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Ruling

Subject: Purchase and Sale of shares.

Question (a)(i)

In relation to the purchase and sale of Company A shares by Company B, and pursuant to sections 110-25 and 110-35 of the Income Tax Assessment Act 1997 (ITAA 1997), will the cost base of the Company A shares acquired by Company B include the price payable by Company B for the shares and the incidental costs of acquisition by Company B (for example broker fees), converted into Australian Dollars at the applicable exchange rate in accordance with section 960-50 of the ITAA 1997?

Answer

Yes

Question (a)(ii)

In relation to the purchase and sale of Company A shares by Company B, and pursuant to subsection 116-30(2) of the ITAA 1997, is Company B's capital proceeds from the sale of Company A shares equal to the market value of those shares as at the time that Company B and Company A enter into the Purchase Agreement, converted into Australian Dollars at the applicable exchange rate in accordance with section 960-50 of the ITAA 1997?

Answer

Yes

Question (a)(iii)

As a consequence of the sale of the shares to Company A, will Company B make no gain and no loss for the purposes of the Capital Gains Tax (CGT) rules?

Answer

Yes

Question (b)

In relation to the acquisition and any subsequent cancellation of Company A shares by Company A, will Company A have any assessable income, allowable deductions, capital gains or capital losses under the Australian income tax laws?

Answer

No

Question (c)

In relation to the purchase and sale of Company A shares by Company B, is there any implication for Company B under the direct value shifting provisions contained in Division 725 of the ITAA 1997?

Answer

No

Question (d)

In relation to the purchase and sale of Company A shares by Company B, do the dividend streaming provisions contained in section 204-30 of the ITAA 1997 and section 177EA of the Income Tax Assessment Act 1936 (ITAA 1936) apply?

Answer

No

Question (e)

In relation to the purchase and sale of Company A shares by Company B, do the capital streaming provisions contained in sections 45A and 45B of the ITAA 1936 apply?

Answer

No

Question (f)

In relation to the purchase and sale of Company A shares by Company B, do the general anti avoidance provisions contained in Part IVA of the ITAA 1936 apply, and will the Commissioner make a determination under section 177F of the ITAA 1936?

Answer

No

Relevant facts and circumstances

Company B will undertake a programme of purchasing Company A ordinary shares by way of on-market purchases. Company B will pay market prices for the shares, and will be acting through a third party broker.

Upon receipt of the broker's confirmation of purchase both companies will enter into a Purchase Agreement.

The price payable by Company A to Company B, specified in each Purchase Agreement, will be nominal. This nominal purchase price would be debited to Company A's profit reserves.

Completion of Company B's on-market purchase of the shares will occur in accordance with the ordinary settlement rules of the stock exchange, and completion of the sale of the shares to Company A will occur in accordance with the terms of the relevant Purchase Agreement

Upon acquisition of Company A shares, Company A will either cancel them or hold them in treasury. Company A may subsequently cancel any treasury shares.

Company B's arrangements with the broker will be on ordinary commercial terms.

As a result of its ownership of a group of companies, Company A indirectly owns assets situated in Australia.

Relevant legislative provisions

Income Tax Assessment Act 1997 Section 100-45

Income Tax Assessment Act 1997 Section 104-10

Income Tax Assessment Act 1997 Section 104-165

Income Tax Assessment Act 1997 Section 108-5

Income Tax Assessment Act 1997 Section 110-25

Income Tax Assessment Act 1997 Subsection 110-25(2)

Income Tax Assessment Act 1997 Subsection 110-25(3)

Income Tax Assessment Act 1997 Section 110-35

Income Tax Assessment Act 1997 Subsection 110-35(2)

Income Tax Assessment Act 1997 Section 116-20

Income Tax Assessment Act 1997 Section 116-30

Income Tax Assessment Act 1997 Subsection 116-30(2)

Income Tax Assessment Act 1997 Section 204-30

Income Tax Assessment Act 1997 Subsection 204-30(1)

Income Tax Assessment Act 1997 Subsection 204-30(3)

Income Tax Assessment Act 1997 Subsection 204-30(6)

Income Tax Assessment Act 1997 Subsection 204-30(8)

Income Tax Assessment Act 1997 Subsection 204-30(9)

Income Tax Assessment Act 1997 Section 207-35

Income Tax Assessment Act 1997 Division 725

Income Tax Assessment Act 1997 Section 725-145

Income Tax Assessment Act 1997 Division 855

Income Tax Assessment Act 1997 Section 855-30

Income Tax Assessment Act 1997 Section 960-50

Income Tax Assessment Act 1997 Subsection 960-50(6)

