dividend Component paid under the Buy-Back, Participating Shareholders must satisfy both the holding period rule and the related payments rule.

Related payments rule

The related payments rule applies if the shareholder, or associate of the shareholder, is under an obligation to make, or makes, a payment in respect of the dividend that effectively passes the benefit of the dividend to another person. The application of the related payments rule will depend on the individual facts and circumstances of the shareholder.

It is considered that the related payments rule will not apply to Participating Shareholders in relation to the Dividend Component of the Buy-Back.

The holding period rule

The holding period rule requires a shareholder to hold the shares, or the interest in the shares, on which the dividend is paid at risk for a continuous period of at least 45 days. In determining whether a shareholder has satisfied the holding period rule, any days during which there is a materially diminished risk in relation to the relevant shares are not counted.

Participating Shareholders have not acquired new shares, or disposed of their existing shares in the Company within the past 45 days. In addition, the Participating Shareholders held their shares in the Company "at risk" within the past 45 days as at no time during these 45 days did Participating Shareholders have a materially diminished risk of loss or opportunity for gain in respect of shares held in the Company. Consequently, Participating Shareholders will satisfy the holding period rule.

Given the above, it is considered that the Participating Shareholders are qualified persons in relation to the Dividend Component of the Buy-Back.

Question 6

Summary

The Commissioner will not make a determination under section 45A of the ITAA 1936 or section 45B of the ITAA 1936 that subsection 45C(3) of the ITAA 1936 will apply in respect of the Capital Component of the Buy-Back.

Detailed reasoning

Sections 45A and 45B of the ITAA 1936 are two anti-avoidance provisions which, if 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 distribution of capital received by the shareholder under a share buy-back can be treated as an unfranked dividend.

Section 45A of the ITAA 1936

Section 45A of the ITAA 1936 is an anti-avoidance provision that applies in circumstances where capital benefits are streamed to certain shareholders (the advantaged shareholders) who derive a greater benefit from the receipt of share capital and it is reasonable to assume that the other shareholders (the disadvantaged shareholders) have received or will receive dividends.

The provision of capital benefits is defined in subsection 45A(3) of the ITAA 1936.

The Buy-Back will be a provision of a capital benefit as defined in paragraph 45A(3)(b) of the ITAA 1936 on the basis that Participating Shareholders will receive the Capital Component as part of the Buy-Back Price.

In order for section 45A of the ITAA 1936 to apply to the Buy-Back, the Commissioner must determine that the Company streamed capital benefits to the advantaged shareholders of the Company who derived a greater benefit from the capital benefits than the disadvantaged shareholders of the Company.

Subsection 45A(4) of the ITAA 1936 identifies a number of circumstances where the advantaged shareholders would derive a greater benefit from the capital benefits than the disadvantaged shareholders.

Under the Buy-Back, Participating Shareholders will receive the same Capital Component and Dividend Component per share, calculated in accordance with the ACPS methodology. In this regard, it is considered that the Company is not discriminating between shareholders in the Buy-Back as the circumstances of the Buy-Back indicate that there is no streaming of capital benefits to some shareholders and dividends to other shareholders.

It is considered that Participating Shareholders are not advantaged shareholders who receive capital benefits whilst other shareholders receive dividends as all shareholders who participated in the Buy-Back received both the Capital Component and Dividend Component based on the number of shares they sold into the Buy-Back.

Accordingly, subsection 45C(1) of the ITAA 1936 will not apply to deem any part of that Capital Component to be an unfranked dividend in the hands of Participating Shareholders. Therefore, the Commissioner will not make a determination under subsection 45A(2) of the ITAA 1936 that section 45C applies to the whole, or part, of the Capital Component of the Buy-Back Price to be received by Participating Shareholders.

Section 45B of the ITAA 1936

Section 45B of the ITAA 1936 applies where:

(a) there is a scheme under which a person is provided with a demerger benefit or 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 demerger benefit or 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.

A "scheme" is defined in section 177A of the ITAA 1936 to mean:

(a) any agreement, arrangement, understanding, promise or undertaking, whether express or implied and whether or not enforceable, or intended to be enforceable, by legal proceedings; and

(b) any scheme, plan, proposal, action, course of action or course of conduct.

