Edited version of private advice

Authorisation Number: 1051650931248

Date of advice: 26 March 2020

Ruling

Subject: Share buy-back

Issue 1

Dividend Component

Question 1

Will the proposed share buy-back by Aust Coy X constitute a buy-back which is an "off-market purchase" for the purposes of Division 16K of the ITAA 1936?

Answer

Yes

Question 2

Will the trustee of the Y Family Trust be taken, for the purposes of subsection 159GZZZP(1) of the ITAA 1936, to have been paid a dividend equal to the difference between the proposed purchase price for the buy-back and the amount debited against amounts standing to the credit of Aust Coy X's share capital account?

Answer

Yes

Question 3

Will the trustee of the Y Family Trust be taken to have been paid a dividend equal to the share buy-back price less $50,000 (the dividend component) out of the profits of Aust Coy X on the share buy-back date for all of the Aust Coy X shares bought back and that the dividend component will be a frankable distribution, regardless of whether the dividend component is paid from Aust Coy X's reserves or retained profits or a combination thereof?

Answer

Yes

Question 4

Because the trustee of the Y Family Trust is a 'qualified person', will the amount of the franking credit on the dividend component be included in the assessable income the trustee of the Y Family Trust in the income year in which the buy-back occurs as long as the related payments rule is also met?

Answer

Yes

Issue 2

Capital Component

Question 1

Will the difference between the purchase price and the dividend component (ie the capital component) not be a dividend?

Answer

Yes

Question 2

Will the trustee of the Y Family Trust be taken to have received $50,000 as the consideration in respect of all the Aust Coy X shares bought back under the buy-back (sale consideration) on the share buy-back date?

Answer

Yes

Question 3

Because the Aust Coy X shares are held on capital account (a) will the shares be taken to have been disposed of for CGT purposes on the share buy-back date pursuant to section 104-10 (CGT Event A1) (ITAA1997) (b) will the sale consideration of $50,000 represent the capital proceeds for CGT purposes pursuant to section 116-20 (ITAA1997) and (c) will the trustee of the Y Family Trust make a capital gain when CGT event A1 happens if the sale consideration exceeds the cost base of the shares or a capital loss if the sale consideration is less than the reduced cost base of the shares?

Answer

Yes

Question 4

Will subsection 159GZZZQ(2) (ITAA1936) have any application.

Answer

No

Issue 3

Anti-avoidance rules

Question 1

Will a determination be made under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 will apply to treat the buy-back value, or any part of it received by the trustee of the Y Family Trust of the share buy-back, as an unfranked dividend?

Answer

No

Question 2

Will a determination be made under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the dividend component of the share buy-back received by the trustee of the Y Family Trust, to classify the payment as an unfranked dividend?

Answer

No

Question 3

Will a determination be made under paragraphs 177EA(5)(a) of the ITAA 1936 to debit Aust Coy X's franking account (or that any such debit would otherwise be nil) or 5(b) to deny the trustee of the Y Family Trust imputation benefits in respect of the share buy-back?

Answer

No

Question 4

Will a determination be made under paragraphs 204-30(3)(a) of the ITAA 1997 to debit Aust Coy X's franking account (or that any such debit would otherwise be nil) or 3(c) to deny the trustee of the Y Family Trust imputation benefits in respect of the share buy-back?

Answer

No

Question 5

Will the general anti-avoidance provisions in Part IVA of the ITAA be applied by the Commissioner?

Answer

No

Question 6

Can the trustee of the Y Family Trust stream the franked portion of the share buy-back dividend to Aust Coy Y under subdivision 207-B of the ITAA 1997 such that Aust Coy Y can claim a franking offset?

Answer

Yes

Question 7

Can the trustee of the Y Family Trust stream any unfranked portion of the share buy-back dividend to Aust Coy Y under section 97 of the ITAA 1997?

Answer

Not applicable

This ruling applies for the following periods:

1 July 20XX to 30 June 20XX

The scheme commences on:

1 July 20XX

Relevant facts and circumstances

The Y Family Trust (YFT) is an Australian resident discretionary trust. The trust was established in month/19XX. The trustee of the YFT is Trustee Coy Pty Ltd (Trustee Coy) and has been trustee since month/19XX.

Mr Y is a beneficiary of the YFT, as are his children, family companies and other specified entities. The trustee can also nominate other beneficiaries.

A family trust election was made in 19XX, Mr Y is the test individual.

The YFT owns 50% of the shares in Aust Coy X Pty Ltd (Aust Coy X).

Aust Coy X Pty Ltd

Aust Coy X is an Australia proprietary company incorporated in month/19XX. Aust Coy X is limited by XXX ordinary shares fully paid at $X each. The Trustee of the YFT holds XX shares, Aust Coy Z Pty Ltd holds the other XX shares.