Income Tax Assessment Act 1936 Section 6

Income Tax Assessment Act 1936 Section 45A

Income Tax Assessment Act 1936 Subsection 45A(3)

Income Tax Assessment Act 1936 Subsection 45A(5)

Income Tax Assessment Act 1936 Paragraph 45A(1)(a)

Income Tax Assessment Act 1936 Section 45B

Income Tax Assessment Act 1936 Subsection 45B(3)

Income Tax Assessment Act 1936 Subsection 45B(5)

Income Tax Assessment Act 1936 Subsection 45B(8)

Income Tax Assessment Act 1936 Paragraph 45B(8)(k)

Income Tax Assessment Act 1936 Subsection 45B(9)

Income Tax Assessment Act 1936 Section 45C

Income Tax Assessment Act 1936 Subsection 45C(3)

Income Tax Assessment Act 1936 Section 128D

Income Tax Assessment Act 1936 Section 177C

Income Tax Assessment Act 1936 Subsection 177C(1)

Income Tax Assessment Act 1936 Paragraph 177C(1)(a)

Income Tax Assessment Act 1936 Paragraph 177C(1)(b)

Income Tax Assessment Act 1936 Paragraph 177C(1)(ba)

Income Tax Assessment Act 1936 Section 177CA

Income Tax Assessment Act 1936 Subsection 177CA(1)

Income Tax Assessment Act 1936 Subsection 177CA(2)

Income Tax Assessment Act 1936 Paragraph 177D(b)

Income Tax Assessment Act 1936 Section 177E

Income Tax Assessment Act 1936 Subsection 177E(2)

Income Tax Assessment Act 1936 Section 177EA

Income Tax Assessment Act 1936 Subsection 177EA(3)

Income Tax Assessment Act 1936 Subsection 177EA(5)

Income Tax Assessment Act 1936 Paragraph 177EA(5)(a)

Income Tax Assessment Act 1936 Paragraph 177EA (5)(b)

Income Tax Assessment Act 1936 Subsection 177EA(14)

Income Tax Assessment Act 1936 Subsection 177EA(17)

Income Tax Assessment Act 1936 Section 177F

Reasons for decision

Question (a)(i)

Summary

Pursuant to sections 110-25 and 110-35 of the ITAA 1997, the cost base of Company A shares acquired by Company B will include the price payable by Company B for the shares and the incidental costs of acquisition by Company B (for example broker fees), converted into Australian Dollars at the applicable exchange rate in accordance with section 960-50 of the ITAA 1997.

Detailed reasoning

In accordance with section 108-5 of the ITAA 1997, the Company A shares acquired on-market by Company B will constitute CGT assets.

Section 110-25 of the ITAA 1997 lists the five elements that are included in the cost base of a CGT asset. Subsection 110-25(2) of the ITAA 1997 provides that the first element is the cost of acquiring the asset, and subsection 110-25(3) of the ITAA 1997 provides that the second element is incidental costs incurred.

Subsection 110-35 of the ITAA 1997 defines incidental costs as consisting of 9 types of cost, of which broker's fees fall within subsection 110-35(2) of the ITAA 1997.

Accordingly the cost base of each Company A share acquired by Company B will comprise the amount paid for each share and the incidental costs including broker's fees.

For CGT purposes, relevant foreign currency amounts are required to be converted into Australian currency at the exchange rate applicable at the time of the transaction or event. Specifically, item 5 of the Table in subsection 960-50(6) of the ITAA 1997 applies. Therefore, an amount included in an element of the cost base of an asset must be expressed in Australian currency.

Question (a)(ii)

Summary

Pursuant to subsection 116-30(2) of the ITAA 1997, Company B's capital proceeds from the sale of the Company A shares will be the market value of those shares as at the time that both companies enter into a Purchase Agreement, converted into Australian Dollars at the applicable exchange rate in accordance with section 960-50 of the ITAA 1997.

Detailed reasoning

In accordance with section 104-10 of the ITAA 1997, CGT event A1 will happen to Company B when it enters into a purchase agreement to sell the shares to Company A.

The capital proceeds from CGT event A1 are the amount of money received or that the taxpayer is entitled to receive plus the market value of any property the taxpayer receives or is entitled to receive in respect of the CGT event (section 116-20 of the ITAA 1997).