In this case, the Buy-Back would constitute a "scheme".

A capital benefit is defined in subsection 45B(5) of the ITAA 1936.

Participating Shareholders will be provided with a capital benefit under the Buy-Back (i.e. the Capital Component of the Buy-Back) in accordance with paragraph 45B(5)(b) of the ITAA 1936. Therefore the conditions of paragraph 45B(2)(a) are met.

Paragraph 45B(2)(b) of the ITAA 1936 requires that, under the scheme, a taxpayer obtains a tax benefit. Subsection 45B(9) broadly provides that a taxpayer obtains a tax benefit if an amount of tax payable would be less than the amount of tax otherwise payable (or payable at a later time) had the capital benefit been a dividend.

Participating Shareholders will obtain a tax benefit in respect of the Capital Component of the Buy-Back. Therefore, the conditions of paragraph 45B(2)(b) of the ITAA 1936 have been met.

Paragraph 45B(2)(c) of the ITAA 1936 provides that it is necessary to have regard to the relevant circumstances of the scheme to determine whether a person or persons entered into the scheme for the purpose of enabling a taxpayer to obtain a tax benefit.

Having regard to the 'relevant circumstances' of the scheme (the Buy-Back), as set out in subsection 45B(8) of the ITAA 1936, it is considered that the Company did not enter into or carry out the Buy-Back arrangement for the purpose of enabling Participating Shareholders to obtain a tax benefit. The inclusion of the Capital Component as part of the Buy-Back Price is appropriate. Further, it is considered that the Capital Component of the Buy-Back cannot be said to be attributable to the profits of the company, nor is the Capital Component being paid in substitution for a dividend.

Accordingly, the Commissioner will not make a determination under section 45B of the ITAA 1936 that section 45C of the ITAA 1936 applies.

Question 7

Summary

The Commissioner will not make a determination under paragraph 204-30(3)(a) of the ITAA 1997 that a franking debit arises in respect of the Buy-Back.

Detailed reasoning

Subsection 204-30(1) 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; and

(b) the member would derive a greater benefit from franking credits than another member of the entity; 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.

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

As part of the Buy-Back, Participating Shareholders will receive an imputation benefit in accordance with subsection 204-30(6) of the ITAA 1997. Accordingly, paragraph 204-30(1)(a) is satisfied.

Paragraph 204-30(1)(b) of the ITAA 1997 requires that Participating Shareholders must derive a greater benefit from imputation benefits received under the Buy-Back than the other members of the Company 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) by reference to the ability of the members to fully utilise imputation benefits.

It is considered that Participating Shareholders will not derive a greater benefit from receiving a franked distribution than any other shareholder of the Company. Accordingly, it is submitted that subparagraph 204-30(1)(b) of the ITAA 1997 is not satisfied in relation to the Buy-Back.

The Company intends to continue paying its shareholders franked dividends in line with its recent dividend payment pattern. Accordingly, paragraph 204-30(1)(c) of the ITAA 1997 is also not satisfied in relation to the Buy-Back.

Therefore, it is concluded that the Company will not be taken to direct the flow of dividends in such a manner as to ensure that imputation benefits are derived by members who derive greater benefit from franking credits while other members receive lesser or no imputation benefits. Accordingly, section 204-30 of the ITAA 1997 will not apply to the Buy-Back and the Commissioner will not make a determination under subsection 204-30(3).

Question 8

Summary

The Commissioner will not make a determination under paragraph 177EA(5)(a) of the ITAA 1936 that a franking debit arises in respect of the Buy-Back.

Detailed reasoning

Section 177EA of the ITAA 1936 is a general anti-avoidance provision that applies to a wide range of schemes designed to obtain imputation benefits.

Specifically, subsection 177EA(3) of the ITAA 1936 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.