The current directors of Aust Coy X are Mr Y (appointed month/19XX) and Mr Z (appointed month/19XX).

Aust Coy X owns XX.XX of the shares in ABC Limited (ABC).

Share buy-back

Mr Y would like to simplify his affairs for estate planning and simplicity reasons and as part of this, Mr Y would like to separate his family's joint interest in ABC and Aust Coy X by having Aust Coy X buy back the YFT's shares in Aust Coy X in consideration for an in specie distribution of shares in ABC equal to XX% of Aust Coy X.

An off-market share buy-back would entail Aust Coy X buying back its shares from the YFT (a selective buy-back) for an agreed price (in the form of an in specie distribution of the ABC shares). Once the shares are acquired by Aust Coy X, they would immediately be cancelled and all rights attaching to the shares would be extinguished.

The share buy-back price would be set with reference to the market value of Aust Coy X at the time of the buy-back, as ascertained by a valuation.

As at 30 June 20XX, Aust Coy X had net assets (at market value) of approximately $XXX. The balance sheet valued ABC at its prevailing listed price and reflected a corresponding deferred tax liability. This reflected the future value of the unrealised gain in the value of the ABC shares.

Relevant legislative provisions

Income Tax Assessment Act 1936

section 97

Division 16K

section 159GZZZK

section 159GZZZM

section 159GZZZP

section 159GZZZQ

section 160APHE

section 160APHL

section 160APHN

section 160APHO

subsection 44(1)

section 45A

section 45B

section 45C

section 177EA

Part IVA

Income Tax Assessment Act 1997

section 104-10

subsection 116-20(1)

section 202-40

section 202-45

section 204-30

subdivision 207-B

section 207-35

Subsection 975-300(1)

Reasons for decision

Question 1

Summary

The proposed share buy-back by Aust Coy X constitutes a buy-back which is an "off-market purchase" for the purposes of Division 16K of the ITAA 1936.

Detailed reasoning

The tax consequences of a share buy-back are set out in sections 159GZZZIA to 159GZZZS of Division 16K of Part III of the Income Tax Assessment Act 1936 ('ITAA1936') and depend on whether the buy-back concerned is "on-market" or "off-market". Where a company buys back shares in itself from a shareholder in the company, the purchase is a buy-back and the relevant shareholder is the "seller" for the purposes of Division 16K of the ITAA 1936.

An "on-market" buy-back happens if the share is listed on a stock exchange and the buy-back is made in the ordinary course of the business of the stock exchange. Any other buy-back is an "off-market" buy-back under paragraph 159GZZZK(d) of the ITAA 1936.

Application to your circumstances

The Y Family Trust (YFT) currently holds XX% of the shares in Aust Coy X Pty Ltd (Aust Coy X). Aust Coy X intends to buy back all of the YFT shares in Aust Coy X. This would constitute a share buy-back. As Aust Coy X shares do not trade on a stock exchange, the transaction will not be made in the ordinary course of the business of the stock exchange. Therefore, the proposed buy-back will be an "off-market purchase" for the purposes of Division 16K of the ITAA 1936.

Question 2

Summary

The trustee of the Y Family Trust will be taken, for the purposes of subsection 159GZZZP(1) of the ITAA 1936, to have been paid a dividend equal to the difference between the proposed purchase price for the buy-back and the amount debited against amounts standing to the credit of Aust Coy X's share capital account.

Detailed reasoning

For an "off-market" buy-back, the difference between the "purchase price" and that part of the "purchase price" that is debited against amounts standing to the credit of the "company's share capital account" is treated as a dividend paid to the shareholder out of company profits on the day of the buy-back under subsection 159GZZZP(1) of the ITAA 1936. The deemed dividend is included in the assessable income of the shareholder under subsection 44(1) of the ITAA 1936.

"Purchase price" is described in section 159GZZZM of the ITAA 1936 as meaning:

·         The amount of money, or the sum of the amounts of money, a seller receives or is "entitled to receive", as a result of or in respect of a buy-back (paragraph (a)); or

·         The market value at the time of the buy-back of any property (other than money) a seller receives, or is "entitled to receive", as a result of or in respect of a buy-back (paragraph (b)); or

·         If the seller has received, or is "entitled to receive", both money and property (other than money) as a result of or in respect of the buy-back, the sum of that amount of money and the market value of the property at the time of the buy-back (paragraph (c)).

The expression "company share capital account" is defined in subsection 975-300(1) of the ITAA 1997 as simply "an account where a company keeps its share capital". Subsection 975-300(2) of the ITAA 1997 provides that if a company has more than one share capital account, the accounts are taken for the purposes of the ITAA 1997 to be a single account.

If the purchase price for an off-market share buy-back is greater than the market value of the share, the difference between the purchase price and that part of the purchase price that is debited against amounts standing to the credit of the company's share capital account is a dividend under subsection 159GZZZP(1) of the ITAA 1936.