There are modifications to this general rule of which the market value substitution rule contained in section 116-30 of the ITAA 1997 may apply.

Subsection 116-30(2) of the ITAA 1997 states:

The *capital proceeds from a *CGT event are replaced with the *market value of the *CGT asset that is the subject of the event if:

(a) some or all of those proceeds cannot be valued; or

(b) those capital proceeds are more or less than the market value of the asset and:

(i) you and the entity that *acquired the asset from you did not deal with each other at arm's length in connection with the event; or

(ii) the CGT event is CGT event C2 (about cancellation, surrender and similar endings).

(The market value is worked out as at the time of the event.)

Company B will receive a nominal amount under each Purchase Agreement for selling the shares to Company A. Therefore, Company B and Company A are not dealing with each other at arm's length in connection with the CGT event. Accordingly, Company B is taken to have received market value of the Company A shares as its capital proceeds.

The market value of Company A shares must also be translated into Australian currency at the exchange rate applicable on the date of the disposal (item 5 of the Table in subsection 960-50(6) of the ITAA 1997) for the purpose of calculating any capital gain or loss on the disposal of Company A shares.

Question (a)(iii)

Summary

As a consequence, the sale of the shares to Company A will result in Company B making no gain and no loss for the purposes of the CGT rules.

Detailed reasoning

In accordance with section 100-45 of the ITAA 1997, the capital gain or loss for the disposal of Company A shares is calculated by comparing:

· the cost base of the share (translated to Australian dollars at the time of acquisition), with

· the capital proceeds (translated to Australian currency at the time of disposal, which is at the time when the Purchase Agreement is entered into).

As previously stated, Company B is taken to have received market value of the Company A shares as its capital proceeds. The market value will be the same as the price payable by Company B to buy those shares on market. Therefore Company B would realise no capital gain and no capital loss from selling the Company A shares back to Company A. This is on the basis that the market value of the shares will be determined at the time that Company B enters into the contract to sell the shares to Company A (that is, the Purchase Agreement) and, at that time, the market value will be the same as the price payable by Company B to buy those shares on-market.

Question (b)

Summary

In relation to the acquisition and any subsequent cancellation of Company A shares by Company A, the Commissioner confirms that Company A will have no assessable income or allowable deductions, and no capital gains or capital losses, under the Australian income tax laws.

Detailed reasoning

In accordance with section 6 of the Income Tax Assessment Act 1936 (ITAA 1936), Company A is not a resident of Australia.

Division 855 of the ITAA 1997 provides that foreign residents are only subject to CGT on taxable Australian property. The following assets are taxable Australian property:

· taxable Australian real property

· an indirect interest in Australian real property

· a business asset of a permanent establishment in Australia

· an option or right to acquire any of the CGT assets (listed above), or

· a CGT asset that is deemed to be Australian taxable property where a taxpayer, on ceasing to be an Australian resident, makes an election under section 104-165 of the ITAA 1997.

Shares are not included as taxable Australian property.

As a result of its ownership of a group of companies, Company A indirectly owns assets which may constitute real property situated in Australia.

On the basis that the value of these assets represent a small fraction of the total assets of Company A, resulting in Company A failing the 'principle asset test' in section 855-30 of the ITAA 1997, it is reasonable to conclude that the Company A shares are not an indirect interest in Australian real property.

Therefore Company A will not be subject to any capital gains or losses under the Australian income tax laws. Subsequently, Company A will also have no assessable income or allowable deductions under the Australian income tax laws.

Question (c)

Summary

In relation to the purchase and sale of Company A shares by Company B, there is no implication for Company B under the direct value shifting provisions contained in Division 725 of the ITAA 1997.

Detailed reasoning

Where a direct value shift (DVS) occurs that has consequences under Division 725 of the ITAA 1997, the rules in the Division apply to modify the adjustable values of affected interests to take account of material changes in market value that are attributable to the DVS.

There is a direct value shift under section 725-145 of the ITAA 1997 if:

· there is a decrease in the market value of one or more equity or loan interests in a company or trust, and either:

· equity or loan interests in the company or trust are issued at a discount to market value, or

· there is an increase in the market value of one or more equity or loan interests in the company or trust.

However, there will only be a direct value shift under section 725-145 of the ITAA 1997 if the decrease in market value and increase in market value or issue at a discount are reasonably attributable to one or more things done under a scheme.

