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Ruling

Subject: Share buy back

Question 1

Is the scheme an off-market share buy back under subsection 159GZZZK(d) of the Income Tax Assessment Act 1936 (ITAA 1936)?

Answer

Yes

Question 2

Is the buy back price of the shares done at 'market value' under subsection 159GZZZQ(2) of the ITAA 1936?

Answer

This is an invalid question for a private ruling. However, we provide general information.

Question 3

Is the 'share capital/retained earning ratio', also known as the 'slice approach' method, acceptable in determining the split of dividend and capital in this specific case?

Answer

No.

This ruling applies for the following period:

The 2010-11 income year

The scheme commences on:

1 July 2010

Relevant facts and circumstances

The company is a passive investment company. It owns a commercial property. The property is leased.

The share capital of the company was X fully paid $Y ordinary shares. These shares were owned by a small number of different, generally unrelated entities. The seller had no other commercial relationships with the remaining shareholders.

An independent market valuation of the property was undertaken by a registered valuer at a later date. This valuation gave a market value of the property. There was no reason why this valuation would have changed between the two dates. All other assets/liabilities of the company are cash and debt instruments, and therefore have no market valuation adjustments. The company is not a reporting entity, and as such it lists all assets and liabilities on its balance sheet at cost.

One of the shareholders approached the company and advised that they would no longer like to be an investor in the company. They requested that a transaction be entered into with either the company or the existing shareholders to buy back their shares. After consideration of the alternatives, the remaining shareholders resolved for the company to buy back the shareholder's shares at an agreed price, and then cancel those shares.

The buy back value of the shares was initially proposed at a certain amount per share. This was based on the valuation of the property less loans relating to the property totalling, giving a lesser net assets at market value. Other assts and liabilities, such as cash at bank and creditors, were considered immaterial and were ignored for this purpose.

After some negotiation, the remaining shareholders agreed to a lower buy back price. This negotiation was undertaken by the tax agents for the company. These agents do not act as the tax agent for the shareholder disposing of the shares.

During the negotiation, you have assumed that any proceeds paid to the shareholder for the cancelled shares would be capital in nature. It has since come to your attention that the operation of Division 16K of the ITAA 1936 may mean that all or part of this payment is in fact a deemed dividend paid to the shareholder from the retained earnings of the company. You require a private ruling so that the share buy back can be treated correctly in the accounts of the company, and the correct documentation can be provided to the shareholder.

The shares were issued at $Y per share. You believe that the average capital per share (ACPS) methodology would not be appropriate in your circumstances. You explain that the significant portion of the excess of the buy back price over the issued price relates to the unrealised revaluation of the property, which is effectively an underlying capital increase. Only a small portion of the buy back price actually corresponds to the seller's entitlement to the accumulated retained earnings of the company and, as such, you believe that only a correspondingly small portion of the buy back price should be treated as a dividend paid out of share capital.

Relevant legislative provisions

Division 16K of the Income Tax Assessment Act 1936

Section 159GZZZK of the Income Tax Assessment Act 1936

Paragraph 159GZZZK(a) of the Income Tax Assessment Act 1936

Paragraph 159GZZZK(c) of the Income Tax Assessment Act 1936

Subsection 159GZZZK(d) of the Income Tax Assessment Act 1936

Subsection 159GZZZQ(2) of the Income Tax Assessment Act 1936

Does Part IVA apply to this ruling?

Part IVA of the Income Tax Assessment Act 1936 is a general anti-avoidance rule that can apply in certain circumstances if you or another taxpayer obtains a tax benefit in connection with an arrangement and it can be concluded that the arrangement, or any part of it, was entered into or carried out by any person for the dominant purpose of enabling a tax benefit to be obtained. If Part IVA applies the tax benefit can be cancelled, for example, by disallowing a deduction that was otherwise allowable.

We have not fully considered the application of Part IVA to the arrangement you asked us to rule on, or to an associated or wider arrangement of which that arrangement is part.

If you want us to rule on whether Part IVA applies we will first need to obtain and consider all the facts about the arrangement which are relevant to determining whether Part IVA may apply.

For more information on Part IVA, go to our website www.ato.gov.au and enter 'part iva general' in the search box on the top right of the page, then select: 'Part IVA: the general anti-avoidance rule for income tax'.

Reasons for decision

Question 1

Division 16K of the ITAA 1936 deals with the tax effect of buy-backs of shares. This division applies where a company buys a share in itself from a shareholder.

Section 159GZZZK of the ITAA 1936 defines the schemes that are covered in Division 16K of the ITAA 1936. Paragraph 159GZZZK(a) of the ITAA 1936 provides that where a company buys a share in itself from a shareholder in a company, the purchase is a buy back. In order to determine whether a buy back is an on-market or off-market buy back, if the share is listed for quotation in the official list of a stock exchange in Australia or elsewhere and the buy-back is made in the ordinary course of trading on that stock exchange, the buy back is an on market purchase (paragraph 159GZZZK(c) of the ITAA 1936). All other buy-backs are treated as off-market purchases.

Therefore, in your case, the buy back is an off-market buy back.

Question 2

A private ruling application is only valid when the provisions enquired about affect the rulee. Section 159GZZZQ of the ITAA 1936 only applies to the seller. As such, a private ruling cannot be issued.

As per section 159GZZZQ, generally, the buy back price for the shares would be the amount of money or property received. If the amount received is less than market value, the seller is taken to have received the market value. If the price was negotiated at arm's length, generally the amount received would be considered to be market value.

Question 3

Practice Statement PS LA 2007/9 discusses share buy backs. There are various methodologies that are discussed in this practice statement. The average capital per share (ACPS) method and the share capital/retained earnings ratio (the slice approach) are considered in your circumstances.

Paragraph 12 of PS LA 2007/9 explains that in the absence of exceptional circumstances, the ACPS method will be applied to determine the capital component. PS LA 2007/9 at paragraph 62 reinforces that ACPS should, prima facie, be applied to determine the capital component in an off-market share buy back with the other methods having particular relevance in specific instances only. Paragraph 64 provides an example of 'particular circumstances', it may be appropriate to use the 'slice approach' where a company is selling off a particular business. In your situation, a shareholder is disposing of their shares. This is not analogous to the selling of a particular business.

Paragraph 69 of PSLA 2007/9 advises that the ACPS method should be used for share buy backs unless companies can demonstrate exceptional circumstances for the use of an alternative methodology. The Macquarie Dictionary defines 'exceptional' as an unusual instance, unusual or extraordinary. Your statement that you do not believe that this methodology would be appropriate in this circumstance does not fit the definition of 'exceptional'.

The 'share capital/retained earning ratio', also known as the 'slice approach' method, is not acceptable in determining the split of dividend and capital in this specific case.

As it is not appropriate to use the slice approach, the average capital per share is the appropriate method to use.