The dividend/capital split is considered in PSLA 2007/9. The ATO considers that there are a number of acceptable methodologies for ascertaining the capital/dividend split, however, 'average capital per share' (ACPS) should be applied to share buy-backs unless companies can demonstrate exceptional circumstances for the use of an alternate methodology. ACPS is obtained by dividing a company's ordinary issued capital by the number of shares on issue.

Application to your circumstances

Aust Coy X intends to buy back the YFT's shares in Aust Coy X in consideration for an in specie distribution of shares in ABC equal to XX% of Aust Coy X. The purchase price of the buy-back will be the market value of the ABC shares provided to the YFT at the time of the buy-back, in accordance with paragraph 159GZZZM(b) of the ITAA 1936.

The difference between the market value of the ABC shares provided to the YFT at the time of the buy-back and that part of that amount that is debited against amounts standing to the credit of Aust Coy X's share capital account ($XX) is a dividend, in accordance with subsection 159GZZZP(1) of the ITAA 1936.

As Aust Coy X is debiting its share capital account by the amount of share capital which is being bought back by Aust Coy X, being the YFT's total portion, this is in line with the ACPS methodology described in PSLA 2007/9. Aust Coy X's ordinary issued capital is XXX, divided by the number of shares on issue, XXX shares, which is $X. Aust Coy X intends to purchase XX shares from the YFT for $XX. Hence, the capital/dividend split is acceptable in this arrangement and the balance of any buy-back price would be a dividend.

Question 3

Summary

The trustee of the Y Family Trust will be taken to have been paid a dividend equal to the share buy-back price less $XX (the dividend component) out of the profits of Aust Coy X on the share buy-back date for all of the Aust Coy X shares bought back and that the dividend component will be a frankable distribution, regardless of whether the dividend component is paid from Aust Coy X's reserves or retained profits or a combination thereof.

Detailed reasoning

Where a share buy-back gives rise to a deemed dividend to the shareholder, the dividend will be regarded as a "frankable distribution". The rules for franking such distributions are governed by Division 202 and 203 of the Income Tax Assessment Act 1997.

A "frankable distribution" means a distribution under section 202-40 of the ITAA 1997 that is not an unfrankable distribution under section 202-45 of the ITAA 1997, among other things, and in particular, a distribution that is not sourced, directly or indirectly, from a company's share capital account under paragraph 202-45(e) of the ITAA 1997.

Application to your circumstances

Trustee Coy Pty Ltd as trustee for The Y Family Trust owns XX ordinary shares fully paid at $X each of the total XXX ordinary shares issued. The amount standing to the credit of Aust Coy X's share capital account for the trustee of the YFT is therefore $XX. This is verified by the Statement of Financial Position for Aust Coy X Pty Limited as at 30 June 20XX, the balance of the Contributed Equity is $XXX.

The trustee of the Y Family Trust will be taken to have been paid a dividend, equal to the share buy-back price less $XX, out of the profits of Aust Coy X on the share buy-back date.

The dividend component will be a frankable distribution, regardless of whether the dividend component is paid from Aust Coy X's reserves or retained profits or a combination thereof, provided that it is not sourced, directly or indirectly, from Aust Coy X's share capital account under paragraph 202-45(e) of the ITAA 1997.

Question 4

Summary

Because the trustee of the Y Family Trust is a 'qualified person', the amount of the franking credit on the dividend component will be included in the assessable income the trustee of the Y Family Trust in the income year in which the buy-back occurs as long as the related payments rule is also met.

Detailed reasoning

A trustee receiving a franked dividend includes both the amount of the dividend and the franking credit in the trust's assessable income (under subsection 207-35(1) and (2) of the ITAA 1997) when calculating the trust's taxable income or loss.

To be entitled to pass on franking benefits to the beneficiaries, the trustee must be a 'qualified person' in relation to the franked dividend. The qualified person test ensures only the true economic owners of shares benefit from franking credits attached to distributions made from the shares.

A shareholder generally meets the qualified person test if they satisfy the:

·         holding period rule; and

·         where applicable, the related payments rule.

Though Part IIIAA of the Income Tax Assessment Act 1936 ceased to have application from 1 July 2002, it is necessary to have regard to the rules in Division 1A of the former Part IIIAA in determining whether an entity is a qualified person for the purpose of the new rules contained in the Simplified Imputation System in respect of a franked distribution made directly or indirectly to the entity on or after 1 July 2002.

Where a company is buying back its ordinary shares, the holding period rule in former section 160APHO of the ITAA 1936 requires the shareholder to have held their shares, on which a dividend has been paid 'at risk', for at least 45 days during the primary qualification period. The primary qualification period begins on the day after the shares were acquired and ends 45 days after the shares become ex-dividend (as defined in former section 160APHE).