The purchase and disposal of Company A shares by Company B involves equity interests in Company A and, as such, Company A could be viewed as the 'target entity' for the purposes of Division 725 of the ITAA 1997. The purchase and disposal by Company B of Company A shares would not cause a reduction in value of any Company A shares as required by section 725-145 of the ITAA 1997, nor an increase in value in any other shares. The market value of the Company A shares held by Company B at all times was the same as the market value of the other shares in Company A.

Therefore, a DVS has not occurred under section 725-145 of the ITAA 1997 because there has not been a decrease or increase in the market value of any interests in the company. The purchase and disposal of Company A shares is not subject to the consequences in Division 725 of the ITAA 1997.

Question (d)

Summary

In relation to the purchase and sale of Company A shares by Company B, the dividend streaming provisions contained in section 204-30 of the ITAA 1997 and section 177EA of the ITAA 1936 do not apply.

Detailed reasoning

Section 204-30 of the ITAA 1997 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.

Where section 204-30 of the ITAA 1997 applies, the Commissioner has discretion to make one or more determinations pursuant to subsection 204-30(3) of the ITAA 1997.

The terms 'stream' and 'streaming' are not defined in the Act. However, the Explanatory Memorandum to the New Business Tax System (Imputation) Bill 2002 defines streaming as 'selectively directing the flow of franked distributions to those members who can most benefit from imputation credits'.

The Explanatory Memorandum provides some guidance on the principle and features of streaming. It will normally be apparent on the face of an arrangement that a strategy for streaming is being implemented. The distinguishing of members on the basis of their ability to use franking benefits is a key element of streaming.

Where one class [of members] is predominantly able to use imputation credits, and the other is predominantly not, it may be apparent that an arrangement is streaming, notwithstanding the presence in each class of a small minority of the other type of member.

Broadly speaking, any strategy directing the flow of franked distributions to members who can most benefit from them to the exclusion of other members may amount to streaming.

Application of section 204-30 of the ITAA 1997

Subsection 204-30(1) of the ITAA 1997 provides that the Commissioner has discretion to make determinations where an entity streams one or more distributions such that:

· an imputation benefit would be received by a member of the entity as a result of the distribution(s)

· that member would derive a greater benefit from franking credits than another member of the entity, and

· the other member will receive lesser (or nil) imputation benefits.

The streaming may take place in a single franking period or over a number of franking periods. The member that derives the greater benefit is the favoured member. The member that receives the lesser benefits is the disadvantaged member.

Meaning of 'imputation benefit'

For streaming to occur, a member better able to benefit from imputation credits must receive one or more imputation benefits. Imputation benefit is defined in subsection 204-30(6) of the ITAA 1997 as:

· a entitlement to a tax offset or, if the member is a corporate tax entity, a franking credit

· an amount that would be included in the members assessable income as a result of the distribution because of the operation of section 207-35 of the ITAA 1997, or

· an exemption from withholding tax (relevant if the member is a non-resident).

Meaning of 'greater benefit from franking credits'

For section 204-30 of the ITAA 1997 to apply, members to whom distributions are streamed must derive a greater benefit from franking credits than other members. Subsections 204-30(8) and 204-30(9) of the ITAA 1997 list the factors relevant in making this determination. The list is not exhaustive, but includes:

· the residency of the members (non-residents cannot fully use imputation credits)

· whether one of the members would not gain the full benefit of the tax offset from the franking credit (for example, corporate tax entities are not entitled to a refund of excess imputation credits)

· if one of the members is a corporate tax entity, whether it would not be entitled to franking credits (for example, because it is a mutual life insurance company), and

· if one of the members is a corporate tax entity, whether it would be unable to make a franked distribution to its members (and therefore would be unable to distribute the franking credits it has received).

Section 177EA of the ITAA 1936

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 shares or an interest in shares, where a franked distribution is paid or payable in respect of the shares or an interest in shares.

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.

Accordingly, the issue is whether, having regard to the relevant circumstances of the scheme, it would be concluded that, on the part of a company, 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.  

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) of the ITAA 1936. 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.

The Australian Tax Office (ATO) will also challenge arrangements that cause an avoidance of 'wastage' of franking credits outside of shareholding patterns. The Explanatory Memorandum to section 177EA of the ITAA 1936 makes it patently clear that it is expected that wastage of franking credits will occur. A commonly encountered situation concerns the presence of non-residents on a company's shareholder register. A typical transaction will stream dividends away from non-residents to residents, thus attracting the provision.