Based on the facts it is considered that the conditions of paragraphs 177EA(3)(a) to 177EA(3)(d) of the ITAA 1936 are satisfied because:

·   The Company is a corporate tax entity. As the off-market share buy-back of the Company's shares constitutes a scheme for a disposition, paragraph 177EA(3)(a) of the ITAA 1936 is satisfied;

·   As each Participating Shareholder received a frankable distribution in respect of the Buy-back shares, paragraph 177EA(3)(b) of the ITAA 1936 is satisfied;

·   The Dividend Component was a fully franked distribution and, as such, paragraph 177EA(3)(c) of the ITAA 1936 is satisfied; and

·   As the relevant taxpayers received imputation benefits as a result of the distribution, paragraph 177EA(3)(d) of the ITAA 1936 is satisfied.

The question is therefore whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of the Company, its shareholders or any other relevant party, there is a more than an incidental purpose of conferring an imputation benefit under the scheme. Under this arrangement, the relevant taxpayers are Participating Shareholders and the scheme comprises the circumstances surrounding the Buy-Back.

Subsection 177EA(17) of the ITAA 1936 provides the relevant circumstances of a scheme that need to be considered in determining whether there was a more than incidental purpose of enabling a relevant taxpayer to obtain an imputation benefit.

The relevant circumstances listed in subsection 177EA(17) of the ITAA 1936 encompass a range of circumstances, which taken individually or collectively, could indicate the requisite purposes. Due to the diverse nature of the circumstances, some may or may not be present at any one time in relation to a particular scheme.

Conclusion

After consideration of the relevant circumstances, and the main purpose of the Buy-Back to allow Participating Shareholders to exit the Company, the Commissioner concludes that the Company and Participating Shareholders did not enter into the Arrangement for a more than incidental purpose of enabling Participating Shareholders to obtain an imputation benefit.

The Commissioner will therefore not make a determination under subsection 177EA(5) of the ITAA 1936.

Question 9

Summary

CGT Event A1 happened to Participating Shareholders upon entering the Buy-Back contract pursuant to section 104-10 of the ITAA 1997.

Detailed reasoning

The shares held by Participating Shareholders will constitute a CGT asset in accordance with section 108-5 of the ITAA 1997.

The shares are taken to have been disposed of for CGT purposes as the Buy-Back will result in a change of ownership as Participating Shareholders will no longer be legal and beneficial owners of shares in the Company (CGT event A1).

Pursuant to subsection 104-10(3) of the ITAA 1997, the time of the CGT event will be on the date when the Company and the Participating Shareholders entered into the contract for the disposal of the Company shares.

Question 10

Summary

Subsection 159GZZZQ(2) of the ITAA 1936 will not apply in respect of the Buy-Back.

Detailed reasoning

Subsection 159GZZZQ(1) of the ITAA 1936 provides that a shareholder is taken to have received an amount equal to the purchase price as consideration in respect of the sale of the share bought back. However, this amount is subject to certain adjustments in order to arrive at the deemed consideration.

Subsection 159GZZZQ(2) of the ITAA 1936 is one of the adjusting provisions. It provides that if the purchase price is less than the market value of the share at the time of the buy-back (calculated as if the buy-back did not occur and was never proposed to occur) the shareholder is taken to have received an amount equal to the market value as consideration in respect of the sale of the share bought back.

Accordingly, subsection 159GZZZQ(2) of the ITAA 1936 will not apply as the Buy-Back Price is equal to market value of each Buy-Back share at the time of the Buy-Back if the Buy-Back did not occur and was never proposed to occur.

Question 11

Summary

$XXXX will be the reduction amount per share for Participating Shareholders in respect of the Buy-Back pursuant to subsection 159GZZZQ(3) of the ITAA 1936 and subsection 159GZZZQ(4).

Detailed reasoning

Pursuant to subsection 159GZZZQ(3) of the ITAA 1936, the deemed consideration upon disposal of the Buy-Back shares is reduced by a 'reduction amount'.

The reduction amount is an amount calculated under subsection 159GZZZQ(4) of the ITAA 1936 and requires a taxpayer to determine the part of the purchase price that is treated as a dividend by section 159GZZZP of the ITAA 1936 and is either included in the shareholder seller's assessable income or is an eligible non-capital amount.

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