The related payments rule applies to a distribution on shares when there is an obligation to pass on the benefit or value of the distribution to someone else. It requires shares to be held 'at risk' for at least 45 days during the relevant qualification period ('the secondary qualification period'). The relevant qualification period begins 45 days before the ex-dividend date and ends 45 days after.

Under both the holding period rule and related payments rules, the qualification periods do not include the day of acquisition or, if the shares have been disposed of, the day of disposal. Also excluded are days where the financial risk of owning the shares is materially diminished. For example, the financial risk may be reduced through arrangements such as hedges, options and futures.

Former section 160APHN of the ITAA 1936 explained the meaning of a "related payment". An actual "payment" was not required - any method of passing the benefit of a dividend to another person could qualify.

The distribution by a trustee of a dividend to a beneficiary of the trust who is presently entitled to it does not constitute the making of a related payment in respect of the dividend (former subsection 160APHN(5) of the ITAA 1936).

Where the trustee has made a family trust election, former subsection 160APHL(10) of the ITAA 1936 provides that there is no deemed short position. This means that in the absence of any positions taken by the trustee to reduce the risk of holding the shares, the only position of the beneficiary would normally be a deemed long position under former subsection 160APHL(7). Accordingly, franking benefits can pass through to the beneficiaries in this situation.

Application to your circumstances

As the YFT has made a family trust election and has satisfied the 45 day holding period for their shares in Aust Coy X the provisions in subsection 207-35(1) and (2) of the ITAA 1997 can be applied, provided the related payments rule is met. The YFT would then include the dividend amount and the franking credit in the trust's assessable income in the income year of the buy-back.

However, if the YFT is only distributing the franked dividend to a presently entitled beneficiary, it is not a related payment and the secondary qualification period will not need to be applied.

Issue 2

Question 1

Summary

The difference between the purchase price and the dividend component (i.e. the capital component) will not be a dividend.

Detailed reasoning

The purchase price paid by the company to the shareholder is the amount of money and/or market value of any property the shareholder receives as a consideration for the buy-back as set out in section 159GZZZM of the ITAA 1936.

In an off-market share buy-back, the consideration paid to a vendor shareholder will generally comprise a return of capital and a fully/partly unfranked dividend. The difference between the purchase price and the part of the purchase price in respect of the buy-back which is debited against the company's share capital account is taken to be a dividend paid by the company to the seller. The amount debited against the company's share capital account is the capital component and is not considered a dividend (section 159GZZZP(2)).

Application to your circumstances

The purchase price received by the trustee of the Y Family Trust in relation to the buy-back arrangement will include an amount of $XX which Aust Coy X will debit against amounts standing to the credit of their share capital account. This amount is not a dividend (section 159GZZZP(2)).

Question 2

Summary

The trustee of the Y Family Trust will be taken to have received $XX as the consideration in respect of all the Aust Coy X shares bought back under the buy-back (sale consideration) on the share buy-back date.

Detailed reasoning

In the case of off-market share buy-backs, the capital proceeds on disposal of the shares exclude the assessable dividend component of the buy-back price.

In respect of the buy-back, the seller is taken to have received as consideration an amount equal to the purchase price in respect of the buy-back (section 159GZZZQ(1) ITAA1936). The amount of the deemed consideration is reduced where there is a reduction amount (section 159GZZZQ(3) ITAA1936). The reduction amount is any amount taken to be a dividend by section 159GZZZP which is an eligible non-capital amount (section 159GZZZQ(4) ITAA1936).

Application to your circumstances

The Trustee of the Y Family Trust will be taken to have received an amount equal to the purchase price in respect of the buy-back as consideration. This amount will be reduced by the assessable dividend (the "reduction amount") in accordance with section 159GZZZQ(3) ITAA1936.

In this instance, the difference between the purchase price and the dividend component is the amount debited against amounts standing to the credit of the company's share capital account. Hence, the Trustee of the Y Family Trust will be taken to have received $XX as the consideration in respect of all the Aust Coy X shares bought back under the buy-back on the share buy-back date.

Question 3

Summary

Because the Aust Coy X shares are held on capital account:

(a) the shares will be taken to have been disposed of for CGT purposes on the share buy-back date pursuant to section 104-10 ITAA 1997 (CGT Event A1);

(b) the sale consideration of $XX will represent the capital proceeds for CGT purposes pursuant to section 116-20 (ITAA 1997); and

(c) the trustee of the Y Family Trust will make a capital gain when CGT event A1 happens if the sale consideration exceeds the cost base of the shares or a capital loss if the sale consideration is less than the reduced cost base of the shares.

Detailed reasoning

CGT Event A1 happens if you dispose of a CGT asset (section 104-10 ITAA 1997). The disposal of shares as part of a share buy-back, is a disposal of a CGT asset. This event occurs when you enter into a contract or, if there is no contract - when the change of ownership occurs (section 104-10(3) ITAA 1997).