The discretion in subsection 177EA(5) of the ITAA 1936

Where section 177EA of the ITAA 1936 applies, the Commissioner has a discretion, pursuant to subsection 177EA(5), to make a determination to debit the company's franking account pursuant to paragraph 177EA(5)(a), or deny the imputation benefit to each shareholder pursuant to paragraph 177EA(5)(b).

Section 177EA of the ITAA 1936 will normally be administered by the Commissioner so as to exercise his discretion in a way that applies paragraph 177EA(5)(a). The effect of this is to debit an appropriate amount to the franking credit account of the company conducting the buy-back, to compensate the revenue for avoided wastage, or streamed, franked dividends.

Application in your case

Section 204-30 of the ITAA 1997 does not apply because the proposal does not involve the streaming of distributions (or the streaming of distributions and the giving of other benefits) amongst the members of Company B. Company A is not a member of Company B and, as such, the sale of an asset by Company B to Company A for nominal consideration cannot form part of a streaming of distributions (or a streaming of distributions and the giving of other benefits) amongst the members of Company B.

Further, Company B has paid all dividends to all members fully franked for a number of years. Hence, Company B cannot be viewed as selectively streaming the provision of imputation benefits amongst its members.  

Section 177EA of the ITAA 1936 cannot apply in this instance, as Company B's purchase and sale of Company A shares does not involve a scheme for the disposition of membership interests in Company B (subsection 177EA(14)), nor does it involve a frankable distribution being paid in respect of membership interests in Company B.

Question (e)

Summary

In relation to the purchase and sale of Company A shares by Company B, the capital streaming provisions contained in sections 45A and 45B of the ITAA 1936 do not apply.

Detailed reasoning

Section 45A of the ITAA 1936

Section 45A of the ITAA 1936 applies where a company streams the provision of capital benefits and the payment of dividends in such a way that capital benefits are received by 'advantaged shareholders' who thereby derive a greater benefit from the capital benefits than other shareholders (who receive dividends).

The Commissioner may make a Determination to the effect that section 45C of the ITAA 1936 applies to all or part of a capital benefit. Such a capital benefit is then deemed to be an unfranked dividend.

Potential capital benefits are outlined in subsection 45A(3) of the ITAA 1936. Subsection 45A(5) of the ITAA 1936 provides that section 45A does not apply if it is reasonable to assume that the disadvantaged shareholders have received (or will receive) fully franked dividends.

The Tax Office will examine all arrangements for evidence of capital streaming.

Section 45B of the ITAA 1936

Section 45B of the ITAA 1936 applies where a 'capital benefit' is provided under a scheme for a 'more than incidental purpose' of conferring a tax benefit. Subsection 45B(5) of the ITAA 1936 provides that the provision of a capital benefit includes a distribution of share capital. Subsection 45B(9) of the ITAA 1936 provides that a capital benefit constitutes a tax benefit in the hands of the shareholder because it is less onerous tax-wise than a dividend. In other words, the mischief addressed by the section is that of a company distributing capital in substitution for a dividend substantially because of its preferential tax treatment in the hands of the shareholders.

Speaking practically, to apply section 45B of the ITAA 1936 requires objective evidence of a substantial tax purpose of substituting share capital for a part of the purchase price which would otherwise be a dividend.

By definition, the purpose test in section 45B of the ITAA 1936 examines why any proportions between capital and dividend have been chosen as they have and if the objective circumstances in subsection 45B(8) of the ITAA 1936 on which the test relies point to a significant tax purpose for the choice, subsection 45B(3) of the ITAA 1936 would authorise an adjustment.

The purpose of any one of the persons who entered into or carried out the scheme is sufficient to attract the operation of section 45B of the ITAA 1936. Relevant persons would include the company and its shareholders. It may be appropriate to attribute the purpose of a professional adviser to one or more of the parties: FC of T v. Consolidated Press Holdings Ltd & Anor 2001 ATC 4343.

A more than incidental purpose includes the 'main or substantial purpose' but does not need to be the most 'influential or prevailing purpose' and will not include a purpose which occurs 'fortuitously or in subordinate conjunction with one of the main or substantial purposes...or merely follows that purpose as a natural incident. A person (or persons) can be found objectively to have two or more purposes, none of which is merely incidental. In such a case, all that is necessary for section 45B of the ITAA 1936 to apply is that one of those purposes is a more than incidental purpose of obtaining a tax benefit. For example, if, objectively speaking, persons entering into or carrying out a scheme of distributing capital have a substantial purpose of obtaining a tax benefit in the form of a capital benefit, the fact that they have other purposes that are more than incidental will not prevent the section from applying.