As required by section 116-20(1) ITAA 1997, if you dispose of shares in a buy-back, the capital proceeds are worked out under Division 16K of the ITAA 1936. In the case of off-market share buy-backs, the capital proceeds on disposal of the shares exclude the assessable dividend component of the buy-back price (see issue 2, question 2 above).

In accordance with section 104-10(4), you make a capital gain if the capital proceeds from the disposal are more than the asset's cost base. You make a capital loss if those capital proceeds are less than the asset's reduced cost base.

Application to your circumstances

When Aust Coy X buys back its shares from the trustee of the Y Family Trust, CGT Event A1 happens, as this is the disposal of a CGT asset. This event will occur when the shares in Aust Coy X change ownership from the trustee for the Y Family Trust to Aust Coy X.

The capital proceeds on disposal of the Aust Coy X shares will exclude the dividend component of the buy-back price. Hence, the capital proceeds will be $XX.

As CGT Event A1 happens when Aust Coy X buys back its shares, section 104-10(4) applies to calculate whether a capital gain or capital loss has occurred. The YFT will make a capital gain if the capital proceeds from the disposal of Aust Coy X shares are more than the shares cost base. The YFT will make a capital loss if those capital proceeds are less than the shares reduced cost base.

Question 4

Summary

Subsection 159GZZZQ(2) of the ITAA1936 will not have any application.

Detailed reasoning

Section 159GZZZQ(2) of the ITAA 1936 operates to increase the deemed consideration in respect of an off-market purchase to market value. This section is only applicable where the purchase price in respect of a buy-back is less than the amount that would have been the market value of the share at the time of the buy-back if the buy-back did not occur and was never proposed to occur.

Application to your circumstances

Aust Coy X intends to purchase its shares back at market value, as ascertained by a valuation. This means that the purchase price is equal to the market value and there is no requirement to increase the deemed consideration. Subsection 159GZZZQ(2) ITAA 1936 will not apply to this arrangement.

Issue 3

Question 1

Summary

A determination will not be made under subsection 45A(2) of the ITAA 1936 that section 45C of the ITAA 1936 will apply to treat the buy-back value, or any part of it received by the trustee of the Y Family Trust of the share buy-back, as an unfranked dividend.

Detailed reasoning

Section 45A of the ITAA 1936 is an anti-avoidance provision which seeks to deal with potential streaming of capital benefits to certain shareholders. If the Commissioner makes a determination under subsection 45A(2) of the ITAA 1936, the amount of the capital benefit or a part of the benefit received by the shareholder is taken by section 45C of the ITAA 1936 to be an unfranked and non-rebatable dividend.

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

A 'capital benefit', as defined in paragraph 45A(3)(b) of the ITAA 1936, is provided to participating shareholders under the buy-back.

Application to your circumstances

Aust Coy X will debit $XX of the Buy-Back Price to its share capital account. This amount is a distribution of share capital to the trustee of the YFT.

Although a 'capital benefit' (as defined in paragraph 45A(3)(b) of the ITAA 1936) is provided to the trustee of the YFT under the buy-back, the circumstances of the buy-back indicate that there was no streaming of capital benefits to some shareholders in lieu of the payment of dividends to other shareholders. Accordingly, section 45A has no application to the buy-back.

Question 2

Summary

A determination will not be made under subsection 45B(3) of the ITAA 1936 that section 45C of the ITAA 1936 applies to the whole, or any part, of the dividend component of the share buy-back received by the trustee of the Y Family Trust, to classify the payment as an unfranked dividend.

Detailed reasoning

Section 45B applies where certain capital payments are paid to shareholders in substitution for dividends. Specifically, section 45B of the ITAA 1936 applies where:

·         there is a scheme under which a person is provided with a capital benefit by a company (paragraph 45B(2)(a));

·         under the scheme, a taxpayer, who may or may not be the person provided with the capital benefit, obtains a tax benefit (paragraph 45B(2)(b)); 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 a taxpayer to obtain a tax benefit (paragraph 45B(2)(c)).

Application to your circumstances

In this case, whilst the conditions of paragraphs 45B(2)(a) and 45B(2)(b) of the ITAA 1936 have been met, the requisite purpose of enabling the trustee of the YFT to obtain a tax benefit - by way of capital distribution - was not present.

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 apparent that the inclusion of a capital element in the buy-back price was appropriate. Further, the capital element of the buy-back price cannot be said to be attributable to the profits of the company, nor does the pattern of distributions that have been made by Aust Coy X indicate that it was being paid in substitution for a dividend.

Question 3

Summary

A determination will not be made under paragraphs 177EA(5)(a) of the ITAA 1936 to debit Aust Coy X's franking account (or that any such debit would otherwise be nil) or 5(b) to deny the trustee of the Y Family Trust imputation benefits in respect of the share buy-back.

Detailed reasoning

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 imputation benefits. In essence, it applies to schemes for the disposition of membership interests, or an interest in membership interests, where a franked distribution is paid or payable in respect of the membership interest or an interest in membership interests. This includes a buy-back with a franked dividend component.

Specifically, subsection 177EA(3) provides that section 177EA of the ITAA 1936 applies if:

·         there is a scheme for a disposition of membership interests, or an interest in membership interests, in a corporate tax entity;

·         a frankable distribution has been paid, or is payable or expected to be payable, to a person in respect of the membership interests or 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;

·         the distribution was, or is expected to be, a franked distribution;

·         except for section 177EA, a person (the 'relevant taxpayer') would receive, or could reasonably be expected to receive, imputation benefits as a result of the distribution; 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 an imputation benefit.

In arriving at a conclusion the Commissioner must have regard to the relevant circumstances of the scheme which include, but are not limited to, the circumstances set out in subsection 177EA(17). The relevant circumstances listed there encompass a range of circumstances which taken individually or collectively could indicate the requisite purpose. Due to the diverse nature of these circumstances some may not be present at any one time in any one scheme.

Where section 177EA applies the Commissioner is vested with a discretion, pursuant to subsection 177EA(5), whether to make a determination. If the company is a party to the scheme the Commissioner has a choice as to whether that determination is to debit the company's franking account pursuant to paragraph 177EA(5)(a), or to deny the imputation benefit to each shareholder pursuant to paragraph 177EA(5)(b).

Application to your circumstances

In the present case the conditions of paragraphs 177EA(3)(a) to (d) are satisfied. Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of Aust Coy X, its shareholders or any other relevant party, there is a purpose more than merely an incidental purpose of conferring an imputation benefit under the scheme. Under this arrangement the relevant taxpayer is the trustee of the YFT and the scheme comprises the circumstances surrounding the buy-back.

The Commissioner has given consideration to all the relevant circumstances of the arrangement with regard to subsection 177EA(17). These circumstances include:

·         The YFT is a long time shareholder in Aust Coy X and bears an appropriate level of economic risk associated with real ownership.

·         The franked distributions arising from the proposed transaction will flow to the YFT in proportion to their shareholding.

·         All of Aust Coy X's shareholder's are resident taxpayers as are the likely beneficiaries which would be entitled to full franking offsets and franking credits in the normal course of events.

·         There is no benefit in streaming Aust Coy X's franking credits to one shareholder in lieu of another as the franking credits are equally applicable to all shareholders.

·         The YFT would not receive any consideration which takes into account the imputation to be received. The share buy-back price is based on the market value of Aust Coy X, with no adjustment for franking credits that may be distributed to the YFT.

·         The YFT will not make a capital loss.

·         Aust Coy X will not source the distribution from unrealised or untaxed profits. It will fund its dividend component from its reserves and retained profits. The reserves will become realised and will therefore be taxed once the ABC shares are distributed in specie.

The Commissioner has come to the view that the requisite purpose does not exist and thus that section 177EA does not apply to the buy-back.

Question 4

Summary

A determination will not be made under paragraphs 204-30(3)(a) of the ITAA 1997 to debit Aust Coy X's franking account (or that any such debit would otherwise be nil) or 3(c) to deny the trustee of the Y Family Trust imputation benefits in respect of the share buy-back.

Detailed reasoning

Section 204-30 applies where a company streams the payment of franked distributions to its shareholders in such a way that the imputation benefits attaching to the distribution are received by those shareholders who derive a greater benefit from them and other shareholders receive lesser imputation benefits, or no imputation benefits.

If section 204-30 applies the Commissioner is vested with a discretion, pursuant to subsection 204-30(3), whether or not to make a determination to debit the company's franking account pursuant to paragraph 204-30(3)(a), or that no imputation benefit is to arise in respect of the dividend to those shareholders who derive a greater benefit pursuant to paragraph 204-30(3)(c).

For section 204-30 to apply, members to whom distributions are streamed must derive a greater benefit from imputation benefits than the members who do not participate in the buy-back. The words 'derives 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.

Application to your circumstances

In this case, a determination will not be made under paragraphs 204-30(3)(a) or 204-30(3)(c) of the ITAA 1997. Aust Coy X has not streamed the payment of dividends to its members in a way that the member would derive a greater benefit from franking credits than another member of the entity. All ordinary shares in Aust Coy X are held by Australian resident taxpayers, thus, all shareholders benefit from franking to the same extent.

Question 5

Summary

The general anti-avoidance provisions in Part IVA of the ITAA will not be applied by the Commissioner.

Detailed reasoning

Part IVA of the ITAA 1936 is a general anti-avoidance provision.

Part IVA of the ITAA 1936 gives the Commissioner the discretion to cancel a 'tax benefit' that has been obtained, or would, but for section 177F of the ITAA 1936, be obtained, by a taxpayer in connection with a scheme to which Part IVA of the ITAA 1936 applies.