The presence of the requisite 'more than incidental' purpose is to be inferred objectively from the circumstances of the arrangement. To facilitate the test and reveal the requisite purpose the section includes a non-exhaustive list of 'relevant circumstances' in subsection 45B(8) of the ITAA 1936 which must be considered in that regard. The relevant circumstances listed therein encompass a range of matters which taken individually or collectively will reveal whether the requisite purpose exists or not. Due to the diverse nature of these circumstances, some may be of little or no weight in ascertaining whether or not the purpose exists.

The circumstances fall into three broad categories which include: the position of the company and its associates in relation to capital and profit (realised and unrealised) and its distribution culture; the tax profiles of the shareholders; and the eight matters from paragraph 177D(b) of the ITAA 1936 that enable the wider tax and non-tax effects of the buy-back scheme to be identified, compared and weighed. The matters in paragraph 177D(b) which are relied on to determine purpose under Part IVA of the ITAA 1936 are included by virtue of paragraph 45B(8)(k) of the ITAA 1936. The Part IVA matters are to be given equal attention with the other matters included in subsection 45B(8) of the ITAA 1936. Indeed, the Explanatory Memorandum to section 45B as enacted in 1998 suggested that the Part IVA matters were the core of the purpose test and the other, more specific circumstances included to give 'further guidance' to the operation of the section. So if a transaction has been structured for a substantial purpose of distributing share capital preferentially for tax reasons, it should be revealed from reference to circumstances in subsection 45B(8) of the ITAA 1936.

If section 45B of the ITAA 1936 is found to apply the Commissioner is empowered under subsection 45B(3) to make a determination that section 45C of the ITAA 1936 applies to the whole or a part of the capital benefit. The effect of section 45C is that the amount of the capital benefit, or part of it, is taken, for the purposes of the ITAA 1936, to be an unfranked dividend paid to the shareholder by the company out of profits. Thus, the capital benefit, or that part of it, becomes fully assessable income of the shareholder.

Subsection 45C(3) of the ITAA 1936 also empowers the Commissioner to make a further determination that the whole or part of the capital benefit was paid under a scheme for which a more than incidental purpose was to avoid franking debits arising in relation to the distribution.

Application in your case

Neither of these provisions applies as a consequence of Company B's purchase and sale of Company A shares.

Section 45A of the ITAA 1936 cannot apply as the transaction does not involve the streaming of capital benefits and the payments of dividends amongst its shareholders. The transaction does not involve any shareholder of Company B receiving a capital benefit (paragraph 45A(1)(a) of the ITAA 1936).

Whilst Company B will sell the Company A shares for nominal consideration, Company A is not a shareholder of Company B and the sale of the shares by Company B to Company A is not covered by the definition of 'provision of a capital benefit' in subsection 45A(3) of the ITAA 1936.

Section 45B of the ITAA 1936 cannot apply as there will be no provision of a capital benefit as defined in subsection 45B(5). That is, there is no provision of an ownership interest in Company B, no distribution by Company B of share capital or share premium, and nothing done by Company B that has the effect of increasing the value of ownership interests held in Company B by any person.

Further, the transaction does not have as a purpose the obtaining of a tax benefit within the meaning of subsection 45B(2)(c) of the ITAA 1936. On the contrary, the transaction is intended to achieve the commercial objective of carrying out a buy-back of Company A shares without diminishing Company A's profit reserves.

Question (f)

Summary

In relation to the purchase and sale of Company A shares by Company B, the general anti avoidance provisions contained in Part IVA of the ITAA 1936 do not apply, and the Commissioner will not make a determination under section 177F of the ITAA 1936.