In general, Part IVA of the ITAA 1936 will only apply to an arrangement where:

·         the taxpayer obtained a tax benefit from a scheme a benefit that would not have been available if the scheme had not been entered into, and

·         it could be objectively concluded that the taxpayer entered the scheme for the sole or dominant purpose of obtaining the tax benefit.

For Part IVA of the ITAA 1936 to apply, there must be a tax benefit which, in order to be identified, consideration must be given to an alternate postulate as to what might reasonably have occurred.

A reasonable expectation requires more than a possibility but a reasonable hypothesis as to what would have taken place.

It is possible for different conclusions to be reached as to what might reasonably be expected if the particular scheme had not been entered into or carried out.

PS LA 2005/24: Application of General Anti-Avoidance Rules suggests that in applying the reasonable expectation test it is useful to consider such issues as:

·         the most straightforward and usual way of achieving the practical outcome of the scheme (disregarding the tax benefit)

·         behaviour of relevant parties before/after the scheme compared with the period of operation of the scheme, and

·         actual cash flow.

In the Explanatory Memorandum to the bill introducing Part IVA of the ITAA 1936 in 1981, it states that section 177E of the ITAA 1936 was designed to operate as a self-contained code within Part IVA for dealing with so called dividend stripping schemes which might not otherwise have come within the general ambit of sections 177C and 177D of the ITAA 1936, particularly because of perceived difficulties in identifying a "tax benefit".

Where section 177E of the ITAA 1936 operates, it deems the scheme to be one to which Part IVA applies (paragraph 177E(1)(e)). This makes it unnecessary to consider the operation of section 177D of the ITAA 1936 and whether an entrant into the scheme did so for the purpose of obtaining a tax benefit. Section 177E of the ITAA 1936 also deems the taxpayer to have obtained a tax benefit, being the non-inclusion in assessable income of the amount that would have been included if the company had paid the dividend described by paragraph 177E(1)(c) (paragraphs 177E(1)(f) and (g)). This makes it unnecessary to consider the operation of section 177C of the ITAA 1936.

If section 177E of the ITAA 1936 operates in a particular case, the Commissioner may apply section 177F of the ITAA 1936 to determine precisely what adjustments should be made in the assessments of the vendor shareholders and of other taxpayers affected by the scheme.

The appropriate determination under subsection 177F(1) of the ITAA 1936 in dividend stripping cases is the inclusion in the assessable income of vendor shareholders of the full amount of the tax benefit obtained in connection with the scheme, as calculated for the purposes of section 177E of the ITAA 1936.

Subsection 177F(1) of the ITAA 1936 uses the word "may". This gives the Commissioner a discretion whether or not to make a determination (Fletcher v. F.C. of T. 88 ATC 4834). A determination will usually be made where the Commissioner believes the provisions of Part IVA are satisfied. However, the discretion will not be exercised if cases arise where the view is formed that there is no real avoidance of tax (Taxation Ruling IT 2627 Income Tax: application of Part IVA to dividend stripping arrangements [IT 2627], at paragraph 31).

This can be particularly relevant to the application of section 177E of the ITAA 1936, where there need not be a tax benefit or a tax avoidance purpose before the section applies.

Section 177E of the ITAA 1936 operates where four pre-conditions, set out in paragraphs 177E(1)(a)-(d) of Part IVA, are satisfied.

Paragraph 177E(1)(a) is the first of the four pre-conditions that needs to be satisfied for section 177E to operate. Paragraph 177E(1)(a) requires that:

as a result of a scheme that is, in relation to a company:

·         a scheme by way of or in the nature of dividend stripping; or

·         a scheme having substantially the effect of a scheme by way or in the nature of a dividend stripping;

any property of the company is disposed of.

IT 2627, at paragraph 10, states the Commissioner's view that in determining what might constitute a dividend stripping scheme for the purposes of section 177E, an important element to be looked at will be any release of profits of a company to its shareholders in a non-taxable form.

Application to your circumstances

In your case, Aust Coy X intends to pay deemed dividends to the YFT, and the YFT intends to pass these dividends on to its beneficiaries.

The dividends paid by Aust Coy X to the YFT, and passed on by the YFT to the beneficiaries will all be assessable to the recipients of the dividends.

Under the arrangement, the payment of fully franked dividends by Aust Coy X to the YFT will require the YFT to include the 'grossed up' amount of the dividends in their assessable income, and be entitled to pass on a tax offset for the attached franking credits. On the payment of franked dividends by YFT to its beneficiaries, the beneficiaries will be required to include the 'grossed up' amount of the dividends in their assessable income, which will be taxed at their marginal tax rates, and will be entitled to a tax offset for the attached franking credits. This treatment would be the same if Aust Coy X had paid a franked dividend in the ordinary course of business, as in previous years, without the buy-back in place.