Detailed reasoning

Section 177C of the ITAA 1936 provides that a tax benefit is obtained in connection with a scheme as follows:

SECTION 177C  TAX BENEFITS   

177C(1)  [Obtaining a tax benefit]  

Subject to this section, a reference in this Part to the obtaining by a taxpayer of a tax benefit in connection with a scheme shall be read as a reference to:

(a) an amount not being included in the assessable income of the taxpayer of a year of income where that amount would have been included, or might reasonably be expected to have been included, in the assessable income of the taxpayer of that year of income if the scheme had not been entered into or carried out; or

(b) a deduction being allowable to the taxpayer in relation to a year of income where the whole or a part of that deduction would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer in relation to that year of income if the scheme had not been entered into or carried out; or

(ba) a capital loss being incurred by the taxpayer during a year of income where the whole or a part of that capital loss would not have been, or might reasonably be expected not to have been, incurred by the taxpayer during the year of income if the scheme had not been entered into or carried out; or

(bb) a foreign tax credit being allowable to the taxpayer where the whole or a part of that foreign tax credit would not have been allowable, or might reasonably be expected not to have been allowable, to the taxpayer if the scheme had not been entered into or carried out;

and, for the purposes of this Part, the amount of the tax benefit shall be taken to be:

(c) in a case to which paragraph (a) applies - the amount referred to in that paragraph; and

(d) in a case to which paragraph (b) applies - the amount of the whole of the deduction or of the part of the deduction, as the case may be, referred to in that paragraph; and

(e) in a case to which paragraph (ba) applies - the amount of the whole of the capital loss or of the part of the capital loss, as the case may be, referred to in that paragraph; and

(f) in a case where paragraph (bb) applies - the amount of the whole of the foreign tax credit or of the part of the foreign tax credit, as the case may be, referred to in that paragraph.

Part IVA of the ITAA 1936 in relation to Company B

Company B will make no capital loss or deductible loss as a result of selling the Company A shares to Company A for nominal consideration and will incur no relevant deductions in relation to its acquisition of Company A.

Therefore, for the purposes of Part IVA of the ITAA 1936, Company B obtains no tax benefit as defined in paragraphs (b) and (ba) of subsection 177C(1) of the ITAA 1936.

Company B also obtains no tax benefit as defined in paragraph (a) of subsection 177C(1) of the ITAA 1936.

In determining whether Company B will obtain a tax benefit as defined in section 177C of the ITAA 1936 it is necessary to identify what might reasonably be expected to have occurred if the relevant scheme had not been entered into or carried out (Macquarie Finance v FCT 2005 ATC 4829, paragraph 204). The expectation of the alternative transaction must be reasonable, as distinct from a mere possibility (FCT v Peabody 94 ATC 4663 at 4671; Law Administration Practice Statement PS LA 2005/24 - Application of General Anti-Avoidance Rules at paragraph 71).

Paragraph (a) of subsection 177C(1) of the ITAA 1936 is directed at identifying whether it would be reasonable to expect that Company B would have derived an amount of assessable income if the present transaction had not been entered into or carried out.

From a financial perspective, Company B will suffer a loss when it sells Company A shares back to Company A for nominal consideration. As such, it cannot be concluded that, but for the actual transaction, Company B would have derived an amount of assessable income from an alternative transaction.

If Company B were to hold the Company A shares rather than immediately selling them back to Company A, then Company B would be in receipt of assessable dividends from Company A as and when Company A pays ordinary dividends to all ordinary shareholders. However, this is not viewed as a reasonably expected alternative.

Part IVA of the ITAA 1936 in relation to Company A

In relation to Company A, for the purposes of Part IVA of the ITAA 1936 it is relevant to consider whether Company A obtains a tax benefit under section 177C or section 177CA, or whether section 177E applies.

Section 177C of the ITAA 1936 tax benefit

The relevant limb of the section 177C of the ITAA 1936 definition of 'tax benefit' relevant to Company A is the non-inclusion of an amount in assessable income (paragraph (a) of subsection 177C(1)). Specifically, whether it is reasonable to expect that Company A would have received an assessable dividend in the absence of the purchase and sale of Company A shares by Company B.

Company A does not own shares directly in Company B and so there is no present ability for Company B to pay dividends to Company A. In any event, as Company A is a non-resident and does not have a permanent establishment in Australia, pursuant to section 128D of the ITAA 1936 no amount would be included in Company A's assessable income even if Company B were to pay a dividend to Company A on shares held directly by Company A in Company B. It is not reasonable to expect that Company A would have received an assessable dividend in the absence of the actual transaction.

Section 177CA of the ITAA 1936 tax benefit

Section 177CA of the ITAA 1936 provides:

SECTION 177CA  WITHHOLDING TAX AVOIDANCE  

177CA(1)  [Application]  

This section applies in relation to a particular amount if a taxpayer is not liable to pay withholding tax on an amount where that taxpayer would have, or could reasonably be expected to have, been liable to pay withholding tax on the amount if a scheme had not been entered into or carried out.

177CA(2)  [Tax benefit]  

For the purposes of this Part, if this section applies in relation to an amount, the taxpayer is taken to have obtained a tax benefit in connection with the scheme of an amount equal to the amount mentioned in subsection (1).

In view of section 177CA it is relevant to consider whether it is reasonable to expect that Company B would have paid an unfranked dividend to Company A (which would attract dividend withholding tax) as an alternative to the actual transaction.

Company A does not own shares directly in Company B and so there is no present ability for Company B to pay dividends to Company A. Company B has paid all dividends to all members fully franked for a number of years, and Company B expects to pay all dividends to all members fully franked for the reasonably foreseeable future. Also, the benchmark franking rules would require any dividends paid by Company B to be fully franked. Hence, it would not be reasonable to expect that Company B would pay an unfranked dividend to Company A.

Section 177E of the ITAA 1936

Section 177E applies to dividend stripping schemes, or schemes with substantially the same effect as a dividend stripping scheme. It applies where:

· as a result of a dividend stripping scheme, any property of the company is disposed of;

· the Commissioner is of the opinion that the disposal of the property represents, wholly or in part, a distribution of profits (whether of the current, a past or a future accounting period) of the company, and

· if the profits represented by the disposal of the property had been paid as a dividend immediately before the scheme was entered into, it would be reasonable to expect that this would result in the amount being included in a taxpayer's assessable income.

For these purposes, a disposal of property of a company includes the payment of a dividend or the making of a loan by the company (whether or not it is intended that the loan will be repaid) [subsection 177E(2) of the ITAA 1936].

Where these conditions are met, the scheme is taken to be a scheme to which Part IVA applies. The taxpayer who would have been assessed is taken to have obtained a tax benefit that is referable to the notional amount not being included in their assessable income.

Section 177E of the ITAA 1936 applies only to schemes with a dominant purpose of tax avoidance. Usually this purpose is to enable the vendor shareholders to receive profits of the company in a substantially tax-free form, thus avoiding tax that would be payable if the profits were paid as dividends to shareholders.

In FCT v Consolidated Press Holdings Ltd 2001 AC 4343, the High Court considered the characteristics of a dividend stripping scheme for the purposes of section 177E of the ITAA 1936. At page 4369, the High Court referred, with approval, to the decision by the Full Federal Court which identified the main characteristics of a dividend stripping scheme, as identified by reference to established case law, as being:

· a target company with substantial undistributed profits creating a potential tax liability

· the sale or allotment of shares to another party

· the payment of a dividend to the purchaser or allottee

· the purchaser escaping Australian tax on the dividends so declared

· the vendor shareholders receiving a capital sum for their shares in an amount the same as or very close to the dividends paid to the purchasers, and

· the scheme was carefully planned for the predominant, if not sole purpose of the vendor shareholders avoiding tax on a distribution of dividends.

The section does not apply if the dominant purpose was, for example, to carry out a corporate reorganisation, the sale of the shares was only incidental and significant assessable gains were received (Consolidated Press Holdings).

Tax Ruling IT 2627, which deals with the interpretation of section 177E of the ITAA 1936, states that the Commissioner may also choose not to apply sanctions under Part IVA where the view is formed that there is no real avoidance of tax.

Application of section 177E of the ITAA 1936 to this arrangement

Section 177E of the ITAA 1936 applies to a scheme by way of or in the nature of dividend stripping, or substantially having the effect of dividend stripping. Section 177E does not apply to Company B's purchase and sale of Company A shares.

In order for section 177E of the ITAA 1936 to apply it would have to be concluded that if a dividend had been paid by Company B immediately before Company B's purchase and sale of Company A shares it would be reasonable to conclude that the dividend would have been included in a taxpayer's assessable income. This requirement cannot be met here as any dividend paid to Company A, for reasons already mentioned above, would not be included in assessable income, as Company A is a non-resident entity that does not have a permanent establishment in Australia (refer section 128D of the ITAA 1936).

Section 177E of the ITAA 1936 will only apply where the scheme is entered into for the dominant purpose of avoiding tax on distributions of profit by way of dividend (FCT v Consolidated Press 2001 ATC 4343 at 4366 to 4367). Here, Company B's purchase and sale of Company A shares is not a scheme entered into for the dominant purpose of ensuring that an assessable dividend is not received by Company A, since Company A is not in a position to receive any dividend from Company B.

Therefore section 177F of the ITAA 1936 has no application.