Therefore, there will not be any 'release of profits of a company to its shareholders in a non-taxable form', and no 'real avoidance of tax' as a result of the proposed arrangement being entered into.

As there will not be any release of profits of a company to its shareholders in a non-taxable form under the proposed arrangement, it is considered that there will be no scheme by way of or in the nature of dividend stripping, or scheme having substantially the effect of a scheme by way or in the nature of a dividend stripping. Therefore, the requirements of paragraph 177E(1)(a) of the ITAA 1936 will not be satisfied, and accordingly 177E of the ITAA 1936 will not apply.

Furthermore, it is considered that even if it was determined that section 177E of the ITAA 1936 did operate in relation to the arrangement, given that the arrangement does not involve any 'real avoidance of tax', the Commissioner would not exercise his discretion under section 177F(1) of the ITAA 1936 to make a determination to include any amounts in the assessable income of the taxpayers involved - in accordance with paragraph 31 of IT 2627.

Accordingly, section 177E of Part IVA of the ITAA 1936 will not apply to the arrangement.

Question 6

Summary

The trustee of the Y Family Trust can stream the franked portion of the share buy-back dividend to Aust Coy Y under subdivision 207-B of the ITAA 1997 such that Aust Coy Y can claim a franking offset.

Detailed reasoning

A trust's franked distributions can, if not prevented by the trust deed, be streamed to beneficiaries for tax purposes by making them specifically entitled to the amounts.

This allows beneficiaries to get the benefit of any franking credits attached to a franked distribution, subject to integrity rules.

A beneficiary of a trust is specifically entitled to an amount of a franked distribution made to the trust in an income year equal to the amount calculated under the formula in subsection 207-58(1) ITAA 1997.

For the purposes of this section, something is done in accordance with the terms of the trust if it is done in accordance with the exercise of a power conferred by the terms of the trust or the terms of the trust deed and the terms applicable to the trust because of the operation of legislation, the common law or the rules of equity as detailed in subsection 207-58(2) ITAA 1997.

As discussed in issue 1 question 4, to be entitled to pass on franking benefits to the beneficiaries, the trustee must be a 'qualified person' in relation to the franked dividend.

A shareholder generally meets the qualified person test if they satisfy the:

-  holding period rule; and

-  where applicable, the related payments rule.

Application to your circumstances

The YFT deed gives the trustee the discretion to treat an amount as income or capital, in accordance with clause 6(n). Therefore, the share buy-back dividend can be treated as income by the trustee. Clause 3(a)(i)(a) gives the trustee the ability to stream that income to specified eligible beneficiaries, including Aust Coy Y. Accordingly the trust deed would allow the share buy-back dividend to be streamed to Aust Coy Y.

As the YFT has made a family trust election it is deemed that the shares are being held 'at risk'. By this mechanism the holding period rule would be satisfied as the YFT has held the shares at risk for greater than 45 days during the primary qualification period.

The related payments rule may also be relevant. The YFT intends to distribute the share buy-back profit to Aust Coy Y. If Aust Coy Y is a presently entitled beneficiary at the time of the buy-back, the distribution of the dividend to Aust Coy Y is not a related payment and the related payments rule would not apply.

If Aust Coy Y is not a presently entitled beneficiary at the time of the buy-back the related payments rule is applicable and the YFT must hold the shares at risk for 45 days during the secondary qualification period.

The date on which the buy-back occurs will affect the start of the secondary qualification period. This period may not have begun at the time of this ruling.

Provided the related payments rule is met, the YFT can stream the franked portion of the share buy-back dividend to Aust Coy Y under subdivision 207-B ITAA1997 such that Aust Coy Y can claim a franking offset.

Question 7

Summary

There will be no unfranked portion of the buy-back dividend and consequently streaming of unfranked dividends has not been considered.

Detailed reasoning

A distribution is frankable to the extent that it is not unfrankable under s202-45 ITAA 1997. The amount by which the purchase price of the share buy-back exceeds the market value, is unfrankable under s202-45 ITAA 1997.

An entity franks a distribution if the entity allocates a franking credit to the distribution under s202-5 ITAA 1997. The amount of the franking credit on a distribution is that stated in the distribution statement, unless the amount stated exceeds the maximum franking credit for the distribution. In that case, the amount of the franking credit on the distribution is taken to be the maximum franking credit for the distribution.

Application to your circumstances

Aust Coy X intends to purchase its shares from the YFT for market value. As there is no consideration in excess of the market value, there will be no unfrankable component under s202-45 ITAA 1997. The buy-back dividend will be allocated a franking credit by Aust Coy X which will be applicable to the dividend as a whole. As addressed in issue 3 question 6 above, the franked dividend can be streamed to Aust Coy Y. It is not necessary to consider streaming of an unfranked portion as there is none in this instance.

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